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September 15, 2004

The deficit

Budget hawks are upset with President Bush because he's allowed the deficit to widen to record levels. There's no question that the deficit is unsustainably high, but I believe the alarms that have been sounded on the left and the right are overblown. I make my argument in a commentary at Businessweek.com. Even though the budget will peak at a record level in 2004, it isn't as bad as independent economists feared. This year's deficit is a record in absolute terms, but it's much smaller as a percentage of GDP than the monster deficit of 1983. And those same analysts believe the budget is likely to fall every year through 2008, as economic growth drives tax revenues higher.

I would never suggest that deficits don't matter. By providing a soft, cushy place for investors to park their cash, they can divert too much money away from more productive investments in private sector jobs, equipment and plant. But the real measure of the Administration's economic legacy won't be its capacity to restrain spending. The real measure of success will be its ability to stimulate economic growth. If the economy continues to grow at even modest rates, the deficit will steadily fall to a more manageable level over the next few years. If that growth fail to appear, the deficit will be just the beginning of the country's economic problems.

In theory, there's nothing so terrible about running a deficit during a time of economic recession or slow down. The real reason that so many people are upset with the Bush deficit is the way he got there. Bush tried to prime the economic pump by cutting taxes. His critics, by and large, would have preferred to see him prime the pump by funneling the money through government programs.

Here are some additional thoughts from a reader.

Phillip R. Denney, who describes himself as an MBA, CFP, and investor representative with ProFutures Capital Management in Austin, Texas says in an e-mail:

I agree that entitlement programs will have a significant impact on the budget as baby boomers retire, however, I do not agree that there are only two options for funding it (decreased spending or raise taxes). I see a third option. The government will probably refinance the Social Security Trust fund by issuing long-term bonds and then pay them off over time. We will run deficits for several years, but gradually it will come back into balance. We are big country with a big economy, so it can be done. Of course we could see a combination of the three options too. Thanks.

Another reader raised an interesting question about why the deficit is measured as a percentage of GDP:

"My big question in the deficit analysis is why you and everyone else relate the deficit to the GDP. The deficit is a function of the US federal budget vs US federal income and not the greater economy as a whole. So why is the deficit not compared to the Federal income? Is a larger portion of the cost of our government being underwritten by loans? I don't know but I think it would be an interesting question."

David Wyss, chief economist at S&P, has the answer. He writes:

"The deficit as a share of government spending is also of interest, and we do look at it that way on occasion, but it is usually less interesting to the press. It also suffers from how to define spending - do we look at a unified number, exclude trust funds, exclude investment? Should it be federal only, or include all government spending? Do we include or net out trust funds receipts/contributions? Because different countries follow different conventions on the base, it makes international comparisons difficult.

We generally focus on the deficit as a percent of GDP for 3 reasons:

1> It makes international comparison easier, since the split between federal and regional budgets differs greatly across countries.

2> We are trying to measure the pressure of the federal borrowing on the US financial market, which is more closely related to GDP. Money borrowed by the government comes out of the pool of available investable funds.

3> The tax base that has to finance the federal government is GDP. The debt is fundamentally the debt of the country, and is paid out of the country's income, not just government revenue."

12:08 AM

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