All about the deficit and why it matters

Author: Mary Deibel

Published: April 15, 2004

This year's record-setting federal deficit, expected to reach $521 billion, has some in the Republican Congress eyeing a return to the fiscal discipline of the 1990s that helped yield federal surpluses four years in a row.

Fired Treasury Secretary Paul O'Neill made headlines with a memoir that accused the Bush administration of believing that "deficits don't matter." But do they? And why should you care?

Q: What's the trouble with deficits?

A: Deficits may not matter much short-term in a flagging economy, experts say, and many think deficits the last year or two helped juice growth enough to boost employment - although not enough yet to reverse the net loss of 1.8 million jobs since a shallow recession hit in March 2001.

Q: Down the road?

A: Economists starting with Federal Reserve Chairman Alan Greenspan say big deficits eventually make interest rates rise for home mortgages, credit cards, car loans and business borrowing and eventually slow growth. But when the Fed has cut interest rates to 40-year lows to jump-start the economy, high interest rates are a tough sell.

Annual deficits also get added to the current $7.1 trillion national debt, with interest on the debt claiming 20 cents of every income tax dollar, second only to the 29 cents that goes to military spending. So Congress and the White House get pressured to raise taxes, cut programs or both.

Q: Doesn't the Bush budget promise to halve the deficit by 2009?

A: Yes, but the White House:

- Doesn't count the $70 billion or so going to Iraq and other hot spots this year.

- Doesn't touch massive entitlement programs such as Social Security and Medicare.

- Proposes permanently extending almost $3 trillion worth of tax cuts enacted since 2001, with major revenue losses put off until after that five-year budget horizon.

"The Bush approach to budgeting is, 'Here comes the tidal wave - let's go for a swim. Let's run up $5 trillion more in debt and make paying it off someone else's problem,' " says deficit hawk Robert Bixby of the bipartisan Concord Coalition.

Q: When will Washington get a grip on deficits?

A: The first test is the mega-billion bill to finance highways, airports and mass transit. The White House is signaling a veto even though Bush hasn't vetoed a single bill in 40 months in office. But because the transportation bill promises so much for lawmakers back home, most in Congress think Bush would lose a veto fight.

Q: Is the White House right to say the deficits are a smaller percentage of the gross domestic product than before?

A: Yes, and no. Bush budget chief Josh Bolten calls a $521 billion deficit "manageable" because it amounts to 4.5 percent of national output compared to the record 6 percent of gross domestic product in 1983 during Ronald Reagan's presidency.

But those figures ignore the fact that Social Security and Medicare weren't running surpluses in 1983, when Reagan and Congress raised payroll taxes 1.9 percent to overfund the system before 76 million baby boomers start retiring in 2008.

Last year, the Social Security retirement fund took in $140 billion more than it paid in benefits, while the Medicare hospital insurance for seniors had a $10 billion surplus. Since 1984, the surplus for both programs has grown to $2 trillion and is invested in interest-bearing government bonds.

The Social Security-Medicare payroll tax money also masks the deficit's size. Subtract those Social Security IOUs, and the revenue needed for day-to-day federal operations falls short by 6.4 percent of GDP.

Q: What does this mean for making the Bush tax cuts permanent?

A: Don't bank on a permanent tax cut. "You can't talk about a permanent tax cut without paying for it," says tax expert William Gale of the Brookings Institution, a Washington think tank. By his count, Bush and Congress would have to cut 50 percent from every federal discretionary program other than defense and homeland security - something nobody wants to do.

The three Bush tax cuts in 2001, 2002 and 2003 carry a 10-year revenue loss of $3.9 trillion, including $1.1 trillion in additional interest on the national debt, the nonpartisan Tax Policy Center reports.

It puts the revenue loss at $274 billion for 2004 alone.

And remember: $250 billion in taxes goes unpaid each year because people don't report all they've earned or don't file and pay income taxes. The IRS is so short-staffed it can't chase down and collect from convicted tax cheats.

Q: How much does the deficit add to the national debt?

A: It took 200 years, from George Washington to Ronald Reagan, to run up a $1 trillion national debt, and 24 years more to top $7.1 trillion - or $24,400 for each man, woman and child in the United States. The nonpartisan Congressional Budget Office says that deficits should add $1.3 trillion to the debt during George W. Bush's term.

Q: When will fiscal discipline return?

A: It's anyone's guess, although it usually takes some outside shock like the 1987 stock-market plunge that forced Congress and Reagan to slash spending.

Clinton Treasury Secretary Robert Rubin, remembered for engineering budget surpluses to lower interest rates and get business to invest in a booming 1990s economy, warns that today's rising deficits could undermine the stock market, global trading, consumer spending and home values.

Van Dorn Ooms of the Committee for Economic Development, a business-backed think tank, worries the trigger could be when Old Europe and other allies no longer want to hold U.S. debt. Noting that foreigners hold 80 percent of the IOUs run up since Uncle Sam went back in the red in 2002, he says, "Fiscal irresponsibility as far as the eye can see isn't a recipe for financial confidence.