Too far to grow

Author: Jodie T. Allen

Published: February 2, 2004

Only last April President Bush assured a group of Ohio factory workers that his economic policies would pass a fiscal fitness test with no strain (and no steroids). "And so, of course, we've got a deficit," said the president, "but I know we can grow out of the deficit with wise policy." Nine months later, Bush no longer seems convinced that the growth cure will suffice.

In his State of the Union/Start of the Campaign speech last week, the president promised that the budget he will soon unveil will "cut the deficit in half over the next five years." This will be done even while making permanent the tax cuts passed in his first term--including those not yet phased in. Also while adding costly new Medicare prescription drug coverage as well as beefing up defense, homeland security, education, job training, and marriage promotion programs. The secret remedy: "limiting the growth in discretionary spending to less than 4 percent."

Gee, that doesn't sound too hard. How come nobody thought of it before? Well, in fact, prior administrations have conjured up similar panaceas, like Reagan Budget Director David Stockman's "magic asterisks," the huge but unspecified cuts in "domestic discretionary spending" that were supposed to do what growth alone could not: fill the budgetary gap left by massive tax cuts.

Which came first. But wait, didn't we outgrow the deficits? Nobody really cut domestic spending, and yet the deficits were gone by the end of the century. Quite the contrary, says Brookings Institution senior economist Henry Aaron. "That analysis has the causation backward." The late '90s economic growth, he points out, followed a series of deficit reduction and reform measures--the 1982 tax-cut rollback, the 1986 tax reforms, large defense cuts, plus tax hikes and "pay as you go" budget restraints under both Bush I and Clinton. "It was growth following good economic policy that led to deficit reduction at the end of the 1990s," says Aaron.

It was also favorable demographics--a boomer generation then entering prime working age--combined with a huge but rarely discussed hike in federal payroll taxes signed into law in 1983. As a result, the Social Security trust funds, which had been slated to run short of cash, began to amass huge surpluses. Of course, the surpluses came mostly at the expense of ordinary wage earners--since the payroll tax hits neither very high earnings nor investment income--so few powerful interests were aroused. And since, despite all the talk about "lockboxes," no effort was made to conserve surpluses in Social Security and other trust funds, the Treasury has borrowed them to cover some $3 trillion--yes, trillion--in defense and domestic spending. In other words, trust-fund growth fueled by tax hikes had a lot more to do with the disappearing deficit than did economic growth fueled by tax cuts.

Now, alas, those favorable factors are operating in reverse. Baby boomers will soon start retiring in large numbers. The Treasury will then need to pay back its trust-fund loans to cover their benefits. That will add trillions more to the non-trust-fund deficit even as the expanding Bush tax cuts add to the red ink.

Even so, the administration should have no trouble cobbling a budget that purports to show a halving of the deficit in the next few years. The recipe for budget gimmickry has become highly refined. To a dash of rosy scenario, add a sprinkling of due-to-expire (but in fact always renewed) special tax breaks, a cupful of unspecified domestic program cuts, and a healthy helping of "management savings." Complete the mix with the tasty alternative minimum tax that is gradually clawing back the ballyhooed tax cuts from millions of taxpayers. Finally, be extra careful to leave out one major ingredient: any costs due to explode outside your five-year time frame.

Not to say that a balanced diet isn't needed. "You can't get to balance from where we are without new revenues," says Brookings economist Isabel Sawhill, coeditor of a new study laying out real deficit-reducing options. "But that doesn't mean you shouldn't make cuts in spending. If done the right way, they would actually make government more effective."

But there is another forgotten lesson from recent decades. Big tax cuts not only cost the Treasury far more revenue than the growth they inspire brings in, but, far from curbing spending, they may actually promote it. For a politician "it's no longer worth it to fall on your sword, to tell your constituents that you saved $10 billion when you can't also tell them that you balanced the budget," says study contributor William Gale. "Once you break the spell of fiscal discipline, tax cuts can not only not constrain spending, they can encourage it."