Fears that Katrina has blown deep hole in deficit

Author: Christopher Swann

Published: September 22, 2005

Just before Katrina hit there was a glimmer of hope that America's budget deficit was starting to improve. The monumental swing from surplus under President Bill Clinton to ever-growing deficit under President George W. Bush seemed to have been halted at least for a while by bumper tax receipts.

Now the hurricane seems likely to send American public finances plunging deeper into the red. The White House, sensing unrest in Republican ranks, has stressed that the total rebuilding cost remains unknown. But, with $62.3bn already appropriated, it seems reasonable to expect the Federal government's final bill will reach $200bn.

Analysts worry that bills for grandiose ventures tend to get bigger. Fiscal experts are losing count of the number of supplemental appropriation bills needed to fund the conflict in Iraq. A recent report by the government's chief investigator said even the Pentagon was struggling to keep track of the funds being spent.

With the fiscal year nearly over, Katrina is unlikely to weigh much on the 2005 shortfall, which the Congressional Budget Office expects to drop from $412bn in 2004 to $331bn. The deficit had been expected to decline further in 2006 to $314bn and then hover between $320bn-$340bn until 2010.

This is starting to look optimistic. Chris Edwards, head of fiscal studies at the Cato Institute, says there is a risk the deficit could top $415bn in 2006 and the impact could be felt into 2007. After 1992's Hurricane Andrew, which also came late in the fiscal year, only 1 per cent of the obligated funds were spent in the first year, 70 per cent in the second and about 20 per cent in the third. A similar breakdown might be expected with Katrina.

Measured against total US debt of $4,900bn, an extra $200bn may seem a drop in the ocean. With demand for US assets remaining strong, there is no sign that it will push up US interest rates.

Provided the spending is out of the way by 2008, Mr Bush is still on target to meet his pledge to halve the deficit in his second term to about 2 per cent of gross domestic product. But Katrina may be enough to set back America's financial recovery by a year.

In the meantime, there is no guarantee that more emergencies will not arise. ?The advantage of being fiscally prudent is that when a rainy day comes along you have much more flexibility,? says Mr Edwards.

Fiscal experts had been urging the president and Congress to try to balance the books before 2009, when real fiscal problems may emerge as the ?baby boomers? hit retirement age. Mr Bush's introduction of a Medicare prescription-drug benefit has added to the problem. John McCain, a Republican senator from Arizona, has urged postponing the scheme. ?The president has claimed that high spending is the problem, not lower taxes, but then he goes on to spend some more,? said Len Burman, a fiscal expert at the Urban Institute. ?There is no free lunch, and all this spending eventually has to be paid for. At some point it will have to be repaid and may also show up in higher interest rates.?