Holding the line?

Feb 8th 2005
From The Economist Global Agenda

George Bush has submitted a budget that is tough on discretionary spending for this coming year. But Iraq and Afghanistan, as well as proposed changes to Social Security and the tax code, still leave black clouds on the fiscal horizon

GEORGE BUSH’S supporters love to compare him with another conservative revolutionary, Ronald Reagan. Up until now, the comparisons have been mostly with the late president’s tough talk and aggressiveness on foreign policy. But on Monday February 7th, Mr Bush submitted a budget for fiscal year 2006 that takes a step in Reagan’s direction on home affairs too, by proposing cuts in a slew of domestic spending programmes.

Headline-writers duly announced “Deep Spending Cuts” and “Sweeping Budget Cuts”. And it is true that many public-sector agencies will be feeling the pain. Mr Bush hopes to cut “mandatory” spending, which includes programmes such as food vouchers (“food stamps”), by $4.5 billion next year and by almost $123 billion over the next ten years. Discretionary spending—that which can be raised or lowered each year through political negotiation—will increase by less than the rate of inflation, meaning a spending cut in real terms. Non-security discretionary spending (ie, excluding defence and homeland security) will even fall in nominal terms—the first such cut, the administration’s summary points out, since Reagan’s presidency in the 1980s.

Several of the proposed cuts are surprising, others (for Mr Bush) less so. In the surprising category is farming: the president proposes cutting the Agriculture Department’s spending by $2 billion, or 9.6%. Much of this reduction would come by capping subsidies (much of which go to big farms) at $250,000 per farm. This will infuriate communities in the farming states of the south, mid-west and west, most of which have up until now been firm supporters of Mr Bush.
Less surprising is the president’s plan to cut $3.7 billion from the Department of Housing and Urban Development (HUD). Mr Bush said in last week’s state-of-the-union address that duplicated or ineffective programmes would be cut. Some of HUD’s programmes were deemed to be among them. These will be transferred in a modified and reduced form to the Commerce Department, which sees a $3.1 billion, or 49%, spike in its budget. Other departments scheduled for cuts are transportation, labour and justice. One notable increase is for international aid: Mr Bush is proposing $1.5 billion in new money for countries that meet certain measurable good-government criteria.

But Mr Bush’s new-found fiscal conservatism is patchy. His current deficits are primarily the result of a collapse in tax revenues, down from 20.8% of GDP in 2000 to 16.8% this year, yet he intends to make his tax cuts permanent. Security spending is also largely exempt from his tight-fistedness. Next year, defence spending will grow by 4.8% in nominal terms, to $419 billion; homeland-security outlays will go up by 1.2%, to $29 billion. And the budget does not include likely “supplementals” for ongoing military operations in Iraq and Afghanistan. Congress has already approved one such supplemental, of $25 billion for fiscal 2005, and is preparing to consider another $80-billion request from Mr Bush.

Indeed, none of these numbers is safe from Congress. Budget hawks fear so-called “Washington Monument proposals”: proposals to cut or close emotive programmes or landmarks, which the public (and their legislators) will never allow. Last year, Mr Bush’s budget proposed eliminating 65 programmes. Four were eventually cut. Thad Cochran, a Republican senator from Mississippi, has already begun shoring up support from farm groups to fight cuts in agricultural subsidies (and farm states are over-represented in the Senate, where each state has two senators regardless of population). The Democrats are, predictably, up in arms too. Nancy Pelosi, the party’s leader in the House, called the latest budget “a hoax on the American people.”

That was the easy part

Mr Bush has received praise for being willing to take on discretionary spending, the main source of power for Congress. But even doing so successfully (which is far from given) would only be a start. Non-security discretionary spending is less than a sixth of the total budget. In the future, the president’s efforts to restrain it will be dwarfed by the impact of two giant entitlement programmes, Medicare and Social Security (pensions). The budget overview acknowledges that, even under the best-case scenario, the retirement of the baby-boom generation in a decade or so will put new, intense pressure on America’s finances. This, the administration argues, makes the reform of the Social Security system all the more urgent.

On current trends, Social Security will begin spending more than it takes in through payroll taxes in 2018, and in 2042 it will deplete its accumulated trust fund. To avoid this, Mr Bush wants to create private accounts: workers would put some of their payroll taxes into personal accounts that would be theirs on retirement. Though the idea holds some long-term promise, the transition costs will be big. No one knows how big until Mr Bush produces a detailed plan, but estimates range between $1 trillion and $2 trillion in the first decade. None of this is included in the budget just unveiled.

Other fiscal pain has also been put off, but cannot be avoided forever. One headache is the Alternative Minimum Tax (AMT). Originally devised to keep rich taxpayers from finding so many loopholes that they pay no taxes, it will soon begin to hit middle-class Americans. Fixing this will be expensive. Mr Bush also says he wants to flatten and simplify the tax code. But to make it revenue-neutral, as he says he would like to do, would require ending popular deductions, for example those on charitable giving and mortgage interest. Public pressure might keep Mr Bush and Congress from pulling off tax-code reform without leaving expensive loopholes.

The budget released this week cheerily shows deficits dropping from a peak of 3.6% of GDP in 2004 to 3.0% next year and just 1.5% in 2009. But even assuming everything goes well for Mr Bush, several things will make this nigh-impossible. AMT reform will have to begin well before 2009 if a middle-class revolt is to be avoided, and is not included in the administration’s calculations. Nor are future supplemental costs for Iraq and Afghanistan.

And after 2009 is when it gets really hard again. That is when Mr Bush’s tax cuts, if made permanent, start to get very expensive, costing over $1 trillion between 2011 and 2016. It is also when the transition costs of Social Security reform would kick in. None of this shows up in Mr Bush’s deficit projections because they look ahead only five years, not the traditional ten. Perhaps he does not dare peek ahead beyond 2010. Or, since he is leaving office in 2009, perhaps he does not care.

Alan Greenspan, the chairman of the Federal Reserve, said recently that “the voice of fiscal restraint, barely audible a year ago, has at least partially regained volume.” Mr Bush has said some of the right things. But it is his deeds, not his words—as well as events in Iraq and Afghanistan beyond his control—that will determine America’s fiscal future.

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