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Thursday, February 08, 2007

How is the Deficit Like Iraq?

Here is David Wessel of the Wall Street Journal with a comparison of Bush's approaches to the deficit and to the war in Iraq. What would the "Deficit Study Group" say?:

Bush's Course on Budget Parallels Iraq, by David Wessel, WSJ (Free): The numbers in President Bush's budget add up -- arithmetically. If his assumptions come true, the deficit will evaporate in 2012.

But there are a lot of ifs -- if Iraq and Afghanistan cost only $50 billion in 2009 and nothing thereafter; if the president and Congress hold growth in ... domestic spending well below inflation; if they let the alternative minimum tax reach deeper into the middle class or raise taxes on others to prevent that; if Congress squeezes $66 billion (4%) from Medicare over five years.

OK. Give him a break. A presidential budget is an opening bid... But is it sound? If former Republican Treasury Secretary James A. Baker III and former Democratic Rep. Lee Hamilton led a budget commission like their Iraq Study Group, what would they say?

They would hardly need to rewrite their cover letter. "There is no magic formula . . However, there are actions that can be taken to improve the situation and protect American interests," they said in the Iraq report. "Many Americans are dissatisfied, not just with the situation...but with the state of our political debate . . Our country deserves a debate that prizes substance over rhetoric, and a policy that is adequately funded and sustainable."

William Gale of the Brookings Institution think tank -- populated by deficit-fearing Democratic wonks ... has been thinking a lot lately about the parallels between Mr. Bush on Iraq and Mr. Bush on the budget. ...

It is a provocative and illuminating exercise. Let Mr. Gale kick it off: The president took the U.S. into Iraq with "falsely rosy scenarios" about the post-Saddam landscape..., he says. Mr. Bush built his tax cuts in 2001 on a similarly unrealistic hope that the budget surplus was large enough to cut taxes without creating deficits.

Let us keep going. As Iraq proved different and more difficult than anticipated, and contingency planning was regarded by the Bush White House as a sign of weakness, ... Mr. Bush vowed to "stay the course." When then-Treasury Secretary Paul O'Neill and Federal Reserve Chairman Alan Greenspan argued for "triggers" to undo tax cuts if budget reality didn't match projections, the White House scoffed. Even when the Sept. 11, 2001, attacks and the wars in Iraq and Afghanistan drove spending on homeland security and the military far above projections, Mr. Bush didn't revisit his fiscal strategy.

Smart critics, even inside the administration, were disregarded and shunned. (Gen. Eric Shinseki on troops levels in Iraq, Treasury Secretary O'Neill on deficits.) Only true believers remained to give the president advice. Eventually, Mr. Bush changed his team -- hiring new secretaries of defense and Treasury -- but too late to get credit from the public or to forge bipartisan consensus in Congress.

Imagine what might have happened differently had Mr. Bush installed Josh Bolten as chief of staff, Rob Portman as budget director and Hank Paulson as Treasury secretary at the start of his second term, instead of waiting two years. Might the conversation on Mr. Bush's ideas for limiting tax breaks for health insurance be bearing fruit, not just taking shape?

Might overhauling the tax code be a legislative issue instead of the title of another report gathering dust on Treasury bookshelves? ... Might he have a shot at leaving the nation's long-term fiscal health better than he found it, instead of leaving a deeper hole...?

OK. Take a breath. The U.S. economy is not Iraq, and today's headlines are upbeat... But look ahead, and there is an unwelcome parallel between Iraq and the budget. Current policy is unsustainable, but there is no easy way out. Extend the president's tax cuts beyond their scheduled expiration in 2009 and 2010, and the fiscal hole is enormous. Let them expire, and the tax increases could derail the economy.

Messrs. Baker and Hamilton had little apparent effect on the president's Iraq policy. Maybe they would have better luck on economics.

That's doubtful. Two reasons, traditionally, that deficits are a problem are the interest payments that flow out of the U.S. to foreign holders of U.S. debt, a net drain of resources from the U.S., and the rise in interest rates that occurs when the U.S. government competes with private sector borrowers for the available funds in financial markets. The rise in interest rates lowers investment and lowers growth causing, in effect, a transfer from future generations to the present (the deficit spending increases current output at the expense of higher output in the future).

So far, we have avoided rising interest rates due to the inflow of funds from surplus countries in Asia and  OPEC, but the worry is that this could change very quickly if funds from foreign sources begin to dry up for any reason. Should this happen that will also exacerbate the second problem, the flow of interest payment out of the U.S. which has been rising in recent years even without interest rate increases due to the rising share of U.S. debt held outside the U.S. And of course, beyond the effects on the interest payments and the inter-generational transfer of resources, rising interest rates could also cause trouble for the U.S. economy more generally. Unlike Iraq, the deficit is not presently a big problem. But it's hard to deny there are risks going forward.

    Posted by on Thursday, February 8, 2007 at 12:35 PM in Budget Deficit, Economics, Iraq and Afghanistan | Permalink  TrackBack (0)  Comments (27)


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