Featured Articles

Rising Budget Deficit — Old Story, New Urgency

Posted on September 15, 2008 by Martin A. Sullivan
Document originally published in Tax Notes
on September 15, 2008.

In this lipstick-smeared presidential campaign, our candidates merrily sing the praises of their ambitious — and expensive — plans for building the nation's economic future. But there is a gathering financial storm that is likely to reduce those dreams to a distant memory come January. Our old friend, the federal budget deficit, is back in town and ready to retake center stage in American fiscal politics.

Last week the Congressional Budget Office announced that the deficit for the fiscal year ending this month will be $407 billion, more than double that of the prior-year figure of $161 billion. The estimated figure for next year is $437 billion. And CBO Director Peter Orszag said that the figure could easily climb to $540 billion if Congress, as expected, extends expiring tax breaks and relief from the alternative minimum tax. (For additional coverage, see previous page.)

Moreover, because the tax cuts scheduled to expire at the end of 2010 are practically guaranteed to be extended by both candidates, deficits of $500 billion or more are probable for the next decade.

These sobering statistics come just days after the Treasury Department announced its takeover of mortgage giants Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation (Fannie Mae and Freddie Mac, respectively), saddling the government with their $5.4 trillion in liabilities. The CBO deficit figures do not include any of the costs of this bailout.

Amazingly, the financially savvy Wall Street Journal and New York Times buried the CBO deficit story. The Journal gave it 11 sentences at the bottom of page A12. The Times described it in five sentences on the bottom of page A17.

In sharp contrast, the Financial Times and The Washington Post got it right. Both highlighted the "CBO bombshell" on page 1 above the fold. And both publications correctly linked revised deficit figures to the mortgage bailout, and in turn highlighted the serious impact of these developments on the next president's room to maneuver.

"A deficit of this magnitude could severely restrain the next administration's agenda," wrote reporter Lori Montgomery for the Post. "The expanding deficit also will increase the national debt and could impair future economic growth, particularly if lawmakers are forced to pay down that debt by raising taxes." Precisely.

Right now, Democrats in Congress, with the support of Sen. Barack Obama of Illinois, are talking about a second stimulus bill that would include tax cuts. In a foreshadowing of a theme you are likely to hear frequently in the coming months, British journalist Krishna Guha of the Financial Times wrote that "weak public finances mean the government does not have unlimited ammunition" to bolster a sagging economy. Guha added that "many Fed officials share this view, which is why the central bank is lukewarm on further fiscal stimulus, preferring to see the limited government funds spent on shoring up the financial system."

So, 2009 could be like 1990: A recession or near-recession looms, deficits are soaring, and a major bailout of the financial sector is inescapable. (Back then it was the savings and loan industry.) In 1990 the need for deficit reduction was so acute that President George H.W. Bush had to break his heralded "no new taxes" pledge before the end of his first (and only, as it turned out) term. In what became an indelible example of the power of the deficit issue to override campaign promises, Congress and the president, with then-Federal Reserve Chair Alan Greenspan urging them on, engaged in protracted negotiations that produced a painful $500 billion deficit reduction plan.

Of course, there is no particular reason to expect the next president and Congress to replay that spectacle of a six-month budget summit. One reason is that the tight constraints imposed by the rules of the 1985 Gramm-Rudman-Hollings deficit reduction law no longer exist.

Facing up to the need to raise revenue is likely to be even more difficult now than it was in 1990. And there may be yet another ominous cloud hanging over the stewards of our nation's finances: Foreign investors, who since the turn of the century have so generously showered their funds on us to keep interest rates low, might get cold feet.

One of Treasury Secretary Henry Paulson's primary concerns in structuring the Freddie-Fannie bailout was about the failing confidence of foreign investors. As Guha observes, "So far there is little evidence that investors are rebelling against the combination of a weak short- and long-term outlook for U.S. public finances. . . . But the bond market could react more violently if it became apparent the rescue was only a part of a larger socialization of loss."

Given the continuing threat of financial crisis — as this is being written, the survival of Lehman Brothers is in question — the next Treasury secretary will almost certainly need the experience and reputation of a Wall Street veteran like Paulson. Reflecting the mood of the markets, Treasury and the Fed will be pushing hard for restraining the growth of the deficit in 2009. And with the September 11 terrorist attacks now seven years in the past, the public is unlikely to let matters slide because of concerns about national security.

Sometimes you wonder why either Sen. John McCain, R-Ariz., or Barack Obama wants to become president.