Economy.com's State Of The Union
Augustine Faucher, Economy.com, 02.10.05, 12:00 PM ET
The state of the union is strong. In 2004 the U.S. economy expanded by 4.4%, the strongest performance since 1999. Employment has also turned around; in December, U.S. payrolls were up by 2.2 million from the prior year. When the Bureau of Labor Statistics issues its revised employment data in March, the report will likely show that payrolls are now above their pre-recession peak.
More important, the expansion should continue through 2005, although growth will slow this year. Most of the optimism comes from the strong financial position of U.S. businesses, with clean balance sheets and a great deal of cash. To maintain profitability, businesses will be looking to expand operations, including investment and hiring. As a result, monthly job growth will average about 200,000, strong enough to reduce unemployment. The weaker dollar will also support growth this year.
However, higher interest rates will be a drag on consumer spending, particularly housing. An end to tax cuts and slower growth in non-defense federal spending will also weigh on the economy. Overall, real gross domestic product in the U.S. should expand by 3.4% this year.
While conditions are currently good, the U.S. economy faces some serious tests. The most pressing near-term problem is the current account deficit. To solve this problem, the U.S. will need a further depreciation in the dollar, higher interest rates and inflation, greater household savings and reduced consumption. Movement toward a balanced budget would also help. The process should be a gradual one over the next few years, but there is the outside possibility of a steep fall in the dollar, leading to sharply higher interest rates and serious problems for the economy.
In terms of economic policy, President George W. Bush has made Social Security reform and the creation of private accounts the primary focus for 2005. However, this may be a mistake for two reasons.
First, the politics of Social Security reform will be very difficult. Democrats have already signaled that they are united and will fight very hard against any changes to the program, particularly using the payroll tax to fund individual accounts. With 60 senators required to break a filibuster but only 55 Republicans in the Senate, passage of Social Security reform looks daunting.
In addition, congressional Republicans will be much less likely to vote for major changes to Social Security if there are not some Democratic votes to provide political cover. Bush might be better off pursuing tax reform first, where it could be easier to get bipartisan support, and then use a successful effort there to build momentum for changes to Social Security.
But the more important reason that restructuring Social Security may be a mistake is that it simply is not an urgent issue. Yes, Social Security does face a long-run funding imbalance. But currently, the program is taking in more in taxes that it's paying out in benefits, and it is projected to continue doing so for more than a decade. And under current forecasts, it can pay all benefits promised under present law until 2042.
By contrast, the rest of the budget is a mess right now. Excluding Social Security, the federal government ran a budget deficit of $568 billion in fiscal year 2004, or almost 5% of GDP. And with military spending continuing to increase, large growth in non-defense spending over the past few years and the president looking to extend tax cuts, the Administration has no real strategy for stemming the current tide of red ink. It's simply bad economics to ignore the real, present problems in the federal budget while worrying about much smaller deficits in Social Security that won't start for years.
The president has also ignored the problems in Medicare, which presents a much greater test than Social Security. Both retirement programs face similar demographic challenges, but Medicare must also deal with health care costs that are expected to soar over the coming decades. In fact, spending on Medicare is expected to overtake that for Social Security in less than 20 years. It certainly doesn't help that Bush signed into law a Medicare prescription drug benefit that increased spending without providing a funding source.
It also appears that the Social Security reforms the Bush Administration is considering would add to the deficit over the next few decades. Right now, most Social Security taxes are used to pay current benefits. If workers instead divert those funds into individual accounts, as the president favors, there won't be enough money to pay present beneficiaries. The Bush Administration plans to borrow the money to fund the transition to individual accounts, apparently under the assumption that the federal government will pay it back decades from now after it cuts benefits promised under current law--although the administration hasn't come out and said that.
This isn't to say we should ignore the problems with Social Security. It does face a long-run funding challenge, and we should consider what role private accounts should play in a modern retirement-income program. But to say that Social Security is the most pressing fiscal problem facing the U.S. and that individual accounts are the only solution is simply flat-out wrong.
The major problem the federal government faces is straightforward. Right now it has promised more in present and future spending than it is willing to raise in taxes. That means huge deficits over the long run that will increase interest rates, reduce national saving and lead to slower long-run economic growth. Social Security is a part of this problem, but only a minor part. Medicare and the rest of the budget are much greater concerns. Ultimately, given the level of spending that the American public desires, it will take tax increases to close the gap. Unfortunately, the president is unwilling to acknowledge that reality.
forbes.com |
