A Surplus Smaller Than It Seemed
(Page 2)
By DAVID FIRESTONE
Economists in and out of government have begun
studying the budget's plunge as a significant
phenomenon in financial history, and reject the
partisan contentions in Washington that the
deficit can be blamed on any single factor, like
the tax cuts or the 9/11 attacks. The biggest
reason for this year's deficit, they say, has been
the recession, while the tax cuts and military-related
spending will have a much greater effect on the
long-term deficit. Tax cuts alone will grow from
26 percent to 44 percent of the decline in 2011,
according to the Brookings-Urban Tax Policy
Center. What has been remarkable, economists
say, is that all three forces combined at once
beginning in 2001 to utterly change the government's
financial outlook.
"It really was the perfect fiscal storm," said
Joel Prakken, chairman of Macroeconomic
Advisers, an analytical company in St. Louis
that developed the economic model of the country
in use by many government agencies, including
the Treasury Department. "So many different
things all seemed to happen at once."
The initial problem, several economists said, was
that the surplus was never as large as it seemed.
The economy of the late 1990's was operating
beyond its capacity, Mr. Prakken said, and the
stock market boom generated so much quick
wealth at the highest levels that the resulting tax
revenues were bound to return to earth.
"The reality of the surplus projections was never
really as good as it looked," Mr. Prakken said.
"Because the surplus was essentially ephemeral, it
declined at a much faster rate than the economy
did, really breathtaking in its reversal."
It was essentially a forecasting error, parallel
to the "irrational exuberance" that Federal
Reserve chairman Alan Greenspan
saw among investors during the 1990's.
Mr. Reischauer said that even the Congressional
Budget Office did not appreciate how much of its
forecast was based on unrealistic expectations;
in fact the legal constraints on the office have
occasionally led to projections that
were far from their mark. But before the
mirage disappeared and the downward direction
of the economy was clear, a consensus developed
in Washington that the surplus justified a major
change in tax policy.
Mr. Bush had campaigned on the promise of
returning the surplus in the form of a big tax
cut, and Democrats disagreed only on the size and
distribution of the cut, preferring to direct
more to middle-class taxpayers. (Democrats
proposed a tax cut of $750 billion that year.)
The budget had been balanced in the late 1990's
using a combination of spending controls and
higher taxes on the wealthy. But by 2001, the
controls had expired and seemed unnecessary.
Mr. Bush's election, giving Republicans control
of both Congress and the White House, broke a
stalemate that had long prevented the adoption
of major tax legislation.
"Once the gridlock was broken, it was hard when
staring at the surplus to argue that there shouldn't
be a tax cut," said Mr. Reischauer, now
president of the Urban Institute. "Of course
there was debate about who should get what
share of it. But because there seemed so much certainty
about the persistence of these surpluses, there
wasn't a proper caution that would have led
lawmakers to say, `We don't know what the situation
will be in the next downturn, we don't know
the priorities of future Congresses, so we
should not have a set of tax cuts that phase
in over a 10-year period.' "
Mr. Bolten, previously the president's deputy
chief of staff, challenged the notion that the
administration had been hypnotized by the surplus
numbers. He said the White House was aware
of the economy's direction at the time of the
first tax cut, and intended it in part as a brake against
further decline.
"The concept of an insurance policy was very
much on the president's mind at that point,"
Mr. Bolten said. "And it turns out to have been
one of the best, if not the best, timed tax cuts ever."
But by the summer of 2001, the economic slide
was too swift to be stopped by a tax cut that
would take years to become fully effective. In August of
that year, after the $1.35 trillion tax cut passed,
the Congressional Budget Office revised its estimate
of the cumulative surplus to $3.4 trillion from
the $5.6 trillion forecast in January.
The Ramifications of 9/11
A month later, the World Trade Center and
the Pentagon were attacked, and the budget
outlook worsened. The attack not only exacerbated the
downturn, but it also brought heavy increases
in domestic security spending, and eventually
led to costly wars in Afghanistan and Iraq. The budget
office estimated that another $300 billion in
military spending would result (long before Iraq
entered the picture), and by January 2002 had taken
its projection of long-term surplus down to $1.6 trillion.
It was clear by then that the 2003 budget
would be in deficit, although the full amount
was not known until just a few weeks ago,
after the passage of two more tax cuts: a $30
billion cut in 2002 and a $350 billion cut in
May of this year. The most recent cut was made
in full knowledge that the nation was looking
ahead to several more years
of deficits, and it was that cut that brought the
loudest criticisms.
"Once it was clear that the confident predictions
had blown up and the picture was frightening,
they still refused to step on the brakes," said
Robert Greenstein, executive director of the
Center on Budget and Policy Priorities. "Instead,
the administration pushed the accelerator down
closer to the floor. It's flabbergasting."
Mr. Bolten, however, said concern about the
deficit was secondary to reviving the economy.
"I think we were always aware of what the
budget projections were," he said. "But in
hindsight, I would not have argued that we
should have done something different, and I don't
think any of the economic advisers would. The priority
was properly placed on getting the economy
back to growth. And if that meant larger deficits
in the short run, well, if there was ever a time
to run deficits, this is it."
He argued that the current-year deficit was still
reasonable by historical standards as a percentage
of the nation's economy, and said the
administration believed the long-term deficit
would be cut in half in five years. President Bush
said the same thing a few days ago, saying that goal
could be achieved "if Congress holds the line on
discretionary spending."
It is hard to find an independent economist
who agrees with that optimistic forecast, barring
a nearly miraculous return to extremely high growth
or draconian cuts in spending. Economists at
the Wall Street firm of Goldman Sachs, for example,
have said all year that their forecast was far
gloomier than the administration's, and issued
a statement last month saying the new numbers
confirmed their warnings.
The numbers make it hard to see how Mr. Bush's
goal can be reconciled with his intention of extending
the tax cuts when they expire. The deficit
could be cut in half by 2006 if the tax cuts
expire on their current schedule and spending
is held to an average increase of 2.7 percent a year - far
below its current level of increase - numbers in
the budget office's forecast say. But if the tax cuts
are extended, even assuming that low level of
spending increase, the deficit would not be cut
in half until 2012, by which time the nation
would have accumulated more than $3 trillion in new
debt.
When Mr. Bush's political spending priorities,
like the Medicare drug benefit, are added to the
tax cuts, the deficit is extended even further. For
that reason, many conservatives are beginning
to bridle at the administration's proposals. As
the conservative Heritage Foundation recently put it
in arguing against the drug benefit, "In the future,
as lawmakers examine the need to extend those
tax cuts and make them permanent, they will
be haunted by budget projections showing an
enormous expansion in Medicare spending."
The conservatives, of course, are arguing against
expanded government spending because it might
endanger the future of the tax cuts. The liberals
are arguing the reverse. Both sides, however,
are in rare agreement with the economists that
their two goals cannot be pursued at once, without
resorting to borrowing that will make life in
America a very different experience for generations
to come.
Copyright 2003 The New York Times Company
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