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Last Updated: Monday, 2 February 2004, 10:36 GMT
Does the US budget deficit matter?
By Steve Schifferes
BBC News Online economics reporter

President George W Bush
How much does Mr Bush want to cut the deficit?
The US will be in the red by almost half a trillion dollars next year - but will the growing budget deficit harm the economy?

The non-partisan Congressional Budget Office says the US government will run up a budget deficit of nearly $500bn in 2004 - a figure likely to be confirmed by the Bush administration when it reveals its budget forecast on Monday.

It is the largest in US history in absolute terms, and, at 5% of GDP, the largest since 1993 as a percentage of the economy.

And within the space of a few years, a projected surplus over ten years of $5.6 trillion has turned into a deficit for the same period of $1.4 trillion.

These are telephone directory numbers, almost hard to imagine.

The budget deficit is now one quarter of total Federal spending, and 80% of the total receipts from Federal income taxes.

It is equal to $1,600 per US citizen this year, and the accumulated deficit over ten years would be nearly $20,000 per person.

Controversial figures

The huge swing in the budget deficit have led some to argue that it is impossible to forecast.

Signs of growth:
State of the US economy

The ups and downs of the economy, the need for more defence spending on the war on terror, and the generous tax cuts for the wealthy, have all changed the budget arithmetic.

The Bush administration believes that is impossible to forecast more than five years in advance, and no longer provides the long-term forecasts that are done by the non-partisan Congressional Budget Office.

And the economic rebound, which has seen economic growth rates of over 8% in the most recent quarter, have led Mr Bush to suggest that the budget deficit will be brought under control as the economy expands.

But many economists argue that this is wishful thinking.

Robert Rubin, Treasury Secretary under Bill Clinton, says that the uncertainty of the future is no reason not to be prudent today.

He argues that by running huge budget deficits, the government is limiting its flexibility to respond to future crises.

Run on the dollar

Mr Rubin, who is now chairman of Citigroup, argues that the adverse consequences of running large budget deficits may "be far larger and occur more suddenly than traditional analysis suggests".

What is at stake in all this is America's economic growth
Benjamin Friedman, Harvard University
In a paper for the Brookings Institution, he argues that "substantial deficits projected far into the future can cause a fundamental shift in market expectations and a related loss of confidence both at home and abroad".

This could lead to a run on the dollar (which is already suffering serious weakness), and a sharp rise in the interest rates demanded on Federal debt, which in turn could hurt the stock market, weaken banks and reduce private sector spending.

The Bush administration is doing its best to ward off such an eventuality by constantly telling the financial markets that it is committed to reducing the deficit, and arguing that it is "manageable" as a proportion of the economy.

And Treasury Secretary John Snow also argues that deficit spending is boosting the US growth rate, which will benefit the world economy.

Long-term investment

But other economists argue that large budget deficits undermine the economy by squeezing out private investment.

Benjamin Friedman, professor of economics at Harvard University, says that "what is at stake in all this is America's economic growth".

He argues that large budget deficits take a substantial proportion of America's savings, preventing it being put to more productive use in the private sector who should be buying new equipment, developing new technologies, and retraining the workforce.

And he points to the Reagan years of high budget deficits, when net investment fell to historic lows and the standard of living and real wages of the typical American family stagnated.

Professor Friedman says that a combination of spending restraint and tax increases - such as those introduced in the l990s - will be needed to close the budget gap.

But he sees little evidence that the Bush administration is committed to either.

Cutting taxes - and spending

Indeed, after a series of big tax cuts, government receipts have now fallen to their lowest post-war level, and payroll taxes that are earmarked to pay for social security and Medicare, the programmes for elderly Americans, now yield more than Federal income taxes.

There are troubling signs that the ship of conservative governance is off-course
Congressman Mike Pence
And the government is using the temporary surpluses in the social security trust funds to reduce the size of the deficit - a risky approach when the baby boomers begin to retire after 2012.

Without these surpluses, the budget deficit will average nearly $500bn per year for the whole of the decade, assuming the tax cuts are made permanent (as Mr Bush would like).

Rumble on the right

But meanwhile, rising government spending is beginning to worry some fiscal conservatives on the Republican right.

John Berthoud, president of the National Taxpayers Union, says the government's record on spending was "abysmal."

At a recent Conservative Political Action conference, delegates - including some Congressmen - questioned whether the Bush administration was conservative enough.

"There are troubling signs that the ship of conservative governance is off-course," said Indiana Congressman Mike Pence.

And Congressman Tom Feeney accused the administration of "baby-sitting the nanny state."

In fact, total defence spending is now higher than all the rest of discretionary Federal spending put together - but pork-barrel politics means that special projects earmarked for the districts of individual Congressmen have risen from $44bn to $70bn, according to the CBO.

Political issue

Cutting the budget deficit will not be easy, as the experience of the 1990s showed.

The Bush administration has made it clear that it has other, higher priorities, including fighting the war and terrorism and cutting taxes.

And it will not be popular for Democrats running for election to call for both the limits on domestic spending and the tax rises that tackling the budget deficit will require.

So postponing addressing the problem - at least until the after the presidential election in November - seems the most likely outcome.

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