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The Honolulu Advertiser
Posted on: Tuesday, February 7, 2006

COMMENTARY
Here comes another unrealistic budget

By Douglas Holtz-Eakin

Copies of President Bush's proposed budget for the 2007 fiscal year arrive on Capitol Hill. Congress faces tough decisions if leaders are to make ends meet.

DENNIS COOK | Associated Press

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The federal budget does not add up.

There is universal recognition among policymakers who gaze out over the legions of baby boomers nearing retirement that the old-age programs — Social Security and Medicare — need a fundamental rethinking that will dictate the size of government and future levels of taxation. There is also universal political recognition that this is a job nobody wants.

For now, most Republicans and Democrats believe it's a job they can put off. Perhaps they find comfort in conventional budget forecasts, which suggest that over the next few years, the federal budget deficit can be easily managed.

Business-as-usual budget projections, such as those recently released by the nonpartisan Congressional Budget Office (CBO), predict deficits in the range of 2 to 3 cents on every dollar of national economic output over the next five years. (The United States currently spends a bit more than 20 percent of its gross domestic product, raises about 17.5 percent in taxes, and borrows the difference.) The CBO shows the deficit shrinking to essentially zero over the next decade.

To appreciate the true size of the fiscal problem, dig down one layer in official budget forecasts. Government forecasts predict that budget deficits will narrow as revenues rise from the current level, which is below the post-World War II average of 18 cents on the dollar, to a level near the postwar peak of 20 cents. Is that realistic? Historically, when taxes reach that level, U.S. politics drive them back down.

Moreover, the rise in tax revenues would primarily come from the expiration of the tax cuts passed between 2001 through 2005.

President Bush has asked Congress to make the current rates permanent, but if he fails it will mean a return to higher top marginal tax rates and higher tax rates on capital gains and dividends, the elimination of the 10 percent tax bracket, scaled-back child credits and an increase in the marriage penalty. Will the U.S. public tolerate that?

In short, it's easy to see why the current level of taxes will fail to cover the type of government Americans have grown used to. That's bad news because despite the GOP's rhetoric, the government will not be getting any smaller.

If anything, current budget forecasts underestimate future spending. The forecasts assume that government will remain roughly the same size as a proportion of GDP. To do that, spending on items other than relentlessly expanding mandatory programs such as Social Security and Medicare must remain fixed in inflation-adjusted terms for a decade.

Quite simply, that's never happened.

Expect military spending to rise, too. On Monday, the revised Quadrennial Defense Review was released alongside the president's budget. Three separate objectives — increasing the pay of the U.S. fighting force, replacing aged equipment (a legacy of the procurement holiday of the 1990s), and "transforming" the troops and their equipment to deliver lethal force quickly and from greater distances — imply a ramp-up in spending that outstrips current budgetary projections because they aren't set in law yet.

Over the next 15 years, military spending is on track to rise by 20 percent and top its Cold War peak by 16 percent.

Amid all this, the baby boomers come marching into retirement, and with them will come a rise in mandatory spending.

By 2016, Social Security, Medicare and Medicaid alone will consume over one-half of federal spending. And later, that will be seen as the good old days; left alone, the burden of these programs just gets worse. Without some tough decisions, the federal government will look like a senior citizens' center writ (very) large.

Fixing the budget is not an issue that either party is engaging now. The Democrats want to avoid offending their constituencies and so have mostly sidestepped initiatives on trimming big entitlement programs. The Republicans have chosen to stand by low taxes and big security spending, and even introduced a new Medicare prescription drug benefit.

This combination falls short of a cohesive package that would ensure a limited but balanced government in the future.

It is safe to say that things will change, because they must.

I'd rather not raise taxes, but unless government remains at its traditional size, I don't see any way around it. On the other hand, just getting rid of the 2001 tax cuts won't solve the problem either; they're just not big enough.

A good leading indicator of real fiscal change — serious change — is whether lawmakers begin to tackle the old-age programs.

Frivolous budget strategies will focus on discretionary spending, or pretend that there is the will, or even a way, to raise taxes fast enough to cover the expanding cost of old-age spending.

A serious approach should embrace strategies for growth that ensure that the economic pie is as large as possible.

It should rethink the package of support for old-age medical care, long-term care services and retirement income.

And it should balance the other demands on the Treasury against the virtues of low, efficient taxes.

But most of all, a serious approach should make sure that the budget adds up.

Douglas Holtz-Eakin was director of the Congressional Budget Office from 2003 to 2005 and chief economist for the Council of Economic Advisers from 2001 to 2003. He is now a senior fellow at the Washington office of the Council on Foreign Relations. He wrote this commentary for The Washington Post.