Deficit a Wake-up Call for Washington
Will Washington have the courage to truly tackle the deficit? Perhaps, but not soon.
Bold action to tackle the deficit in the next couple of years doesn’t appear likely, despite pledges by veteran lawmakers in both parties, the Obama administration and incoming freshmen in Congress to get serious about it.
Each party is dug in, unwilling, in the near term, to join forces on deficit reduction. They all know something must be done eventually. Just hoping that a rising economy over time will be enough to erase long-term red ink is fantasy, especially with an aging population, soaring health care costs and more demands on federal aid programs.
Some mix of major spending cuts and revenue increases will ultimately be required.
For now, though, politicians are betting they have more time. They’re willing to talk about various options but aren’t ready to cast votes that could threaten their careers.
And for a while, the deficit -- about $1.3 trillion for fiscal 2010 -- will shrink a little. As the economy improves, individual and business tax receipts will increase, and the need for spending on unemployment benefits and other safety net programs will shrink.
The annual shortfall declined by more than $100 billion from fiscal year 2009 to fiscal 2010, from about 10% of GDP to 8.9%. And over time, there will be a gradual reduction in the huge outlays for military operations in Iraq and Afghanistan.
That gives lawmakers a bit of an out. They won’t want to jeopardize their reelection with tough votes if the big crunch is still years off.
Recommendations of the president’s deficit commission, chaired by former Sen. Alan Simpson (R-WY) and former Clinton White House Chief of Staff Erskine Bowles, call for restraining Social Security, retooling Medicare and Medicaid, altering the home mortgage interest write-off, lowering tax brackets and ending more than 150 deductions in the federal tax code.
The commission’s overall prescription is almost too hot to touch for now. Even one or two of the primary proposals would amount to very heavy lifting for a Congress that is clearly divided.
Still, Obama will try to make Republicans full partners in the deficit fight, probably making a direct pitch to them in his State of the Union speech early next year.
If he succeeds in scoring even modest deficit reduction in the near term, he’ll claim credit for developing bipartisan cooperation. If the effort falls flat, he’ll say he tried and blame partisan congressional gridlock.
Both sides may be at least a little more cooperative next year, after the lame-duck session ends, as we expect, with a deal giving the GOP a temporary extension of the Bush-era cuts for all taxpayers and handing Democrats extended jobless benefits.
Some small steps are possible, even in this toxic political environment. Obama has taken an initial step, proposing a two-year freeze on federal employees’ pay. A plan to cut the size of the federal workforce also might win a nod from both sides. Savings would be limited, though, in comparison to the huge overall budget of the government.
The parties may also come together to reduce some defense programs, such as new subs and jet fighters, and research on future weapons systems. They may also agree to close some costly overseas military bases in Germany and Japan.
Other options include delaying a large federal commitment in green technologies and flattening the budget for science research. Plus some trimming of congressional earmarks, which are special projects nurtured by Senate and House members specifically for their states or districts. Earmarks amount to peanuts, though, in the overall budget -- less than 1%. It’s also possible that there will be some paring of foreign aid spending, but, like earmarks, foreign aid spending is comparatively small.
Odds of serious, bold and substantial deficit cutting improve after 2012. If Obama is reelected, he can push tough fixes without having to face voters again, and he is sure to make the need to attack the deficit central to his 2012 campaign.
A Republican in the White House would likely claim a mandate to proceed. No matter who rules, the deficit report will shape tax and spending debates. Already, for example, there’s some evidence that tax breaks -- credits and deductions -- are increasingly seen as the same as other spending, requiring offsetting tax hikes or corresponding program cuts. Still, there’s little appetite for that approach so far, especially among Republicans.
The long-term trend for the deficit is clearly up. With spending on Medicare and Medicaid expected to double by 2020, the worst is yet to come. Interest payments are piling up. They already equal more than 6% of GDP and will jump to nearly 9% in 10 years. By 2020, interest payments alone will be about $1 trillion a year.
Inaction would foul the economy’s engine. Interest rates would likely soar as lenders, foreign and domestic, demand higher returns to buy Treasury notes. Indeed, if interest rates were higher today, the pressure to act might be greater, especially if high deficits are partly to blame and if China or another big investor became skittish about U.S. Treasuries.
But even with towering debt, size and heft count. As the largest economy in the world, and one of the most diversified, the U.S. is still an attractive investment.