Evans On The Economy -- The Deficit Returns With A Vengeance

Drops in tax receipts, corporate profits wipe out gains.

Four questions about the return of the deficit: Whose fault is it? How much larger will it get? When will the U.S return to surplus? Does it matter? After posting a surplus of $236 billion in Fiscal Year (FY) 2000, the Federal budget deficit will rise to an estimated $165 billion in FY 2002, $265 billion in FY 2003 and $325 billion in FY 2004. That's a $561 billion swing in four years -- and if there had not been a recession and stock market collapse, the surplus would have risen another $200 billion over that period. So what accounts for the $761 billion shortfall? Regardless of what some Democratic politicians say, the Bush tax cuts account for only $150 billion of that gap. During the later years of the Clinton Administration, total Federal government spending rose about 4% per year, but so far under the Bush Administration it has increased 10% per year. About half of that represents automatic increases caused by the recession, and about half represents increased discretionary purchases, including a larger defense budget. I estimate that each of those factors accounts for about an extra $150 billion in spending, for a total of $300 billion. The shortfall in tax receipts due to the recession is estimated at slightly over $300 billion. The net result is that if there had been no Bush tax cut and no increase in discretionary expenditures, the surplus still would have disappeared because of the recession. The Bush programs then added about $300 billion more to the deficit. There is no secret about how the Clinton Administration turned the Federal budget position around from a $290 billion deficit in FY 1992 to a $236 billion surplus in FY 2000. Tax receipts rose an average of 8% per year, and expenditures rose an average of 3.2% per year. Excluding the cutbacks in defense, expenditures rose 4% per year. When Bush took over, most estimates -- including mine -- assumed that receipts would rise about 6.5% per year, and expenditures would rise about 5.5% per year, in which case the surplus would have increased about $50 billion per year indefinitely. Obviously no one is blaming the Bush Administration for the recession, which started more or less on the day he took office. Nonetheless, the collapse of the stock market and corporate profits have meant the reduction in tax receipts has been far greater than had previously been associated with a modest downturn. No one will ever be able to prove the case one way or another, but I think the recession would have been more severe without the tax cut in late 2001, although admittedly the deficit would have been somewhat smaller. Anyway, we are now facing a $325 billion deficit two years from now, with little chance of it turning around. I assume that sooner or later the economy will start to move ahead fast enough that the unemployment rate will decline, the one-time expenditures following the terrorist attacks will be phased down, and the Federal budget will get back on track, with revenues rising 6.5% per year and expenditures rising 5.5% per year. But with a deficit of $325 billion, the arithmetic works in the "wrong" direction, in the sense that expenditures in absolute terms will still be rising faster than receipts, even though they are rising more slowly in relative terms. Hence the deficit continues to widen with those percentage growth figures unless major cutbacks are made in current programs -- or tax rates are raised. What difference does it make? The higher deficit will have its major impact on the economy in two areas. First, it will crowd out private sector investment. Second, it will inhibit the stock market recovery, which means stock prices will probably rise less than their long-term average of 8% per year. The main result of the bigger deficit will be that paychecks will grow even less rapidly in nominal terms and will decline in real terms. Michael K. Evans is chief economist for American Economics Group, Washington, D.C., and president of the Evans Group, an economics consulting firm in Boca Raton, Fla.

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