A trail of red ink

By Robert B. Archibald and David H. Feldman

Originally published September 15, 2004

THE CLOSE of a president's term provides an ideal time to review his fiscal legacy and to compare it with his predecessor's. Let's ask which president, Bill Clinton or George W. Bush, left the nation's fiscal house in better order.

When President Bush took office, the federal government had just run a budget surplus for 2000 of more than $236 billion. In the eight years of the Clinton administration, the burden of the national debt on the average American family of four had fallen by $9,200, measured in constant 2003 dollars. The Congressional Budget Office was forecasting a $2 trillion surplus between 2002 and 2006.

By contrast, the CBO forecast for this year is a deficit of $422 billion, and over the past four years the federal government has racked up almost $900 billion in added debt. This is a $3 trillion budget turnaround.

The administration would like you to believe that this sea change in the federal budget is a result of the mini-recession of 2001 and the slow recovery. A few years of economic growth and all will supposedly be well. The facts tell a different story. The recession did indeed eat up the surplus in 2002, but recent deficits have soared despite good economic growth in 2003 and this year.

Even assuming that the recovery will continue to produce solid real income growth averaging 3 percent a year, the CBO forecasts sizable deficits for the remainder of the decade. These estimates understate the likely flow of red ink since they don't include pressure on discretionary spending due to population growth and their projections assume a 15-fold increase - to 33 million - in the number of taxpayers subject to the alternative minimum tax. Congress would never stand for that. The CBO forecasts beyond 2010 are rosier because they presume that the Bush tax cuts will expire.

The budget mess is not a result of explosive spending growth. When Mr. Clinton left office, federal spending consumed only 18 percent of the nation's income, down from the 22 percent he inherited from the first Bush administration. The Clinton administration was truly fiscally conservative. Despite increased spending on homeland security and the war in Iraq, the government now spends only 20 percent of the nation's income, which is actually less than the average over the past 25 years.

The bleak budget picture is driven largely by the Bush administration's signature tax cuts. In 2000, federal taxes raked in nearly 21 percent of gross national product. This year, that figure has fallen to 16 percent, a number not seen since a brief dip in federal revenue and spending right before the Korean War in 1950.

Why should the average American care about arcane budget numbers once derided by candidate Bush as fuzzy math?

The first reason is that spending on Medicaid, Medicare and Social Security is about to begin a sustained increase. The government will need to shift revenue to these programs or severely prune the benefits. But exploding national debt means revenues that could be used for these social programs must be diverted to pay added interest costs. Brookings Scholars Alice Rivlin and Isabel Sawhill estimate that by 2014, $1 out of every $5 of individual income taxes will be needed to finance the extra debt service costs of our higher national debt.

Government borrowing also competes with private firms for scarce funds. Less financial capital available for private firms means less investment in productivity-enhancing tools or research and development. The result is slower wage growth in the future.

Foreigners now purchase well over half the debt issued by the U.S. government. Nearly $2 trillion of the national debt is owed to foreign holders, and the interest on this debt represents a foreign claim on U.S. tax revenue that cannot be shirked. Their historical appetite for U.S. debt obligations has kept investment in the United States higher than it otherwise would have been. But this dependence on foreign capital is risky.

If foreign investors lose their appetite for buying ever-increasing volumes of U.S. debt, the result could be a precipitous decline in the value of the dollar and/or a spike in U.S. interest rates. The dollar already has weakened substantially against the euro, and in this era of globally mobile capital, foreign dollar holders have alternative ways to hold their wealth that were not available in earlier decades. While not likely at present, an Argentina-style currency crisis is no longer unthinkable.

Mr. Bush's tax cuts have squandered the surplus that originated with his father's more responsible tax policies and that was nurtured by the Clinton administration's own tax policy and spending restraint. The costs of this fiscal train wreck cannot be avoided forever. Today's children and young adults will pay higher taxes and earn lower wages in the future as a consequence.

Robert B. Archibald and David H. Feldman teach economics at the College of William and Mary in Virginia.