Q & A about federal deficit

Posted: Thursday, July 17, 2003

WASHINGTON The Bush administration now projects that the federal deficit will set records both this year and next a total of $930 billion in red ink in just two years.

To put that number in perspective it surpasses the amount of debt the country's first 39 presidents from George Washington to Jimmy Carter managed to amass. Here in question and answer form is a look at how that flood of red ink will affect the economy.

Q: I thought it wasn't that long ago that politicians were boasting that the surpluses would be so big during the coming decade that we would end up paying off the national debt.

A: That's correct. Shortly after taking office in January 2001, President Bush projected that the surpluses for the 10 years from 2002 to 2011 would total $5.6 trillion, enough to give taxpayers a big tax break and pay off the national debt held.

Q: So what happened?

A: A recession, increased homeland security spending after the Sept. 11 attacks and increased defense spending to fight wars in Afghanistan and Iraq have all combined to cut government revenue projections and boost government spending.

The three tax cuts President Bush has pushed through Congress to bolster the flagging economy have also added to the red ink. Some private estimates now put the deficits over the same 10-year period at more than $3.5 trillion.

Q: It seems incredible that budget forecasters could be so far off the mark going from projections of $5.6 trillion in surpluses to possibly $3.5 trillion in deficits.

A: Economists say that in budget forecasting little changes can make a big differences. And the changes that have occurred the country's first recession in a decade, the terrorist attacks and two wars have not been small. In addition, the bursting of the stock market bubble has meant that a flood of revenue from capital gains profits suddenly dried up.

Q: With the economy facing all of these problems, isn't it standard theory for the government to run deficits in an effort to jump-start economic growth?

A: Yes. Private economists believe not only fiscal policy spending and tax decisions but also monetary policy interest rate decisions made by the Federal Reserve have a role in getting a weak economy moving again.

Q: Since the Bush administration has been increasing spending to fight terrorism and cutting taxes, shouldn't economists be happy with the deficits?

A: Few economists take issue with running budget deficits at the present time to bolster the weak economy. The trouble, they contend, is that Bush's tax cuts have sizable costs that will extend well after the economy begins to grow at faster rates.

Q: What harmful impacts does a budget deficit have? After all, the country has only had six years of budget surpluses out of the past 45.

A: The big problem is that the government borrowing crowds out the borrowing that private companies need to make investments in new plants and equipment. It is this investment that is critical to boosting productivity. Rising productivity is the key to increased living standards for all Americans.

Many economists also believe that big deficits drive up interest rates, meaning that the money that corporations are able to borrow comes at a higher cost. In addition, consumers end up paying more for their auto loans and home mortgages.

Q: How can that assumption be correct? With budget deficits soaring currently, Americans are enjoying the lowest interest rates in more than four decades.

A: Economists say the interest rate problem will not occur now, when the economy is so weak that corporations have little desire to borrow money.

The problem will occur when the economy starts growing at a faster clip and companies' demand for increased capital bumps up against the government's borrowing needs.

Sung Won Sohn, chief economist at Wells Fargo Bank, said that a $400 billion deficit could translate into consumer interest rates down the road that will be 1 percentage point higher than they otherwise would have been.

Q: Once the economy begins growing at faster rates, won't that help bring down the deficits?

A: Yes, but even under the generally optimistic economic assumptions used by the administration, the deficit, after hitting a record $455 billion this year, will climb even higher to $475 billion in 2004 and only dip to $304 billion in 2005. All three of those deficits would exceed the previous record deficit in dollar terms of $290 billion set by Bush's father in 1992.

Q: The administration contends that the real impact of the deficit should not be measured in dollar terms but as a percent of the total economy. Is that correct?

A: Yes. But the deficit this year and next will be 4.2 percent of the total economy, close to the 6 percent record set in the Reagan years. Josh Bolten, director of the White House Office of Management and Budget, says deficits have exceeded 4.2 percent of GDP in six of the last 20 years.

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