August 19, 2006

August 19, 2006 | Commentary on Federal Budget

The real worry about U.S. budget policy? Spending

What's really going on with the budget deficit?

The latest report from Washington was that the deficit had shrunk to $260 billion - down from $318 billion last year and down to 2 percent of the economy (as measured by the gross domestic product). This was even better news than the July report, which projected a $296 billion deficit. With so many different numbers bandied about, it's hard to tell what's really going on.

Some see the deficit as the sole measure of success - or failure - of Washington's budget policy. That seems sensible: If you spend more than you bring in, something's out of whack. But by focusing solely on this measure, you miss figuring out what might be out of whack. President Bush may well be close to meeting his deficit goal, but we shouldn't ignore other important issues.

It's more important to focus on how large a share of the economy spending and taxes are. We could have a balanced federal budget, the way most states do. But if the budget were balanced yet consumed 100 percent of the economy, we would be much worse off than we are today. A balanced budget doesn't help much when spending is growing by leaps and bounds.

Sure, some observers contend that forecasts like the one that came last month from the White House's Office of Management and Budget overestimate the deficit early in the year to show progress in cutting the deficit when results come in. But worrying whether their early estimates are intentionally high ignores the real issues in play. Better to examine the change from last year's actual deficit.

The recent deficit reduction was driven exclusively by surging revenue. Revenue increased by $249 billion, while spending increased by $191 billion. This revenue growth was beyond all experts' expectations. It's being driven in large part by huge increases in income for things like capital gains and other types of investment earnings. This is strong proof that the 2003 pro-growth tax cuts, which lowered the cost of work, saving and investment, are working even better than planned.

Tax collections grew nearly 15 percent in 2005, the largest jump in more than two decades. Now they are expected to top last year by nearly 12 percent. Tax collections are projected to reach 18.3 percent of GDP by year's end, surpassing the historic average of 18.1 percent of GDP. Contrary to popular belief, Americans are paying more taxes than ever, even after the Bush tax cuts.

But what about spending? This is where the single-minded focus on the deficit becomes a problem. The good news is unexpected revenue growth overshadowed the bad news of persistent spending growth.

Federal spending has grown 45 percent since 2001, 8 percent this year alone. Not just for defense, but for things like the Rock and Roll Hall of Fame and Museum, an indoor tropical rain forest in Iowa, and huge subsidies to farmers to not grow crops.

When George W. Bush took office, spending was 18.4 percent of GDP. By the end of this year it will reach 20.3 percent. While his strong tax policy has helped the economy, his spending policies have not. If policymakers had reined in spending to grow at the same rate as the economy, they would have virtually eliminated the deficit by now.

The real worry about Washington's budget policy is spending. As baby boomers start to retire, the budget will spiral out of sight, fueled by Social Security, Medicare and Medicaid. That comes on top of recent spending growth. By reasonable accounts, the budget could reach 50 percent of GDP by 2050 - and continue to grow after that. The deficits and spending levels of today don't foretell the harm this will bring. However, the stagnant economies of Europe, complete with high tax-and-spend welfare policies and soaring unemployment, do.

To be sure, pro-growth tax policies are working. As a pleasant distraction, they are also driving down the deficit, masking the effect of high spending. But don't be fooled by all this crowing about reducing the deficit. Washington shouldn't rest on its deficit-reduction laurels.

Alison Acosta Fraser is Director of the Thomas A. Roe Institute for Economic Policy Studies.

About the Author

Alison Acosta Fraser Senior Fellow and Director of Government Finance Programs
Domestic and Economic Policy

Related Issues: Federal Budget

First appeared in the Philadelphia Inquirer