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WebMemo #844 on Federal Budget

September 16, 2005

Hurricane Costs Send Budget Projections Deeper into the Red

By

President Bush has pledged to do whatever it takes to rebuild the lives and communities devastated by Hurricane Katrina. This pledge comes with a price tag. To deliver this kind of aid, Congress and the President must set priorities and make sacrifices and trade-offs to pay for it. Offsetting the cost of rebuilding is all the more important because the rebuilding effort follows a 33 percent expansion of the federal government since 2001, a period that saw:

  • The 2001 No Child Behind Act, the most expensive education bill in American history, which led to a 100 percent increase in education spending;
  • The 2002 Farm Security and Rural Investment Act, the most expensive farm bill in American history;
  • The 2003 Medicare Modernization Act, the most expensive Great Society expansion in history;
  • A war in and the rebuilding of Iraq that, while justified, could cost between $300 and $600 billion, in total;
  • International spending leap 94 percent;
  • Housing and Commerce spending surge 86 percent;
  • Community and regional development spending jump 71 percent;
  • Health research spending increase 61 percent;
  • Veterans' spending increase 51 percent; and
  • The number of annual pork projects leap from 6,000 to 14,000.

Federal spending on Katrina relief and reconstruction spending could top $200 billion (plus tax incentives).[1] This paper incorporates these cost estimates into a 2005-2015 budget baseline.

The Congressional Budget Office's (CBO) most recent 10-year baseline budget projections, released in August 2005, show a rapidly improving budget picture, with discretionary spending increases slowing, tax revenues swelling, and the budget approaching balance by 2015.[2] Unfortunately, these projections are the result of an unrealistic set of assumptions that Congress requires CBO to include, such as that:

  1. No additional supplemental funding will be appropriated for the war on terrorism;
  2. Over the next decade, lawmakers will limit discretionary spending increases, which have averaged 9 percent per year since 2000, to the rate of inflation; and
  3. Steep tax increases for nearly every taxpayer, resulting from the expiration of the 2001, 2003, and other tax cuts, and no updating of the income thresholds for the Alternative Minimum Tax (AMT).

Additionally, these projections were made before Hurricane Katrina destroyed the Gulf Coast.

This linked table shows more realistic projections. It differs from CBO's projections in three ways: 1) it incorporates additional supplemental funding for the war on terrorism and rebuilding the Gulf Coast; 2) it assumes discretionary appropriations expand at the rate of the economy's growth after 2006; and 3) it assumes that tax cuts now set to expire are made permanent and that the AMT is fixed.[3]

Under these more realistic assumptions, the budget deficit would top $500 billion in 2008 and reach $873 billion by 2015. These deficits would still not be large enough to significantly raise interest rates or reduce economic growth. However, runaway government spending reduces economic growth by diverting productive private-sector resources to the less productive government. Furthermore, large budget deficits increase the likelihood of major tax rate increases that would impose severe burdens on taxpayers and the overall economy. Because all spending must eventually be paid for with taxes, the only way to guarantee long-term tax relief is with long-term spending control.

These budget projections may understate the challenge of achieving long-term spending control. According to CBO, the retirement of the Baby Boom generation will combine with an unaffordable prescription drug benefit to increase projected Medicare spending by 9 percent annually. Medicaid spending will rise by nearly 8 percent annually, and Social Security will cost 6 percent more each year. Add in the costs of Iraq and Katrina assistance, and it is clear that no economic boom could provide the tax revenue necessary to keep pace with such large structural, persistent spending hikes.

Even these estimates could prove overly optimistic. CBO's mandatory spending baseline assumes that several entitlements will remain nearly frozen through 2015. History suggests, however, that lawmakers will continue expanding these programs by 4 to 6 percent annually and create additional new entitlement programs on top of them. The Office of Management and Budget (OMB) estimates that CBO's numbers strongly understate the cost of the Medicare drug benefit.[4] Recession, terrorist attacks, and an extended American presence in Iraq would each reduce tax revenues and bring about steep spending increases. Projections must always allow a large margin of error, and yet all signs point to rapid spending increases and a deteriorating federal budget.

It is imperative that lawmakers make choices and sacrifices when providing relief and recovery funds for Hurricane Katrina. Lawmakers can improve the federal budget outlook by:

  • Redirecting their states' earmarks to the Gulf Coast, where the money is more needed ($20 billion annually, plus the $24 billion of earmarks in the recent highway bill);
  • Eliminating corporate welfare spending ($60 billion annually);
  • Attacking waste, fraud, and abuse, which have grown unchecked for the two decades following the 1984 Grace Commission report (over $100 billion annually);
  • Addressing the 40 percent of federal programs that, according to the government's own assessments, fail to show any positive impact on their intended beneficiaries (untold billions annually);[5]
  • Replacing the unaffordable Medicare drug entitlement with the Medicare drug discount card (as much as $2 trillion over the next 20 years); and
  • Most importantly, enacting a federal Taxpayers' Bill of Rights capping the growth government at the inflation rate plus population growth. Such a cap would help lawmakers set priorities and make trade-offs and could save as much as $3 trillion to $4 trillion over the next decade.[6]

Unless lawmakers make difficult decisions now, they will dump the largest debt in world history into the laps of the next generation. Within a decade, tax increases would need to reach $7,000 per household (a 37 percent tax hike) just to balance the budget, and that amount will only grow. Future taxpayers will judge today's lawmakers by the budgetary decisions they make now.

Brian M. Riedl is Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

Show references in this report

[1] The cost estimate for Katrina is a very rough estimate at this point.

[2] "Congressional Budget office, "The Budget and Economic Outlook: An Update, August 2005, Table 1.4, located at /static/reportimages/7E313708F2A711A1F8B35797D6B14E62.pdf.

[3] See Appendix 2 for methodology.

[4] The Congressional Budget Office compares its Medicare drug benefit cost estimate with the Office of Management and Budget's estimate in a February 2, 2004 letter to Rep. Jim Nussle, posted at http://www.cbo.gov/showdoc.cfm?index=4995&sequence=0.

[5] For examples of waste and over 500 recommended budget reforms, see See Brian M. Riedl, "How to Get Federal Spending Under Control," Heritage Foundation Backgrounder No. 1733, March 10, 2004, at www.heritage.org/Research/Budget/bg1733.cfm; as well as Brian M. Riedl, "A 'Victory' Over Wasteful Spending? Hardly," Heritage Foundation Webmemo No. 839, September 14, 2005, at http://www.heritage.org/Research/Budget/wm839.cfm.

[6] For more on TABOR, see Brian M. Riedl, "Restrain Runaway Spending with a Federal Taxpayers' Bill of Rights," Heritage Foundation Backgrounder No. 1793, August 27, 2004, at www.heritage.org/Research/Budget/bg1793.cfm.

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