Bush budget envisions lower taxes, record deficits

The $2.23 trillion plan appears to take calculated risks as it tries to boost the economy.

In unveiling his proposed budget yesterday, President Bush has reignited debate over an issue that just a few years ago seemed to have been vanquished: soaring federal deficits.

The $2.23 trillion budget for fiscal year 2004 would hold down spending on most domestic programs while boosting defense and homeland security. The proposal, now headed for Capitol Hill, would also cut taxes by $670 billion over 10 years and reform Medicare, including the addition of a prescription drug benefit, to the tune of $400 billion. The administration is now projecting a deficit of $307 billion this year, up from $157 billion.

But the fiscal year 2004 (FY2004) budget does not include the cost of a war with Iraq, estimated at $50 to $60 billion. Nor does it include any large-scale relief to the states, which are suffering their worst fiscal crisis in 50 years.

The administration appears to be making a calculated risk that it can fund its priorities while stimulating a listless economy through tax cuts - all without ballooning the deficit to the point where it indisputably hurts the economy. "Nobody is happy, and certainly not me, about the return to deficits," White House budget director Mitchell Daniels told a recent Monitor breakfast. "But stuff happens, as the bumper sticker says." Mr. Daniels noted that there still would have been a three-digit deficit this year even without the Bush tax bill. The projected deficit of 2 to 3 percent of gross domestic product "is better than 12 of the last 20 years," he said. "Not good enough for me, but we do have to keep some perspective here."

Deficit hawks aren't buying the "stuff happens" argument, and see the president's proposed 2004 budget as no less than a fundamental redefinition of the term "fiscal conservative." "Their priorities are tax cuts, period, end of statement," says Stan Collender, a budget expert at Fleishman Hillard Inc. "After that, everything comes second, including balancing the budget."

Most of the proposed budget increase is not security related, he says. Bush would increase defense spending by 4.2 percent. But the tax cut, says Mr. Collender, would add $50 to $60 billion to the deficit - and higher interest rates. A $304 billion deficit would be a record in dollar terms, but not as a percentage of the economy. Under President Reagan, the deficit went to 6 percent of GDP.

With Baby Boomers, trouble ahead?

Other economists are less worried about the effect of a big deficit for now - but trouble could hit when Baby Boomers begin to retire in 2008. "Demographically, we're in the eye of the storm," says Eugene Steuerle, an economist at the Urban Institute. By running up the deficit now, he adds, "we're taking the sand out of the sandbags while waiting for this upcoming storm."

Of course, the president's budget is just a proposal - the opening salvo in a quest to reach a convergence of views with Congress on how the government should allocate money. And just because Republicans now control both Congress and the White House, that does not portend smooth sailing for Bush's spending goals. The particularly tight margin of control in the Senate (51-49) means any handful of senators could cause trouble. Congress, in fact, has yet to finalize the budget for fiscal 2003, which started four months ago; most agencies are running at last year's funding levels. When and if war with Iraq starts, today's budget calculations may be moot.

Lower demand for corporate borrowing

On Wall Street, the view is right out of Mad Magazine: "What, me worry?"

The pinstripe set is not overly concerned about red ink, because of its relation to the size of the economy. "We need to keep the overall budget gap in proper perspective," says William Sullivan, a money-market economist at Morgan Stanley in New York.

But there are few economists who see the government's deficits as causing interest rates to rise substantially. This is in large part because corporate demand for borrowing is lower in the sluggish economy.

"Last year, corporations quite dramatically slowed their demand for credit and I think it will be subdued in 2003," says Paul Kasriel, chief economist at the Northern Trust Co. in Chicago. Mr. Kasriel expects that consumers will also slow their borrowings as they try to repair balance sheets and increase savings.

This is not to say that the deficit is unnoticed. Kasriel, for example, is concerned about the sharp growth in government spending. In FY2002, he says, discretionary spending rose 13.1 percent. For FY03, it's projected to be up 8 percent, and may be higher. In the coming fiscal year, Bush is saying he'll hold the growth of government spending to 4 percent. "I don't think that's possible with the growth of defense spending and it being an election year," he says.

Once the economy returns to a steady growth rate, deficits will slow, says Scott Grannis, a principal in Western Asset Management in Pasadena, Calif.

In fact, Mr. Grannis says, the government is better off running some kind of modest deficit. This allows the Treasury market to operate efficiently and keeps Wall Street firms busy buying and selling government bonds. "At a $200 billion deficit, you have a fairly liquid market, and that performs an important public service," says Grannis.

Maybe Alfred E. Newman was really a bond trader at heart.

Staff writers Liz Marlantes and Ron Scherer contributed to this report.

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