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US stares at a $1 trillion deficit. How bad is that?

The number ballooned amid the banking bailout. Tax hikes may lie ahead.

By Ron SchererStaff writer of The Christian Science Monitor / October 16, 2008

SOURCES: Office of Management and Budget, 2009 estimate by Committee for a Responsible Federal Budget/Rich Clabaugh–STAFF

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NEW YORK

The US government's extraordinary effort to rescue the banking system may have pulled America's economy back from the brink, but it comes at a cost – helping to push an already bloated deficit up to an estimated $1 trillion for this fiscal year.

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That would be a record in today's dollars – and would represent the highest level of federal red ink as a share of the overall economy of any US budget since the 1940s. For each household, this year's deficit would pile on an extra $8,620 of federal debt.

As a result, future presidents may have to rein in spending and raise taxes to pay down that debt. If they don't, foreign lenders at some point could scale back their purchases of US debt, sending interest rates soaring.

"There are times when you need to run up the deficit and this is one of them," says Maya MacGuineas, president of the Committee for a Responsible Federal Budget, a nonpartisan group in Washington that came up with the $1 trillion estimate. "But we ran them up when we did not need to, and we have no plan to stop running them up. We have become serial deficit spenders."

It could be worse. The rising estimates of the deficit are based in part on the calculation that tax revenues will shrink as the economy contracts and unemployment rises. If the recession is less severe because of the bank rescue, then the deficit will be smaller. If Congress enacts a new economic stimulus package, the deficit could go up.

Another unknown is the actual costs of the $700 billion financial rescue bill. In the first year of the three-year program, the US Treasury might spend $400 billion, estimates Stanley Collender, managing director at Qorvis in Washington and a budget expert. But the Congressional Budget Office is not likely to count it as a direct expense since it might be considered a loan or an investment.

"As long as you treat it as a loan or capital transaction, then you have to look at the difference between the initial expenditure and the amount you would expect to get back," says Barry Bosworth, a senior fellow at the Brookings Institution, a Washington think tank. "Maybe it will be scored at a cost of $100 billion or higher. Otherwise, the budget deficit would be way over $1 trillion."

If the deficit does reach $1 trillion this year, it would represent 7.5 percent of the gross domestic product, the highest percentage since World War II when it skyrocketed to 30 percent of GDP. "The big difference is back then we owed it to ourselves, to Americans," says David Walker, head of the Peter G. Peterson Foundation and former US comptroller general.

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