Are US deficit forecasts too large?

Uncle Sam's books are aglow with red ink.

Experts reckon the federal deficit will be at least $400 billion in the current fiscal year.

Over the next 10 years, the deficit will mount to a cumulative $4.1 trillion, figures the Center on Budget and Policy Priorities (CBPP) in Washington. That calculation assumes the tax cuts in this year's tax legislation are extended and the extra costs of the Iraqi occupation and of a Medicare prescription-drug program are included.

The deficit in 2013 will be $530 billion, this projection maintains. After the baby boomers retire and collect their Social Security and Medicare payments, the budget picture looks even worse.

The Social Security trust funds will be exhausted in 2042. Thereafter, payroll taxes will not be sufficient to cover quite fully the benefits promised retirees and the disabled. The funds would need another $3.5 billion in today's dollars, earning interest at Treasury rates, to pay all scheduled benefits over the next 75 years, the Social Security Board of Trustees reports. The long-term financial problems are "very serious," states Jo Anne Barnhart, commissioner of Social Security.

Medicare is in worse shape, with unfunded benefits equaling $5.9 trillion.

It all sounds horrific. But it may not be so bad. The Social Security deficit projected by actuaries amounts to 1.92 percent of the total payroll that will be taxable over 75 years. As a percentage of national income, the shortfall is less than three-quarters of 1 percent. And real wages by 2042 - when the shortfall begins - will be about 40 percent higher than today because of higher productivity.

Even if no adjustments to Social Security are made, retirees in 2042 could be more affluent than those of today.

Further, new research suggests federal-revenue estimates in long-term budget projections, such as those made by the Congressional Budget Office, the scorekeeper for Congress, may be far too modest.

"There is some good news," says Michael Boskin, chairman of the Council of Economic Advisers under the first President Bush. In a lengthy new paper, Mr. Boskin calculates that total deferred tax on retirement-saving vehicles, such as 401(k)s, IRAs, some life insurance, private and government pensions - money owed to Washington eventually - amounts to almost $12 trillion, when calculated in terms of today's dollars.

That's as large as the sum of the 75-year actuarial deficits in Social Security and Medicare, plus today's total national debt. It's big, big money.

This huge stash of future revenues could make Uncle Sam's fiscal burden easier to manage in the decades ahead.

"I'm not saying the whole $12 trillion is left out of their [CBO long-term] calculation," says Mr. Boskin, now a Stanford University economist. "But a sizable piece of it is."

When employees and others put money into 401(k)s and many other savings vehicles, they use before-tax dollars. When they take the money out after retirement or earlier, they pay income tax on not only the money invested, but on the accumulated earnings.

Already, after 20 years of existence of some tax-deferred savings plans, the revenue coming in from tax payments on withdrawals exceeds by a little the revenue being lost on tax-free money invested in these plans. This revenue surplus will grow in the years ahead.

Boskin is on the advisory board of the CBO and has encouraged the agency to take account of deferred taxes in its 10-year projections of revenues, required by Congress. But in projections beyond a decade, the CBO merely assumes federal revenues will amount to 19 percent of gross domestic product (GDP) - about the average for recent years.

Boskin projects tax revenues rising to 24 percent of GDP by 2040, roughly equaling outlays, if the laws remain unchanged. That's not likely over several decades.

As the tax cuts of the past three years demonstrate, the tax code is malleable. Congress can raise or cut taxes. And Americans may not accept a tax burden greater than 19 percent of GDP for long.

That 19 percent may include some deferred tax revenues. The CBO has initiated a staff study of this question.

"It is a potentially important aspect of future tax receipts," says Douglas Holtz-Eakin, director of the CBO.

Whether some key assumptions in the Boskin study are correct is an open question. For instance, Boskin assumes the average marginal tax on income from 401(k) and other such plans will be 28 percent. But it could be closer to 20 percent. And how much of the money in these accounts will be withdrawn earlier than retirement and thus not be so large, with fewer taxes due?

Going back to the present, one way of looking at this year's budget deficit makes it look even grimmer. Dean Baker, an economist with the Center for Economic and Policy Research, calculates the deficit for the "core" budget for 2003.

This eliminates revenue from payroll taxes for Social Security and Medicare, as well as for the retirement program for government employees. "Core" revenues reach about $1 trillion and total outlays $1.7 trillion. So the core deficit runs about $700 billion.

Washington, however, is glad to use surplus payroll revenues for general spending purposes - giving IOUs (special Treasury bonds) to the trust accounts in return.

CBPP economist Richard Kogan sees "severe fiscal distress" ahead when the baby boomers retire.

Boskin, in effect, sees deferred taxes on the multitudes of baby boomers themselves covering some of their own pension costs.

But he suspects Americans in the future will live longer on average than Social Security actuaries reckon, thereby making the system's deficit worse.

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