Massive deficit looms as America ages

Repressed report points to serious long-term problems with public finances in the US

Was it really only three years ago, when President Clinton was in the White House, and the first decade of the 21st century was hailed as America's coming age of fiscal plenty?

A forecast $5,000,000,000,000 federal budget surplus between 2001 and 2010 has turned into an expected deficit of at least $1,500,000,000,000. But George W Bush is turning standard economics on its head.

What matter record deficits which will top $300bn in fiscal 2004 and 2005 (and that's not counting the cost of the Iraq war, for which Congress has passed a $75bn six-month supplementary spending bill)? The White House response has been the third largest tax cut in US history, worth an official $350bn, but which which may ultimately cost double that. America, this President believes, can have guns and butter. Or as Mitch Daniels, the President's outgoing budget director, put it: "We have returned to an era of deficits but we ought not to hyperventilate about this issue."

Perhaps, however, we should, if a new study here is even one-quarter correct. Written at the US Treasury's behest by two eminent academics - Jagadeesh Gokhale and Kent Smetters - the pamphlet bears the deceptively innocuous title Generational and Fiscal Imbalances: New Budget Measures for New Budget Priorities. It was supposed to have been issued as an annexe to the proposed federal 2004 budget published on 3 February this year, but its contents were so explosive that it did not appear. Its conclusion, put simply, is that current budget measurements and future projections grossly understate the financial burden piling up for future generations as retirees, expecting decent health care and pensions from the state, account for a steadily greater share of an ageing population. The first wave of babyboomer retirements at the end of this decade will be a mere foretaste of what will follow.

The Fiscal Imbalance, or FI, is defined by Mr Gokhale and Mr Smetters as the difference between what the government is committed to spend over the coming generations, and the resources available to do so, i.e. between present public debt plus the present value of all future federal spending, and the present value of future federal tax receipts. A sustainable fiscal policy requires FI to be zero. In fact, the authors argue, it is an almost incomprehensibly and vast $44,200,000,000,000.

That sum is more than ten times greater than net existing US public debt, and four times the current US GDP. Future healthcare costs, in the form of Medicare, accounts for four-fifths of the total. Most of the rest comes from the government's Social Security obligations, mainly pensions. Without corrective policies, the study further warns, the FI will grow by $1,600,000,000,000 a year (14 per cent of GDP) to reach $54,000,000,000,000 by 2008.

And what are those corrective policies? The authors provide three theoretical possibilities: an immediate and permanent tax claiming an extra 16 per cent of payrolls; a permanent 66 per cent hike in income taxes, or the permanent elimination of all future discretionary spending. All three, obviously, are politically inconceivable. But they illustrate how gargantuan is the problem that Mr Bush's successors may face. In comparison, the arguments over his latest tax cut package are squabbles over a pre-teen's pocket money.

Yet the package sets the psychological climate, evidence of an addiction to debt which the longer it lasts, the harder it will be to break. Against this background, Mr Bush's hypocrisy in January's State of the Union message is all the more breathtaking. "We will not pass along our problems to other Congresses, other presidents and other generations," the President declared. To be fair, he was talking about Iraq, and what appears to have been the largely imaginary problem of Saddam Hussein's weapons of mass destruction. But with his tax cuts and the fiscal deficits stretching as far as the eye can see, he was doing precisely that.

Some warning voices have been raised. With his customary politeness, Alan Greenspan has implied the tax cuts are the wrong answer to today's problems. And what about spending cuts to counterbalance them? "I must say the silence is deafening," the Fed's chairman told Congress this month.

But the White House pays little attention. Defence spending continues to soar. During his 2000 campaign, Mr Bush proposed part-privatisation of Social Security, and his administration eyes some form of privatisation of Medicare but nothing has happened. For the moment, historically low interest rates mean that financing the deficit is easy. But that is likely to change and the private sector will start competing more fiercely for available savings. The result will be higher interest rates, which may throttle the recovery on which Mr Bush is counting for his re-election next year.

At the state level the picture is even bleaker. The combined budget deficits of the 50 states and the District of Columbia may hit $50bn this year, and $70bn or more in 2004. Many states moreover (unlike the federal government) are constitutionally required to balance their books. The result? Fired workers and reduced services, cuts in education budgets which force higher tuition fees, and increases in state taxes, all of which may wipe out whatever meagre goodies trickle down from the Bush tax cuts, whose benefits will flow disproportionately to the well-off.

For the record, Mr Daniels and his colleagues maintain that all will be well when the economy picks up, swelling state and federal coffers with tax receipts, and the stock market takes off again, turning investors once more into carefree spenders. But others see a darker plot. The Bush crowd, they believe, is deliberately creating a deficit problem that will indeed prove unsustainable. At some point massive federal spending cuts will become unavoidable, et voilà, the smaller government of which America's true conservatives dream.

Fortunately, the US can still rely on others to hold its currency, and thus live beyond its already very considerable means. For the time being, the tumble in the dollar is no more that an overdue correction of an overvalued currency, that may indeed boost America's exports and revive the economy. But it may be the harbinger of something worse. From most objective standpoints, the US presents a sorry picture.

"Suppose for a minute we were talking about a developing country that had gaping current account deficits year after year," Kenneth Rogoff, the IMF's managing director remarked recently à propos the US, "that had had budget ink spinning from black into red ... open-ended security costs and and a real exchange rate that had been inflated by capital flows." With all that, Mr Rogoff noted, "its fair to say [the Fund] would be pretty concerned." The US however, in the international financial system as in the international security system, plays by a different set of rules. But in the former at least, for how much longer?