Hate the Deficit?

Posted February 18, 2005 at 3:03pm

Ever since President Bush released his budget earlier this month, members of the president’s Cabinet have made repeated trips to Capitol Hill, each delivering the same underlying message: “The prolonged period of weakness in the economy, the events of 9/11 and the war on terrorism have left us with difficult budget choices.”

Hundreds of departmental press assistants, speech writers and Congressional liaison officers have been filling hearing rooms as dozens of chairmen and ranking members dissect testimony, and an equal number of official stenographers have been recording the proceedings.

But this ritual will be deeply flawed, because the fundamental premise upon which the administration’s proposals will be offered is untrue. The current budget mess in Washington has little to do with slower-than-normal economic growth, the attacks on 9/11, or the resulting war on terror. Let me explain.

In fiscal 2000 we had a tax code that allowed us to collect 20.7 percent of GDP in federal revenues. By fiscal 2004 that code had been rewritten so that it generated revenues equal to only 16.3 percent of GDP. That 4.3 percent decline wiped out about $500 billion in government receipts.

The subpar performance of the economy may have hurt a lot of family budgets, but it was not a factor in the deterioration of the federal balance sheet. And while counterterrorism, Iraq and homeland security spending grew by a significant amount, it was not nearly enough to move the economy from surplus to deficit — much less account for any of the $400 billion-plus deficits we now face.

There may be disagreement as to why the U.S. economy has been weaker than normal, but there is no real argument over how weak it has been. The average rate of real annual economic growth in this country over the past 50 years is 3.4 percent. Since January 2001, we have grown at only 2.8 percent. That may not sound like much, but if real GDP had grown at the average rate of 3.4 percent, the U.S. economy would have been about $322 billion larger than it is today. And under the current tax law, the federal government would have collected about $52 billion of that additional GDP.

But the slow economy not only reduced federal revenues, it also reduced interest payments on the public debt. To offset economic weakness, the Federal Reserve pushed interest rates dramatically below the levels that existed in January 2001. Even though the Fed is now tightening, interest rates remain and are expected to remain far below fiscal 2001 levels.

The Congressional Budget Office has recently projected that the average interest rate paid by the federal government on the public debt in fiscal 2006 will be 3.8 percent. That is down from 6.2 percent in fiscal 2001 — a change that leaves the government with a savings of more than $80 billion, even if the growth in the debt is not taken into consideration. As a result, slow growth in some ways actually improved the government’s balance sheets during this particular business cycle.

The same cannot be said of the attack on Sept. 11, 2001. The increased military and homeland security spending that took place following the attacks clearly increased government outlays. But a review of the increases in spending on programs and activities related to defense, foreign assistance, law enforcement and homeland security indicate that the amounts involved were not nearly large enough to erase the $236 billion surplus the country enjoyed in fiscal 2000.

By far the biggest increase in spending was in the Defense budget. In fiscal 2004, the last year for which we have complete figures, Defense Department outlays were $157 billion above fiscal 2000 levels. At least $37 billion of that was tied to military pay and benefit adjustments (particularly for health benefits) that would have occurred irrespective of the war on terrorism. Around $11 billion was related to military operations in Afghanistan, and less than $1 billion was related to military operations in the Philippines and other parts of the world excluding Iraq. Increased expenditures to expand American intelligence capabilities might be estimated to account for another $10 billion.

Of the remaining $100 billion, more than 60 percent was required for the additional expenses related to operations in Iraq. While substantial arguments have been made that U.S. operations in Iraq should not be counted in the cost of the war on terror, total military expenditures related to 9/11 total less than $120 billion even if Iraq is included.

Foreign assistance also grew by more than 50 percent during the period, but not all of the increase was related to the war on terror. For instance, the Global Aids Initiative and the President’s Millennium Challenge Grants accounted for a significant portion of the increase. Between Fiscal 2000 and Fiscal 2004, the total increase in federal outlays for foreign assistance was $8.2 billion.

Prior to the 9/11 attacks, the United States was spending a little more than $20 billion a year on activities that are now considered homeland security (excluding the Defense Department). For the current fiscal year, the president requested $42 billion for those same activities, a $22 billion increase.

The combined total increase for all of these activities was less than $150 billion, even if Iraq and a number of other expenditures not tied to counter terrorism are included — far less than the $236 billion budget surplus we experienced in fiscal 2000.

It was not the terrorists who created our current budget problems, and it was not the U.S. or global economy. It was instead the changes in tax policy that we ourselves decided to make. Now that we are facing the tough choices of how deeply we cut assistance to our schools, our elderly nutrition programs and our investment in scientific research, we should understand that the choices were not forced on us by happenstance or by the evil design of some outside force. They are necessary because of the deliberate decisions we ourselves made and for which all of us as citizens are responsible.

Scott Lilly is a senior fellow at the Center for American Progress.