Next Year’s Budget Was Decided by Last Week’s Headlines

Posted September 22, 2008 at 1:46pm

Even by federal budget standards, $700 billion for the financial markets bailout plan is a great deal of money. I barely drink, and I still found the number to be totally sobering.

[IMGCAP(1)]What’s obvious about this sudden additional spending is that the federal budget situation got so dramatically and significantly worse last week. What may not be so immediately obvious is that everything that everyone, including the presidential candidates, has been thinking and planning for the next few years now has to be revised, revisited, downsized and, in many instances, dropped entirely.

In fact, assuming that the plan announced last week by Treasury Secretary Henry Paulson gets enacted, we’re likely to look at the third week in September 2008 as the point when next year’s budget, that is, fiscal 2010, effectively was decided.

It’s possible that the plan will include a creative way to pay for the purchase of assets that doesn’t involve spending federal dollars. Or, as was done with the savings and loan bailout, it’s also possible that some part of this new economic emergency effort will be classified as “off-budget” and won’t officially increase the federal government’s red ink. That doesn’t mean the money won’t be spent; it just means it won’t be counted. Some are suggesting that it should be off-budget so that it increases the national debt but not the deficit and, therefore, doesn’t constrain other spending and taxing initiatives. And, of course, it’s even possible the plan won’t be enacted.

But at this point, the overwhelmingly likelihood seems to be that the plan will become law in the next few weeks; that it will include actual, on budget spending; and, therefore, that the 2009 federal deficit will increase to levels hardly ever before mentioned in science fiction or fantasy novels, let alone in economic texts.

The official $438 billion Congressional Budget Office projection for the deficit released early this month didn’t include a number of other things that, while almost certain to occur, are not legally allowed to be included because they haven’t actually been enacted yet. When these very likely tax and spending changes — including a fix for the alternative minimum tax and the full cost of activities next year in Iraq and Afghanistan — are added to the CBO number, the more realistic 2009 deficit estimate exceeds $600 billion.

That’s the base on top of which the Paulson plan will be added. It’s unclear at this point how quickly the $700 billion will be spent, but my guess is that Treasury will want to move very quickly. In addition, with fiscal 2009 starting in about a week, the government will have the entire fiscal year to implement the plan. Because of that, I’m assuming that at least $400 billion will be spent next year.

That would increase the deficit to $1 trillion or more. (My apologies for the italics, but it’s hard not to use them in this situation.) If what’s left of the $700 billion is spent in 2010 and activities in Iraq and Afghanistan continue that year, the deficit for two consecutive years could be close to that level.

And it could be even more: None of this includes other announced, already implemented, or still possible elements of the government’s efforts to bail out the credit markets, or a possible additional stimulus bill. In addition, the substantial additional borrowing the government will have to do to finance this deficit, along with the additional debt it has already started to incur to implement the American International Group Inc. bailout and other things, indicates that there likely will be upward pressure on interest rates and, therefore, that the government’s interest expense could be growing as well.

A deficit of this size means that, whoever it is, the next president’s options in every area will be extremely limited. It’s hard to see, for example, how any of the major spending initiatives of either presidential candidate can now be proposed or considered with the same enthusiasm that existed before last week.

But it’s also hard to see how the 2001 and 2003 tax cuts, which expire at the end of 2010, get extended as easily or completely as they might have before. In fact, nothing else that might be considered in the next few years has the potential to reduce the dramatically increased deficit by as much as quickly as scaling back on these cuts or letting them expire.

Some provisions, like marriage penalty relief and the $1,000-per-child tax credit, might still be a slam dunk. But others, like the top marginal tax rate, capital gains, dividends, estate and gift taxes, and small business expensing, are clearly in jeopardy now.

The other area that could provide the most rapid deficit reductions will be activities in Iraq and Afghanistan. Although the savings may not be as great as some are anticipating, there is little doubt that the pressure on the president and Congress to withdraw the troops next year just got much greater.

All of this is why some people have started to ask who would want to be president in this extraordinarily fiscally tough environment. My guess is that you can now extend that question to the chairmen of the House and Senate Budget committees and director of the Office of Management and Budget.

Stan Collender is managing director at Qorvis Communications and author of “The Guide to the Federal Budget.” His blog is Capital Gains and Games.