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Red Ink Is One Badge of Courage

In times of war, the political will for fiscal discipline evaporates.

Red ink will probably flow in Washington until the carnage has stopped in Afghanistan.

With the government inching toward a deficit, President Bush's 10-year tax package is facing increased opposition in Washington. But observers doubt sufficient political will can coalesce around fiscal discipline while Osama bin Laden is on the loose, and probably won't take shape before the November 2002 election is over.

Since Sept. 11, the U.S. government has tagged $45 billion for emergency relief and airline bailouts, and Congress is currently debating $50 billion to $100 billion in tax relief and additional unemployment insurance. Including tax cuts and rebates already planned for 2001 through 2003, and defense spending, total fiscal stimulus in the works for the next six quarters amounts to some $320 billion to $370 billion.

The hefty spending will probably end a four-year stretch of budget surpluses. At the beginning of this year, the Congressional Budget Office expected the government to have an excess of $311 billion for fiscal 2002, but now the government could run deficits of between $50 billion and $100 billion over the next several years, said Charles Gabriel, political analyst for Prudential Securities. Social Security is no longer off limits, and will be used to pay for many of the government's spending programs.

"The 'save Social Security first' mentality has temporarily been replaced with the patriotic 'we are all Americans' paradigm: we will spend whatever we need to, do whatever we need to," said Gabriel. "We have temporarily waived concern about the politics of fiscal discipline. The question now is whether we go back and try to restore some of that

sense of responsibility that goes with social security."

Reagan Revisited

Some analysts worry it may be difficult to revive the spirit of fiscal discipline that existed before the terrorist attacks. "It's going to be very hard to rebuild the coalition that led to controls on spending," said Steve Clemons, Vice President of the New America Foundation, a centrist think tank in Washington. "The real issue is whether Bush now pursues a Reaganesque heavy spending, low taxing program. That's what Reagan's people did, and it forced Bush to raise taxes."

The threat of a return to Reagan-era budget deficits makes tax breaks for the wealthiest classes an obvious target for Democrats, who tried to get a repeal of cuts for the highest income brackets earlier this year to help cover $300 billion in prescription drug benefits over the next 10 years.

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Under George W. Bush's $1.35 trillion, 10-year tax package approved this June, taxation for the top income bracket would fall to 38.6% in January of 2002 from 39.6% before the bill was passed. That rate would then fall to 37.6% in 2004 and 35% in 2006. But Democrats wanted to freeze taxation rates for the top bracket at 38.6%. Government revenue from individual income taxes totaled $1.07 trillion in 2001, while the Office of Management and Budget estimates that income tax reductions approved under the June law should drain some $33.5 billion from the government treasure chest in 2004, another $42.3 billion in 2005 and $57.3 billion in 2006.

House Democrats tried to push a repeal again yesterday as part of the fiscal spending proposal, but the $100 billion package passed without it. The fiscal spending package now goes to the Senate, where the issue could be raised again.

Democrats might also oppose rollbacks in the estate tax and try to block any initiatives to lower capital gains taxes. But November 2002 elections and a murky outlook for economic growth could deter them from pushing too hard. Even if a repeal were to pass, President Bush would probably veto it.

"Two big negatives are the Bush veto threat, and that politicians are going to be nervous about asking for a tax hike," said Greg Valierre, policy and government analyst for Charles Schwab's Washington research group. "Maybe

House Democrat from New York Charlie Rangle would like to undo cuts for the wealthy, but a lot of moderate Democrats would be really leery about calling for tax hikes. Nobody's going to want to do it ahead of the elections next fall."

The problem is, after 2002 elections, there is only a one-year window during which fiscal discipline could be restored, says Steve Clemons. Bush will be up for reelection in 2004, and he'll have few political incentives to raise taxes then.

If it doesn't happen now, it'll cost the government later. "If you have bad behavior for only one to two years, in a 10-year budget cycle that's very resolvable. If you turn back to fiscal balance, then you bring interest rates down. Your economy should get a net bump up. As you get more economic activity, more taxes come in, that helps keep the government in order. That can resolve naughty behavior," says Clemons. "But if you go for two presidential cycles without discipline, it will take some very, very strong increases in taxes."

The U.S. also has aging baby boomers to worry about, so spending Social Security recklessly could be risky. Social Security is now supporting just 12% of the population, but that will rise to between 20% and 25% by 2012. "The problem is we're aggravating the demographic time bomb that the U.S. already has," says Clemons. "We were ahead of Europe and Japan because we were setting aside money for the baby boom generation." By 2012 net increases in Social Security funds could become decreases, and some estimates suggest the government would have to raise payroll taxes by as much as 30% to 40%.

Ultimately, much of what happens to fiscal discipline in the coming months -- and years -- hangs on whether acts of bioterrorism escalate, what happens in the Middle East, and how quickly the economy responds to rate cuts and fiscal stimulus.