By Christopher Farrell President's Bush's Sept. 7 address to the nation on the Iraqi occupation made one thing perfectly clear: Fiscal policy is a mess. There is no question the federal government should run a deficit to fight an economic downturn. Loose fiscal policy is supporting the incipient recovery. But federal budget deficits "as far as the eye can see" threaten to undermine the economy's long-term vigor over the next decade. Fiscal profligacy creates the risk that the economy will not live up to its growth potential, producing less wealth and fewer jobs for years to come.
Let's go to the numbers first. The Bush Administration was already projecting a record budget deficit of $475 billion in 2004. Now it's asking for another $87 billion to pay for war and reconstruction, and it's widely expected Bush & Co. will come back and ask Congress for still more taxpayer dollars.
So the budget deficit will run to at least $525 billion -- and that's before adding in the cost of a Medicare drug benefit totaling $400 billion over the next decade, making the reasonable assumption that the Administration's temporary tax cuts will be made permanent during the 2004 campaign for the Presidency, and taking into account the increase in entitlement-program spending as baby boomers finally reach retirement age.
FINANCIAL DELUSIONS. These are stunning figures. But it's not the actual dollar numbers that are scary. Supply-siders are right. The U.S. economy is wealthy enough to carry federal budget deficits ranging from 4% to 6% of gross domestic product for years. There's nothing inherently wrong with a long-term deficit, either. Companies and households often run a deficit reflecting a rational decision to invest in future earnings -- just ask a new homeowner or leveraged-buyout maestros Kohlberg, Kravis, & Roberts.
However, a corporate or household budget deficit can also signify confused priorities, a lack of discipline, and financial delusion, with catastrophic consequences -- witness the travails of heavyweight boxer Mike Tyson and struggling telecom WorldCom. It's the policy incoherence represented by the government's budget deficits that's disturbing.
What exactly is the Bush team's plan? How will yawning budget deficits make life better for taxpayers, citizens, and communities a decade from now? Even the Administration seems to recognize that its favored tactic of demanding a new round of tax cuts every year no longer works as a fiscal-policy blueprint. But it hasn't come up with an alternative set of tactics.
SIXTIES FLASHBACK? It's far too early to draw military analogies between the quagmire of Vietnam and Iraq, although in a disturbing echo of that earlier conflict the Administration's confident statements seem increasingly out of sync with the mounting death and injury toll on the ground.
Still, there's a big difference between the two wars. Even opponents of war in Iraq agree that the U.S. has a major financial and moral responsibility to rebuild the devastated country. The divisive issue is that the war's opponents would now like to pursue reconstruction with more multilateral cooperation than the Administration and its neocon firebrands are willing to embrace.
The parallels on the economic front are more instructive. As with Iraq, the Administration and the Pentagon played down the initial cost of war in Vietnam, underestimating by some 90% the eventual $500 billion price tag. In the 1960s and 1970s, Democrat and Republican Administrations pursued a policy of guns-and-social-spending to minimize the economic pain of waging an unpopular war, and the budget deficit started its long climb higher to the politically toxic levels of the 1980s and early 1990s. This time around, the Administration's policy is guns-and-tax cuts. And, once again, the red ink in mounting.
STEEP PRICE. The critical economic difference between then and now is that inflation won't take off in the 2000s the way it did in the 1960s and 1970s. The Federal Reserve won't make the mistake of monetizing the federal budget deficit by tolerating high inflation rates. The global bond market vigilantes will make sure the Fed holds to an anti-inflation course. But the result, as measured in jobs and wealth will be the same: The underlying rate of economic growth will slow down, making everything from paying for retirement to funding research and development more costly.
There's still time for the Administration to embrace a sound fiscal framework that makes its policy tradeoffs clearer. Already, it appears the Administration is reluctantly accepting that it can no longer pretend Iraq can be rebuilt on the cheap. It also seems to recognize that cutting taxes to put pressure on Congress to reduce spending won't work. But the Bush Administration has yet to figure out that the price of continuing to treat budgets with disdain is too high. Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over Minnesota Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BusinessWeek Online