This Year's Budget Battle Could Be Bloody

With the long-term outlook worsening, the debate will highlight stark differences in how the parties would attack problems

By Laura D'Andrea Tyson

It's budget season in Washington, and this year's political debate is likely to be especially partisan. It is, after all, an election year, and voter interest is shifting from the war on terrorism to the economy. Since September 11, Democrats and Republicans have cooperated in their support of the President's campaign against terror, but they have clashed over economic policy. And as the long-term budget outlook for the federal government has worsened, so have the prospects for bipartisanship. The political and economic stakes are high. Fundamental economic issues will be at the core of this year's budget debates, and the differences between the parties are large and significant.

According to recent numbers from the nonpartisan Congressional Budget Office (CBO), during the past year the 10-year surplus for the federal government declined by an astonishing $4 trillion. A year ago, both parties vowed to use Social Security surpluses only for Social Security. Now these surpluses must be used to cover deficits in the rest of the federal budget for the next 10 years. A year ago, the CBO predicted the government would pay off the entire federal debt within 10 years. Now the federal debt is slated to climb by $4.2 trillion, requiring an additional $1 trillion in interest payments.

Moreover, these projections are optimistic. They do not include the President's request for an additional $48 billion for the military and homeland security. They do not include a prescription drug program for Medicare, promised by both the President and Congress and a high priority for voters. They do not include funds to cover either the extension of expiring tax credits or relief from the individual alternative minimum tax that threatens to engulf millions of middle-income taxpayers over the next 10 years. And they rest on the smoke-and-mirrors premise that all of the Bush tax cuts will be rescinded in 2010. A more realistic set of assumptions would show that the 10-year budget surplus has already vanished.

What are the policy implications of this remarkable reversal in the nation's fiscal well-being? First, any stimulus package to ensure the economy's recovery over the next 12 months must be small, temporary, and targeted. According to another recent CBO report, the Republican proposals championed by President Bush fail on all counts. The centerpiece of these proposals--accelerating the reduction in marginal income tax rates, scheduled to take effect between 2004 and 2006--would cost $54 billion. Only one-quarter of the resulting tax relief would occur in 2002, however, and all of it would go to the top 30% of income-earners, who are much less likely than middle- and low-income earners to boost spending in response to lower taxes.

In contrast, the Democratic stimulus package recently proposed by Senator Tom Daschle (D-S.D.) is limited to temporary measures, including a tax rebate for low-income families, an extension of unemployment benefits, and an expanded tax credit for depreciation on new investments. These measures would boost demand this year without deepening the long-run budget deficit.

The disappearance of the 10-year budget surplus means that the Democrats should challenge the Administration to provide not just a one-year but also a long-term budget plan. Congress and the American people have the right to know how President Bush proposes to restore fiscal discipline while enacting his tax cuts, boosting spending on the military, and meeting commitments to a growing number of retirees.

The President might try to deflect Democratic calls for a long-term budget reckoning by emphasizing the huge uncertainties that surround long-run budget projections. He would have a valid point, but not an excuse for inaction. As Federal Reserve Chairman Alan Greenspan advised in his recent congressional testimony, given these uncertainties, the Administration and Congress should devise budgetary rules that make tax cuts and spending contingent on the realization of specified targets for the budget surplus and the federal debt. Greenspan offered the same advice in last year's testimony, but it fell on deaf ears.

A heated partisan battle over budgetary priorities will shed light on the fundamental differences between Democrats and Republicans. Some of these differences revolve around the role of government. Should Social Security be privatized? Should Medicare offer a prescription- drug benefit for all of the elderly, or will a tax credit to purchase private drug coverage suffice? And some of these differences revolve around fairness. Should payroll taxes paid by low- and middle-income Americans be used to finance scheduled tax cuts for the wealthiest 20%, who receive as much in total income as the remaining 80%? Finally, these differences revolve around whether the federal government should pay for its promises or rely on deficit spending with detrimental effects on long-term interest rates and economic growth. These are partisan debates worth having in an election year.

Laura D'Andrea Tyson is dean of London Business School.

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