The High Cost of War

The billions needed for Iraq could exact a toll on the still-fragile economy -- and on Bush's political fortunes

The somber George W. Bush who faced TV cameras on Sept. 7 was a far cry from the jaunty leader in a pilot's jumpsuit who declared victory over Saddam Hussein just four months earlier on the deck of a U.S. aircraft carrier. Back then, Bush's victory speech was met with a banner that declared: "Mission accomplished." Now, with American casualties in Iraq mounting and chaos spreading, a President known for his optimism was forced to make a grim concession: Rebuilding war-torn Iraq would be long, hard, and costly.

To underscore the new reality, Bush requested a colossal $87 billion. Along with the big price tag came a belated recognition that a strapped U.S. could not bear the burdens alone. An Administration long suspicious of the U.N.'s intentions in Iraq was now prepared to go, 10-gallon hat in hand, back to the Security Council to seek U.N. troops and reconstruction money.

Bush had little choice. The costs of intervention are beginning to mount -- for his own political fortunes and, potentially, for a still-fragile U.S. economy. The number of Americans who say the President deserves reelection is at an all-time low of 40%, and his party's once-huge lead on foreign policy has dwindled. Meanwhile, without substantial international help, the occupation's cost could send the U.S. budget deficit spiraling past $500 billion in 2004 and threaten GOP plans for future tax cuts. If the red ink persists, rising interest rates could jeopardize future growth.

The depth of the problem became clear on Sept. 7, when the President asked Congress for $87 billion, including $51 billion for military operations in Iraq and $11 billion for Afghanistan. Reconstruction would get an additional $20 billion. That amounts to an 11% hike in discretionary spending. Federal spending next year would be nearly 20.5% of U.S. gross domestic product, the highest in a decade, while tax revenues will fall to barely 16%, the lowest level in 50 years. Says Robert L. Bixby, executive director of the Concord Coalition, a budget-watchdog group: "The Administration is pursuing a big-government agenda but is unwilling to pay for it."

Indeed, investors are growing wary of deficits nearing 5% of GDP. While interest rates have not yet reacted, "the markets are getting more concerned," says Banc of America Securities (BAC ) strategist Gerald B. Lucas.

Of course, if the U.S. can extricate itself from Iraq quickly, the fiscal fallout would be limited. The bond market is not likely to drive up rates much to finance a temporary expense -- especially when there is little private demand for capital. But if the U.S. is still stuck in Iraq as the economy takes off, and companies start competing with the Treasury for cash, the crunch would drive up rates and could undermine the recovery.

While it is impossible to know how long the U.S. mission will last, defense experts have several scenarios -- from expensive to wildly expensive. The U.S. now has 180,000 troops in and around Iraq, according to the Congressional Budget Office. The CBO estimates that 67,000 troops would cost $14 billion annually. Steven M. Kosiak, director of budget studies at the Center for Strategic & Budgetary Assessments, projects the five-year cost of a 90,000-strong occupation at $105 billion. Bush's request "could just be the first of many installments," says Representative John M. Spratt Jr. (D-S.C.), top Democrat on the House Budget Committee.

The costs of rebuilding Iraq are even more uncertain. The White House concedes the tab might be $75 billion, but Kosiak says it could top $100 billion over five years. The Administration insists those extra costs would be picked up by U.S. allies and by the sale of Iraqi oil. But so far that hasn't happened -- and it may never happen.

Despite a prediction by Deputy Defense Secretary Paul D. Wolfowitz that Iraq could produce up to $100 billion in oil revenues over the next two or three years, expectations have been sharply lowered because of sabotage and the decrepit state of Iraq's oil infrastructure. Now, White House aides figure the oil fields will generate just $12 billion in '04 and $20 billion each in '05 and in '06. But private analysts say the take is likely to be lower. An ongoing deployment of about 60,000 troops and an annual reconstruction bill of $20 billion could saddle the U.S. with an annual Iraq tab of $30 billion after 2004, even allowing for modest assistance from other nations.

Such costs add to an already soaring deficit. Instead of the 10-year surplus of $5.6 trillion that Washington anticipated two years ago, Goldman, Sachs & Co. now estimates the nation faces a $5.5 trillion deficit in the decade 2004-13.

That means rough going for tax-cutters and big spenders. Republicans have a long list of new tax cuts, including new business tax breaks, efforts to make the '01 and '03 cuts permanent, and new incentives for savers and individual purchasers of health insurance. Business breaks, which included corporate rate cuts and investment incentives, were a top priority of many business lobbyists. Now, worries one, "there's just no way."

At the same time, bigger deficits make it tougher for lawmakers to spend freely. A big highway bill, for example, will be delayed at least until next year, when backers hope the outlook will brighten. And a $400 billion Medicare drug benefit also faces opposition from conservatives who question a new entitlement at a time of fiscal stress.

The Administration prefers another course: help from afar in the form of a new U.N. resolution that provides more peacekeepers and cash assistance to Iraq. Secretary of State Colin L. Powell predicts approval, a different outcome from the spring, when the Security Council rejected a U.S. pitch for help before the invasion. The difference, he told BusinessWeek: "We're not talking about going to war. We're talking about going to peace."

Analysts agree a deal can be cut -- with U.S. concessions. "The diplomatic process is now going in the right direction," says Karsten D. Voigt, a senior official in the German Foreign Ministry. While there is little dispute over U.S. control of military operations, the U.N. wants a political role in Iraq -- and other countries want a share of reconstruction contracts, which have been an American preserve.

Washington has O.K.'d Security Council review of any blueprint for a political transition, but Europeans may press further by seeking a U.N.-approved civilian overseer. The White House insists that U.S. proconsul L. Paul Bremer III must stay in charge. "America sees him as the last hope between them and complete chaos," says François Heisbourg, head of the Foundation for Strategic Research in Paris. "This could be a very sticky point."

Even if a deal is reached, the Pentagon isn't counting on a lot of help from abroad. With few infantrymen available from Europe, the U.S. hopes to enlist Islamic nations such as Pakistan and Turkey, as well as India. And the cash contributions are likely to be just a few billion dollars -- a fraction of the money collected for Desert Storm.

There's no question that the deteriorating Iraq situation is starting to damage President Bush at home. A Sept. 3-5 Zogby Poll found just 40% of Americans believe he deserves reelection -- down from 49% in June. Continuing bloodshed in Iraq "has the capacity to make foreign policy a liability to Bush rather than a great strength," says Columbia University historian Alan Brinkley. "The impact has been significant, but not irreparable."

By finally confronting the financial costs of the Iraq war, President Bush has taken a first step to repair the damage done to both the country's international prestige and his own political stature. He still has 14 months to stabilize Iraq before facing the voters, and a strengthening economy also could help restore his luster. But if the President and his advisers have learned one thing about Iraq since the war's end, it's that predictions are guesses at best and that more nasty surprises may lie ahead.

By Richard S. Dunham, Howard Gleckman, and Stan Crock in Washington, with John Rossant in Paris and Jack Ewing in Frankfurt

    Before it's here, it's on the Bloomberg Terminal.