Budget Lessons From New York?

There's good news and bad news on the budget-deficit front. New York City is projecting a $1.4 billion surplus for the current fiscal year, a remarkable turnaround from last year's $6.9 billion deficit. The net fiscal position of the combined state budgets has also turned from deep red to black in recent months -- another surprising inversion.

But the federal budget deficit appears only to be getting worse and worse. The latest Congressional Budget Office report added another $1 trillion to the projected deficit over the next decade, for a total of $2.4 trillion. And that's a best-case scenario. The actual figure could get as high as $5.5 trillion if the 2001 and 2003 income- and inheritance-tax cuts, which are scheduled to expire, are made permanent.

This election season has seen both Republicans and Democrats in Washington pile on tax cuts and new entitlements in an unprecedented rush of fiscal folly. By 2008, millions of Baby Boomers will turn 62 and begin to retire, drawing down increasing billions from Social Security. The clock is ticking. It is past time for Washington politicians to behave responsibly and start to get the budget in hand.

Urgent measures need to be taken. First and foremost, Washington must be pragmatic, not dogmatic. New York City Republican Mayor Michael Bloomberg, and many other mayors and state governors, turned their fiscal positions around with startling speed by raising taxes and cutting spending. Now, with a surplus in hand, Bloomberg is planning to rebate much of the higher real estate taxes he imposed. That's a flexible approach.

Unfortunately, the Bush Administration has taken a rigid, ideological position on tax cuts. Making the income and inheritance cuts permanent, as the President is aiming to do, would lock in deep budget deficits and freeze tax policy in the face of unheard-of government obligations. It makes economic sense to cut taxes deeply during a recession, but not in a strong expansion. And legislating expensive new entitlements, such as the Medicare drug benefit, makes more political than fiscal sense, too.

Next, the Bush Administration and Congress must restore the confidence of overseas investors. Federal Reserve Chairman Alan Greenspan correctly argues that foreign investors will probably finance U.S. deficits. They will, but only if investors trust that those deficits will be modest and under control. Right now, apprehensive individual and institutional foreign investors are boycotting American stocks, bonds, and Treasuries. Only the central banks of China and Japan are buying dollar assets -- Treasury bills -- to curb their own currencies from rising and to keep their economies growing. This vote of no confidence from private investors around the world is quite serious, and it puts the U.S. recovery at risk.

The U.S. economy has amazing strength and vitality. American productivity growth is exceptionally healthy, corporate profits are high, and growth in recent quarters has generated unexpected tax revenues for cities and states. This year's projected $477 billion federal deficit will almost certainly come in lower, but not nearly low enough. With proper fiscal stewardship, the U.S. economy could probably grow enough to provide for the boomers' retirement. But politicians have to start making choices and showing some leadership.

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