ANALYSIS: Deficit spending is tough medicine

Wednesday, January 7, 2009 | 4:28 p.m. CST; updated 4:40 p.m. CST, Wednesday, January 7, 2009

WASHINGTON — It's a painful dilemma. The expected growth of the federal government budget deficit to $1.2 trillion this year could swamp future generations with a tidal wave of debt. But failure to spend huge piles of money on stimuli could capsize an already foundering economy.

The deficit projected by the nonpartisan Congressional Budget Office on Wednesday is an unprecedented number of dollars. As a percentage of the U.S. economy, it would be the largest since World War II.

And the $1.2 trillion deficit is just for the budget year that began Oct. 1.

The proposed deficit will grow even more if President-elect Barack Obama's sweeping stimulus package is enacted. That could add nearly another $1 trillion or more to the red ink over two years.

If you add in what the federal government still owes from past years, the total national debt now stands at $10.64 trillion.

That's roughly $37,000 for every man, woman and child in the United States. And with spending rising and tax revenues falling, the total debt is expected to approach $12 trillion by year's end.

Yet there's a consensus, shared by Democrats and many Republicans, that some form of major stimulus — either new spending, tax cuts or a mix — is needed to tame what is already the worst recession in a generation and to prevent it from widening into another Great Depression. Republicans generally argue for larger tax cuts as part of the stimulus brew.

"I've never seen harder days to be a deficit hawk," said Robert Bixby, the executive director of the Concord Coalition, a nonpartisan group that advocates fiscal restraint.

"The numbers that are being thrown around now for stimulus are just huge. The whole thing is just turning into a massive wish list," Bixby said.

Still, he said, "a credible case can be made that you need some stimulus," so long as it is short term and doesn't include permanent new spending programs.

It's hard to believe that just eight years ago — as President Bill Clinton was leaving office and Texas Gov. George Bush was preparing to be sworn in — there was a projected $5.6 trillion 10-year budget surplus. Both Clinton and Bush talked of using part of it to retire the national debt by the end of the decade. That would be the end of next year.

Instead, the bursting of the technology bubble, big Bush tax cuts, the  Sept. 11 attacks, wars in Afghanistan and Iraq, increased spending on homeland security, a mild recession in 2001 and the heavy one now intervened.

Heavy public spending is a traditional antidote for healing severe recessions, regardless of the impact on deficits. The big-spending, FDR-type programs of the 1930s are often held up as an example.

Many economists note that when President Franklin D. Roosevelt turned cautious in 1937, cutting spending and raising taxes in an attempt to get the deficit under control, it backfired and touched off a new sharp downturn that lasted through 1938.

"The prevailing opinion is that, if we have to increase the deficit, let's increase the deficit. We'll fix it later," said former congressional budget analyst Stanley Collender.

Some conservative economists argue that major spending on public works projects in Japan in the 1990s did little to shorten that nation's decade-long recession.

Obama mentioned the new gloomy CBO deficit projection at his news conference on Wednesday. "We know that our recovery and reinvestment plan will necessarily add more," he conceded.

But "unless we take decisive action, even after our economy pulls out of its slide, trillion-dollar deficits will be a reality for years to come," he said. "Our problem is not just a deficit of dollars, it's a deficit of accountability and a deficit of trust."

Obama's plan is designed to create some three million jobs. He said he would seek longer-term, offsetting cuts in unnecessary spending and changes in Social Security and Medicare to help bring government spending in line. He named a management consultant to head a new White House position on eliminating government waste and improving efficiency.

This year's deficit will equal 8.3 percent of the nation's gross domestic product, the CBO said. That makes it larger than the previous postwar record of 6 percent reached in 1983 under President Ronald Reagan. But it's still dwarfed by deficits during World War II: 30 percent of GDP in 1943, 23 percent in 1944 and 22 percent in 1945.

Among the risks of ever-expanding deficits: Interest payments on the debt will become a larger and larger slice of the government's total budget pie, eventually squeezing out other crucial spending. That could mean draconian spending cuts, big tax hikes or both.

Ever-increasing deficits would also pressure the U.S. to borrow more and more from overseas creditors, principally China, Japan and Britain. If any of those countries decided to flee Treasuries or other dollar-denominated assets, it could send shock waves through the global economy — and sharply force up U.S. interest rates.

The new deficit projection follows a study by the Peter G. Peterson Foundation in New York that the sum of America's liabilities and financial commitments now exceeds the collective net worth of its citizens, in part due to the drop in America's net worth from lower home values and the government's unfunded promises for social insurance programs such as Medicare and Social Security.

Peterson, a billionaire co-founder of the Blackstone Group LP private equity firm and commerce secretary under President Nixon, is a leading crusader for deficit discipline and financed the 2008 documentary movie "I.O.U.S.A" that warns of the dangers of runaway deficits.

Obama and Congress need to "not only turn the economy around and boost consumer confidence but put a process in place that will lead to tough choices getting made to strengthen the government's financial condition once the economy begins growing again," says David M. Walker, Peterson foundation chief executive.


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