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The Fiscal Year 2005 Budget: Lasting Deficits, No Financial Market Reaction

Author: Roger M. Kubarych
February 5, 2004
Council on Foreign Relations

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The Bush administration’s latest budget proposal for fiscal year 2005 came out this week. It is a massive undertaking, well over a thousand pages in length, and gives impenetrable detail, comprehensible to a relative handful of specialists, on hundreds of governmental activities. Moreover, the US Congress almost never passes any President’s budget intact. Indeed, opposition politicians usually declare the proposal as “dead on arrival,” because it contains program cuts (or new programs) that are anathema to them or because it contains tax provisions they find unacceptable.

Despite these handicaps, the budget message is important. It spells out the White House’s economic assumptions. It also makes concrete an administration’s philosophy of government, expresses its priorities, and lays out the broad outlines of its fiscal policy intentions. And in a presidential election year like this, it serves a dual purpose as campaign platform.

Economic assumptions

The Bush administration is content to go along with the consensus of private sector economists with some modest, but revealing, refinements. It is somewhat more conservative than the consensus on near-term economic growth prospects but more optimistic for the longer term. It believes inflation will be moderate throughout the rest of the decade.

Economic Assumptions

Calendar years

2004

2005

2006-2009 avg.

Real GDP growth

2005 Budget

4.4%

3.6%

3.3%

Consensus

4.6%

3.7%

3.2%

CPI

2005 Budget

1.4%

1.5%

2.2%

Consensus

1.7%

2.1%

2.4%

Unemployment rate

2005 Budget

5.6%

5.4%

5.1%

Consensus

5.8%

5.5%

5.3%

Three-month Treasury bills

2005 Budget

1.3%

2.4%

4.0%

Consensus

1.3%

2.6%

3.9%

10-year Treasury notes

2005 Budget

4.6%

5.0%

5.7%

Consensus

4.7%

5.4%

5.6%

Significantly, the White House is willing to assume a substantial increase in the yield on 10-year US Treasury securities, to an average of 4.6% for 2004 and 5.0% for 2005. That means it is effectively warning potential investors in US Government debt that they will lose money if they buy now. Presumably this odd marketing strategy is not worrisome because most purchasers of US Treasuries these days are foreign central banks and governments. Their goal is to stabilize their currencies against the dollar, rather than to achieve a profitable return on their bond investments.

Philosophy of Government

Every Republican president starts out with the objective of lowering taxes. Some succeed; many fail. President Bush, like Ronald Reagan in 1981, based his entire administration on tax cutting. But unlike other Republicans, Mr. Bush has not tried to restrain discretionary government spending with equal fervor. Domestic discretionary spending is projected to go up by about 4% next year, after an 8% rise in fiscal 2004. Partly this reflects the war on terrorism. That has produced sizable outlays for homeland security, as well as for the military. This priority shows through in the new budget, but with some curious changes. For example, federal funding for local fire departments so that they can respond better to possible terrorist attacks is slashed by a third. A different priority is to expand high-tech military spending, especially on advanced aircraft and missile defense. Since the main beneficiaries are only a few aerospace companies, this is as close to an “industrial policy” as the United States ever gets.

Bush Budget Summary in $ billions

fiscal year

2003

2004

2005

Outlays, total

2158

2319

2400

Discretionary, total

826

908

914

defense

388

433

429

non-defense

438

475

485

Mandatory, total

1179

1254

1308

Social Security

470

492

510

Medicare

246

266

290

Medicaid

165

183

188

Other

298

314

320

Net interest

153

156

178

Receipts

1782

1798

2036

Deficit

-375

-521

-364

As for the military actions in Afghanistan and Iraq, they have, of course, lifted defense outlays in the current fiscal year. Oddly the 2005 budget submission provides no budgetary authority for either operation past September 2004. Defense experts predict a supplementary appropriation of about $50 billion will be required. That adjustment alone would lift the projected deficit to over $400 billion, from the published figure of just $364 billion.

On the domestic side, the budget proposes some cutbacks in spending in a few program areas, notably environmental protection, the Commerce Department, agriculture, and road building. But these cuts serve more to emphasize the Bush administration’s sense of priorities than to achieve major spending reductions.

The most ambitious new program, a prescription drugs plan for senior citizens, will almost certainly cost several hundred billion more than is reflected in the administration’s five-year budget estimates. In sum, the Bush philosophy encompasses a big government, but financed by debt rather than taxes.

Fiscal policy intentions

The Bush administration strategy unabashedly embraces fiscal activism. This is most evident in the two tax reduction programs of 2001 and 2003. Even Bush budget analysts did not recognize just how massive the impact of tax changes would be when they were initially proposed. The best way to see that is to compare the projections for federal government revenues as a proportion of GDP in the new budget with those put forward in last year’s document. The Bush policy initiatives of last spring have reduced that ratio by an astonishing 1.3 percentage points.

Revenues as proportion of GDP

fiscal year

2004

2005

Bush 2004 budget projection

17.0

18.0%

Bush 2005 budget projection

15.7

16.9%

Campaign platform

President Bush will go to the voters with a clear message: that post 9-11 he took measures to enhance national security, while meeting priorities in education, health, and other areas, and reviving economic growth. The Democratic candidate will counter that he has spent too much money in the wrong way on defense, spent too little on education, the environment, and other social needs, not introduced comprehensive national health insurance, and cut taxes too much for the wealthy. The outcome of the election could be paper thin.

Most likely, the Bush budget will not be legislated before the November election. If the president is reelected, much of it will survive, although with substantial revisions. If he is defeated, it will be discarded. US financial markets recognize its irrelevance for the economy and for near-term movements in stock and bond prices. Accordingly they have registered little or no reaction.

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