from Follow the Money

Muddle through until the end of 2008, and then it is someone else’s problem

May 6, 2006

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That, according to George Packer, is the Bush Administration’s current strategy for Iraq:

“As a strategy, this amounts to muddling through the rest of the Bush Presidency, without being forced to admit defeat, until January of 2009, when the war will become the new President’s problem.” 

The Bush Administration’s fiscal policy is sort of similar.  Muddle through with $300b deficits in good times until the end of 2008, hope bad times don't come and then, those deficits – and the growing costs of caring for the baby boom -- are someone else’s problem.    The same is true with the external deficit, except there, just keeping the external deficit from getting a lot worse will be a bit of challenge.

This year’s fiscal deficit looks to be a bit smaller than initially forecast.    With a progressive income tax, a skewed distribution of income (and taxing exercised stock options as income not capital gains) generates real revenues.   But with a strong economy, the deficit should be falling, not just stable. 

Every time I look at the CBO’s revenue numbers, I am reminded how lucky the Administration is that it didn’t take Paul O’Neil’s advice and eliminate the corporate income tax.  Double taxation and all.  The corporate income tax has been the star performer of the last two years – corporate tax revenues are up 30% so far this year, after rising by 50% in 2005.   Forecast a 30% increase through the end of the fiscal year, and corporate income taxes will basically have doubled between 2004 and 2006, going from $190b to $360b.  That’s real money.  And then there would be the optics of getting rid of taxes on oil companies just as their income surged …

The US external situation is similar to the fiscal situation – worse actually.  Even if Treasury Under Secretary Tim Adams pulls off a miracle and generates some of the orderly rebalancing the Stephen Roach now expects, the next President will inherit an enormous external deficit.    I have been updating some of my forecasts for the current account deficit.  Supporse the trade deficit peaks at $820b in 2006 (high oil) and then starts to fall as exports grow at 9% and imports at only 5% in 2007 and 2008.  I am still looking at a current account deficit that stays around $1100 billion (above 7% of GDP) for the rest of the Bush Presidency.   

That pesky income balance.   Rising rates on the United States existing debt and the normalization of rates on debt contracted earlier combine to push net interest payments from around zero in 2005 to maybe $200b in 2008.   That drives up the current account deficit even as the trade deficit begins to fall.  And between 2005 and 2008 the US net international investment position – the broadest measure of US external debt -- basically doubles, rising from say $3.2 trillion to well over $6 trillion – barring big capital gains on our overseas assets …

And with a net international investment position of $6 trillion plus generating an income deficit of less than $200b, I am including a bit of dark matter in my forecast as well. 

$6 trillion more in external debts than external assets, and the need to borrow $1 trillion a year as far as the eye can see.  That’s the legacy the Bush Administration would leave for its successor if – and I still think it is a big if – the policies needed to put the world on a path of orderly adjustment are put in place in 2006 and start to yield results in 2007.   If nothing happens and the trade deficit continues to expand, the US external position in 2009 would be substantially worse.  And if you don't believe in dark matter, the United States' real income balance is worse now, and it will be even worse then.

One last housekeeping note: the graphs on my previous post are down for reasons I don't fully understand.  Since the graphs are central to the post, I took the post down temporarily as well – I’ll bring it back up, along with the existing comments, once I get the help I need to fix the graphs.

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