Several reasons to care about federal deficit

Tax increases, smaller Social Security checks may be the effects

No solution this election year

On The Money

Your Money

March 14, 2004|By Lorene Yue

To hear it from federal budget watchers, your golden years are on the verge of tarnishing.

Reacting to the combination of the largest U.S. population group nearing retirement and a hefty deficit, Federal Reserve Chairman Alan Greenspan on Feb. 25 recommended cuts to Social Security and Medicare benefits for future retirees. It wasn't a popular suggestion, but it spotlighted the problems of government overspending.

The White House has said the deficit in fiscal 2004, which ends Sept. 30, will total $521 billion. The nonpartisan Congressional Budget Office estimates the deficit this year will be $478 billion and then fall to $258 billion in five years. Neither the Bush administration figure nor the CBO's projections take into account emergency spending for Iraq over the next few years or a proposal to reform the alternative minimum tax.

The budget office said federal deficits over the next decade will total $2.75 trillion if Congress goes along with President Bush's proposed 2005 budget.

That represents a reversal from the large surpluses that had been anticipated when the president took office in 2001. (The White House projects a deficit of $364 billion in fiscal 2005.)

"We have a large deficit, and it's OK today, it's OK tomorrow, but not 10 years from now," said Dean Baker, co-director for the Center for Economic and Policy Research, a nonpartisan think tank in Washington.

Expect more talk, but little action, on deficit solutions this election year.

There are several reasons why you should care about the deficit:

Social Security

The eldest of the generation born after World War II will turn 62 in 2008, the earliest age to collect Social Security benefits. After that, wave upon wave of baby boomers will come crashing through the retirement door.

"Most people in Washington know baby boomers are going to retire and put a major strain on the government when they collect their Social Security, Medicare and pay less in taxes," said Robert L. Bixby, executive director of the Concord Coalition, a nonpartisan group in Washington that advocates fiscal responsibility. "That makes it a much less opportune time to run a large deficit."

Percentage of GDP

Rather than using raw numbers, economists prefer to measure the deficit as a percentage of the gross domestic product. Using that formula, the Congressional Budget Office expects the 2004 deficit to be 4.2 percent of GDP, far from a record. The ratio rose to 6 percent of GDP in 1983.

The government can handle a 4 percent deficit for a couple of years, but not many more beyond that. Bush said his goal is to cut the deficit in half in the next five years, and if the economy picks up, that means you'll be paying down the tab through income and capital gains taxes. The idea is that you would be making more money than you are now, so you might not complain too loudly.

Money from abroad

To finance everything from postal services to highway maintenance to military defense, the U.S. government has been borrowing more than $500 billion a year, and more foreign countries are dishing out the cash.

"For the last two to three years, it's been foreign central banks, mostly Asian," that have been buyers of U.S. debt, said Baker.

Foreign countries now hold 37 percent of the federal debt, the highest percentage ever. And that troubles some fiscal watchers. "If they decide to invest elsewhere, we have a huge hole to fill," Bixby said.

Inflation

"The reason the deficit has really increased at a dramatic amount is the fiscal stimulus has increased dramatically," said Anton Pil, who heads up fixed income for J.P. Morgan Private Bank in New York. "When you have very easy money and a high deficit, over a long period of time there tends to be inflation."

Roughly every 1 percent of GDP deficit bumps the 10-year interest rate up 0.25 percent, said Pil, pointing to a Federal Reserve study.

Taxes

Brace yourself for possible tax increases unless the economy kicks into overdrive or the government pares back spending.

"You can't just increase spending and pay for it out of thin air," Baker said. "Presumably, we will see higher taxes and we could see smaller Social Security checks."

Lorene Yue is a Your Money staff writer.

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