The 'ticking budget' facing the US

The budget proposals laid out by the administration of US President George W Bush are highly controversial. The Washington-based Economic Policy Institute, which tends to be critical of the President, looks at possible fault lines. US politicians and citizens of all political persuasions are in for a dose of shock therapy. Without major changes in current policies and political prejudices, the federal budget simply cannot hold together. News coverage of the Bush budget will be dominated by debates about spending cuts, but the fact is these will be large cuts in small programs. From the standpoint of the big fiscal trends, the cuts are gratuitous and the big budget train wreck is yet to come. Under direct threat will be the federal government's ability to make good on its debts to the Social Security Trust Fund. As soon as 2018, the fund will begin to require some cash returns on its bond holdings in order to finance all promised benefits.

The trigger for the coming shock will be rising federal debt, which will grow in 10 years, by conservative estimates, to more than half the nation's total annual output.

This upward trend will force increased borrowing by the federal government, putting upward pressure on interest rates faced by consumers and business. Even now, a growing share of US borrowing is from abroad. The US Government cannot finance its operations without heavy borrowing from the central banks of Japan and China, among other nations. This does not bode well for US influence in the world. The decline of the dollar is a warning sign that current economic trends cannot continue. The dollar is already sinking. Before too long, credit markets are likely to react, and interest rates will creep upwards. That will be the shock.

Interest-sensitive industries will feel pain immediately - sectors such as housing, automobiles, other consumer durables, agriculture, and small business. Some will recall the news footage of angry farmers driving their heavy equipment around the US Capitol in the late 1970s. There will be no need for constitutional amendments to balance the budget. The public outcry will force Congress to act. Whether it will act wisely is another matter. How did this happen?

By definition, the deficit means too little revenue and too much spending - but this neutral description doesn't adequately capture the current situation. Federal revenues are at 1950s levels, while spending remains where it has been in recent decades - much higher. In addition, the United States has two significant military missions. The Bush administration's chosen remedy is the least feasible one. Reducing domestic spending, or eliminating "waste, fraud and abuse" is toothless because this slice of the budget is too small to solve the problem. Indeed, if Congress were rash enough to balance the budget in this way, there would hardly be any such spending left. Law enforcement, space exploration, environmental clean-up, economic development, the Small Business Administration, housing, veterans' benefits, aid to state and local governments would all but disappear. It's fantasy to think these routine government functions could be slashed. The biggest spending growth areas are defence (including homeland security), and health care for the elderly and the poor. To some extent, increases in these areas are inevitable. The US population is aging, and the nation does face genuine threats in the world. But serious savings can only be found where the big money is. Savings in health care spending that do not come at the expense of health can only be achieved with wholesale reform of the entire system, public and private. Brute force budget cuts or spending caps would ill-serve the nation's elderly and indigent.

On the revenue side, the lion's share of revenue lost to tax cuts enacted since 2000 will have to be replaced.

Some rearranging could hold many people harmless and focus most of the pain on those with relatively high incomes. Finally, blind allegiance to a balanced budget will have to be abandoned. There is no good reason to fixate on it, anyway. Moderate deficits and slowly rising federal debt can be sustained indefinitely. Borrowing for investments in education and infrastructure that pay off in future years makes sense. The sooner we face that reality, the sooner workable reforms can be pursued. First on the list should be tax reform to raise revenue, simplify the tax code, and restore some fairness eroded by the Bush tax cuts. Second should be a dispassionate re-evaluation of the huge increase in defence spending over the past three years, much of it unrelated to Afghanistan, Iraq, or terrorism. Third must be the start of a serious debate on large-scale health care reform. One thing is certain - destroying the budget in order to save it is not going to equip the US economy and government for the challenges of this new century.