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And The Budget Says . . .
. . . the supply-siders were right all along.


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Larry Kudlow

Is there more sanity in the federal budget than people think?

The latest budget numbers closing out fiscal year 2004 show slower spending growth, stronger tax receipts, and a $413 billion deficit that came in about $100 billion less than the Office of Management and Budget predicted at the start of the year and $64 billion lower than the Congressional Budget Office estimate.

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Overall, according the Treasury Department, tax receipts increased 5.5 percent in fiscal year 2004 compared to a 3.8 percent decline in fiscal year 2003. Income-tax withholdings gained 2.5 percent versus a loss of 2.2 percent in the prior year. Corporate tax collections exploded 43.7 percent on the shoulders of near-record corporate profits.

What’s going on? It’s clear: At lower marginal tax rates, the rising economy is throwing off a lot more tax revenues. Score one for the supply-siders.

Overall budget outlays increased 6.2 percent in the recent fiscal year, which is less than last year’s 7.3 percent. Excluding spending for defense and homeland security, as well as entitlements for healthcare and Social Security, domestic discretionary federal spending increased by a very moderate 3.4 percent in fiscal year 2004. If you remove net interest, then the budget increase was only 3 percent — just a bit higher than the inflation rate.

As a share of gross domestic product, the deficit came in at 3.5 percent. That’s the same fraction of national income as last year. This deficit share of GDP is also lower than Europe’s and only about one-third of Japan’s. This is more than acceptable. In the early 1980s the deficit share of the economy was over 6 percent, but that didn’t stop the Reagan boom, which followed large-scale tax cuts and deregulation measures.

Believe it or not, there are still people out there who cling to the view that deficits drive up interest rates. How can they justify that when the current interest rate structure is at a 45-year low with the Treasury-bond yield around 4 percent? In fact, the 10-year note was yielding around 6 percent in 2000 when the budget was throwing off unwise and unusually high surpluses that drained the economy of private sector resources.

The point is, deficits don’t drive up interest rates, and at current levels they are not damaging the economy as many pundits and politicians might lead you to believe. That said, there is certainly a strong case to be made for greater budget discipline in Washington.

It’s clear from the debates and the campaign trail that neither President Bush nor Senator Kerry has a comprehensive plan to limit budget spending. Kerry has committed to roughly $2.5 trillion in new spending, which he will be disappointed to learn will not be covered by his $600 billion to $800 billion worth of tax-hike proposals. More, slower economic growth under a higher-tax economic policy will throw off fewer tax revenues. In short, the Kerry plan looks like a super budget-buster.

Bush has a number of spending proposals himself, especially for healthcare and education. Then there is the as-yet-unknowable spending necessary to finance national security in the global war against radical Islamist terrorism.

But the interesting fact to come out of the new budget numbers is that neither spending nor deficits are as bad as the critics have warned. Most in the fraternity of so-called Washington budget experts never acknowledge this, but a low-tax, high-growth economy, coupled with budget spending limits, is what will move us back to balance in the years ahead.

Spending aside, this has been the Bush plan all along. Over time, you have to believe that a Republican president acting with GOP majorities in the House and Senate will move toward at least some measurable budget restraint.

There’s no question that clear budget policy rules to limit federal spending would be wise pro-growth policy. Nor is there any question that entire departments, agencies, commissions, and unworkable and overlapping programs should be abolished in a thorough-going federal government restructuring. Corporations have done this time and again over the past two decades. Why can’t Uncle Sam?

— Larry Kudlow, NRO’s Economics Editor, is CEO of Kudlow & Co. and host with Jim Cramer of CNBC’s Kudlow & Cramer.



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