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July saw the biggest budget deficit for that month since 1994. In the 12 months through July, tax receipts were $1.817 trillion, down 12% from the previous 12 months, while spending was $2.009 trillion, up 9%. The combination of reduced receipts and increased spending produced a fiscal deficit in the 12 months through July of $192 billion. That same month, the Office of Management and Budget estimated a fiscal deficit for 2002 (the fiscal year ending September 30) of $165 billion, roughly 1.6% of GDP. Now comes the budget debate, which should last through the November elections. So far, most of the attention has focused on the deficit itself. Since the deficit is not large by historical standards, or relative to GDP, it won't have much negative effect on the economy by itself. But the key issue is how government spending and tax decisions affect private-sector investment and future growth. So several negatives can be drawn from the increasing budget deficit. At present, the government is growing much faster than the private sector, diluting the productivity growth and private-sector investment that powered the economy in the 1990s. More, given the politics of the budget deficit, it's hard to see progress on restructuring the tax code or on Social Security reform — both of which are pressing economic issues. The accounting techniques used in evaluating legislation cause a short-term twisting of budget decisions (e.g. tax cuts that expire abruptly, new programs where only the initial spending is counted). This makes for bad trade-offs within the budget and for economic inefficiency in trying to guess what will happen in future years. The existence of a fiscal deficit probably makes these problems worse. In our current budget process, tax and spending decisions are assumed to have little effect on the economy. With the growth in the budget deficit, the bias in the system is increasingly toward spending (assumed not to cost much in terms of economic growth as tracked through GDP) and away from tax-rate cuts (which are assumed not to bring much economic benefit). This bias causes a drag on the longer-term U.S.-growth-rate potential,
a trend that is exacerbated by the fiscal deficit. — Mr. Malpass is the Chief International Economist for Bear Stearns.
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fiscal year 2002 (ending September 30), the U.S. will probably run a budget
deficit of at least $155 billion. The deficit in the following fiscal
year may be as large or larger. In February 2001 — before the recession
was recognized — the estimates were for a $283 billion surplus in
fiscal year 2002 and a $334 billion surplus in 2003. How things have changed.
