October 2002
By ROBERT PEGG
After running budgetary surpluses for four years, the federal government is again running a deficit. Economists estimate the federal deficit to be about $150 billion this year, requiring the government to once again borrow to pay for its operations. As a result, Congress recently passed legislation designed to increase the national debt limit to pay for obligations such as Social Security. The national debt is fairly evenly split between debt held by the public (more than $3 trillion in outstanding Treasury bonds and other securities) and the government's obligations to pay for future Social Security benefits. While some of the public debt had been paid down in recent years through the surplus of the late 1990s, the part of the debt accounted for by Social Security will continue to rise as "Boomers" retire in increasing numbers.
The reason the federal government once again is running deficits is the growing imbalance between revenue collections and spending. For the last several years, strong income gains and the booming stock market have meant huge checks for the Internal Revenue Service every April. This year, however, individual income tax revenues were down, as the recession, a weak stock market, and last year's tax cut took hold.
Several factors contributed to the decline in individual tax receipts. In previous years, high equity prices boosted capital gains and realizations of stock options. However, with equity markets weak, capital gains and option realizations have been substantially lower, reducing incomes and taxes paid. In addition, because of the recession, income growth has weakened, placing fewer earners than expected into higher income tax brackets. Lost jobs and layoffs also reduced tax payments. Some of the decline also results from the lower tax rates that were included in last year's tax cut, as well as payments to taxpayers who did not get their rebate checks in 2001.
In addition to lower revenue collections, a number of factors have been driving up government spending growth. In fiscal year 2002 (which began last October), federal spending is running more than 10 percent ahead of last year's pace, which is well ahead of both inflation and economic growth. Higher spending resulting from the "War on Terrorism"Ñpushing defense spending up 16 percent this yearÑis primarily responsible for the growth. Spending also has increased in the Transportation Department, up by more than 20 percent this year, largely due to the cost of additional security at the airports and subsidies for the airline industry.
Spending is up even further because of the economic recession, resulting in higher payments for income transfer programs such as unemployment insurance. These programs, however, serve two important purposes during a recession. First, they help families and individuals weather job and income losses. Second, they help to stabilize the economy by expanding fiscal outlays during a time of private-sector contraction.
Yet, another important contributor to increased federal spending has been the higher cost of health care. Spending on Medicare is up more than 10 percent so far for this fiscal year, primarily because of greater use of medical services and higher reimbursements for health care providers. Spending on Medicaid, the health-insurance program for the poor, is up almost 15 percent in fiscal year 2002. Many economists believe that the recession has boosted Medicaid enrollment, driving up costs.
One factor that has helped restrain federal spending has been lower interest payments on federal debt. Payments have been down 18 percent in this fiscal year. With the federal government running budget surpluses between 1998 and 2001, debt payments had decreased and lower interest rates further reduced the government's costs of servicing the debt.
The fiscal problem going forward is not the deficit in fiscal year 2002; instead it is the developing longer-term imbalance between taxes and spending, between revenue collections and expenditures. The war on terrorism has just begun; the impending retirement of the Baby-Boomer generation is approaching; last year's income tax cut will cost increasingly more in future years. Moreover, medical costs will continue to rise rapidly and with it, federal health care spending despite government cost-containment efforts. Pressure also will mount for other types of government spending. Already in 2002, we have seen a new and large farm subsidy bill, as well as calls for expensive prescription drug benefit programs. As a result, with tax revenues falling and spending on the rise, federal budget deficits are back.
About the author: Mr. Pegg is president of Kirkbride Asset Management, the New York City-based investment advisory firm which serves businesses, institutions and private individuals.