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The current legal limit on the amount of debt that the federal government can accrue is about $7.4 trillion, and the Bush administration has now hit that limit faster than anyone thought possible. As a result, Treasury Secretary John W. Snow recently sent a letter to Congress announcing that the federal government has stopped putting money into the federal employees' pension fund in order to avoid breaching the debt limit. Less than a decade ago, some Republicans thought this kind of shell game was grounds for impeachment of then Secretary Robert Rubin. Before the Treasury runs out of accounting gimmicks, most likely sometime in mid-November, a lame duck Congress will have to act to raise the debt ceiling.

Since 1917, Congress has periodically established a total legal limit for federal debt in order to discourage lawmakers from running persistent deficits. While temporary deficits in times of recession are seen by many to be a logical and desirable result of an economic downturn, the current situation is an undesirable failure of policy.

When the economy slows, revenue will decline as unemployment increases and incomes decline, and thus payments for social programs rise and income tax collections drop off. In addition, the federal government can smooth out the economic downturn by maintaining or increasing spending levels. Both of these factors will result in a deficit. It seems logical therefore to think that a recovering economy will improve the budget situation.

However, an improvement in the budget situation will occur only if the right tax and budget policy is in place. In the 1990s, for example, a strong economy, coupled with sound fiscal policy, led to unprecedented surpluses.

Will an economic recovery today lead to the same outcome? Unless there are changes to the nation's economic policy, the answer is "not likely." Part of the answer comes from the fact that revenues for 2004 were just 16.2 percent of gross domestic product (GDP) – the lowest in half a century – and are expected under current policy to remain at relatively low levels. With current and projected outlays around 20 percent of GDP, it doesn't take an economist to figure out that something is fundamentally out of balance.

A more complex answer about the impact of the economy on the current fiscal situation comes from an analysis of the "cyclically adjusted deficit" by the Congressional Budget Office. The cyclically adjusted deficit is an estimate assuming that economic output and employment are growing at historically average rates. In essence, it is the deficit when a weak economy is assumed away. The report concludes that the economy's current impact on the deficit is just 11 percent – leaving the remaining 89 percent of the current deficit a result of tax and budget policies.

While an exceptionally strong and sustained economy would certainly help, this deficit will not "just go away" – a shift in policy will be required to return to fiscal solvency. In fact, the CBO's 10-year baseline deficits of $2.3 trillion already project solid growth of over 4 percent for next year and over 3 percent for the next five.

In fact, far from being primarily caused by the economy, this current budget situation is the direct result of failed tax and budget policy. The economic performance under current policy has been far less than ideal, and has not lived up to what was promised. Despite assurances that there was plenty of money for tax changes, the record surpluses of just a few years ago have been turned into massive, permanent deficits in record time; and a disproportionate share of the benefits have gone to high-income individuals. Despite predictions that the tax changes would spark the economy and job creation, median incomes have declined and job growth has been disappointing.

These disappointing outcomes are also coupled with increases in poverty and a surge in the number of uninsured. In short, the changes to the tax code over the last four years have not worked for the nation and have not worked for the majority of Americans.

On the budget side, massive deficits together with growth in military spending are squeezing other vital domestic investments. To date, Congress has failed to pass a budget and has passed just four of the 13 annual appropriations bills. "Continuing resolutions" to keep the government from shutting down have been the rule, not the exception – and massive impenetrable omnibus bills are being used to sweep unfinished business under the rug.

What is needed is a fundamental shift in the direction of tax and budget policy, including:

  • Tax reform – A new tax system needs to be put in place that 1) encourages job creation, technical innovation, and long-term growth, 2) reverses the trend of providing huge tax breaks for the wealthy with little left over for the middle class, and 3) raises additional revenue to finance vital domestic investments and international priorities.
  • Budget reform – Fixing the process by which annual spending levels are determined is a necessity. Some elements of a reform might include implementing the balanced, bipartisan PayGo rules that worked in the 1990s, setting sensible spending targets, and keeping the system as open and transparent as possible. Setting tax cut priorities before assessing spending needs is irresponsible – we need to assess needs and then think about what revenue is needed to keep the system sound and stable.

Failure to adopt tax and budget reforms will keep us on the same track of reckless fiscal irresponsibility, and the debt ceiling gimmicks will continue. The cost of the continuing failure to provide domestic investments, and the burden of unsustainable deficits, will inevitably fall on the shoulders of average Americans and our children. We can and must do better.

John S. Irons is the associate director for tax and budget policy at the Center for American Progress.

Links:

Snow letter to the majority leader of the Senate: http://www.treas.gov/press/releases/reports/frist.pdf

Washington Post article on the impeachment of Rubin:

http://thomas.loc.gov/cgi-bin/query/F?r104:1:./temp/~r104nPrkLc:e51756:

CBO budget update (revenue at 16.2 percent of GDP): http://www.cbo.gov/showdoc.cfm?index=5773&sequence=2

Center on Budget and Policy Priorities study on deficit estimates:

http://www.cbpp.org/9-7-04bud.htm

CBO report on cyclical deficits: http://www.cbo.gov/showdoc.cfm?index=5802&sequence=0

The Treasury has suspended sales of some securities due to reaching the debt limit: http://www.publicdebt.treas.gov/

Additional news reports on reaching the debt limit:

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