The Next Fiscal Crisis: A Federal Budget Calamity

As the U.S. loads up on debt, even the most modest campaign promises will go unfulfilled.

By Richard Sammon, Senior Associate Editor, The Kiplinger Letter

September 24, 2008

An already tight federal budget vise in Washington will get a whole lot tighter as the federal government implements a sweeping rescue plan for the credit markets, assuming as much as a trillion dollars in bad mortgage-related debt in order to shore up the entire financial system.

The budget deficit is already out of control, with huge implications for government policy and, further down the road, for the nation's economy. No quick fixes are possible.

Even before the financial rescue plan was hatched, the deficit was headed for $600 billion in 2009, about 4% of gross domestic product (GDP) and a 50% spike over 2008. That's well above what the White House was projecting publicly earlier this summer and, obviously, nowhere near the balanced budget President Bush once promised. That means the government will be borrowing at least one of every five dollars it spends. In fact, the deficit would be well over $800 billion if Social Security surpluses were not included in the balance sheet, a practice that hides the hard truth.

Deficits will grow exponentially, now that Washington is on the hook for hundreds of billions in risky debt from faltering investment firms. First, there was the rescue of Bear Stearns, then Fannie Mae and Freddie Mac and then giant insurer AIG. Now comes the proposal working its way through Congress at an initial cost of $700 billion. That will probably mean a 2009 deficit nearly a trillion dollars, though some or even most of the money may eventually be paid back.

The huge deficits mean the national debt will also skyrocket -- over $10 trillion by Jan. 20 when a new president takes over, almost twice what it was when Bush was sworn in. The rising interest payments, about a tenth of the budget, mostly go overseas to pay the coupon on Treasuries held by foreign creditors, such as in China and Japan.

The gross national debt -- all that the government owes -- is getting very close to 70% of GDP and will soon reach levels not seen since the World War II. By comparison, Britain's national debt is 43% of GDP. France's, Canada's and Germany's each hover around 65%. Japan has the biggest debt -- a whopping 195% of GDP.

Also at risk: more funding needed to rebuild and expand the Army and Marines, beef up job training, shore up Medicaid, lend more to small businesses and boost science research.

And looming on the horizon: almost certain bankruptcies for Medicare and Social Security if cutbacks aren't made or new sources of revenue found.

The budget crisis will tie the hands of the next president. Instead of a first 100 days filled with new initiatives, it'll be like 1993, when Bill Clinton faced a big deficit and swapped a planned tax cut for a big tax increase. Neither Barack Obama nor John McCain dwells on the deficit now, but whoever wins in November will be forced to address it next year.

McCain's big tax cuts would be a hard sell. His plan to extend Bush's cuts and add more would cost $627 billion over 10 years, according the Tax Policy Center. Even if it spurred the economy and brought in more revenue, there would be a lag and the deficit would still rise. McCain's plans to rein in spending, freezing many domestic programs at current levels and ending earmarks, would save only $20 billion a year, barely denting the deficit.

Obama wouldn't fare much better. His tax hike on upper-incomers, along with cuts for most others, would add $595 billion in revenue over 10 years. But that wouldn't go far in fulfilling his promises to spend $15 billion more a year on alternative energy, $18 billion on education and $100 billion on health care, all the while maintaining a robust defense and national security budget, which is over $515 billion this year -- not counting the Iraq war.

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