Posted on 3-7-2003
The
Levitating US Economy
By Allan Sloan, NEWSWEEK, 7 July 2003
- Signs of growth suggest Bush's policies may be paying off. But is it
all an illusion?
Feeling a little better about the economy lately? It's easy
to see why. Stocks are up $2 trillion--23 percent--since March, according
to Wilshire Associates. The recent tax cut means larger paychecks.
Interest rates are still low, housing values keep jumping. Millions of
advance tax refunds will soon go in the mail, and the Federal Reserve
Board cut short-term interest rates again last week. So if you've got a
salary and a stock portfolio and a house, as many of us do, life is
good.
Then there's a new study by Stanford economist Michael Boskin with
comforting (albeit debatable) news: a hitherto-overlooked $15 trillion
tax windfall awaiting the government. It's the result, Boskin says, of
baby boomers' retirement accounts. That's enough to pay off the national
debt, fix Social Security and have a few bucks left over.
Hmmm. Maybe President George W. Bush was right after all, skeptics
like me notwithstanding. Maybe you really can cut federal taxes by
trillions of dollars, in times of budget surpluses, as well as deficits,
without adverse consequences. And add a prescription-drug plan for
Medicare without raising taxes or cutting services to pay for it. Maybe
combining big tax cuts with a war and lots of other defense spending can
produce a market miracle: the levitating economy.
But hold on. The problem with levitation is that unless the laws
of physics--or fiscal gravity--have been repealed, it's only an illusion.
Many Wall Street experts now expect long-term interest rates--more
important to the economy than short rates--to start rising. General
Motors last week sold a record $16.5 billion of fixed-rate bonds. It's a
bet of sorts that today's cheap interest rates won't last. Other big
players, like Ford, may soon float giant issues, too.
Should rates start to rise, it could spell the end of our big
house party. People flocking to buy new homes with cheap mortgages have
propped up the economy, as have homeowners who get spending money by
refinancing mortgages. If rates get high, bye-bye re-fi.
The federal-budget deficit is metastasizing, thanks to tax cuts,
spending increases and economic weakness. The nonpartisan Congressional
Budget Office predicted a 2003 deficit of $145 billion last August. The
current estimate is $400 billion. It will probably approach $500 billion
when an update is issued in late August. Deficits this --year and next
could total $1 trillion. And don't expect the stock market to produce tax
revenues to bail out the budget, as it did in the late 1990s. Stock
prices are already so high relative to profits and asset values that
year-after-year returns of 20 percent are inconceivable.
It's a lot easier to radiate optimism--the president's
specialty--than to deal with what's truly going on. Smoke, mirrors and
fuzzy math have obscured the true state of federal finances since
President Bush pushed through his initial cut in 2001. Take recent tax
legislation, which says this year's cuts total $350 billion over 10
years. Cuts phase out to reduce their budget impact. The legislation had
so many tax sunrises and sunsets--Washington's terms for cuts' beginnings
and ends--that it should be called the Fiddler on the Roof Act. One
example. The child tax credit stays at $1,000 for a few years, falls to
$700, rises to $1,000 in stages, then falls to $500.
Intentionally or not, these cuts are structured in ways that would
cost millions of middle-class families some or all of the relatively
meager tax breaks they've gotten, starting in 2006, when the Bushies'
patchwork fix of the dreaded alternative minimum tax expires. You can't
believe things will stay this way. Make some realistic assumptions--the
sun won't set on cuts, the alternative minimum tax won't be allowed to
ensnare 30 million taxpayers and so on--and you come up with long-term
fiscal numbers that are simply scary.
Goldman Sachs--not exactly a den of Democrats--estimates a deficit
of $4.5 trillion over 10 years. (It would be $7.1 trillion if we weren't
using the Social Security surplus to pay current expenses rather than
setting it aside for retirees.) The national debt owned by the public
would more than double. And higher borrowing costs would undermine the
beneficial effects of cutting taxes. The Center on Budget and Policy
Priorities, a liberal think tank whose numbers are widely respected,
predicts only a $4 trillion deficit. But even so, it calculates that
interest costs on the publicly held national debt will rise to $414
billion in 2013, up from $157 billion this year. That's $257 billion down
the drain every year forever. Deficits are expensive.
Rates are low now because the Fed has cut short rates, which it
controls, to juice the economy, and has jawboned the bond market into
lowering long-term rates. But when business borrowing picks up and the
Fed changes course, look out. Foreigners are financing about half our
deficits. It may be a cliche, but we're becoming as hooked on foreign
money as we've been on foreign oil. That can't be a good thing.
Some folks say people like me are green-eyeshade types who obsess
over numbers and have no vision. And that we don't appreciate the dynamic
benefits of tax-free savings accounts, such as the huge new programs Bush
is now pushing. These would provide tax-free returns on capital assets,
would benefit primarily high-net-worth taxpayers with ready cash to set
aside and reduce tax revenues by hundreds of billions of dollars.
This is where Michael Boskin--the economist we talked about
before--comes in. Boskin's new paper, previously mentioned in Barron's
and BusinessWeek, offers the insight that projected taxes on withdrawals
from boomers' savings accounts have been underestimated or ignored. He
says that future taxes generated by those accounts are worth $14.7
trillion in today's dollars. That's five times the $2.8 trillion the
accounts cost in forgone tax revenues and interest on the ensuing higher
national debt. You can practically hear the speeches invoking these
numbers.
But some of Boskin's math can be challenged. About $5 trillion of
the benefit comes from a complicated piece of accounting: Boskin
calculates retirement accounts' investment returns one way and translates
future tax dollars into today's dollars a different way. You can't spend
accounting gains. Then there's $6.7 trillion that Boskin says will come
from taxes on profits generated by the extra capital these accounts will
create. Seems a little thin to me, although Boskin insists I'm totally
wrong to disregard it. Make these two adjustments, and much of the
remaining windfall disappears. There are definitely $2.5 trillion to $3
trillion of potential taxes on accounts that currently exist and that the
government has already footed the bill for. That's not chopped liver, and
pointing it out is a valuable service. But that money--which the
government may never see, as Boskin himself says, if tax laws
change--doesn't come close to covering the looming deficits, let alone
fix Social Security.
Boskin said that he's trying to show that retirement accounts will
be a rich source of future tax revenues, and that he's not proclaiming
them a miracle cure. "I am certainly not saying there is not a
long-term problem," Boskin said. "There certainly is. All I'm
saying is that this piece of the puzzle has received insufficient
attention."
When I asked the White House how the country can indefinitely
raise $500 billion or so a year to cover the deficit, I couldn't get
specific answers. Instead, a senior official told me that the big problem
isn't today's deficits, but the enormous long-term problems of Social
Security and Medicare.
A good point. But instead of shoring up Social Security and
Medicare--or preparing beneficiaries for sacrifices--the administration
and Congress are just partying on. Cut taxes, add benefits, borrow
whatever it takes. Yeah, the market's rising and rates are low. But
that's for now. Levitation is a nifty trick. But it doesn't last very
long
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