The budget (credibility) gap

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Ever since the White House Office of Management and Budget (OMB) issued its Mid-Session Review last month, the administration has been doing cartwheels celebrating the fact that the budget deficit for fiscal 2006, which ends on Sept. 30, will be less than $300 billion. After the administration projected a 2006 deficit of $296 billion last month, the Congressional Budget Office (CBO) recently estimated that the 2006 deficit would be $260 billion. Compared to recent deficits of $377 billion (2003), $413 billion (2004) and $318 billion (2005), a deficit of $260 billion does represent some improvement. But it is improvement based on a pitiful standard.

As recently as 2000, the federal government ran a budget surplus of $236 billion. Also keep in mind that fiscal 2006 represents the fifth year of an economic expansion. So, moving from a surplus of $236 billion near the peak of one business cycle to a deficit of $260 billion in the fifth year of the expansion in the next cycle effectively represents a half-trillion-dollar deterioration in the fiscal balance -- hardly a reason for celebration.

Moreover, the Bush administration has been a bit too disingenuous as it rounds the corner in its unearned fiscal victory lap. For example, in his July 15 weekly radio address following OMB's revised forecast, President Bush hailed the "tremendous difference" between "• ur original projection for this year's budget deficit [of] $423 billion" and OMB's July forecast of $296 billion. In fact, the "original projection" of the 2006 fiscal balance was provided by the administration's fiscal 2002 budget, which incorporated a 10-year tax cut of $1.6 trillion (roughly equal to the sum of the 2001 and 2003 tax cuts). In the 2002 budget, the administration projected a budget surplus of $305 billion for fiscal 2006. It wasn't until February, when the 2006 fiscal year was more than a third over, that the $423 billion deficit was forecast. Thus, the real "tremendous difference" between "• ur original projection" of the 2006 deficit and the OMB's July projection is a deterioration of more than $600 billion, not the $127 billion improvement ($423 billion vs. $296 billion) that Mr. Bush was gloating about.

On Aug. 18, the administration's principal economic advisers held a press conference after meeting with the president at Camp David and after CBO's latest forecast estimated that the 2006 budget deficit would be 2 percent of gross domestic product (GDP). That level, the CBO reported, is "smaller than the average budgetary outcome recorded since 1965: a deficit of 2.3 percent of GDP." Alluding to that fact, Treasury Secretary Henry Paulson argued that the deficit is at "a very comfortable level as a percentage of GDP." However, as the liberal-oriented Center on Budget and Policy Priorities reported the day before, the "six-year swing" in the budget balance from a surplus of 2.4 percent of GDP in 2000 to a deficit of 2 percent of GDP in 2006 represented "the worst six-year deterioration in a half century." Interestingly, the preceding six-year period (1994-2000), when the fiscal balance improved from a deficit of 2.9 percent of GDP to a surplus of 2.4 percent of GDP, represented the second-largest six-year improvement in the nation's fiscal balance in half a century. (The largest, 5.5 percent, occurred from 1992 to 1998.) "Given the fact that we've got the need to finance a war" and pay for hurricane damage, Mr. Paulson said, a deficit of 2 percent of GDP was "quite noteworthy." Equally noteworthy is the fact that defense spending in 2006 will be 4 percent of GDP, a half-percentage point above the 3.5-percent average during the Clinton administration and 1-percentage point above defense's share of GDP in 2000. That minor difference, and hurricane disaster relief, accounts for a small portion of the six-year swing of 4.4 percent of GDP in the budget balance.

For all the fiscal grandstanding over the CBO's deficit projection of $260 billion, it must be noted that the on-budget deficit (which excludes the massive annual surplus currently being generated in the Social Security trust funds) will be $437 billion in 2006 (or 3.3 percent of GDP). The $177 billion difference roughly reflects Social Security's $75 billion cash-flow surplus (the amount by which Social Security tax revenue will exceed Social Security benefit payments in 2006) and $100 billion in trust-fund interest income (which the federal government must pay to service the debt it incurred by borrowing previous Social Security cash-flow surpluses).

At the same Camp David press conference, Council of Economic Advisers Chairman Edward Lazear said "[l]abor force participation was up last month primarily because jobs are available and because wages are growing." In fact, the seasonally adjusted labor force participation rate, 66.2 percent in July, was unchanged from June. (OK, before rounding, it moved from 66.174 to 66.197.) Moreover, the labor force participation rate (i.e., the percentage of the civilian noninstitutional population 16 years and over that is either working or looking for work) has actually declined by a full percentage point during the Bush administration, falling from 67.2 percent in January 2001 to 66.2 percent today. If the labor force participation rate were 67.2 percent today, then the unemployment rate would be 6.2 percent, not the reported 4.8 percent, which is based on the lower participation rate of 66.2 percent. Regarding the claim that "jobs are available," fewer than 300,000 private-sector jobs were created during the second quarter, according to the nonfarm payroll survey. Compared to the quarterly average of nearly 483,000 jobs during the previous six quarters, private-sector job creation was down nearly 40 percent in the April-June period. (Even the 483,000 quarterly average during the preceding year and a half -- supposedly labor-market nirvana -- was 27 percent below the 661,000 average quarterly increase in private-sector employment throughout the entire eight years of the previous administration.)

As for Mr. Lazear's claim that "wages are growing," it is true that the seasonally adjusted nominal wage "grew 0.4 percent in July," as a White House fact sheet asserted in early August. But it is not true that this growth was "faster than inflation," as the same fact sheet claimed. In fact, inflation-adjusted wages actually declined in July, as the Labor Department reported two days before the Camp David press conference. Mr. Lazear also said that "business investment is strong." However, recent revisions to the GDP accounts significantly downgraded the average annual growth rate of business investment from 7.8 percent to 5.8 percent during the 2003-05 period. In the second quarter, business investment in equipment and software actually declined, while overall business investment increased at only a 2.7 percent annual rate. He also said that "investment in non-commercial real estate is strong," but nonresidential investment, which had been growing quite rapidly in recent years, has now declined for three quarters in a row, including falling by an annualized rate of 6.3 percent during the second quarter.

Responding to a question about why "polls show that the public doesn't give the president more credit for managing a good economy," Mr. Lazear replied: "[I]f we look at the behavior rather than the responses to polls, the behavior is consistent with a strong economy." As proof, he said, "We see consumption being high. In fact, the [personal] saving rate is negative right now."

When did negative personal saving become a hallmark of a great economy? Before 2005, the last time the personal saving rate was negative was 1933, in the midst of the Great Depression. If personal saving were positive -- it averaged more than 9 percent during the 1970s and 1980s and more than 5 percent during the 1990s -- then America would not have to rely on foreign central banks and private foreign investors to finance its outlandish budget deficits in recent years.