- The Washington Times - Saturday, January 15, 2005

Here’s one story you won’t find on tomorrow’s front pages: “The U.S. budget deficit is shrinking rapidly.” The headline would be accurate, but the mainstream media are much more interested in talking down this booming economy than telling it like it is.

Last week’s Treasury report on U.S. finances for December shows a year-to-date fiscal 2005 deficit already $11 billion less than last year’s. In the first three months of the fiscal year that began last October, federal cash outlays rose 6.1 percent and tax collections grew 10 percent. When more money comes in than goes out, the deficit shrinks.

At this pace, the 2005 deficit is on track to drop to $355 billion from $413 billion in fiscal 2004. As a fraction of projected gross domestic product, the new-year deficit will fall to 2.9 percent, compared with last year’s 3.6 percent.

Wire reports are loaded these days with accounts of an expanded trade gap (driven mostly by slower exports to stagnant European and Japanese economies, along with higher oil imports due to the energy price peak). But not a report I can find mentions the sizable narrowing in U.S. fiscal accounts.

Behind this really big budget story is the even-bigger story: The explosion in tax revenues has been prompted by the tax-cut-led economic growth of the last 18 months.

With 50 percent cash-bonus expensing for buying plant and equipment, productivity-driven corporate profits ranging around 20 percent have generated a 45 percent rise in business taxes. At lower income-tax rates, employment gains of roughly 2 million are throwing off more than 6 percent in payroll-tax receipts. Personal tax revenues are rising by nearly 9 percent.

Meanwhile, in the wake of strong stock market advances over the last two years, non-withheld revenues from individuals — including investor dividends and capital gains now taxed at only 15 percent — have jumped more than 14 percent.

Following the Clinton cap-gains tax cut and savings expansion bill of 1997, investment-related tax collections led to bull-market budget surpluses in the pre-September 11 period of 1997-2001. However, despite the flood of new revenues, this year’s federal budget is still overspending. Domestic spending on nonentitlement programs (excluding homeland defense) is rising by 4.1 percent. That’s more than twice the pace of core inflation. But this may be changing.

According to The Washington Post’s reporter Jonathan Weisman, the Bush budget totals planned for fiscal 2006 may be essentially unchanged from the totals for fiscal 2005 (excluding defense and homeland security). Mr. Weisman wrote the administration’s first really tough budget request (due out next month) “would freeze most spending on agriculture, veterans and science, slash or eliminate dozens of federal programs, and force more costs, from Medicaid to housing, onto state and local governments.”

The rapid growth of federal health care and other entitlements would also slow markedly. Though the numbers are still unavailable, this sounds a bit like Ronald Reagan’s tax-cutting budget of 1981. In addition to reducing the top personal tax rate to 50 percent from 70 percent, the Gipper proposed budget cuts worth nearly $100 billion in today’s dollars.

Of course, the political screaming over the forthcoming budget has already begun. A passel of Democrats and at least one Republican, Wyoming Sen. Craig Thomas, have sent a protest letter to Josh Bolten, director of the Office of Management and Budget. Former Gov. John Engler of Michigan, a Republican and current president of the National Association of Manufacturers, has pledged to fight the elimination of various protectionist subsidies to his member firms.

However, Judd Gregg, New Hampshire Republican and chairman of the Senate Budget Committee and a long-time Bush ally, is set to support the administration’s new budget discipline. This includes, by the way, Mr. Bush’s plan to reduce Social Security benefits by replacing wage indexing with a price-level formula and extending the retirement age — one or the other, or both — in return for personal saving accounts.

By the way, Treasury Secretary John Snow just completed a Wall Street tour where leading bond traders told him not to sweat the transitional costs for personal accounts. The traders said an additional $100 billion a year over the next decade for transitional financing will be easily manageable. “A rounding error,” one senior trader told Mr. Snow.

A supply-side tax-reform movement, a shrinking budget deficit, new-found spending discipline, and a determination to confound conventional wisdom by reforming Social Security has George W. Bush’s second term off to a roaring start — even before he is officially sworn in.

Lawrence Kudlow is co-host of CNBC’s nightly “Kudlow & Cramer” and is a nationally syndicated columnist.

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