Behind All This Budget Posturing, Shadows Grow

Citizen anger is appropriate. Because the U.S. government is threatened with closure on Tuesday--although the Treasury almost certainly won’t default on its bonds--the game of chicken the White House and Congress are playing over the federal budget could still end up costing taxpayers $40 billion.

That’s $160 more in taxes for every American, the penalty the United States may have to pay in added interest if its credit rating is damaged by temporary default on U.S. Treasury securities or even by investor dismay at shenanigans the Treasury will have to resort to this week to make timely payments on U.S. debt.

Talk of “chicken” is misplaced. What’s going on is not a game but a serious power struggle between a Republican Congress and a Democratic President for authority over the federal budget. Fundamental questions of political priorities and philosophy lie behind the tactical maneuvering.

But the weapons both sides are using are potentially explosive. Congress has added conditions anathema to President Clinton to bills that lift the ceiling on the national debt, allowing government to pay workers, keep Post Offices open and pay interest on Treasury securities. The President has vowed to veto those bills and damn the consequences.

But those interest payments are critical. In the past week, some in Washington and the financial markets of Wall Street have scoffed at danger and said a temporary default would be a harmless way to make a point about government spending.

That is not true. Even though brief government shutdowns have occurred during similar confrontations in the past, that is not possible today. First, there is a lot of U.S. debt out there--almost $4 trillion worth, with 20% held by foreign holders.

Then there’s the matter of derivatives. Investment houses have split principal from interest on Treasury securities, allowing separate contracts to be written for the income stream. Breakdowns of such contracts would cause a cascade of default worldwide.

Most important, U.S. debt is the risk-free benchmark for other debt and interest rates here and abroad. Once you introduce the risk of default, however temporary, assumptions change. All U.S. debt would then bear slightly higher interest rates. Estimates last week were that one quarter of 1% would be added, or about $40 billion extra on the national debt.

Okay, the Treasury won’t let that happen. It will dip into trust funds such as the federal employees retirement fund and the Social Security Trust Fund which has a vast surplus, approaching $400 billion today, because there are many more taxpaying workers than retirees--a situation that will reverse in the next century.

Yet even to tap trust funds, Treasury would have to engage in financial trickery, calling its borrowing by another name, for instance. There would be challenges in the Supreme Court and growing suspicions around the world about U.S. credit-worthiness.

And that brings us to the crux of the matter, the budget deficit and the national debt itself. The debt now totals some $3.6 trillion if normal intra-government borrowing is excluded.

The debt is growing because each year the federal government spends more than it collects in income and other taxes--aside from Social Security contributions.

You hear claims that the deficit is coming down and will be under $200 billion this year, compared to $300 billion five years ago. But that’s not really true. Some $65 billion will be borrowed from the Social Security trust fund to bring this year’s deficit down; without that, the deficit would be $262 billion.

Nothing really wrong with paying bills with money that won’t be needed for Baby Boomer retirees until after 2010.

But it does mean that the federal government is using Social Security taxes to finance other purposes.

Those taxes are high--many young people have more deducted for Social Security than for income taxes. So the government is making it hard for young people to save while spending their retirement contributions for current purposes.

It sounds unwise and it is, which is why there’s growing sentiment that federal spending be reduced and the budget deficit eliminated.

But most people are unclear on how hard it will be to eliminate the deficit. Only 34.5% of the federal budget these days is discretionary expenditure--subject to annual votes by Congress. That includes the $262 billion defense budget and support for education, policing, economic development, industry, agriculture and other purposes amounting to $266 billion.

The other 65.5% of the budget is mandatory--expenditures for Medicare, $271 billion; Social Security, $351 billion, and interest on the national debt, $257 billion in fiscal 1996, ending next Sept. 30.

In the current battle, Congressional Republicans are trying to get authority over the mandatory areas, in order to make cuts in Medicare. They have a point that such programs need reform.

But the White House is resisting them and winning popular approval, according to Gallup Polls which say that most people don’t want the Republican budget cuts. And the Republicans themselves are suspect, offering massive tax cuts while pledging to eliminate deficits.

So debt and deficits may go on draining the economy like a silent illness. The effect of massive interest is subtle. “Interest payments divert money that could be used for more productive national investments,” notes Professor Michael Duffy, an authority on tax policy at USC.

The economic pie grows more slowly, there is less to go around and people quarrel with each other for “their share.”

“Debt and deficits are really a way of selling the assets of the country, the legacy of the grandparents who built such vast wealth here,” says economist Barry Bosworth of Washington’s Brookings Institution.

Sure, there’s enormous wealth still to draw on, Bosworth says. But as less is added with each new generation, problems arise.

That’s why many Americans are uneasy. But they’re also confused. And their elected leaders are squabbling when they should be getting together and making tough decisions for the country’s future.

So citizen anger is justified. But citizen resolve will be required if the deficit is truly to be eliminated and ominous trends turned around.