Deficits Now Drive Federal Budget Debate

President Bush will unveil a $2.3 trillion, election-year budget Monday that for the first time in his presidency shows the financial and political strains of a ballooning federal deficit.

In a bow to deficit hawks of both parties, Bush will call for the elimination of 64 government programs and holding the growth of non-security related federal spending to 0.5%, according to congressional officials familiar with administration plans. In addition, the president will drop or trim several proposals he previously supported, and will seek to impose caps on government spending -- although not on future tax cuts. “This is going to be a challenging year for making sure we spend the people’s money wisely,” Bush told a gathering of Republican congressional leaders in Philadelphia on Saturday.

Administration officials have struggled in recent days to quiet restive Republicans in the wake of news that the president’s budget would show a deficit for the current fiscal year of $521 billion-rather than $307 billion as the administration originally predicted or $477 billion as the nonpartisan Congressional Budget Office recently forecast -- and that the new Medicare prescription drug law would cost one-third again as much as lawmakers were told when approving it only three months ago.

Budget director Joshua Bolton also faced sometimes contentious grilling Friday from Republican lawmakers angered by rising Medicare costs and word that Bush intends to boost spending on the National Endowment for the Arts -- a tiny agency, but one long loathed by GOP conservatives.

Bush himself came in for a pointed question Saturday when Senate Budget Committee Chairman Don Nickles (R-Okla.) asked how much political muscle the president was ready to put into controlling spending. The president said “the first test of whether we can keep spending down” would come on a six-year highway and mass transit bill.

The administration plans to seek $256 billion for the highway measure, according to congressional officials. That would put it on a collision course with Senate Republicans who have signaled they want to spend $311 billion and with the chairman of the House Transportation Committee, Rep. Don Young (R-Alaska) who wants a gasoline tax increase to help fund a $375-billion package.

The sharpened focus on deficits is new as a political and policy issue for the president, who came to office at a time of record budget surpluses and who has had to devote comparatively little time to the issue until now. Indeed, one can trace the broad outlines of the administration’s story in office through its handling of the deficit issue in each of its annual budgets.

In 2001, a newly inaugurated Bush argued that Washington was running such large surpluses it could afford to give voters $1 trillion-plus in tax cuts and have plenty left over. One year later -- with the nation reeling from 9/11 and the economy stumbling out of recession -- few worried about deficit spending and the president didn’t need to explain why he proposed it. By last year, however, the administration felt somewhat more constrained. In its taxing-and-spending plan for fiscal 2004, and officials said that “through unavoidable, unfortunate and unwelcome events, the budget has returned to deficits.” But they described the deficit they foresaw as “moderate.”

“We ought not [to] hyperventilate this issue,” then-budget director Mitchell E. Daniels Jr. said in a speech last year.

Even now -- with the CBO raising its deficit estimates for the next decade by nearly $1 trillion and GOP allies complaining -- the White House is trying not to act precipitously. Bush has stuck with his declared goal of cutting the deficit in half in five years. Bolton has told congressional leaders that the president’s new budget will show the deficit declining from 4.5% of the gross domestic product this year to 1.5% in 2009.

In taking such a measured approach, the president may be pursuing a prudent political course. A recent Gallup poll found only 4% of Americans surveyed said that the deficit was the most important issue facing the nation, while 16% said the most important issue was the economy and another 16% said it was “fear of war.” In addition, polls show few people believe Democrats would do any better than Republicans in reducing the deficit.

Still, some political analysts argue that under the right circumstances, a deficit can suddenly balloon as a powerful political issue. As evidence, they cite Ross Perot’s 1992 campaign and the issue’s emergence during the 2000 presidential contest when Sen. John McCain (R-Ariz.) bid for the GOP nomination and former Sen. Bill Bradley (D-N.J.) challenged Vice President Al Gore.

“There’s a vulnerability here, especially if the economy is perceived not to be doing well,” said Kathleen Hall Jamison, director of the Annenberg public policy center at the University of Pennsylvania. One reason the deficit has not played a bigger political role, beyond these few campaigns, is that the argument most often used against them is surprisingly weak.

Since the 1980s, deficit hawks have consistently warned that government overspending corrodes the economy’s performance by “crowding out” private borrowing, driving up interest rates and slowing growth.

But there is little statistical evidence of such a direct link. As skeptics point out, Washington has undergone one of the greatest fiscal whipsaws in American history during the last three years, with the 10-year budget outlook swinging from a $5.8-trillion surplus at the start of 2001 to a $2.9-trillion deficit now.

Despite such a swing, market interest rates have remained at near-record lows.

Hawks such as Clinton Treasury Secretary Robert E. Rubin have recently advanced a somewhat re-tooled argument -- that in addition to being corrosive, a deficit also makes America vulnerable to financial panics such as those that have swept developing countries in recent years.

The nub of the argument is that to finance its overspending Washington must borrow heavily from abroad and foreigners could dump U.S. debt if they began having doubts about the country’s economic or political performance. But this argument too has generated considerable skepticism, not least because among the biggest holders of U.S. debt are foreign central banks which analysts say are not prone to panic selling.

In the end, the most powerful case against a deficit -- and one that may revive them as a political issue in a way that could prove difficult for the president to parry -- is that in borrowing and spending now, Washington is passing the bill to future generations. “We are borrowing from our children,” said William Niskanen, a former Reagan administration official and chairman of the libertarian Cato Institute. What could give that argument real weight politically is that it is the same one the president uses to press for overhauling Social Security and Medicare, which many believe would be the domestic centerpieces of a second Bush term.

“The Social Security and Medicare shortfalls compel change,” the administration said in last year’s budget. “They must not be left hanging over the heads of our children and grandchildren.” These words could come back to haunt Bush as he seeks to win congressional approval for his election-year budget with its call to make the tax cuts of the last three years permanent.

The long-term cost of making the tax cuts permanent is estimated to be roughly that of fixing Social Security and Medicare. The result is that the president could land himself in uncomfortable spot of decrying one financial hole even as he endorses creating a similar-sized one.

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Times staff writers Janet Hook and Edwin Chen contributed to this report.