The Levitating Economy
By Allan Sloan
Monday 07 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 The problem with levitation is that unless the laws of physics--or fiscal gravity--have been repealed, it's only an illusion.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.