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What do record deficits mean for you?

The ballooning federal budget deficits could cause higher interest rates and hard choices for Congress in the years ahead.
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Deficits as far as the eye can see. That was the word this week from the White House, which projected the federal government will spend a record $455 billion more than it takes in this year, and $475 billion more next year. Those are big, scary sounding numbers — but what do they mean for you and me?

In the short term, probably not a lot. In fact many economists argue that deficit-spending now should help stimulate the ailing economy, leading to far stronger growth in the year ahead and ultimately bringing down the unemployment rate, which is currently at a nine-year high of 6.4 percent.

But in the long run the government’s massive fiscal imbalances are grossly understated by the typical five- and 10-year outlooks published by the White House and the Congressional Budget Office. Within a few years - if not sooner - rising deficits could lead to higher long-term interest rates and put increasing pressure on Congress to make hard decisions about raising taxes or cutting federal programs and benefits.

The White House Office of Management and Budget’s latest update forecasts accumulated deficits of $1.9 trillion between now and the end of fiscal 2008, when its forecast ends. That compares with deficits of $1.4 trillion forecast in February and cumulative surpluses of $5.6 trillion forecast shortly after President Bush took office in 2001.

Still, OMB director Josh Bolten said the deficits, at about 4.2 percent of the nation’s gross domestic product over the next two years, are “manageable” and nowhere near the 1983 record of 6 percent.

“4.2 percent of GDP … is higher than any of us would like to see,” said Bolten, who took over the White House office just last month. “But it it’s still lower than six of the last 20 years. And … the projection (shows) it heading straight down. So it’s not causing a problem to the economy now. Exactly what level might cause a problem, I don’t know and wouldn’t speculate.”

That approach drew howls of outrage this week from deficit hawks across the political spectrum.

Richard Kogan, a senior fellow with the generally liberal Center on Budget and Policy Priorities, noted that White House chose to compare its fiscal record with that the of the Reagan administration, the first time in U.S. history that peace and prosperity was accompanied by a rising national debt.

“On a fiscal prudence scorecard Reagan would get the lowest grade in history,” he said. “The Bush administration is setting an incredibly low standard for itself, to say that being the second-worst in history is something to be proud of.”

The Concord Coalition, a bipartisan coalition of political and business leaders concerned about the budget deficit, was hardly more measured in its assessment, complaining of “deception and denial” in the White House and on Capitol Hill.

To say that current deficit levels are manageable and reasonable is “an open invitation to higher deficits,” the group said in a report. “Policy-makers need to stop the hemorrhage of red ink, face up to the necessary trade-offs and negotiate a new balanced budget plan. Without restoring such a firm goal, fiscal policy will continue its downward spiral.”

Ken Goldstein, an economist with the Conference Board, a business research group in New York, argues that today’s budget deficits “cut deeper” than they did 20 years ago because they come at a time of huge state and local budget deficits, leaving the overall government position with regard to the economy in worse shape.

And he said the rising demands for spending on the military and homeland security, combined with the recent passage of a tax cut worth at least $350 billion over 10 years, leaves the government handcuffed in trying to improve the national infrastructure or deal with even more difficult problems like the impending retirement of the baby boom generation.

That eventuality was very much on the mind of Federal Reserve Chairman Alan Greenspan this week when he called for more fiscal responsibility from Congress, saying the budget deficit “matters a great deal.”

In fact many economists say the biggest budget problems are not even reflected in the latest budget projections. They warn of a potential fiscal train wreck in the making as the government piles up trillions of dollars in obligations to pay Social Security and Medicare expenses for generations of baby boomers now approaching retirement.

Economists Jagadeesh Gokhale and Kent Smetters of the conservative American Enterprise Institute estimate the current imbalance for the two massive entitlement programs at $43 trillion, dwarfing the reported $3.5 trillion national debt. Economists at the more centrist Brookings Institution estimate the gap at $59 trillion.

To put even the smaller figure into perspective, Smetters, an assistant professor at the Wharton School, said the government could eliminate all its so-called discretionary spending forever — everything other than Social Security, Medicare and interest on the national debt — and still not close the gap. Or to put it another way, the government would have to raise federal income taxes by 70 percent — permanently — to close the gap.

Obviously nobody at the American Enterprise Institute is advocating those kinds of massive tax increases or spending cuts. But Smetters and Gokhale argue that Congress does not appreciate the size of the fiscal problems because federal accounting essentially masks the true size of the growing imbalance. A paper published this week by the two economists contends that a more accurate accounting would show the federal imbalance growing by nearly $9.7 trillion between now and 2008 — more than five times the size of the projected budget deficits.

“We are talking about a huge, huge problem,” said Smetters.