As one former Treasury secretary made waves Tuesday with his critical account of life in the Bush administration, another warned of a potentially disastrous financial crisis brought on by rising federal budget deficits.
Robert Rubin, Treasury secretary under President Clinton, warned of a “very substantial” risk that continued high budget deficits could bring on a cascading series of economic and political problems including rising interest rates, a falling stock market and a sharp decline in the value of the dollar.
Rubin, currently a top executive and director at Citigroup, said the fundamental problem is that financial markets and investors, particularly foreign investors, will lose confidence in the ability of the U.S. political system to control the deficit and will demand higher interest rates to compensate for the rising risk of inflation.
“While there is no way to quantify this risk, I think they are levels of increase that could be very substantial and could have a severe impact on the economy,” Rubin said in a conference call with reporters sponsored by the Center on Budget and Policy Priorities.
The CBPP is a liberal group, but Rubin’s call for fiscal restraint has been embraced by more conservative groups as well, including the business-based Committee for Economic Development and the bipartisan Concord Coalition.
Ironically Rubin’s concerns also were shared by the former Treasury secretary of the moment, Paul O’Neill, who has dominated headlines in recent days with his assertions that President Bush was disengaged on economic policy and began planning for an invasion of Iraq shortly after assuming office.
While the Bush administration has launched an investigation into O’Neill’s possible misuse of classified documents on Iraq, it may have been O’Neill’s concern about rising budget deficits that ultimately got him fired in late 2002, according to “The Price of Loyalty,” an account of his tenure in Bush’s Cabinet published Tuesday.
In a November 2002 meeting, O’Neill warned Vice President Dick Cheney of a potential “fiscal crisis” brought on by soaring budget deficits, according to an excerpt of the book published in The Wall Street Journal.
“Reagan proved deficits don’t matter,” Cheney retorted, making clear that the administration, flush with victory in the midterm elections, intended to forge ahead with plans for another major tax-cut package.
O’Neill, who opposed the $350 billion tax-cut package, was left “speechless,” according to the book, and soon was jobless as well.
In a talk-show appearance over the weekend, O’Neill’s successor, Treasury Secretary John Snow, reaffirmed the administration’s commitment to cut the deficit in half over the next five years.
“This is an administration committed to fiscal responsibility,” Snow told ABC’s “This Week.” “This budget that comes forward will be one that advances the priorities of the country but within a fiscally responsible framework.”
Tax cuts and an economic downturn helped fuel a record $374 billion budget gap last year, or about 3.5 percent of U.S. gross domestic product, the highest proportion since 1993. The White House expects that to hit about 4.2 percent this year before dropping to less than 2 percent of GDP in fiscal 2006, according to the White House Office of Management and Budget. The non-partisan Congressional Budget Office, in an analysis published in August, comes to a similar conclusion.
But Rubin and others contend that such budget projections are based on wildly unrealistic assumptions. For example, White House and CBO projections presume that Congress will allow certain tax cuts to “sunset” as scheduled, although the Bush administration already has asked for extensions on some, and other extensions are considered likely as well.
Similarly the CBO projection assumes Congress will not remedy a widely recognized problem with the alternative minimum tax, which is on track to ensnare tens of millions of middle-class taxpayers by the end of the decade. Nor do the latest CBO estimates account for the cost of the Medicare prescription drug benefit passed by Congress late last year.
Adjusted projections from a variety of sources including Goldman Sachs, Decision Economics and the Brookings Institution all estimate deficits closer to 3 percent of GDP over the next decade for a total of $5 trillion or more, compared with the $1.4 trillion in cumulative debt projected by the CBO. Even the International Monetary Fund, an organization generally associated with debt in underdeveloped countries, warned last week that the rising U.S. budget deficit and the associated growth in the nation's current account deficit threaten the stability of the global financial system.
In a paper presented at an economic conference last week, Rubin and two co-authors similarly warned of fiscal and financial disarray that could result from a projected $5 trillion in budget deficits over the next decade.
“Substantial ongoing deficits may severely and adversely affect expectations and confidence, which in turn can generate a self-reinforcing negative cycle among the underlying fiscal deficit, financial markets and the real economy,” Rubin wrote in the paper, co-authored by Peter Orszag of the Brookings Institution and Allen Sinai of Decision Economics.
In the conference call with reporters, Rubin acknowledged that long-term budget projections are notoriously unreliable, but he said that is no reason to throw fiscal caution to the winds. It is far more difficult, he noted, to find the political will to cut spending and raise taxes than it is to cut taxes and increase spending.
“We live in a very complicated world, geopolitically and in other respects,” he said. “I think the risks are greater on the upside then the downside. It seems to me no matter what may ultimately happen, the prudent thing to do is to have a sound fiscal policy in the context of the best estimates that you can make.”
Rubin made no secret of his political preferences, saying the leading Democratic presidential candidates all are properly focused on the long-term fiscal problem, although he said he is not involved in any campaign. He said the candidates are rightly steering clear of specific deficit-reduction programs for fear of adverse reactions, since any realistic program would require both federal spending reductions and tax increases in his view.
The right way to restore fiscal discipline, he said, is for a president to work with leaders of both parties in Congress. That is the approach Rubin recommended in the early 1990s to President Clinton, who inherited a budget deficit that was about 4 percent of GDP and left office with the first surplus since the 1960s.