Deficit Is Arriving Under Forecasts

Good News for White House
Comes on Economy's Climb,
High Level of Tax Receipts
By JACKIE CALMES
Staff Reporter of THE WALL STREET JOURNAL
June 9, 2005 10:27 a.m.; Page A3

The White House, which hasn't had much good news since President Bush's second term began, is about to start spreading some: This year's deficit is coming in lower than anticipated, thanks to the economic recovery and higher-than-expected tax receipts.

While the administration and Congress won't officially revise their separate annual deficit projections until midsummer for fiscal 2005, which ends Sept. 30, government and private-sector analysts agree the shortfall is more likely to be about $350 billion, rather than the $427 billion the administration forecast in January. Treasury Secretary John Snow is expected to carry the tidings to London for this weekend's summit of finance ministers from the Group of Eight leading nations, who have harped on the growing American debt and foreign borrowing.

Administration officials say the improved fiscal picture suggests the president is on track to deliver more quickly on a campaign promise to cut the annual deficit in half as a share of the total U.S. economy, to 2.3% of gross domestic product. (By comparison, last year's $412 billion deficit was 3.6% of GDP.) Private analysts don't put much stock in that promise, however; even if Mr. Bush claims victory, the nation still faces long-term deficit problems. Overall federal spending is increasing, including for war costs. More broadly, spiraling health-care costs for Medicare and Medicaid programs, including a prescription-drug benefit for seniors starting next year and a wave of baby-boomer retirements after 2008, will drive federal deficits to unsustainable sizes.

"These are the good ol' days. These are the best of times," says Congressional Budget Office Director Douglas Holtz-Eakin, a former administration economic adviser. "After this, it gets worse."

Accentuating the positive, the administration yesterday unexpectedly released an updated economic forecast that will be used to calculate the revised budget projections in July. Officials said economic growth would continue at a 3.4% annual rate, just under what they projected in December. While rising energy prices nudged up the inflation forecast to 2.3% for the year, inflation is projected to fall back to the earlier estimate of 2.1% after that. The administration sees interest rates rising over the next few years -- both short-term rates largely influenced by the Federal Reserve Board and also bond-market rates, which have been surprisingly low.

"With the president's focus on spending discipline, we are seeing positive signs for the American economy, and for the federal government's balance sheet," Budget Director Joshua Bolten said in a statement.

His Office of Management and Budget wouldn't speculate on a narrower 2005 deficit projection. But private forecasters have begun doing so, especially after CBO last month suggested the deficit would be closer to $350 billion than the $394 billion it had earlier forecast for the president's 2005 budget.

A narrowing deficit makes life easier for the administration in several ways. It can more readily counter complaints from European allies -- which have larger deficits as a share of their economies -- that the U.S. needs to do more to get its economic house in order, just as Mr. Bush is about to attend a G-8 meeting next month in Scotland. At home, a smaller deficit eases his argument for making his first-term tax cuts permanent, blunting Democrats' complaints that those tax cuts and war costs are exacting an economic toll on the nation.

But a narrower deficit has downsides for the president as well. "The bad news, of course, is that as the deficit comes down cyclically, the pressure ... is lessened" to get Congress to make tough changes in tax and spending policy to reduce deficits for the long term, says Goldman, Sachs & Co. chief economist William Dudley.

Also, deficit calculations complicate Mr. Bush's flagging drive to overhaul Social Security. A narrower deficit is possible largely because Mr. Bush and Congress are counting surpluses for Social Security; until 2017, the system is expected to draw more in workers' payroll taxes and interest than it pays out in benefits. Some congressional Republicans are urging the White House to earmark the Social Security surpluses to create the personal retirement accounts that Mr. Bush has proposed. But he won't do so, White House advisers say, given his commitment to showing a reduced deficit.

Mr. Bush's promise to halve the deficit by fiscal 2009, when he leaves office, starts from his administration's own projection last year that the 2004 deficit would be $521 billion, or 4.5% of GDP. So half would be a figure equal to 2.3% of GDP, officials say. But private analysts considered the administration's projection inflated, just as they did this year's forecast of a $427 billion deficit for 2005, so the administration "could create an environment in which the numbers then come in better than expected," said Morgan Stanley economist David Greenlaw. While his and other analysts' projections have proved too high, he added, "using numbers in the $420 billion range really were not supportable by any stretch of the imagination."

The CBO this week, in its latest monthly budget report for the first two-thirds of the fiscal year through May, tried to account for the improved deficit picture. It said federal tax revenue had risen by 15.4% compared with the same eight months of fiscal 2004, more than double the 7% growth in federal outlays so far. The 2005 deficit through May was $273 billion, narrower by $73 billion from the comparable period a year before.

Individuals' income-tax payments were up 20%, and the CBO suggested the growth was "more concentrated" among taxpayers who pay the highest rates -- the wealthy whose incomes have grown faster than those of lower-income Americans in recent years. Such conclusions can't be certain until more data are available in the coming year. Another factor, the CBO said, were lower-than-expected tax refunds. Corporate revenues in the first eight months were 48% higher, reflecting profits growth in 2004. The CBO said its next report, which will reflect June 15 estimated-tax payments, will be the first to gauge corporate profits for 2005.

Its director, Mr. Holtz-Eakin, said in an interview that offsetting the good news on increased revenues is the pressure on the White House and Congress to fix the alternative-minimum tax. The AMT was intended to make sure that wealthy taxpayers can't claim so many tax breaks that they avoid any liability, but increasingly it is snagging the middle-class -- bringing billions of dollars more to the Treasury, but at the risk of a taxpayers revolt. Federal spending, meanwhile, is up significantly for Medicare, defense, farm subsidies, education, homeland security and interest on the federal debt.

In short, Mr. Holtz-Eakin said, "I don't see anywhere in this picture where there's room for big improvement."

Write to Jackie Calmes at jackie.calmes@wsj.com