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Deficits loom over national fiscal policy

Tom Abate
The San Francisco Chronicle
Thursday, November 4, 2004

Newly re-elected President Bush faces a range of economic challenges including gaping deficits, soaring health care costs and conflicts over trade.

But Bush looked beyond these issues in his victory speech Wednesday to spell out the economic priorities of his second term, pledging to overhaul the nation's outdated tax code and to strengthen Social Security for the next generation.

Speaking moments after Vice President Dick Cheney called the election a mandate, Bush offered no details in his brief remarks, meant to cheer supporters and soothe opponents at the end of a long and bitter campaign.

Conservative economist Tim Kane, with the Heritage Foundation, said enlarged Republican majorities in the House and Senate have emboldened the administration and will give Bush the clout to turn his promises into law.

"This president has been about big ideas," Kane said, predicting that Bush will use his post-election strength to push "legislation that may be more principled, more conservative, less compromising."

But Dean Baker, with the liberal Center for Economic and Policy Research, said Bush won't be able to cut taxes and revamp Social Security without risking even bigger deficits or making deep spending cuts in other programs.

"It's not a question of political opposition, it's just the arithmetic," he said. "I just don't see how they get the money."

Many financial experts agree that the budget deficit, already at a record $415 billion in fiscal 2004, will put some brakes on Bush's ambitious plans. Still, most observers expect the president to move immediately to make permanent a series of tax cuts that are due to expire in four to six years.

Greg Valliere, chief strategist for Schwab Washington Research Group, is betting that Bush will succeed in keeping taxes on dividends and capital gains at 15 percent, rather than reverting to 35 percent at the end of 2008.

But an analysis by Goldman Sachs economist Jan Hatzius suggests that permanent tax cuts and other suggested changes, such as indexing the alternative minimum tax so inflation doesn't drive it into the middle class, could turn the 10-year deficit estimate of $2.3 trillion into a $5.5 trillion bath of red ink.

Eugene Steuerle, an economist with the nonpartisan Urban Institute who worked on the 1986 tax revision during Ronald Reagan's second term, said concern about runaway deficits will limit efforts to rewrite the tax code. He drew an analogy between then and now.

"When you move into an era where there are significant deficits, you can't rely on deficit increases to pay for the costs of tax cuts," he said.

Indeed, there was talk Wednesday that Republicans are considering partially replacing lost income tax with a national sales tax, but -- as the Goldman analysis observed -- because that would disproportionately hit seniors and other low-income people, it "would likely stiffen the Democrats' spine."

Likewise, the Goldman analysis said tentative Republican plans to amend the Social Security system by allowing people to divert a portion of their payroll taxes into private retirement accounts could lead to a further $1 trillion to $2 trillion expansion of the deficit over the next 10 years. In the long run, a switch to private accounts would mean high-income workers would stop subsidizing Social Security payouts to those making less, another political time bomb according to the Goldman outlook.

Mark Zandi, chief economist for Economy.com, said that in addition to his tax and Social Security plans, Bush is likely to seek oil exploration tax credits and other incentives sought by energy producers. And although trade isn't a front-burner issue now, it will be in January when global quotas on apparel expire and imports from China "surge in and pummel the U.S. market," Zandi said.

Joseph Quinlan, chief market strategist for Banc of America Capital Management, said Bush, hardly an internationalist during his first term, had to seek help from abroad to prevent the Iraq war from bleeding the Treasury, and court foreign investors who underwrite growing U.S. debt.

"He'll have to change his stripes in the second term," Quinlan said. "He'll have to be more user-friendly to the rest of the world."

Bush will also have to manage his way through the quiet demographic crisis outlined Wednesday by Douglas Holtz-Eakin, director of the Congressional Budget Office, the nonpartisan research agency of Congress.

The aging of the Baby Boomers and steadily rising health care costs have put the federal Medicare and Medicaid programs on an unsustainable course, Holtz-Eakin said. "This requires doing something," he said, although his job prevents him from making policy recommendations.

But Kane, the conservative economist, said voters had endorsed Republican fixes to taxes and Social Security. Predicting a strong federal jobs report Friday, Kane said Bush would enter 2005 "with the winds really pushing the sails of the economy," adding that Bush is "ready to do things that he would like to be remembered for.''



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