Psst, the deficit's shrinking

Larry Kudlow
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Posted: Jan 13, 2005 12:00 AM
Here?s one story you won?t find on tomorrow?s front pages: ?The U.S. Budget Deficit Is Shrinking Rapidly.? The headline would be accurate, but the mainstream media is much more interested in talking down this booming economy than telling it like it is.

This week?s Treasury report on the nation?s finances for December shows a year-to-date fiscal 2005 deficit that is already $11 billion less than last year?s. In the first three months of the fiscal year that began last October, cash outlays by the federal government increased by 6.1 percent while tax collections grew by 10.5 percent. When more money comes in than goes out, the deficit shrinks.

At this pace, the 2005 deficit is on track to drop to $355 billion from $413 billion in fiscal year 2004. As a fraction of projected gross domestic product, the new-year deficit will descend to 2.9 percent compared with last year?s deficit share of 3.6 percent.

Wire reports are loaded these days with accounts of an expanded trade gap (driven mostly by slower exports to stagnant European and Japanese economies, along with higher oil imports from the peak in energy prices). But there?s not a single report I can find that mentions the sizable narrowing in U.S. fiscal accounts. Behind this really big budget story is the even-bigger story: The explosion in tax revenues has been prompted by the tax-cut-led economic growth of the past eighteen months.

With 50 percent cash-bonus expensing for the purchase of plant and equipment, productivity-driven corporate profits ranging around 20 percent have generated a 45 percent rise in business taxes. At lower income-tax rates, employment gains of roughly 2.5 million are throwing off more than 6 percent in payroll-tax receipts. Personal tax revenues are rising at a near 9 percent pace.

Meanwhile, in the wake of strong stock market advances over the last two years, non-withheld revenues from individuals -- including investor dividends and capital gains that are now taxed at only 15 percent -- have jumped by over 14 percent.

Following the Clinton cap-gains tax cut and savings expansion bill of 1997, investment-related tax collections led to bull-market budget surpluses in the pre-9/11 period of 1997-2001. However, despite the flood of new revenues, this year?s federal budget is still overspending. Domestic spending on non-entitlement programs (excluding homeland defense) is rising at a 4.1 percent rate. That?s more than twice the pace of core inflation. But this may be changing.

According to the Washington Post, the Bush budget totals planned for fiscal year 2006 may be essentially unchanged from the totals for fiscal year 2005 (excluding defense and homeland security). According to reporter Jonathan Weisman, the administration?s first really tough budget request (due out next month) ?would freeze most spending on agriculture, veterans and science, slash or eliminate dozens of federal programs, and force more costs, from Medicaid to housing, onto state and local governments.?

The rapid growth of federal health care and other entitlements would also be slowed markedly. Though the numbers are not yet available, this sounds a bit like Ronald Reagan?s tax-cutting budget of 1981. In addition to reducing the top personal tax rate to 50 percent from 70 percent, the Gipper proposed budget cuts that would be worth nearly $100 billion in today?s dollars.

Of course, the political screaming over the forthcoming budget has already begun. A passel of Democrats and at least one Republican, Sen. Craig Thomas of Wyoming, have written a protest letter to Josh Bolten, director of the Office of Management and Budget. Former-Gov. John Engler of Michigan, a Republican and the current president of the National Association of Manufacturers, has pledged to fight the elimination of various protectionist subsidies to his member firms.

However, Sen. Judd Gregg, the New Hampshire Republican who is the current chair of the upper chamber?s budget committee and a long-time Bush ally, is set to support the administration?s new budget discipline. This includes, by the way, Bush?s plan to reduce Social Security benefits by replacing wage indexing with a price-level formula and extending the retirement age -- one or the other, or both -- in return for personal saving accounts.

By the way, Treasury Secretary John Snow just completed a Wall Street tour where leading bond traders told him not to sweat the transitional costs for personal accounts. The traders said that an additional $100 billion a year over the next decade for transitional financing will be easily manageable. ?A rounding error,? one senior trader told Snow.

A supply-side tax-reform movement, a shrinking budget deficit, newfound spending discipline, and a determination to confound conventional wisdom by reforming Social Security has George W. Bush?s second term off to a roaring start -- even before he is officially sworn in.