A Roaring Start

Here's one story you won't find in tomorrow's front pages: The US budget deficit is shrinking rapidly. Today's Treasury report on the nation's finances for December shows a fiscal 2005 year-to-date deficit that is already $11 billion less than last year's. After the first three months of the fiscal year beginning last October, cash outlays increased by 6.1% overall, while tax collections grew by 10.5%. Consequently, the 2005 deficit is on track to drop to $355 billion from $413 billion in FY 2004.At this pace the new year deficit as a fraction of projected GDP will descend to 2.9% compared to last year's deficit share of 3.6%. While wire reports today were loaded 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), not a single report I could find mentioned the sizable narrowing in US fiscal accounts. The really big budget story is the explosion in tax revenues prompted by tax-cut led economic growth over the past eighteen months. Under 50% cash bonus expensing for the purchase of plant and equipment, productivity-driven corporate profits ranging around 20% generated a 45% rise in business taxes. At lower income tax-rates, employment gains of roughly 2.5 million are throwing off over 6% in payroll tax receipts.Personal tax revenues are rising at a near 9% pace. Meanwhile, non-withheld revenues from individuals-- including investor dividends and capital gains now taxed at only 15%-- have jumped by over 14% in the wake of strong back-to-back yearly stock market advances. It was these investment-related tax collections following the Clinton capgains tax cut and saving expansion bill of 1997 that led to bull market budget surpluses in the 1997-2001 pre-9/11 period. However, with the flood of new revenues, this year's federal budget is still overspending.Domestic non-entitlement program spending excluding homeland defense is rising at a 4.1 rate, more than twice the pace of core inflation. But this may be changing. According to this morning's Washington Post, the first really tough Bush budget planned for FY 2006 (due out next month) may be essentially unchanged from this year's expected totals outside of defense and homeland security.According to reporter Jonathan Weisman, the administration's budget request "... 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 no numbers are yet available, all this sounds a bit like Ronald Reagan's tax-cutting budget in 1981. In addition to reducing the top personal tax-rate to 50% from 70%, the Gipper proposed budget cuts that would be worth nearly $100 billion in today's dollars. Of course the political screaming has already begun. A passel of Democrats and at least one Republican-- Sen. Craig Thomas of Wyoming-- have written a protest letter to Office of Management and Budget director Josh Bolten. Former Republican Michigan governor John Engler, now president of the National Association of Manufacturers, has pledged to fight the elimination of various protectionist subsidies to his member firms. However, long-time Bush ally Sen. Judd Gregg, New Hampshire Republican and current chair of the upper chamber's budget commitee, is set to support the administration's new budget discipline. This include's, by the way, Bush's plan to reduce Social Security benefits by replacing wage indexing with a price-level formula, or extending the retirement age, or both in return for personal saving accounts. Treasury Secretary John Snow has just completed a Wall Street tour where leading bond traders told him that an additional hundred billion dollars a year over the next decade for transitional financing necessary to reconstruct the ailing Social Security program will be easily manageable. " A rounding error," one senior trader told Snow. With supply-side tax reform on the way, shrinking budget deficits, new-found spending discipline and a president determined to confound conventional wisdom by reforming Social Security, George W. Bush's second term is off to a roaring start even before he is officially sworn in next week.