WASHINGTON – Comptroller General David Walker’s most troubling briefing paper shows the federal budget growing progressively larger until spending reaches nearly half the economy’s total output in 2040.

Now, federal spending is nearly 20 percent of gross domestic product, the economy’s annual output, and many people think that is too big. In addition, the government collects 16.2 percent of GDP in taxes. The rest is red ink.

In his briefing paper, Walker has a special name for each page of grim fiscal deterioration, each with differing assumptions about how the nation responds to budget challenges over the next 36 years.

“We start with a haircut,” he said, thumbing through the pages that show federal spending starting to explode as the Baby Boom reaches retirement. “The next page is a scalp, and then we go to decapitation, and finally disembodiment.”

In 2040, the deficit would be nearly 30 percent of GDP, according to his figures, which assume that President Bush’s tax cuts are made permanent and spending rises at the same rate as the economy.

This is the ominous fiscal picture looming in America’s near future, Walker said, a picture that neither President Bush nor Sen. John Kerry is addressing extensively in the presidential campaign. Both candidates promise to cut the deficit in half by 2008, before the real fiscal bomb explodes. At the same time, both candidates make proposals that would add to the deficit.

The Walker briefing paper implies that the beginning of a monster deficit lurks just beyond the turning of the decade as Social Security, Medicare, defense and other spending start to mushroom. To contain the deficit, severe steps must be taken, he said, and the best time to start is now.

According to Walker, who heads the Government Accountability Office, the fiscal time bomb awaiting the United States could mean that taxes would have to be raised 250 percent, government programs would have to be sharply curtailed, and the U.S. would turn into a Third World country with enormous debt. If nothing is done, he said, the U.S. economy would be at risk – and in hock to the rest of the world. Interest on the debt alone would total nearly half of all federal spending in 2040.

Liberal and conservative economists alike say the United States must address its long-term spending and deficit problems, and that would mean reducing Social Security and Medicare benefits along with raising taxes – all unpopular proposals.

Glenn Hubbard, a former Bush economic adviser, said the country must come to grips with the long-term deficit issue, and focus on so-called “entitlements” like Medicare, Social Security, and Medicaid.

“These deficits wouldn’t be a huge problem if we were not looking at a fiscal catastrophe coming down the road, which is the retirement of the Baby Boomers,” said Len Burman, an Urban Institute economist and former Treasury official in the Clinton administration.

Walker, Hubbard, Burman and other analysts said the sooner the U.S. starts to address the long-term deficit issue, the better off it will be – and the easier the transition will be.

But in the current Bush-Kerry contest, the deficit has not been a major issue despite the dire scenarios. One reason is that interest rates have stayed low during the last four years despite larger deficits brought on by Bush’s $1.9 trillion tax cut and a recession.

The government borrows money from private financial markets to finance its deficit, issuing interest-paying bonds to lure capital to meet the bills. When the government is competing aggressively with private borrowers for funds, analysts say it tends to put upward pressure on interest rates.

But now U.S. government finance has gone global, with America financing a growing portion of its deficit financing overseas. Since Bush took office, the share of U.S. debt owned by foreigners has risen from 30 percent to more than 40 percent. Japan and China are the two largest holders of U.S. debt securities.

If the foreign money spigot is tightened or turned off as the deficit widens, that could have severe adverse consequences on the U.S. economy, economists said. The value of the dollar could come under intense pressure or interest rates in the U.S. could jump higher, and perhaps trigger an economic downturn, they speculate.

But in the short run, there is little evidence that today’s higher deficits have much of an impact on interest rates, Hubbard said. The Bush administration calls them “manageable.”

Analysts say there is a tipping point when the deficit begins damaging the economy – they just don’t know where that tipping point is. All they’ll say is that the country is drawing closer.

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(c) 2004, Chicago Tribune.

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AP-NY-10-24-04 2058EDT

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