Tue Jan 6, 2009 6:13pm EST
By Jeremy Pelofsky and David Lawder
WASHINGTON (Reuters) – Politicians want American consumers to resume spending to pull the economy out of its tailspin, and the U.S. government is leading by example with a potential $1 trillion deficit in 2009 — even before a massive stimulus plan.
The Congressional Budget Office is set to release its projections on Wednesday for the fiscal 2009 budget deficit and experts believe it will not just set a new record beyond the $455 billion set in 2008, but could hit $1 trillion as the economic recession saps federal revenues.
While that figure likely includes some of the impact of a $700 billion bailout package for the financial industry and U.S. automakers, it does not include any of economic stimulus measures Congress hopes to pass, which could cost another $775 billion over two years.
President-elect Barack Obama is contemplating large tax cuts to the tune of about $300 billion and potentially as much if not more in infrastructure projects and other spending to try to jolt the economy out of recession.
North Dakota Sen. Kent Conrad, chairman of the Senate Budget Committee, said that a $1 trillion deficit was not just a possibility for 2009, but that an average of $1 trillion could be added to the national debt annually over the next decade.
“We’re on an unsustainable course,” he said in an interview with Reuters, adding that he had not yet seen the CBO figures.
“It’s obvious we have to have a recovery package,” the North Dakota Democrat noted, but Congress must also address longer-term issues, such as the costs of the Medicare health care program and Social Security retirement system.
TOUGH CHOICES AHEAD
Obama said on Tuesday he expects to inherit a deficit approaching $1 trillion and his administration would have to make tough budget choices. But economists agree now is not the time for the country to tighten its belt.
“We don’t want to lock ourselves into 30 years of budget deficits, but this crisis is so dangerous that it would be a mistake to adopt very, very conservative budget balancing policies in the middle of this,” said Kenneth Rogoff, an economics professor at Harvard University.
Rogoff noted that the deficit would also swell from an expected steep dropoff in tax revenue and argued the U.S. economy could afford a large stimulus if necessary.
“No one quite knows how the stimulus is going to work and no one is even sure it will work,” Rogoff said. “You certainly don’t want to be tightening the budget into this recession if you don’t have to.”
Some Republicans and conservative Democrats have expressed concern that the stimulus package could bust the federal budget with new programs that will require funding for years to come.
“As the economy gets stronger, we’re not going to need these programmatic initiatives,” New Hampshire Sen. Judd Gregg, the ranking Republican on the Senate Budget Committee, said on CNBC.
To win over Republicans for the big stimulus package, the proposal Obama plans to offer Congress is expected to include tax breaks for individuals and businesses.
House Democratic leaders are pushing rules that would embrace the concept of tighter budget controls, but conservative Democrats want a commitment that new spending and tax cuts would be paid for elsewhere in the budget.
TREASURY TIPPING POINT
To finance the deficit, the government will need to issue an unprecedented amount of debt — up to $2 trillion for fiscal 2009.
If investor appetite does not keep up with the flood of supply, yields on U.S. Treasury securities would rise, pushing up interest rates for a broad range of borrowers and blunting the benefits any stimulus plan would provide to the economy.
These concerns are already creeping into the market, with benchmark yields rising off record lows as the Treasury auctions a whopping $166 billion in securities this week.
But analysts say these worries may abate, particularly if the economy weakens further, driving more money into safe-haven Treasuries.
“There is plenty of demand for a borrowing program as large as contemplated by the (stimulus) proposals that are floating out there,” said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey.
“That doesn’t mean you can be complacent and just borrow indefinitely. If you were truly irresponsible on the fiscal front, it could be possible to overwhelm the demand and even before the recovery phase you could have a nasty interest rate response,” he said.
North Coast Investment Research 