WASHINGTON — As the Obama administration wrestles with how to pay for a costly revamp of the health care system and whether to spend more to spark a nearly lifeless economy, it faces shrinking fiscal room to maneuver. With each passing day, the outlook for the government's finances grows dimmer.
Skyrocketing federal budget deficits increasingly are limiting the government's ability to take on new financial commitments. Investors also are starting to worry about something once unthinkable: that the U.S. government could default on its debts someday.
The federal budget deficit is the annual sum of what government spends beyond what it collects in revenues. This year's deficit is on course to balloon to a figure equivalent to 12 percent of the nation's gross domestic product, the total annual value of all goods and services produced. That's double the peak Reagan-era deficit, which was the post-World War II high until now.
A June study by the Brookings Institution, a center-left policy research group, found that current increases in spending and continuation of most George W. Bush-era tax cuts will combine to produce a 10-year deficit of $9.1 trillion. That will drive interest payments on the national debt — the total of accumulated annual deficits — to about 3.8 percent of the GDP by 2019.
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Interest payments on the debt that high would surpass defense spending as a percentage of the GDP. Taxpayers would get nothing in return. All that spending on interest would go only to holders of government bonds who'd financed the past deficit spending.
"All of these figures are poised to rise further after 2019, implying that the situation is unsustainable," wrote researchers William Gale and Alan Auerbach, the Brookings authors.
Fear of rising federal debt is hardly new. It's intensifying now, however, because America's deep recession comes on the eve of retirement for 75 million baby boomers, those born from 1946 to 1964. The first wave of boomers already is reaching retirement age. Boomer retirement will strain federal health and Social Security spending as never before.
President Barack Obama often cites the looming fiscal crisis as one reason that he wants to revamp the health care system to create more competition and control costs.
However, budget experts both left and right fear that Obama is seeking to offset these new funding obligations by tinkering with the tax code on the margins, yielding what they call "phantom savings" that may not materialize.
"For anyone who has been here more than a few years, does anyone believe this is really going to be budget neutral?" Stuart Butler, a budget analyst for the Heritage Foundation, a conservative research center, said during a Brookings forum this month on the looming fiscal crisis.
Taxing the health plans of people who earn more than $200,000 may prove an attractive populist ploy, but it won't yield enough revenue to address the looming fiscal problems, said Diane Lim Rogers, the chief economist for the Concord Coalition, a bipartisan budget-watchdog group.
"Economists and tax-policy experts know how we would reform the tax system if we were to clean it up and make it a sustainable revenue system, and we know that more than how we would contain health care costs," Lim Rogers said in an interview.
The logical place to start, she argues, is by allowing the Bush-era tax cuts to expire as scheduled at the end of 2010. That would restore tax brackets to where they were in the late 1990s, a period of steady economic growth. Obama has said, however, that he'd extend the Bush tax breaks for all but the richest 5 percent of taxpayers.
Extending the tax cuts in their entirety would add $2.6 trillion to the deficit over 10 years. Ending them for the top 5 percent of earners reaps $600 billion in revenues, but still adds $2 trillion to the deficit over 10 years.
"Congress has to pass an extension and President Obama has to sign it. It's a huge thing that is within our policymakers' control right now and that policy experts know something about," Lim Rogers said. "I call that the big policy lever that is available to us, but we seem to be ignoring that it is sitting there glowing red."
Republicans are campaigning against government spending, offering amendment after amendment in Congress to try to reduce it, something they were unable or unwilling to do when they ran Capitol Hill in the Bush years.
"Democrats have promised their health plan will be paid for and won't add to the deficit, but the facts just don't add up. Right now, just one section of the . . . (health committee's) bill would spend $1.3 trillion. It's not plausible that this wouldn't add to the deficit, which has already swelled by more than a trillion dollars, thanks to bailouts and stimulus money," Senate Minority Leader Mitch McConnell, R-Ky, said recently.
"So when Democrats predict their health care plan won't cause people to lose their current insurance and won't add to the national debt, Americans are right to be skeptical."
The nonpartisan Congressional Budget Office said that major parts of the health care bill would add $611 billion to the deficit, about half of what McConnell said, but still a significant amount given the looming crisis.
For now, Republicans aren't saying how they'd raise sufficient revenue to reduce the long-term deficits that will come from the pending boomer retirement.
"The good news is they're waking up the people. The bad news is it is not evident to me (that) they're willing to sit down and put everything on the table," said Isabel Sawhill, a top-level budget official in the Clinton administration.
Another reason to fear the nation's eroding financial outlook: It could raise the cost of borrowing for everyone. If investors who purchase U.S. government debt, mostly China and Japan, view it as risky or fret that inflation could result, they may demand a higher interest-rate return in exchange for their investments.
That higher interest rate would mean even greater interest payments on the debt. That's no farfetched possibility. In March, Chinese Prime Minister Wen Jiabao worried publicly about the safety of investing in U.S. government debt.
"The fears of the market about higher interest rates, inflation . . . are legitimate. They're justifiable," Marty Regalia, the chief economist of the U.S. Chamber of Commerce, said in a recent interview. "They may prove wrong, but it's not like the meandering of deranged minds. We have put things in train that historically, and theoretically, suggest that we are going to have these problems."
(David Lightman contributed to this article.)
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