The Clock Is Ticking on the Deficit

01/28/2010 1:00 pm EST

Focus: MARKETS

Knight Kiplinger

Editor-in-Chief, The Kiplinger Letter, Kiplinger's Personal Finance, and Kiplinger.com

Knight Kiplinger, editor-in-chief of The Kiplinger Letter, says the hard work of cutting the federal budget deficit has yet to begin.

Time is running out to attack the deficit. The once-distant problem is now up close. Soaring deficits are jacking up the national debt, resulting in higher interest rates and raising odds of an even weaker dollar, stunting economic growth and lowering Americans’ future standard of living.

Spending is out of control. For years, it averaged 20% of gross domestic product. This year, 25%.

Even after the economy fully recovers, outlays won’t ebb. Growing ranks of retirees mean Medicare and Medicaid costs will keep soaring, even if health care reform successfully curbs increases in the cost of care—an iffy proposition at best. Such entitlement programs account for 54% of the budget and have climbed 6.4% on average a year since 2000.

[Meanwhile,] discretionary spending over the past decade has risen an average of 7.5% a year. The annual deficit equals about 10% of GDP, the highest since World War II. Worse, the mountain of debt will continue to accumulate, even if politicians in Washington manage to rein in spending and trim the yearly deficit. In fiscal 2009, federal public debt rose by a third, to $7.8 trillion.

By 2014, it’ll equal a whopping two-thirds of GDP. The interest payments alone will be staggering, soaring to as much as $800 billion a year by the end of the decade and gobbling up 16% of the total budget.

Servicing the debt may become the single biggest item in the federal budget, surpassing Medicare and defense. That’ll raise the cost of borrowing for everyone and risks derailing the US economic engine.

There are no easy fixes. Eliminating the federal deficit by the end of this decade is a pipe dream. Even paring it to 3% of GDP by 2015, as President Obama proposes, will be tough, though potentially achievable. Holding it at that level, economists say, is critical: It would stabilize the federal debt level and relieve pressure on interest rates.

The political obstacles are huge. Elected officials in both parties agree: Belt-tightening is needed. But it’s usually someone else’s waist they want cinched.

Though voters are increasingly troubled by swollen deficits in the abstract, they’re not enthusiastic about cutting programs that directly benefit them.

Still, the pressure to do something is mounting. And those in power now, at the White House and in Congress, risk big losses come November if they ignore it.

Bottom line: Don’t count on a cure just from spending cuts or tax hikes. Real deficit trimming is likely to come only with robust economic growth, as Uncle Sam’s coffers start to fill with tax revenues from thriving businesses. Unfortunately, that’s not likely to begin for another year or two.

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