WASHINGTON, Jan. 7 (UPI) -- The U.S. budget deficit is burgeoning from rising defense and security spending, even as tax cuts are lowering government revenue, amid increasing demands on the budget from the retiring baby boom generation, the International Monetary Fund cautioned once again Wednesday.
But the IMF's warnings and its prescriptions for dealing with the budgetary as well as trade deficits are unlikely to have much impact on U.S. policymakers, if any, particularly in a presidential election year.
Since the Bush administration took over in 2001, the federal budget balance has deteriorated rapidly, and the government deficit is expected to exceed 4 percent of gross domestic product for the current fiscal year.
"And that deficit is likely to be sustained...which raises longer-term issues," not just for the U.S. economy, but for overall global economic prospects, said Charles Collyns, deputy director of the IMF's western hemisphere department in a phone conference with reporters. The group released a study Wednesday on U.S. fiscal policies and priorities for long-run stability, which Collyns said was based on discussions with U.S. authorities over the summer.
The IMF warned that the large fiscal deficits will likely continue over the next decade as the administration keeps on cutting taxes on the one hand, while increasing defense and social spending on the other. That, in turn, could lead to a rise in interest rates, even though the international agency did not specify by just how much monetary policy could be tightened. It also noted that higher interest rates would crowd out private sector investments and ultimately hamper business and productivity growth as well as consumer spending.
In the near-term, of course, prospects for the U.S. economy and indeed the world economy, appear to be looking much better than they did a year ago. With U.S. asset prices on the rise once again and GDP outpacing analysts' expectations in the third quarter, a brighter outlook for the U.S. economy has been key to improving prospects for both Japan and Europe.
Still, the IMF said that in the longer-term, the ballooning budget deficit and net foreign liability position in the United States will be the biggest dark spot in the global economy moving forward, and could "eventually" raise real interest rates in industrialized nations by 0.50 to 1.00 percentage points.
"The United States is on course to increase its net external liabilities to around 40 percent of GDP within the next few years...this trend is likely to put pressure on the U.S. dollar, particularly because the current account deficit increasingly reflects low savings rather than high investment," the IMF stated.
The Bush administration has continuously argued that the current account deficit largely stemmed from the fact that foreign investors were attracted to U.S. markets, and would continue to put their money in the United States, making a current account imbalance a non-issue for the overall domestic economy. But the IMF's Collyns said while such an argument may be true if the amount were smaller, but he said the pace in which the deficit was growing as well as its sheer size made the current account deficit a significant liability to U.S. economic prospects.
At the same time, the IMF warned that the evaporation of fiscal surpluses accumulated over the 1990s "has left the budget less well-prepared to cope with the retirement of the baby boom generation, which will begin later this decade and place massive pressure on the social security and Medicare systems."
"Without the cushion provided by earlier surpluses, there is less time to address these programs' underlying insolvency to address these programs' underlying insolvency before government deficits and debt begin to increase unsustainably, making more urgent the need for meaningful reform," the IMF added.
As such, the international agency argued that the United States should focus its economic policy on restoring a budget balance, and quickly at that. While the IMF recognized the need for more military and security spending in light of the terrorist attacks and new global risks that need to be addressed, it nonetheless stressed the need for more disciplined spending by the government. It also called for better, and broader, ways of increasing the tax base, for example by reducing corporate and personal income tax preferences including corporate tax shelters and mortgage interest deductibility. It also reported that energy taxes "which are comparatively light in the United States", could be a good way of increasing government income.
While economists may argue on whether the IMF's assessment of the state of the U.S. economy and its suggestions for dealing with the ballooning deficits, it is unlikely that U.S. policymakers will take much, if any, of the IMF's warnings and suggestions to heart. For one, neither the Republican nor Democratic administration has had a track record of not taking much notice of what the IMF suggests about directing the U.S. economy.
But more significantly, the United States is the single largest shareholder in the IMF, and is effectively its boss. Unlike many developing nations or countries in financial crises such as Argentina or Turkey, the United States is the biggest provider of funds to the international agency. As such, it does not borrow money from the IMF, and thus it is free from the so-called conditionalities that the IMF would impose upon those countries that would become borrowers of their funds.
And given that the IMF is prescribing such measures such as eliminating corporate tax shelters and introducing bigger energy taxes as the nation gears up for a presidential election, such unpopular policies suggested by an international organization are highly unlikely to gain much support among U.S. policymakers.