No Money? No Problem!

Can the federal government afford to pay $200 billion or so to repair the damage from Katrina? Of course not--but we're going to spend it anyway. So how are we going to get the money? We're going to borrow it, primarily from foreign lenders, such as the central banks of China and Japan. Borrowing is how we've been able to pay for the war in Iraq and cut taxes at the same time.

And borrowing is how we'll pay for the additional tax cuts that Congress is likely to consider next month.

Washington math, you see, isn't the same as household math. With household budgets, there are caps on how much you can borrow--banks will extend you only so much credit-card and mortgage debt with which to hang yourself. That provides some discipline. Not so in Washington, where Republicans' borrow and spend has replaced Democrats' tax and spend.

The fact that Congress is preparing to cut a variety of taxes by up to $90 billion over five years at the same time Katrina is going to send spending to the moon is living proof of that. What are the government's priorities? Who can say, given that Congress is planning to help pay for those cuts by trimming social programs like Medicaid and food stamps by $35 billion over five years, even as President Bush is pledging to spend what it takes to help poor people affected by Katrina.

No, I'm not making this up. These tax and spending cuts, called for in the congressional budget adopted this spring, were supposed to be considered by Congress last week under the budget reconciliation process. Even though that's now been deferred to next month, Senate budget committee chairman Judd Gregg, a Republican from New Hampshire, told me in an interview that the tax cuts and social spending reductions are still on track. Raising taxes--or letting tax cuts expire on schedule in future years--isn't on the table, he said. On Friday, President Bush ruled out tax cuts to pay for Katrina and talked about spending cuts--none specified--to help cover the tab.

Borrowing endlessly for Katrina and Iraq and tax cuts and Homeland Security is possible only because foreigners are willing to keep buying U.S. Treasury securities despite the relatively low interest rates they pay. At least for now. The cost of hocking ourselves to the eyeballs shows up in the line of the federal budget that says how much interest we're paying. Interest will run about $350 billion in the current fiscal year, according to projections by the nonpartisan Congressional Budget Office. It rises to $385 billion next year, $426 billion the year after and so on. This is without Katrina. Just the interest on Katrina--call it 4 percent on $200 billion--is $8 billion a year. While $8 billion is trivial in a world of $2 trillion federal budgets, it's still $40 billion over five years. That's more than the aforementioned $35 billion of social-spending cuts would save.

Households--and even states and cities--have to prove to lenders that they can afford to borrow. But for Uncle Sam, who borrows in dollars and can print as many dollars of Treasury securities as he wants, it's always let the good times roll. Or the bad times. Just keep on spending and borrowing, because at least for now, there's no limit to the debt that Uncle Sam can rack up with foreign and U.S. lenders. (Forget the federal debt ceiling, which has political impact but no financial impact.)

Katrina, like 9/11, really is a one-time emergency that no one can reasonably budget for. It's a short-term problem, albeit a horrendously expensive one. Congress has already authorized $62 billion in Katrina spending and about $8 billion in Katrina-oriented tax cuts for the Gulf Coast. However, almost none of this will show up in the federal budget until 2006--in Washington, the year 2006 starts this Oct. 1. What will the new math look like? Before Katrina, the Congressional Budget Office projected a $503 billion deficit for 2006. That becomes about $540 billion when you make some realistic spending and tax adjustments. Toss in $160 billion for Katrina, and you're looking at a $700 billion deficit.

About a quarter of it is interest the government pays to federal trust funds by giving them Treasury IOUs rather than cash. These include the Social Security trust fund ($97 billion) and federal-employee pension funds and such ($70 billion). Uncle Sam will need to borrow cash--call it $500 billion--to cover the rest of the shortfall. Most of it will come from foreigners.

We'll muddle through and borrow for Katrina. But one day, we'll have one Katrina--or one other unexpected problem--too many. We'll finally spook the financial markets on which we're now so dependent. Federal borrowing costs will rise, the economy will tank, we'll all be hurt. Instead of a "perfect storm" of the physical variety, we'll have one of the financial variety. And like Katrina, it's going to be devastating.

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