WASHINGTON — If the Bush administration has seemed exceptionally concerned about the long and sometimes sickeningly steep slump in the stock market, there is good reason. It is more than the blind trusts of top officials being hammered or the political risk that voters in November, worried about their retirement savings, will blame the party in power.
Beyond all that, it has dawned on top Bush officials — if not yet the public — that the federal budget is literally being held hostage by Wall Street.
Mitchell Daniels, the embattled director of the White House Office of Management and Budget, didn’t use exactly those words at his midyear briefing last week, the one where he announced that the deficit for the current year is likely to hit $165 billion.
What Daniels did point out is that a dangerous gap has appeared, unexpectedly, between the growth of the economy and the course of federal revenues — a gap which makes it far harder than ever to find a safe course of fiscal policy for the nation.
The stark fact, he said, is that while the economy "has been much stronger than we projected in February," when President Bush submitted his budget for next year, tax receipts are "much weaker than expected."
The likely reason: Capital gains, mutual fund distributions and other stock-market-related incomes have slumped, along with the Dow Jones and Nasdaq averages — after booming during the 1990s.
In an interview after the briefing, Daniels told me that when he came to the job from his corporate post in Indiana, the career folks at OMB told him one of their time-tested rules of thumb has been that "every 1 point of growth in the gross domestic product yields $28 billion in additional taxes."
Back in February, the budgeteers, erring on the side of caution, said that after the short near-recession of 2000-01, they expected the economy to grow hardly at all — less than 1 percent — this year. In fact, it has done much better; the final quarter of 2001 saw growth at a 1.7 percent annual rate and the first quarter of this year, 6.1 percent.
If the old rule held, that should have translated into billions in extra revenue. But, in fact, Daniels said, "receipts in 2002 are now estimated to decline outright by $124 billion, or 6 percent, from 2001. The last time revenues fell to that extent was in 1955."
Virtually all of the anticipated decline — 98 percent of it — is in individual income taxes, and most of that — perhaps as much as two-thirds — can be traced to the stock market’s yielding losses, not gains, for investors.
This growing dependence on Wall Street introduces a dangerous element of volatility into government economic policy. It is difficult enough to anticipate cycles in the overall economy; guessing the ups and downs of the stock market is an impossible burden for any administration to shoulder.
We got to this point through a combination of forces. The tax reforms of the Clinton years made the revenue system more progressive; that is, higher-income people paid more of the bills. And growing income inequality — the tendency of the well-educated and highly skilled to make increasing multiples of what the less-educated and unskilled receive — compounded that effect.
As a result, the top 1 percent of taxpayers now furnish more than one-third of the income tax receipts; the top 5 percent pay more than half; and the top 50 percent pay all but a small fraction — 4 percent — of what the government receives in personal income taxes.
During the boom years, high-income people cashed in on the stock market and the government cashed in on them. Between 1995 and 2000, capital gains tax payments almost tripled and income taxes on realized stock options more than doubled. Like a heroin addict, the government got hooked on that revenue and forgot that it was exceptional.
How to deal with this problem is uncertain; J.D. Foster, Daniels’ associate director for economic policy and a Treasury veteran, told me there is no precedent for such a prolonged stock market decline in a period of economic growth.
But Daniels is convinced that it would be dangerous to assume this is just a temporary, one-time phenomenon. With "more volatility" in revenues, he said, "we have to be able to anticipate the effects better."
That caution would have been useful before the president recommended and Congress passed that $1.3 trillion, 10-year tax cut last year. But it certainly is needed now.
Since 9/11, neither Congress nor the president has exerted any real discipline on government spending. What Daniels has described poses even greater danger to coherent fiscal policy.
David Broder can be reached at The Washington Post Writers Group, 1150 15th St. NW, Washington, DC 20071-9200.
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