Federal Deficits Matter After All.

It will be recalled that in 2002, Vice President Dick Cheney famously told Treasury Secretary Paul O'Neill that the economic lesson of the Reagan administration had been that "deficits don't matter."

Democrats, who'd suddenly became deficit hawks during the economic boom of the 1990s when the Clinton administration managed to leave the budget in surplus, argued that the Bush administration tax cuts of 2001, coupled with cost of the war in Afghanistan and the looming war in Iraq, would imperil the economy.

Undaunted, the administration and a Republican-controlled Congress enacted a new round of tax cuts and pushed ahead in 2003 with an expansion of Medicare drug coverage. By the time it took effect in 2006, the wars in Afghanistan and Iraq were costing $12 billion a month. The 2006 budget was $163 billion in the red, but the economy was booming and it seemed Cheney had been right.

By early 2008, the economy had slowed enough that Congress was passing stimulus packages. Democrats had retaken control and become less hawkish about deficits. When the 2008 fiscal year ended on Sept. 30, 2008, the deficit stood at $438 billion. But the world had changed two weeks earlier when the financial markets imploded.

Since then, stimulus has followed stimulus and bailout has followed bailout. The estimated budget deficit for this year stands at $1.8 trillion, four times what it was a year ago. The White House Budget Office estimates a $1.2 trillion deficit in 2010 and nearly $1 trillion in 2011.

Desperate times call for desperate measures, but at some point deficits start to matter a great deal. If foreign investors lose confidence in U.S. debt and inflation begins to take hold, it will make today's economy look like the good old days.

Dealing with deficits while simultaneously trying to rebuild and remake the U.S. economy is going to require personal and political sacrifice the likes of which most Americans have not endured in their lifetimes. Less pork, fewer freebies and exemptions, fewer favors to the powerful and powerless alike.

Last week, President Barack Obama said he would ask Congress to restore the "pay-as-you-go" rules that were in effect from 1990 to 2002.

That means new entitlement spending or tax cuts will have to be offset by budget cuts or tax increases. "Congress can only spend a dollar if it saves a dollar elsewhere," the president said.

So called "discretionary spending" — essentially everything except Social Security, Medicare and payment on government debt — would not be included. The "pay-go" rules would not reduce the deficit, but only keep it from growing larger.

What would be included is Obama's plans to reform health care by requiring mandatory coverage and enacting a new public health care option. His plan, much touted during last year's presidential campaign, to pay for it by increasing taxes only on the wealthiest Americans, vanished with the economic crisis.

Under pay-go, Congress would have to fund the new plan by increasing taxes on most Americans, including the middle class. Most often mentioned is eliminating the 50-year-old tax exemption on employer-paid health insurance, one of middle-class America's most cherished tax breaks.

Republicans can be expected to make much of that, but they should tread carefully. As The New York Times reported last week, back in 2001, the Congressional Budget Office estimated that the government would run $800 billion-a-year surpluses between 2009 and 2012. Today that same office estimates $1.2 trillion-a-year deficits.

Of that $2 trillion-a-year swing, The Times' analysis shows that reduced tax receipts because of the recession account for about 37 percent of the total. About a third can be attributed to the Bush tax cuts, the Medicare prescription drug plan and other legislation President George W. Bush espoused. Some 20 percent are the result of Obama continuing spending on previous Bush administration policies, including the Iraq war.

Only 10 percent of the deficit swing — most of it from the stimulus bill enacted in February — can be laid directly at Obama's feet.

In short, if deficits do matter, there's plenty of blame for everyone. And plenty of sacrifice will be required of everyone to fix the problem.

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