Usually, in the year following a presidential election,

BY JOHN LABATE In Need of Deficit- Defying Tricks Executives believe that sawing the deficit in half at least should be Bush s top priority Usually, in the year following a presidential election, the promises of the campaign trail give way to a more sober set of realities. But so far, President Bush has not given much ground on the priorities he cited in his campaign reforming Social Security, overhauling the tax code and making the last round of tax cuts permanent. And that s just what worries many business leaders and economists. Even those who support some of these initiatives in concept question whether this is the best time to push them. Despite the administration s pledge to cut the deficit in half by the end of 2008, few believe the country is able to pursue both the Bush agenda and deficit reduction at once. You ve got to start focusing on bringing the deficit down, says David Wyss, chief economist at Standard & Poor s. Given the promises [the president has] made, it will be hard to do. You can t cut taxes to zero and try to make it up in volume. It just doesn t 2005 REAL GDP GROWTH PREDICTIONS (%) Q1 Q2 Q3 Q4 John Lonski, Moody s 3.8 3.5 3.5 3.4 Diane Swonk, Mesirow Financial 4.1 4.0 4.1 4.3 David Wyss, Standard & Poor s 3.5 3.4 3.1 2.9 Blue Chip Econ. Indicators 3.3 3.5 3.5 3.5 work. My guess is he won t get a lot done. To begin addressing the deficit, government spending must be held in check to a far greater degree than during the prior four years, and the economy will have to remain buoyant, at the very least. Of course, the administration did get good news recently: The deficit for fiscal 2004, which was projected to reach $500 billion, came in at $412 billion although even that figure is a record. Still, the concern is widespread. In Treasury & Risk Management s biannual economic survey of CFOs, treasurers and controllers, 52% of the 204 readers surveyed cited addressing the problem of the rising federal deficit when asked what should be the administration s top priority for the next four years. No doubt, the weight of the deficit is taking its toll. Already, the value of the dollar has been driven lower, even though the U.S. economy has been otherwise showing signs of relative strength. Today, for instance, the euro is up 54% from its low in 2002 against the dollar. Most economists expect the dollar to remain

Dave Whamond 300 weak against the euro and the 200 yen in 2005. Of course, a weak dollar is a double-edged sword: It makes U.S. 100 goods less expensive and more attractive at home and abroad compared with 0 products made in Europe and Japan; it -100 also can make services and production outsourced by U.S. companies more expensive, depending on the country to -200-300 which a company is outsourcing. The good news for the moment is that the -400 rates on U.S. Treasuries have remained subdued, a sign that non-u.s. investors -500 are not stampeding for the doors because of the underlying weakness a low dollar can imply. The dollar is a real issue, says Diane Swonk, chief economist at Mesirow Financial in Chicago. The problem is once the dollar is on a trajectory, HEY, BIG SPENDER U.S. Federal Budget Deficits/Surpluses ($Bln) 107 22 69 126 236 96 98 00 02 04 Source: U.S. Office of Management and Budget it s hard to get it off even if it s wrong. Swonk is very bullish compared to her colleagues. And a strong economy is absolutely necessary to dig out of deficit mainly because it generates more tax revenues. The federal budget surpluses of the late 1990s were made possible by a 25% average annual increase in equity prices, which went a long way toward fattening government coffers with taxes from capital gains, according to John Lonski, chief economist at Moody s Investors Service. Between 1996 and 2000, the average annual growth in government revenues was 8.4%, far above the 4.9% growth in receipts over the last twelve months. In other words, the tax cuts of last year produced far less stimulus than an expanding equity market. The problem for the Bush administration: While economists tend to be optimistic about next year s growth prospects, many expect that real GDP growth will be slightly off from 2004 levels. The consensus opinion of 53 economists compiled 127 158 375 412 by Blue Chip Economic Indicators has real GDP growth at 3.5% in 2005 versus 4.4% in 2004. The biggest reason for the slowdown: Consumer spending is expected to cool in the face of a declining housing market and rising debt levels. The scenario could get darker if Federal Reserve chairman Alan Greenspan, thought to be in his last year as interest rate czar, becomes more aggressive about raising rates, a development that s not anticipated at this point. If getting receipts to contribute enough is a long shot, then keeping government outlays in check seems close to impossible, given the continuing wars in Iraq and against terrorism, for starters. According to Lonski s calculations, overall revenues would have to increase at least 2.9% faster than outlays to cut the deficit to around $200 billion by 2008, assuming GDP close to trend. It is doable, just not likely given the recent track record of Con-

gress and the administration. During the last 12 months, while tax receipts rose 4.9%, outlays were up 4.3%, not nearly enough by Lonski s estimates. Rising costs are also working against stronger growth, particularly given a climate in which passing on higher costs is not guaranteed. First and foremost has been the rising cost of energy, which is expected to level off in 2005. But companies also must swallow smaller, equally indigestible chunks. According to the T&RM survey results, 32% of respondents expected compliance costs, including Sarbanes-Oxley, to range between $1 million and $5 million. That was more than double the group that expected that level of spending in 2003. In 2004, 13% claimed they would spend in excess of $5 million, versus the 5% that made that claim the year before. Whether, and by how much, such spending demands contribute to corporate decisions not to spend elsewhere remains debatable. Certainly, the choppy pattern of payroll growth in 2004 was a surprise, considering the relative strength in the overall economy. I think business decision making is still being guided by above average risk aversion, says Moody s Lonski. Until they become less risk averse, they ll use labor sparingly. Business outlays for new equipment may also be an area being hit by the current cautious environment. Lonski argues the figure to watch is capital spending relative to depreciation, which in the third quarter was reported by the government at 121% of depreciation, well below the average of 139% for the period between 1993 and 2000. That means that businesses are spending more for replacement of old, worn-out equipment but not as much in excess of that for other capital needs as in the prior decade. What would help? A strong rebound in business confidence, in the form of more steady hiring and consumer and capital spending, would go a long way in providing President Bush the kind of growth he ll need to take a sizable chunk out of the deficit in the years ahead. Without it, Bush will need more than a few nifty tricks up his sleeve. 2005 Biannual Economic Confidence Survey Treasury & Risk Management surveyed 204 CFOs, treasurers and controllers at companies with revenues of more than $500 million between Dec. 3 and Dec. 15, 2004 MOST RECENT FISCAL YEAR REVENUES 42% More than $500 million, but less than $1 billion More than $1 billion, but less than $5 billion More than $5 billion, but less than $10 billion More than $10 billion 11% 17% 30% WHAT SHOULD BE THE ADMINISTRATION S TOP PRIORITY AS PRESIDENT BUSH STARTS A NEW TERM? Address the national healthcare problem Cut the deficit 11% 52% IS THE MOUNTING FEDERAL DEFICIT 12/04 Having no significant negative effect on the economy 26% Undercutting confidence in the U.S. economy 74% Make the tax cuts permanent 9% DO YOU BELIEVE THE MOUNTING FEDERAL DEFICIT WILL Move to strengthen the dollar Privatize Social Security Simplify the tax system 6% 3% 13% Significantly add to the growth of the economy Push up interest rates and slow economic growth Not be a major plus or minus Be a significant drag on the economy 2% 25% 51% Other 6% 22% 0 10 20 30 40 50 60 0 10 20 30 40 50 60

HOW WOULD YOU GRADE THE BUSH ADMINISTRATION S OVERALL HANDLING OF? A 4% 11% NA B 44 50 NA C 36 24 NA D 9 11 NA F 7 4 NA HOW WOULD YOU GRADE THE BUSH ADMINISTRATION S OVERALL HANDLING OF TRADE POLICY? A 3% 4% 6% B 38 44 50 C 36 32 31 D 17 17 11 F 6 3 2 WHERE DO YOU EXPECT THE FED FUNDS RATE TO BE 12 MONTHS FROM NOW? Up 25 basis points Up 50 basis points Up 75 basis points Up 100 basis points or more 34% 4% 36% 26% DO YOU BELIEVE THE FEDERAL RESERVE HAS BEEN TOO SLOW TO RAISE INTEREST RATES? Yes 14% 20% NA No 86% 80% NA ARE HIGHER OIL PRICES HAVING AN IMPACT ON? 24% ARE HIGHER ENERGY PRICES PUTTING A DAMPER ON YOUR BUSINESS PERFORMANCE? 7% 32% 76% 61% No impact No impact A slight drag on growth A slight impact A significant drag on growth A major impact ARE YOU CONCERNED ABOUT INFLATION? 5% 19% DO YOU FEEL YOU HAVE REGAINED PRICING POWER, MEANING YOU CAN RAISE YOUR PRICES TO COVER HIGHER COSTS? 29% Not at all 76% 71% Somewhat Yes Very concerned No DO YOU EXPECT YOUR COMPANY S OPERATING MARGINS TO SHRINK OR GROW OVER THE NEXT SIX MONTHS? Shrink 15% 13% 11% Grow 44 53 48 Remain the same 41 34 41 DO YOU EXPECT YOUR COMPANY S OPERATING MARGINS TO SHRINK OR GROW OVER THE NEXT 12 MONTHS? Shrink 17% 15% 11% Grow 55 58 67 Remain the same 28 27 22

HOW MUCH WILL IMPLEMENTING SARBANES-OXLEY AND OTHER NEW CORPORATE GOVERNANCE AND ACCOUNTING RULES COST YOUR COMPANY? Less than $50,000 10% 18% 30% More than $50,000, less than $150,000 9 12 18 More than $150,000, less than $500,000 19 21 19 More than $500,000, less than $1 million 17 14 14 More than $1 million, less than $5 million 32 29 14 More than $5 million 13 6 5 IS YOUR CAPITAL INVESTMENT EXPECTED TO INCREASE, DECREASE OR STAY THE SAME OVER THE NEXT SIX MONTHS? Increase 46% 49.3% 43% Decrease 7 5.3 9 Remain the same 47 45.3 48 OVER THE NEXT 12 MONTHS? Increase 56% 58% 56% Decrease 10 9 8 Remain the same 34 33 36 WHAT DO YOU CONSIDER THE SINGLE GREATEST THREAT TO ECONOMIC GROWTH IN THE NEXT 12 MONTHS? 12/04 6/04 The value of the dollar 16% 5% Oil prices 19% 10% Sharply higher interest rates 25% 25% Trouble in Iraq 17% 4% The threat of terrorism in the U.S. 18% 47% Inflation 5% 9% ARE U.S. POLICIES TOWARD IRAQ HAVING A POSITIVE OR NEGATIVE LONG-TERM IMPACT ON? Positive 10% 7.4% 12% Negative 61 56.4 43 Neither 29 36.2 45 USING AN INDEX OF 100, HOW CONFIDENT ARE YOU ABOUT THE STATE OF FOR THE NEXT SIX MONTHS? 100=very confident; 1=very pessimistic Average 70% 77% 71% DOES YOUR COMPANY PLAN ADDITIONS, REDUCTIONS OR NO CHANGE TO ITS WORKFORCE IN THE NEXT 12 MONTHS? Add to workforce 47% HOW CONCERNED ARE YOU ABOUT THE FUNDAMENTAL STRENGTH OF THE RETIREMENT SYSTEM IN THE U.S.? 5% 35% Reduce workforce No change 18% 35% 0 10 20 30 40 50 Very concerned Somewhat concerned Not concerned 60% DO YOU EXPECT THE DOLLAR TO BE STRONGER OR WEAKER AGAINST THE EURO OVER THE NEXT 12 MONTHS? Stronger 32% 52% 44% Weaker 50 25 35 Remain the same 18 23 21 DO YOU EXPECT THE DOLLAR TO BE STRONGER OR WEAKER AGAINST THE YEN OVER THE NEXT 12 MONTHS? Stronger 35% 45% 40% Weaker 44 27 34 Remain the same 21 29 26