Thursday, February 26, 2009
A credible budget?
ON THURSDAY Barack Obama unveiled a draft budget that promises to cut the deficit from a vast $1.75 trillion in fiscal 2009 (which ends this September) to $533 billion in 2013, when his first term ends. As a share of GDP, the draft has the deficit falling from this year’s post-war high of 12% to just 3%. Is that promise credible? At a minimum, Mr Obama seems more fiscally honest than George Bush, whose accounting gimmicks vied with Enron’s. Mr Bush’s budgets routinely excluded unavoidable outlays, such as those for wars and natural disasters, incorporated tax increases and spending trims that he knew would never occur, and masked his policies’ impact on the deficit by shortening the forecast horizon to five years from ten. Mr Obama puts most of the missing items back in the budget, and restores its horizon to ten years. However, he undoes some of this laudable clarity with a rosy economic forecast. To boost revenue, Mr Obama will let Mr Bush’s 2001 tax cuts for the 2% of richest Americans (typically those earning more than $250,000) expire as scheduled at the end of 2010. Many popular tax deductions, such as those for local taxes, mortgage interest and charitable gifts, will be limited for the rich. A yet-to-be-designed cap-and-trade programme for carbon emissions will raise additional revenue starting in 2012. To curb spending, Mr Obama promises to remove most American troops from Iraq before the end of 2010, reduce payments to privately managed Medicare plans and farmers and find other savings. Mr Obama told Congress in will have to sacrifice some worthyhis address on the 24th that “everyone priorities for which there are no dollars. And that includes me.” Yet the evidence of such sacrifice remains scarce. He appears to earmark his tax increases and spending cuts mostly to pay for his long-standing priorities: making permanent the worker tax credit in the fiscal-stimulus plan; expanding public subsidies to reduce the number of those without health insurance (though no details have been provided) more money for parents, students, the disabled and the unemployed; investment in alternative energy; and extra deployments to Afghanistan. And he suggested that he will need more money to bail out banks than the $700 billion already authorised. A $250 billion facility is being set aside for this, one reason why this year’s deficit is so huge. Most of Mr Obama’s targeted deficit-reduction comes not from his own actions, but from the expiry of the stimulus, a halt to bail-outs, and the natural restoration of tax revenue as the economy pulls out of recession, growing by a robust 4% on average from 2010 through to 2013. And therein lies the biggest threat to the president’s plans. Mr Obama’s forecast is already more optimistic than the private sector consensus was in January, and that consensus has since become more pessimistic. Ben Bernanke, the Federal Reserve chairman, said this week that the recession would end this year only if the financial system stabilises, which so far it has not. A longer recession or long-term stagnation pose two distinct fiscal risks. First, Mr Obama will be (rightly) reluctant to raise taxes, and tempted to extend parts of the stimulus package if unemployment is not dropping by 2010. Premature fiscal tightening, after all, could lengthen the recession, as Japan learned in the 1990s. Second, a longer recession makes it harder for America to grow out burden as it, and other countries, have done at previous debtof its debt peaks. Because of stagnating output and declining prices, Japan’s nominal GDP in 2005 was smaller than in 1996, contributing mightily to a climb in that country’s net debt from 29% of GDP to 85% (it will reach 98% this year). One worrying parallel for America is that its nominal GDP will probably decline this year for the first time since 1949 (the administration optimistically sees it creeping up by 0.1%) So Mr Obama’s 3% deficit target may be much harder to reach than he thinks; and it may not be tough enough anyway. Using reasonable policy assumptions, Alan Auerbach of the University of California at Berkeley, and William Gale of the Brookings Institution, think the deficit will bottom out near 5% of GDP in 2013 then climb to almost 6% by 2019, while debt continues to rise as a share of GDP. That is before the government has to deal with the full impact of the surge in health and pension entitlement costs. The academics reckon higher taxes or lower spending equal to a staggering 8% of GDP a year are necessary to contain those costs and stabilise the long-run debt. Despite his inspiring rhetoric, Mr Obama’s plans for dealing with those long-term obligations have been frustratingly vague. He called on Americans to “address the crushing cost of health care” but proposes to spend many billions more, not less. He reportedly abandoned support for a commission to restore solvency to Social Security, the public-pension system, because congressional Democrats objected to this loss of their authority. He had a golden opportunity to introduce the idea of the rich and carbon-emitters paying higher taxes as part of a broad reform of a monstrously inefficient tax system, and so make the economy more productive. He passed it up. In fairness, these are early days in his presidency, and stabilising the economy needs to be his priority. The summit and the speech to Congress were just part of the essential process of softening up the public for the long, contentious chore of fixing entitlements and the tax system. It was also an opportunity for Mr Obama to counter the pervasive economic gloom that he himself engendered with his warnings of “catastrophe” if his stimulus plan was not passed. With the rhetorical flair for which he is famous, he asserted that Americans would triumph because “amid the most difficult circumstances”—his voice briefly descending to a warm and coaxing growl—“there is a generosity, a resilience, a decency”. As if to prove his point, legislators gave one of their longest ovations to Leonard Abess, a Miami banker in attendance who sold most of his bank for $927 million and gave $60 million of the proceeds to 471 current and past employees. Even amid the gloom, there are occasional flashes of light.