The Obama Budget: A Delicate “Balancing Act”
February 2nd, 2010 . by economistmomThe Obama Administration released their FY2011 budget proposals on Monday morning. I’ll be analyzing it further over the rest of this week, but in listening to the President’s remarks about it (video above) and from my initial read on how the whole budget is being pitched to the American public, it strikes me that the Administration is playing a very delicate “balancing act”–pun intended.
On the one hand, the Administration wants to appear sufficiently concerned about the short-term economy by proposing deficit-financed stimulus spending and tax cuts. On the other hand, they want to appear sufficiently committed to fiscal responsibility and the idea that the government will get back to living within its means once the economy has recovered. These are not inconsistent fiscal policy goals to be pursuing (even simultaneously), and in fact, concentrating on stimulus or deficit reduction alone would pose greater risk to the economy. But it is still a challenge to find the optimal balance between these goals.
And on the one hand, the Obama Administration likes to blame the Bush Administration for the deficits they inherited. But on the other hand, the Obama Administration continues to propose not only the extension of Bush policies in their own budget, but the deficit-financed extension of Bush policies in their own budget. So they are choosing to continue the very behavior they have condemned, instead of coming up with their own (and better) behavior. This is another delicate balancing act in terms of the “selling” of the Obama budget to the American people as something “new and improved” from the supposedly-awful Bush budgets of the past.
Related to both of these “balancing acts,” I worry that with all the Obama Administration’s recent emphasis on small business tax cuts as promoting “Main Street”-type business (versus evil “Wall Street”-type business), that pretty soon the Obama Administration will be convinced (by the Republicans with whom they’re trying to reach out to in the spirit of bipartisanship) that they can’t even let the upper-income Bush tax cuts expire, because those rich individual taxpayers became rich from their small businesses. Might all of the “fiscally irresponsible and economically ineffective Bush tax cuts” become the “economically responsible and fiscally harmless Obama tax cuts” in the end?
So here’s how budget director Peter Orszag blogged about the budget on Monday morning. In terms of the fiscal responsibility goal, Peter laid out the Administration’s strategy as involving four key elements. I’m for all these ideas in principle, and I’m glad to see them in the Obama budget. But I’m worried about how they’ll work out in practice.
- Reinstate the statutory pay-as-you-go rules to avoid new commitments to deficit-financed spending. Peter explains that such rules worked during the Clinton Administration and that: “PAYGO forces us to live by a simple but important principle: Congress can only spend a dollar on an entitlement increase or tax cut if it saves a dollar elsewhere.” The problem is that the Administration’s concept of PAYGO (and embraced by Congress, albeit only in “unipartisan” manner) exempts over $3 trillion worth of (what would have to be newly enacted) policies, according to the Administration’s own numbers in Table S-7 of their budget; these exempted policies include AMT relief, extension of the bulk of the Bush tax cuts, and the Medicare “doc fix” (to avoid scheduled cuts to physician payments). While the Administration isn’t proposing to extend all of the Bush tax cuts, they do propose to extend and deficit finance and exempt from PAYGO about $2.4 trillion out of the $3.1 trillion ten-year cost for the full complement.
- A “non-security” three-year discretionary spending freeze and some tax increases (on the rich and on fossil fuels) to get part of the way toward a sustainable budget deficit within the ten-year budget window. As Peter explains, these proposals could theoretically get deficits down to about 4 percent of GDP (vs 5 percent without them) by 2015. But realistically and relative to current law, there’s just not much to grab onto here. The spending “freeze” is not an across-the-board freeze, but more a bottom-line freeze–and is expected to save $250 billion (over ten years). Of the tax increases Peter mentions, the largest (worth nearly $700 billion) would not reduce the deficit relative to current law because they are the high-income portions of the already-scheduled-to-expire Bush tax cuts, and the second largest (worth nearly $300 billion) is for the provision to limit itemized deductions–the proposal that Congress immediately rejected when the Administration presented it in last year’s budget. (That this year it’s not being proposed as a way of funding health care reform isn’t going to make any difference.) The proposals to reduce tax expenditures currently given to fossil fuels industries makes good policy sense (for both economic and environmental reasons), but these provisions would raise only less than $40 billion over ten years.
- A presidentially-appointed, bipartisan fiscal commission to get the rest of the way there. Peter explains that getting deficits down to 4 percent of GDP based on steps 1 & 2 above isn’t good enough to get to “sustainable”–that a commission will have to figure out the policies to get us the rest of the way down to 3-percent-of-GDP deficits. The goal according to Peter? (emphasis added): “to look at a range of proposals and put forward a bipartisan recommendation to balance the budget excluding interest payments on the debt by 2015.” I think the first goal of the commission ought to be to help the President utter the phrase “higher taxes” (or at least “revenue enhancements”?) so that the tough choices can begin to be discussed in an open manner. Whether telling it like it is about the need for everything (tax increases and spending cuts) to be on the table would be consistent with the goal of forming a truly bipartisan commission remains to be seen. After all, the President needs to appoint this bipartisan commission because Congress can’t even agree in a bipartisan manner on the formation of such a commission–let alone on the tough choices the commission would consider and recommend.
- Enact health care reform for longer-term sustainability. (Well, we’ve seen how easy this part is…) Peter’s always been right that it will be absolutely essential that we start “bending” the health care cost curve as soon as possible if we hope to achieve fiscal sustainability well beyond the ten-year budget window. But this–and in fact entitlement reform more generally–has little to do with the goal of getting the deficit down to 3 percent of GDP by 2015.
So there is a lot for the Obama Administration to juggle and “balance” in this budget, in terms of the short-term versus longer-term economic goals, the continuation of Bush policies versus the fresh start of Obama policies, and speaking the easy “happy talk” versus telling it like it is about the necessary hard choices. It will take courageous and forceful leadership on the part of President Obama to get this right. Good intentions and ideas aren’t going to be enough.
(In response to the release of the budget, the Concord Coalition released this initial statement and posted these further observations on the “Tabulation” blog on Monday.)
Having not been on this blog during the last administration, I can’t decide whether the post above is just kind or partisan. Let me put the four points Diane makes into plain speak.
1. Although PAYGO in concept is a good idea, the current version of PAYGO excludes to many things as to make it an ineffective instrument of policy. Furthermore, PAYGO makes a lot more sense when you are starting close to balance than it does as a plank of a deficit reduction policy. It’s more a deficit nonexpansion policy.
2. The spending freeze is actually on a small part of the budget and, even on this part of the budget simply holds this spending to the rate of inflation which is already the growth rate it sits at in the CBO baseline. The proper implication of the “freeze” is that the other parts of the budget are not frozen and will therefore grow faster than the CBO predicts, resulting in the administration’s spending proposals exceeding the CBO baseline by $500 billion.
3. The bipartisan commission is a good idea, the administration’s proposal is a less good one for two reasons. First off, the target for budget reduction is not the right target. 3% of GDP in a full employment economy is an insufficient target for serious budget management. Second, there is still a chance (a chance because details are still forthcoming), that the commission will not be bipartisan at all.
4. While Peter’s point about health care is conceptually correct, there is nothing in the current bill that will materially restrict the growth of health care spending. In point of fact, the Medicare trustees have estimated that health care spending would be higher under the Senate bill (old version) than would have been the case under current law. Yes, this comes with more coverage, but, if the point is to control spending then the control of spending is the proper metric.
Thus, we had better hope that the budget meets the first part of the President’s balancing act because it has no chance of doing the second.
Diane,
Re: the exemption of extension “the bulk of the Bush tax cuts” from PAYGO, is it correct to assume that not only does this exemption mean that the exempted Bush tax cuts need not be offset to be extended, but also that any of these exempted Bush tax cuts that eventually are reversed can be used as “offsets” for otherwise non-offset sending increases or tax reductions, so that the latter can comply with PAYGO rules?
To use a simplified illustration, suppose:
1. Total spending* is currently $100.
2. Bush tax cuts representing $30 are extended under two scenarios:
Scenario #1 in which those extensions are NOT exempted from PAYGO and Scenario #2 in which those extensions ARE exempted from PAYGO.
3. Those exempted Bush tax cuts are later reversed, increasing revenue by $30.
In Scenario #1, spending must decline now by $30 to $70 and the deficit thus reduced by $30. Later, when those extended Bush tax cuts are reversed and revenue increases by $30, spending can be increased to $100 (with no change in the deficit at that time).
In Scenario #2, spending can remain at $100 (so no deficit-reduction), and later when the extended Bush tax cuts are reversed and revenue increases by $30, total spending can be increased to $130 (because the $30 of revenue derived from reversal of those tax cuts can now be called “offsets” for incremental spending).
So Scenario #2 (exemption of the extension of the Bush tax cuts) not only means that PAYGO allows for the deficit to be permanently $30 higher, but also allows for total spending* to increase by as much as $30 if those tax cuts are later reversed.
* Technically referring to total spending in categories to which PAYGO applies, but if we hold spending in other categories constant for this illustration (i.e., ceteris paribus), it can refer to total overall spending.
Is the above correct?
RE: my illustration above, I’m assuming that the extension of those Bush tax cuts, if not exempted, would be offset via lower spending rather than via $30 in increases in other taxes (the latter would increase overall taxation by $30 anyway, but via other taxes rather than reversal of those Bush tax cuts).
And Brooks’ illustration, and the complexity of it (despite the fact it’s well written), illustrates why partial PAYGO, when starting from a deficit, is not worth it.
It gets you into the same problem as the health care bill which is “paid for” by a bunch of revenue and cost offsets that do not require the bill to come about. In effect, it means that you take money out of your left pocket to pay a bill in your right one. Of course, the bill in your left pocket that the money was intended to pay in the first place is still there….
I guess the new misleading Administration talking point du jour (or unfortunately for my sanity, du an) is:
“PAYGO forces us to live by a simple but important principle: Congress can only spend a dollar on an entitlement increase or tax cut if it saves a dollar elsewhere.”
Um, well, except for increasing discretionary spending or tax expenditures (the latter being essentially spending subsidy entitlements usually masquerading as tax cuts, but apparently in this case masquerading as “nothing to see here, folks — move along now”.)
Said differently, PAYGO, starting from a $1.3 trillion deficit virtually guarantees that the deficit will not go down since any pain that would take the deficit down will instead be used to create gain somewhere else. The deficit won’t decline but since the new spending or new tax advantages are “paid for” they aren’t bad. There’s no consideration of the counterfactual here.
As I said once long ago, CBO scoring needs to be changed so that the only offsets that are considered in “scoring” are those that are germane to the policy in question. Thus, you could use permit offsets to raise revenue to cover the increased energy costs in cap and trade because without the bill, there would be no market for offsets.
You can’t use tax increases on health care policies or reductions in Medicare spending however to offset the extension of health care benefits because those policy choices are available under current law and could be used instead to reduce the deficit.
I’m all for PAYGO once we are (close to) a balanced budget. From where we are today, PAYGO is a method to freeze (excuse the word), the current, highly unbalanced situation.
One correct Brooks, I suspect it’s “des ans” rather than “du an”. Sorry for your sanity (and mine as well)
Oops, meant correction of course
Steve,
On the French, I wasn’t sure because I don’t speak French. I looked it up and saw “an”. I know (think) “ans” is plural (I recall seeing this back in 1989, the 100 year anniversary of the Eiffel Tower http://fineartamerica.com/images-medium/eiffel-tower–100-ans-alison-falivena.jpg). Are you sure “ans” is correct in that phrase?
By the way, your need to correct the typo on “correction” reminds me of how my girlfriend, whose first language is Cantonese, used to mispronounce “pronunciation” as “pronounciation”. I told her that’s probably one word she shouldn’t mispronounce.
(As a note, I don’t mean to imply any disrespect for immigrants who have learned a new language; on the contrary, I appreciate and respect it. And as someone who learned Spanish through study and some time abroad — and who has always envied those who learned second languages just by growing up in a bilingual environment — I appreciate the great difficulty of getting even close to the fluency of native speakers.)
Steve,
I disagree that even a weak PAYGO is necessarily “not worth it” in terms of direct effect on budgets. Even though it is, as you say, “swiss cheese” (and I would note again the significance of the exclusion of tax expenditures, in addition to discretionary spending, the Bush tax cuts, AMT, and doc fix), it is still plausible that it could induce some degree of fiscal restraint (for example, Congress may have thought twice about these absurd, pandering, irresponsible $250 checks to Social Security recipients to help them cope with not getting cost-of-living adjustments simply because they had no increase in “cost of living” to which to adjust; Similarly, it could make the difference at some point between enacting or not enacting a deficit-financed expansion of healthcare entitlement subsidies).
As you know, I too have a low opinion (to say the least) of the rhetorical use of the term “offsets” vs. actual effects. But if requiring “offsets” means either a bit more fiscal discipline than would otherwise occur and/or has the effect of inevitable tax increases or spending “cuts” occurring sooner rather than later, I’d rather have that requirement (even in very limited form) than not have it.
All that said, if it creates the false impression of bringing or representing a much larger degree of fiscal responsibility and in turn shields the politicians from serious action for years, it is harmful rather than helpful on balance. But that’s how I see the two sides of the scale of desirability: a potential direct effect of some degree of unknown degree of fiscal responsibility vs. the potential indirect effect of delaying more substantive action by easing political pressure.
In aviation there’s a phenomenon called the coffin corner. If you fly too slowly, airflow over the wing will “stall” and you will lose lift. If you fly too fast, approaching the speed of sound, the airflow will separate from the wing, losing lift. This latter effect is called Mach buffet.
Because of these effects, you must fly faster than the stall speed but lower than the Mach buffet speed. the problem is that the stall speed increases with altitude, and the Mach buffet speed decreases with altitude. If you fly high enough, the two limits cross and there is no speed at which the aircraft can maintain lift. The term “coffin corner” refers to the zone near this crossing point on the graph of speed limits vs. altitude.
Pilots who like to ride the edge by flying very high, where the two speed limits are close to each other, risk losing control of the aircraft if any upsetting event occurs. For example, encountering a sudden headwind can cause the Mach limit to be exceeded. Once the aircraft loses lift at high altitude, recovery can be difficult to impossible.
By analogy, our government’s spending has been flying far too high. If we raise taxes beyond the historical limit of 20% of GDP, the economy will shrink. If we borrow or print money, interest rates will increase, causing the economy to shrink. A shrinking economy will make the predicament even worse.
The only way out is to reduce spending smoothly and immediately, while we still have control. Otherwise economic forces will send government spending into an uncontrolled dive. The government’s social safety net will be destroyed.
This is what progressives are failing to foresee.
Flying high is nice, but flying lower beats crashing. The only exception is when you are flying over a thunderstorm, as Air France 447 apparently did. That’s something a pilot should never do, because if your balancing act fails, you fall into the thunderstorm with no hope of regaining control.
AMT,
Your argument is dependent on an assumption of the degree to which taxation above 20% of GDP would reduce GDP growth (or per your apparent, more extreme assumption, make the economy shrink). I’d be interested in seeing whatever analysis you can share to support your assumption. Without it, one cannot know if your argument is “garbage in, garbage out” — a logical argument based on an invalid key premise.
I guess my sense is there is no magic number. I do believe that converting capital from private distribution to public distribution through taxation and spending reduces the efficiency of the deployment of that capital outside a limited set of areas.
If this is the case, higher spending is worse for the economy than lower spending. Having said that, I’ve never seen an analysis that says there’s a magic number like 20% above which we fall off a cliff.
Steve and AMT,
In The Tyranny of Dead Ideas, Matt Miller has a chapter in which he disputes the assumption that higher taxes will hurt the economy, writing “America’s taxes and spending can rise substantially from where they are today with little or no impact on the economy.” And I don’t think he means as a net result of the benefits of lower deficits and debt. You can read his arguments, for whatever their worth. I take them with a huge grain of salt, not just because I don’t find the arguments and analytical points themselves convincing (they leave open too many questions), but because he may have a liberal bias and/or less than fully sincere due to an agenda — he is a senior fellow at the (liberal) Center for American Progress. Also his formal economics education is not as great as that of most of the experts to whom we look on such questions — he has a B.A. in economics (magna cum laude, Brown University), but no advanced degree. (Of course, a good journalist can often present a strong case by appropriate use of experts even if he lacks expertise.)
For greater expertise and quite possibly greater objectivity, I recommend a different view from Nariman Behravesh in Spin-Free Economics
In honor of Len Burman’s excellent op-ed today and Diane’s excellent posts on the important subject of “tax expenditures”, those spending subsidies masquerading as lower taxes http://www.washingtonpost.com/wp-dyn/content/article/2010/02/01/AR2010020103072.html, I have refined (below) my “true meaning” translation of that excerpt from Obama’s SOTU speech:
We also took MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD TAKE steps to get our economy growing again, save as many jobs as possible, and help Americans who had become unemployed.
That’s why we MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD extended or increased unemployment benefits for more than 18 million Americans; MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD made MAKE health insurance 65 percent cheaper for families who get their coverage through COBRA; and MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD passed 25 different tax cuts, MOSTLY NEW SPENDING ON SUBSIDIES IN THE FORM OF TAX EXPENDITURES.
Now, let me repeat: We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD cut taxes, MOSTLY REALLY NEW SPENDING ON SUBSIDIES IN THE FORM OF TAX EXPENDITURES. We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD cut taxes SPEND TODAY ON SUBSIDIES for 95 percent of working families. (Applause.) We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD cut taxes for small businesses. We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD cut taxes SPEND TODAY ON SUBSIDIES for first-time homebuyers. We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD cut taxes SPEND MORE TODAY ON SUBSIDIES for parents trying to care for their children. We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD cut taxes SPEND TODAY ON SUBSIDIES for 8 million Americans paying for college. (Applause.)
I thought I’d get some applause on that one. (Laughter and applause.)
As a result, millions of Americans had more to spend on gas and food and other necessities, all of which helped businesses keep more workers. And we haven’t raised MADE FUTURE TAXPAYERS PAY MORE INSTEAD OF RAISING income taxes by a single dime on a single person. Not a single dime. (Applause.)
Because of the steps we took TO MAKE FUTURE TAXPAYERS PAY MORE, there are about two million Americans working right now who would otherwise be unemployed. (Applause.) Two hundred thousand work in construction and clean energy; 300,000 are teachers and other education workers. Tens of thousands are cops, firefighters, correctional officers, first responders. (Applause.) And we’re on track to add another one and a half million jobs to this total by the end of the year.
The plan that has made all of this possible, from MAKING FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD HAVE the tax cuts THAT ARE MOSTLY SPENDING ON SUBSIDIES to MAKING FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD HAVE the jobs, is the Recovery Act. (Applause.)
Darnit, my strike-throughs in word (on which I wrote it out) don’t show up here. I used strike-throughs to adjust tenses and put a line through “tax cuts” several times when replacing with “SPEND MORE TODAY ON SUBSIDIES”. Looks better with the strike-throughs. I’ll check later on how to do that with html tags.
testing
strike-throughtagok, hopefully this will work re: the strike-throughs. Again, an excerpt from Obama’s SOTU speech, refined further to reflect the “subsidy spending” true nature of tax expenditure “tax cuts”.
We also
tookMADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD TAKE steps to get our economy growing again, save as many jobs as possible, and help Americans who had become unemployed.That’s why we MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD extend
edor increasedunemployment benefits for more than 18 million Americans; MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULDmadeMAKE health insurance 65 percent cheaper for families who get their coverage through COBRA; and MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD passed25 different tax cuts, MOSTLY NEW SPENDING ON SUBSIDIES IN THE FORM OF TAX EXPENDITURES.Now, let me repeat: We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD cut taxes, MOSTLY REALLY NEW SPENDING ON SUBSIDIES IN THE FORM OF TAX EXPENDITURES. We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD
cut taxesSPEND TODAY ON SUBSIDIES for 95 percent of working families. (Applause.) We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD cut taxes for small businesses. We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULDcut taxesSPEND TODAY ON SUBSIDIES for first-time homebuyers. We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULDcut taxesSPEND MORE TODAY ON SUBSIDIES for parents trying to care for their children. We MADE FUTURE TAXPAYERS PAY MORE SO TODAY WE COULDcut taxesSPEND TODAY ON SUBSIDIES for 8 million Americans paying for college. (Applause.)I thought I’d get some applause on that one. (Laughter and applause.)
As a result, millions of Americans had more to spend on gas and food and other necessities, all of which helped businesses keep more workers. And we
haven’t raisedMADE FUTURE TAXPAYERS PAY MORE INSTEAD OF RAISING income taxes by a single dime on a single person. Not a single dime. (Applause.)Because of the steps we took TO MAKE FUTURE TAXPAYERS PAY MORE, there are about two million Americans working right now who would otherwise be unemployed. (Applause.) Two hundred thousand work in construction and clean energy; 300,000 are teachers and other education workers. Tens of thousands are cops, firefighters, correctional officers, first responders. (Applause.) And we’re on track to add another one and a half million jobs to this total by the end of the year, ALL AT THE EXPENSE OF JOBS, WAGES, AFTER-TAX INCOME, AND BENEFICIAL GOVERNMENT SPENDING IN THE FUTURE.
The plan that has made all of this possible, from MAKING FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD HAVE the tax cuts THAT ARE MOSTLY SPENDING ON SUBSIDIES to MAKING FUTURE TAXPAYERS PAY MORE SO TODAY WE COULD HAVE the jobs TODAY AT THE EXPENSE OF FUTURE JOBS (ETC.), is the Recovery Act. (Applause.)
Oh, and as I’ve noted previously, the above is not meant as opposition to or ridicule of fiscal stimulus, just of misleading, “all gain, no pain” semantics.