Saturday, February 13, 2010

Obama Budget proposals

President Obama's ten year budget proposals reveal the true extent of America's government debt crisis. As the Times reports, by President Obama’s own optimistic projections, federal government's budget deficit will peak at 11% of GDP in 2010 and will not return to what are widely considered sustainable levels (3% of GDP) till next ten years.

The budget projects that the deficit will peak at nearly $1.6 trillion in the current fiscal year (2009-10), a post-World War II record, and then decline to $1.3 trillion in the 2010-11 fiscal (starting October 2010), but will remain at economically troublesome levels over the remainder of the decade. Over 10 years, the budget is expected to save an estimated $1.2 trillion, mainly by ending the Bush tax cuts for the richest Americans and freezing some domestic spending for three years.

Obama's $3.8 trillion budget for fiscal year 2011 incorporates proposals to overhaul the health care system and energy policies, which are languishing in Congress. It also contains a $266 billion proposal on tax credits for hiring and new job-creation investments, and on other short-term stimulus including extended unemployment compensation.

As the Times writes, it does not make the really hard choices about entitlement programs — Medicare and Medicaid, especially — and about taxes that are essential to cut annual deficits and to begin paying down an accumulated debt (both domestic and foreign), which is forecast to equal 77% of GDP by 2020, the highest since 1950. The President has already proposed a widely criticized three year freeze on all non-defense discretionary spending to rein in the spiralling federal debt.

The real deficit picture is likely to turn out to be far worse, as this graphic shows, since in the last 30 years, about 80% of four-year budget forecasts have been too optimistic.

The budget has also been criticized for not doing enough to address the steep unemployment challenge and trying to put deficit reduction (through spending freeze) over short-term fiscal support to pull the economy out of the bottom. In fact, the budget proposals forecast the unemployment rate to be 9.8% at the end of 2010, 8.9% at the end of 2011, and 7.9% at the end of the Presidential election year of 2012.

Economix points to the figures on US government revenues and expenditures recently released by the Office of Management and Budget. Interestingly, even as the shares of individual income tax has remained stagnant, excise and corporate taxes have declined, payroll taxes (which includes Social Security and Medicare taxes) have become a much larger source of revenue for the federal government over the years.

On the expenditure side, the decline in defense has mirrored the worrying increase in health care expenses.

This superb graphic, courtesy Brad de Long, captures the reasons for the steep deficits. The Bush era tax cuts and its impact tower over all others, including the impact of the current recession. The Iraq and Af-Pak wars too have contributed substantially. In contrast and surprisingly, the fiscal stimulus appears to have had very limited impact, adding credence to the increasingly widespread belief that the Obama administration got too much caught up with barking down the wrong tree and not expanding the ARRA for fear of increasing the deficit.

As this excellent editorial in the Times points out, to seriously address the debt problem, President Obama will have to fix health care, broaden and raise taxes and reform social security. It estimates that given the rising health care costs and an aging population (and its impact on Medicaid, Medicare, and Social Security) without these serious reforms, federal debt in the United States would grow from 53% of GDP in 2009 to more than 300% by 2050.

The graphic above also clearly indicates that the stimulus spending has contributed only a miniscule share to the increased public debt burden. This also goes against the growing chorus that another round of stimulus spending will be suicidal in the efforts to unwind the debt burdens. As Joseph Stiglitz recently wrote, "The US economy needs another stimulus, and it needs it now."

Mark Thoma draws the distinction between the need for a short-run deficit to boost demand and reduce unemployment now, with the need to implement health care reforms to address the long-run imbalance in the budget. He writes, "Whether we spend more or less to fight the employment problem that exists right now has little to do with solving this (health care and long run imbalance) problem, and there's no reason at all for concern about the long-run problem to stop us from doing more now. No reason except deficit fetishness that refuses to separate the long-run health care cost problem from the largely independent short-run needs of those who are struggling to find employment in an economy that is still losing jobs."

Paul Krugman points to the annual President's Economic Report which shows that the stimulus fades out fast starting in fiscal 2011 (which starts in October 2010), even as unemployment being around as high as it is now. He feels that a premature stimulus exit (or not having another round of stimulus) has the danger of repeating 1937 when the FDR administration exit the stimulus when the economy had barely started to recover, thereby deepending the recession.

Update 1
The San Francisco Fed's economic outlook forecasts the persistence of economic output gap well into 2012.

Unemployment and GDP forecasts for the next two years are also available.

Update 2 (7/3/2010)
CBO report on the Budget and Economic Outlook is available here (see also a presentation here, pdf here)

Update 3 (17/3/2010)
David Leonhardt has an excellent summary of the need to balance between increasing taxes (increasing marginal tax rates etc) and cutting expenditure (health care reforms etc) in order to meet America's unsustainable public debt. Taxes fell from 21% of GDP in 2000 to a 60-year low of 15.1% in 2009.

This superb graphic clearly captures the difference between expenditure and revenues with projections for the next fifty years. As can be seen, the solution has to necessarily involve Medicare and Medicaid.

See also this NYT graphic and article on how the trillion dollar deficits were created during the last decade.

Update 4 (16/4/2010)
Via Mark Thoma

Update 5 (29/9/2010)

David Leonhardt summarizes the fiscal situation facing the US, "The bulk of the deficit problem instead comes from three popular programs, Medicare, Social Security and the military, and they happen to be the ones the Republican pledge exempts from cuts. But it’s impossible to fix the deficit without making cuts to these programs or raising taxes. To suggest otherwise is to claim that 10 minus 1 equals 5."

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