Saturday, May 22, 2010


I will admit it. Although I cited Congressional Budget Office (CBO) figures in my last post, I did not read the report in any degree of detail. Having now looked over the figures in some detail, I am more sympathetic to people who are alarmed at our long-term financial system and Obama's big-spending ways and warn that they are unsustainable. But I am not prepared to let Bush off the hook either.

My old assumption was the Bush inherited a balanced budget and intentionally destroyed it with his tax cuts, creating a structural deficit. (The wars and Medicare D didn't help either). Then in 2008 the economy fell into severe recession, exploding the cyclical deficit. Obama added some short-term stimulus spending that temporarily raised the deficit even higher. But with the expiration of the stimulus and economic recovery, we will be back to the same structural deficit we had before recession hit.

In this I was not entirely wrong, but only partly right. The Bush Administration long disguised the full extent of the structural deficit they had created by claiming that its tax cuts would expire on January 1, 2011. The CBO dutifully made its deficit projections by assuming that this would happen. Not surprisingly, deficits were projected to drop considerably beginning in 2011.

The Obama Administrtion proposes to let the tax cuts on incomes over $250,000 a year expire, but to keep the tax cuts on all other incomes. This substantially increases the structural deficit, though not as much as if all the tax cuts were extended. This is not the only action that increases the deficit, but it is, the CBO comments, by far the biggest ticket item.

There are other changes as well. The most obvious one is health care reform but, if the CBO is to be believed, taxes to pay for it will essentially match expenditures (with a small deficit some years and a small surplus others). The Obama Administration also wants to index the Alternative Minimum Tax (AMT) so that middle income people will not slowly be pushed into the AMT by inflation. Let the record reflect that bracket creep is a regressive and oppressive way to raise taxes and I support indexation. Fortunately, the revenue loss from indexing the AMT is offset by various minor proposed tax increases, so the net effect is essentially zero.

Another accounting gimmick to disguise the full extent of the structural deficit is to mandate cuts in Medicare reimbursement rates. The Obama Administration eliminates this, acknowledging (in effect) that it will not happen. This raises the deficit by a modest but growing amount, reaching $45 billion by 2020. Various other spending increases are proposed, none all that large, but they add up. To partially disguise the full extent of the increased spending, the White House makes unrealistic assumptions about cuts in defense spending. Its proposals to freeze discretionary non-defense spending in the near term do not make even a minor dent in the deficit.

Still, treating health care reform as a wash and the AMT and other tax tweeks as a wash, the other spending increases don't seem all that large or disturbing. And, in fact, in the earlier budgets, the bulk of Obama's deficit increase seems to be holding onto the Bush tax cuts. Without them, the earlier deficit increases don't seem so large at all. But over time, they increase because of one deadly, deadly item -- interest on the national debt.

The most baneful effect of sustained deficits is the interest they run up over time. Ronald Reagans tax cuts did, in fact, starve the beast, but not in the way he intended. Government spending did not drop as a result of his tax cuts, but his large, sustained deficits did change its composition. As more and more of the budget became devoted to paying interest on the national debt, less and less was available for social programs -- or anything else. Of course, interest rates were higher in the '80's. Currently, interests rates on US Treasury Bonds are at all-time lows. Too low, in fact. They are a sign that investors are afraid of taking risks and fleeing to safety. But this will not continue. Sooner or later, the world economy will improve, and rates on US Treasury bonds will go up.

According to CBO estimates, if the Bush tax cuts are allowed to expire in their entirety and no other change is made in the budget, structural deficits will run between 2% and 3% of the GDP. Under the Obama projected budget, structural deficits will be between 4% and 5%. And, the CBO estimates, structural deficits in the 2-3% range are sustainable, while deficits in the 4-5% range are not. In effect, if the deficit stays at 2-3%, debt will stabilize between 60% and 70% of GDP because we will be able to pay off old debt as quickly as we accumulate new. Interest payments will remain stable. At 4-5%, however, debt will continually escalate, reach 90% of GDP by 2020 and then -- who knows. The result of this escalating debt is that more and more of the budget will be eaten up by debt service and less and less will be available for anything else. Bruce Bartlett estimates that debt service will consume 20% of revenues before 2020, causing interest rates to rise and forcing drastic budget cuts.

So, while I continue to defend Obama's current profligacy as necessary to jump-start the economy, once the economy is jump started, he needs to do a great deal more to cut the deficit. Allowing all Bush tax cuts, not just the top rates, is a good first step. We desparately need the revenue, and the Tea Party crowd will be more willing to let rich people be taxed if they know they have to pay too. ;-). Once that is done, it should be possible to get structural deficits down to a sustainable 2-3% with not-too-drastic modifications.

And what else do I suggest, either to bring the deficit down to 2-3%, or to eliminate it altogether? Off the top of my head, raise the ceiling for paying Social Security taxes, or eliminate it altogether. Raise the retirement age, phasing it up to 70. And, despite howls of protest about death panels, consider applying effectiveness research to Medicare.

But mostly I think I need to take the Budget Simulator.



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