Obama's Trillions

The Obama Administration formally launched its budget blueprint yesterday. They did a masterful job of cultivating the press in pre-release preview commentary and by and large got a favorable hearing. Too bad, because this budget plan falls short in so many ways. My reflections on the plan:

1. How it works. The budget architecture is simple. There are a bit over $2 trillion in deficit reduction that come from (a) “cutting” Iraq/Afghanistan to $50 billion a year from an illusory baseline of hundreds of billions of dollars per year, and (b) enacting a cap-and-trade climate policy that auctions carbon emissions permits beginning in 2012. The remainder is over a trillion dollars of tax increases on upper income individuals (higher rates, higher capital gains taxes, taxation of carried interest) and businesses (ending deferral of overseas earnings, etc.) to fund additional spending (notably in education and energy) and tax credits (“making work pay,” EITC, etc.) for lower-income individuals – including those that have no income tax liability. There is also the “health care reform” gambit that I will discuss below.

2. Philosophy. This is a tax and spend budget document. As noted above, the spending reductions are largely illusory, the tax increases are real, and the redistribution is transparent. This should surprise nobody. President Obama had a liberal Senate track record, campaigned by promising budget goodies to a large number of constituencies, made raising taxes on productive individuals and their businesses a commitment, and explicitly promised low-income transfers.

3. It’s risks. This budget has enormous political and economic risks. As noted above, the spending reductions are illusory. In addition, the cap-and-trade revenues are an incredible political lift. There has never been a climate bill that auctioned 100 percent of the permits. There has never been a climate bill that passed the Senate. There has never been a climate bill that has been voted on the floor in the House. In short, there has to be an incredible shift in the history for this to happen in a timely enough fashion to get the $700 billion. Odds are that it won’t happen and the deficit will be higher.

Notice as well that the tax hikes on individuals and businesses are both politically difficult. The business community will react vociferously to ending deferral and the battle on taxing productive Americans and small businesses will be fierce. They are also economically dangerous. What if the economy is not strong by 2011? When the Obama Administration was defending the long-lived spending from the stimulus bill that arrived in 2011, 2012 and 2013, the argument was that the economy might still need stimulus. If so, why is it a good idea to hit it with a massive tax hike? In short, these revenue increases are risky.

In contrast, the tax credits and spending that the revenue will be transferred to are already on the books courtesy of the “stimulus” bill. Odds are that all the revenue will not show up, all the spending and transfers will not go away, and deficits are higher.

In short, there is nothing but upside political and economic risk to this budget. Deficits could be $1 trillion as far as the eye can see, debt will continue to pile up, our international creditors will get antsy, and a potentially-struggling economy will be festooned with a burden of excessive spending.

4. ­Meeting its goals. The Administration has made a great show of its “honest” budgeting. Some credit is certainly due, but I think this has been overdone. Nobody was fooled when the Bush Administration left Iraq and Afghanistan out of its budgeting or by pretending that the doctors would get huge cuts in payments for treating Medicare patients. The Obama Administration does show these items, but do we really believe that the costs will be $50 billion in 2011 and beyond? What is the difference between a “plug number” of $50 billion and a plug of $0? Either the budget shows the intended policy or not. Similarly, do we really believe that docs will never get a payment increase? And why is $250 billion the right number for the remainder of the financial bailout? Yes, the budget has a number for nearly everything, but the numbers themselves matter and not all of these are particularly informative.

The other major goal is to cut the deficit in half – to $533 billion – by 2013. As noted above, I think this is at risk. But it is also sensible to ask: is this the right goal? After all, taking the budget at face value, the economy is projected to be fine by 2013 (unemployment down to 5.2 percent), revenues will have recovered (and been raised substantially), and we will still have a deficit of one-half a trillion dollars? Given the looming debt explosion from the entitlement programs and the residual debt from the Bush years and the economic meltdown, a more aggressive target is in order.

5. Health Care Reform. The budget creates a $650 billion “reserve fund” for health care reform. Essentially, this is a commitment from the Administration to Congress that says “if you do health care reform, we will support shifting about $300 billion in other (largely health care) spending into health care and raising about $350 billion in new taxes.” Put aside the difficulty of paring back the deductibility of mortgage interest and charitable deductions and assume for a moment that this gives Congress money to spend on health care reform.

Now, I am a firm believer that we need health care reform, and I agree with the Administration’s notion that health care reform is part and parcel of taking on the Medicare and Medicaid entitlement explosion. But there are two parts to health care reform: (a) lowering the health care bill for individuals and the nation as a whole, and (b) providing financial assistance (insurance) to help cover individuals bills. It makes sense to undertake the reforms that will lower the overall bill (changes in practice patterns, better treatments for chronic diseases, etc.) and plow the savings into expansions in private health insurance. That is “cost reforms first” and “coverage expansion second.” This will work, but will be a slow and difficult process.

The health care reserve fund sends the wrong message and likely will lead to immediate coverage expansions – indeed the political pressure will be for budget-busting “universal” coverage – and coverage expansion centered in government programs. It would likely lead to even larger budget pressures; perhaps so large that it undercuts the momentum of reform and sets the U.S. back yet another decade in dealing with its most pressing domestic policy issue. That would be a serious misstep on the path to reform; one hopes that the Obama Administration will be flexible and serious about bi-partisanship in working with Congress on this issue.

Now the attention turns to Congress and how much it follows the lead of the new Administration. The Congressional Budget Office will put out its price tag for the new budget (look for it to conclude deficits are larger than advertised) and Congress will have to wrestle this aspirational document back to political reality.