Obama's Fiscal-Discipline Trial Balloon

So it appears that Obama has floated a deficit reduction “plan,” and it seems like much deeper voodoo than anything we could have come up with. I use the scare quotes because, as always with this President, there’s no actual plan with details we could evaluate (and maybe criticize). All he did was float some ideas out to the Washington Post.

Call it Economic Management by Press Release.™

Peter Orszag, a capable guy that you wouldn’t make for a liar or a political hack, said that they’re going to cut the federal deficit in half by the end of Obama’s first term. That’s the political spin you’re supposed to take away from this: Fiscal discipline is something Republicans promise but Democrats achieve.

Except that Bush’s highest deficit was last year’s, at about $450 bn, or 3% of GDP. Obama’s first year in office will feature a deficit of $1.2 TRILLION, 8% of GDP, a post-WWII high.

WaPo says that cutting this deficit in half by 2013 would mean a deficit in that year of over $500 bn. The cut-in-half deficit we’re supposed to be all streamy about will be higher than that of any of the Bush years.

And they’re not even counting the stimulus plan and the increased debt-service payments from it! They could easily run a trillion dollar deficit in 2013 and say they kept their promise.

Ok, so much for political theater. On to brass tacks. Federal spending this year will be a whopping 26% of GDP, far above the postwar norm of about 22%, with tax collections about 16% of GDP. By 2013, Obama wants spending down to 22% and taxes up to 19%, for a deficit that would amount to about 2% of GDP or a bit less. I can’t make that figure tie out with Orszag’s projection of a $500 bn deficit unless you assume the economy is going to be growing at just about the fastest rate in history. Who knows, maybe they actually believe their own rhetoric.

It’s considerably more likely that the economy will not grow appreciably in real terms over the next five years. You can’t pump federal spending 4 or 5 percent of GDP above trend and not suffer major reductions in overall productivity. The government doesn’t invest, it spends. That’s one point.

The other point is that you can’t increase aggregate production in the economy unless you increase real rates of return on capital. And that’s the one thing this budgetary trial balloon doesn’t talk about. Let’s look at how they want to cut the deficit from 8% of GDP to less than 3% (keeping in mind that 3% was the high range of the Bush years, and the level that caused Democrats to eviscerate us in the campaign as fiscal profligates).

First, they want to defund the wars in Iraq and Afghanistan. Figure at the far outside, there’s $100 bn a year there. Next they want to fiddle with entitlement spending. Figure there’s a big fat zero there. Older people vote, and they have enough time to march on Washington and scare the living daylights out of Congresscritters in their home districts. Third, they want to let the Bush tax cuts expire. The only way for that to raise much money is for wealthy people to start making money again. With an economy on life support, on top of caps on executive pay, that’s not likely to happen. Figure there’s $100 bn/year there at the outside. Fourth, they want to treat the capital gains of investment managers as ordinary income so they can be taxed at a much higher rate. That will only cause those managers to pass the cost onto their limited partners in the form of lower investment returns. You might get some money out of that trick, but it will come back out as lower performance (and thus lower taxes) in the economy as a whole, so I’m calling that one a wash.

And what if they decide to go for broke and raise taxes heavily on all high earners? Even Democratic economists agree that this is a very effective way to keep a recession going.

I don’t see a way for this Administration to run a deficit any lower than one trillion dollars in any of the next four years. The very fact of extremely high federal spending as a share of GDP is self-perpetuating, because it keeps the private economy from recovering. Add the disincentive of higher marginal tax rates on top of that, and you’re just asking for more weakness.

At the rate we’re going, and given the advice he’s getting, Obama might find himself thinking that he might need to start a world war, to get us out of this mess. God forbid.