Saturday, August 29, 2009

Deficit projections: all of them gloomy, some more than others

The writing is on the wall. It's past time to face a reality harsher than most Americans, including some of the most financially astute, imagined a year ago.

The graph above comes from today's Washington Post, which shows multiple gloomy projections of the deficit. All scenarios are gloomy--some more than others, but all gloomy. It accompanies an article titled "Tax Pledge is a Target As Deficits, Debt Grow: Obama Advisors will not rule out tax hike."

Excerpts of that article are below. My comments are at the end.

During last year's campaign, President Obama vowed to enact a bold agenda without raising taxes for the middle class, a pledge budget experts viewed with skepticism. Since then, a severe recession, massive deficits and a national debt that is swelling toward a 50-year high have only made his promise harder to keep.
The Obama administration has insisted that the pledge will stand. But the president's top economic advisers have refused to rule out broad-based tax increases to close the yawning gap between federal revenue and government spending and are warning of tough choices ahead.
Obama, meanwhile, has vowed to pay for any new initiatives and to draft an overhaul of the health-care system that eventually would save the government money, driving deficits down. But effective health reforms would take decades to produce savings. In the meantime, White House budget director Peter R. Orszag acknowledged, "there are additional steps that will be necessary."
Treasury Secretary Timothy F. Geithner and White House economic adviser Lawrence H. Summers have both delicately sidestepped the tax question on Sunday talk shows. Orszag has also refused to discuss what steps Obama might take to reduce the deficit in the budget blueprint he will present to Congress in February. But budget analysts say he has few real options.
"If you rule out inflating our way out of the problem and defaulting on the debt, there are two ways: Cut spending or raise taxes," said William G. Gale, an expert on fiscal policy at the Brookings Institution. With more than 80 percent of federal spending devoted to politically untouchable programs such as Social Security, Medicare and Medicaid, he said, "it's going to be really hard to make significant headway on the spending side. So that means you've got to think about taxes."
Spending cuts were a big part of the solution the last time the nation faced such a towering debt. In the aftermath of World War II, with the debt exceeding the country's entire economic output, the government slashed military expenditures. Within two years, Washington was spending less than it took in. Fifteen percent inflation also helped by reducing the real value of the debt. When the country went to war again in Korea and then Vietnam, tax increases helped keep the budget largely in balance and the debt continued to fall.
Today's problem is more complex. Obama not only faces the fallout from the worst economic downturn in 30 years, but also inherited the debt piled up by his predecessor, Republican George W. Bush. Bush invaded Iraq and approved an expensive new prescription drug benefit for the elderly while pushing through one of the biggest tax cuts of the post-war era -- worth an estimated $1.6 trillion in foregone revenue by the time the provisions expire next year. This was the first time the United States had not adjusted its fiscal policy to meet its wartime needs, according to "The Price of Liberty," a book on war financing by Goldman Sachs vice chairman Robert D. Hormats.
After running surpluses in the late 1990s, the government began spending far more than it took in, forcing the Treasury to increase borrowing from China and other creditors. During the Bush administration, the portion of the debt held by the public jumped from just over $3 trillion to nearly $6 trillion. Federal rescue efforts in the face of last fall's financial meltdown have rapidly driven the debt higher. Today it stands at nearly $7.4 trillion, or about 52 percent of the overall U.S. economy.
"There's no question in my view that Bush was the most fiscally irresponsible president in the history of the republic," said David M. Walker, the comptroller general under Bush who now advocates for deficit reduction. Obama "was handed a bad deck," he said. "But the question is, are you making it better or not? And so far the answer is no."
Obama campaigned on a promise not to raise taxes for anyone earning less than $250,000 a year -- about 97 percent of taxpayers. As part of the pledge, he said he would keep some of the Bush tax cuts, including a new 10 percent rate for the lowest bracket, a higher tax credit for children and a lower penalty for married couples filing jointly. He planned to let other Bush tax cuts that benefit mainly the wealthy expire, a move that would raise rates for the top two income brackets. He also proposed to finance a major expansion of health coverage by placing new tax increases on the rich. When he unveiled his first budget, Obama predicted that his fiscal policies would stabilize the debt at around 70 percent of the economy.
This week, after updating the budget to reflect the depth of the recession, the White House conceded its earlier predictions had been wrong.

It's clear to everyone who has taken the time to look carefully at the numbers that tax revenues need to go up.

The question is how to make them go up in a smart way? Real economic growth would be a great way to generate more tax revenues, but there are no sure-fire recipes for that, especially with an aging population. Hyperinflation would drive up tax revenues, but that's not very smart, and would ultimately be counterproductive.

Leaving aside magical economic growth or hyperinflation, there are two alternatives to raise additional tax revenues:

1) raise tax rates

2) broaden the tax base by simplifying the tax code and getting rid of many of the bed buffaloes that create economic inefficiency and unfairness in our tax system

Both options are painful politically and will require some political strength. Option #2 is especially tough, because powerful special lobbying interests are behind each and every one of the bed buffaloes. The more we do of Option #2, the less we need to do of #1.

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