James Pethokoukis

Politics and policy from inside Washington

Obama deficit panel veers dangerously off track

Oct 26, 2010 16:39 UTC

Here’s the problem with President Barack Obama’s deficit reduction commission: Exploding debt caused by out-of-control healthcare spending is an Extinction Level Event for the U.S economy.  By 2050, according to the Congressional Budget Office, the national debt will likely be three times as big as the overall economy with Medicare and Medicaid gobbling up half the budget.

And that’s not even the worst news. Such a fiscal path would cause an economic implosion long before 2050. Financial Armageddon. Yet the Obama panel almost certainly won’t come to agreement on any fixes for healthcare entitlements. Probably not Social Security, either.

But the group is eyeing $1 trillion in annual tax breaks as a way of cutting the budget. These “tax expenditures” include a variety of credits and deductions for federally favored activities. Many economists on both sides – and a few brave politicians – agree, however, that such favoritism introduces harmful market distortions.

While low interest rates and lax regulation had star billing in the American housing bubble, the $89 billion mortgage deduction in 2008 also was a supporting player. It’s also true an aging society and advancing technology are prime drivers of rising healthcare costs. But so too is giving related benefits a $131 billion annual tax break.

Let’s say America axed mortgage-interest deductions, child tax credits and the ability of employees to pay their portion of their health-insurance tab with pretax dollars. All these are mentioned in a Wall Street Journal story on Monday. Analysis by Americans for Tax Reform finds the net effect would be a $2.4 trillion tax hike over the next five years. (Mortgage interest deduction: $638 billion; child tax credit: $60 billion; exclusion for employer-provided health insurance: $1.66 trillion, including higher FICA taxes.)

Such a fiscal drain would surely put America back into recession, unless marginal tax rates were also lowered to compensate.  Cutting the total amount of tax expenditures by half might allow the top income tax rate to be cut from 35 percent to 25 percent.  That is what you want in an ideal, pro-growth tax system: low rates applied to a broad base.

The politics are treacherous. That’s why major reform hasn’t happened in a generation. Back in 1986, Congress agreed to eliminate scores of tax loopholes for individuals. But lawmakers wisely sweetened the bitter medicine at the last minute by lowering the top marginal tax rate by nearly half, making those breaks less valuable. Many businesses were also willing to accept fewer tax breaks and pay higher total taxes in exchange for a simpler code and a lower rate, although this didn’t make it into the final bill.

Obama’s panelists should draw on this experience. They could advocate trimming some of the $90 billion in annual business tax breaks and subsidies while also paring the tax rate on profits, currently the second highest among advanced economies. And if they want to trim tax breaks for individuals, sharply lower marginal rates should accompany.

Austerity alone won’t solve America’s debt problem. We also need to boost growth. Some on the Obama panel seem to have forgotten this.

COMMENT

Any free marketer should be against all these welfare giveaways. We use euphemisms like “tax credits” but in reality they are not different than entitlement payments. They distort the free marker and have one group of people (renters) subsidize another group (mortgage debtors).

If the new Congress is truly free marketers, they will eliminate all these unfair welfare giveaways.

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Midterms are already locked and loaded

Oct 26, 2010 14:02 UTC

I think John Podhoretz aptly sums it up:

We’ve had 18 months of data points from many different sources that all tell the same story: Americans who vote have radically changed direction when it comes to which party they prefer. In both 2006 and 2008, voters said they preferred Democrats by margins of 8 to 12 points, and on Election Day handed Democrats landslide victories. But Republicans have led in the so-called “generic polls” since March 2009 without letup — and the gap between the two parties has remained stable at a level comparable to the previous Democratic advantage. This means that, probably at minimum, 16 percent of the electorate has shifted from voting Democrat to declaring its intention to vote Republican. That is an astonishing degree of change, and it’s why you’ve heard so much talk about this being an unprecedented election.

This Intrade chart supports his point:

intrade

Austerity by default

Oct 26, 2010 13:55 UTC

Some folks want austerity in the worst way. They may just get it, says the NYTimes:

What could result is “deficit reduction by gridlock,” said John Podesta, the president of the progressive Center for American Progress and a chief of staff in the Clinton White House. That would be the outcome if Republicans, as expected, block additional unemployment aid and if the parties deadlock in the lame-duck session over pending appropriations and the Bush tax cuts that expire Dec. 31. That would leave lower spending levels in place for the fiscal year 2011 and force Mr. Obama and Republicans to try to reach a tax compromise next year.

Again, I find it hard to believe that Congress would ensure a recession by letting all the Bush tax cuts expire. I still think a deal gets struck in January.

Geithner’s view may be askew

Oct 26, 2010 13:35 UTC

Ed Yardeni thinks Tim Geithner is off point:

Tim Geithner thinks he can solve the world’s economic problems by getting countries with large trade surpluses to reduce their surpluses and by getting countries with large deficits to reduce their deficits. The problem is that fixing the world economy isn’t as simple as suggested by Mr. Geithner. Multilateral approaches rarely work because it is so hard to get universal agreement on what to do.

China’s competitive advantage has less to do with the foreign exchange value of its currency than the pitiful provision of social welfare by the nation’s government compared to the abundance of social welfare provided by the American government. This is the major source of the global economy’s imbalance. This is why the US trade deficit with China has totaled $1.8tn since December 2001, when China joined the World Trade Organization. That number contributed greatly to China’s record hoard of international reserves, which totaled $2.6tn during August. Think of that sum as the money that the Chinese did not spend on social welfare at home, but did so abroad, especially in the United States.

Problems must be recognized to be solved. There is, in fact, growing recognition of the causes of the global imbalance. The Chinese may be starting to move toward providing a better standard of living for their workers, though there is little discussion yet about providing a comprehensive social welfare safety net anytime soon. European social welfare states are moving to downsize their safety nets. In the US, the November 2 congressional elections will determine if Americans have the determination to bring back a modicum of fiscal discipline.

COMMENT

Chinese Supplier Survey: Yuan Appreciation Will Hurt Exports

We talk so much about how China needs to allow its currency, the renminbi (or yuan) to appreciate. We talk some about how an appreciation of the renminbi will bring back American jobs (by making Chinese exports relatively more expensive and U.S. exports relative less so) ­– though that is debatable. But we talk very little, if at all, about the effect of a renminbi appreciation on manufacturers, on workers, and on consumers in China.

It’s a gap I have been lamenting (and the reason we’re working to ask small and medium-sized suppliers in China what their perspectives are on U.S./China trade). So I was absolutely thrilled this morning to get a press release highlighting the results of a survey of Chinese suppliers. The bottom line? “China suppliers are convinced the yuan’s appreciation will affect exports negatively, even if the currency strengthens only 2 percent against the US dollar.” (It has already strengthened about that much since the summer.)

Find more survey results at http://futureofuschinatrade.com/article/ chinese-supplier-survey-yuan-appreciatio n-will-hurt-exports

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