James Pethokoukis

Will House Speaker John Boehner commit Republicans to raising $1 trillion in taxes as part of President Obama’s last-minute push for as much as a $4 trillion debt reduction deal? Obama and the GOP meet Sunday evening, but things continue to develop quickly:

1) Various news accounts Saturday morning made it sound as if Boehner was flirting with some convoluted deal where some taxes would be raised – including the high-end Bush tax cuts – but lowered later as part of major tax reform, with maybe some of the savings from fewer deduction going to reduce debt.

2) Then on Larry Kudlow’s radio show this afternoon, the WSJ’s Steve Moore said his paper’s reporting was accurate and the GOP were being “tempted” by this offer.

3) Then I got this from a GOP congressional source later in the afternoon:

WH is demanding major, unambiguous tax hikes. To get spending caps & entitlement tweaks, greater economic pain appears to be the WH’s asking price. It is increasingly likely that we aren’t going to see a ‘big’ deal if the WH doesn’t budge. Speaker looks to be holding strong. …

Their fierce insistence on higher taxes is beyond bizarre.

After months of demanding ‘clean’ increase to avert economic calamity (default), WH threatens economic calamity (default) unless they get economic calamity (trillions in tax hikes). No wonder these guys are governing over an economic calamity (9.2% & growth malaise), w an economic calamity on the horizon (debt explosion as mapped out in president’s budget).

[Update 7:39 PM] Appears that the basic framework for future tax reform could not be resolved.

The bipartisan consensus on tax reform (broader base & lower rates) was championed by President’s fiscal commission, and yet now is being rebuked by the President. Lowering top rates that would help make America more competitive was too large a leap for a true class warrior.

That Team Obama wants higher higher taxes is not news.  But the growing GOP allergic reaction is. I think these comments gives good insight into how the GOP perceives the evolving deal. And I hope that second part is true. Tax reform should only be done in the context of lowering marginal tax rates, especially if Democrats aren’t offering entitlement reform that would move things toward a more market-based system such as the one outlined in Rep. Paul Ryan’s bold and visionary Path to Prosperity.

I also doubt whether the spending cuts being offered by the Obamacrats are largely legit and not a manipulation of the CBO baseline by a) cutting defense spending that was never going to happen and b) pushing cuts to Medicare providers that Congress will later undercut. My best guess remains a smaller spending cut deal + no tax increases + a hike in the debt ceiling.

This is Obama in his weekly radio address today:

Both sides are going to have to step outside their comfort zones and make some political sacrifices,” Obama said. “And we agree that we simply cannot afford to default on our national obligations for the first time in our history.

Obama says he wants a big deal, maybe because he needs an economic win to counter the faltering economic recovery and deprive the GOP of the “big spender” line of attack in 2012. Maybe he is finally listening to Tim Geithner and Jack Lew.  It all reminds me of President Ronald Reagan and Soviet leader Mikhail Gorbachev at the 1986 arms control summit in Reykjavik, Iceland. Reagan walked away from a deal that would have eliminated nuclear ICBM’s in a decade because it would hobbled research into the Strategic Defense Initiative. Reagan was right to walk away then, and Boehner would be right to do the same now.

The media accounts of the tax reform deal being cooked up by President Obama and House Speaker Boehner aren’t all that clear. But it is looking like a big tax increase:

– The White House is insisting that as part of any deal the current tax rates on the middle class—the child tax credit, etc.—would be made permanent, while the lower rates on capital gains, dividends and the higher income brackets would expire after 2012. Taken by itself this would be a tax increase pure and simple and violate the GOP’s campaign pledge.

But here’s what we’re told is Mr. Boehner’s political kicker: The proposed deal would also include some kind of “trigger” device, so far undefined, that would compel House and Senate negotiators to complete tax reform discussions over the next several months. We’re told the White House has said it is open in principle to a top rate of 35% on individuals and something like 26% or 27% on corporations—in return for closing various loopholes.

More troubling than these details is the staggered timing. Republicans would be putting their fingerprints on a tax increase in return for spending cuts as a first order of business, which would raise the dividend and top income tax rates to 39.6% (from 35%), or 41% if you include the phase-out of deductions. (Plus the 3.8% payroll tax hike baked into ObamaCare.) Only then would Mr. Obama and the Democrats negotiate the details of tax reform and lower overall rates. (Wall Street Journal editorial)

– With House Speaker John Boehner’s encouragement, President Obama is pushing for congressional leaders to strike a far-reaching agreement to reduce the deficit by more than $4 trillion over 10 to 12 years, which would include more than $1 trillion in new revenues, officials said. (The Hill)

– Boehner would have to agree to revenue boosts through tax-code reform, including closure of loopholes then coupled with lower corporate tax rates, all of which is designed to spur economic growth. The new revenue could reach up to $1 trillion over a ten-year period, funds that could be used for deficit reduction. Boehner and his top aides insist there will be “no tax increases.” (Politico)

– Such a deal could go as high as an eye-popping $3 trillion in overall deficit reduction, but as much as $1 trillion would be in revenues: $700 billion from letting the Bush tax cuts for the highest income brackets expire and another $300 billion from increased revenues, from auctioning off frequencies, increased payments to federal pension plans and ending agriculture subsidies in addition to ending tax breaks such as deductions for corporate jets, yachts and race horses. The deal would come with a pledge, or clawback provision, to revisit comprehensive tax reform in the coming years so as to offset the higher taxes on the wealthy by eventually flattening and broadening the tax base. (Time)

All very confusing, but the best I can make of it is this: higher taxes now in exchange for a promise of tax cuts later to be “paid for” by reducing tax breaks/deductions/loopholes with perhaps some of that money going toward deficit reduction.

I can tell you this: Democrats need a lot more tax revenue to make their long-term budget plans works. This is why Obama has not offered a long-term budget plan. The need for massive tax increases would then be clear to all. In private, liberal economists all talk about a need for a value-added tax to raise the additional revenue.

But a liberal think with close ties to the White House, the Center for American Progress, recently released a budget plan that goes out to 2035. It shows taxes as a share of the economy rising dramatically to nearly 24% of GDP vs. around 18-19 percent historically. And I am guessing they would go even higher if the table went beyond 2035. If Boehner and the Republicans don’t hold the line now on taxes, this is the American future

When economists are expecting 100,000 or so net new jobs, and the Labor Department reports measly gains of just 18,000 (plus an increase in the unemployment rate to 9.2 percent), the reaction sounds like this:

– “All in all, an employment report with no redeeming features whatsoever – employment, unemployment, hours and wages all disappointed.”- Barclays

–  ”The June jobs report was a shocker. It was far worse than expected, and weak on all key dimensions – job creation, unemployment, the length of the workweek, and hourly earnings. The recent pattern of jobs suggests that the economy hit a brick wall in May.” — IHS Global

– “Overall the June Employment Report was quite disappointing, with basically no positive offsets to the poor headline results.” — Goldman Sachs

–  ”The June employment report was universally weak and undoes the modest improvement in the economic data we have seen over the last two weeks. We are back where we started; the risk of a cold summer, similar to last year, is palpable.” — BofA Merrill Lynch

–  ”It is hard to excuse this report on supply-chain disruptions and it suggests that growth momentum evaporated as the second quarter drew to a close.”- RDQ Economics

–  ”Unfortunately, leading labor market indicators like temporary help employment, aggregate hours worked and first-time jobless claims remain weak and thus do not suggest an imminent reacceleration in the labor market.” — MKM Partners

Indeed, if the labor force, which shrank again, was as big as it was when President Obama took office, the unemployment rate would be north of 11 percent. As it is, the broader U-6 measure surged to 16.2 percent from 15.8 percent. But with an economy growing at just 2 percent or so, expectations should be low.  If the economy picks up in the second half, so should job growth.

But we have a long way to go before getting the unemployment even back to 8 percent or so by Election Day 2012, needing some 255,00 jobs a month. Obama’s political team seems to think the unemployment rate does not matter. We shall see. At his new conference today, Obama offered plenty of excuses, including blaming uncertainty over the debt ceiling:

We’ve always known that we’d have ups and downs on our way back from this recession. And over the past few months, the economy has experienced some tough headwinds — from natural disasters, to spikes in gas prices, to state and local budget cuts that have cost tens of thousands of cops and firefighters and teachers their jobs. The problems in Greece and in Europe, along with uncertainty over whether the debt limit here in the United States will be raised, have also made businesses hesitant to invest more aggressively. The economic challenges that we face weren’t created overnight, and they’re not going to be solved overnight.

Hardly the stuff for a soul-stirring campaign ad. A few other observations:

1) Will Obama now make a renewed push for a payroll tax cut extension to be part of the debt ceiling negotiations?

2) Will Tim Geithner leave sooner rather later to be replaced by someone with a job-creation background like GE’s Immelt or Facebook’s Sandberg?

3) Will Rs dig in even further against raising taxes?

4) Will Obama’s approval numbers fall below the plateau they’ve sort of been stuck on (not counting the OBL  bounce.)

5) Will the weak economy nudge another GOPer to get into the 2012?

Why are Republicans demanding a debt deal that has big spending cuts but no tax increases? (Besides, of course, the fact that spending is the problem and the last thing this weak economy needs is a tax hike?) Maybe it’s because the last time they agree to one of these “$2 in spending cuts for every $1 in tax hikes” agreements, they got snookered.

An explainer from Americans for Tax Reform (which created the chart):

In 1990, President George H.W. Bush was promised $2 in spending cuts for every $1 in tax hikes by Congressional Democrats. That’s not what happened.

All $137 billion in tax hikes went through. Most notable was raising the top marginal tax rate from 28 percent (the Reagan low) to 31 percent (itself a setup for the 1993 Clinton tax hike of this rate all the way up to 39.6 percent). There were also increases in “sin” taxes and the Medicare payroll tax, as well as the yacht “luxury tax” that President Obama seems so intent on re-visiting on the jet plane manufacturers.

Not only did the $274 billion in promised baseline spending cuts never materialize–baseline spending was actually $22 billion higher than what CBO projected it would be before the deal. This despite another tax hike/baseline spending cut deal in 1993 (the Clinton tax hike) and the GOP takeover of Congress in 1995.

Larry Kudlow breaks it down, even has a chart!:

The blue line you see is President Obama’s budget. The green line is Congressman Paul Ryan’s budget.

Now, Paul Ryan’s is of course a couple of trillion dollars lower than Obama’s over the next ten years. But what do they both have in common? They both go up. As in spending more, not less. As in, roughly $40-45 trillion dollars more. That’s a whole lot of taxpayer money, folks. Now why is this? It’s because of something called the “current services baseline” which includes population and inflation increases built into the budget. Entitlements have their own formulas. So when you hear a politician tell you they’re cutting spending, they’re actually referring only to reducing the growth of spending. Rarely, if ever, do they actually reduce the level of spending.

Here’s yet another scam: big budget deals say they “cut” (there’s that word again) a couple of trillion dollars over ten years. But most of it is targeted for the last couple of years, as in years eight, nine, and ten. So basically it’ll never happen. It’s four or five congresses from now. Laws change. Deals are broken. At the end of the day, the only thing that really matters is next year’s budget. Will it be cut?

When I look at this budget stuff, I focus on spending, taxes, interest and debt as a share of the economy. That way I don’t get dragged down into the world of comparing baselines. Here, for instance, is how the CBO looks at the Ryan plan:

The WaPo’s Ezra Klein has cooked up a chart attempting to show previous debt deals had plenty of tax increases in them, even more than what Obama is demanding:

Klein:

As you can see on the graph, in each case, taxes were at least a third of the total, and in Reagan’s case, his massive tax cuts were followed by deficit-reduction deals that actually relied on tax increases. Today, tea party conservatives would be begging Sen. Jim DeMint to primary the Gipper. … The one-third rule doesn’t break down until you get to the deal Obama reportedly offered Republicans in the first round of debt-ceiling talks: $2 trillion in spending cuts for $400 billion in taxes, or an 83:17 split. And that, if anything, understates how good of a deal Republicans are getting.

This isn’t going to persuade conservatives of anything, the bit about Reagan in particular. The Gipper was promised big spending cuts in 1982 that never materialized. And the Bush deal has gone down in infamy among those on the right. Here is Grover Norquist:

The spending interests in Washington, D.C., convinced President Ronald Reagan in 1982 that they would cut $3 of spending for every $1 of tax increase that Reagan would permit. The tax hikes were real, painful and permanent; the spending restraint never materialized. Then only eight years later, the same spending interests concocted the infamous Andrews Air Force Base budget summit that negotiated a supposed deficit reduction deal with President George H.W. Bush. It was to cut spending by $2 for every dollar of tax increase. Again, the tax hikes were real and spending increased more rapidly after the deal than before.

As for the Obama offer, I have no idea what that red line is supposed to represent. How much, for instance,  is baseline tinkering due to the wind down of the wars in Iraq and Afghanistan? That could account for as much as $1.4 trillion of the $2.0 trillion in cuts Obama is offering. Permanent tax increases in exchange for accounting chicanery?

One of the outside economic-analysis firms that the White House likes to quote is Macroeconomic Advisers. Here’s what the firm said yesterday about where the U.S. economy is heading (bold is mine):

Assuming current fiscal policies remain in force, our economic model suggests that interest rates will rise considerably over the next decade, with the yield on the 10-year Treasury note reaching nearly 9% by 2021.

– Private interest rates will rise as federal borrowing competes for saving that might otherwise finance private investment.

– In addition, yields could rise if there is growing risk associated with current fiscal policy.  If such risk is systemic, it raises yields generally.  If it reflects a growing probability of sovereign default, it raises Treasury yields relative to private yields.

– Rising rates would be a precursor to something worse: a full-fledged fiscal crisis with further sharp increases in yields, declines in stock prices, and a plummeting dollar.

This is bad. Really bad. The official budget forecasts ones typically hears about in the media are from the Congressional Budget Office. And those forecasts assume Uncle Same can borrow at low interest rates, like, forever. The super-cautious CBO baseline predicts the U.S. government will add an additional $6.8 trillion in debt over the next decade, bringing cumulative debt held by the public to $18.2 trillion. Debt as a share of the economy would be 76.7 percent. The forecast also assumes short-term interest rates average 3.3 percent, long-term 4.8 percent.

But MA thinks long rates will hit 9 percent. This would cause U.S. indebtedness to explode. The CBO, at the request of Rep. Paul Ryan, recently looked at how various interest rate scenarios would affect U.S. debt (chart and graph via the Committee for a Responsible Federal Budget):

Note the scenarios that has interest rates at close to 9 percent. It would add an additional $5 trillion to the national debt by 2021. That would push the U.S. debt-to-GDP ratio to an alarming 98 percent of GDP.

But those calculations tend to understate the problem because they are based on the CBO’s baseline forecast. Its “alternative fiscal scenario” – which many budgeteers think is a more accurate – assumes debt-to-GDP will already be 101 percent in 2021.

But again, this is assuming low interest rates. The MA scenario could push that level even higher. And again, this also assumes all that debt would not effect economic growth. Here is how the CBO says various economic variables affects its forecasts

CBO estimated that 1 percent higher interest rates each year could increase deficits by $1.3 trillion over ten years. CBO also estimated a few other “rules of thumb” to show how changes in inflation and economic growth have significant impacts on budget forecasts. The projections show that lower economic growth of just 0.1 percentage point each year could increase deficits by $310 billion over ten years, while 1 percentage point higher inflation each year could add almost $900 billion to deficits.

Turns out, the CBO looked at how at the deluge of debt from its “alternative fiscal scenario” would impact the economy (and, in turn, total indebtedness). The results are absolutely frightening:

Of course, the U.S. would have a debt crisis long before we hit that 250 percent of GDP level. And if MA is right,  the crisis might come sooner rather than later.

The president says it’s time to go big (via Reuters):

After weeks of impasse, President Barack Obama and top congressional leaders are aiming for “something big” as they resume budget talks on Thursday to avert an imminent default. With Republicans showing new flexibility on taxes, Democrats say Obama will push negotiators to double their target to $4 trillion in budget savings over 10 years. That would be an ambitious goal, but there have been a few hints of progress since talks hit a brick wall two weeks ago.

1) If Obama wants a $4 trillion debt reduction package, how about the one his own debt commission produced last December:

2) But I don’t think Obama will agree to  or propose anything as sweeping as that. Instead, I would expect more than $1 trillion in savings from defense cuts, most of which will be tweaking the baseline of projected spending, which assumed perpetual war in Iraq and Afghanistan. Along with interest savings, that would be put you right around $2 trillion. Republicans may be offering $200 billion in new revenue from user fees and asset sales.

3) So how to close the remaining gap of roughly $2 trillion? Maybe another $400 billion in Medicare and Medicare savings.  And tweaks in how you measure inflation for Social Security benefits and tax brackets gets you another $150 billion, assuming Rs don’t view that as a tax hike.  And in his April speech, Obama called for $770 billion in non-security discretionary spending cuts over 12 years. To me, it still looks close to $1 trillion gap.

4) And recall that Obama’s debt speech which called for $4 trillion in debt cuts over 12 years would actually cut debt by just $2.5 trillion over ten years.

Let’s keep in mind that if President Obama had his druthers, the debt ceiling would’ve already been raised some $2 trillion via a “clean vote” in Congress. No spending cuts. Yes, I know  Obama said the following this earlier this week:

I believe that right now we’ve got a unique opportunity to do something big — to tackle our deficit in a way that forces our government to live within its means, that puts our economy on a stronger footing for the future, and still allows us to invest in that future.

But that’s Obama trying to make it sound like it was his goal all along to link a debt-limit bill with deficit reduction. Of course, it was Republicans who forced him to accept such a linkage. This was Team Obama in April (via The Hill):

White House press secretary Jay Carney said it is “imperative” that a debt-limit vote not be “held hostage to any other action, because of the consequences of not raising the debt ceiling.” Jack Lew, the director of the Office of Management and Budget, struck a similar tone in an interview airing this weekend. “Our very strong view is that the debt limit should be passed as a clean, standalone bill,” he said in an interview with Bloomberg TV’s “Political Capital With Al Hunt.”

Also keep in mind that since the November elections, Obama has a) blown off his own debt reduction commission, b) offered an official budget that added $10 trillion in new debt over 10 years, c) had to be nudged, according to reports, by Treasury Secretary Geithner into giving a debt speech, which turned out to be smoke and mirrors and can’t even be scored by the Congressional Budget Office.

The evidence strongly points to Obama not really caring much about debt reduction right now. It also points to him believing – as do many left-of-center economists – that the debt issue is a long-term problem and that any near-term austerity is big risk with such a weak economy. Macroeconomic Advisers, a economic consulting firm respected by the White House, just put out this analysis of the the debt reduction plan put forward by Obama’s commission (bold is mine):

Assuming current fiscal policies remain in force, our economic model suggests that interest rates will rise considerably over the next decade, with the yield on the 10-year Treasury note reaching nearly 9% by 2021. We estimated the effects of a fiscal contraction that is patterned after the so-called Bowles-Simpson plan and that averts this dire scenario. The plan would pare more than $4 trillion from the federal debt by 2021 relative to current policy. Roughly two thirds of this contraction is from spending cuts, the rest from tax increases. For a given path of long-dated yields, the macroeconomic effects of the fiscal contraction are sizable. “Fiscal drag” would reduce real GDP growth by 0.4 to 0.5 percentage point per year through 2015, leaving the unemployment rate a percentage point higher by then.

This is key: Keynesian models like this assume all spending cuts and taxes increases slow growth by reducing overall demand. (Former Obama economist Christina Romer, however, thinks tax increases are less harmful.) The White House has the same kind of models. Slower growth hurts incomes and jobs, which, in turn, hurts the standing of the guy in the Oval Office.

There is a high likelihood that Obama believes spending cuts and tax increases in 2011 and 2012 would hurt his re-election.  This is why he would prefer a clean debt ceiling bill – or, since that is not possible, a debt reduction bill that’s as small as possible. (Or, even better, one with a bit more stimulus in it, like a payroll tax cut extension.) Every dollar in spending cuts or tax hikes makes him just a bit more likely to lose in 2012. From his perspective, better to push off austerity to 2013 — 0r beyond.

The Republican charge is a body shot aimed right at the belly of President Barack Obama’s re-election effort: He made it worse.

No, not that White House efforts at boosting the American economy and creating jobs and “winning the future” were merely inefficient or wasteful, which they certainly were. Even Obama finally seems to understand that. “Shovel-ready was not as shovel-ready as we expected,” he joked lamely at a meeting of his jobs council.

Rather, that the product of all the administration’s stimulating and regulating is an economy that’s in significantly worse competitive and productive shape than when Obama took the oath in January 2009. He was dealt a bad hand, to be sure – and then proceeded to play it badly. At least, that is what Republicans have been saying. “He didn’t cause the recession as we know,” presidential candidate Mitt Romney said in New Hampshire yesterday. “He didn’t make it better, he made things worse.”

Team Obama offers a different narrative, of course. As the president said in his State of the Union address earlier this year, “Two years after the worst recession most of us have ever known, the stock market has come roaring back. Corporate profits are up. The economy is growing again. … These steps we’ve taken over the last two years may have broken the back of this recession.” He somehow failed to insert his usual boilerplate about the economy losing 700,000 jobs a month when he took office.

But Obama is correct, to a degree. The economy is growing (slowly) now and adding jobs (modestly) whereas neither was happening back in early 2009. Of course, economies in recession will eventually recover even without government action. So the question is whether Obamanomics helped, hurt or was inconsequential.

The centerpiece of Obama’s plan to “push the car out of the ditch” was the trillion-dollar (including interest expense on the borrowed money) American Recovery and Reinvestment Act. A recent article in The Weekly Standard determined that it may have cost as much as $278,000 for each job created. But that’s generous. Respected Stanford economist John Taylor, perhaps the next chairman of the Federal Reserve, has analyzed the actual results of the ARRA. Not what the White House’s garbage-in, garbage-out models say happened, but what actually happened as gleaned from government statistics. Taylor, simply put, looked at whether consumers actually consumed and whether government actually spent in a way that produced real growth and jobs. His devastating conclusion:

Individuals and families largely saved the transfers and tax rebates. The federal government increased purchases, but by only an immaterial amount. State and local governments used the stimulus grants to reduce their net borrowing (largely by acquiring more financial assets) rather than to increase expenditures, and they shifted expenditures away from purchases toward transfers. Some argue that the economy would have been worse off without these stimulus packages, but the results do not support that view.

Indeed, the results are horrifying. The two-year-old recovery’s terrible tale of the tape: A 9.1 percent unemployment rate that’s probably closer to 16 percent counting the discouraged and underemployed, the worst income growth and weakest GDP growth of any upturn since World War II, a still-weakening housing market. Oh, and a trillion bucks down the tube. Oh, and two-and-a-half years … and counting … wasted during which time the skills of unemployed workers continue to erode and the careers of younger Americans suffer long-term income damage. Losing the future.

Next, add in healthcare reform that Medicare’s chief actuary says will not slow the overall growth of healthcare spending. (Even its Obama administration godfather, Peter Orszag, warns that “more drastic measures may ultimately be needed.”) And toss in a financial reform plan that the outspoken and independent president of the Kansas City Fed says he “can’t imagine” working. “I don’t have faith in it all.” Indeed, markets continue to treat the biggest banks as if they are still too big to fail.

But wait there’s more. Obama created a debt commission that produced a reasonable though imperfect plan to deal with America’s long-term fiscal woes. But he stiffed it and then failed to supply a plan of his own, sowing the seeds for an impending debt ceiling crisis and making an eventual fiscal fix that much harder. One more step along the path not taken, along with pro-growth tax and regulatory policies that would have reduced policy and economic uncertainty and unleashed the private sector to invest, expand and create.

Elections have results. So do bad policies. Obama’s choices on taxing and spending and regulating, sorry to say, seem to have made things worse.