James Pethokoukis

Oh yes, America’s fiscal situation is a dreadful mess.

The White House says the federal government will run a $9 trillion budget deficit over the next decade. As a percentage of the total economy, the United States looks to have an astounding debt-to-GDP ratio of 11 percent this year, with that number declining to around 4 percent from 2015 though 2019. And total debt held by the public will rise to 68 percent of GDP by that year versus 33 percent in 2001.

Those numbers, however, are actually a bit on the rosy side. In his blog, Douglas Elmendorf, director of the Congressional Budget Office, notes that the forecasts presume no change in current tax laws, such as the continued existence of the Bush tax cuts and the alternative minimum tax (AMT), which grabs more and more taxpayers ever year at a lower and lower income level.

Such forecasts also assume annual spending increases grow at the rate of inflation. But tomorrow is rarely the same as today in Washington. A more realistic scenario — if the AMT were indexed for inflation, most of the Bush tax cuts continued and spending rose as it has in the past — would see the deficit at 8.5 percent of GDP in 2019. That is a level, before the current crisis, not seen since World War Two.

Budget numbers like these are generated on a cash accounting basis. They don’t take into account the underfunding of America’s vast entitlement programs and the annual changes in the net present value of those programs.

Calculated on an accrual basis, much as a corporation would estimate its pension and healthcare liabilities, the annual deficit number would be at least $6 trillion this year.  In 2008, for example, the headline budget number — the one calculated on a cash in, cash out basis — was $454 billion. But if you ran the number as the federal deficit plus the net present value of all those unfunded liabilities, the deficit was $5.1 trillion with total fiscal obligations at $66 trillion. As Elmendorf dryly puts it: “Putting the nation on a sustainable fiscal course will require some combination of lower spending and higher revenues than the amounts now projected.”

And that is The Choice. Does America want to be a low-tax nation with a government that does less than it does now, or a higher-tax nation with an even bigger public sector? Right now, it sort of wants both. You can see that not only in today’s budget numbers, but also in the healthcare debate, where a fair reading of the polls reveals Americans want to contain costs while also having every high-tech solution and test available to them.

The politicians are certainly no better. When the Republicans wanted to fix Social Security, Democrats argued the program was in good shape. And now when Democrats want to trim Medicare costs, the GOP plays the defender of seniors.

So put me down for 8.5 percent in the 2019 debt-to-GDP ratio office pool, OK?

From the Office of Management and Budget:

The Administration contemporaneously acted to address the financial crisis and get credit flowing again through the Financial Stability Plan, and worked to help homeowners facing foreclosure through the Homeowner Affordability and Stability Plan. In addition, the Administration took action to forestall the failure of two of the Nation’s largest automobile manufacturers and to strengthen the non-bank credit market. All together, these efforts—along with the ARRA—increased the deficit in the short run. In fact, 64 percent of the current deficit is directly attributable to rescue and recovery efforts and other countercyclical programs that were essential in preventing a deeper and more costly recession.

Bruce Bartlett, who has a new booking coming out, was nice enough to run some budget numbers so I wouldn’t have to:

I was looking through the new CBO projections and saw a point worth emphasizing.

CBO projected a deficit of $1,186 billion in January before Obama took office.  It now projects a deficit of $1,587 billion, an increase of $401 billion.  If one goes through the March update (pp. 6-7) and the August update (pp. 52-53) and adds up all the changes to the January estimate, you find that the deficit increase since January consists of $46 billion in lower than expected revenues due to the economy (11.5%), $129 billion in higher spending due to technical re-estimates (32.2%), and $226 billion due to legislative changes to both spending and revenues (56.3%).

This suggests that we would have had a deficit of at least $1,361 billion this year even if McCain had won (January deficit plus lower revenues and technical changes and no legislative changes)—assuming no stimulus and assuming that the economy would have done as well as it has done without it.  That’s only 14% less than the deficit currently projected. And keep in mind that some of the legislative changes are due to higher defense spending and other non-stimulus related programs.

But McCain undoubtedly would have supported some sort of fiscal stimulus.  It might have been more tax- than spending-oriented, but would have increased the deficit nevertheless.  If we assume that McCain’s stimulus would have been half the size of Obama’s that leaves us with an estimated deficit of $1,474 billion under McCain—only 7% less than the deficit now estimated.

More to come on this, but the WH is predicting that as a percentage of GDP, annual budget deficits will decrease to around 4 percent over the next decade from 11 percent in 2009. Or will they? The Congressional Budget Office has some doubts (via the Director Doug Elmendorf’s blog):

Those projections generally follow the rules, originally established in
law, that have traditionally governed baseline projections.  However,
some of the resulting assumptions may underestimate potential deficits.
Because they presume no changes in current tax laws, the projections
incorporate increases in revenues that would result from the expiration
of tax reductions enacted earlier in this decade and provisions that
have kept the alternative minimum tax (AMT) from affecting many more
taxpayers.  They also assume that future annual appropriations grow
each year at the rate of inflation.  Those assumptions result in
projected revenues that, as a percentage of GDP, would be high by
historical standards, and projected discretionary spending that,
relative to GDP, would be low by historical standards. Many other
outcomes are possible.  If, for example, those tax reductions were
continued, the parameters of the AMT were indexed for inflation, and
future annual appropriations were to remain at their 2009 share of GDP,
the deficit in 2019 would reach 8.5 percent of GDP, by CBO’s estimates.

And once more, another person in Washington involved with helping create the financial crisis gets to keep his job. In a bit of a  summertime surprise,  President Obama has renominated Ben Bernanke as Fed chairman.

1) So not only does the White House release its new budget forecast on the same day as the Congressional Budget Office releases its forecast so there aren’t two separate days of terrible stories, it also drops this bomb to further dilute the impact. The news might even generate a nice stock market reaction Smart politics.

2) I am mildly surprised. Although, Bernanke seemed to have the backing of Wall Street, the politics were not as clear. What president would not rather have his own pick in the post? And while most economists praise the Fed’s efforts to keep the recession from becoming a depression, politicians in both parties have attacked the Fed’s big bailouts, as well as its handling of the BofA-Merrill merger. Plus, Bernanke terribly underestimated the potential severity of the financial crisis in its early days. If Obama wanted to make a switch, there was enough there to justify it.

3) Bernanke got lucky with the timing. If his term was up in January of 2011 instead, he might get more of the blame for a lackluster economic rebound. As it is, he gets credit for engineering the rebound — and given the mood six months ago, any rebound is a good rebound. But another year of high unemployment might alter those views.

4) I think Obama should get credit for not picking an obvious dove like Janet Yellen, but I am not sure she was really a ever a viable option. I think Larry Summers was viewed as both too independent and too outspoken, a real wildcard. Bernanke is a known quantity in the position who has worked with the White House every step of this crisis.

Mickey Kaus gives his theory:

It’s easy to forget that, even if Obama’s health care effort is bogging down, the effort itself still serves his presidency as a crucial time-waster, tying up Congress and giving him a reason to postpone (or the public a reason to ignore) those other divisive, presidency-killers. Obama needs some excuse for putting off unpopular Democratic demands; health care’s a good one. If he keeps failing to pass health care until spring, that might not be such a bad outcome. In fact, even quick passage was maybe never in his interest. There are things more unpopular than struggling. … Cap and trade, immigration legalization, “card check”—these are not what you’d call confidence building appetizers leading up to the main course of Obama’s presidency.

Me: None of it works when Americans have less and less confidence in Obama. And that number will continue to work against him as long as unemployment stays high.

Is the light at the end of the tunnel an oncoming train? That’s the worry of many economists who fret that after a couple of quarters of moderate growth, the U.S. economy will either lapse into a state of torpor or relapse into recession. In a new Financial Times op-ed, Nouriel Roubini says that weak labor markets, weak banks, weak consumers, weak profits and weak trade creates a strong risk of just such a “W-shaped” economic scenario.

If so, unemployment would remain really high. And, given that prospect, you just know incumbent Democrats facing re-election in 2010 would love to vote for Son of Stimulus. The big drawback: Doing so would risk the wrath of budget-conscious independents, as well as bond investors who share Warren Buffett’s stated concerns that all this red ink could sink the dollar.  Plus, a backup in interest rates would negate any positive effects from more stimulus.

But Olivier Blanchard, chief economist at the International Monetary Fund, may have cracked the code on to boost the economy and not spook bond investors and budget hawks. Blanchard’s grand bargain, one I have been suggesting for months, is for government to spend more money in the short term to boost growth while simultaneously taking strong action to reduce the long-term budget deficit. “The trade-off is fairly attractive,” Blanchard said in a report this week. “IMF estimates suggest that the fiscal cost of future increases in entitlements is 10 times the fiscal cost of the crisis. Thus, even a modest cut in the growth rate of entitlement programs can buy substantial fiscal space for continuing stimulus.”

Fiscal space is good! When you’re dealing with gobsmacking budget numbers, small cuts (or even just nicks in the rate of growth) can make a huge, real-world difference. As the Peterson Foundation figures it, Uncle Sam has run up some $55 trillion in long-term liabilities. Minor tweaks that make that number a bit more manageable in the future would create huge fiscal opportunities for more pro-growth measures today.

One example: the Dartmouth Institute for Health Policy and Clinical Practice calculates that if Medicare spending across America “grew at the San Francisco rate of 2.4 percent per year instead of the current national average (3.5 percent), Medicare would achieve a cumulative savings of $1.42 trillion between now and 2023.” That’s a nice chunk of change. Or, as an analysis I commissioned from the American Enterprise Institute revealed, extending the Social Security retirement age while at the same time indexing benefits to inflation rather than wages would turn a $5 trillion present value deficit into a $5 trillion surplus.

Can America afford to upgrade its rotting transportation infrastructure and electrical grid while also, say, lowering corporate and investment tax rates to a more internationally competitive level? Yes and yes. If entitlement liabilities are downscaled, the U.S economy can generate more than enough future economic growth and excess tax revenue tomorrow to “pay for” smart investments today. That would create jobs and strengthen America’s economic foundation -– and keep the bond vigilantes at bay.

My Reuters colleagues break the news that the White House is revising upward its ten-year budget forecast to $9 trillion from $7 trillion:

“The new forecasts are based on new data that reflect how severe the economic downturn was in the late fall of last year and the winter of this year,” said the official, who is familiar with the plans.

“Our budget projections are now in line with the spring and summer projections that the Congressional Budget Office put out.”

The CBO said in June that deficits between 2010 and 2019 would total $9.1 trillion. The official said the 2010-2019 cumulative deficit projection replaces the administration’s previous estimate of $7.108 trillion.

Me: Expect the CBO to also crank up its forecast, which will be higher than the administration’s. Also, this is further evidence that the common wisdom that people don’t care about budget deficits (no matter what the polls say) is wrong. C’mon,  leaking such news on a late Friday afternoon?

Things I am “wee weed up” (which I think means “agitated”) about: the long-term budget deficit, the Long Recession, the state of U.S. competitiveness, the cancellation of “The Sarah Connor Chronicles” (now and forever!),  breaking my Kindle by putting my elbow on the screen and then leaning my full 205 pounds on my elbow (I mean, Amazon never said “not” to do that),  Washington humidity, not being at Jackson Hole, health exchanges, the housing market, Rick Schroeder in “24″ in season six (currently watching on DVD via NetFlix), my six-day summer cold,  my commute which is even slower in the summer (something about “hot” rails, the Cubs falling out of the pennant race (now and forever, apparently) …

What’s good for the donkey is good for the elephant — or at least as politically effective.

For years, Democrats hampered Republican efforts to overhaul Social Security by making three main arguments. First, reform was a just a euphemism for kill, thus Republicans were violating the social-insurance contract with older Americans Second, building a new Social Security system around personal investment accounts would subject peoples old-age to the vagaries of the financial markets. Third, there was no Social Security crisis, only a successful, decades-old program that merely would need a couple of tweaks down the road (presumably when Democrats again controlled the White House and Congress).

Did these argument hold water? Not really. Various Republican ideas would have changed the program only for younger people. And if you don’t think the stock market is a good long-term investment, then you’re also betting that the American economy will underperform, thus calling into question the country’s ability to meet its long-term Social Security obligations. Finally, it is indisputable that Social Security is underfunded and benefits will need to be cut or taxes raised sharply.

Whatever the accuracy of their arguments, Democrats were able to stymie Republican efforts to fix Social Security, most notably President George W. Bush’s 2005 attempt. Now Republicans are using the same playbook to stop President Barack Obama’s plan to reform America’s healthcare system.

Today’s arguments are similar to those from 2005. Healthcare reform would eviscerate Medicare for the elderly by making cuts to pay for expanded coverage for younger Americans, and that’s unfair since seniors have paid for their benefits. Treatment decisions would be left to the vagaries of Washington bureaucrats. And hey, there really is no crisis since a) polls show most people are satisfied with their current healthcare plan, and b) even if healthcare spending takes up a greater share of GDP in the future, it’s not a big problem since the entire American economy will be much bigger.

But Republican arguments are just as flimsy as the Democrat version four years ago. Rising costs mean less take-home pay for American workers, and Medicare, to a great degree, is what’s driving those costs since it makes using pricey, premium medicine seem cost free to seniors. (And despite Republican claims, the average senior will get $100,000 from Medicare than what he puts in.) What’s more, the U.S. could be spending far less on healthcare, including Medicare, and getting equally good results. Still, those economic realities are just a distraction when your goal is more about political victory than solving a national problem.

The politics may be dicey, but anyone truly serious about overhauling the American healthcare system needs to acknowledge that total spending must be reduced and that any aspect of the system — including Medicare and employer-based health insurance — that distances patients from the true costs of their healthcare is part of the problem. Republicans could even, theoretically, support a bare-bones public option if it had low premiums but high deductibles and co-payments to increase consumer awareness. (Just as Democrats should be able to support a system based on more private health insurance if there were substantial subsidies for the poor.)

Of course, that would be sound economic policy and the current debate has precious little to do with that.