Obama's Planned Fiscal Squeeze Could Choke Economic Recovery
The White House projection that the deficit will narrow by 5.5% of GDP in just two years has to be considered a long shot for economic and political reasons.
Outside of demobilization from war, only one other period saw a two-year fiscal contraction even half as great. That 1936-to-1938 fiscal reversal of 5.4% of GDP helped trigger the economy's relapse in 1937 to extend the decade-long Great Depression.
Could the White House's plan to withdraw stimulus while simultaneously raising taxes be a recipe for repeating history?
The Obama administration does not acknowledge such a risk. Rather, it expects the economy to grow at a roughly 4% rate in 2011 and 2012, even as it hits the fiscal brakes.
Those assumptions are "pretty optimistic" to UniCredit Research economist Harm Bandholz.
His own view is this: "The upcoming years will remain very painful ... (with) a sluggish economy and high unemployment."
The White House projects receipts will jump from 14.8% of GDP this year to 18.1% of GDP in fiscal 2012, due to tax hikes and a stronger economy.
Slower-than-forecast growth would mean a smaller rebound in tax revenues and bigger deficits.
While the economy grew at a 5.9% rate in the fourth quarter, Bandholz attributes all of the growth to a temporary inventory bounce and stimulus, which is set to peak at mid-year. Without those factors, he expects the economy "to perceptibly lose momentum" through 2010.
The other reason the White House forecast may prove unachievable is that Congress shows no sign of being ready to tackle deficits.
A case in point was the one-man filibuster by Sen. Jim Bunning, R-Ky., last week of a bill to extend emergency jobless benefits, because the measure will be financed with debt. Under pressure from both parties, he backed down.
The incident underscores the difficulty of reaching a bipartisan deal to pay for new spending. And that bill only had a $10 billion price tag.
Bunning's stand "highlighted the utter inability of Congress to offset new spending with corresponding cuts or tax hikes," said Greg Valliere, chief political strategist at Potomac Research. "Despite all the hot air from Congress decrying deficits, there's a lack of seriousness on taking strong action."
Valliere expects that to continue as long as 10-year Treasury yields remain at their historically low level near 3.7%, which suggests the nation has yet to approach a limit on its borrowing capacity.
At the moment, the only danger signs have been ratings-agency suggestions that America could lose its AAA credit rating if Washington doesn't show signs of getting on a path that is more sustainable than the one mapped out by President Obama's budget.
The fact that the White House plan likely understates near-term deficits only bolsters the case for a proactive approach to reducing the long-term deficit to avoid a premature backup in interest rates that would work against recovery.
Ideally, Washington should offset the cost of new legislation for spurring job creation and keeping the recovery on track, said James Horney, director of federal fiscal policy at the liberal Center on Budget and Policy Priorities.
But Horney added that additional stimulus measures won't materially worsen the long-term debt picture and could help avoid a relapse that would cause another flood of red ink.
Panel Posturing?
Obama's new bipartisan fiscal commission will provide an opportunity to signal that the U.S. is committed to getting its finances in order, Horney said.
But it could have the opposite effect. Horney said it's not clear if 14 of 18 panel members — the minimum number needed to make a recommendation — can agree on an approach and, even if they do, whether Congress will adopt it.
Between fiscal 2010 and fiscal 2012, the White House's budgeted path would go from a stimulus of about $460 billion to deficit reduction of $60 billion. This includes all existing and proposed stimulus measures, which would all largely phase out by 2012; all of the tax hikes in the White House budget; and the impact of health care reform tax increases ramping up ahead of new spending.
Proposed tax hikes include expiration of Bush-era investment and income tax cuts for high earners; limiting itemized deductions for high earners; taxes on banks and other business activity; and expiration of the Making Work Pay tax credit for 95% of working families in 2012.
That amounts to a fiscal swing of about 3% of GDP. The rest of the 5.5% tightening would stem from reduced emergency safety-net spending and higher revenues as the economy improves.
|
