Obama’s Difficult Fiscal Summer

PALO ALTO – Barack Obama’s administration suffered a string of fiscal setbacks this summer. But has it learned anything in recent months?

First, at the G-20 Summit in Canada, President Obama was soundly rebuffed by Canadian Prime Minister Stephen Harper, Great Britain’s new prime minister, David Cameron, and German Chancellor Angela Merkel, among others, on his demand for additional fiscal stimulus (more government spending). They are instead pursuing fiscal consolidation, following the immense explosion of public deficits and debt in the 2008-09 recession, and have called for cutting deficits in half by 2013 and stabilizing the government debt-to-GDP ratio by 2016. 

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Obama said at the summit that he will propose tough deficit-reduction measures next year. But talk is always cheaper than action. Thus far, the Obama administration has followed the opposite strategy, letting rip with new spending, while hoping that concern over deficits and debt will lead to pressure for higher taxes, possibly even a European-style value-added tax.

But American voters aren’t cooperating. To the surprise of many on the political left and most pundits, the clamor for a big expansion of government has not materialized. Instead, there has been a backlash against the barrage of federal government spending, deficits, and debt.

Most political prognosticators are expecting large losses for Democrats in the November 2010 mid-term elections over this issue. Voters want less spending, not higher taxes. They sense that the American economy has out-performed the Western European economies largely because of its less expansive government.

Second, the International Monetary Fund, under the G-20’s “Mutual Assessment Process,” suggested that the United States cut its fiscal deficit by 3% of GDP more than planned – over $400 billion in additional cuts per year. The IMF believes current fiscal plans will deter US economic growth.

Recently, the European Central Bank reiterated its position that serious fiscal consolidation would generate enough increase in private-sector confidence that gains in spending by households and businesses would more than offset lower spending by governments. The OECD, however, cautions governments not to consolidate too rapidly in a slow global recovery.

America’s major trading partners want the US to grow and buy more of their exports. As their economies recover, massive US government borrowing also will crowd out their government and private borrowers. The US deficit for 2010 is roughly $1.3 trillion. That is larger than the elevated borrowing by all other G-7 countries – the United Kingdom, France, Germany, Italy, Japan, and Canada– combined, plus profligate Portugal and Greece. In short, the rest of the world wants the US to get its fiscal house in order as soon as possible.

Third, the administration issued its mid-year budget update, which projects huge deficits as far as the eye can see. The proposed solution: a commission to recommend a path to balance the primary deficit (the deficit excluding interest payments) in 2015.  

Presidents used to propose paths to a balanced budget. Now Obama wants to shift responsibility to an independent commission composed of Democrats and Republicans.

Moreover, the goal of balancing the primary budget in 2015 is hardly encouraging. By then, Obama would have almost doubled the government debt-to-GDP ratio from an inherited safety zone of 40% to a danger zone of almost 80%, a level not seen since the immediate aftermath of World War II. And, of course, the longer-term deficits, driven by baby-boomer retirements and rising health and pension costs per beneficiary, grow progressively worse thereafter (the commission will also recommend how to get the longer-term deficit under control).

Fourth, the House of Representatives decided not even to attempt to pass a budget this year. This remarkable evasion is the first time the House has not passed a budget since the procedural reforms 35 years ago created the congressional budget committees and rules that legislators were supposed to use to control deficits.

Fifth, Obama announced a new series of stimulus proposals just weeks before the mid-term elections. His political opponents quickly observed that this amounted to an admission that the first stimulus had failed. One proposal – immediate tax deductibility for capital investment – should be part of a permanent (and overdue) corporate-tax reform, but Obama has proposed it as a one-year measure to induce businesses to move capital spending forward to 2011.

Sixth, Budget Director Peter Orszag, the Obama administration’s leading deficit hawk – at least prior to joining the administration – has resigned (to be replaced by Jack Lew, a budget director under former President Bill Clinton).

So who will now counsel Obama that piling on additional deficits and debt to fund a vast expansion of spending is bad economics, that the costs are likely to far outweigh the benefits, and that raising taxes will do permanent long-term damage to the economy? Certainly not his effusive cheerleaders for the costly, ineffective February 2009 stimulus bill, a vast array of social engineering and pork that was ill suited to deal with the sharp contraction in private employment in the recession. Certainly not the businessmen and women in the Cabinet, based on their real world experience; there aren’t any.

Let’s hope that the late conversion to tough deficit rhetoric gets a lot of play. Voters have a way of holding elected officials accountable for their pronouncements. Without that, political leaders cannot be expected to show a lot of courage. Fortunately, it appears that voters in the US are far ahead of the politicians.