Risk & Compliance

Wishful, and Dangerous, Thinking

Barack Obama's budget: The president has not explained to Americans that if they want bigger government, they will have to pay for it.
Economist StaffMarch 6, 2009

A president’s first budget proposal is more than a set of figures. It is also an outline of his philosophy of government. The plan Barack Obama delivered on February 26th envisages an ambitious and costly expansion of the government’s role in the lives of Americans. Its centrepiece is a big expansion of state-provided health care-for which he has budgeted $634 billion over the next decade while admitting that yet more will be needed. He will fill in the details in coming weeks (see article) while insisting the plan meets several criteria: it must extend insurance to the 15 percent of Americans who now lack it, it must help slow the growth in costs, and it must be paid for.

Economist spending

Add increased spending on education, energy and other initiatives, and federal expenditures, excluding defence, would rise to a new high of 18 percent of GDP in the coming decade. Small-government conservatives fume, yet this is what Mr. Obama victoriously campaigned on and, at least in the case of health care, what Americans seem to want. The ranks of the uninsured have grown as care becomes more expensive and more employers, through whom most workers get insurance, drop or curtail benefits. Losing a job often means losing health insurance too, making unemployment doubly traumatic.

Although Mr. Obama’s revenue plans are not clad in the ambitious rhetoric of his spending initiatives, they are just as profound. To pay for his plans and get the deficit down to manageable levels, he would return top tax rates to where they were before George Bush cut them, extract more from the rich by capping their deductions, increase taxes on corporations and auction carbon-emission permits. At the same time, he promises permanent tax cuts for 95 percent of workers.

Sadly, these plans are deeply flawed. First, Mr. Obama’s budget forecasts that the economy will shrink 1.2 percent this year then grow by an average of 4 percent over the following four years. It might if the economy were to follow a conventional path back to full employment. But this is not a conventional recession. The unprecedented damage to household balance sheets could well result in anaemic economic growth for years, significantly undermining the president’s revenue projections. The economic outlook continues to darken and the stockmarket has already tumbled to 12-year lows. Mr. Obama may either have to renege on his promise to slash the deficit to 3 percent of GDP in 2013 from more than 12 percent now, rein in his spending promises or raise taxes more.

Second, Mr. Obama’s scattershot tax increases are a poor substitute for the wholesale reform America’s Byzantine tax code needs. Limiting high earners’ deductions for mortgage interest, local-government taxes and other things is certainly more efficient than raising their marginal tax rates even more. But it would be better to replace such deductions for everyone with targeted credits, abolish the alternative minimum tax (an absurd parallel tax system that ensnares a sizeable chunk of the upper middle class), and implement a broad sales tax. Rather than simply eliminating the sheltering of corporate income from abroad, Mr. Obama could have broadened the corporate tax base and lowered the rate. In sum, Mr. Obama could simultaneously raise more revenue and make the tax code simpler and more conducive to growth. But he hasn’t.

Tell It Like it Is
Finally, by asking only the richest 2 percent of Americans to pay more, Mr. Obama is building his vision of a more activist government on a shaky foundation. Mr. Bush’s tax cuts raised the proportion of American families that pay no federal income tax (or are net recipients of tax credits) from 33 percent to 38 percent; Mr. Obama’s will raise it to 44 percent, according to the Tax Policy Centre, a research group. Although many of these people do pay payroll taxes, Mr. Obama is also intent on reducing the link between payroll taxes and the pension and health-care benefits they were supposedly designed to pay for. It certainly makes sense to keep poor people off the income-tax rolls, but removing a sizeable chunk of the middle class weakens the political bond between taxpayer and government, and will lead to pressure for more such spending.

Mr. Obama’s team rightly points out that Mr. Bush’s tax cuts disproportionately benefited the wealthy at a time when their share of income was anyway rising for more fundamental reasons. But the recession is already undoing some of the rise in inequality as the capital gains, bonuses and Wall Street profits that fuelled much of the gains in top incomes turn to dust. This could further imperil Mr. Obama’s revenue projections, if the rich people he is relying on to pay virtually all his bills end up a lot less rich than they were. Much as Mr. Obama would like to shield the middle class, he needs to level with Americans: if they want a bigger government, one that will help them in all sorts of ways, they should be prepared to pay for it.