Obama and the Deficit

When framing the 2010 budget, one would hope that the Obama Administration brings to the task a greater sense of economic realism than that which has characterized its economic policy making decisions to date. In particular, one would hope that it recognizes how ineffectual its fiscal stimulus package has been and how very weak the present US economic recovery is likely to be. This is especially the case when one recalls how, when presenting its fiscal stimulus package earlier this year, the Administration assured us that with the fiscal stimulus unemployment would peak at around 8 1/4 percent, rather than anywhere near its present 10 1/4 percent level.

On scoring the 2009 fiscal stimulus package, the Congressional Budget Office estimated that even were there to be a full economic recovery, the US budget deficit would remain in the region of 4-6 percent of GDP by 2019. The CBO also estimated that over the next decade the US would experience the largest ever peace-time increase in it public debt. Recognizing how optimistic the CBO's underlying economic assumptions were, including its supposing a relatively robust economic recovery and its not making allowance for increased public health care spending, one would think that long-run US fiscal sustainability will require a medium-term reduction in the US primary budget deficit of at least 3 1/2 percentage points of GDP.

In formulating the 2010 budget, the Administration will be confronted with a basic dilemma. Fiscal sustainability will require some combination of deep expenditure cuts and tax revenue enhancements. Yet the present fragile state of the US economy would argue against an early start to budget consolidation. Indeed, it may very well still require a second fiscal stimulus package.

The appropriate way for the Administration to thread the budget needle would be to maintain near term fiscal support to the economy but to couple this near term support with credible policy commitments to medium term spending cuts and revenue enhancements. In the latter respect, the Administration should consider making serious commitments as to how to rein in entitlement spending on the Social Security, Medicare, and Medicaid programs. It should also consider substantive steps at limiting tax deductions on mortgage borrowing and on corporate debt, higher energy taxes, a federal consumption tax, and measures to ensure better tax compliance.

Desmond Lachman is a resident fellow at AEI.

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