Wednesday, February 16, 2011

A Budget shaped by political constraints

Business Times - 17 Feb 2011

A Budget shaped by political constraints

Obama hopes a compromise will lead to reforms of social programmes and the tax system


THERE is one good thing you could say about US President Barack Obama's federal budget proposals in the form of US$3.7 trillion blueprint for 2012 which were released on Monday. The White House's proposals - a revision in the plan for the current fiscal year coupled with a plan for the coming years - include proposals to cut the deficit by US$1.1 trillion through major spending cuts and large tax increases.

So as the White House envisions it, the federal deficit would grow under the budget plan from around US$14 trillion today to close to 'only' US$21 trillion in five years. But most experts believe that these numbers reflect over-optimistic forecasts that assume the acceleration of the current economic recovery to be followed by a new economic boom combined with relatively low interest rates.

The main problem is that 2011 will already see the biggest one-year debt increase in American history - a jump of US$2 trillion - with the federal deficit expected to reach US$15.476 trillion by the end of the current fiscal year on Sept 30. That means that the overall debt will exceed the size of the entire American economy.

Under these conditions - a massive federal deficit that amounts to 102.6 per cent of the GDP - any serious effort to bring it down may require not huge, but gigantic, spending cuts and not large, but gigantic, tax increases. But politics makes it unlikely that either the White House or the Congressional Republicans will be ready to call on the American people to make these necessary sacrifices.

The White House's budget plan does put forward a few gutsy ideas that are bound to anger powerful constituencies in the Democratic Party, especially those associated with its progressive left wing. The budget freezes domestic spending for five years, cutting home heating aid for the poor and raising interest rates on student loans. And there are also plans to make serious cuts in the defence budget and raise taxes on oil companies and other businesses that maintain large contingencies of lobbyists in Washington.

But President Obama's budget proposals - assuming that most of them would be approved by Congress - fails to come up with any ideas to deal with the main sources of the ballooning deficit - the rising spending on health insurance for the poor and the elderly (Medicare) and on the national insurance programme (Social Security) - not to mention a bunch of tax loopholes for consumers and businesses.

Indeed, the budget plan doesn't include some of the proposals for significant entitlement and tax reforms recommended by President Obama's bipartisan deficit commission last December. While President Obama and his budget director Jack Lew have praised the work of the commission and probably agree with most of its recommendations, they also recognise the political constraints - the liberal Democrats' opposition to cuts in spending and conservative Republican resistance to raising taxes - on any dramatic effort to make changes in existing policies.

So instead of trying to shove a big plan on cutting the federal deficit through Congress - which is what British Prime Minister David Cameron is doing with his massive budget cuts - President Obama and his aides are hoping to start a process of legislative debate that could eventually lead to a grand compromise between the two major political parties and that would involve structural reforms of the government financed social programmes and the tax system. Of course this debate could equally lead to a political impasse that would make it impossible to put the US fiscal house in order any time soon.

The White House plan does actually call for increasing government spending on transportation and education, which President Obama described as part of his long-term strategy to improve US education, innovation and infrastructure and part of the 'Winning the Future' strategy he outlined during the last State of Union Address.

'As we move to rein in our deficits, we must do so in a way that does not cut back on those investments that have the biggest impact on our economic growth, because the best antidote to a growing deficit is a growing economy,' President Obama explained in the introduction to his budget plan. The president is also calling for the expiration of the tax cuts for the wealthiest Americans that had been adopted under President George W Bush and were extended at the end of the last year.

But the Republicans who control the House of Representatives and who together with conservative Democrats can dominate the legislative process in the Senate have already called for US$60 billion in cuts in 2011 and are unlikely to approve the White House's spending programmes. And the Republicans are also opposed to some of the proposed cuts in the Pentagon budget that have been proposed by Secretary of Defence Robert Gates.

'This budget ignores the problems,' said House Budget Committee chairman Paul Ryan, a Republican from Wisconsin. 'This budget does more spending, more taxing, more borrowing, and at the end of the day, if we don't turn this around, that's going to cost us jobs,' he said.

Congress still needs to complete the 2011 spending bills that are four months overdue as it studies President Obama's budget plan for 2012. Indeed, the first test of the willingness on the part of the White House and the Republicans to reach a grand bargain on cutting the deficit will come soon when Congress will have to vote to raise the debt ceiling.

Tea Party activists are urging the Republicans to refuse to raise the debt ceiling unless the White House acceded to their demands to make more drastic cuts on government spending on domestic programmes.

But there is very little support among Americans for such a move that could lead to the shutting down of the government while creating major anxiety in the financial markets. The White House is hoping that it would emerge as political winner if and when such a legislative showdown with the Republicans takes place.

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