Everything you need to know about Obama's $3 trillion debt plan
The Buffet rule, "class warfare," and the key role of taxes in the $3 trillion debt plan
Today, President Obama outlined proposals to reduce the medium-term federal budget deficit. His proposal would pay for the $447 billion stimulus package he proposed last week and reduce the 10-year federal budget deficit by an additional $3.2 trillion, according to OMB estimates.Skip to next paragraph
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The $3.7 trillion ($3.2 trillion + $447 billion) in budget savings is categorized as follows:
–$257 billion in mandatory spending
–$320 billion in health care spending
–$1,084 billion in defense spending (overseas contingency operations)
–$1,573 billion in tax revenues
–$436 billion in net interest savings
The proposals would bring the deficit down to about 2.7 percent of GDP by 2014, where it would hover and then eventually fall to about 2.3 percent of GDP by 2021. The debt/GDP ratio would peak at just under 77 percent of GDP in 2013 and would fall to 73 percent by 2021. The budget would be in primary surplus by 2017 and reach a primary surplus of 0.9 percent of GDP by 2021 (all data according to OMB).
Some initial reactions:
(1) Going big
The debt-limit deal signed in August had two parts. OMB estimates that the first part will reduce spending by $1.2 trillion (this may seem confusing, because the commonly-used figure for this part was $900 billion originally).
In combination with the debt-limit deal, then, the new proposals would (a) pay for the stimulus package the President proposed and (b) still reduce 10-year deficits by $4.4 trillion. Changes of this size constitute “going big” in current budget parlance and should be applauded.
In contrast, the Joint Select Committee needs to come up with “just” $1.5 trillion in deficit reduction to avoid the automatic second-round cuts. The President is asking Congress to go well beyond that and make a much more significant dent in the fiscal problem now.
(2) Compared to what?
The baseline that OMB uses is a measure of “current policy”: it assumes the extension of all of the 2001 and 2003 tax cuts, the indexation of the AMT for inflation, the non-reduction of Medicare provider payments, and the continuation of military operations at full throttle in Iraq and Afghanistan (it does not appear to assume that the run-of-the-mill temporary tax policies, the so-called “extenders,” are extended).
I have argued elsewhere that, in many ways, it makes more sense to use current law as the baseline. (http://www.brookings.edu/events/2011/0817_deficit_committee.aspx) Ultimately, the most important thing is where the proposal ends up in terms of deficits, debt, taxes, and spending. The President’s proposal would put the country on a more sustainable fiscal path and buy significant time to deal with long-term problems.
The combination of the President’s stimulus proposal and the medium-term deficit reduction measures would raise the deficit by $300 billion in 2012, and then would reduce the deficit (all, relative to baseline) by $23 billion in 2013, by almost $300 billion in 2014, and by increasing amounts thereafter. If the economy has fully recovered by 2013, it will be able to bear the burden of changes in the direction and magnitude of the deficit. But if the economy is still weak, the increase in fiscal drag in 2013 and 2014 may cause significant problems.
(4) The Role of Taxes
The President is right to call for tax increases as part of medium-term deficit reduction. As I described last month, any credible proposal to solve our fiscal problem will include an increase in government revenue.
–All major durable deficit reduction packages enacted in the last thirty years, including the 1983 Social Security reforms and the 1990 and 1993 budget agreements, included both tax increases and spending cuts.
–The only way to provide shared sacrifice is by including tax increases in the package. Spending cuts do not require any significant sacrifice from very high-income households.
–The notion that government can be reduced in size by holding taxes low has not fared well over the last 30 years. The “starve the beast” approach was tried by Presidents Reagan and George W. Bush, who cut taxes, but ended up raising spending. In contrast, when President Clinton raised taxes, government also reduced spending, resulting in better fiscal discipline on both sides of the budget.
–Tax increases will be needed, too, because historical revenue levels will not be sufficient to pay for the costs of an aging population with rapidly rising medical costs. Even with significant reforms of Medicare and Medicaid, health costs will place a significant burden on the federal budget.
–Because the debt-limit deal focuses only on spending cuts, adding tax increases as one part of the new package will help, in all of the ways described above. The overall package looks to have about a 2:1 ratio of spending cuts to tax increases.
–A combination of tax increases and spending cuts is in accord with the wishes of the American public, who vastly prefer a combination of the two types of budget solutions to a solution that involves spending cuts alone.