April 09 , 2010
Obama’s Secret Plan to Raise Taxes
While Obama basks in the glory of his healthcare reform victory, the problem of America’s financial health remains to be sorted out. Critics of healthcare reform point out that America can’t afford this new entitlement, and that Obama’s spending plans are bankrupting the country. But among all the noise from clashing TV talking heads, strident radio talk show hosts, and angry blogs, it’s hard for the average voter to make sense of the fiscal picture and what is happening.
To really understand how good or bad America’s finances are, there is really only one number that needs to be known, the debt to GDP ratio. This is the value of all the outstanding debt of the government divided by the size of the economy. The size of the debt alone isn’t useful, because if America owes 500 billion dollars, that is not the same as when France owes 500 billion dollars.
What is the proper or safe debt to GDP ratio for a country? The answer is partly political, and partly reflects economic factors such as how good is the credit of the country (and the US has the best, because it can literally print dollars if it needs to), how high are interest rates, and what is the long-term growth rate of the economy. The EU criteria for joining the Euro was having a debt to GDP ratio below 60%. It would be safe to say that 60% is acceptable, but that in general, the country should be lowering that number during good economic times so that it can safely raise that number during bad.
The budget deficit is how much new borrowing the government is doing in a given year to fund its operations. If the deficit size is much smaller than the growth in the economy, then the ratio falls, if it is larger, it rises.
The best non-partisan source for projections about the Federal government finances is the CBO ( Congressional Budget Office). So let’s look at what the CBO said a year ago, and what it is saying now. A year ago, the CBO projected the effects of Obama’s budget plans. It predicted that 2009 would have tax revenues of 2.2 trillion dollars and spending would be 4 trillion dollars, with a deficit of 1.85 trillion (13.1% of GDP) and the debt to GDP ratio to be 57%. For 2010, they predicted revenues of 2.3 trillion dollars, expenses of 3.7 trillion, and a deficit of 1.4 trillion (9.6% of GDP), and debt to GDP ratio climbing to 65%. Going out to 2019, they predicted revenues of 4 trillion, expenses of 5.1 trillion, and a deficit of 1.2 trillion (5.7% of GDP), with debt to GDP ratio climbing up to 82%. These were scary numbers, and generated significant political opposition to Obama’s stimulus (which was a mix of spending and tax cuts) and his unaccounted for healthcare proposals.
But in the last year, things turned out much better than the CBO anticipated. Expenses came in lower, primarily because the banking sector healed and 250 billion dollars of TARP money did not get spent. In addition, the improvement in the economy helped the biggest TARP recipients such as Citigroup, Bank of America, General Motors, and AIG to pay back far more than was anticipated. The latest numbers suggest that the final cost of the 700 billion dollar TARP program, after repayments, will be under 100 billion dollars. Cheap actually, for preserving our financial and auto sectors. It may turn out to even be a wash depending on what price the government sells its shares for in the next few years.
This month the CBO released new numbers, including actual results for 2009, and projections for the future. 2009 actually had revenues of 2.1 trillion, expenses of 3.5 trillion, a deficit of 1.4 trillion (9.9% of GDP), and debt to GDP ratio came in at 53%. So the actual deficit for 2009 came in 450 billion less than what the CBO was saying in March 2009. For 2010, they predict revenues of 2.2 trillion, expenses of 3.5 trillion, and deficit of 1.4 trillion (9.4% of GDP), with a 62% debt to GDP ratio. For 2019, they now predict revenues of 4.4 trillion, expenses of 5 trillion, and a deficit of 640 billion dollars (3% of GDP) with a debt to GDP ratio of 67%, a number that will have been stable since 2011. So based on this it looks like America’s fiscal situation has stabilized to a large degree, albeit with total debt a little high. But these numbers assume no changes to current tax laws and make conservative predictions about future spending growth. One big assumption is that the Bush tax cuts on income and capital gains and dividends, which are supposed to expire in the next two years, will not be renewed. And these predictions did not include the cost of the healthcare program. So what does Obama intend to do?
Obama has tipped his hand. The CBO has taken preliminary Obama proposals for the 2011 budget and projected them out. In these proposals the main fiscal items are that the wars in Iraq and Afghanistan are wound down, the healthcare reform is enacted, and the Bush tax cuts are extended for most Americans, except those making over 250,000 dollars. The taxes on capital gains and dividends will be raised to 20% for those making over 250,000, while keeping the current rate schedule for those making less. Also the inheritance tax will be reinstated with an exemption for the first 3.5 million dollars, and the excess taxed at 45%. In addition, Obama is proposing to index the Alternative Minimum Tax to inflation and reduce the marriage penalty. The net result of all this can be guessed.
Using the President’s preliminary budget, the CBO projected in 2010 revenues of 2.1 trillion, expenses of 3.6 trillion, a deficit of 1.5 trillion (10.3% of GDP) and 63% debt to GDP ratio. For 2019 they now project revenues of 4.2 trillion dollars, expenses of 5.4 trillion, and a deficit of 1.2 trillion (5.3% of GDP). Debt to GDP ratio will have risen to a scary 87%, and continue to rise further. Obviously, these numbers are unsustainable. At some point, the deficit will have to be narrowed further, to probably less than 3% of GDP, and the debt burden ratio put on a downward path. When will Obama do this?
I predict it will happen in 2013. Between now and then the natural rebound of the economy is predicted to send tax revenues soaring by a trillion dollars per year, while spending will rise only 200 billion dollars. So for the next three years, we will have a falling deficit despite a partial renewal of the Bush tax cuts and the increased spending plans of Obama. But by 2013, that trend will have played out, and further deficit reduction will mean hard choices. In 2014, the CBO projects the President’s plan will yield a deficit of 4% of GDP. To create financial stability, Obama will probably aim to get that down to 2%. Which will mean 2% of GDP worth of spending cuts or tax increases. 2% of GDP in 2014 will be around 350 billion dollars. Spending cuts will have to come out of mainly defense, social security, and medical programs (Medicare, Medicaid, etc.). Tax increases will likely be broader based than Obama campaigned on in 2008.
The political calendar favors this scenario. Obama will not have to make these hard choices until 2013, which means after he is safely reelected. Obama may also benefit from the CBO’s conservatism in projections. The CBO was very pessimistic in early 2009, but the actual numbers came in much better than they had guessed.
If the economy rebounds faster in 2010 and 2011 than the slow pace the CBO is guessing, then Obama may find the deficit picture brightening on its own. This happened to Bush from 2004 to 2007, and to Clinton in the late 90’s. Prudence however dictates to plan for a major tax hike in 2013.
