Too Little, Too Late

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Even if President Obama gets everything he asked for in his new proposals, it won't reduce our growing public debt. And he won't get it all.
As President Obama's former chief of staff memorably pointed out, no serious crisis should go to waste. Two serious crises now happening at the same time have received the president's special attention, although less for the opportunity they offer for radical change than for the pressing political need to do something.

The first is unemployment, which has drifted back up to a punishing 9.1% rate and threatens to move higher if the economy slides back into recession. The second is soaring federal debt that has helped spawn an angry GOP-controlled House, forcing the president to get serious about the long-term crisis of federal finance.

President Obama has recently made fresh proposals to address both crises, but even if enacted in their current forms—an unlikely prospect—they're not enough.

To reduce debt over the long run, the president would hike taxes on the rich and cut spending, including cuts on Medicare and Medicaid outlays. To reduce joblessness in the short run, his "American Jobs Act" would temporarily cut payroll taxes on both employer and employee and hike spending, with funds going to various recipients, including state and local governments.

Scoring these huge numerical pluses and minuses in terms of their net impact on long-term debt is no simple task. The nonpartisan Congressional Budget Office has not yet assessed the new package, perhaps because it is waiting to see how much of it actually gets passed. President Obama has threatened to veto any bill that cuts Medicare without boosting taxes, while Republican House Speaker John Boehner has condemned the president's debt plan for "pitting one group of Americans against another."

But let's assume for the moment that the package survives intact and that all of the estimates are correct. What would be the net contribution to the goal of long-term debt reduction?

Answer: The contribution would be large enough to notice. But even with those generous assumptions, it would fall short of the goal Barron's set for debt reduction last spring (see "Grow Up, Guys!" May 2).

Our prescription was that federal debt held by the public be allowed to rise each year, but no faster than growth in current-dollar gross domestic product. Federal debt held by the public, which excludes debt held by the federal government itself (and thus owes to itself), is now at around two-thirds, or 67% of nominal GDP, a 60-year high. Based on our best estimates, the president's latest package of tax cuts, tax hikes, spending cuts and spending increases would have the net effect of reducing this debt, but still mean the debt would grow to about three quarters, or 74%, of GDP by 2021

The effects on employment are also difficult to gauge. But if fiscal stimulus used to be likened to stepping on the gas pedal, then the Obama package is like hitting the gas and the brakes at the same time. Single people operating small businesses earning $200,000 or more, who qualify as rich under the tax-hike proposal, will be grateful for lower payroll taxes on a temporary basis; but they will not look forward to higher income taxes on a permanent basis. The destimulating effects of the latter will probably more than quash the job-creating impulse encouraged by the former.

What about the danger that reduced federal spending and higher taxes will slow the economy? Whether the federal government really does have much of an impact on short-term economic growth by increasing or decreasing budget deficits is a matter of some debate. But those who worry that such fiscal contraction can have huge short-term effects on the fragile economy should take some comfort in the fact that the planned debt-reduction is backloaded to the later years.

The OMB numbers actually show an increase in the debt in 2012, turning into a small decrease in 2013, once the effects of the job stimulus are included. And depending on the state of the economy in 2013, extra fiscal stimulus can always be applied to offset those effects. Getting politicians to spend money during a perceived crisis isn't normally very hard. The reverse is what's difficult.

THE BARRON'S ESTIMATE OF THE publicly held debt at 74% of nominal GDP by 2021 already reflects the debt-reducing effects of the Budget Control Act of 2011 (worth $2.2 trillion), which became law early last month. It also incorporates the CBO's new assumption that debt-servicing costs will be much diminished, given low interest rates (worth $0.7 trillion).

On net, Barron's scored the debt-reduction of the Obama package at a total of $2 trillion; the $1 trillion in savings claimed from Iraq and Afghanistan drawdowns was disallowed, since it already seemed reflected in standard projections. But, for example, the $1.57 trillion claimed from taxing the rich and boosting taxes on corporations is fully credited, even though noticeably lower estimates in key cases had been released by Obama's own Treasury Department.

Our 74% estimate for 2021 also takes CBO's 2021 projection for current dollar GDP growth at face value. The agency recently stipulated that this projection may err on the high side. If it is too high, then the ratio is too low.

As the CBO keeps warning, the next 10 years are really the calm before the storm, given the "aging of the population and rising costs for health care." Hard as it is to believe, the U.S. could eventually be in danger of going the way of Greece, unless some hard choices are made.