The Coming Deficit War: Why You Will Be Paying More To Uncle Sam (Or Getting Less From Him)

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The New Republic’s Noam Scheiber has a piece up this morning describing the bipolar economic pressures that the White House is now struggling with: the need for more stimulus spending vs. the need for less deficit spending. (I also have a piece in the next issue of the magazine–subscribe here $1.99 for six weeks–on the same topic.) This challenge shapes the battlefield for the next major clash in Washington, both as a matter of policy and politics.

In terms of policy, there is a real need for the U.S. to establish some credibility in international credit markets. In terms of politics, polls suggest that all the Tea Party disdain for federal spending and debt could have an impact on Congressional midterm elections in 2010. As we all wait to find out how the White House will play its hand, the tea leaves suggest something big might be in the offing.

But before getting into such speculation, let’s take a moment to understand the problem.

In early November, President Obama’s top accountant Peter Orszag traveled to New York University, where he depressed a lot of college kids by describing just how hard the current recession is likely to hit them. He also made some key statements about how the Obama Adminstration sees the deficit problem. Apologies for the extended excerpt, but it is about as concise a statement you will find on the current deficit dilemma. (Emphasis mine.)

Just a few weeks ago, the Administration released the year-end statement of the federal government – a final accounting of what we took in and what we spent for fiscal year 2009, which ended in September.

The results were not a surprise, but they were still sobering: the deficit for last fiscal year was $1.4 trillion, or 10 percent of our economy. Next year’s deficit is expected to be about the same size, and current projections show $9 trillion in deficits over the next 10 years, averaging about 5 percent of GDP. Deficits of this size are serious – and ultimately unsustainable.

So how did we get here? Of the $9 trillion in deficits projected over the coming decade, nearly $5 trillion comes as a result of failing to pay in the past for just two policies — the 2001 and 2003 tax cuts and the creation of a Medicare prescription drug benefit.

The cost of the tax cuts will total about $4 trillion over the next decade, including the additional interest on the debt the federal government will have to pay since the tax cuts were deficit financed. The Medicare prescription drug bill will add about another $700 billion to the deficit – bringing us to about $5 trillion total for the cost of just these two policies.

In addition, roughly $3.5 trillion can be attributed to automatic economic stabilizers. As the economy enters recession, certain spending programs, such as unemployment insurance and food stamps, automatically increase and revenues tend to decline. Although this helps to ameliorate the economic downturn by stimulating demand, it also leads to higher deficits.

Finally, there is the Recovery Act which accounts for just 10 percent of the entire deficit over the next decade. All told, the entire $9 trillion deficit reflects the failure to pay for policies in the past and the cost of the worst economic downturn since the Great Depression and the steps we had to take to combat it.

Now, assigning blame never solves a problem, but it is important to understand that we didn’t get where we are merely as a result of bad luck. It was the result of decisions – conscious, but unfortunate – and it will take deliberate action for us to work our way out of this situation. And it’s critically important that we do just that.

This is a big deal, or it should be. In the middle of a massive spending spree to counter the recession, the Obama Administration is broadcasting the admission that its own policies are “unsustainable.” And there are signs that the White House will do something about it. Shortly after the speech, word leaked out that Orszag was considering a five percent cut in discretionary spending for all Cabinet agencies, with the exception of Defense and Veterans Affairs. [Correction: While several news organizations reported on the five percent cut proposal after the speech, the original request for agencies to create, as one option, budgets that shrunk by five percent was issued by Orzsag in the summer, and initially reported then.]

Scheiber notes that this proposal is controversial not just among Democratic appropriators on the hill, but among some of Obama’s own advisers.

Many congressional liberals were livid, and, according to multiple sources, Larry Summers’s National Economic Council reacted negatively to the emphasis on the deficit. (“The economic team has a healthy debate about most major issues,” says an administration official. “Getting people back to work is central to addressing the deficit. Similarly, putting the country back on a fiscally sustainable path is vital to confidence in the economy.”) The concern among wonks outside the administration is that clamping down on domestic discretionary spending without touching entitlements would take money out of the economy in the short term while doing nothing to close the long-term deficit.

To be clear, the real issue is not short-term spending. It’s what to do when the economy returns to something like normalcy and the U.S. government is still living beyond its means. There are really only two options: Take in more revenues (mainly through tax increases) or spend less (through cuts to entitlements or discretionary accounts). Neither option is going to be politically popular, Tea Party protests aside. The habit of both political parties for several decades has been to win office by promising voters more money–either through tax cuts or spending–not less. This will have to change.

There are a number of options being bandied around, including a possible new Value Added Tax. This may seem like a shocking notion, but it is not as shocking as you might think. Consider this release from the accounting firm KPMG.

More than half of senior business executives surveyed by the Tax Governance Institute (TGI) expect some type of value-added tax (VAT) to be introduced in the United States within five years.

Acknowledging the need for additional revenue to help address the growing chasm between the country’s existing revenue flows and its built-in expenditure obligations, 57 percent of the executives in the TGI survey said they believe VAT legislation will be introduced in the United States within five years, while 18 percent expect it within 10 years.

“The survey responses underscore a recognition that the short- and long-term outlook for the U.S. fiscal deficit is bleak unless some combination of spending cuts and additional revenue is implemented within the next decade or sooner,” said Hank Gutman, KPMG tax principal and director of the Tax Governance Institute, and former chief of staff of the U.S. Congressional Joint Committee on Taxation.

Another possibility is a BRAC-like commission, which has been proposed by Senators Kent Conrad and Judd Gregg. Here is a quick summary of how it might work:

A group of congressional budget hawks, led by Senators Kent Conrad and Judd Gregg, have proposed forming a commission that would make proposals designed to reduce spending or increase federal revenue throughout the government. Unlike most advisory panels, this commission would have the special power possessed by Base Realignment and Closure (BRAC) commissions: Congress would have to vote on its recommendations on a straight yes-or-no vote, without the possibility of amending the commission’s proposals. Conrad, Gregg, and their allies realize that reducing Congress’ flexibility in this manner is the only way to induce Congress to approve politically painful tax hikes and spending cuts (just as it’s the only way to induce Congress to approve base closures).

President Obama has now clearly raised expectations that something must happen. In China, Obama raised the possibility of the U.S. slipping into a “double-dip recession” if the deficits are not handled. On Tuesday, Obama announced that fiscal responsibility “is one of the central goals of this administration.”

Now whatever does happen is sure to be packaged to seem like a win for everybody. But make no mistake, the only route to fiscal responsibility, barring a miraculous economic boom that floods the treasury, is for the American people to either get less from the government or pay more to the government. In this case, the numbers don’t lie.