Making a Good Budget Better

Alice M. Rivlin
Alice Rivlin
Alice M. Rivlin Former Brookings Expert

March 26, 2009

President Obama sent Congress a bold budget reflecting the values of his campaign and the dire economic straits he inherited. This plan would, however, raise deficits to unsustainable levels well after the economy recovers. Now Congress has a chance to make the budget better by reducing the long-term deficits.

Or it could make it worse.

The president’s budget reflects the candidate’s diagnosis of America’s economic ills and offers good remedies. It proposes investments in education, science and infrastructure that will, if spent effectively, enhance the productivity of American workers. Steps toward health-care reform, especially electronic medical records and research on the cost-effectiveness of treatments, will help make the system more efficient.

Most of these targeted cures enjoy wide public support, but that support starts to erode when it comes to paying the bill.

Designed to facilitate a rapid economic rebound, the budget’s humongous multiyear deficits (overwhelmingly attributable to the recession itself, the financial rescue and the temporary stimulus) are both inevitable and appropriate. But as the economy recovers, that higher spending should be recouped. The “pay-fors” in the Obama budget are well designed, but they are not big enough to compensate for the increased spending once economic growth returns.

Obama would shift tax burdens from average working Americans to those who earn most, but the proposed shifts are modest and, on balance, would reduce future revenue. The president would turn the temporary Making Work Pay credit into a small permanent tax cut for most workers and enhance the earned-income tax credit for low-wage earners. He would return the top tax-bracket rates to the Clinton-era 36 and 39.6 percent from the Bush-era 33 and 35 percent.

Restricting tax deductions to a maximum of 28 percent is a good idea, but it should be pushed further. It would be preferable to convert deductions to credits, so that all taxpayers get the same benefit from a given dollar of, say, mortgage interest paid. Differential subsidies to upper-income homeowners are not only unfair but encourage the building of more McMansions.

The other major “pay-for” in the budget is the cap-and-trade plan, since auctioning pollution permits would generate revenue. Tightening the emissions cap over time would raise the price of carbon-based fuels in a reasonably efficient way, encourage shifts to alternative fuels and reduce the amount of heat-trapping carbon-dioxide being released into the atmosphere. The impact of rising transportation costs on low-income people would be mitigated by the proposed income tax changes in favor of low-income workers.

The pay-for package is persuasively designed, but it will not fully compensate for the rising spending. The Congressional Budget Office estimates that, if the president’s budget were approved, deficits would remain above 4 percent of gross domestic product even after the economy recovers and that the national debt as a percentage of GDP would nearly double, from 42 percent in 2008 to 82 percent by 2019. Since much of that increased debt would be held by the Chinese and other foreigners, America’s vulnerability would be heightened.

Congress could greatly improve the president’s budget by accepting its main outlines but adding steps to reduce long-run deficits. Lawmakers could phase out the income tax cuts at a lower level by protecting, say, 92 percent of taxpayers from tax increases instead of 95 percent. They could convert tax deductions to tax credits in a way that raises more revenue or redesign the climate-change proposal to increase revenue faster (perhaps adding a small gas tax increase that would rise in the future).

Congress could increase funding for health-care reform by including part of employer-paid health benefits in taxable income. It could put the Social Security system on a sustainable long-term basis by making minor tweaks to benefits and revenue to take effect a decade or more hence. Or it could pare back future spending on programs not contributing to raising productivity. All of this may sound politically poisonous, but so does unsustainable long-term borrowing.

There is also a serious risk of Congress making the president’s proposal much less fiscally responsible by accepting the new spending and tax cuts but rejecting the pay-fors. That is a scary scenario that only strong, responsible congressional leadership can avoid.