Obama and the Deficit

The Obama Administration will likely propose to reduce the deficit to 3% of GDP by 2016 in its next budget. This goal is a far cry from the older norm of trying to balance the budget and shows how serioulsly out of balance the budget is and how much we have had to compromise our fiscal goals as a result. Can the administration achieve even this limited goal? I think not. They may find a way to achieve it on paper but if the economy remains as depressed as most economists believe it will over the next 5 years, the big changes in spending or revenues that would be required would not only be politically infeasible but probably economically undesirable as well. It would be better to focus on the longer term (the years after 2016) and on health care spending, Social Security, and taxes in particular.

The current health care bill does not do enough to constrain costs, and could be strengthened by, for example, not indexing the thresholds for the excise tax on high end plans and by providing more flexibility and authority to the independent Medicare commission in the Senate bill. Social Security should be reformed by constraining the growth of benefits for the more affluent and by increasing the normal retirement age. Although allowing the Bush tax cuts to expire at the end of 2010 as they are scheduled to do under current law is one way to get more revenue, the entire tax code needs to be simplified and the myriad deductions and preferences (totalling close to $1 trillion a year) need to be pared back.

The administration’s proposal to limit such deductions for the top brackets makes enormous sense and should be reconsidered by the Congress. Alternatively, we may need a new value added tax that would partially replace the income tax (on individuals and corporations) and could be earmarked for health care. If it were enacted soon but phased in only after the economy recovered as proposed by Len Burman and by myself and Henry Aaron here, it would reassure financial markets, encourage households to consume now before the tax took effect – thus helping the recovery along – and promote more saving over the longer run. We will probably need a bipartisan commission to jump start the process since our political system seems paralyzed by partisanship, but our ability to regain some measure of economic stability may well depend on whether our elected officials can find a way to place the public interest above their own more narrow interests.