Getting Real About the Deficit

The more I think about the budget deal Obama agreed to last week, the less apocalyptic it seems to me. It's true that, macroeconomically speaking, this is the wrong time to be cutting spending, but let's face it: $38 billion in spending just isn't that big a deal at a macro level. It may have a negative effect, but it's a pretty small negative effect.

So let's put the macro-level considerations aside for a moment and just look at the cuts from a pure budgetary perspective. There are a couple of things we can say. First, domestic discretionary spending has gone up about 4-5% a year in real terms over the past decade (and a bit faster than that in the past few years), and it's difficult even for a hardcore liberal to pretend that this level of growth leaves no room for even modest cuts. Second, given the amount of smoke and mirrors in last week's budget agreement, the level of actual spending reductions it contains is probably no more than about $20 billion. Maybe not even that much. This is just not Armageddon, and pretending otherwise doesn't do much except wreck our credibility with the public on fiscal issues.

But that's all short-term stuff, and it's small potatoes from either side of the aisle. What about the longer-term deficit? What should Obama propose in his speech tomorrow? Politically, it's appealing to say that he should propose nothing. He should just say no to the Republican proposal to gut Medicare and leave it at that.

And politically maybe that really would be the wisest course. But we liberals have been saying for years that discretionary spending isn't really a long-term problem. Healthcare is. And that's right: if you want to address the long-term federal deficit, you have to address Medicare. Republicans got their discretionary pound of flesh in this round of budgeting, and they'll probably get a bit more in the years to come. But Medicare is still the real problem.

So if I had my druthers, I guess it would be for Obama to make some genuinely courageous proposals, not the kind of faux courageous proposals that we've gotten from Paul Ryan. That means making it clear that PPACA already does a lot to rein in Medicare costs, but more needs to be done. It means letting all the Bush tax cuts expire, not just the cuts for the rich. It means adding further cost controls. It means adopting some conservative ideas about cost sharing. It means scheduling a steady increase in Medicare payroll taxes over the next couple of decades, maybe a tenth of a percentage point a year from 2020 to 2040. It means acknowledging both that Medicare costs can't keep rising at their current rate forever and that as America ages Medicare is going to require a bigger chunk of tax money.

Personally, I'd like to see the long-term deficit get addressed. I'm not quite sure how that's going to happen as long as Republicans stick to their blood oath never to raise taxes, but I'd like to see Obama make the choice clear. My guess is that if the price of keeping Medicare intact is a return to Clinton-era tax rates, a modest future increase in the payroll tax, and some moderate but real cost controls, the American public will buy it. That's just not a big price to pay. But they won't pay it unless someone lays out the stakes clearly.

As for Social Security — well, I've all but given up on that. I continue to think that a deal on Social Security is eminently possible and would be good both for Social Security itself and the liberal project writ large. My argument is here. But nobody on the left seems to be buying this at the moment. It's a shame.

This is all pie in the sky until a few more Republicans have the guts to stand up to Grover Norquist and acknowledge demographic and fiscal reality. In the meantime, Democrats don't really have a serious negotiating partner. But then, the Republican proposals are pie in the sky too, and taken together this means that serious progress isn't likely until 2013 or later. While we're waiting for conservatives to grow up and return to the real world, though, we liberals shouldn't just stonewall long-term deficit issues, tempting though that is. Instead, we ought to be crystal clear that we really do take the long-term deficit seriously, and we ought to be crystal clear about what our competing vision is for addressing it. Then, when the time comes, we won't be caught flatfooted. That would be a nice change.

Smoke and Mirrors Watch

Here's AP reporter Andrew Taylor digging into the $38 billion in spending cuts that Republicans agreed to and finding that an awful lot of it is smoke and mirrors:

Instead, the cuts that actually will make it into law are far tamer, including [...] $2.5 billion from the most recent renewal of highway programs that can't be spent because of restrictions set by other legislation. Another $3.5 billion comes from unused spending authority from a program providing health care to children of lower-income families.

....The spending measure reaps $350 million by cutting a one-year program enacted in 2009 for dairy farmers then suffering from low milk prices. Another $650 million comes by not repeating a one-time infusion into highway programs passed that same year. And just last Friday, Congress approved Obama's $1 billion request for high-speed rail grants — crediting themselves with $1.5 billion in savings relative to last year.

About $10 billion of the cuts comes from targeting appropriations accounts previously used by lawmakers for so-called earmarks....Republicans had already engineered a ban on earmarks when taking back the House this year.

Republicans also claimed $5 billion in savings by capping payments from a fund awarding compensation to crime victims. Under an arcane bookkeeping rule — used for years by appropriators — placing a cap on spending from the Justice Department crime victims fund allows lawmakers to claim the entire contents of the fund as budget savings. The savings are awarded year after year.

And this report from CBS News notes two other phantom cuts: $1.7 billion left over from the 2010 census and $2.2 billion in subsidies for health insurance co-ops that are going to be funded anyway via the healthcare reform bill. This stuff alone adds up to $27.4 billion, all of it money that wouldn't have been spent anyway. I suppose you can argue that some of it might have gotten reallocated if it hadn't been removed legislatively, but I doubt that the tea party true believers are in a mood to buy that. If these reports are correct, the bill contains only about $11 billion in hard cuts. Basically, it looks as if the tea partiers may have gotten snookered by their own side.

Is the Economy Turning Sluggish?

From Catherine Rampell:

When 2011 began, Macroeconomic Advisers, a forecasting company, expected that America’s economic output would shape up to rise at a 4.1 percent annual rate in the first quarter, the highest pace in over a year....Today, after an especially weak report on February’s trade deficit, the group’s economists lowered their first quarter G.D.P. estimate to a sorry 1.5 percent annualized. If borne out, that rate would be slower than each of the last two quarters, at a time when the economy desperately needs to be rocketing forward so that companies will hasten their hiring.

Who knows? Maybe Macroeconomic Advisers will turn out to be wrong. But it's sure looking more and more like this is an awfully bad time to start cutting federal spending.

The Public and the Debt Ceiling

Responding to an unconfirmed Wall Street Journal article suggesting that President Obama might be willing to negotiate with Republicans over increasing the debt ceiling limit, Jon Chait says:

There's a massive weakness in [the GOP] position that Democrats have not tried to exploit. Republicans are winning leverage by communicating their willingness to do something really unpopular, but they are communicating this inside Washington without having to communicate it outside Washington. If Obama insists he will only sign a clean debt limit bill, and will negotiate budget changes as part of the budget, what do Republicans do? They become solely responsible for the consequences of refusing to raise the debt ceiling. Let them go explain that to their business backers. 

Really unpopular? Here's a poll in January showing that 71% of Americans oppose increasing the debt ceiling. Here's a poll in February putting the number at 62%. Here's another one from March putting it at 60%. And here's one from April that put it at 62% after it was explained that raising the debt ceiling meant the United States might default on its debt.

Now, I don't think these numbers will stay this high once the debt ceiling fight takes center stage and everyone gets a better idea of what it really means to refuse to raise it. Still, like it or not, liberals have long since lost the public opinion battle over the deficit. Poll after poll makes it clear that most people want to cut federal spending and don't want to raise the debt ceiling. Sure, it's a vague sentiment, and it falls apart when you ask them what they want to cut, but the fact remains that the public is largely on the Republican side of this battle right now. I happen to agree with Chait and others that Obama would be better off sticking to his guns and demanding a clean bill, but it's also worth acknowledging that this strategy starts from the bottom of a pretty deep hole. As usual, the liberal community has done a crappy job of selling the public on our perspective. Now we're paying the price.

The Republican Plan

This is from the LA Times this morning:

Kudos to the Times copy desk for writing an unusually clear and accurate headline.

Defunding the Left

Battles over competing priorities are the meat and drink of politics. Conservatives want to defund Planned Parenthood, liberals want to cut defense spending. But Republican strategists have long understood that there's a deeper level to politics, one where the goal isn't merely to fight the opposition's agenda, but to actively undermine the infrastructure and funding that allow the opposing party to exist at all. In the past, the GOP has focused on three primary defunding strategies: Killing off private sector unions, packing minority voters into gerrymandered districts, and championing tort reform as a way of eating into the earnings of defense attorneys:

You can think of this triumvirate—unions, minority redistricting, and tort reform—as Defunding 1.0. And most of it hasn't stopped: Republicans are still battling private-sector unions and pressing for tort reform. But private-sector unions have mostly been beaten, and tort reform has turned out to be a tough nut to crack. So the GOP has moved on to Defunding 2.0, with a brand new trio of pet projects.

This is from my short piece on defunding the left from the upcoming issue of the magazine. To find out what Defunding 2.0 is all about, you know what to do. Just click the link.

Americans Hate Everyone

So here's the latest Gallup poll, asking people whether various groups have "too much power." The funny thing about it is that Americans apparently think that everyone has too much power:

Churches and the military manage to escape the "too much power" box largely thanks to support from huge numbers of Republicans. Labor unions and the federal government go the opposite way, but Democrats don't support them enough to keep their overall numbers from being pretty dismal. Lobbyists, banks, and corporations come in for mostly bipartisan abuse.

Roughly speaking, I'd say that this poll doesn't tell us much aside from the fact that American political beliefs are fairly incoherent. But we knew that already. Beyond that, an awful lot of Americans apparently feel that they themselves have no voice to speak of, which must mean that everybody else has too much. And they might be right.

And to put a timely political spin on this, the lousy showing of the federal government goes a long way toward explaining why Obama "lost" the battle with John Boehner and the tea party over spending cuts. Without taking sides on whether Obama himself deserves any of the blame for this, the fact is that it's pretty much impossible to win a political battle when the public is on the other side. And this poll makes it pretty clear that a big plurality of Americans are in favor of defanging the federal government.

Of course, they're largely in favor of this only when proposed spending cuts are aimed rather vaguely at "discretionary programs" or some such. Boehner won this round because the actual reductions on the table were never made concrete. (In fact, they're still trying to figure out exactly which line items are going to be cut.) However, when it comes to something big and well known, like Medicare, this dynamic shifts in the opposite direction and Boehner will almost certainly be on the losing side of public opinion if he tries to push for big cuts. Political strategy matters in all this, but public opinion matters even more. That's the main reason Boehner won this round and it's the main reason he'll lose the next one if he overreaches.

From House Speaker John Boehner, staking out an early position on the upcoming fight to raise the nation's debt ceiling:

The president says I want you to send me a clean bill. Well guess what, Mr. President, not a chance you’re going to get a clean bill. There will not be an increase in the debt limit without something really, really big attached to it.

This is hardly a surprise. We've been talking for months about how there's going to be a big battle over the debt ceiling, and obviously big battles have to be fought over something. Boehner is just being a little more bellicose about this than usual.

So what's the "really, really big" thing that Boehner has in mind? Maybe I'm being obtuse, but I'm at a bit of a loss over this. I don't think Boehner can get away with demanding concessions on side issues like Planned Parenthood or EPA regs. He lost on that already, and his position won't be any better in a couple of months. As for straight budget issues, what's the point? The House is working on a budget right now and it will land on the president's desk soon enough. That's the place for a fight over FY2012 outlays.

So what else is there? Some kind of deal on slashing Medicare? Maybe, but I'd be pretty surprised if Boehner really wanted to tie the Republican Party to big Medicare cuts in an extremely public battle like this. Permanent extension of the Bush tax cuts? Something else?

I know that I'm demonstrating a lack of imagination here, but I'm hard-pressed to see what kind of big things Boehner can really attach to a debt ceiling bill. Help me out.

Are Roth IRAs a Time Bomb?

Everybody loves Roth IRAs. I'm pretty sure Marian and I max out our Roth contributions every year, and why not? Withdrawals are 100% tax free. What's not to like?

Well, for one, the fact that withdrawals are 100% tax free. Down the road this means lots of savings income free of taxes and a significant loss of revenue for the federal government. That's why Gerald Scorse took to the pages of the LA Times this weekend to say that it's time to retire the Roth IRA. Megan McArdle thinks this is a harbinger:

I'm less excited about Roth IRAs than most people who write about personal finance, and that's because over the years, I expect we're going to see a lot more op-eds like Scorse's. When I look at the budget problems we face, I'm skeptical that Congress is going to live up to its promise to keep its hands off that money. At the very least, I'd bet that high earners are going to see some sort of surtax on their Roth withdrawals.

Of course, I think this is true of non-Roth retirement savings as well. Ultimately, Congress is going to be faced with penalizing people who didn't save adequately for retirement by cutting their benefits, or penalizing people who did save, by raising taxes on their savings. For a lot of reasons, I expect them to err on the side of penalizing savings. This may have some very ill effects on capital formation in the US — but by the time they're making this decision, everything they do is going to have some very ill effects on something.

For what it's worth, I think Roth IRA's are safe. Congress fiddles with ordinary tax rates all the time, and it's well understood that just because a particular rate stands at one level today is no guarantee that it won't be higher or lower in the future. But Roth IRAs are different: these come with an absolute promise that they won't be taxed, and I don't expect Congress to renege on that. I'm pretty sure they've never reneged on a similar promise in the past, and Roth IRAs are so widely held that the political backlash would be huge if they tried.

In any case, Scorse doesn't recommend this. All he says is that Congress should halt new contributions to Roth IRAs or, at a bare minimum, stop expanding the Roth IRA program. He doesn't suggest taxing withdrawals from existing IRAs.

As for retirement savings, I'm not sure why this is any kind of crisis, either now or in the future. Social Security is the main vehicle by which the federal government gets involved in retirements, and it's in good shape. It can remain in good shape forever with fairly minor tweaks to revenue and benefit levels, and I expect those tweaks to be made eventually. There's no reason Uncle Sam has to stick his hands into your Roth IRA in order to accomplish this.

As for the rest of our long-term deficit problem, who knows? The federal government is obviously going to have to raise more money in the future, but I'd be very surprised if higher taxes on savings vehicles were a major part of how this happens — and certainly not taxation of Roth withdrawals, which would break a clear promise and provide very little additional revenue. I'd guess instead that over time we're going to raise another 5-7% of GDP via higher taxes on ordinary income, elimination of some tax expenditures, higher rates on dividends and capital gains, and possibly even a VAT.

In the meantime, though, Scorse is probably right: Congress and the president should resist the temptation to expand Roth IRAs. As long as they're fairly smallish savings vehicles for middle class families, they aren't doing much harm and they're probably safe from congressional meddling. It's probably best to keep them that way.

Why Did Obama Cave?

I've been sick all weekend, and my brain is still a little bit fuzzy. Still, I've been trying to figure something out: what does President Obama really think about the deficit? Did he cave in to Republicans because he didn't have much choice, or does he really think that cutting the budget is a good idea? I'll get to that in a bit, but first, here's Ryan Avent making the case that the budget deal was, substantively speaking, a bad idea:

I think it's worth remembering a few important things. First, the federal government did not need to cut spending in this fiscal year. There is no immediate fiscal crisis; on the contrary, yields on American government debt remain extraordinarily low. Second, macroeconomically speaking, now is a bad time to be cutting spending. The economy remains very weak, state and local governments are already trimming back public spending and placing a big drag on economic activity, and there's plenty of contractionary developments in the pipeline already, from the impending end of QE2 to the impact of rising oil prices....Third, had America actually been facing a crisis or had it simply been an opportune moment to trim back state spending, this was just about the worst way to go about cutting. The cuts don't touch on the real sources of the long-term budget problem.

This is pretty much the conventional wisdom among left-of-center economists, and my guess is that Obama agrees. But if so, why did he agree to the Republican cuts? He might have felt like he was over a barrel and had no choice, but that still wouldn't explain why he talked about the deal so enthusiastically after it was done. There has to be more.

But what? My best guess is also the most boring one: He actually thinks the cuts are a good idea. Macroeconomically they don't make sense, but as a signal they might be pretty powerful. Here's how.

Most center-left types think that our first best economic policy option is more spending now, while the economy is still weak, combined with much less spending in the future, when the long-term deficit threatens to spiral out of control. But Obama probably figures, correctly, that the deal he cut during the lame duck session last year was the last stimulus he was going to get. More spending just isn't in the cards. So what's the second best policy option?

Well, the biggest problem with the first best option has always been that it's not credible. You need some way of signaling the market that you're serious about long-term deficit reduction, and there's really no way to do that as long as you're spending gobs of money in the present. That might be a risk you're willing to take as long as stimulus spending is feasible (since the substantive gain of the stimulus outweighs the drawback of lost credibility on long-term cuts), but it's not worth taking once further spending is out of the question. At that point, the long-term signal becomes your most important policy goal. So my guess is that (1) Obama is serious about wanting to rein in the long-term deficit, (2) he thinks the cuts in this year's budget are a good way of signaling his seriousness, and (3) he also thinks that a few tens of billions of dollars in lost spending will have such a minor macroeconomic effect that it's a small price to pay.

Now, I'd also guess that the last few months of economic data have persuaded Obama that the economy is rebounding, which makes the risk of cutting current-year spending even less. I'm not so sure about that, myself, but there's no question that economic signals are mixed right now. We're obviously headed for a slow recovery at best, but probably a recovery nonetheless.

So, anyway, that's it: my best shot at reading Obama's mind. I suspect Obama really is a long-term deficit hawk and figures that the current budget battle, though not really of his choosing, can be turned to his advantage. He's agreed to cuts but has also shown that he'll fight against crazy cuts, and he thinks that will help him take the high ground when he unveils his own long-term deficit program on Wednesday. This isn't how the events of the past week look to us liberals, of course, but I'll bet it's approximately what they look like to independents. And as we've all learned over the past couple of years, Obama doesn't really care much about how liberals view events.

Front page image: Zhang Jun/Xinhua/ZUMAPRESS.com