Gloom from Doom

Nouriel Roubini enunciates the doleful prospects for fiscal reform:

On Monday the Obama administration released its fiscal year 2011 budget, which forecasts fiscal deficits of $1.55 trillion (10.6% of GDP) and $1.3 trillion (8.3% of GDP) for 2010 and 2011 respectively. To support economic recovery in the near term, the administration plans to increase spending on several stimulus measures: extending unemployment benefits and health care subsidies for unemployed workers; providing tax and credit incentives for small businesses to invest and hire workers; extending payroll tax cuts for the middle class; and increasing funding for states, infrastructure and transportation. Meanwhile, the administration plans to begin to reduce the fiscal deficit in 2012 and bring it below 4% of GDP by 2014 by adopting fiscal consolidation measures and reducing the primary deficit. It aims to do so by raising taxes on high-income households and investors, and cutting spending on health care and discretionary programs.

These proposals fall short of aggressive fiscal reforms, and the fiscal deficit is likely to remain near $1 trillion and exceed 5% of GDP over the next decade (and trend higher thereafter). Near-term spending on fiscal stimulus and defense will remain high at least until 2011, as Obama’s proposed three-year freeze on discretionary spending excludes defense and entitlements. A sluggish and jobless economic recovery and weaknesses in the financial and household sectors will keep revenues subdued and constrain tax hikes. Rather than yielding savings, as projected by Congress and the administration, the health care reform legislation will burden the fiscal deficit over the next decade. Health care mandates and subsidies will raise government spending, while cost savings from the proposed reforms will be small and accrue only in the longer term. The elimination of the “public option” proposed for health insurance might reduce fiscal costs, but not having one will keep insurance premiums high.

Obama simply lacks the political support to implement aggressive fiscal reforms. The Senate recently voted against Obama’s proposals on spending freezes and the establishment of a fiscal commission, whose role would be to send fiscal reform legislation to Congress that would have to be voted on or thrown out without the possibility of amendments. Moreover, if policymakers extend the 2001 and 2003 tax cuts beyond 2011, when they are scheduled to expire, the impact on the fiscal deficit and U.S. fiscal credibility would be immense. Washington has not signaled strong support for wider tax reforms, such as introducing a value-added tax.

Despite the ticking fiscal bomb, midterm and presidential elections in November 2010 and 2012 respectively will further constrain the political will to undertake necessary reforms. With a subpar economic recovery and an unemployment rate above 8% during 2011-12, the Democrats, struggling to maintain power, are unlikely to approve spending cuts, while the Republicans, seeking to revive their prominence, will be unyielding on tax hikes. Even if Obama manages to establish a fiscal commission by executive order, Congress will be wont to reject any radical fiscal reform proposals.

Sadly, that’s pretty much the way I see events unfolding. Even crisis is unlikely to save us from ourselves since crisis is more likely to strengthen the hand of central planners than weaken it.

3 comments… add one
  • Wait till public employee pension plans run afoul and the States run into really big trouble.

    But hey, we’ll just make it a right and *poof* there will be money!!

    Hmmm…does the U.S. printing press go up to 11?

  • Andy Link

    Steve,

    Additionally, those public employee pensions are not insured by the PBGC.

  • Here in Illinois the challenge that public pensions present is distinctive if not unique: their sanctity is written into the state’s constitution. It is a level of obligation above the state’s support for public education or anything else funded by the state government. Even if the state defaulted, the public pensions would remain, would still have to be paid, and couldn’t be reduced.

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