Obama's fiscal policy

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In this column for the Financial Times, I say that once the recovery is secure, taxes are going to have to go up--and not just on the top sliver of incomes.

This year's budget deficit will be about $1,400bn or roughly 10 per cent of gross domestic product. This comprises $1,200bn, as recently estimated by the independent Congressional Budget Office, plus another $200bn from the first year of the fiscal stimulus. What happens after that? A new analysis for the Brookings Institution by Alan Auerbach and William Gale estimates that the deficit will average at least $1,000bn a year over the next decade - and this on the basis of some pretty optimistic assumptions.

It assumes an orderly recovery, much as from previous recessions: no lost decade of slow growth. It assumes that the provisions in the stimulus law expire when the act says, even though the administration and Congress hope to make many of them permanent. It takes no account of new outlays under the housing plan or the forthcoming financial stability plan. And it assumes the administration does not embark on comprehensive healthcare reform, even though the White House insists it will.

Even under these favourable assumptions, an annual deficit of $1,000bn or more persists. The Auerbach-Gale study also looks further ahead and estimates a "long-term fiscal gap" - "the immediate and permanent increase in taxes" that would be needed to keep the ratio of government debt to GDP constant at its current level. Under those same favourable assumptions, the necessary tax increase is between 7 per cent and 9 per cent of GDP, about equal to the take of the present federal income tax.

This is not to argue against a short-term stimulus. For now, it makes sense to let the debt rise. If anything, the US economy needs a bigger jolt than it will get from the law Mr Obama signed last week. Yet the longer the fiscal gap is allowed to persist, the harder it will be to close. The question is whether, once the recovery is secure, deliberate action can restore fiscal balance before a new crisis forces a draconian response on this or some other administration...

Obama's fiscal responsibilty summit was first-class theater, but did not advance the discussion very far. Mind you, I don't think that the theatrical aspect is bad or unimportant. On the contrary. As I've argued before, a big part of what Obama has to do is speak to the general public over the heads of Congress about what needs to be done. That is what events like yesterday's are about. Treating political opponents courteously and radiating calm non-ideological pragmatism are the way he gets the country behind him. But he has to align opinion behind the correct, challenging, substantive policies, not merely behind a mood of can-do co-operation. If you do that and nothing else, you are Tony Blair.

On long-term fiscal consolidation, I don't see much honesty as yet on what it will take to deal with the problem. Obama's thinking seems to boil down to greater efficiency and higher taxes on the rich. That will be insufficient even to close the current-policy deficit, let alone pay for all the big new things (universal health care, affordable college for all, etc, etc) Obama wants to do.

I also think it is a mistake to promise to halve the deficit by the end of the first term--even supposing he could do it. If this is an unusually prolonged recession, as it may well be, this  timetable is much too fast. He needs to retain the flexibility to keep fiscal policy loose for as long as necessary. You move to fiscal consolidation when the recovery looks solid, not according to the demands of some pre-arranged schedule. You show you are ready to do it when circumstances allow, rather than promising to do it regardless.

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