Stress Testing the Budget

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The shape of the budget had been widely trailed so it did not come as a great surprise, but to find the administration making no effort at all to prepare public opinion for future fiscal tightening was still a disappointment. Its excuse is that ideas for tax and entitlement reform cannot be thrust upon a Congress (or a country) as divided as this one; if the White House were to attempt it, the effort would only backfire and the chances of getting the reforms passed might actually diminish. You need something closer to consensus first, says the administration. It's an obvious evasion, though much of the press seems to be lapping it up. Short of an outright fiscal crisis, a consensus for fiscal restraint isn't going to emerge spontaneously. Raising taxes and curbing entitlements is never going to be popular. Support will have to be built, and Obama should be trying to build it.

With House Republicans in their present mood, getting to a balanced approach won't be easy. I can see why it's tempting for the White House to let the GOP hack gleefully away at a sliver of the budget, or better still prod them into shutting the government down altogether and one way or another turn public opinion back behind the Democrats. Nonetheless it's an abdication of leadership to do this. In some ways I think I give Obama more credit than many of his advisers. I think he could rally the country around the policy changes the country needs if he were to try. But when has he ever tried? When has he ever led--apart from when campaigning? What a waste.

As for the nuts and bolts of the budget, I agree with Maya MacGuineas and the Committee for a Responsible Federal Budget.

It is encouraging that the Administration identifies some areas for real savings. However, the total level of savings is far short of what is needed and too many heroic assumptions are used to achieve them. This budget fails to meet the Administration's own fiscal target, it fails to tackle the largest problems areas of the budget, and it fails to bring the debt down to an acceptable level.

While we can certainly appreciate the difficult political environment in which the budget is introduced, the glaring omission of any significant entitlement reforms and the excessive use of 'fill-in-the-blank' budgeting does not help to advance the conversation.

This recession and the entirely justified (in my view) fiscal response to it will end up adding more than 30 percentage points to the debt-to-GDP ratio. The president's budget holds the ratio at just under 80% of GDP in the 10-year budget window--but this is before the entitlement burdens really kick in, and it assumes (among other things) that long-term fixes for the AMT and the Medicare doc fix somehow happen along. (The White House audaciously demands credit for allocating revenues to solve these problems, rather than simply ignoring them altogether as previous budgets have; fine, except that its AMT fix is only good for three of the ten years and its doc fix for two.) I agree with the FT's Robin Harding that these deficit projections, unambitious as they are, are unlikely to be met, while so much of the budget is left off the table.

Fiscal policy needs a hypothetical stress test, just like bank capital. Let's be optimistic and suppose that the deficit projections do hold, and that a debt ratio of 80% can be comfortably supported at full employment. What happens when we enter the next recession with debt at that level? Assume another really serious downturn, and another 30-odd percentage points of debt. Worried yet? That's why the problem won't wait another ten years, and why sort-of-stabilising at 80% won't do.

My Monday column for the FT was on the same subject.

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