The Trillion Dollar Fix

Facing the biggest financial crisis of our generation, the Obama administration has certainly been busy. In the first hundred days, the administration has pushed through the largest stimulus package in U.S. history, steered Chrysler and GM toward a managed reorganization, and stress tested our banking system. Treasury Secretary Geithner has floated multiple plans to rebuild Wall Street with a mixture of public and private capital. And if, as many critics have claimed, the administration's proposed packages have not always been harsh enough to put the fear of God into wayward bankers, the administration certainly managed to scare the bejeesus out of them Monday morning with the fighter plane that buzzed Manhattan's financial district.

It's probably no exaggeration to say that Obama's presidency will ultimately stand or fall on its handling of the financial crisis. And at this point, with respect to all the frantic activity, the polls seem to be saying, so far, so good. Even though a recent New York Times/CBS survey suggests that Americans don't expect the country to be out of recession by the end of his first term, Obama's approval ratings are in the mid-sixties.

Of course, Jimmy Carter's early approval ratings hit 70% before beginning their long downward slide. And Bush's ranged as high as 95% after 9/11. As the Wall Street prospectuses all say, past performance is no guarantee of future results.

Still, Obama's performance thus far ought to offer some clue: has he set the stage for economic victory, or defeat? In some sense, for all its exertions, the Obama administration hasn't actually done all that much.

There is, to be sure, the stimulus. It is indeed large, filled with scores of spending plans, alleged to be "temporary." Like the recently discontinued tax on telephone service -- originally enacted to fund the Spanish-American War -- many of these programs will undoubtedly be with us for decades to come. As of now, however, most of the stimulus money remains to be spent.

Yet while the stimulus package will provide some modest boost to aggregate demand, it in no way addresses the central problems the Obama administration faces. The Medicare and Social Security systems are about to start draining the budget, rather than contributing to it. The "stress tests" are starting to tell us what we already knew: Large parts of the banking sector need more capital, which won't be easy to raise in the current economic environment. The recession, and especially the decline of Wall Street, is badly undercutting Federal tax revenues. All of these problems are just revealing themselves. And they will get worse before they get better.

So far, Obama's only proposal for dealing with the funding shortage is a tax increase on high earners, leaving "95% of working families" untouched. But the math doesn't work. In 2006, the latest year for which data are available, the top 5% of families took home a whopping 36% of national taxable income, and paid 20% of that, or around $600 billion, in Federal income tax. But even before the president's ambitious health care plan emerges from the Congressional policy grinder, the CBO estimates that his budget plans to spend an additional $400 billion each year. He's not going to get there with a small, or even a large, tax increase on high earners. For one thing, the share of national income collected by the top 5% has undoubtedly dropped sharply since 2006, because their incomes tend to depend more on capital and business income, and on bonuses, all of which have fallen off. (That's why tax revenues fell off so steeply in 2001.) And work by economists Thomas Piketty and Emmanuel Saez suggests that the deeper the crisis, the longer and deeper the hit to top incomes: the lessening of the gap between rich and poor during the fifties and sixties may in fact have been largely attributable to the deleterious effects of the Great Depression and World War II.

Even if this weren't the case, it's not really feasible to pay for everything simply by doubling taxes on the wealthy -- because federal income taxes aren't the only taxes they pay. Higher incomes are disproportionately concentrated in places with high state and local taxes, like New York City. There's a practical limit to how high a percentage of income you can take from even the wealthiest financier, not least because they have more discretion about how, and whether, they make money, which means that raising taxes above a certain level rapidly starts depressing the amount of income available to tax. Even most European countries don't try to pay for their welfare states just by soaking the rich.

Up until now, Obama has largely done the fun part of governing: promising people free stuff. To be sure, even some of that is fairly unpopular, but the auto bailouts have undoubtedly pleased the UAW more than they have angered the rest of the population, and most of the bank spending has occurred under programs originated in the Bush administration. Now, however, the bill for Obama's central proposals is about to come due. Unless Obama thinks he can borrow something like a trillion dollars a year indefinitely, he is going to have to ask Americans to make sacrifices to pay for the goodies.

And the taxes needed to pay for the new programs are not the only costs he will ask us to bear. Like most as yet unimplemented programs theoretically designed to make the world a better place, a cap-and-trade regime for reducing carbon emissions polls well. But when Americans actually have to start paying more for gas, electricity, and heating oil, they will not be so enthusiastic -- especially if their budgets are still shrinking. And if health care is not to carry a shocking price tag, it will have to achieve some sort of savings through rationing: drug makers simply don't make enough in profits to foot the entire bill through lower pharmaceutical prices. Richard Epstein has argued convincingly that ClintonCare foundered because most American voters have health insurance they are satisfied with. In theory, they support a government health care program--but when they are confronted by the details of how their health care will change, that support evaporates.

Neither Obama's legacy, nor the economy's performance, will be much affected by what has happened in these early days. The real test for both will be how he handles the tough choices ahead.