FT.com / Columnists / Clive Crook - The fiscal hole that must be filled: While Barack Obama was in Europe last week, Congress was voting on his budget. Because of the administration’s surpassing ambitions, and because of the colossal demands its budget will place on domestic and international capital markets, the outcome of this debate will matter more in the end for the US economy, and even for the world economy, than all of London’s pleasant if ineffectual global summitry.
Both houses of Congress passed versions of the budget that are close to what Mr Obama proposed. Yet what comes next is still unclear. This will be decided in the House-Senate conference to reconcile the two versions, and in the tax and spending measures that follow. At this stage only one thing is sure: the permanent excess of spending over revenue in the long-term fiscal outlook.
The administration’s original proposal, you recall, left a persistent budget deficit of roughly 3 per cent of gross domestic product. This has nothing to do with stimulus: the gap is there 10 years out and beyond, long after the economy is assumed to have experienced a prompt, strong, and sustained recovery. Taking account of newer data, and using slightly less optimistic near-term assumptions, the Congressional Budget Office has already upped that projected deficit to 4 per cent of GDP.
Even before the budget, the country’s underlying fiscal gap, reflecting demographic and other distant pressures on public spending, had been estimated at 8 per cent of GDP. On the administration’s plans, the US economy will prepare to greet that eventual shortfall with a big structural deficit already in place.
But that is not all. One of the most expensive commitments in the budget is healthcare reform. Towards the full cost of this initiative – estimated at $1,200bn (€890bn, £810bn) or higher over 10 years – the budget merely calls for a 10-year “downpayment” of $600bn. So even that 3 per cent full employment deficit (4 per cent, according to the CBO) was a deliberate underestimate.
And still it gets worse. Congress’s new versions of the budget tweak here and there, paying lip service to the need for fiscal control, but taken together point in the direction you might expect, towards even bigger long-term deficits. Both chambers have agreed to scale back spending on future financial bail-outs, and to trim relief for the alternative minimum tax (a parallel tax code originally aimed at the very rich, which is starting to affect middle-class households). These are delusional economies. More will have to be spent on bail-outs before this crisis is over, and it is the closest thing to a political certainty that the ever-encroaching AMT will continue to be pushed back, at the cost of forgone revenue, year by year.
Also bear in mind that the budget’s signature spending initiative now looks more likely to pass, whereas its signature revenue-raising initiative looks doomed.
The House has written language into its budget that would allow healthcare reform to pass in both chambers with simple majorities, rather than with the supermajority normally required in the Senate. The Senate bill does not include such language, but the version that emergesfrom the conference might. If so, this momentous reform could be enacted without a single Republican vote. At the same time, reflecting the reluctance of many Democrats, the Senate has as good as ruled out this same procedure for carbon cap and trade, the implicit energy tax that was projected to raise hundreds of billions.
In short, whether it intends to or not, Congress is leaning towards making the long-term deficit even bigger. It is preparing to underwrite a large and permanent expansion of the government’s spending obligations while failing to provide for a corresponding expansion of the tax base. A crucial question is therefore whether, and for how long, Mr Obama will continue to be bound by his pledge to raise income taxes “by not one cent” for almost all Americans.
Mr Obama intends to squeeze the rich, but the scope for this may be more limited than US liberals would wish. Few Americans seem aware that the US income tax code, as a recent Organisation for Economic Co-operation and Development study showed, is already one of the most progressive.* Even before the rise in top marginal rates promised by Mr Obama, the US income tax collects 45 per cent of its revenues from the highest-income decile. Compare that with Britain at 39 per cent, Canada at 36 per cent, France at 28 per cent, Sweden at 27 per cent and an OECD average of 32 per cent.
This difference is only partly explained by the less-equal US income distribution. The fact that the US has no broadly based national sales tax – value added taxes make Europe’s overall tax codes less progressive still – only underlines the point. The US tax system raises comparatively little revenue; what little it raises already comes disproportionately, by international standards, from the rich.
I have previously argued that the US will need a VAT. Even before Mr Obama unveiled his ambitions for healthcare reform, wage subsidies to help the working poor, better education and the rest, the US middle class was seriously undertaxed. The government’s promises, on present plans, will be unaffordable. If they are honoured regardless, the only question is which comes first: broadly based tax increases or fiscal collapse. Welcome home, Mr President.
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