President Obama releases the politically-weighty final budget of his first term on Monday. It covers the fiscal year beginning October 1 and also contains long-term budget projections. However, none of the major proposals it contains will pass Congress in this presidential election year; it is as much a campaign document as an actual budget. The key budget date in 2012 is not now, but December 31. That’s when some major tax cuts expire, the mandatory budget cuts triggered last year commence and legislation raising the federal debt limit will again be needed.
So what does the President’s new budget tell us that is of interest? It may look different after the election, but, for now, enormous deficits will continue. Namely, a higher than expected $1,330bn for this year and $901bn for next year. As a share of gross domestic product, these deficits continue to be among the largest ever experienced. That translates into a grim outlook for federal debt, which currently exceeds 65 per cent of GDP and is widely expected to be above 90 per cent by 2020. Since 1789, it has been that high only during the second world war.
The main cause of these deficits is the financial collapse of 2008 and the Great Recession that followed it, which President Obama inherited. Federal tax revenues plunged, and higher countercyclical spending, such as unemployment insurance, was triggered. Indeed, the US economy is still very weak, having grown only 1.6 per cent last year. That’s why this new budget will propose one last round of fiscal stimulus ($350bn in tax cuts and spending increases) to accelerate recovery. That would be followed by $3,000bn of deficit reduction actions (half of which would come from tax increases on individuals), beginning next year. This approach of stimulus now and long-term deficit reduction soon thereafter is, in my view, the correct one.
Let’s return to the critical issue of timing. This presidential election year, in keeping with history, is not one for major tax and spending changes. Knowing this, the Obama administration has made Monday’s budget a framework for re-election. Indeed, it is consistent with the president’s recent more populist stance, especially in its call for broad tax increases on wealthy individuals.
But, there will be a profound budget moment on December 31 this year – one of the biggest in American history. This is the day when all of the Bush tax cuts expire, including the ones affecting the middle class. If these aren’t renewed, federal tax revenues are projected to rise sharply, by some $3,600bn over ten years. The date is also the starting point for $1,200bn of mandated discretionary spending cuts over the next decade, triggered by the failure of the Congressional Super Committee last November to reach agreement. Half of these will come from defence. And lastly, the date also marks the point when legislation to raise the federal debt limit, the object of much acrimony last summer, will be necessary again.
This confluence of important budget events is virtually unprecedented, especially during a lame duck Congressional session and just after a presidential election. It presents a golden opportunity for truly fixing America’s alarming deficit and debt trajectory. That’s because the new president, whoever he may be, can veto any new tax and spending legislation, such as an extension of any of the Bush tax cuts. But, December 31 is a world away, and it’s much too soon for that sort of optimism.
The writer is founder and chairman of Evercore Partners and former deputy US Treasury secretary, 1993-94
