Orlando's Outlook: President Obama's Goldilocks budget
Bottom line For the first time in four years, the House of Representatives, the Senate and the Obama administration have all submitted federal budget proposals for fiscal 2014, which begins on Oct. 1, 2013. So voters now have the rare opportunity to place each of these documents side-by-side on their kitchen tables, to judge for themselves whether the focus and direction of each plan passes muster. At first blush, in fact, voters may find themselves thinking—much like Goldilocks—that the budget submitted by the Republican-controlled House looks much too cold, the Democratic-controlled Senate’s plan is way too hot, but President Obama’s middle-of-the-road proposal appears just right. Appearances can be deceiving, of course, so we offer up our critical analysis on the relative economic impact of each of these three non-binding fiscal-policy blueprints.
House looks to balance the federal budget The House got the ball rolling in mid March, proposing to balance the budget and eliminate the annual deficit in 10 years’ time. They achieved this worthy objective without raising taxes, which should result in stronger economic growth. Their focus is to reform health-care spending for people 55 years of age and younger, which reduces the rate of growth for Medicare spending over the next decade. They also proposed to restore $500 billion in defense spending over the next 10 years, which President Obama had cut, to improve our military preparedness in an uncertain world.
Senate wants to raise tax rates In January, when the House authorized the temporary suspension of the then-current $16.4 trillion debt ceiling until May 19, there were two very interesting quid pro quos attached to the bill: the Senate was required to produce a federal budget for the first time since 2009, and if they failed, then their congressional pay would be suspended. Senate Majority Leader Harry Reid (D-N.V.) and Budget Committee Chairman Patty Murray (D-Wash.) successfully shepherded the bill through the Senate before the end of March, and President Obama signed it into law. The Senate’s legislative priorities raise taxes by $975 billion and cut defense spending by an additional $240 billion over the next 10 years, both of which are likely to reduce economic growth. Importantly, the Senate did not propose any changes to Medicare, Medicaid and Social Security. All told, they propose reducing the federal budget deficit to 2.2% of Gross Domestic Product (GDP) by 2023.
President Obama’s budget On Wednesday, President Obama submitted a $3.77 trillion budget proposal for fiscal 2014, with a projected $744-billion deficit. That compares with an estimated $973 billion deficit in the current fiscal year, and trillion-dollar deficits in each of his previous four years, so we are making some modest progress in reducing the deficit. In total, President Obama has added some $5.8 trillion to the deficit since he became president, and federal debt now approximates $16.5 trillion, for a debt-to-GDP ratio of 100%, which we believe is too excessive; a more comfortable ratio, by comparison, would be in the 50% to 65% range.
Here are some of the highlights of President Obama’s budget proposal:
- Fix the COLA The government has long known that the current Cost of Living Allowance (COLA), which uses the nominal year-over-year change in the Consumer Price Index (CPI), overstates inflation. That’s a problem, because this metric is used to calculate annual cost-of-living increases for Social Security benefits and to set income-tax brackets. But a new chain-weighted CPI formulation more accurately calculates inflation, which reduces the growth rate in entitlement benefits and raises income-tax revenue by putting taxpayers into higher tax brackets sooner. The president proposes saving $230 billion over 10 years, which is a nice start. But buried in the fine print, President Obama wants to exclude certain groups at his own discretion (such as the elderly and the poor) from this new, more accurate COLA. So a universal application of this change would produce greater benefits.
- Medicare savings The president is looking to save $400 billion over a decade by reducing health-care payments to hospitals, doctors, insurance companies and drug providers. Included in this sum is a $19 billion cut to Medicaid and $57 billion in higher premium payments from rich Medicare beneficiaries. But this plan, quite simply, will not work, as the president would merely force some of these health-care providers at the margin to withdraw from the Medicare/Medicaid system, rather than work for what they believe are below-market levels of compensation. With the full implementation of the Affordable Care Act coming down the pike next year—along with an estimated 30-35 million new indigent patients—that would unintentionally engineer a massive health-care rationing bottleneck, with less providers trying to service a surging population. Much better ideas are to fix tort reform to ameliorate the practice of defensive medicine and thus reduce costs; allow the sale of insurance across state lines to lower costs; and provide Medicare recipients with a fixed budget so they can comparison shop for better services at lower costs. In addition, the president’s slashing of flexible spending accounts in half this year is a disaster, and that needs to be reversed.
- Curb deductions While the president believes that millionaires and billionaires should pay more in taxes, he defines those people in his fine print as roughly the top 3% of Americans, individuals who earn $200,000 or more and families that earn $250,000 or more. He proposes to limit the value of their tax breaks on popular items like mortgage interest, charitable contributions, state and local taxes, and real estate taxes, to a maximum cap of 28%. Generally speaking, caps of this sort are coupled with reductions in rates. But as part of the fiscal cliff deal on New Year’s Day, President Obama raised marginal and Medicare tax rates, reduced up to 80% of allowable itemized deductions and phased out all personal exemptions, cut flexible spending accounts in half, and raised rates on capital gains and dividends while tacking on a health-care surtax. President Obama hopes to raise $529 billion in additional revenue over the next 10 years, but all of this will likely slow economic growth.
- Buffett rule Named after Warren Buffett, President Obama proposed a new minimum 30% tax rate from the first dollar of income with no benefit of deductions for households earning $1 million or more, which could raise an estimated $53 billion over 10 years. Speculation is that the president also wants a 35% rate for incomes over $10 million. The underlying thesis here is that the president doesn’t think that the rich are paying their fair share. According to 2010 IRS data, however, the top 1% of America (those earning $361,000 or more) earned 18.6% of the total income in U.S., but they paid 37.8% of the total U.S. taxes. So it would appear that the wealthy are, indeed, paying far more than their fair share already.
- Retirement account limits President Obama has proposed a $3 million limit on tax-deferred individual retirement accounts, such as IRAs and 401(k)’s. We’ve been hearing that something like this has been in the works for some time, and it raises uncomfortable comparisons with the recent financial crisis in Cyprus, and the failed proposal to seize assets from guaranteed savings accounts.
- Carried interest The White House is proposing to end the preferential tax treatment of private equity and hedge-fund profits known as carried interest. This had been set at the old capital gains tax rate of 15%, which is now up to 20% plus the 3.8% health-care surtax. President Obama wants the new rate to rise up to the new marginal tax rate of 39.6%, and Republicans may be willing to agree to this provision as part of a larger compromise.
- Tobacco taxes rise to fund pre-school President Obama wants to raise federal cigarette taxes from $1.01 per pack currently to $1.95, to raise $77 billion over 10 years to fund his proposal for mandatory pre-school for four year olds. But this is a very regressive tax, hitting the poor disproportionately hard, so it’s unlikely Congress would approve his proposal.
- More defense cuts In addition to the $600 billion in automatic sequester cuts allocated to defense over the next decade, the president is proposing another 0.7% cut to defense, with another round of base closings, next year. Aside from the obvious hit to the economy, at some point we have to wonder whether we can properly defend ourselves and our global allies against rising, unstable nuclear threats such as Iran and North Korea.
- Corporate tax reform President Obama says that he would like to reduce the corporate tax rate from a statutory 39% current rate (the world’s highest), which leaves our U.S.-based companies in an uncompetitive position. But the global corporate average is 25%, and he does not have any thoughts on how to repatriate $1 trillion in overseas cash. He would like to raise tax rates on foreign earnings, and his proposed clean-up of the corporate tax code includes saving $44 billion over 10 years with changes to energy tax breaks, as well as corporate jets.
Conclusion While President Obama has trumpeted the tax hikes and spending cuts within his budget proposal as “balanced,” we’re less than enthused. More importantly, embedded in his proposal, President Obama is projecting nominal GDP growth of 5.6% in 2016, along with low CPI inflation of 2.2% and benchmark 10-year Treasury yields of 1.2%. In sharp contrast, the U.S. economy has been limping along with GDP growth of about 2% for the past four years. With all due respect to President Obama, we saw nothing in his 2014 budget proposal which suggests that his combination of tax hikes and spending cuts will somehow triple the pace of economic growth over the next three years.