What is a deficit hawk to do?

I love the title of the Obama administration's budget document, "A New Era of Responsibility." But do the numbers back up the marketing? In particular, should deficit hawks rejoice in this new found responsibility in the nation's capital? Are we about to put federal government on a sounder fiscal footing, leaving a smaller debt to future generations?

Few economists would blame either the Bush or Obama administrations for running some degree of budget deficit during economic downturns. While we might argue about the size of the appropriate deficit, lower tax revenue and greater outlays on, say, unemployment insurance are a natural and appropriate response to recessions and their immediate aftermath. What is more telling is what happens to the budget picture during periods of economic normalcy.

With that perspective in mind, let's compare the previous and current administration.

During the period 2005 to 2007, the U.S. unemployment rate hovered in the ballpark of 5 percent. What was the budget balance? According to OMB historical documents, the budget deficit averaged just under 2 percent of GDP during those three years.

Now compare these results to the new Obama budget. For the moment, let's put aside concerns about the economic forecast on which the budget is based and take their figures at face value. According to the Obama administration numbers, the economy will reach normalcy of 5 percent unemployment in year 2014, and they project unemployment remaining at that level thereafter. (I infer they take 5 percent to be an estimate of the natural rate of unemployment, which seems reasonable.) What happens to the budget balance when we get to that long-run equilibrium? According to their numbers, under their proposed policies, the budget deficit will average a bit over 3 percent of GDP during that time.

The bottom line: If you are a deficit hawk who lamented the Bush budget deficits, the new administration's budget should not make you feel much better. President Obama will give us different fiscal priorities than President Bush did, but the borrowing and debt imposed on future generations will not be very different, at least if the numbers presented in the Obama administration's own budget document can be trusted.

Girl Your Marginal Benefits

Ever wondered what would happen if someone were to write a love song while sitting in an economics class? Click here to find out. The song is called "Girl Your Marginal Benefits."

Ten Facts about Kevin Murphy

The Chicago economist has a fan club.

A Speech from the CEA Chair

Christy Romer defends the stimulus bill.

Thanks to Mark Thoma for the pointer.

Rosy Scenario, or the Audacity of Hope?

Here (in red) are the growth forecasts used to put out the new Obama administration budget, followed by the consensus forecast of a panel of "Blue Chip" private forecasters (in blue, naturally). (Source. Go to Table 3.)

2009: -1.2% -1.9%
2010: +3.2% +2.1%
2011: +4.0% +2.9%
2012: +4.6% +2.9%
2013: +4.2% +2.8%

Accumulating the difference, you find that Team Obama projects about 6 percent higher GDP in 2013 than do private forecasters.

A related news story:

The Obama administration's outlook has private economists wondering: Has Rosy Scenario made a comeback?...

Nariman Behravesh, chief economist at IHS Global Insight, a major private forecasting firm, called the administration's forecasts "way too optimistic" and said it could represent a return to the overly optimistic forecasts of previous administrations confronted by surging budget deficits.

"They used to joke during the Reagan years that the highest ranking woman in the administration was Rosy Scenario," he said. "We may be seeing a return of Rosy Scenario."

The actual highest ranking woman on the economic team is named Christy, not Rosy, and here is what she had to say:

Speaking to reporters Thursday, White House economist Christina Romer called the projections an "honest forecast" by the administration's professional forecasters. "I'd reject the premise that we're noticeably rosier," she said. "We certainly are somewhat more optimistic, but certainly nothing out of the ballpark."

Moving the Goal Posts

From the Committee for a Responsible Budget:

In constructing their budget baseline – the metric against which the costs of policy changes are measured – the Administration departed from the practice of assuming a “current-law” baseline, and instead decided to use a “current-policy” baseline. A current-law baseline assumes that changes in the budget will occur as they are scheduled to under the law (i.e. provisions scheduled to expire will be allowed to do so). Instead, Obama’s baseline assumes: 1) the practice of patching the AMT on an annual basis will continue; 2) all of the 2001/2003 tax cuts will be made permanent; 3) the wars in Iraq and Afghanistan will continue to cost as much as in FY2008 (inflation adjusted); 4)Congress will continue to enact “Medicare Pay Patches;” and 5) funding will be allotted for anticipated disaster relief....

Taken together, the measures in the Obama baseline will increase this new current law baseline deficit by $482 billion (excluding interest) in FY2013 and more than $5 trillion over ten years. (Interest payments account for another $1.5 trillion over ten years, but some of this is due to already-enacted legislation such as the economic stimulus). President Obama will use this baseline, rather than a current-law baseline, to assess whether new policies meet the goal of budget neutrality, and from this metric his proposals reduce the deficit by roughly $2 trillion over ten years....

The budget includes many policies that have been omitted in recent budgets, such as the cost of patching the Alternative Minimum Tax and funds for operations in Iraq and Afghanistan. The Administration should be commended for the increase in transparency in the budget resulting from including the policies they support. This is a vast improvement on the past practice of omitting policies that would clearly be part of the budget.

However, by putting these policies not just in the budget, but in the baseline, the Administration gives itself a free pass on paying for patching the AMT, making the 2001 and 2003 tax cuts permanent, and the costs of not abiding by the slated Medicare physical payment cuts. Choosing not to offset the costs of these policies is a clear violation of the PAYGO principle, where the cost of new policies should be offset through additional savings.

Assuming that war spending will continue at FY2008 levels (adjusted for inflation) – an amount even beyond what President Bush’s policy would have required – strikes us as a gimmick to build up the spending amount in order to reduce it and claim “savings”.

Tax Rates of the Rich and Poor

I posted this information a while back, but it is all the more relevant today in light of President Obama's recently proposed tax changes.

From a recent CBO report, here are effective tax rates (total taxes divided by total income) for 2005, the most recent year available:

Lowest quintile: 4.3 percent
Second quintile: 9.9 percent
Middle quintile: 14.2 percent
Fourth quintile: 17.4 percent
Percentiles 81-90: 20.3 percent
Percentiles 91-95: 22.4 percent
Percentiles 96-99: 25.7 percent
Percentiles 99.0-99.5: 29.7 percent
Percentiles 99.5-99.9: 31.2 percent
Percentiles 99.9-99.99: 32.1 percent
Top 0.01 Percentile: 31.5 percent

N.B.: These figures include all federal taxes, not just income taxes.

That is, even before the Obama tax hikes, the rich face average tax rates more than twice those of the middle class, and about seven times those of the lowest quintile. These data do not tell you the optimal degree of tax progressivity, but they do describe the starting point from which policy is working.
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Update: Here are the CBO data graphed for David Leonhardt's article on the Obama policy changes: