Ryan v. Obama on short-term deficits

House Budget Committee Chairman Paul Ryan released his proposed budget resolution today. As I’ve done in the past I’m going to compare his proposal to the President’s budget. I’d like to include Senate Budget Committee Chairman Patty Murray’s proposal but she has chosen not to do a budget this year.

In this post I’m just going to compare the short-term deficit and debt effects of the two proposals. While I’d like to use comparable numbers, CBO has not yet rescored President Obama’s proposal because the President released his budget six weeks late. So for now I’ll compare Ryan’s numbers to Obama’s. That is suboptimal but the best we can do for now, and I am confident it doesn’t change the overall picture. Let’s start with deficits.

 

ryan v obama short-term deficits (apr 2014)

A few things jump out.

  • Chairman Ryan’s deficits are lower than President Obama’s throughout the budget window.
  • The difference is significant in the early years.
  • President Obama’s budget would reduce deficits below their historic average only after he leaves office.
  • The gap between the two stabilizes around 1.5 percentage points of GDP.
  • Chairman Ryan’s budget gets to balance, President Obama’s does not.

The most politically potent aspect is balance vs. no balance.

Now let’s compare the short-term debt effects of the Ryan and Obama budgets. Debt held by the public is (sort of) the accumulation of past deficits and a few surpluses.

ryan v obama short-term debt (apr 2014)

 

  • Both propose to reduce debt/GDP over the next decade.
  • Chairman Ryan’s debt is in all cases lower than the President’s.
  • Over time the difference is significant: Ryan’s 10th year level is 13 percentage points lower than Obama’s (caveat: This will change a bit when we get the CBO rescore of the President’s budget).

The notable points here are (1) the growing gap over time and (2) the President’s decision to reduce debt/GDP over time, albeit slowly. In past years he was content to stabilize debt/GDP in the short run.

Fiscal politics and strategy

At first glance the Obama and Ryan budgets appear quite similar to what each proposed last year. Because the downward slope is so gentle, President Obama’s declining debt/GDP path is more significant politically than as a policy matter. It allows him to say his budget would reduce debt over time, at least in the short run. He couldn’t say that last year.

In this midterm election year, Chairman Ryan has offered House Republicans a tremendous political advantage: BALANCE. This reminds me of 2011.

The two political parties have traditionally competed over which party was “the party of lower deficits and less debt.” Many elected officials and their campaign advisors have traditionally seen significant political advantage in labeling their opponents as being for higher deficits and more debt.

This debate is somewhat silly, as the principal fiscal policy difference between the two parties has usually been more about the size of government than about which party wants to borrow less from the future. Nevertheless, the political effects of deficit/debt comparisons are significant.

The same is true for a balanced budget. The economic difference between balance and a 1 percent deficit is not dramatically different from the difference between a 1 and a 2 percent deficit. But the politics of a balanced budget can be powerful.

In 2011 President Obama proposed his budget in February. Chairman Ryan then proposed a budget with a significantly more aggressive deficit and debt reduction path, thus seizing the political advantage in this partisan competition. The numbers clearly showed that (House) Republicans were for much lower deficits and debt than the President.

And then the President modified his budget in April, proposing significantly lower deficits than he did two months prior. He purported to match the deficit reduction in the Ryan budget–this was a lie, but he claimed it. (See Bob Woodward’s book for details on both the internal process and the lie.) What’s significant today is that in 2011 President Obama reacted to the political weakness he then faced by being for higher deficits and debt than House Republicans. He proposed more policy changes, some of which involved more political pain, just so the could claim to match House Republicans on deficits and debt.

Fast forward three years. It’s happening again.

Chairman Ryan has teed up a significant political tool for House Republicans: they can be for a balanced budget, in contrast both to President Obama’s higher deficits and debt and to the Senate Democrats’ lack of a budget.

This is a potent weapon for the mid-term election battle. Congressional Republicans can be not just opposed to something unpopular (Obamacare, of course), but for something popular. They can expand their topline economic message to have three legs rather than just one.

  1. The Obama economic recovery is terribly slow [and we can fix it over time through pro-growth policy changes].
  2. I voted for a balanced budget and long-term entitlement reforms. [The President's budget doesn't balance. Senate Democrats don't have a budget.]
  3. I want to repeal Obamacare [and replace it with (choose your favorite reform alternative)].

I’ll end with three important strategy questions:

  1. Are House Republicans a governing majority? Ryan’s balanced budget provides a political advantage only if House Republicans pass it. Can Chairman Ryan and Boehner/Cantor/McCarthy find 218 R votes for the Ryan budget?
  2. Will Republicans recognize the political and rhetorical advantage that a balanced budget gives them and integrate it into their core election message, putting it on a level playing field with both “weak Obama recovery” and Obamacare? Or will they bet all their mid-term election prospects on a single issue?
  3. Will President Obama react to House passage by modifying his budget proposal as he did in 2011? Or will he cede the rhetorical high ground on deficits, debt, and a balanced budget in favor of attacking the details within the Ryan budget?

 

Why high government debt is a problem

The Obama Administration is trumpeting that the budget deficit has been cut by half, “the largest four-year reduction since the demobilization from World War II.” Indeed, CBO projects the deficit this year will be 3 percent, maybe dropping a few tenths over the next few years before beginning an inexorable climb driven by demographics, health cost growth, and unsustainable entitlement benefit promises to seniors. If you listen to the President, our only problem is that future one and that’s a few years off. Now that deficits have come down, he says we’re OK for the time being. Deficits around 3 percent will hold debt constant relative to the size of the U.S. economy, and he appears to think that’s fine.

I don’t. Look at this graph from CBO.

deficits-vs-debt

In their recently released annual Economic and Budget Outlook CBO lays out the four costs of higher debt (page 7).

  1. “Federal spending on interest payments will increase substantially as interest rates rise to more typical levels;”
  2. “Because federal borrowing generally reduces national saving, the capital stock and wages will be smaller than if debt was lower;”
  3. “Lawmakers would have less flexibility … to respond to unanticipated challenges;”
  4. “A large debt poses a greater risk of precipitating a fiscal crisis, during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates.”

CBO attributes these damaging effects to “high and rising debt,” and doesn’t distinguish between high (where we are now, in the mid 70s as a share of GDP) and future entitlement spending-driven growth. The same logic applies both to today’s high debt and to future even higher debt. These are real and significant costs we are bearing today.

It’s obvious that we can’t allow debt to increase forever as it will begin to do a few years from now but there’s an additional important question that is being largely ignored. Momentarily setting aside future projected debt growth, is debt/GDP in the mid-70s acceptable? Should the goal be to not let the problem get worse, or both to solve the future debt growth and, over time, to reduce debt/GDP to be closer to the historic pre-crisis average?

CBO has done policymakers a great service by explaining these four costs of high and rising debt, and I wish more members of Congress understood them and talked about them. This is important enough that it’s worth the time to understand it well. You can find a slightly expanded version from CBO on pages 9 and 10 here.

I want to expand a bit on CBO’s points. I’ll take them in reverse order and start with the last one, the increased risk of a fiscal crisis. Those on the left who argue that high debt isn’t a problem like to (a) pretend that this increased risk is the only consequence of high debt, and then (b) dispute that the higher risk is significant enough to cause concern. I worry that when the U.S. has doubled its debt/GDP in five years, and when our future debt path looks like it does, that the risk of a fiscal crisis is significant. But this risk is unknowable, and even if we could somehow measure this risk, we can never know when that crisis would occur. My stronger arguments are (1) fiscal crisis risk is undoubtedly higher at a higher debt level; (2) the risk is only going to increase on our current path as debt increases; and (3) there are three other costs to higher debt, so even if you’re not worried about crisis risk, you need to address those other costs.

Moving up the list we get to CBO’s “less flexibility” point. CBO’s projected debt path assumes a (very) slow but basically steady return to macroeconomic health. If we have another recession, terrorist attack, or war, the numbers will be worse, and whatever increased government spending or fiscal stimulus we will then need will be initiated from a much weaker starting point (a much higher level of debt). Because our debt is so high we are poorly prepared to address future risks that require significant short-term deficit spending or tax relief.

Then we get to the cost with the greatest political impact: lower future wages. This is really a cost of the big recent deficits that resulted in today’s higher debt, and an additional cost of projected future deficit growth. The reduced national saving caused by big deficits leads to a smaller capital stock. This lowers productivity and therefore wages. To reduce our public debt government would have to save more (or even, perish the thought, balance the budget), leading to higher national saving, a bigger capital stock, higher productivity and higher future wages. To be politically crass: lower government debt means more shiny new factories with high wage American jobs. I’m willing to sacrifice quite a lot of government spending in exchange for higher future wages.

Finally, the item at the top of CBO’s list is the one most likely to drive Congressional action. Our government debt is now 37 percentage points above its pre-crisis average, but government interest payments are relatively low because interest rates are low because the short-term economy is still weak. When the economy eventually recovers and the government debt rolls over, that additional debt is going to increase government net interest payments by about 1.85 percent of GDP (37% X CBO’s 5% 10-year Treasury rate). Relative to the rest of the federal budget, 1.85% of GDP is enormous. That increased interest cost is as much as the federal government will spend this year on all military personnel (uniformed + civilian) plus all science, space, and technology research plus all spending on the environment, conservation, national parks, and natural resources plus all spending on highways, airports, bridges, and all other transportation infrastructure. Higher debt means higher interest costs which will squeeze out spending for other things that government does. It will also increase pressure to raise taxes even further.

Government debt is twice as large a share of the economy as it was before the financial crisis. In addition to increasing the risk of another catastrophic financial crisis, high government debt squeezes out other functions of government, creates pressure for higher taxes, leaves policymakers less able to respond to future recessions, wars, and terrorist attacks, and lowers future wage growth. This problem will only increase as entitlement spending growth kicks into high gear a few years from now, but simply stabilizing debt/GDP in the mid 70s is an insufficient goal. Don’t rest on your laurels because deficits are smaller than they used to be. High government debt is a big problem.

Response to Senator Cruz on the debt limit

Response to Senator Cruz on the debt limit

On the Mark Levin show Thursday Senator Ted Cruz said:

The single thing that Republican politicians hate and fear the most, and that is when they’re forced to tell the truth. It makes their heads explode. And actually look, this debt ceiling example is a perfect example. The Republican members of the Senate, they all wanted the perfect show vote. So the whole fight was, was every Senator in the Senate going to consent to allow a clean debt ceiling, to allow Barack Obama to get a blank check to raise our debt, while doing nothing about spending, with just 51 votes? Now in order for that to happen, all 100 Senators have to consent to it. Now there were an awful lot of Republican Senators who thought that was perfect, cause then they could all vote no, and go home and tell their constituents, “See, I voted no, I did the right thing.” But it only happens if they allow it to happen. And all I did was very simple, I said, listen, when I told Texans when I ran for office, that I’m going to fight with every ounce of strength I have to try to help pull this country back from the fiscal and economic cliff, I wasn’t lying to them, I meant it. So if your ask of me is will I consent to let Harry Reid to do this on 51 votes, the answer is no. I will vote no at every stage against it, because it’s irresponsible, because it’s wrong, because we’re bankrupting our children. And Republicans’ heads exploded, because it meant … Look, make no mistake about it. This was their desired outcome. An awful lot of Republicans wanted exactly what Barack Obama wanted, exactly what Nancy Pelosi wanted, exactly what Harry Reid wanted, which is to raise the debt ceiling, but they wanted to be able to tell what they view as their foolish, gullible constituents back home they didn’t do it, and they’re made because by refusing to consent to that they had to come out in the open and admit what they’re doing and nothing upsets them more.

In one respect I agree with Senator Cruz. Senate Republican Leaders did “want” the clean debt limit bill to pass the Senate and they wanted the political cover of voting no. Senator Cruz exposed this through his objection, forcing not just Senators McConnell and Cornyn, but a bunch of others as well, to vote aye on cloture so that they could get to a final passage vote where the bill passed but all Republicans voted no.

But they were right to vote aye on cloture. Senator Cruz skips over why the others wanted this outcome: the only other legislative alternative was not increasing the debt limit. At that point no one, including Senator Cruz, had an alternative strategy to pass a debt limit bill that cut spending, or repealed or modified ObamaCare, or made any other good policy change.

If you want to defeat a bad bill you need both a better policy and a viable legislative strategy to achieve it. In some cases that legislative strategy could be blocking enactment of any bill, but that would not have worked here. In this case I believe strongly that not raising the debt limit is far worse than enacting a clean debt limit increase.

This then provokes a series of questions for Senator Cruz.

Q1: “Do you agree that not raising the debt limit is a worse policy outcome than enacting a clean debt limit increase?”

If the answer is yes, then:

Q2: “What was your alternative legislative strategy for enacting a debt limit increase that also contained some other reform?”

If the answer is “I didn’t have one,” then:

Q3: “Weren’t the Senate Republicans who supported cloture therefore doing the right thing, even at some political cost to themselves?”

It’s easy for any one person to design a bill that is (debt limit increase + X), where X is a good fiscal or other policy reform. It’s much harder to get a lot of votes for any particular such bill. House Republican leaders were unable to pass such a bill in the House with any X, good or not-so-good.

And once the House had passed the only debt limit increase it could pass, Senate Republicans were stuck in a take-it-or-leave-it position. Informally we say the House jammed Senate Republicans: Senate Rs were forced to choose between two outcomes, both of which they hated. Had House Republicans been able to pass a debt limit increase with an additional reform attached, then Senate Republicans would have had available another, less worse, option.

Last year I proposed a legislative strategy (including in the Wall Street Journal) to get a small policy concession along with a debt limit increase. The House did a version of this strategy and, as a result, successfully pressured a Democratic Senate into passing a budget resolution. I pushed a variant of this strategy again in September, but this time House Republicans couldn’t execute because they didn’t have the votes.

As was the case in last fall’s CR/shutdown battle, this week Senator Cruz did not have a legislative strategy with an endgame. He neither presented an alternative strategy to his colleagues nor pursued one as a lone wolf on the Senate floor. In both cases he simply made a single aggressive tactical legislative move that didn’t point toward an alternative outcome, then accused his colleagues of being cowardly, unprincipled, and deceptive for not following his lead into a blind canyon.

Some will say, “At least Senator Cruz was willing to fight!” Unfortunately, this argument always stops there, and never explains how a willingness to fight without a strategy translates into a policy win. Legislative conflict is not a schoolyard tussle in which the bigger or tougher guy usually wins. It’s not a Hollywood movie in which the hero triumphs simply because he is virtuous. Legislative conflict is more like chess in that the battle is waged according to strict rules. Those who favor bigger government know how to play chess and some of them are quite good at it. Many of those who favor smaller government now seek praise for tipping over the board or eating the pieces. While momentary rebellion is flashy and can feel good for a moment, it’s not a strategy to win, not how you change policy. And the goal is to change policy for the better, not just to build a bigger mailing list, right?

It’s frustrating because I agree with many of Senator Cruz’ substantive policy goals. I want a smaller government and a larger private sector, less government spending, and less debt. I want to replace ObamaCare with consumer-driven health policies. I am frustrated by the President’s economic policies, by those who twist policy to suit their self interests, and by politicians in both parties who facilitate that behavior.

But having the right policy goal isn’t enough to succeed, to change policy. You also need a legislative strategy with an endgame and some chance of success. As best I can tell Senator Cruz didn’t have one last fall and he didn’t have one earlier this week. His tactical legislative moves, then and now, need to be considered in that context. The same is true for his public comments surrounding those legislative moves. His objection this week served only to expose that Republicans were boxed in, forced to choose between facilitating passage of a bill they didn’t like and an even worse policy outcome. And they were boxed in because they could not build sufficient support for a unified legislative strategy that had a chance of success.

I hope that in the future Senator Cruz can use his intellect, political savvy, and external base of support to produce effective strategies that produce the good policy results we both support, instead of using his prodigious skills and resources only to assign blame for the bad outcomes.

Two presidential errors on unemployment insurance

Two presidential errors on unemployment insurance

Last week President Obama said:

But there’s an economic case for [extending additional unemployment insurance benefits], as well. Independent economists have shown that extending emergency unemployment insurance actually helps the economy, actually creates new jobs.  When folks like Katherine have a little more to spend to turn up the heat in her house or buy a few extra groceries, that means more spending with businesses in her local community, which in turn may inspire that business to hire one more person — maybe Kathy.

By leaving out one word, President Obama got this exactly wrong. The missing word is temporarily.

The “helps the economy” case for increased government spending on additional unemployment benefits is a traditional fiscal stimulus argument: if the government increases spending, people will have more income. They will then spend some/most of it, generating more income for others, and so on. Depending on the type of spending, economists estimate/guess the fiscal multiplier of a dollar of increased government spending (or tax cuts!), then calculate the increase in GDP that will result. From this they estimate the increased employment that will flow from the government’s fiscal stimulus.

Economists like to argue about the size of multipliers for various types of fiscal stimulus. But as best I can tell, they don’t argue that a temporary fiscal stimulus results in temporary economic growth. Once government stops spending money, the beneficial growth effect, however big or small it may be, dissipates.

Now the hope of a traditional fiscal stimulus is that it jump-starts an economy stuck in a rut, providing a big enough temporary boost that the recovery becomes self-sustaining even after the stimulus is withdrawn. Think of it like a strong cup of coffee early in the morning. If all goes well, the initial jolt gets you going enough that you maintain a high energy level even after the caffeine hit has worn off.

It is quite difficult to make such an argument for such a small proposed policy change. An additional $25 B in government spending, in a $16.6 trillion economy, doesn’t come close. It would be like hoping that one sip of coffee will jump start your day. Qualitatively the argument can hold, but it’s not big enough to be credible (assuming you buy the assumed fiscal multipliers in the first place).

President Obama should have said “extending emergency unemployment insurance temporarily helps the economy.” But he didn’t say that because it’s a much weaker argument. By omitting this key word, he implied that this policy is unambiguously good for the economy as a whole, and not just for the recipients of the added benefits.

President Obama then doubled down on his flawed argument by adding:

That’s why, in the past, both parties have repeatedly put partisanship and ideology aside to offer some security for job-seekers with no strings attached.  It’s been done regardless of whether Democrats or Republicans were in the White House.  It’s been done regardless of whether Democrats or Republicans controlled Congress.  And, by the way, it’s been done multiple times when the unemployment rate was significantly lower than it is today.

In the current legislative context “with no strings attached” mostly means “without cutting other government spending, either now or in the future, so there is no net deficit increase.” President Obama wants to increase government spending by $6 B over the next three months (or $25 B over the next year when it inevitably gets extended) without any budget offsets. Deficits and debt would be higher if he gets his way.

His problem is that this turns his fiscal stimulus into a net economic loser over time. If you buy the Keynesian models, the initial positive bump to GDP from the fiscal stimulus is temporary, but in exchange for that you get a permanent increase in debt because you’re not offsetting the added government spending.

That added debt creates an additional fiscal burden (higher interest payments) and the higher budget deficits create an economic cost as well, as lower national saving leads to a smaller future capital stock, slower productivity growth, and lower future wages.

So, even in a CBO-scored view of the world, in which fiscal stimulus works and fiscal multipliers are big enough to matter, a temporary, not-offset increase in government spending like that proposed by the President, results in:

  • a temporary increase in economic growth and jobs;
  • a permanent increase in debt and net interest costs;
  • and a net decline in economic growth and income over time, as the short-term benefits dissipate and the long-term costs gradually accumulate.

This does not definitively mean you shouldn’t do the policy, by the way. You might conclude that a little added growth and job creation now is worth a bigger economic and fiscal downside in the future. Or you might think the compassionate benefit of helping the unemployed is worth the aggregate downsides of a policy that is a net fiscal and macro negative over a longer timeframe. The President said this yesterday when he said that helping some (unemployed) Americans is more important than economic growth for all Americans. Even if you agree with the President’s value choices, that does not excuse his flawed economic arguments.

If you limit your view to only the next year, then what President Obama said is true: the traditional macro models show increased economic and job growth from his proposed policy change. A more comprehensive, longer view allows you to see both the costs and benefits of the President’s policy, and you have to decide whether slamming a couple of Red Bulls now is worth the caffeine crash later.

Although, given the size of this policy, maybe this is more like taking a couple of sips of Red Bull. While the President got his economic arguments precisely backward because he ignored the out-year costs, this is a debate about a fairly small policy change. Relative to a $16+ trillion economy, this really isn’t big enough to matter much either way.

Still, that doesn’t excuse bad economic arguments.

(Official White House photo by Pete Souza)

The fiscal Gordian knot

The fiscal Gordian knot

Here is the fiscal Gordian knot:

Congressional Republicans will only agree to sequester relief if offset by mandatory spending cuts, but President Obama and Congressional Democrats will only agree to mandatory spending cuts if taxes are also increased, and Republicans won’t raise taxes.

This fiscal Gordian knot caused the Super Committee to break down in late 2011. There was no agreement to replace the automatic discretionary spending cuts (aka the sequester) that President Obama proposed and signed into law in the Budget Control Act of 2011. He made a fundamental miscalculation when negotiating that law: he mistakenly assumed that Republican defense hawks would squawk so loudly at the disproportionate defense cuts imposed by the sequester that some Republicans would be willing to support tax increases in exchange for higher defense and non-defense discretionary spending.

The sequester replacement negotiations earlier this year were a second attempt by the President to untie the knot. That time he used political force, trying to bludgeon Republicans into agreeing to tax increases. Again he failed.

As the Republican demand to defund ObamaCare dissolved last week, the President and Leader Reid once again erred. Unsatisfied with a straight extension of current law spending and the debt limit and a political victory over Republicans, they increased their demands. They shifted from a sure-win defensive posture to an aggressive but risky offensive posture, demanding higher spending offset in part by tax increases.

House Budget Committee Chairman Ryan floated a sound and predictable Republican alternative: substituting mandatory spending cuts (specifically, changes to entitlement programs proposed by the President in his budget) to offset higher discretionary spending for defense and (I think) non-defense. This formed the core of Speaker Boehner’s recent offer to the President. The President rejected this offer because House Republicans were unwilling to also raise taxes. For a third time the President failed to untie the fiscal Gordian knot.

The negotiation now lies with Senate Leaders Reid and McConnell. (VP Biden, the only member of the President’s team with a proven track record of closing deals with Republicans, has apparently been locked away at Leader Reid’s insistence.) While the form of the Reid-McConnell negotiation is about the timing for when short-term extensions of the continuing resolution and the debt limit would next expire, the underlying substance of the negotiation is this fiscal Gordian knot. Both leaders are trying to structure both this negotiation and the next to maximize their leverage to achieve their respective fiscal goals.

Democrats had the advantage last week when they were playing defense, trying to block Republican demands to defund or delay parts of ObamaCare. The combination of the Cruz-Lee vaporware defund strategy, a House Republican conference unable to agree on anything, a Republican party message that was muddled at best, and an effective use of the bully pulpit by the President led to plummeting poll numbers for Congressional Republicans. Many Senate and some House Republicans seemed anxious to negotiate a deal that would temporarily both end the government shutdown and extend the debt limit deadline. With Leader McConnell’s tacit approval, Senator Collins kicked off the compromise attempt by initiating a rump group negotiation with a few Democrats. Leader Reid killed this fledgling bipartisan negotiation and once again took matters into his own hands, leading to the current discussion with his Republican counterpart.

Republicans now have a slight medium-term advantage for three reasons. I suspect that Democratic appropriators don’t feel as strongly about wanting to raise taxes as Congressional Republicans feel about not wanting to raise taxes. When they are eventually forced to choose, I’ll bet that enough Democrats (specifically, the appropriators) will accept entitlement spending cuts to fully offset higher discretionary spending, without any tax increases.

In addition, current law defaults to a position Republicans are more willing to accept than Democrats. Senators Cruz and Lee learned that he who favors current law has a significant tactical advantage in a shutdown fight. President Obama’s sequester in current law means the same is true on spending, but this time it favors fiscal conservatives.

Finally, when the public debate was “government shutdown vs. defunding ObamaCare,” Democrats had a communications advantage. Now the debate is shifting to “whether to bust the 2011 bipartisan budget deal by increasing spending and taxes.” That is right in the wheelhouse of today’s Republican party.

By insisting on tax increases to offset higher discretionary spending, Leader Reid and President Obama are doing what neither Boehner nor McConnell has been able to do for several weeks: unite Congressional Republicans. And Republicans have a strong counter: we will agree to higher discretionary spending as long as it’s offset only by entitlement spending cuts proposed by the President. I appreciate that many Democrats think it’s outrageous not to also raise taxes (and they’re nuts for thinking that), but that’s not the point. The key is that while most House and Senate Republicans felt forced into a shutdown over “defunding ObamaCare,” I’d bet that most of them will reject any Reid proposal to unravel the only bipartisan fiscal success of the past five years or to increase spending funded by higher taxes, even if such a rejection means that the government shutdown continues.

If Leader Reid and the President continue to insist on more spending and higher taxes, and especially if they want to try to enact it now, I think it backfires on them. They will reunite Congressional Republicans and give Republicans a much stronger rhetorical perch than they have had so far. Unfortunately, they would also continue the current stalemate.

(photo credit: Jay Allen)

 

An introduction to the debt limit

This post offers a plain vanilla explanation of the debt limit. This is basic background aimed at fiscal policy novices. I oversimplify in a few places for ease of understanding and push some caveats and complexities down to footnotes. Some of my past readers may find this too elementary, but it’s a foundation I can build upon in future posts that will offer more detail and discuss the current stalemate.

The federal government’s fiscal year begins October 1, so federal fiscal year (FY) 2013 just ended and FY 2014 just began last week. In FY 2013 the federal government collected about $2.813 trillion in revenues and spent about $3.455 trillion. The difference between those two numbers, $642 billion, is the unified budget deficit for Fiscal Year 2013. We say unified budget deficit because we’re looking at all money flowing into the federal government (revenues) and all money flowing out (spending), and not distinguishing among different sources or uses of those funds. In other contexts, usually having to do with Social Security, we might want to treat on-budget and off-budget spending and taxes differently, but for this discussion we will use unified numbers.

I think of these enormous numbers as representing flows of cash. (Please see the footnotes below for two caveats: [1] [2]) The key question: if last fiscal year the government spent $3.455 trillion in cash but collected “only” $2.813 trillion in cash, where did it get the other $642 billion in cash it needed to pay the rest of its bills?

The federal government borrowed it. The Treasury department sold IOUs that we call Treasury bonds (technically bills, notes, and bonds, depending on the timeframe). Investors paid cash for these IOUs, and in exchange they got a promise that Treasury will pay them back later, in full, with interest, and on time. We say that Treasury issued debt to raise cash. Treasury’s issuance of debt is a means to an end: it is the mechanism Treasury uses to get the cash it needs to pay all the government’s bills (which we call government obligations) on time.

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The President’s irrelevant debt limit threat

Late last week President Obama called Speaker Boehner to say that he wouldn’t negotiate on the debt limit.

This strikes me as an irrelevant threat. As best I can tell, no one was proposing such negotiations. Indeed after the tax increase fight last December, Speaker Boehner made a point that he would henceforth return to regular order rather than engage in ad hoc one-on-one negotiations with the President.

To increase the debt limit one needs the House and Senate to pass identical bills which raise (or suspend for a time) that limit, and then for the President to sign that bill, or at least not veto it. To pass identical bills it may be necessary for Speaker Boehner and Leader Reid to negotiate. But the President and his advisors don’t have to be part of that discussion. Speaker Boehner needs only the President’s reluctant after-the-fact acquiescence to a House-Senate agreement legislated without the President’s direct participation. To succeed Speaker Boehner does not need President Obama’s up-front and public approval.

Had the President wanted to make a threat that mattered, he would have told the Speaker “If you send me anything other than a clean debt limit bill, I’ll veto it.” That would have been a red line. He didn’t make such a threat, and that’s intentional. But the actual threat made by the President sounds tough to his allies without actually constraining his future options. The President won’t have to retreat (again) from a red line threat, because he hasn’t actually drawn a red line.

The legislative reality is that in the current House-Senate configuration, President Obama will never veto a debt limit bill.

He won’t have to. If there’s a provision that he hates enough that he would veto it if it were attached to a debt limit bill, he can simply threaten a veto, publicly and/or privately. He can tell Leader Reid, “Harry, don’t send me that bill or I’ll have to veto it.”  And, if the threat is unequivocal enough, Leader Reid will then ensure that a bill containing that provision does not pass the Senate.

Alternatively, the President can use his bully pulpit to urge his allies in Congress to block any bill that contains the offending provision. The bully pulpit and the hammer of a veto threat (rather than a veto) are sufficient tools for President Obama to prevent big policy changes that he detests being attached to a debt limit extension.

The simplest example would be if the House were to pass a debt limit extension that also “defunds” ObamaCare. While President Obama could threaten a veto of such a bill, and he might, it’s likely an unnecessary threat. Acting on their own, Senate Democrats and Leader Reid would never allow such a provision to pass the Senate, thus obviating the need for a Presidential veto. In this case the veto threat matters only if it’s needed to shore up Democratic votes.

Now let’s return to the actual threat made by the President. It’s easy to imagine Speaker Boehner turning to his staff and saying, “The President just cut himself out of our debt limit negotiations with the Senate. Let’s see what we can work out with them.  If the White House doesn’t like something we want attached, they can try to convince Harry to block it. We can’t big stuff like defunding or even Keystone on this bill, but there may be a small win or two that Harry would accept despite carping by the White House.”

Now it may happen that Leader Reid, either on his own or at the behest of the President, refuses to allow the Senate to consider anything other than a clean debt limit bill. The President might still get his desired result, if Leader Reid is on exactly the same page and if the Senate position prevails in the upcoming back-and-forth with the House.

But by saying “I won’t negotiate,” the President has moved himself into the background, into a position of indirect influence through his allies on the Hill. This is most likely to matter on important but second-tier issues, things which the President opposes but which Senate Democrats may be willing to accept, or may find they have no alternative but to accept because no other legislative path to enacting a debt limit increase is possible.

The key for Congressional Republicans is then to exploit whatever procedural leverage they can generate, combined with policy differences (or differences in intensity) between the President and Congressional Democrats.  House Republicans can attach a modest policy change to a debt limit bill and maybe get enough Senate Democrats to swallow it. If they do, the President will have to accept it, because he can’t risk vetoing a debt limit extension over the inclusion of a second-tier policy he doesn’t like.

House & Senate Republicans did this last spring. They attached a “no budget no pay” provision to a debt limit extension. Senate Democrats accepted it, and the President signed the bill after insisting on a clean bill. As a result of this provision, the Senate passed a budget resolution for the first time in years. This was a modest policy and process win, but a win nevertheless.

The President says he refuses to negotiate on this bill.  That should suit Congressional Republicans just fine.  They can and should instead try to work something out with their colleagues on the other side of the aisle. The President’s ineffective threat may provide an opportunity to get a small policy win or two as an attachment to a debt limit extension.

 

Boasting about a 4.2% deficit?

Boasting about a 4.2% deficit?

Here’s President Obama in his weekly address on Saturday:

In a little over three years, our businesses have created more than 6.5 million new jobs.

… Corporate profits have skyrocketed to all-time highs.

… Our housing market is healing.

… And our deficits are shrinking at the fastest rate in decades.

If you studied my post last Wednesday on the CBO baseline update, this should strike you as an odd boast.

CBO projects that under current law we would have a deficit of 4% of GDP for 2013, meaning that our debt/GDP will continue to rise. CBO further projects that under the President’s budget we would have a deficit of 4.2% of GDP for 2013, slightly higher than their projected deficit under current law.

President Obama’s words:  Our deficits are shrinking at the fastest rate in decades.

Translation 1:  The rate at which we’re rolling backwards is slowing dramatically.

or Translation 2:  Our debt problem is getting worse much more slowly than in recent years.

That is not something you should boast about.  You’re supposed to boast when things are getting better, not when they’re getting worse more slowly.

A mistake in my deficit post

I made a mistake in my Wednesday post about CBO’s new deficit projection. I simply misread (and then misreported) CBO’s explanation of why their revenue projection increased.

CBO projects that revenues will increase significantly from last year (2012) to this year (2013) for three reasons:

  • The tax increases legislated in the January 2nd “fiscal cliff” law;
  • Some taxpayers realized their income in late 2012 rather than 2013 in anticipation of 2013 rate increases;
  • For other reasons, personal income increased from 2012 to 2013.

These are all reasons why the U.S. Government is projected to collect significantly more revenues in 2013 than it did in 2012. In my earlier post I had mistakenly said these were reasons why CBO’s most recent baseline update had increased from January/February until now.

CBO’s Jan/Feb baseline document (and, indeed, their August baseline update last summer) had already incorporated tax increases scheduled to occur under then-current law. CBO did not leave them out of their Jan/Feb projection as I wrote earlier.

CBO’s revenue projection increased from their Jan/Feb baseline document to now simply because they have increased their estimate of the magnitude of the second factor listed above.

I apologize for any confusion I caused. While it’s important that I correct this, the error and correction don’t change the fundamental lessons from that post.

You can see the corrected post here.  Thanks to a friend for pointing out my mistake.

CBO’s new deficit estimate

CBO’s new deficit estimate

Update: In the original version of this post I erred in explaining why CBO increased their revenue projection.  I simply misread the CBO document. A fuller explanation of my error is here. Corrections are in green below.

CBO released their updated economic and budget baseline today, in advance of their estimate of the President’s budget due out later this week. At first the headline sounds like good news: the deficit for this year will be “only” $642 B, 4% of GDP. That’s about $200 B smaller than CBO projected for this year in their January baseline document. Should we celebrate?

No, not unless you like the “fiscal cliff” tax rate increases and you like the government owning Fannie Mae and Freddie Mac. Those are the reasons why the deficit projection declined.

Deficits and Debt

You should know three benchmarks when thinking about federal budget deficits, each measured in % of GDP:

  1. A roughly 3% deficit will hold debt/GDP constant;
  2. The historic average deficit (pre-2008 crisis) is about 2% of GDP; and
  3. Of course, a balanced budget is zero deficit.

Any time you hear a deficit number, compare it to zero, two and three, and you’ll have a good feel for where we are. A 4 percent deficit for this year is not good: it’s almost twice as high as the historic average, and it’s high enough that our debt will continue to increase faster than our economy will grow.

You will hear “But that 4 percent projection is much lower than the 5.4% projected in January. Surely that’s good news.  It is certainly an improvement over where we thought we were this year.”

This is where we need to review levels, rates of change, and expectations. This is tricky so I’ll break it down into small steps.

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