"A Disappointing, Procyclical, and Highly Politicized Budget" by Ed Dolan Ed Dolan's Blog April 11th 2013

The White House has officially unveiled its budget for fiscal year 2014. I hope to have a chance to look at some of the numbers and programs in depth over the coming weeks, but the overview alone confirms what many leaks have suggested, namely, that this is a disappointing, highly politicized document. Here are some first impressions:

A commitment to continued procyclical austerity

The first thing the proposal makes clear is that the White House has joined Congressional Republicans in a bi-partisan commitment to austerity. It promises $1.8 trillion of additional fiscal consolidation over 10 years, in addition to $2.5 trillion already achieved, about the same as the GOP is looking for. The only difference is a fig leaf’s worth of proposed new revenue in the White House version, $1 for each $2 of spending cuts.

Under the proposal, federal tax receipts would reach 20 percent of GDP by 2020, about same as would have been allowed by such conservative initiatives as a balanced budget amendment proposed last year by Sen. Orin Hatch. True, some Republicans have held out for a still lower target, but even capping tax receipts at 20 percent of GDP would, in view of the demographic realities of an aging population, mean a much smaller government than Americans have become accustomed to during most of the post-World War II period. (See here for some relevant charts.)

The path of fiscal policy under the budget proposed by the White House continues the procyclical pattern that has prevailed for most of the past decade. A countercyclical policy would move the structural balance (that is, the surplus or deficit adjusted to take account the state of the business cycle) toward deficit when the economy is operating below its potential and toward surplus only after it approaches or reaches full employment. Instead, the pattern since 2010, and continued under the budget plan, is exactly the opposite. As the chart shows, the structural balance has been moving steadily toward surplus since 2010, slowing the recovery, and will continue to do so through 2015. Only after 2016, as the economy approaches full employment, will fiscal policy become expansionary again. That is just the point at which, by the logic of countercyclical policy, it should be moving into structural surplus in order to claw back a bit of fiscal room for maneuver before the next recession.

Tax reform? What tax reform?

The budget overview contains some brave words about tax reform. The President believes, we are told, “that today’s tax code has become overly complex and inequitable and that we should immediately begin the process of reforming the individual and business tax systems.” Amen.

Disappointingly, though, when it comes to specifics, there is no real commitment to broad reform, only some tinkering. Broad tax reform would require elimination of whole categories of tax expenditures, deductions, credits, preferences, and other loopholes. It should, arguably, include new, broad-based revenue sources like a VAT or a carbon tax. It should also include sharp reductions of payroll taxes and cuts to corporate profits taxes (or even their elimination), coupled with taxation of all capital income at ordinary rates. This budget contains no such initiatives.

What it does offer is a cap on deductions at 28 percent for wealthy individuals, along with a “Buffet rule,” that is, a floor on total taxes paid by high-income households. There is also a welcome proposal to eliminate the carried interest loophole that has permitted wealthy taxpayers like Mitt Romney to pay far less in proportion to their incomes than most middle-class households. As far as the distributional effects of the tax system go, such changes are welcome. Over the past 30 years, the share of total income earned by the top 1 percent of taxpayers has nearly tripled while their share of total taxes has only doubled. It is easy to argue for a reversal of that trend.

However, the cap on deductions plus a Buffet rule would do nothing to reduce the complexity of the tax code. In fact, such proposals would seem to make in more complex still. Even the proposed caps on loopholes are subject to loopholes of their own. For example, the White House proposes that the charitable deduction remain available in full to the wealthiest households. Presumably, the political motivation is the widespread misconception that charitable deductions are primarily a channel through which the rich help the poor. Unfortunately, a closer look reveals that at best a third of deductible contributions go to truly charitable purposes.

Meanwhile, the budget is full of new proposals for tax credits to encourage one or another favored project. There are tax credits to encourage small businesses to hire workers, increase wages, and make new investments within high-poverty communities. There are more tax credits to encourage retirement savings, child care, and college. It is not that those are unworthy goals. The problem is that the piecemeal use of tax credits to pursue them directly conflicts with essential goals of broad tax reform, which are to apply similar tax rates to similar activities no matter who engages in them, while keeping marginal tax rates low for everyone.

Energy policy: All-but-one of the above

When it comes to energy policy, the budget promises to continue an “all of the above” strategy:

Investing in clean energy R&D, promoting the safe production of natural gas, encouraging States to cut energy waste with a Race-to-the-Top challenge to cut energy waste and modernize the grid, creating an Energy Security Trust to fund research efforts that would help shift cars and trucks off oil, and making permanent the tax credit for renewable energy production.

This really should be called an “all-but-one of the above” strategy. The missing element is any proposal for full-cost pricing of energy, that is, for making energy producers and consumers bear the external costs they impose on their neighbors in the form of pollution, road congestion, and the security risks of energy dependence. Instead, the budget is premised on the politically popular myth of affordable energy—the idea that we can clean up the environment and solve our problems of energy security while simultaneously encouraging pollution and waste with low energy prices. What we need, instead, is simultaneous reform of energy policy and fiscal policy through a revenue-neutral shift away from taxes on incomes and profits and toward carbon taxes, road use taxes, and the like.

The good, the bad, and the political

Yes, there are some good things in the budget proposal to balance the bad. There is a promise to make at least a down payment on the country’s infrastructure deficit, which, as I have argued, is at least as worrisome as the budget deficit. Unfortunately, even that promise has a bias toward politically popular repairs to roads and bridges while neglecting unglamorous but even more urgent upgrades to hidden bits of infrastructure like dams, water mains, and sewage systems.

There are other welcome promises, including proposals to control medical costs and to cut farm subsidies. Unfortunately, any concrete proposals are sure to face fierce opposition from entrenched interest groups. Every dollar of excess medical cost means a dollar of excess revenue to some health care provider. Reductions to farm subsidies will run into the headwinds of agribusiness lobbyists and the small-state bias of voting in the Senate. The fact that these promises appear as one-liners in the very last section of the budget overview suggests that the White House does not intend to expend much political capital pursuing them.

In short, the budget proposal is, as we have been led to expect, a fundamentally political document. Some of its features, like the Buffet rule and a ban on deductions for corporate jets, are aimed at shoring up the administration’s liberal base. Other features, like the “balanced” mix of taxes and spending cuts, are designed to position the White House as the occupant of a reasonable middle ground while casting Congressional opponents as extremists.

Will it work? Probably not. There is, of course, a small chance of compromise, provided that the administration, having already moved far to the right, moves most of the remaining distance toward the conservative agenda. More likely, though, we will see another year with no budget at all—another year of continuing resolutions and after-midnight stopgap measures, and another year of postponing urgently needed decisions.


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