Tax Analysts Blog

Future Shock

Posted on Jul 29, 2009

Fast forward to November: Congress passes a respectable but downsized health care reform financed with spending cuts and a miscellany of revenue hikes. These include new taxes on high-end insurance plans and a modified version of the President’s plan to trim the value of itemized deductions. The House Democrats’ plan for a surtax on the rich has faded from view. With big smiles for the cameras our leaders declare victory.

Now what happens?

Congress still has to pass a budget for fiscal year 2010 that began on October 1. Revised budget projections released in August show a deficit even larger than estimated in the spring. Congress ignores that unpleasant fact and sticks to the deficit targets it set in the April 29 budget resolution. With a few real tax hikes and spending cuts, a lot of anguish, and a lot gimmickry (including the omission of a permanent fix to the AMT) Congress squeaks by with a budget plan that barely passes its own low standards for fiscal responsibility. To deflect criticism, congressional leaders stress their latest version of pay-as-you-go budget rules that hold the promise of fiscal rectitude in the future.

But the Chinese government wants action. And no less than three senior administration officials--Geithner, Orszag, and Summers--assured Chinese officials meeting in Washington that the administration will act.

It will be in January 2010 that the real fun begins. The formerly mixed signals the economy had been sending now clearly point to recovery. This means we have reached the all-important turning point where government fiscal policy must pivot from massive deficits to massive deficit reduction. The priority is no longer fighting a recession but preventing soaring federal debt setting America on a course of long-term economic stagnation.

As always, the budget process in 2010 (for FY2011) will begin with the President. All the easy deficit reduction proposals (the proverbial "low hanging fruit") have already been used in health care reform and in the FY2010 budget. At a bare minimum, unless it wishes to abandon any claim to fiscal responsibility, the administration must put deficits on what economists call a “sustainable path.” That roughly translates into keeping the debt-to-GDP ratio constant. Congress can do that by keeping the deficit-to-GDP ratio at three percent. That will be difficult because the 2019 deficit is now projected to be in excess of five percent. (One percent of GDP is about $150 billion.)

Post healthcare reform, the administration is likely to look first to the social security program to trim the budget deficit. On top of the list in this category of proposals will be extending the social security payroll tax to families with incomes in excess of $250,000--a proposal Obama first offered during the presidential campaign.

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