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Obama Misdiagnoses Source of Deficits

Posted By Brian Riedl On February 17, 2010 @ 1:00 pm In Economics | Comments Disabled

President Barack Obama [1]

President Obama says he wants to reduce America’s record trillion-dollar deficits. Too bad he hasn’t even correctly diagnosed their cause.

During his State of the Union Address, the president asserted: “At the beginning of the last decade, America had a budget surplus of over $200 billion. By the time I took office, we had a one-year deficit of over $1 trillion and projected deficits of $8 trillion over the next decade. Most of this was the result of not paying for two wars, two tax cuts, and an expensive prescription-drug program.”

In other words, it’s President George W. Bush’s fault.

This can’t be true. Mr. Bush implemented the three policies mentioned by Mr. Obama in the early 2000s. Yet by 2007 — the last year before the recession — the budget deficit stood at only $161 billion. So how could those policies cause trillion-dollar deficits from 2009 through 2020?

Let’s unpack Mr. Obama’s claim.

His methodology measures the combined cost of the three policies against a “budget baseline” — a snapshot of what the budget would look like for the next decade if today’s tax and spending policies are maintained. Think of the budget baseline as the do-nothing default option.

The first problem is the president’s baseline deficit of “$8 trillion over the next decade.” This likely refers to the 10-year, $8.9 trillion deficit in the White House’s budget baseline last year.

Yet this baseline contained numerous questionable assumptions. It assumed that spending in Iraq and Afghanistan would continue growing forever, while spending on regular discretionary programs (which has doubled over the past decade) would slow to approximately 2 percent annual growth for most of the decade.

The baseline also incorporated provisions of Mr. Obama’s own stimulus bill that had already been enacted — deficit spending that he obviously didn’t inherit from his predecessor. Thus, the $8 trillion baseline deficit figure is not credible.

And that’s not all. By writing a baseline that assumes spending in Iraq and Afghanistan would continue growing forever (which was never U.S. policy), the president overstates the “inherited cost” of these wars over the next decade by $1 trillion. In reality, troop pullouts will drastically reduce the impact of Iraq and Afghanistan on future budget deficits.

Overall, the president’s data contains too many dubious assumptions to be useful.

So how much of the deficit is really caused by the tax cuts, war spending and Medicare prescription-drug entitlement?
One easy method is to begin with a more realistic budget baseline, using data from the more neutral Congressional Budget Office (CBO). Maintaining today’s tax and spending policies (and assuming a gradual troop drawdown in Iraq and Afghanistan) would, using CBO data, bring $13 trillion in deficits over the next decade.

Compare that to the 10-year cost of the tax cuts ($3 trillion), Medicare prescription-drug entitlement ($1 trillion) and Iraq and Afghanistan spending (approximately $600 billion, again assuming a gradual troop drawdown). This adds up to $4.6 trillion, or just over one-third of the $13 trillion in baseline deficits.

This contradicts the president’s claim that most of the deficits result from those three policies.

Even this methodology does not tell the whole story. After all, if Washington collects $3 trillion in taxes and spends $4 trillion, who’s to say which of the spending programs “caused” the resulting $1 trillion deficit? One could pinpoint any $1 trillion group of spending programs and blame them for the budget deficit.

A better way to diagnose the cause of long-term deficits is to measure taxes and spending against their historical averages. This more comprehensive methodology shows that long-term deficits are overwhelmingly driven by runaway entitlement spending.

By 2020, the CBO-based budget baseline projects that federal spending will reach 26.0 percent of the economy (5.3 percent of the economy above the 40-year spending average). Revenues will settle at 17.7 percent of the economy (just 0.6 percent of the economy below the revenue average) — and even that assumes all tax cuts are extended.

So as deficits expand by 5.9 percent of the economy, nearly 90 percent of the growth will come from higher-than-average spending, and just over 10 percent from lower-than-average revenues.

Virtually all of this new spending will come from surging Social Security, Medicare and Medicaid costs (driven primarily by 77 million retiring baby boomers), as well as net interest on the national debt. These four expenditures will cost $26 trillion over the next decade — surging from $1.6 trillion this year to $3.6 trillion in 2020. That is causing the massive budget deficits over the next decade — and must be the focus of any serious effort to reduce the budget deficit.

Finally, there is some hypocrisy at work. Mr. Obama criticizes Mr. Bush for “not paying for two wars, two tax cuts, and an expensive prescription-drug program.” Yet he would extend $3.9 trillion of these policies (while repealing $700 billion in tax cuts) without paying for them, either. By his own logic, he’s almost as irresponsible as Mr. Bush.

Cross-posted from The Washington Times [2]


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[1] Image: http://www.foundry.org/wp-content/uploads/Obama-100217.jpg

[2] Cross-posted from The Washington Times: http://www.washingtontimes.com/news/2010/feb/16/riedl-obama-misdiagnoses-source-of-deficits/?page=2

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