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In what could prove to be one of the greatest hypocrisies ever to come out of the Washington D.C., Obama today released his 2010 budget proposal. Titled "A New Era of Responsibility," the document contains a blueprint for the biggest expansion of government spending and deficits since WW II, with heroic assumptions for how much extra tax can be squeezed out of the rich, and how all the extra spending can be reined in at some point in the future.
This chart shows both the history of federal receipts and outlays, and what Obama's budget assumes they will in future years. Federal receipts are assumed to skyrocket at double-digit rates in 2010 and 2011, despite only a modest recovery, as higher taxes and new limits on deductions presumably succeed in grabbing hundreds of billions of extra dollars from the pockets of the rich. Receipts are then expected to stabilize at just over 19% of GDP, even though they have averaged less than 18% of GDP over the past 40 years and have only exceeded 19% for a handful of those years.
Spending will surge this year, but is then expected to perform the never-before-seen feat of not growing at all for the next 5 years, even as the government brings a huge portion of the population under its healthcare wing and countless government programs expand in coming years thanks to the recently passed "stimulus" bill. Spending is expected to stabilize at just over 22% of GDP, even though it has averaged about 20% for the past 40 years and has only barely exceeded 22% in a handful of those years.
Even if you believe these projections, this president has the gall and the daring to label a massive and unprecedented increase in government spending and taxation a "return to responsibility."
The potential pitfalls of this exercise inspire dread rather than optimism. What if higher tax rates don't elicit higher revenues? What if spending just keeps ratcheting higher, as it always has in the past? What if interest rates rise, making trillion dollar deficits massively expensive to finance? What if an expansion of government slows the growth of productivity, which in turn results in an economy that grows below "potential" for many years to come?
I don't think you have to look too far or too hard to realize that this document is, for the market, the Sum of All Fears.
16 comments:
Scott,
I think by "A New Era of Responsibility," Obama means the rich are going to be "responsible" for financing failed Liberal programs. "Their fair share.." and all that.
Ha! Why didn't I think of that?
I think you have summed up concisely where the market seems to be headed. There already exists unprecedented headwinds, but the New New Deal is an another animal entirely...
btw interesting article citing Bill Gross...
"things will never be the same. Risk taking has been destroyed and any animal spirits must come from Washington. Global growth rates -- low, low, low -- asset classes will be readjusted for that outlook. That is -- stocks will be more of a subordinated income vehicle as opposed to a 'stocks for the long run' growth vehicle."
http://www.dailyfinance.com/2009/02/26/bill-gross-the-747-billion-bond-man-declares-the-death-of-equ/
I'm reminded of a comment that Gross made sometime in 2002 I believe, as credit spreads were soaring and corporate bond markets were a miserable place to be. He laid out the case for why corporate bonds would never recover and investors who bought them would never see the light of day. It was a new era, etc. The next year corporate bonds were stellar performers.
"What if higher tax rates don't elicit higher revenues? What if spending just keeps ratcheting higher, as it always has in the past? What if interest rates rise, making trillion dollar deficits massively expensive to finance? What if an expansion of government slows the growth of productivity, which in turn results in an economy that grows below "potential" for many years to come?"
1) What if higher tax rates lead to higher income growth and revenues as they did under Clinton as opposed to slower income growth and decreased revenues as under Bush? (Empiricism matters!)
2) Well of course government spending goes up Scott. In any civilized democratic capitalistic society government spending goes up over time (although not necessarily as a percentage of output). (That's just a historical fact.)
3) How on earth will interest rates go up (from 0%) in a liquidity trap in the immediate future? (Go look at your IS-LM curves!)
4)What if government expansion leads to increased productivity due to increased investment in underinvested projects such as on human capital and public fixed investment? (It's happened before.)
5)I'm not how you define "potential" but in my definition technology is mostly endogenous and employment is almost entirely exogenous. (I'm in favor of long term growth as much as anybody but never underestimate a short term economic problem's ability to negatively impact a long term growth prospective.)
Mark: Higher tax rates under Clinton were not necessarily the source of faster revenue growth. Don't forget the significant cut in capital gains taxes in 1997, coupled with the huge decline in capgains taxes on houses. Capgains revenue was literally off the charts during 1997-2000. The dot-com boom also contributed to gigantic revenue gains.
Obama is projecting multi-year declines in spending, and I am not aware of any year in history in which nominal spending did not increase from the prior year. Administrations routinely underestimate the potential for new government programs to grow like Topsy. I would be surprised indeed if there were ever a new government program that didn't end up costing far more than it was projected to.
With Obama projecting spending at 22% of GDP, I automatically figure it will be 23-24% before too long. I think the market is figuring the same thing. This budget proposal is absolutely the most outrageous thing that has come out of Washington in my lifetime.
We may be in a liquidity trap right now (though I wouldn't necessarily agree), but it is dangerous to assume we'll be stuck in one forever or even for the next few years. Interest rates are already rising, by the way, with 10-yr Treasury yields up almost 100 bps from their lows. If the Fed's monetary expansion results in higher inflation, as the gold market is telling us, then interest rates could easily rise to 7-10% in the next 5 years.
The likelihood of Obama's massive government spending resulting in an economy-wide increase in labor productivity is about as close to zero as anything I can imagine. If the private sector spent that amount of money, productivity gains would almost certainly result. The potential for waste and fraud in an $800 billion expansion of spending are mind-boggling.
The market is voting with its feet these days. A massive government expansion will require an equally massive increase in tax burdens, and I can't see how that translates into anything but less investment and less technology and less productivity in the future.
Hi Scott,
The "Sum of All Fears" for the market is an excellent way to describe the direction Obama is trying to take us -- probably conveying a more serious tone than "Government Gone Wild."
It seems to me that your concerns are reasonable that these big new spending programs will just keep getting bigger, increased tax rates won't bring in the expected revenues, productivity growth is likely to slow, and government borrowing costs (interest rates) will eventually begin to rise and perhaps skyrocket.
Although it won't be fun to live through this "New Era of Irresponsibilty," won't it all be short lived by the very negative consequences you list? It seems just the notion (Obama's favorite word) of this New Era is already knocking markets downs.
What worries me, however, is what happens when these ideas begin to fail and Uncle Sam can't increase borrowing or taxing any more? Will our people admit bigger government doesn't work and accept a return to rugged individualism (unlikely), or will they elect politicans who will double down and move to direct wealth confiscation (stronger guidance for those invisible hands) to fund even bigger government? (eg. everyone with over $200K in GLD shares needs to pay a 5% gold tax, etc.)
I also wonder what Obama will do when recovery begins to emerge and the Bernanke Fed starts to shrink the money supply to avoid excess inflation. (I'm assuming Bernanke has the understanding and guts to jump on this.) Will Obama simply appoint a new Fed Chairman who will risk runaway inflation instead? Can we even trust that an independent Fed will survive this era? I can hear the Democrats attacking the Fed now for raising interest rates and hurting their New Era spending (borrowing) programs.
Mark
Mark: Those are all the key questions. I agree with you that we are not facing calamity, and there are some scenarios that aren't so bad and lead to good things eventually.
The best scenario would be that the market and the country wake up to what is going on and his plan runs into trouble in Congress. Obama gets the message and back off and/or tones things down. The Republicans get religion (finally!) and come back with some sensible proposals.
But there is so much uncertainty in the meantime that the market is left in a weak position. I still think these lows can hold, because they are predictive of an extremely weakened economy battered by deflation. The market is pretty much fully aware now that bad things are all around us.
If any good thing has been overlooked by the market, it is the inherent dynamism of the US economy and its ability to exceed expectations time and time again.
It's instructive that Mark only posits the Clinton years for his command economy theory that higher tax rates lead to more income growth and federal revenue. As Scott implied, income and federal receipts grew despite higher taxes, not b/c of them, due to other factors (dot-com and tech boom, cap gains rate cuts, etc).
Why not look at how well tax hikes have done since the New Deal, since that's what The One and his allies in Congress are proposing to reconstruct? When rates were cut in the 1920s 1960s, and 1980s, guess what? We had very nice growth. What happened in the decades when we raised rates, ie, in the 1930s and 1970s? Oh, yes, that's right -- not such a pretty picture...
Sorry, I posted too hastily. I threw in the 1920s right after I said let's look at data since the New Deal! So I'll amend my post to say let's look at data since the end of World War I -- good save, right?!!
Don't forget that Obama's own economic expert, Christina Romer, has done empirical research that shows tax cuts have a powerful impact on economic growth. Where is she, by the way? Under the bus already?
Re: Bill Gross
If memory serves, he was also looking for a long-term extension of the bear market in stocks right around the lows of 2003. Don't know why anyone pays any attention to a bond manager's predictions about the stock market. I have a great deal of respect for Gross's ability to manage bond money, but like a lot of other celebs, he seems compelled to offer opinions outisde his circle of comepetence. Speaking of circle of compentence and speaking outside thereof, Buffett sets the standard for being an idiot savant in a very narrow area, and just being something of an idiot outside of it. See his views on tax policy for starters.
Buffett proves that just because you're rich doesn't mean you're smart, especially when it comes to tax policy.
Jon S.,
Top marginal personal and capital gains tax rates were increased in 1934/1936, 1942/1944 and 1950/1951. GDP growth was stellar in 1934-1937, 1942-1945 and 1950-1953. (Please don't feed me the totally irrelevant line "but two of these periods were times of war.") Marginal tax rates are my research interest. If there is any empirical research that suggests that lowering top marginal tax rates increases economic growth I think that I would be aware of it. The reason is quite simple. I think my thesis will be the first to do just that (under very unique circumstances) and thus it will be truly groundbreaking.
Scott,
Please stop spreading dissinformation about the Romers' paper. We've already been over that ground again and again. David Romer himself has stated that the conclusions of the paper were "Hyper-Keynesian" not supply side. The paper's conclusion was that the only kind of tax change that had a significant effect on short term GDP growth were tax changes (cuts) that increased federal deficits (provided there was not a preexisting recession). In short: deficits stimulate the economy.
Scott.
Please keep up the good work.
You know you're needed when some people actually believe that the government confiscating my money is somehow better for the economy than me keeping my money and spending it as I see fit - like in my business for example.
I am one of those small business owners who pay taxes as a self employed. Every dollar that government takes from me is a dollar I cannot spend on health care, wages, equipment, software, .........
In any event - and as much as many seem to want there to be - there really is no free lunch.
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