Friday, February 5, 2010
The data for the forecast section of these charts is taken directly from Obama's FY 2011 Budget. The forecasts presented in this budget rely, as all forecasts ultimately do, on several critical assumptions. Together, these are among the most heroic and daring assumptions I have ever seen coming from the Office of Management and Budget. They are so off the charts that I don't think they will ever see the light of day. And that would be a good thing, because otherwise we will be facing a very unpleasant economic future.
To begin with, economic growth is expected to average about 4% per year over the next 5 years. That is quite a bit higher than the "new normal" consensus, which sees growth averaging about 2.5-3% per year. I don't really have a problem with that, since I think the "new normal" consensus is too pessimistic. But regardless of how optimistic 4% sounds, the growth projections the administration is using imply that it would take 10 years or more for the economy to return to its potential, or full employment growth. That would amount to a decade of very frustrated voters.
Next, we have the assumption that, thanks to 4% growth and higher tax rates, there will be a surge in tax receipts stronger than we have ever seen before in post-war history. Amazingly, the administration is making little or no allowance for the likelihood that rising tax rates (e.g., the expiration of the Bush tax cuts, the imposition of big taxes on cadillac health insurance policies, the limitation of deductions on high-income earners) and rising tax burdens might a) retard economic growth and/or b) result in lower-than-expected revenues (e.g., due to increased evasion). In other words, if the Laffer Curve asserts itself and/or the economy performs according to the "new normal" consensus, we would likely discover that tax receipts are significantly lower than the administration is projecting.
In the past, strong growth in tax receipts has been primarily a function of unusually strong economic growth, but the administration is not projecting unusually strong economic growth, as I have noted above. This is yet another reason to think it very unlikely that the economy would generate the spectacular growth in profits and incomes necessary to fuel the revenues projected in this budget.
Conclusion #1: it is very likely that the budget is seriously over-estimating federal revenues.
On the spending side, the administration is projecting a significant increase in the size and scope of government. The chart below, from Keith Hennessey's excellent blog post, shows that Obama's 2011 budget projects a substantial increase (on the order of 1% of GDP per year for the foreseeable future) in the size of government relative to what was proposed in last year's budget. Talk about daring assumptions! This alone is a very disturbing development, because it projects a permanently and much higher level of government involvement in the economy than we have ever before seen in peacetime.
I think it's safe to say that the projected level of spending shown in this chart is the absolute minimum that is likely to result if Obama's budget wishes become reality. Never in postwar history has any government program (and Obama is assuming the creation of quite a few new ones) not exceeded its initial cost estimates. Few if any programs are ever terminated, and most just continue to grow like Topsy.
Conclusion #2: it is very likely that the budget is seriously underestimating federal spending.
And from these conclusions, it follows that Obama's budget is very likely underestimating the federal budget deficit by an order of magnitude.
To think that U.S. federal deficits could end up being on the order of 7-10% or more of GDP for the foreseeable future is simply mind-boggling. The only precedent that exists in modern times for a developed economy with these kinds of deficits is Japan over the past 20 years, and that is not exactly an encouraging comparison—Japan has experienced an average real growth rate of only 1.1% per year since 1990.
Many will call me a starry-eyed optimist, but I simply can't accept the proposition that the voters will allow Congress and the President to lead us down a budget path such as is laid out in Obama's 2011 budget. Already it is becoming clear that cap-and-trade is dead, that card check is dead, and that healthcare reform is all but dead. The January Massachusetts Senate vote was the tipping point, as I predicted last month. Who would have thought, just one year ago, that Obama would now be on the defensive? That the only piece of legislation he championed would be an economic stimulus package that has completely failed to deliver its promised results? This is not the stuff upon which heroic and transformative budgets are built.
The Tea Party is now advancing, and the liberal agenda is retreating. This year will likely prove to be a very exciting time in the political and economic spheres. It still pays to be optimistic.
Posted by Scott Grannis at 2:49 PM