On Monday, February 14th, President Obama released the 2012 budget that totaled over $3.7 trillion in government spending, but also includes spending reductions of $1.1 trillion over the next ten years. That is in contrast with the Republican Study Committee that lists cuts of $2.5 trillion over the next ten years. A review of both proposals show a distinct difference in priorities. While both emphasized cuts to discretionary spending, the Republican plan will take a much deeper cut on domestic spending. Our budgetary issues are significant and either plan will be distasteful to a number of Americans.
You might be asking why do we have to balance the budget. Actually, the U.S. does not have to balance the budget. One must recognize that most Americans have not balanced their "budgets" and continue to carry credit card and loan balances to maintain their standard of living. However, it is important that the U.S. establish a more responsible path to dealing with rising deficits. Just as an individual's credit rating can decline when their spending patterns become irresponsible, the U.S. can lose their top credit rating unless they can rein in future deficits. If the U.S. continues along this profligate path, then our future economic prosperity will take a hit as borrowing costs rise, which will impact consumers and businesses alike.
Alternatively, you might be asking why not balance the budget NOW. It is the same reason why Americans do not pay off all of their credit card debt in one month. Imagine paying off $14,750 in one year, which is the average balance for households with credit card debt. (Note: By the way, over 51% of U.S. households carryover a balance each month.) Think about how that would impact how they live. Correspondingly, drastically cutting government spending to balance the deficit in a year would have a profound effect on economic activity, social stability, and national security.
While Obama's plan centers on strategic spending initiatives aimed at boosting future economic growth, the focus of Republicans is on lowering government spending and hoping that will spur private investment. Obama hopes to add funding of $148 billion toward research and development with most of that centering on alternative energy. In Principles of Microeconomics and Mankiw's Externalities, there is a concept called technology spillovers where the impact of one firm's research and production efforts can positively impact another firm's activities. He hopes that subsidies and tax credits to specific industries will result in advancement in finding alternative sources of energy. While there is debate among economists over this effect, we can infer that President Obama believes this effect to be relatively significant and eventually lessen our dependence on crude oil and lower energy costs in the future.
On the other hand, Republicans side with economists that think the technology spillover effect is relatively small and they want to unleash the power of capitalism and the private sector. In order to do this, a closer inspection sees the potential for much collaterial damage to ordinary and middle-class Americans. While it seems that simply reverting spending levels from fiscal year 2011 to fiscal year 2008 is reasonable, one must recognize that after adjusting to inflation and population increases that the level of services received by Americans will be lower than what they received three years ago. In particular, giving up federal control of Fannie Mae and Freddie Mac is particularly dangerous because it is key source of financing for many middle-class Americans. Given the toxic state of their balance sheet, it is very questionable whether they would be able to attract enough private capital to remain afloat and that could leave great uncertainty in the housing market.
On the positive side, these spending cuts can fuel future economic growth and greater productivity. Lower deficits will be looked upon favorably abroad and lead to lower interest rates. There also can be room to lower taxes for both consumers and businesses. That can boost investment spending and hopefully result in more job creation. On the downside, they are not well positioned to handle the potential aftereffects of Middle East instability due to large reductions in alternative energy sources. Also, there is scant mention to declining infrastructure needs that the private sector historically underserves.
There are concerns about spending reductions and how it can affect social stability. While one of President Obama's goals is to minimize income inequality, tough choices on specific programs could alleviate those concerns. First, there will be a number of government programs that will either be eliminated or reduced. One proposal will involve a reduction of $2.5 billion in subsidies to the poor to handle rising energy costs, so that will affect their spending for food, transportation, and other activities. Another involves eliminating Pell Grant funding in the summer. Pell Grants are given to low-income students, so its elimination will slow matriculation rates in college for this group. Scaling back community development grants will burden distressed areas that are already having trouble generating jobs and encouraging economic development.
The defunding of these programs will hurt, but would be much larger if not obtaining additional revenue streams from high income households. In particular, Obama would like to limit mortgage interest and charitable deductions on households earning $250,000 or more. This would essentially be a tax increase, but is consistent with his pledge to not raise taxes on the middle class. Though Jerry Howard of the National Association of Home Builders asserts that this is a tax increase on the middle class, one should note that the median household income was $50,221 as of 2009, which is significantly lower than $250,000. On the other hand, this does have the potential to impact home purchases in affluent areas and could spell trouble for non-profit organizations that are more dependent on private fundraising now that government support is trending downward.
Of course, these concerns will be magnified under the Republican plan. All of the above would occur, but at much higher rates. Another potential concern is shifting the costs of Medicare and Medicaid from the federal government to the states in meeting the health care needs of the indigent. States would be forced to find alternative funding sources or decide to not cover health care services for many of their citizens. This has the potential to disrupt the social fabric of the U.S. with many not realizing the actual impact until it is too late.
Lastly, national security could be an issue, in particular if Obama's initiatives are passed. Specifically, his budget will call for a 5% reduction and he hopes that this will occur as troops leave Iraq as projected and the Pentagon is able to generate $78 billion in saving. Many communities depend on economic activity from the military, so this will politically difficult to acheive. When looking at the Republican plan, there was no mention of cuts in defense spending, so their emphasis remains on maintaining strong national security. Given the hot spots across the globe, its emphasis can be easily justified.
In summary, it is highly doubtful that either proposal will be fully adopted because the political cost will be too much to bear for much of Congress. However, it is imperative that our political leaders be upfront with Americans on the importance of addressing our deficit problems and how it will negatively impact our future growth, if it goes unaddressed. There are no easy solutions where we can rely on waste and inefficiency to solve our fiscal problems. In particular, changing demographics will be a huge obstacle as Social Security benefits and rising health costs will quickly absorb a large portion of upcoming budgets. Tough choices that involve some combination of reductions in government spending or raising taxes will inevitably cause short-term harm to the economy, but making the right strategic choices now can better position Americans to enjoy prosperity in the future.
You wrote:
ReplyDeleteHe hopes that subsidies and tax credits to specific industries will result in advancement in finding alternative sources of energy.
Apparently the nation is put at risk by Obama's belief that government can change the laws of physics and chemistry. We are decades from having energy alternatives that can compete with hydrocarbons -- except for nuclear power, which the government refuses to fully exploit.
While there is debate among economists over this effect, we can infer that President Obama believes this effect to be relatively significant and eventually lessen our dependence on crude oil and lower energy costs in the future.
Total nonsense. The AGGREGATE consumption of oil is going to climb because more and more people around the world are buying cars, flying on planes and crisscrossing countries on buses, trains and trucks, and crossing oceans on ships.
Increases in the number of miles vehicles will travel on a gallon of gas are meaningless next to the increase in the number of motorized vehicles carting people everywhere on the planet.
You wrote:
ReplyDeleteOn the other hand, Republicans side with economists that think the technology spillover effect is relatively small and they want to unleash the power of capitalism and the private sector.
Aha. Like opening up domestic oil & gas territory to drilling? Seems like killing three birds with one drill-bit. Let's see. High-paying jobs for a lot of people. Reducing our oil imports (not our consumption, however), and funneling royalties, fees and taxes to local, state and the federal governments, right here in America. Where's the problem?
In order to do this, a closer inspection sees the potential for much collaterial damage to ordinary and middle-class Americans.
Yeah. An increase in high-paying jobs is bad news for the middle class? Not likely.
Here's another way to improve the US economy. End the tariff on imported ethanol. Our bizarre farm policies now include a 44-cent per gallon tariff on ethanol from Brazil. You want collateral damage -- see corn prices and connect the price of corn with the price of every product in which corn is used.
If our lame-brain politicians had not decided to subsidize the hapless and nearly helpless ethanol industry, we could all eat for less. Meanwhile, Brazil has ethanol for export.
@ no_slappz, I appreciate the feedback and hope it is not the last time that you comment. You make a good point when you say that we might be years or even a decade or more from finding a reliable source of alternative energy. However, one can make the argument that subsidizing research in this area can quicken its development if done right.
ReplyDeleteYou do make a good point about how the U.S. should consider ending subsidies on ethanol production and I actually point this out in a previous blog.
As for drilling for more oil in the U.S., I would actually use your initial point to counteract the value of this activity. Would increasing oil production along our borders significantly change world oil prices, even if it is fruitful and effective, which is also debatable? I would say no based on rising oil demand from China, India, and other developing countries.
As to your point that oil production would create high-paying jobs, I agree, but most of those jobs would be concentrated on the coasts. When you think about the rest of the U.S., cuts in government spending affecting FNMA, FHLMC, energy costs, and infrastructure spending will curtail economic activity, especially in the short run. While I recognize that oil production technology has improved dramatically, there is still the environmental risk of increasing oil production and oil spills can greatly impact other industries, such as tourism.
You wrote:
ReplyDeleteWould increasing oil production along our borders significantly change world oil prices, even if it is fruitful and effective,...
Straw man argument. Who cares what increased domestic drilling does to world prices? The point is to reduce the risk of too much dependence on foreign supplies.
Meanwhile, global oil consumption is only going UP. India and China are anticipating huge, huge, huge increases in the number of people in both countries who get their first cars. Even if those cars went 100 miles on a gallon of gas (which they won't) it is likely there will be 200 million more cars on the road by 2050.
And more planes in the air, more ships at sea, more buses, more trucks and more railroads.
Why in the world would we, as a nation, sit on the sidelines when this explosion of transportation is occurring.
YOu know computers and data centers are HUGE consumers of electricity, which comes mainly from coal in the US. However, I hear nothing about punishing computer users for absorbing such massive quantities of electricity that comes from our dirtiest energy source.
You wrote:
When you think about the rest of the U.S., cuts in government spending affecting FNMA, FHLMC, energy costs, and infrastructure spending will curtail economic activity, especially in the short run.
FNMA failed due to the mismanagement of legislators. And if you believe that FNMA was doing a good thing by buying mortgages granted to people with lousy credit scores, dubious job prospects and NO downpayment money, then we have different ideas about what defines good financal sense.
Infrastructure spending? Please. This is a terrible game of spending money to repair some cracks in the road or upgrade a bridge rather than doing something that itself will advance the economy -- like building nuclear power plants. Repairing a road merely keeps the same old traffic flowing -- at a huge expense when you add up the high labor and material costs.
While I recognize that oil production technology has improved dramatically, there is still the environmental risk of increasing oil production and oil spills can greatly impact other industries, such as tourism.
As we have seen from the BP oil spill in the Gulf, the impact on the water was close to ZERO. The dead marine life simply did not appear. Anyway, your comment suggests you think that alternative energy -- wind and solar -- is somehow harmless to the environment.
To produce any meaningful amount of electricity, it will take solar panels covering millions of acres to do the job. In other words, the habitat of every living thing in those sunny spots will suddenly be shaded -- changing everything for the flora and fauna there. In the perpetual shade, much of that wildlife will die and become extinct, which will drive the Sierra Club nuts.