The Obama budget: What's ahead for fiscal policy and the economy?
With Barack Obama winning the US presidential election, what do fiscal policy and the budget outlook look like over the next few years under an Obama administration and stronger Democratic Party majorities in Congress? And what are the implications for...
With Barack Obama winning the US presidential election, what do fiscal policy and the budget outlook look like over the next few years under an Obama administration and stronger Democratic Party majorities in Congress? And what are the implications for the economy? This article can only be considered a first rough stab as the final programmes could look much different and have different costs after the negotiating process with Congress is done in the months and quarters ahead. Nevertheless, some broad outlines have been clear for sometime.
Based on his campaign, Obama's major policy initiatives that will widen the budget deficit relative to the Congressional Budget Office (CBO) base case scenario under current policy legislation are: tax cuts for the middle class (effectively an extension of the Bush tax cuts for the bottom 95 per cent of income earners that are due to expire in 2011), and expanded healthcare coverage.
Meanwhile, the key measures that are likely to reduce the deficit relative to the CBO base case are tax increases for the top two marginal tax rates, affecting the top 5 per cent of income earners, and the money saved through a phased withdrawal of the US military from Iraq. Energy policy, as currently envisioned, is expected to be deficit neutral, with revenue from the introduction of a cap-and-trade system for carbon emissions used to pay for various green energy initiatives. These are the medium term plans from his campaign that Obama said he planned to pursue.
However, the incoming administration will also wrestle with the ongoing financial crisis, which is now guaranteed to oversee a dramatic deterioration in the federal budget over the next few years.
According to HSBC's latest estimates the 2009 deficit is likely to come in at around $800 billion, or about 5½ per cent of GDP. This assumes a new $250 billion fiscal stimulus, enacted under either Obama shortly after his inauguration on January 20, 2009, or President Bush in the next few weeks.
The $800 billion deficit assumes that Obama delays introduction of a new healthcare policy until 2010 (given the likely length of time it will take to get broad support, even with a Democratic Congress), while also delaying the income tax increases until 2010, given the recession. On top of the $800 billion deficit, the $700 billion Troubled Assets Relief Programme (TARP) needs to be funded. Meanwhile, the Treasury has also issued debt to fund the Supplementary Financing Programme (SFP) that provides cash to the Federal Reserve Bank (Fed).
Looking at 2010 and beyond, when the Obama programmes are expected to be mostly fully up and running, it is expected that the economy will still be operating well below full employment so that the 2010 budget deficit will be around $650 billion, falling to about $450 billion in 2013.
The estimates here are largely based on projections provided by two non-partisan groups who have provided costs of the Obama measures, the Tax Policy Centre and the Committee for a Responsible Federal Budget. Under these conditions, the public debt to GDP ratio rises from 37 per cent before the financial crisis hit, to just under 52 per cent in 2009 and then stabilising at about 54 per cent in 2011- 2013. This is of course a huge jump, but in a banking crisis this is to be expected. For instance, during the Swedish banking crisis in the early 1990s, the public debt to GDP ratio jumped from about 40 per cent to 80 per cent in the space of three years. The US outlook is not nearly as dire, but does warn that there may be some upside to the 54 per cent estimate.
The upside risk exists because the analysis takes at face value Obama's promise to make spending cuts (such as Medicare cost reductions, reducing wasteful spending, reforming government contracting,) which may prove difficult to implement.
Moreover, some increased spending on defence may prove unavoidable, even if an Iraq withdrawal saves money as planned. The reason is that Obama has committed to doing more in Afghanistan, which, if followed through, may require a larger "boots on the ground" strategy that ends up being more expensive than currently envisaged. All of these elements provide some risk that the budget deficit ends up being larger still in the next few years.
The best way to increase confidence about medium-term fiscal responsibility would be for the new administration to commit to gradually reducing the deficit to 2½ per cent of GDP by 2013, and hopefully a little earlier if the economy can return to full employment earlier. Under these conditions, the public debt to GDP ratio should stabilise at under 55 per cent. Although much higher than the 37 per cent before the crisis, there is still a crumb of comfort from the fact that such debt, relative to the size of the economy, will still be lower than many countries in Europe (although not all) and Japan.
On the more optimistic side, the Treasury could unwind the SFP programme, and if credit conditions normalise in three or four years, perhaps the Treasury could start selling some of the toxic mortgages (say, around $100 billion or so in 2012), that will be bought under TARP in the next few years. If that were to happen, then the public debt could be $700 billion or so smaller in 2013. This would take the public debt ratio down a bit to 50 per cent by 2013, instead of 54 per cent.
This report was compiled by the Marketing Department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.
Based on his campaign, Obama's major policy initiatives that will widen the budget deficit relative to the Congressional Budget Office (CBO) base case scenario under current policy legislation are: tax cuts for the middle class (effectively an extension of the Bush tax cuts for the bottom 95 per cent of income earners that are due to expire in 2011), and expanded healthcare coverage.
Meanwhile, the key measures that are likely to reduce the deficit relative to the CBO base case are tax increases for the top two marginal tax rates, affecting the top 5 per cent of income earners, and the money saved through a phased withdrawal of the US military from Iraq. Energy policy, as currently envisioned, is expected to be deficit neutral, with revenue from the introduction of a cap-and-trade system for carbon emissions used to pay for various green energy initiatives. These are the medium term plans from his campaign that Obama said he planned to pursue.
However, the incoming administration will also wrestle with the ongoing financial crisis, which is now guaranteed to oversee a dramatic deterioration in the federal budget over the next few years.
According to HSBC's latest estimates the 2009 deficit is likely to come in at around $800 billion, or about 5½ per cent of GDP. This assumes a new $250 billion fiscal stimulus, enacted under either Obama shortly after his inauguration on January 20, 2009, or President Bush in the next few weeks.
The $800 billion deficit assumes that Obama delays introduction of a new healthcare policy until 2010 (given the likely length of time it will take to get broad support, even with a Democratic Congress), while also delaying the income tax increases until 2010, given the recession. On top of the $800 billion deficit, the $700 billion Troubled Assets Relief Programme (TARP) needs to be funded. Meanwhile, the Treasury has also issued debt to fund the Supplementary Financing Programme (SFP) that provides cash to the Federal Reserve Bank (Fed).
Looking at 2010 and beyond, when the Obama programmes are expected to be mostly fully up and running, it is expected that the economy will still be operating well below full employment so that the 2010 budget deficit will be around $650 billion, falling to about $450 billion in 2013.
The estimates here are largely based on projections provided by two non-partisan groups who have provided costs of the Obama measures, the Tax Policy Centre and the Committee for a Responsible Federal Budget. Under these conditions, the public debt to GDP ratio rises from 37 per cent before the financial crisis hit, to just under 52 per cent in 2009 and then stabilising at about 54 per cent in 2011- 2013. This is of course a huge jump, but in a banking crisis this is to be expected. For instance, during the Swedish banking crisis in the early 1990s, the public debt to GDP ratio jumped from about 40 per cent to 80 per cent in the space of three years. The US outlook is not nearly as dire, but does warn that there may be some upside to the 54 per cent estimate.
The upside risk exists because the analysis takes at face value Obama's promise to make spending cuts (such as Medicare cost reductions, reducing wasteful spending, reforming government contracting,) which may prove difficult to implement.
Moreover, some increased spending on defence may prove unavoidable, even if an Iraq withdrawal saves money as planned. The reason is that Obama has committed to doing more in Afghanistan, which, if followed through, may require a larger "boots on the ground" strategy that ends up being more expensive than currently envisaged. All of these elements provide some risk that the budget deficit ends up being larger still in the next few years.
The best way to increase confidence about medium-term fiscal responsibility would be for the new administration to commit to gradually reducing the deficit to 2½ per cent of GDP by 2013, and hopefully a little earlier if the economy can return to full employment earlier. Under these conditions, the public debt to GDP ratio should stabilise at under 55 per cent. Although much higher than the 37 per cent before the crisis, there is still a crumb of comfort from the fact that such debt, relative to the size of the economy, will still be lower than many countries in Europe (although not all) and Japan.
On the more optimistic side, the Treasury could unwind the SFP programme, and if credit conditions normalise in three or four years, perhaps the Treasury could start selling some of the toxic mortgages (say, around $100 billion or so in 2012), that will be bought under TARP in the next few years. If that were to happen, then the public debt could be $700 billion or so smaller in 2013. This would take the public debt ratio down a bit to 50 per cent by 2013, instead of 54 per cent.
This report was compiled by the Marketing Department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.