Obama’s Sideshow Budget Will Yield Little Real Fiscal Progress

The Obama budget confirms what we already knew—neither tax reform nor significant increases in revenues are on the table. Neither are major entitlement programs such as Medicare and Social Security. The coming budget debate will be fought over a small sliver of spending. This is ground where Republicans feel quite comfortable and Democrats do not.

But as this chart shows, spending is in fact only half of the story. And the spending that both President Obama and the congressional GOP want to target is not only a tiny share of federal outlays, it has been growing more slowly than programs such as Medicare, Medicaid and Social Security, which appear to be exempt from budget cutting.

Mostly due to one-off responses to the Great Recession, such as TARP and the stimulus, all spending as a share of Gross Domestic Product ballooned in 2009-10. While spending will slowly fall over the next couple of years—thanks to an improving economy, the merciful end to various government bailouts, and President Obama’s proposed spending freeze for some domestic programs, overall outlays would settle in at about 23 percent of GDP through the end of the decade according to Obama’s fiscal plan.

That’s too high, especially since most costs of the aging Baby Boomers won’t have kicked in yet. But having a bloody battle over 12 percent of spending is something like the management of a bankrupt company using all of its energy to cut the travel budget, instead of trying to figure out why customers stopped buying its products.

Despite wild claims from some on the political right, taxes as a share of the economy in the first two years of the Obama Administration have hovered at less than 15 percent of GDP. That’s their lowest level since the early 1950s. Taxes in fact are far lower today than during Ronald Reagan’s presidency. You could look it up (or look at the chart)

Some of this was due to the rotten economy. But some has been thanks to tax policy over the past couple of years. Not only did Obama extend the Bush-era tax cuts through next year, but he’s convinced Congress to enact some targeted reductions of his own. Among them: a more generous Child Credit, a more expansive Earned Income Credit, a Making Work Pay Credit, generous tax breaks for companies that buy new equipment this year, and the payroll tax holiday enacted last December (which replaced the work credit).

In today’s budget proposal, Obama would increase taxes to 17.9 of GDP in 2013. This is just about what revenues averaged under Reagan. And it would be a step in the right direction. Except the chances of it happening hover around zero.

Obama would get there mostly with a collection of ideas that he failed to sell to even a Democrat Congress. They include: allowing the 2001 and 2003  tax cuts to expire at the end of 2012, capping the value of itemized deductions at 28 percent, taxing the compensation of hedge fund managers and other financiers at ordinary income instead of capital gains rates, and increasing  taxes on multinationals.

These proposals will make lobbyists happy and even richer than they are. But there is no chance that tea-party obsessed congressional Republicans would support any of them. Thus, even with an improving economy, tax revenues are likely to remain a relatively small share of the overall economy through Obama’s first term.

The upcoming debate over that small chunk of non-defense domestic spending that is subject to annual congressional review is healthy and important—and it will get very nasty. But compared to burgeoning entitlements on one hand and tax revenues that remain near historic lows on the other, the fight over 12 percent of the budget is a fiscal sideshow.