Wharton’s Kent Smetters, UC Berkeley’s Alan Auerbach and NYU’s David Kamin discuss the latest White House budget proposal.
Undue optimism on the budget deficit and low visibility on the pain points for underprivileged Americans seem to be the hallmarks of the Trump administration’s $4.4 trillion budget proposal for fiscal year 2019 that was presented on Monday this week. The budget calls for increasing defense spending by $300 billion, spending $200 billion on infrastructure projects over the next decade, building a wall on the U.S.-Mexico border, lowering drug prices through increased competition and providing six week’s paid family leave to new parents.
But the budget also projects higher economic growth than estimated by the Federal Reserve and others, and notwithstanding White House officials’ stated dislike for “trillion-dollar deficits forever,” it is expected to add $7 trillion to the fiscal deficit over the next decade. The budget also calls for cutting spending on food stamps programs for the poor, Medicare allocations, and conservation and environmental programs.
ValueWalk’s March 2021 Hedge Fund Update: Klarman, Loeb, Reddit And Much More
Welcome to our latest issue of issue of ValueWalk’s hedge fund update. Below subscribers can find an excerpt in text and the full issue in PDF format. Please send us your feedback! Featuring Seth Klarman and Dan Loeb's investment in Intel, losses and profits from Reddit's frenzy, and an analysis of hedge fund pay. Q4 Read More
According to Alan Auerbach, professor of economics and law at the University of California, Berkeley, and director of its Burch Center for Tax Policy and Public Finance, “The big picture is [that] it’s a proposal that would sharply cut domestic spending, increase defense spending, extend some of the tax cuts that were just passed and make it all work through unrealistic economic projections.”
The budget prioritizes the tax cuts that Trump signed into law in December “at a significant cost” of about $1.5 trillion by adding an additional $600 billion to that bill, said David Kamin, a New York University School of Law professor and former Special Assistant to the President for Economic Policy in the Obama administration.
“The game that’s constantly being played is that, ‘Hey, we’re not going to make really big, bold decisions early on, but by the end of the 10-year [budget] window on somebody else’s term — a future president — we think we’ll get our act together,” said Kent Smetters, Wharton professor of business economics and public policy. Put another way, they are “constantly kicking the can down the road” on those bold decisions, he added. “And no president’s ever gotten close to that 10-year vision.” Smetters is also faculty director of the Penn Wharton Budget Model, which provides dynamic modeling tools for data-based analysis of policy proposals.
Auerbach, Kamin and Smetters discussed the budget proposal during a recent segment on the [email protected] radio show, which airs on SiriusXM channel 111. (Listen to the full podcast using the player at the top of this page.)
“Congress is expanding the deficit by about 2% of GDP at a time which is probably the least justified within the business cycle, and doing it on a permanent basis.”–David Kamin
“There are two primary messages [in the budget],” Office of Management and Budget director Mick Mulvaney said in a press briefing. “Number one, you don’t have to spend all of this money, Congress. But if you do, here is how we would prefer to see you spend it. The other message is that we do not have to have trillion-dollar deficits forever.”
But Auerbach, Kamin and Smetters say the deficit problem is actually worse than it seems due to the economic projections used to prepare the budget. “They used economic assumptions that put their budget projections off by a couple of trillion dollars to make it look like it has lower deficits than would in fact be the case,” said Kamin.
“They assume a 3% growth rate of real GDP, which is probably about a percentage point too high,” said Auerbach. “If you bring it down to a more realistic projection, you would have very substantial deficits during that [10-year] period, and a very high level of national debt at the end.” Over the course of the next decade, the federal deficit is expected to balloon by $7 trillion.
In any event, “very little” of the proposals are likely to get any immediate action in Congress this year, said Kamin. He noted that White House budgets are essentially “vision documents” and some are “more honest” than others about the vision they have laid out. “This one grades relatively low on that front,” he said.
“Budgets are aspirational documents,” added Auerbach. “Putting something in a budget doesn’t necessarily mean you expect something to happen. It’s a way of trying to start a conversation.”
Smetters noted that the increased emphasis on infrastructure spending “will not do much for economic growth.” An analysis conducted by the Penn Wharton Budget Model this week shows that while the budget proposes $200 billion in new spending on infrastructure over the next decade, changes to other infrastructure programs in the same proposal actually reduce federal spending between $185 billion to $255 billion over 10 years. Thus, federal spending on infrastructure under the White House budget could rise by at most $15 billion in a decade – or it could decrease by as much as $55 billion.
“We’ve gotten to a bad place where nobody is willing to take responsibility for fiscal policy being realistic.”–Alan Auerbach
Smetters noted that only some of the additional infrastructure spending that is proposed would amount to a real increase. Some of that “is just paying cities to do what they otherwise would be doing,” he said. Many cities have “strategically” held back their infrastructure spending, “waiting for some kind of a subsidy to do essentially what they would have been doing anyway,” he added.
Deficits at the Wrong Time?
Kamin said the deficit expansion comes at a bad time. He recalled that stimulus programs were introduced in the aftermath of the Great Recession of 2008, but the austerity measures that followed came much too soon. “We could have had additional fiscal expansion upfront that could have helped the labor market and prevented at least some significant pain that Americans felt in the wake of the Great Recession,” he noted. Now, as the economy is close to full employment, that approach is being flipped, he added. “Congress is expanding the deficit by about 2% of GDP at a time which is probably the least justified within the business cycle, and doing it on a permanent basis.”
Smetters, however, thought the Great Recession saw “a big response” from the government. “It was mainly a monetary response. We tripled the money supply. In many ways, the Great Recession could have been even much bigger [than the Great Depression of 1929]. That is why I think it really requires bipartisan support.”
Room for Bipartisan Support?
Health care reform is one area where Kamin has hopes for a bipartisan deal. “I worry about whether this administration is in fact devoted to that kind of reform,” he said. “But I think it’s an area where we’ve seen some progress. It’s key to a long term fiscal trajectory as well as the economy.”
Smetters has worries about bipartisan support, or the absence of it, as it relates to the Federal Reserve. He said the Fed’s “independence … is constantly being eroded and attacked along with some of the other institutions in Washington, [such as] the CBO (Congressional Budget Office).”
“We’re going to have a new tax that everybody’s going to equally hate – it’s called the value-added tax.”–Kent Smetters
All said, optimism about the impact of the budget ran low among the three experts. “We’ve gotten to a bad place where nobody is willing to take responsibility for fiscal policy being realistic,” said Auerbach. “As long as the economy is strong, we’re likely to just continue to run larger deficits and not make difficult choices. That’s going to be fine for the short run, but when we have the next recession and the debt to GDP ratio isn’t what it was in 2008 … it’s going to be a lot worse.”
In addition, if interest rates were to increase by one percentage point, it would be “incredibly costly,” said Smetters. “That’s $1.5 trillion over the next 10 years of additional deficits. We’re really skating on thin ice right now.” The problem is while tax revenues are declining, mandatory spending is up, and that would lead to higher deficits, he added.
Ultimately, Smetters said if it’s going to be politically hard to cut entitlements, a new tax would have to be introduced to make the math work. “We’re going to have a new tax that everybody’s going to equally hate — it’s called the value-added tax,” he said. “The Democrats hate it because it’s [a] flat [tax]; Republicans hate it because it’s a sneaky tax, [and so] it is something that everybody can hate together. I don’t see any other way of getting out of this without something like a value-added tax.”
Article by [email protected]