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The Economics of the 2011 State of the Union: The Cost

January 26, 2011

The Cost, Part 1 of a two-part series

Last night, President Barack Obama spoke to the American people about American exceptionalism and the path the president hopes the United States will take in 2011.  As part of this path he also put forth a challenging economic and fiscal plan for the United States. In this post I’ll address and discuss some of the economic policies behind President Obama’s 2011 State of the Union.

The President centered the first third of the State of the Union address around the themes of Infrastructure, Education, and Innovation. His speech emphasized that addressing and re-thinking federal  policies on these fronts would be crucial to the United States not only overcoming the economic recession, but also for it to address a threat from unnamed countries to America’s economic and international dominance in what he deemed a “Sputnik moment”.  Unfortunately for the President’s “Sputnik moment”, the collection of economic policies he proposed will inflate federal spending, dovetailing with his promise to institute a five-year  freeze on non-defense discretionary spending; and will likely not pass a Republican controlled house whose focus is only on the deficit.

Unfortunately for Barack Obama, instituting the five-year freeze on non-defense discretionary spending actually amounts to a spending cut on discretionary programs. This means that it will be hard for him to keep his promise to balance the budget while “make(ing) sure we’re not doing it on the backs of our most vulnerable citizens”. Furthermore, I worry that the tax reforms he’s proposed also don’t add up with the cost of the federal programs he wants to implement.

While things such as expanding funding for research on green technologies, high-speed rail, high-speed wireless internet, and access to higher education are things that everyone agrees are good for the country in the long-run; not everyone wants to pay for them. Barack Obama’s promise that “we must confront the fact that the government spends more than it takes in” means that in addition to his five-year  freeze on non-defense discretionary spending, implementing them will require significant tax reforms or spending cuts on other projects. Looking at the numbers behind Obama’s proposals will tell us how likely it is he can pass these measures.

To pay for green technologies, the president promised to stop subsidies given to the oil industry. This is likely a reference to a budget proposal the President put forth in February 2010. The proposal would eliminate government subsidies going to international oil companies through both direct subsidies and laws that allow them to write off a wide range of standard business expenditures. Unfortunately its hard to get good numbers on how much tax income this would generate, but it seems to range from $36.5 billion to $45 billion over the next ten years; with the New York Times placing it at around $4 billion a year. This would barely pay for the proposed high-speed rail line from Boston to Washington DC that is expected to cost $117 billion over 30 years. This doesn’t leave much left for funding research and development or any other large projects.

President Barack Obama’s other proposals to help increase revenues also seem to fall short of balancing the budget and offsetting the cost of the policies he’s proposed. Things such as eliminating earmarks and medical malpractice reform are useful in their own right but do little to solve the budget problem, accounting for only $22 billion of estimated U.S. federal spending in FY 2015 . Note: I’m using 2015 numbers because that’s what I have to work with from these estimates.

The real substantive budget proposals Barack Obama has put forward come in the form of removing President Bush Jr’s income tax break for the top 2% of Americans (those making over $250,000 a year); and from eliminating corporate and individual tax loop-holes. By eliminating the tax breaks for the top 2% of the U.S. population it is estimated the government would take in an additional $54 billion in revenues for FY2015. The president’s suggestion that he would simplify and reform the tax code while lowering the corporate tax rate is likely a reference to the “Bowles-Simpson Plan”. The Bowles-Simpson plan was put forth by the deficit commission and is series of plans to reduce tax loop-holes for individuals and corporations while lowering the nominal tax-rate. This would on the whole increase tax-revenues, however as an economist I’d like to put forth a word of caution as many studies have shown the resilience and pervasiveness of tax evasion. That being said, the Bowles-Simpson plan would raise an estimated $75 billion in federal revenues for FY 2015. According to these numbers, together these two plans would reduce approximately 9 percent of the roughly $1.4 trillion FY2011 annual deficit. Even with a reference to an additional estimated $78 billion in proposed savings from cuts in defense spending over five years, it looks doubtful that President Obama can both balance the budget and pay for his ambitious agenda in the coming years.

Analysis

Now, these numbers indicate that there are significant savings that Barack Obama can obtain through redressing tax rates and loopholes that benefit corporations and the extremely rich. But even if he’s able to pass both of these reforms, a potentially difficult task in itself, the FY 2011 federal budget will still face significant shortfall. With Republicans clamoring for a balanced budget, and some members even willing to stand their ground to the point of potentially forcing a sovereign default of the U.S. government, it seems unlikely that President Obama will be able to redirect these savings to fund his spending proposals. It will be a difficult remaining two years for the President and he may free up some money with tax-reforms, but the current political situation and focus on first solving the deficit will weigh heavy on his aspirations.

Part 2, The Benefits, Coming Soon

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