Entitlement Reform Likely Remedy for U.S. Fiscal Deficits

Oxford Analytica expects the Obama Administration to embark on entitlement program reform as early as this autumn, in an effort to address ballooning government deficits that could retard economic recovery.

“If widening federal shortfalls drive up long-term interest rates, they will undermine both current efforts to stimulate the economy and US trend growth potential, ” OxAn says in UNITED STATES: Swelling deficit could retard recovery.

Therefore, the Obama administration is likely to unveil a medium term plan to assuage market concerns about the sustainability of US public finances — involving entitlement reform — perhaps as soon as this as this autumn.

The prospect of the budget deficit remaining in excess of 1 trillion dollars per year over the next decade raises a number of concerns about longer-term interest rates and the value of the dollar:

Persistently large deficits can harm a country’s longer-run economic growth potential by:

• stoking inflationary expectations;
• raising long-term interest rates; and
• reducing the level of national savings and investment.

The IMF observes that with US discretionary (non-entitlement program and debt maintenance) spending already low by historical standards, correction of the budget deficit will require significant revenue increases. The IMF’s recommended remedial measures include:

• broadening the tax base by reducing the deductibility of corporate debt and mortgage interest;
• introducing a federal consumption tax;
• hiking energy taxes; and
• improving tax compliance.

However, all of these measures — with the possible exception of tightening tax compliance — would be politically costly for the Obama administration.

Comments

[Mad Hedge F...:]

This is way overdue. I met with Dr. Christina Romer, chairman of the Council of Economic Advisors, who practically tore my ear off proselytizing her new found religion, health care reform. Appointed by Obama to advise him on all things economic, Dr. Romer had this hot potato dropped in her lap six weeks ago in one of her daily briefings to the President. With the enthusiasm and ebullience of a new found convert, Dr. Romer laid out goals that were nothing less than revolutionary. She plans not to just “socialize” medicine, but to fundamentally rebuild the entire health care infrastructure of the US. Tax incentives will be created to encourage value over volume. People can keep existing plans they like. Technology will be applied to cut costs, not only to come up with more complicated and expensive cures. Existing subsidy programs for the poor will be folded into the new plan, offering coverage to 46 million uninsured. Providers will get cash incentives for prevention. Individuals will gain the advantages of risk pooling. Pre-existing conditions will be covered. All of this will be made revenue neutral through the taxation of employer paid insurance and savings through new efficiencies. If the administration can pull all of this off, the benefits will be huge. An annual 1.5% reduction in health care costs will add 8% to GPD and increase family incomes by $10,000/year by 2040. This will boost corporate profitability and competitiveness, labor mobility, the quality of life, and reduce the budget deficit and unemployment. Failure will see health care spending rocket from the current 18% to 33% of GDP in 30 years, and the number of uninsured explode to 76 million. Romer spewed out statistics as only an economics PhD from MIT can. Oh, and now or the stuff you care about. The economy will shrink in Q2, see no growth in Q3, and turn positive by Q4. The issue doesn’t affect me, as I have always avoided health care, insurance, pharmaceutical, and biotech stocks like the plague; they being subject to capricious government approvals, and therefore inherently unpredictable. These are the opening shots of a political dogfight that will ensue over the next three months and dominate the media.

Jun 25 01:08 PM

[Neil459:]

If there is entitlement reform it will be covert like the Clinton Administration changing the way CPI was calculated. This administration can not afford to alienate welfare participants, retirees, or government workers.

Jun 25 01:14 PM

[InnocentsAb...:]

Nice to see the bear market is over, so we can forget about the umpteen trillion dollars in entitlements for the ultra wealthy, and return to worrying about the US government paying too much for medical care for the poor.

Jun 25 01:51 PM

[The Geoffster:]

Sadly, the promise of freedom embodied in the Declaration of Independence and the Constitution never came to fruition because most people wanted government to do things for them rather than leave them alone. As Ben Franklin replied to a woman when asked what form of government he had given her, "A Republic madam, if you can keep it." The problem with socialists is that their concept of heaven is my concept of hell.

Jun 25 02:24 PM

[conceptwizard:]

Bernanke told the committee that the ratio of federal debt held by the public to the gross domestic product (GDP) will likely rise from 40 percent before the onset of the financial crisis to 70 percent in 2011.

Warning that a continuation of such levels of debt could drive up the cost of government borrowing—a disastrous prospect for an economy dependent on a continuous stream of loans from China, Japan and other countries—Bernanke said that the deficits would have to be reduced substantially either through tax increases or budget cuts. “The Federal Reserve will not monetize the debt,” he declared.

He made clear that his prescription for “fiscal balance” was dramatic cuts in what remains of social programs, rather than tax increases. He zeroed in on the basic programs upon which tens of millions of Americans depend—Social Security and Medicare.

Noting projections of rising outlays for these entitlement programs as millions of baby boomers retire, he said “we will not be able to continue borrowing indefinitely to meet these demands.” Speaking of “difficult choices,” he said, “Congress, the administration and the American people must confront how large a share of the nation’s economic resources to devote to federal government programs, including entitlement programs.”

He said that if these programs were not reined in, taxes would have to be raised, and then made clear his preference, calling for “spending and budget deficits” to be “well controlled.”

Whatever the entiltlements programs are now, they are going to be a lot less.

Jun 25 04:48 PM

[Gregman2:]

The biggest entitlement we've had in a generation was the Cheney-Halliburton Iraq War.;-)

Jun 26 05:09 PM