Wednesday, July 01, 2009

Promises Broken

In yesterday's WSJ Roger Altman--former deputy secretary of the Treasury in the first Clinton administration--wrote that it's not a matter of if President Obama will raise taxes but when. And he thinks that in order to get a grip on the growing budget deficits, it will be soon:

Only five months after Inauguration Day, the focus of Washington's economic and domestic policy is already shifting. This reflects the emergence of much larger budget deficits than anyone expected. Indeed, federal deficits may average a stunning $1 trillion annually over the next 10 years. This worsened outlook is stirring unease on Main Street and beginning to reorder priorities for President Barack Obama and the Democratic congressional leadership. By 2010, reducing the deficit will become their primary focus.

Why has the deficit outlook changed? Two main reasons: The burst of spending in recent years and the growing likelihood of a weak economic recovery. The latter would mean considerably lower federal revenues, the compiling of more interest on our growing debt, and thus higher deficits. Yes, the President's Council of Economic Advisors is still forecasting a traditional cyclical recovery -- i.e., real growth of 3.2% next year and 4% in 2011. But the latest data suggests that we're on a much slower path. Probably along the lines of the most recent Goldman Sachs and International Monetary Fund forecasts, whose growth rates average about 2% for 2010-2011.

A speedy recovery is highly unlikely given the financial condition of American households, whose spending represents 70% of GDP. Household net worth has fallen more than 20% since its mid-2007 peak. This drop began just when household debt reached 130% of income, a modern record. This lethal combination has forced households to lower their spending to reduce their debt. So far, however, they have just begun to pay it down. This implies subdued spending and weak national growth for some time.

Altman goes on to suggest that some form of VAT will be considered and acknowledges that getting it passed will be an immense challenge for President Obama especially in light of his oft-repeated campaign promise to not increase taxes on those earning less than $250K a year.

The first President Bush's infamous "read my lips, no new taxes" pledge ended up being a millstone around his political neck that helped sink his chances for reelection to a second term. Could a breaking of President Obama's promise not to raise taxes on "middle-class" Americans have the same impact?

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