Three Shaky Pillars of Obama Fiscal Policy

Published September 15, 2014


Now in his sixth year in office, President Obama has made it clear he is not interested in serious reform of the major spending programs that are causing, and will continue to cause in the future, so much fiscal distress for the federal government. He wants to retain the current welfare state as it is, and in fact expand it with the new spending enacted in Obamacare. Instead of serious entitlement reform, he would rely on three policies to close future deficits: steep and unprecedented defense cuts, lower payments for services in the Medicare program, and higher taxes.

Recent events and data make it clear that this approach to fiscal consolidation is, at best, a risky bet for the U.S. economy.

The most obvious budgetary threat at this point is in the defense budget. The recognition that ISIS poses a direct threat to U.S. security and global interests is rapidly shifting expectations about what a prudent defense posture will be in coming years. In addition, Russia’s aggressive incursions into Ukraine have also made it clear that the peace dividend from the end of the Cold War is now at least partially in jeopardy (even though it has already been spent many times over).

Current budget forecasts are out of sync with these realities. The most recent projections from the Congressional Budget Office (CBO) show the federal deficit rising from 2.9 percent of GDP in 2014 to 3.6 percent of GDP in 2024. This forecast assumes defense spending will fall to just 2.7 percent of GDP in 2024, down from 4.6 percent of GDP in 2014. From 1974 to 2013, the nation spent an average of 4.5 percent of GDP on defense commitments. Spending on national security has not been as low as it is now projected to be in ten years since just before World War II.

The strategy for dealing with ISIS that the president announced last week calls for limiting the U.S. military role to airstrikes, additional advisors, special forces missions, and the training of militia willing to fight ISIS on the ground in Syria. The budgetary consequences of even this rather modest commitment are not known at this time, but it is clear there will be some additional cost. The only question is how much more will need to be added to the defense budget in fiscal year 2015. The U.S. role could very easily be expanded in coming months, depending how events unfold, thus driving up costs still more.

Given the realities of the global environment, it is far safer bet to assume that the U.S. will be required to spend something closer to the post-war average on national security than the historically low amounts built into Obama administration budget plans. This shift alone will add at least 1 to 2 percent of GDP to federal deficits each year over the coming decade compared to baseline estimates.

The administration and its allies have also been trumpeting the recent slowdown in the growth rate of health spending and in particular the slowdown in Medicare cost escalation. CBO’s most recent forecast shows Medicare spending rising at an average annual rate of 5.6 percent in the coming decade, driven heavily by the influx of millions of baby boomers into the program. This growth rate is still far below previous forecasts. In 2010, CBO projected Medicare spending would grow at an average annual rate of 7.0 percent through 2020.

Continued slowing of Medicare spending is almost entirely dependent on enforcement of payment rate reductions that are widely considered unrealistic. For starters, Medicare’s forecast continues to assume large reductions in physician fees from the Sustainable Growth Rate (SGR) formula. These cuts have been overturned by Congress every year going back more than a decade. CBO estimates a permanent “doc fix” would add more than $150 billion to the deficit over the coming decade.

Even more consequential is the SGR-like cut contained in the Affordable Care Act (ACA) for hospitals and other institutions providing services to Medicare patients. The “productivity adjustment factor” will cut what Medicare pays for services provided by these institutions by an average of about 1 percent each year based on the expectation that hospitals and other medical facilities can make up for the lost revenue with higher productivity. But the actuaries who analyze Medicare’s finances have warned repeatedly that these cuts are not likely to be sustained indefinitely because, in time, the compounding effect of a new reduction in payments every year will make it as unrealistic as the SGR.

Real-world consequences of this kind of blunt, across-the-board cut will be reduced access to care for seniors. Actuaries warn that many hospitals will have to stop serving Medicare patients to avoid losing so much money that they have to close altogether. And, like the SGR, a “fix” will add hundreds of billions of dollars to current Medicare budget projections.

The Obama administration’s last best hope for avoiding a legacy of looming fiscal catastrophe is the imposition of higher taxes. In 2010, a Democratic Congress levied new taxes totaling more than $1 trillion over a decade in the Obamacare legislation, according to CBO. The president then followed that up by insisting on new taxes on upper income households as part of a deal to make permanent the bulk of the Bush-era tax policy. This tax hike was expected to raise revenue by another $600 billion over ten years.

However, the expected revenue from these tax hikes will only materialize if the economy performs well. Unfortunately, CBO’s most recent projections show a sharp slowing of economic activity compared to prior forecasts, and a commensurate drop in the projected tax revenue. As noted in a report from the Committee on a Responsible Federal Budget, CBO has lowered its ten-year revenue baseline by $1.8 trillion since February 2013. The lower revenue forecast is due mainly to an expectation that American workers will earn less in the future than previously expected, and thus pay less in federal taxes.

This is yet another reminder that the most important factor in cutting future budget deficits remains strong economic growth. Through the ACA and other regulatory policy, the Obama administration has imposed hurdles to business investment and formation, and new costs on hiring. No amount of tax hiking will ever offset the revenue losses associated with tepid economic growth.

The federal government has piled up massive debt during President Obama’s term in office — nearly $6.2 trillion from 2009 to 2013. Long-term forecasts show no end to the red ink, even if defense cuts, Medicare reductions, and tax hikes of the Obama years remain in place indefinitely. But it is far more likely that these policies will never produce the deficit reduction assumed in current projections. The Obama budget legacy is thus likely to be one of looming fiscal disaster.

James C. Capretta is a senior fellow at the Ethics and Public Policy Center, a visiting fellow at the American Enterprise Institute, and a contributor to e21.

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