The Mysterious White House/CBO Deficit Disparity

It's a perennial Washington mystery, one that probably increases public skepticism about politics and politicians. How does the White House calculate that the administration's fiscal 2013 budget would reduce the deficit by $4 trillion, whereas the Congressional Budget Office estimates that the same budget would raise the deficit by $3.6 trillion?

And do either of these estimates accurately reflect our fiscal outlook?

Sad to say, although the mystery can be resolved with an examination of disparate assumptions, and of the arcane concept of baseline, the debate over these figures shows a lack of seriousness in dealing with our deficit problems.

The divergence in the revenue estimates reemerged on Friday, when the Congressional Budget Office released a report entitled "The Economic Impact of the President's 2013 Budget."

Never mind that President Obama's budget has been out since mid-February, and that CBO already published in mid-March an estimate of its effects on the federal deficit. And never mind that back in March CBO and the White House had the same 10-year deficit projection-around $6.5 trillion.

This new document presents CBO's attempt to show how the Obama budget, if adopted by Congress, would affect private-sector economic decision-making, such as individuals' decisions to work and invest, and companies' decisions as to how to expand. CBO began working on this type of analysis when Douglas Holtz-Eakin became CBO director in 2003.

CBO's findings:

*     If present policies were unchanged, the budget deficit would be $2.9 trillion over the next decade. That is called the baseline estimate.

*     Under the president's policies, without macroeconomic effects, the deficit would increase to $6.4 trillion over the next decade, or $3.5 trillion more than the baseline.

*     With CBO's estimated macroeconomic effects, the deficit would increase to $6.55 trillion, or $3.65 trillion above baseline.

Such effects include a shrinkage of the capital stock due to higher taxes on capital gains and dividends, higher interest rates and higher ratios of debt to GDP due to increased government spending and borrowing, and a smaller labor supply due to higher transfer payments and a reduction in wages from lower productivity.

Let me underscore: These projections raise the deficit, in contrast to the White House's claim that President Obama's proposals would lower it. In his February budget, the president wrote, "Together with the deficit reduction I signed into law this past year, this Budget will cut the deficit by over $4 trillion in the next decade."

Why such different outcomes from the nonpartisan CBO and the president's budget office?

The explanation lies in the assumptions behind the baseline budget, meaning the budget that would happen in the absence of any policy change. CBO assumes that the Bush tax cuts will expire at the end of 2012, as is written in law now. The White House assumes that Congress will extend the Bush tax cuts, as it did late in 2010.

The White House also assumes that the alternative minimum tax will be adjusted each year to protect millions of middle-class families, as it has been in the past; that the estate and gift taxes will continue at current levels; and that Medicare reimbursements to physicians will not be cut. Therefore, the president's budget uses a different baseline of a deficit of $8.7 trillion over ten years, and cuts it to $6.7 trillion.

Inevitably, disparate assumptions about taxes and spending lead to different projections of revenue, outlays, and deficits.

As CBO's economists recognize, if the Bush tax cuts do expire in December, economic growth will slow and revenues will be lower.

For example, due to slower economic growth, CBO estimates that government's 10-year receipts under the president's budget would be $30 trillion, compared to the White House figures of $40 trillion.

Second, since the president's budget assumes that the Bush tax cuts will not expire, allowing some of them to expire would count as deficit reduction. Allowing the Bush tax cuts to expire for couples making over $250,000 annually ($200,000 for singles) nets $20 trillion over ten years, the largest component of the $40 trillion in tax increases.

And, it may be noted, the White House fails to anticipate any adverse economic consequences from these tax increases. That is unrealistic.

Whatever the assumptions and outcomes, it is plain that the government is running, and is likely to incur, deficits that are too big for healthy economic growth.

How to reduce them?

Possibilities include reforming Medicare and Social Security, especially in light of the new warnings from the Medicare and Social Security Trustees that the trust funds would be exhausted sooner than previously thought. The implication: benefits must then be reduced or funded in part out of general revenues.

Spending could also be trimmed from large projects such as high-speed rail, energy loan guarantees, and subsidies for electric cars.

The White House's published budget numbers are not only inconsistent with current law, they are also inconsistent with his statements. In his baseline, taxes do not rise on the wealthiest Americans, which they are scheduled to do under current law. Therefore his proposals to raise such taxes ostensibly reduce the deficit. Under CBO's baseline, taxes on all Americans rise on January 1, 2013, so keeping current tax rates for low- and middle-income Americans raises the deficit.

The frightening part of all this is that both baselines are unrealistically low. If Obama is reelected, then the deficit will expand, in all likelihood. Historically, 10-year budget proposals by any administration, Democratic or Republican, tend to be unduly optimistic, forecasting reductions in deficits that never happen.

The sad truth is that presidential budgets are even more unrealistic than ever, and in Washington are no longer taken seriously. And the same is happening on Capitol Hill. The Democratic Senate has not adopted a budget resolution for three years, and is only now moving towards constructing one for fiscal 2013.

America has seen four years of deficits exceeding $1 trillion. Despite games with the budget baseline, deficit reduction remains as important as ever. We are, to use the old expression, fiddling while Rome burns. And the arithmetical obfuscation serves to hide the reality from voters, who, on Election Day, will have a say about the direction of our budget and our economy.