CoverStory

We the government

Obama won’t let debt or sluggish growth slow his plans for an activist, expansive state

By Mary Kissel

Ron Johnson spent his career running a small plastic sheeting company he founded with his brother-in-law in Oshkosh, Wisconsin, before entering politics, and had never been to Washington, DC before winning a seat in the Senate. So it is no surprise that when the blue-eyed accountant sits down with the Wall Street Journal editorial board (of which I am a member) in January he whips out a PowerPoint presentation to talk about the realities after January’s “fiscal cliff” deal, which has been panned by both sides of politics for good reason. As the pack of 23 slides shows with devastating simplicity, the world’s largest economy is living far beyond its means.

“Every American should understand this,” the Senator says, as he pats the pile of paper. The first slide, titled “structural deficit, % of GDP”, sports two bright lines: one red for spending, the other green for revenues. The interaction of the two results in a splash of red starting in the mid-1970s, with a brief, green period of surplus in the Clinton era of the late 1990s. Then the deficits reappear as a vast sea of red stretching through 2036. This is not a partisan estimation: The figures are drawn directly from the White House’s Office of Management and Budget and the Congressional Budget Office.

Nor is the imbalance a new phenomenon. The US has been living on borrowed money for a long time, and especially since the advent of President Lyndon B. Johnson’s Great Society programs. Between 1959 and 2008, US federal spending averaged 20.2 per cent of GDP, compared to 18.1 per cent of average revenues. The difference now is that imbalance has soared to previously unimaginable levels, thanks to two years of Democratic control of the legislative and executive branches of government, between 2009 and 2010.

The numbers will surprise anyone who believes President Barack Obama’s claims of a “balanced approach” to fiscal management. Federal spending as a percentage of GDP in the US is now a stunning 23 per cent, a level commensurate with many struggling European economies. For most of the past three decades, that same percentage in the US was a manageable 19 per cent. Still, even that level is high by historical standards. “Just 2 per cent in 1910,” Senator Johnson muses. The only reason the US hasn’t suffered a run on its debt is because the dollar is the world’s global currency.

Consider the absolute numbers. Federal spending in President Obama’s first term reached a record $14.1 trillion, with a $5.1 trillion deficit racked up under his watch. The US has had four consecutive years of more than trillion-dollar annual deficits. The binge has had little to do with the Pentagon, as Democrats like to claim. Of that $5.1 trillion deficit accumulated from 2009 to 2012, only $611 billion is attributable to wars. Nor is the debt a function of the “Bush tax cuts”, which “cost” only $680 billion over the same period in the government’s static accounting.
The vast bulk of the rest of the gaping deficit comes courtesy of the Nancy Pelosi-led 111th Congress, which passed a behemoth $830 billion stimulus package in February 2009 that was a vast expansion of entitlements, masked as necessary “investments”. Not a single Republican voted for the stimulus, much of which was wasted — most infamously on fanciful green energy projects that no private sector business would touch, and that ultimately went bankrupt. The inaptly-named Affordable Care Act, also known as Obamacare, was signed into law the next year.

Senator Johnson flips to the slide on Obamacare with a grimace. The Congressional Budget Office estimates the new entitlement will cost the US $2.4 trillion from 2016 to 2025, against $1.4 trillion in taxes, fees and penalties — all to solve a problem that could have been significantly curbed with tort reforms and commonsense liberalisation of health insurance across state lines. Average healthcare premiums have already risen more than $5,000 annually. And this is a program that was sold to voters as a money saver.

Even if President Obama and Congressional Democrats wanted to cut spending, which they have shown no interest in doing, the structure of the federal budget makes such cuts politically difficult to achieve without tackling entitlements. In 2012, mandatory entitlement spending on programs such as Medicare, Medicaid and Social Security comprised 59 per cent of the budget, up from only 26 per cent in 1962. By 2022, mandatory spending will eat 64 per cent of the budget.

Oh, and don’t forget the interest on the debt, which will consume 11 per cent of the federal pie, up from 6 per cent in 2012 and 6 per cent in 1962. And that assumes investors don’t get spooked by America’s deficits and flee the dollar, causing interest rates to spike.

“Bet you didn’t know this,” Senator Johnson says, waving a slide showing the US and Greek flags. Government debt per capita is $52,147 in the former and $35,764 in the latter. US gross federal debt hit $16.4 trillion as of 31 December, and is projected to reach $26 trillion by 2025. That’s up from $10.6 trillion at the beginning of President Obama’s first term, and $5.8 trillion at the beginning of his predecessor George W. Bush’s first term.

This crushing amount of debt has disturbing consequences. Government borrowing crowds out more productive private sector borrowing, creates uncertainty for investors and suffocates growth. Since the end of World War II, the US economy has expanded by an inflation-adjusted average of 18.5 per cent in the 13 quarters following a recession. The Reagan recovery hit a stunning 19.6 per cent. But the Obama recovery, saddled by debt, higher taxes, and regulatory uncertainty, has been a measly 7.2 per cent.

It is the weakest recovery since the Great Depression and has been accompanied by persistently high levels of unemployment, with many workers falling out of the workforce altogether. The average annual household income of middle-class Americans has fallen to $50,678 in August 2012, from $55,198 in January 2009, according to the latest data available. So even though the economy is slowly mending, Americans are worse off than they were when the recession started.

None of this will surprise students of history. No country has ever embarked on a program of higher taxes and government spending and grown in a sustainable fashion. In Europe, Greece, Italy, Spain, and other nations are discovering the limits of profligacy as investors have raised the price of borrowing and the bills for decades of spending have suddenly come due. In Asia, Japan has endured more than two decades of sluggish growth after a raft of stimulus packages and tax hikes. These policies simply do not work.

Keynesian stimulus does not produce sustainable economic growth because the money government spends is not free; it has to come from either higher taxes or increased borrowing. Government has no competitor to force it to spend money efficiently, nor are public servants enlightened individuals. Their incentives are to accrue money and power for themselves, regardless of whether or not it is in the public interest.

None of this history has informed the Obama administration. If anything, the president has been remarkably sanguine about America’s debt burden. Speaker of the House John Boehner, who negotiated the recent fiscal cliff deal for Republicans, told my colleague Steve Moore that at one point during their talks, the president remarked, “we don’t have a spending problem”. When Boehner kept pressing the wisdom of spending restraint, Obama retorted, irritated, “I’m getting tired of hearing you say that”. Vice President Joe Biden ended up doing most of the haggling with Republicans, as he has in the past.

Why would an American leader ignore such grave threats to his nation’s prosperity? One explanation is that President Obama doesn’t understand economics, given he spent his career in academia and as a community organiser before entering state politics, and then the Senate. But that seems unfair to such a highly educated man, who told the House GOP in 2010, “The major driver of our long-term liabilities, everybody here knows, is Medicare and Medicaid and our health-care spending. Nothing comes close.” He is aware, at least superficially, of the numbers that Senator Johnson touts in his slides.

The better explanation is that President Obama is an ideologue of the left who never intended to cut spending or reform entitlements. His goal is to remake America into a European-style, socialist state with nationalised health care and less income inequality, never mind the slower growth and permanently higher unemployment that results from such redistribution. His rhetoric about a “balanced approach” to fiscal matters is a fiction, meant to paint Republicans as extremists bent on cutting entitlement programs and protecting the rich, rather than as politicians trying to reform welfare programs and grow the economy so the poor can better themselves.

Which means that Republicans will have a very difficult, if not impossible, time striking a bipartisan fiscal deal with this White House before Americans go to the polls again in 2014 for Congressional elections. This is a highly unusual situation, given many of the most productive reforms in the past few decades have happened under divided government under periods of economic stress. President Ronald Reagan would not have achieved his landmark tax deal were it not for the cooperation of Democratic Speaker Thomas “Tip” O’Neill. Bill Clinton could not have reformed welfare without the help of Republican Speaker Newt Gingrich.

Perhaps that is why Republicans have tried so hard to find common ground. In February 2010 President Obama commissioned two retired politicians, Democrat Erskine Bowles and Republican Alan Simpson, to chair a deficit commission to produce bipartisan solutions to America’s fiscal woes. They endorsed sweeping tax reform in the form of lower, flatter rates and fewer deductions, and supported sensible options to reform Social Security, such as raising the retirement age or linking future payments to inflation. (Under White House orders, the widely touted Simpson-Bowles deficit reduction plan didn’t offer any new ideas on Medicare, Medicaid, or Obamacare.) The President ignored their advice.

In 2011, Republicans tried again with their larger House majority — this time, by threatening not to raise the debt ceiling to pay for the Obama administration’s out-of-control spending to get Democrats to the negotiating table. The two sides agreed to form a bipartisan “super committee” to try again to find a bipartisan solution to the debt problem. The GOP offered to raise some $250 billion over 10 years by limiting tax deductions. In exchange, Democrats offered to cut spending by $750 billion over the same period, though without any serious reform to Medicare, Medicaid, or Obamacare — which are, as Senator Johnson’s slides show, the main contributors to the nation’s deficit.

The President unilaterally quashed those negotiations too, telling Speaker Boehner in a closed-door meeting that he wanted a $1 trillion tax increase before anything else. The two sides eventually agreed to cut $1.2 trillion from domestic spending and defence over 10 years, starting in January 2013, a process known as a “sequester”. To put those numbers in perspective, the sequester would lop off a measly $109 billion in federal spending this year, against a more than trillion-dollar annual deficit. Meanwhile, the expiration of the Bush tax rates, plus new Obamacare taxes, were set to wallop the economy even further.

So the President entered 2013 with a strong hand. He had passed Obamacare, ensured tax rates would automatically rise, and had a sequester in hand that would hit programs Democrats like the least, especially the Pentagon. Republicans, on the other hand, had no leverage other than their House majority and the fact that the President had promised on the campaign trail not to raise taxes on 98 per cent of Americans. The fiscal cliff negotiations, as they were dubbed, weren’t expected to achieve much — and they didn’t.

The two sides eventually struck a deal that included the largest tax hike in two decades, in exchange for the extension of the Bush tax rates for the middle class, which both sides could tout as a political victory. Democrats won more spending increases and various carve-outs for special interest groups, such as Hollywood and the green energy lobby. Now prominent Democrats like Representative Pelosi are calling for even more tax hikes, to facilitate yet another round of stimulus spending.

Which brings us back to Senator Johnson’s slides, which illustrate the stark choices ahead on the current course. The federal government spent $3.5 trillion in 2012, up from $2 trillion a decade ago. Republican Budget Committee chairman Paul Ryan’s House budget would still spend $4.9 trillion in 2022. The Obama budget, which no Democrat in the House voted for, envisions Washington spending $6 trillion by that year. Social Security is already broke and is projected to have a $5.1 trillion deficit by 2032.

The only solution to America’s debt is to trim spending and grow the economy, as Reagan understood when the US faced a similarly dire fisc in the 1980s. This year’s deficit is projected to hit $1.3 trillion. Raising taxes on the “rich” won’t plug the hole — the Obama tax increases this year are estimated to raise around $60 billion annually. Senator Johnson calculates that if federal revenue were back to normal levels, around 18.5 per cent of GDP in a healthy economy, rather than today’s 15.7 per cent, Washington would reap $435 billion annually.

The challenge for Republicans is “to educate” the public about these realities, Senator Johnson notes, adding that Representative Paul Ryan, the former Vice Presidential candidate, managed to do just that in last year’s campaign when he harped on the inconvenient truth that Obamacare funnelled $716 billion out of Medicare. The Obama administration made an economically weak welfare program weaker while creating another the country cannot afford.

The question for Republicans is which numbers to focus on. Will voters understand something as abstract as the government’s spending as a percentage of GDP, or is the comparison to Greece more compelling? Is it better to talk about how quickly entitlement programs are going bankrupt, or how soon America’s military will be unable to afford to fight wars on two fronts simultaneously? Is it more shocking to talk about how slow growth is affecting employment prospects for youth and minorities?

These are just a sampling of the many dilemmas Americans will have to grapple with if they don’t get the debt under control — fast. Will they? In an interview after our editorial board meeting, Senator Johnson admits “political leaders are prone to misleading the American public”. He continues: “Look at this past election. We spent about $7 billion; how much did people actually learn? And of course, you have the president who wins re-election basically saying the solution to the problem is just make the top 2 per cent pay their fair share and [have] a ‘balanced approach’ to deficit reduction. Obviously it’s hollow. It has no substance. It’s not going to work.”