Obama’s Deficit Plans May Use Over-Optimistic Growth Forecasts

By Ryan J. Donmoyer and Roger Runningen

Feb. 27 (Bloomberg) -- President Barack Obama’s promise to slash a record deficit may rely on economic-growth projections for the coming years that are too optimistic.

The $3.55 trillion budget proposal for 2010 the president unveiled yesterday projects 3.2 percent economic growth next year, thanks to a $787 billion fiscal-stimulus measure he signed into law earlier this month that is aimed at creating jobs and consumer demand.

That is twice the 1.5 percent growth projected by the Congressional Budget Office before the stimulus bill was enacted and higher than the 2.1 percent consensus growth estimate by analysts in the Blue Chip Economic Indicators survey. Even those projections may be too optimistic: Federal Reserve Chairman Ben S. Bernanke said this week the U.S. is suffering a “severe” contraction, and a government report today may show the economy shrank more than previously forecast in the fourth quarter.

“One glaring, central risk to the budget’s projections is the economic outlook,” said Joseph Minarik, a senior vice president at the Committee for Economic Development, a Washington-based public policy institution. The budget assumes “the economy is going to turn around more rapidly,” said Minarik, a former associate director at the Office of Management and Budget under President Bill Clinton.

Tax Increases

Obama’s blueprint pledged to trim a $1.75 trillion deficit projected for the current fiscal year ending Sept. 30 to $1.17 trillion next year. The budget assumes economic growth will be sustained even after 2011, when Obama plans to ask Congress to enact tax increases that would cost top-earners, Wall Street executives and multinational corporations almost $1 trillion in higher taxes.

“We are economists and not soothsayers, and all forecasts are subject to a substantial margin of error,” Christina Romer, head of the White House Council of Economic Advisers, said at a press conference yesterday in Washington. In a downturn as severe as this recession, “usual patterns surely provide less guidance than in more ordinary times,” she said.

The plan would reverse eight years of policies under President George W. Bush that reduced taxes on the wealthy. It would do so by reinstating top tax rates and other measures that were put in place to reduce deficits during Clinton’s administration, when economic growth averaged 4 percent a year.

The difference is Obama inherits an economy at far greater risk because of unemployment and a credit crunch than the one Clinton was given when he took office in 1993, experts said.

Bad Economic News

Figures yesterday showed orders for durable goods fell 5.2 percent in January, twice as much as forecast, and the number of Americans filing initial applications for jobless benefits soared to 667,000 last week. Deutsche Bank AG chief U.S. economist Joseph LaVorgna said it’s “conceivable” the economy will shrink as much as 10 percent in the first quarter.

Still, Obama is counting on the economy roaring back to produce higher tax revenue to help pay for projects such as an additional $750 billion in new aid for the financial industry and an overhaul of the health-care system he estimates will cost $635 billion. He also wants to increase defense spending to send additional troops to Afghanistan.

Additional Revenue

After $338 billion in tax collections this year, White House economists predict an additional $195 billion will come into the Treasury in 2010, and forecast $332 billion more revenue in 2011.

“You can’t spur economic growth on your left hand in this economic environment while on your right hand you’re raising taxes,” said Tim Speiss, a partner in charge of the personal wealth group at Eisner LLP, a New York-based accounting and advisory firm.

The budget also assumes the government will reap almost $646 billion over 10 years, beginning in 2012, from the so- called cap-and-trade system of government-issued permits to pollute; and $175 billion over 10 years by forcing insurance companies to compete for Medicare insurance business under the Medicare Advantage insurance program.

At the same time, the budget contains savings from a reduction in farm subsidies; forcing the wealthy to pay higher premiums for Medicare prescription drugs; reducing Defense Department procurement programs, and anticipated decreases in the costs of the wars in Afghanistan and Iraq, down about $10 billion to $130 billion in 2010.

Student-Loan Subsidies

Obama, 47, wants to end the $4 billion in annual federal subsidies for student-loan providers such as Sallie Mae and Citigroup Inc., leaving the government as the sole provider of federally backed college lending. The government currently offers direct loans through colleges, as well as guarantees for loans made by private lenders such as New York-based Citigroup and Reston, Virginia-based Sallie Mae, officially SLM Corp.

The bulk of the additional revenue would come from the approximately 2.6 million Americans who currently pay in the top two income tax brackets, which take effect at $164,550 of taxable income for single taxpayers and $200,300 of taxable income for married couples who file joint returns.

Obama’s proposal would cap the value of deductions for items such as charitable donations, mortgage interest and investment expenses at 28 percent for people in the top brackets, or 30 percent less than they would otherwise receive.

And it would force executives at private-equity firms, venture-capital firms, some hedge funds and other partnerships that receive a 20 percent so-called carried interest in the firm’s profit to pay rates as high as 39.6 percent, up from the capital-gains rate of 15 percent they currently owe.

Corporate Taxes

The budget also proposes $353.5 billion in higher taxes on corporations over the next decade, the bulk of which would come from changing rules that allow U.S.-based multinational corporations such as General Electric Co. to defer U.S. tax on profits they earn overseas. The budget also targets a widely used accounting method known as “last-in, first-out” for a tax increase and would repeal several benefits for oil and gas companies.

Obama’s budget would keep in place Bush’s tax cuts that benefit lower- and middle-income earners, and it preserves at least one policy that benefits the more affluent: a preferential tax rate on corporate dividends.

Before Bush, dividends were taxed as ordinary income, at rates as high as 39.6 percent in the 1990s. Obama would increase the tax rate on most capital gains to 20 percent, the level set by Clinton in 1997.

At the same time, Obama’s budget would make permanent the tax reductions for low- and middle-income earners that were included on a temporary basis in his stimulus package. That includes a payroll tax credit worth up to $800 per family and increases take-home pay by an estimated $67 a month.

Other policies would extend tax subsidies for the working poor, such as a more generous child tax credit for larger families.

To contact the reporters on this story: Roger Runningen in Washington at rrunningen@bloomberg.net; Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net;