And the Other Shoe Drops...How Obama is Going to (try To) Balance the Budget

President Barack Obama, fresh off the victory on the Stimulus Package, is getting ready to prepare what can only be called an ambitious budget plan.

Mr. Obama intends to cut the budget deficit by half in four years, largely by raising taxes on businesses and the upper class. The only real significant cuts are expected in defense, where there will rapid decrease in spending on Iraq and Afghanistan. Some how, at the same time, Obama plans aggressive government intervention into fields he deems necesssary. This would include key changes to environmental policies and a major expansion of health coverage that Obama hopes to enact later this year.

Obama proposes to dramatically reduce those numbers by the end of his first term, cutting the deficit he inherited in half, said administration officials, speaking on condition of anonymity because the budget has yet to be released. His budget plan would keep the deficit hovering near $1 trillion in 2010 and 2011, but shows it dropping to $533 billion in 2013 - still high in dollar terms, but a more manageable 3 percent of the overall economy.

Overall, tax collections under the plan would rise from about 16 percent of the economy this year to 19 percent in 2013, while federal spending would drop from about 26 percent of the economy, another post-war high, to 22 percent. How does his projections expect government spending to drop in 2013? Because they predict a 5% growth of GDP from 2011-2013. Anyone want to take that bet?

First of all, it is much easier to cut 'half' of the approximately $1 trillion over budget that Obama will be this year. Of course, Obama himself laughed at using percentage of GDP as any kind of measure of the deficit. He called it the worst use of statisitics in last year's campaign. Funny to hear his advisors use the same statistics now. Additionally, even if use percentage of GDP as your standard, Obama;s budget levels will be the highest four non-war time years on record.

Obama still lacks simple understanding of what makes a financial recovery. First, the groundwork entails rebuilding confidence in the markets. Obama, Timothy Geithner, and Larry Summers have done much to destroy any remaining confidence the market had over the past few weeks. Nothing will destroy any rebuilding of confidence than heavy tax increases on those that create jobs in this country, i.e. businesses and the higher income brackets (who disproportionately include those that start small businesses). For example, the president will propose to tax the investment income of hedge fund and private equity partners at ordinary income tax rates, which are now as high as 35 percent and could return to 39.6 percent under his plans, instead of at the capital gains rate, which is 15 percent at most. I understand the reasoning behind this, from a fairness point of view; but from an economic point of view, this is the worst possible time to double the income of groups that still have investment capital available. I am not sure what the economic principle behind this is. Remove more capital from a market already squeezed from the credit crisis? How could this possibly help the economy? The business community, both large and small, coalescing in their belief that they must fight these proposals.

In fact, in some ways it is similar to the Jimmy Carter recession of 1980. Why? Well, the Carter Administration and the Federal Reserve at the time were focused on limiting inflation. Thus, as the economy went into a tailspin, what did they do? They increased interest rates, peaking at close to 17% at the end of 1980.So what did that do? It severely restricted free capital in the markets, and turned a bad recession into a terrible one. And how was reversed? Only when the Federal Reserve came to its sense and started reducing interest rates, and Reagan passed the largest tax cuts in history. Even before these had major effects, the markets started recovering, because confidence slowly built. It led to the longest post-war expansion in history.

So what does Obama do? Well, it is accepted as fact that the Fed has little power to do anything, unlike 1981. Even former Chairman Alan Greenspan and current Chairman Ben Bernanke agree with that. So, Obama passed the Stimulus, and is planning TARP II on top of TARP I. Fine; the argument is that the markets need capital to grow; capital is the oxygen that drives capitalism. So what does Obama do in his budget?He gurantees there will be serious restriciton in capital markets because of tax increases.

Here are some numbers If you add TARP I and II (atleast proposed) and the stimulus, it comes to about $2 Trillion in today's dollars; with interest, that comes to almost $4 Trillion. In 2013, if the Obama Administration's numbers are right, the tax increase for that single year will amount to $600 Billion. For the years 2010-2013, taxes will remove an additonal $2.3 Trillion out of the economy, and that is without interest. Thus, the taxes Obama is proposing will more than negate the stimulus that we are now suggesting.

Again, how does this make fiscal sense?

The other side will argue that these taxes will come in later years, and the stimulus is needed right now. True, except they assume that all things being equal, and they never are. The assumption is that businesses and the wealthy will not change their behavior following the tax increases. That is an outright lie. We know for a fact that is not true. Thus, tax proceeds will be far less than the Obama budget people are predicting, even with the higher taxes.

And this doesn't even start to talk about increased budgetary spending, like health care...I guess that is coming in the next column.