I think health care will dominate the first month or two of the 2010 American domestic policy debate. But by the end of February we will either have a law or the bill will have died.

Jobs, deficits, and taxes will dominate the rest of the 2010 American domestic policy debate:

  • The unemployment rate is 10.2%. The Administration projects it will remain in the high 9s throughout 2010, even as it projects real GDP to grow 2 – 3%. (2.0% year-over-year growth, and 2.9% comparing Q4 2009 to Q4 2010).
  • The Administration projects a 2010 deficit of 10.4% of GDP, compared to 11.2% this year. They project an average budget deficit for the next ten years of 5.1%, and a 4% deficit at the end of the decade. Those are unsustainably high deficits.
  • The Administration projects steadily rising debt held by the public, from 41% of GDP in 2008, to 56% this year, to 66% next year, to 77% by the end of the decade.
  • CBO’s projections for deficits and debt are even more pessimistic than the Administration’s.
  • Under current law, the Bush tax cuts are scheduled to expire on at the end of 2010. If no new law is enacted, on January 1, 2011 (oversimplifying a bit):
    • The individual income tax rates will increase from 10/15/25/28/33/35 to 10/15/28/31/35/39.6%.
    • Capital gains rates will increase from 15% to 20%.
    • Dividend tax rates will increase from 15% to being taxed as ordinary income.
    • The estate tax will return to its pre-2001 state: a $1M exemption and a top rate of 55%.
    • The AMT “patch” will again expire, as it does each year after Congress fixes it only one year at a time.

The problem for the President is that there are tensions among these problems.

  • Accelerating GDP and job growth requires big fiscal or monetary stimulus. The Fed has the dial set to 11, so fiscal stimulus is all that’s left. As a policy matter, a big new stimulus program would substantially further increase at least the short-term deficit and take at least a few months to even begin to have an impact. As a political matter, the Administration has poorly managed stimulus implementation and communications to the point that even they are afraid of the word “stimulus.” The President’s communications and political advisors are, I imagine, groaning at the thought of the President’s policy answer to slow job growth being another stimulus. Then again, they’re probably also panicked about another year of 9+% unemployment.
  • Getting serious about budget deficits requires some combination of big spending cuts and/or big tax increases.
    • While Congressional Republicans are almost never able to muster the votes for big spending cuts, at least they’re generally willing to talk about them as the preferred solution. (How’s that for faint praise?) I have seen no indication that the President or any of his allies (except House Majority Leader Steny Hoyer) are willing to significantly slow the growth of spending. To have a measurable effect on the long run spending problem, one has to address demographics and health care cost growth in Medicare and Medicaid. But Director Orszag routinely ignores demographics in his presentations, arguing the long-run problem is only about health care costs. The President and his allies have lowered their long-term fiscal goal for health care reform to only slight improvements in our deficit picture. Even those small improvements are contingent on wildly optimistic assumptions about future Congressional behavior.
    • That leaves tax increases. The Administration already has baked into their projections revenue gains from allowing the top rates and capital tax rates to rise. Getting a lot more revenue (measured in percentage points of GDP) requires either returning to pre-Reagan tax rates or a new source of revenue. Q1: Will the President propose a new value-added tax (VAT), which would raise taxes on all consumers and break the President’s pledge? Q2: Will he instead propose a new business activity tax (BAT) which would have similar effects but which he could claim taxes businesses rather than individuals?
    • As worried as the President’s Congressional allies might be about the policy and political impacts of dangerous deficits, it’s hard to imagine them preferring to spend election year 2010 pushing for big spending cuts or big tax increases. I imagine they’ll be looking for ways to punt.
  • The scheduled automatic tax increases pose another conundrum. On the one hand, they need the revenues to prevent future deficits from being even worse than projected. On the other, if the economy is still soft at the end of 2010, tax increases are counterproductive. And while some on the left may think it’s easy to raise the top two individual tax rates, they forget that there was a broad bipartisan consensus in 2001 and 2003 to lower those top rates. The partisan dispute in 2003 was over cap gains and dividends, not the individual rates. This is largely because the top rates have been politically redefined as small business tax rates. When Congressional Republicans insist on votes throughout 2010 to prevent tax increases on successful small business owners during a time of economic weakness, will moderate and nervous Congressional Democrats want to vote against small business?

Within the White House the budget process is almost certainly driving these decisions. In my experience, most big Presidential budget decisions take place in November and December, to be rolled out in the State of the Union address and the release of the President’s Budget in the first week of February.

Here’s a policy checklist of questions they need to answer:

  1. Do we propose a new fiscal stimulus? If so, do we offset it in the outyears with spending cuts or tax increases? Or do we (misleadingly) claim we’re using returned TARP dollars to finance it?
  2. What do we do if we’re not going to propose a new fiscal stimulus, but our Congressional allies charge forward anyway?
  3. Do we propose a major deficit reduction package in next year’s State of the Union address and President’s Budget? If so, does it include entitlement spending cuts (unlikely), even bigger tax rate increases, or a new revenue source?
  4. How hard do we push back if moderate and nervous Congressional Democrats want to postpone the tax increases scheduled to take effect at the end of 2010?