January 26, 2010 6:56 pm

White House signals shift to tackle deficit

The Obama administration will pivot from recession-fighting to fiscal consolidation beginning in the fiscal year 2011, Peter Orszag, the White House budget director, has told the Financial Times.

“We face two problems – the GDP gap and elevated unemployment, and the fiscal outlook,” Mr Orszag said in a interview. “We view 2011 as a transition year in which we are starting to move towards the latter problem while still paying attention to the former.”

Two key components of this shift will be a spending freeze for many government agencies and a bipartisan fiscal commission to develop a plan to fix public finances, set to be announced by President Barack Obama in Wednesday’s State of the Union address.

The push comes as the Congressional Budget Office said that the 2010 deficit would hit 9.2 per cent of gross domestic product. It warned that even on current law assumptions that ignore the likely extension of some Bush tax cuts and other tax reliefs, US debt would climb to 67 per cent of GDP by 2010 and interest payments would “skyrocket” to 3.2 per cent.

Doug Elmendorf, the CBO director, said if the Bush tax cuts were made permanent, the alternative minimum tax indexed for inflation and spending increased in line with GDP, “the deficit in 2010 would be nearly the same, historically large share of GDP that it is today”.

Obama administration officials hope the spending freeze, fiscal commission and the 2011 budget set to be unveiled next week, will convince the bond market and voters that they are serious about tackling the deficit while avoiding premature cuts that might jeopardise economic recovery.

The spending freeze – which covers all discretionary spending by federal agencies excluding defence, international affairs, homeland security and veterans affairs – covers about one eighth of total spending.

The remaining seven-eighths is made up of mandatory spending on entitlement programmes such as Medicare and Social Security plus defence and security related spending.

“It will save $250bn over ten years relative to the baseline,” Mr Orszag said. He said it sends a “signal” that the administration is willing to make tough choices but added “it is only a small part of what needs to be done”.

The plan for a freeze from fiscal 2011 onwards allows for a final additional burst of infrastructure spending as part of a proposed “jobs package” – that would be accounted for as part of the 2010 budget year.

The commission will be charged with developing plans to tackle both medium-term deficits and longterm spending on entitlement programmes.

However, even if Republicans agree to name members for the commission, they may select anti-tax hardliners to represent them, making it impossible to reach agreement.

Experts say it was difficult to generate political support for far-reaching fiscal consolidation when there was no pressure from the bond market.

Administration officials believe it would make more sense to develop proposals that would be presented after the mid-term vote in November – rather than put specific proposals out now and risk legislators locking themselves into fixed positions.

The commission would also provide an insurance policy against a rebellion in the bond market. If long interest rates started to move rapidly, the administration would have a structure in place to move quickly.

Alternatively, if there was no crisis but there was gradually building pressure from financial markets, by November the political climate may be more conducive to tackling the fiscal problems.

In the past Mr Orszag and Treasury Secretary Tim Geithner have cited 3 per cent of GDP as a reasonable medium-term deficit target – a number also used in discussions with Congress about the fiscal commission, according to Congressional aides.

However, Mr Orszag declined to comment as to whether the administration’s budget would offer proposals to bring the medium-term deficit all the way down to 3 per
cent or whether it would rely in part on additional proposals from the commission to achieve this.

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