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The Mother of All Budget Deficits

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
February 9, 2010

IN THIS ISSUE:

1.  Obama’s Record Large 2011 Federal Budget

2.  Obama to Halve the Deficit by 2013 (Not)

3.  Obama Proposes $1 Trillion in Tax Increases

4.  Soaring Debt Now a National Security Threat

5.  Winners & Losers in Obama’s Budget

6.  January Unemployment – Good News & Bad

Introduction

Ever since the surprising election of Republican Scott Brown to the Senate seat held for over 40 years by the late Ted Kennedy, many political pundits have predicted that President Obama would have to move to the political “center” and scale back his liberal agenda.  But unlike many politicians before him, I do not believe that Obama has any intention of moving to the center.  In fact, he has said as much recently, even if he loses the House of Representatives in November.

As clear evidence that Obama is not moving to the political center, take his record-breaking federal budget proposal for fiscal 2011 that he unveiled last week.  With absolutely no regard for the public’s growing alarm over out-of-control government spending and trillion dollar budget deficits, the president proposed a record $3.83 trillion federal budget for fiscal year 2011 and increased its estimate of the 2010 budget deficit to a record $1.6 trillion. 

Within the budget and its various 10-year fiscal projections, Obama plans to raise taxes by over $1 trillion over the next 10 years, largely on the backs of individuals making over $200,000 a year and American families that make over $250,000 a year.  Here, too, this is hardly the sign of a man who is moving to the political center.  And all of this is happening just as the economy is crawling back from a credit crisis and the worst recession in a half century.

It remains to be seen if the American electorate will respond with a sweeping change in Washington this coming November, or if the current groundswell against skyrocketing government spending and record deficits will have faded away, as Mr. Obama is hoping.  The latest Rasmussen poll found that 75% of Americans are “angry” about federal spending. 

This week, we will take a close look at the president’s monster budget and record budget deficits as we go along.  As should not surprise you, I am going to criticize President Obama in the pages that follow.  Most importantly, you should know that I also beat up on both former presidents - Bush (43) and Bush (41) - for big spending and running large budget deficits.

Finally, we will take a look at the latest good unemployment news.  Unfortunately, the latest unemployment report was not all good news.  It’s a lot to cover, so let’s get started.

Obama’s Record Large 2011 Federal Budget

When defending his massive spending and record budget deficits, President Obama frequently says that he inherited a “trillion dollar deficit” from former President Bush.  That claim is not true.  To put this in perspective, the non-partisan Congressional Budget Office concluded that Bush’s federal budget deficit for FY2008 was $454.8 billion

The CBO deficit number did not include the $700 billion “Troubled Asset Relief Program” (TARP) that President Bush signed into law in late 2008 during the sub-prime crisis to shore-up major banks and insurance companies in the form of loans secured by troubled securities.  If you add the $700 billion in TARP to the $454.8 billion, then you get a deficit of over $1 trillion.   

The problem is, the Treasury only spent apprx. $400 billion of the $700 billion TARP in 2008, and over $300 billion was left over when Obama took office in early 2009.  So how President Obama can claim that he inherited a trillion dollar budget deficit from Bush is beyond me.  Yet that is Obama’s story to justify his out-of-control spending in 2009, including the massive $787 billion “stimulus package.”  

What we do know is that the federal budget deficit for FY2009 was a record $1.42 trillion, largely on Obama’s watch.  During 2009, Obama presented his budget proposal for FY 2010 which included another projected deficit of $1.4 trillion for this year.  But as we learned early last week, the Obama administration now predicts that the 2010 budget deficit will be even higher.

President Obama presented his latest federal budget for FY2011 early last week, and it is yet another whopper.  You may recall that Obama’s first federal budget submitted last year for FY2010 was an enormous $3.6 trillion, as compared to Bush’s last budget of $3.1 trillion.  When Obama submitted the 2010 budget last year, the projection was for a budget deficit of $1.4 trillion this year, but his latest budget projections show the FY2010 deficit topping $1.6 trillion which is almost double Bush’s last deficit (even if you include the $400 billion in TARP money).

President Obama’s proposed federal budget for FY2011, which begins on October 1, would ratchet government spending up to a whopping $3.83 trillion with a deficit of at least $1.3 trillion.  I say “at least” $1.3 trillion because some of the economic assumptions made in the budget and deficit projections are too rosy in my opinion (more details below). 

So much for Obama moving to the center!  He will continue to run $1+ trillion deficits, even though the latest Rasmussen poll found that 75% of Americans are “angry” about out-of-control federal spending, and the likelihood that the Democrats will take a drubbing in the November mid-term elections.

Here are the latest budget deficit estimates from the White House Office of Management & Budget (OMB), based on Obama’s latest federal budget request for FY2011.  If these projections prove accurate, the US national debt would almost double by 2020.

Projected Federal Deficit

There are several important reasons why these deficit projections are too optimistic, in my opinion.  First, the White House OMB assumes that economic growth or GDP will increase by 4% in 2010, which could be quite optimistic as I have suggested in the last few weeks.

Second, the OMB assumes that economic growth or GDP will increase by 5.2%-6.1% annually in the five years 2011-2015, with no recession.  Most economists would agree that this scenario is way too optimistic.  Even the Congressional Budget Office, which is also historically too optimistic, projects that annual real GDP growth will average only 3.8% a year in 2011-2015.

Annual GDP growth of 5.2%-6.1%, versus 3.8%, over five years is a huge difference and clearly suggests that the Obama deficit projections for at least 2012-2015 are far too optimistic.   In fact, both sets of economic assumptions could be too optimistic.

Third, both the OMB and the CBO assume that inflation is going to remain subdued over the 10 years shown above, with the Consumer Price Index hovering just over 2% annually.  Likewise, both the OMB and the CBO believe that interest rates will remain relatively low over the next 10 years, with the 3-month Treasury bill rate remaining well below 5%.

As noted above, many economists agree that these economic assumptions are too optimistic.  Here’s the latest from the economists at banking giant Wells Fargo: “The federal budget proposed this week includes a set of economic forecasts for growth that is significantly above the general expectation for long-term growth for the U.S. economy. Yet, large federal deficits persist and these deficits assume significant foreign capital inflows at very low rates. We suspect this is a very low probability outcome.”

We are on course to double the national debt over the next decade, and there is no way that inflation and interest rates are going to remain at these low levels… unless we have another recession.  As I have also suggested in recent weeks, this is entirely possible if not likely.

Winners & Losers in Obama’s Budget

If you consider it a “win” to get more money from the federal government, then the following groups are winners in President Obama’s $3.83 trillion 2011 budget proposal.

Education: As a huge perk to the teachers unions, the Department of Education outlays would more than double from $32.4 billion in 2009 to $71.5 billion in 2011.  Obama puts money into a laundry list of other education initiatives, from a $1.6 billion increase in child care funding to making permanent the expansion of Pell Grant payouts.  He also proposes $3 billion more into K-12 education generally, with up to an extra $1 billion if Congress reworks the education system in the way he wants this year.

Civilian Research & Development: Saying it’s a key to the nation’s long-term economic recovery, Obama would significantly increase spending for basic, non-defense science research in a range of departments for a total of $61.6 billion in civilian research.  Obama pledged to double R&D funding for the National Science Foundation, the Department of Energy’s Office of Science and the National Institute of Standards and Technology.  More money is going to develop clean energy alternatives, expand biomedical research, cure cancer and develop a more reliable electric grid.

Small Business: The president touted the importance of small businesses to the economy at length during his State of the Union, and his budget gives small companies some new advantages.  Obama’s budget would eliminate capital gains taxes for investments in the smallest tier of business and provides for a total of $28 billion in loan guarantees aimed at businesses with few employees or little revenue.

Harry Reid & Nevada: In a veiled effort to help Senator Harry Reid, who may be defeated in November, Obama pledged that the government would guarantee $36 billion more in loans for companies seeking to build new nuclear plants in Nevada.  But at the same time, his budget would close YuccaMountain in Nevada, which is our primary repository for nuclear waste.  How do you build more plants with nowhere to store the spent fuel rods?

These are just some of the big winners in the president’s new budget.  If you consider it a “loss” to get less money from the federal government, then the following groups are losers in President Obama’s $3.83 trillion 2011 budget proposal.

NASA & the Moon: Obama’s budget calls for NASA to cancel its Constellation Program that has been designed to return people to the surface of the moon.  Instead, the budget actually adds $6 billion to NASA’s budget over the next five years for projects such as robotic rocket systems.

Some Defense Contractors: The president’s budget would increase the 2011 Defense Department budget by only 3.4%, well below the request.  As a result, several DOD programs are on the chopping block.  One of these would be the halting production of the Boeing C-17 aircraft, saying additional planes are “not needed.” 

Oil & Gas Producers: Obama’s budget would increase the Department of Energy’s 2011 budget by 7%, with most of the added spending going to research on alternative and green energy.  At the same time, the new budget would terminate eight different arrangements, mainly tax benefits/incentives that boost oil and gas production and exploration.  Removing subsidies for domestic oil and gas producers essentially amounts to a $36.5 billion cost increase for the companies over 10 years, which of course will be passed on to consumers.

Other Losers: Department of the Interior (-1.6%); Department of Labor (-2.1%); HUD (-4.6%); Agriculture (-5.9%); Justice (-12.7%); and Commerce (-36.0%).  [Source White House OMB]

Obama to Halve the Deficit by 2013 (Not!)

President Obama frequently promises that he will cut the federal budget deficits in half by 2013.  Obviously, I don’t believe that will happen because, as discussed just above, the economic assumptions are too optimistic, and government revenues will fall short of these projections.  Yet it is these flawed projections that Obama uses to make his claim. 

Even if the projections were to prove accurate, I still find it more than a little disingenuous to boast that you will halve the deficit by 2013 when you more than doubled it in your first full year in office! 

For Obama to deliver on his promise, either taxes have to go up or government spending has to go down, or some combination of the two.  You know what that means!

Here’s a graphic look at how the Obama administration is counting on bringing in revenue and spending it in fiscal 2011, when they predict a budget deficit of $1.3 trillion.  Keep in mind that income taxes in 2011 include large tax increases on “the rich” as discussed below.

Federal Revenues and Spending in Fiscal 2011 

Obama Proposes Over $1 Trillion in Tax Increases

As many were expecting, President Obama announced along with his 2011 budget request a host of tax increases, especially for high income earners, as I warned in my January 12 E-Letter. Taxes on high-income earners alone would rise by at least $1 trillion over the next 10 years, under the budget plan put forward by Obama last week.

The bulk of that increase comes as certain tax cuts enacted under President George W. Bush will expire at the end of 2010.  At that point, the top two income-tax rates, which affect individuals earning more than $200,000 a year, or $250,000 for married couples, will return to 36% and 39.6%, from 33% and 35% now.  Mr. Obama would extend the Bush tax cuts, including the 15% rate on capital gains and dividends, for single taxpayers making less than $200,000 and couples earning less than $250,000.

Under the budget plan, capital gains and dividends would be taxed at 20%, up from 15% now, for people at those upper income levels.  Limits on upper-income earners’ ability to claim personal exemptions and itemized deductions will also snap back next year, without any action needed from Congress or the president.  The only action Congress will have to take is to extend the Bush tax cuts for individuals and families making less than $200,000 and $250,000 respectively.

As in last year’s budget, Obama proposed last week to go further by limiting the value of those benefits, which include deductions for mortgage interest and some charitable contributions.  The highest income earners under current law can lower their taxes significantly via those deductions, but that will be reduced considerably under Obama’s new proposal.

The bid to lower the limit on itemized deductions stalled in Congress last year amid strong resistance from Republicans and even some Democrats.  It is also opposed by a battery of interests including realtors and charities.  So it remains to be seen if it will pass this time around.

Hedge fund managers would see their partnership profits taxed at ordinary income rates, rather than the much lower capital-gains rate, under Mr. Obama’s proposals.  That plan, which was also proposed in last year’s budget, passed in the House but did not in the Senate, where members of both parties worry that a tax increase on so-called “carried interest” could harm entrepreneurship and investment.  It will!

Obama also proposes to permanently reinstate the estate tax, which was repealed for one year on January 1 for 2010, back to the 45% level, with an exemption for estate wealth under $3.5 million.

Obama also proposes putting limits on the use of family trusts that have helped wealthy families lower their estate tax liabilities, which the White House estimates would increase government revenue by $23.7 billion over 10 years.

All in all, it will be one of the largest tax increases in history and, unfortunately, most of it doesn’t require a vote in Congress or signature by the president.  Liberals refuse to realize that if you raise taxes on “the rich,” tax revenues from this group can actually go down, not up.

Soaring Debt Now a National Security Threat

The national debt is now $12.35 trillion and it increases by almost $4 billion every day.  Of that total, $7.85 trillion is held by the public, and $4.50 trillion is held by intra-governmental agencies and trust funds – all of it in government debt securities. 

Of the $7.85 trillion held by the public, apprx. half of that is owned by foreign entities, some of which do not have America’s best interest at heart.  The US government now borrows one of every three dollars it spends, with many of those funds coming from foreign countries.  With the national debt on track to double in the next decade, our vulnerability to foreign powers will increase significantly.

Our skyrocketing debt weakens America’s standing around the world and our ability to act.  It strengthens China and other world powers including cash-rich oil producers and others.  It puts long-term defense spending at risk and undermines the power of the American system as a model for developing countries.

Richard Haass, president of the Council on Foreign Relations and a senior national-security adviser in both the first and second Bush presidencies, recently said: “We’ve reached a point now where there’s an intimate link between our solvency and our national security. What’s so discouraging is that our domestic politics don’t seem to be up to the challenge. And the whole world is watching.”  When the CFR makes statements like this, you know things are dire.

Aside from the fact that each American next year will chip in more than $800 just to pay interest on our national debt, that situation means America’s government is largely dependent on continued large loans from foreign creditors and subject to the whims of international financial markets.  A foreign government, through the actions of its central bank, could put pressure on the US in ways its military never could.  

Think China, should it decide to halt purchases of US Treasury debt, or worse, should it decide at some point to unload part or all of its near trillion dollar holdings of US debt paper.  Even under a more benign scenario, a debt-ridden US is vulnerable to a run on the American dollar that begins abroad.  Some would argue it is already underway given the dollar’s decline last year.

January Unemployment – Good News & Bad

Employers shed jobs at a slower pace in January, but the nation’s unemployment rate edged lower, according to the latest unemployment report last Friday.  Nonfarm payrolls dropped by 20,000 in January, even though the pre-report consensus called for payrolls to increase by 15,000.

But in a surprise, the nation’s unemployment rate, which is culled from a separate survey, edged down from 10% in December to 9.7% in January, the lowest level since August.  In a further hint of recovery, the “underemployment” rate, which includes part time and discouraged workers not looking for work, fell to 16.5% in January from 17.3% in the prior month.

Some positive trends were evident in a cross-section of industries.  The manufacturing sector added jobs for the first time in three years - 11,000 jobs.  The retail sector added 42,000. Temporary help services also hired 52,000.  The federal government also added another 33,000 jobs, about 9,000 of which were due to hiring in preparation for the 2010 Census.

The average hourly workweek also increased to 33.3 hours in January after hitting 33.2 in the prior month. Average hourly earnings also tracked higher by 0.3%, past expectations calling for a 0.2% rise.  That’s the good news.

Now for the bad news.  The construction industry lost 75,000 jobs in January, which was more than expected.  There were also job losses in transportation and warehousing.  The Labor Department revised December’s job losses from 85,000 to 150,000.  

Making matters worse, apprx. 2.5 million Americans were unemployed in January but were not counted as unemployed because they had not looked for work in the four weeks preceding the survey.  If we include all of the unemployed and the underemployed, the real unemployment rate is approaching 20%.

Perhaps the worst news was the revelation by the Labor Department that it discovered in making its year-end revisions for 2009 that they failed to count over 1 million people as unemployed last year.  After these revisions, the US economy lost apprx. 8.4 million jobs in the recession, not the 7.2 million previously estimated.  That leaves little doubt that this has been the worst recession since the Great Depression.

That’s all for now.  For those of you who are thinking of firing off a nasty e-mail to me for criticizing President Obama this week, just be reminded that I similarly criticized presidents George W. Bush and his father before him for spending too much and running up the deficits and the national debt.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Greatest spend-while-you-can budget in history
http://online.wsj.com/article/SB10001424052748704107204575039671922399114.html

Obama Budget: Wealthy Face Tax Increases
http://online.wsj.com/article/SB10001424052748704107204575038733246595218.html?mod=WSJ-hpp-LEFTWhatsNewsCollection

Tax increases can’t address the coming entitlements crisis
http://online.wsj.com/article/SB10001424052748704041504575045250168889076.html


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