Smoke, Mirrors & Almost No Budget Cuts

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
April 19, 2011

IN THIS ISSUE:

1.  Smoke, Mirrors and 2011 Budget Cuts

2.  The Paul Ryan Republican Budget

3.  Ryan Budget vs. Obama Budget

4.  Obama a Fiscal Moderate??

5.  Obama’s $4 Trillion Fairy Tale

BREAKING NEWS!!  I’m sure you’re already aware of yesterday’s statement by Standard & Poor’s changing the outlook on US Government’s AAA debt rating from “stable” to “negative.”  While this action doesn’t actually affect the current standing of US debt, it definitely sends a message about the future stability of the “safest investment in the world.”

I’m not going to delve into the Standard & Poor’s statement this week other than to say that it underscores the theme of this week’s E-Letter.  Smoke and mirrors budget cuts won’t fool the rating agencies any more than they will the foreign investors we depend upon to finance our folly.  Our elected officials had better get their act together sooner rather than later or we’re all in for a very rough time ahead.

Introduction

The federal budget battles have begun and the Republicans have shown, right out of the gate, that they are not up for the fight.  They promised $100 billion in spending cuts in 2011 during the 2010 campaign; they then whittled that down to $61 billion; and in the end, they settled for $38 billion – which after accounting tricks will be much less than that as I discuss below.

Now, we’re on to the fight over the 2012 federal budget.  President Obama’s budget request in February for FY2012 called for spending of $3.73 trillion and a deficit of $1.1 trillion (see my February 22 E-Letter).  Then on April 5, House Budget Committee Chairman Paul Ryan (R-WI) rolled out a controversial long-range budget that would slash federal spending to below 2008 levels starting in FY2012, shaving over $6 trillion off of Obama’s projections over the next decade.

Today we will look at some of the major differences between the Ryan plan and Obama’s budget plan that he announced in February.  The differences are stark!  Unfortunately, the Ryan budget plan cuts so much spending and contains so many other controversial issues, it probably has zero chance of being passed.

Not to be outdone, the Congressional Progressive Caucus (including many of the most powerful Democrats in Washington) offered up yet another long-range budget proposal that claims to balance the budget in 10 years.  How is that?  Can you say higher taxes?  You are not going to believe the details in this so-called “People’s Budget.”

Of course, we cannot fail to note that President Obama addressed the nation last Wednesday with his plans to get our out-of-control spending under control.  He claims his plan would cut $4 trillion out of the deficit over 12 years.  As with most Obama oratories, his proposal was long on rhetoric but short on details.  It also drew many of its provisions from a surprising source.  I’ll fill you in as we go along.

This week, I’ll discuss all of the above, but first I’m going to highlight the latest Congressional Budget Office report showing how the continuing budget resolution recently passed by Congress falls far short of its goal to cut spending by $38 billion in the remaining months of the 2011 fiscal year.  How much short?  Try over 99% - read on to find out why.

Smoke, Mirrors and 2011 Budget Cuts

I’m sure you’ve heard the old saying that “Figures don’t lie but liars can figure.”  Well, the new 2011 budget deal – billed as cutting $38 billion in spending – is showing that Republicans and Democrats alike are definitely in the liar camp.  That’s because a new CBO report states that only about $352 million (less than 1%) of the $38 billion in spending cuts will actually be applicable to the current 2011 budget year.

But wait, didn’t our elected officials tell us that the budget cuts were supposed to reduce the 2011 budget year deficit?  Yes, they did.  Go back and look through the articles and you’ll find that most mention a timeline for the cuts being the number of months remaining in the 2011 fiscal year.  While some of the cuts will supposedly provide savings in future budget years, that’s not what they were supposed to be working on.

Let’s review:  The Republicans initially wanted about $100 billion in spending cuts in the current 2011 budget year, while the Democrats originally wanted none.  After much negotiation, the Republican-controlled House passed a budget with $61 billion in spending cuts.  Senate Democrats then countered with a plan of their own with $33 billion or so in spending cuts.

After much haggling and posturing, including the threat of shutting down the government, the powers that be agreed to a 2011 budget with $38 billion of spending cuts.  Now we learn from the CBO that even this small number is bogus, and the real savings in the current budget year will be a paltry $352 million.  To put it in perspective, the $352 million is:

0.35% (.0035) of the Republicans’ original $61 billion target for spending cuts;
0.02% (.0002) of the projected 2011 deficit of $1.6 trillion;
0.0025% (.000025) of the apprx. $14.3 trillion total national debt; and
0.0037% (.000037) of the $9.6 trillion of national debt held by the public.

I’m not sure that this spending cut even qualifies as being a drop in the bucket.  So how can you get from $38 billion to a measly $352 million?  A recent Washington Post article explains:

The CBO study confirms that the measure trims $38 billion in new spending authority relative to current levels, but many of the cuts come in slow-spending accounts like water-and-sewer grants that don’t have an immediate deficit impact.

A separate CBO analysis provided to lawmakers but not released publicly says that $5.7 billion in savings claimed by cutting bonuses to states enrolling more children and reducing the amount of money available to subsidize health care cooperatives authorized under the new health care law won’t produce a dime of actual savings. CBO believes they are simply cuts to spending authority that is unlikely to be used anyway.

But those cuts to mandatory benefit programs, while producing no deficit savings, can be claimed under budget rules to pay for spending increases elsewhere in the legislation. All told, $17.8 billion in such savings is claimed but just a tiny portion of it would actually reduce the deficit.

This is the most mind-blowing political sucker punch that I have seen since the back-room deals that brought us ObamaCare.  Even worse, both political parties were willing participants in this scheme to fool the American public.  If you agree with me that our Representatives and Senators had to know that these measures were little more than window dressing, how can we expect them to address the real budgetary issues that span decades into the future?  Pundit Phillip Klein probably said it best;

“Unfortunately, it now appears that the new Republican majority has done what it attacked Democrats for doing when they controlled the House. They negotiated a back room deal, didn't release the details until 2 a.m., and the more we have of the details, the more we find out that the actual deal is filled with accounting gimmicks. Not a good way to earn back the trust of conservatives who grew disillusioned with the GOP the last time they controlled the House.”

The Paul Ryan Republican Budget

Congressman Paul Ryan may be a welcome exception to the ranks of RINOs (Republicans In Name Only) who claim to want lower spending but cannot bring themselves to make the hard decisions necessary to attain it.  Ryan has produced an alternative to the Obama 2012 budget that, compared to Obama’s budget, would cut spending by $6.2 trillion and reduce deficits by $4.4 trillion over the next 10 years. 

The House voted on Ryan’s budget last Friday and it passed along party lines by a vote of 235 to 193.  Not one Democrat voted for the bill.  While not actual legislation, the Ryan budget will serve as a non-binding guideline for government spending in the future.  Here is a summary the new budget proposed by Rep. Ryan as passed by the House:

Discretionary spending:  The Ryan budget would bring non-defense spending back to pre-2008 levels where it would be frozen for 5 years.  For defense spending, Ryan’s budget would not impose cuts, but would accept $78 billion of savings identified earlier by Defense Secretary Robert Gates.

Financial system:  The Ryan budget would repeal the Dodd-Frank financial reform bill as well as eliminate Fannie Mae and Freddie Mac by reducing their government guarantee and ending taxpayer subsidies.  It also supports enacting measures to bring back transparency and accountability to the Government Sponsored Enterprises (GSEs).

Entitlement programs:  The biggest change would be that it proposes to repeal the Affordable Care Act (ObamaCare).  In addition, it would change the way states receive federal Medicaid money by establishing block grants that are indexed for inflation and population growth.  It would do the same with the food stamp programs in each state.  The Ryan budget would also consolidate the dozens of different job-training programs sponsored by the federal government into more accessible career scholarships.

The Ryan budget would privatize Medicare, allowing future beneficiaries to choose from a menu of private options rather than the current standard Medicare plan.  Beneficiaries would get subsidies to help purchase coverage, with the wealthy getting smaller subsidies than those with lower incomes.  These subsidies would grow each year at the rate of GDP growth + 1%, without regard to increases in Medicare costs.  For Social Security, Ryan proposes a bipartisan process to “work together to enact common-sense reforms.”  Unfortunately, that’s Washington-speak for kicking the can down the road.

Taxes:  The Ryan budget would reform the tax code by consolidating the current six brackets and cutting the top individual marginal tax rate from 35% to 25%.  It would also prevent the Bush tax cuts from expiring in 2013 and essentially make them permanent.  Corporate tax rates would also be lowered from 35% to 25%, but it would also scale back loopholes and deductions.

A big part of the House Budget Chairman's plan rests on the assumption that President Obama’s healthcare law will be repealed.  Over the next decade, that would cut $1.4 trillion in spending alone, according to Ryan’s budget.  Those savings, however, wouldn’t go directly to deficit reduction, because Ryan would also repeal the elements of healthcare reform that are aimed at raising revenue or reducing costs.

A study just released by the Heritage Center for Data Analysis projects that the Ryan budget will help create nearly one million new private-sector jobs next year, bring the unemployment rate down to 4% by 2015, and result in 2.5 million additional private-sector jobs in the last year of the decade.  It would spur economic growth, with $1.5 trillion in additional real GDP over the decade.  According to Heritage’s analysis, it would result in $1.1 trillion in higher wages and an average of $1,000 in additional family income each year.  

That remains to be seen, of course, since the Ryan budget uses the same economic and inflation assumptions used in the Obama budget, and neither plan factors in a possible recession over the next decade.

Of course, the Ryan budget has been roundly criticized by those on the left and the White House.  They vehemently object to making the Bush tax cuts permanent, especially for the “rich” and lowering the corporate tax rate to 25%.  The cuts in Medicare and Medicaid were branded as “un-American.”  I could go on and on with more criticisms from the left, but I’m sure you’ve heard most of them by now.

Ryan Budget vs. Obama Budget

If you read my March 29 E-Letter, you know that the Congressional Budget Office now estimates that Obama’s 10-year budget proposal will add $9.5 trillion to the national debt over the next decade, if enacted.  The latest CBO figures project the national debt to increase by more than $2 trillion above what the White House projected in February over the decade. 

By comparison, Paul Ryan’s “Path to Prosperity” budget calls for reducing spending by $6.2 trillion over the next decade.  The Ryan budget spends less on nearly every major category of the budget.  Two exceptions are security and defense spending and spending on Social Security. Both are kept steady and relatively unchanged from Obama’s proposed budget.

Ryan’s plan has $40 trillion in spending over the next 10 years with an increase in the national debt of $5.1 trillion.  (Yes, even Ryan’s controversial budget plan does not balance the budget over the next decade.)  By comparison, Obama would spend $46 trillion in the coming decade and increase the national debt by $9.5 trillion according to the CBO.

Obama a Fiscal Moderate??

As odd as it may sound, President Obama’s budget proposals sound somewhat tame when compared to those of the Congressional Progressive Caucus (CPC).  The CPC, as its name implies, is made up of some of the most liberal members of the House of Representatives.  According to its website, the CPC seeks to “promote economic justice, protect civil liberties, promote global peace and security, and advance environmental protection and energy independence.”

Given the marching orders above, it’s not surprising that the CPC would produce its own budget alternative and call it the “People’s Budget.”  According to the Executive Summary on the CPC website, the People’s Budget “…eliminates the deficit and stabilizes the debt, puts Americans back to work, and restores our economic competiveness.” 

The CPC claims that their budget would eliminate deficits and actually create a budget surplus by 2021.  Supposedly, it would also balance the primary budget by 2014, reduce public debt as a share of GDP to 64.1% by 2021 and reduce deficits by $5.6 trillion from 2012 to 2021.  It would also produce a budget surplus of $30.7 billion in 2021.  However, to provide these benefits, the CPC budget takes on some major budgetary sacred cows.  Highlights of the major provisions of this progressive pipe dream are as follows:

Individual Income Tax Policies:  Among other things, the CPC budget would allow the Bush-era tax cuts to expire at the end of 2012, but extend marriage relief as well as credits and incentives for children, families, and education.  It would also immediately rescind the upper-income tax cuts in December’s tax deal and index the Alternative Minimum Tax for inflation for a decade (the AMT “patch” is fully paid for).  New income tax rates of 45%, 46%, 47%, 48%, and 49% would be added for high earners and all capital gains and qualified dividends would be taxed as ordinary income, at the new higher (45%-49%) income tax rates. 

Corporate Tax Reform:  For corporate taxes, the CPC budget would tax US corporate foreign income as it is earned domestically, eliminate corporate subsidies for oil, gas and coal companies and enact a new “financial crisis responsibility fee” (whatever that may be) and a so-called “financial speculation tax” for activities related to derivatives and foreign exchange transactions, as well as reinstate Superfund taxes.

Health Care:  The CPC budget would do away with all false pretenses and enact a “single-payer” public option for universal health care.  It would also negotiate prescription drug payments with pharmaceutical companies, as well as prevent a cut in Medicare physician payments for a decade.  In other words, it would maintain the Medicare “doc fix.”

Social Security:  The CPC budget would raise the taxable maximum on the employee side to 90% of all earnings above $106,000 (indexed for inflation) and eliminate the taxable maximum on the employer side.  This is a HUGE tax increase!  Accordingly, it would also increase benefits based on higher contributions on the employee side.

Defense Savings:  In perhaps the boldest proposal, it would end the US involvement in Iraq and Afghanistan beginning in 2013.  It would also reduce baseline defense spending by reducing strategic capabilities, conventional forces, procurement, and R&D.

So to balance the budget, the CPC proposes to substantially increase taxes just as we are recovering from a major recession and hobble our military in a world that is growing more dangerous by the minute.  Once done, perhaps we can all circle around the campfire and sing Kumbaya.  These proposals are among the worst things we could do for national defense and the economy, but liberals never let inconvenient facts stand in their way of their world view.

Of course, I don’t think anyone even on the left expected this budget to be passed.  Sure enough, it was roundly defeated in the House last Friday by a vote of 347 to 77.

Even so, perhaps the most profound effect of the CPC budget, in my opinion, is that it makes Obama’s budgetary proposals seem moderate in comparison.  There’s probably little doubt that “Obama the progressive” would like to embrace some of the aspects of the People’s Budget, but he knows the electorate is more interested in reining in government spending than increasing their own taxes, and there’s an election coming up next year.  However, having a really liberal budget for comparison purposes might help to make Obama’s proposals look almost sensible.

Obama's $4 Trillion Fairy Tale

Last Wednesday, President Obama delivered his much awaited speech on deficit reduction over the long-term.  He chose to give the speech before an audience of students at George Washington University during the middle of the day when most Americans were at work, as opposed to delivering it from the Oval Office in prime time.  The president announced his plan to cut $4 trillion from the current projected deficits over the next 12 years.  It is most interesting that he chose 12 years when all of the other proposals cover 10 years, making it hard to compare.

Obama roundly criticized the Republican budget plan put forth by Rep. Paul Ryan (with Ryan conveniently seated in the front row so the cameras could focus on him).  He castigated the GOP and promised that Social Security, Medicare and Medicaid would only be cut by identifying waste, duplication, etc.  He vowed that all three agencies would remain under federal control and would not be block-granted to the states as some have proposed.  As I have written many times, we all know that the national debt cannot be brought down without cuts to entitlements.  Once he vowed that there would be no such cuts, the rest of his speech was meaningless.

The president finally embraced some of the recommendations from his “Debt Commission” released late last year, even though that group did not get enough votes to make its recommendations a mandate.  Obama’s proposals included a mixture of spending cuts and tax increases, with little in the way of specifics.  The president vowed that the Bush tax cuts for the top two income tax brackets would be eliminated.  Obama said he would convene a bi-partisan “budget summit” in May when lawmakers would be asked to come up with a legislative framework for comprehensive debt reduction.

The president’s proposals had no teeth whatsoever in them.  He certainly didn’t call for a balanced budget amendment or any other specific laws he would like to see passed.  And most importantly, he did not say that he will revise his 2012 budget proposal that calls for spending over $3.7 trillion with a projected deficit of $1.1 trillion.  If the so-called “budget summit” doesn't convene until sometime in May, and likely doesn't come up with anything concrete until late summer, Obama's $3.7 trillion budget probably never gets reduced.

So it very likely comes down to a standoff between the Paul Ryan budget and Obama’s.  Thus, Congress will likely pass a budget somewhere in between.  And like the latest $61 billion in spending cuts proposed by the GOP and the $30 billion proposed by the Democrats -- which landed at $38.5 billion -- the final 2012 budget will likely land much closer to Obama’s proposal than to Paul Ryan’s, unfortunately.

It is clear to the whole world that our leaders in Washington are NOT serious about reigning in spending and reducing our debt, and that our national debt will continue to balloon.  I don't know when, but one of these days foreigners are going to significantly reduce or stop buying our debt.  When that happens, bond rates will skyrocket, the dollar will crash and another even greater financial crisis will unfold. 

Sorry to end on such a somber note, but it is what it is.     

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

The Presidential Divider
http://online.wsj.com/article/SB10001424052748703730104576260911986870054.html?mod=WSJ_Opinion_LEADTop

Highlights of Paul Ryan Budget Plan
http://online.wsj.com/article/SB10001424052748703806304576242612172357504.html

The liberals' new budget: massive tax hikes & gut defense
http://washingtonexaminer.com/politics/2011/04/liberals-plan-gut-defense-and-tax-tax-tax

The President Has Moved to the Left
http://www.realclearpolitics.com/articles/2011/04/14/the_president_has_moved_to_the_left_109550.html


Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert, Mike Posey (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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