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Analysis/Comment Last Updated: Apr 14, 2011 - 5:23 AM


Dr. Peter Morici: Getting serious about reducing US federal deficit; Gas prices, consumers and the economy
By Professor Peter Morici
Apr 13, 2011 - 1:25 AM

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President Barack Obama returns to the Oval Office through the Rose Garden after surprising students from Altona Middle School in Longmont, Colorado, April 11, 2011. During his statement Friday night, President Obama mentioned a letter he received from the mother of an Altona student who worried that her son's trip to Washington, DC, would be canceled if there was a government shutdown.

Dr. Peter Morici: Getting serious about reducing the US federal deficit; President Obama and Congressional Republicans are tabling proposals to balance the budget, and Americans have a right to be skeptical. Separately, an analysis on the implications of rising gas prices for consumers and the economy, is also presented.

Since 2007, spending has increased $1.1trn and the deficit has jumped from $161bn to $1.6trn. The President’s February budget projects the deficit will fall to $772bn by 2022. However, that forecast is dubious, because it assumes 4% growth over the next four years, which few economists would endorse, and cuts in Medicare payments to physicians and hospitals, few political observers believe will materialize. More likely, deficits will exceed $1trn, or even $1.5trn, for many years to come.

The President will propose higher taxes on the wealthy and plugging some corporate tax loopholes but that simply won’t do it. His budget already assumes repeal of the Bush tax cuts for those earning over $250,000. Even raising income taxes by 50% on all families earning more than $200,000 would not yield much more than $250bn a year. The resulting capital flight would reduce taxable income, and job losses would drive up federal social spending—net deficit reduction would not be large.

Although some loopholes could be plugged, moderate Democrats and Republicans agree US corporate taxes are too high for American companies to be competitive. Most revenue that might be found fixing abuses will eventually have to be put into lower corporate taxes for those firms bearing more than their fair share of the burden.

At the core of the fiscal mess are the rapidly growing bills for Medicaid and Medicare, and Social Security.

On health care, the fundamental problem is that federal and state governments pay 55 cents of every dollar spent on health care. A private market for health care no longer exists, and government reimbursements set most prices for health care services.

Germany and Holland, like the United States, have systems of private insurers. In those countries, although government reimbursements account for nearly 80% of payments, health care costs are half of what Americans pay.

Those governments keep costs down by better regulating prices, but in the United States drug manufacturers, health insurance companies and hospitals each have enough influence with the Congress or the President to keep real reform from happening.

A solution requires significantly lower prices for drugs and many health care services, and the President’s health care law doesn’t provide for those—witness the jump in cost of drugs, health insurance premiums and the like in 2011. Now the President is boxed in by past actions to defend a policy that adds additional subsidies to a broken system and increases the deficit.

The Republican plan—Congressman Paul Ryan’s Path to Prosperity—would replace federal Medicaid with block grants to the states and Medicare with vouchers to seniors to buy private insurance, but those tactics would merely shift the problem of paying too much for health care services onto state budgets and the backs of the elderly.

Also, Europeans don’t have the additional burden of abusive malpractice suits but tort lawyers have among their ranks too many prominent contributors to the Democratic Party for any solution to be possible there.

On Social Security, the basic problems are that Americans are living much longer and retiring long before their health requires, and the ratio of retirees to working age Americans is too high and rising. Higher taxes would cripple US international competitiveness with rising Asian economies, and individual retirement accounts risk leaving many elderly without adequate support, especially if they live past 75.

Simply, the retirement age needs to be raised to 70 for Americans under the age of 55. Only that solves the problem and other solutions are unworkable.

When Democrats and Republicans are willing to start seriously regulating prices for health services, and embrace a substantial and immediate increase in the retirement age, Americans will know they are serious. Until then, it would be great drama but for the fact we are saddling our children with an unbearable debt.

Can the President Change the Narrative on Wednesday?

Gas Prices, Consumers and the Economy

Gasoline prices are soaring passed $4.00 a gallon in many places and driving will continue to be more expensive. Unless consumers are determined to again recklessly pile up credit card debt, higher gas prices will profoundly slow other purchases and the economic recovery.

Over a three year period, most folks don’t have much control over how much they spend on rent and mortgage payments, utilities, tuition, and food, or how much they drive. Gasoline absorbs 15% or more of most household budgets, and the necessity of getting to work and driving kids to soccer practice does not relent when gas prices jump.

With gas prices up from $2.75 a gallon since last September, higher prices translate into a 5% cut in discretionary income, and Americans will be eating fewer restaurant meals, wearing fewer new clothes, curtailing summer vacation plans, and postponing furniture purchases and home improvements.

As most money paid for higher priced gasoline leaves the country to pay for more expensive imported oil and does not return to buy US exports, this shift in consumer spending reduces demand for what Americans make and slows economic recovery.

GDP was up 3.1% in the fourth quarter of 2010 and employers are hiring again—unemployment may not be as low as we would like but it is coming down. But for the first quarter of 2011, economic forecasters have lowered estimated growth to 2.7% from 3.4% just a month ago, and if growth stays that subdued, 50,000 or more jobs will be lost each month on account of higher energy prices.

Gasoline prices are likely to continue rising, and the impact on jobs creation and unemployment will worsen. China continues to grow at 9 or 10% a year, and Beijing regulates gasoline prices and subsidizes oil imports to meet growing domestic needs. This pushes the impact of tight global oil supplies and Middle East disturbances onto the United States and other big importers.

Oil prices could easily stay above $125 a barrel and gasoline prices could pierce $4.50 a gallon before moderating this summer or fall. That would further slow growth to about 2% and kill most jobs creation.

Growth at less than 2.5% is difficult to sustain. At less than 2.5% growth, most businesses can meet new demand by raising productivity, hiring slows or stops in most industries, and layoffs accelerate in slower growing sectors—pessimism grows, retail sales slow and the conditions for a new recession emerge.

US policy has been to discourage domestic drilling for oil and gas and bank on alternative energy—such as solar, wind and nuclear. Events in Japan make nuclear power a much less likely option than three months ago, and fully electric vehicles that could exploit more abundant electricity from alternative sources are at least ten years away from having any significant impact on US gasoline consumption.

Freeing up drilling for domestic oil and gas, greater emphasis on natural gas use for urban fleets, and more rapid build out of high-efficiency gas powered cars, hybrids and plug in hybrids would do a great deal to rev up the US economy, create jobs and reduce the grip of foreign oil.

Higher gasoline prices are always painful, but if more of the gasoline purchased were refined from domestic oil and more resources were focused on reducing domestic gasoline use altogether, the money spent would stay in the United States to create jobs. American prosperity would be much less vulnerable to events in the Middle East, Africa and other unstable places around the globe.

Debt Ceiling Battle: This magical debt ceiling of $14.3trn, is it a number we need to worry about?

Peter Morici,

Professor, Robert H. Smith School of Business, University of Maryland,

College Park, MD 20742-1815,

703 549 4338 Phone

703 618 4338 Cell Phone

pmorici@rhsmith.umd.edu

http://www.smith.umd.edu/lbpp/faculty/morici.html

http://www.smith.umd.edu/faculty/pmorici/cv_pmorici.htm

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