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Obama's Deficit Demons Can Be Vanquished In Second Term Thanks To Political, Economic Momentum

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WASHINGTON -- It may come as a surprise to President Barack Obama's critics, but the one domestic issue that defined his first term in office was reducing the federal budget deficit.

The size and impact of the president's economic stimulus package was trimmed out of fear of sticker shock. Federal workers have seen their pay frozen so that Obama could send a signal on deficit reduction. Even the signature achievement of his administration, health care reform, was premised on the idea that it would save the country money -- and it will, if properly implemented.

The primary theme of the president's reelection campaign was not a set of job creation proposals, but a plea for fairness in curbing the deficit. The rich, Obama said again and again, should have to pay their fair share, not only for moral reasons, but for fiscal ones. Without higher taxes on the wealthy, former President Bill Clinton said during the campaign, the “arithmetic” just wouldn’t work.

After closing out his first term with the "fiscal cliff" drama, Obama begins his second term facing three possible fiscal standoffs, each with the potential not only to set the domestic agenda for the rest of his presidency, but to define his economic legacy.

As it turns out, that's not such a bad place to be. What Obama needs in the second term is a combination of steadfastness and luck: a steady hand politically and a continued revival of the global economy.

Three standoff scenarios are currently the talk of the Beltway:

1. The debt-ceiling fight. Obama is thought to have the upper hand going into the latest battle over the debt limit, while congressional Republicans have everything to lose if they continue to play the role of hostage-taking obstructionists. They are already showing signs of bending, trying to stall the coming late-February face-off for another three months, pushing it as far back as June.

2. A government shutdown. Leaders of both parties believe the GOP will be blamed for a default or a federal shutdown if Congress doesn't fund the government when it runs out of money at the end of March, even if Republicans help pass a debt-ceiling extension.

3. The “sequestration.” The automatic budget cuts due to go into effect in early March will hit GOP-affiliated defense contractors hard, without cutting Social Security or Medicare benefits.

Getting through all three scenarios leaves Obama the opportunity to defuse the deficit as a political issue, perhaps without taking a hatchet to the social safety net.

He also may be able to shrink the deficit a surprisingly good deal. Obama has set a target of $4 trillion in deficit reduction over 10 years -- a number that even many deficit hawk economists view as more than sufficient to stabilize the economy. Budget and spending deals he made in his first term are worth $2.5 trillion. So he’s already not too far from that target, and the GOP may be unable to stop him from getting the rest of the way there.

Of course navigating this tricky course will take both political will and the right policy priorities. Obama has himself repeatedly proposed cutting both Social Security and Medicare in the name of deficit reduction during prior standoffs, and has caved on other important policies as negotiations have come down to the wire. Will he stand firm this time?

The underpinnings of the current manufactured crises give him a chance. Despite the ubiquitous deficit hyperventilation in and around the Capitol, the fiscal situation Obama faces is not dire or insurmountable. Deficit woes are and always have been more political than economic.

The consensus of mainstream experts is that there is little risk of catastrophe in running large deficits over the next few years, and that the budget gap can be narrowed dramatically without attacking programs that benefit the elderly or the disadvantaged, as long as the economy continues its slow but steady recovery.

"The recovery is going along pretty well, in spite of the political system's attempts to derail it," said Alice Rivlin, a centrist Democrat who has worked with GOP stalwarts including former Sen. Pete Domenici (R-N.M.) and Rep. Paul Ryan (R-Wis.) on deficit-reduction plans.

The way Rivlin sees it, the biggest threats to the improving economy are those coming from Congress, either in continued brinkmanship or in cutting too deeply too fast.

"The thing not to do is to get hysterical about the current level of the deficit, but focus on the real problem, which is the future debt," Rivlin said. Deficits are the annual shortfalls the government runs, while debt is the long-term bill it owes. Deficits are now running above $1 trillion, but are projected to drop.

Total U.S. debt is about $16.4 trillion -- a scary, oft-cited number that's about equal to the country's total annual economic output. But that includes some $5 trillion that the government owes itself, primarily to the Social Security Trust Fund. The less-frightening amount that economists care about is what Uncle Sam owes the public, and that's a little over $11 trillion, or about three-quarters of the GDP. Such a debt level is historically high, but nowhere near a record. And it looks even better next to the significant assets the government holds.

Rivlin notes that while such debt ratios have sparked problems in other countries, including interest rate spikes and even banking crises, they're another matter for the United States. So far, investors have been perfectly comfortable with American debt. The only objective measurement of investor confidence -- interest rates on Treasury bonds -- are at record lows, indicating high confidence. Foreign governments in China and Japan have in fact been increasing their purchases of U.S. debt.

"The world has always been willing to lend us money at relatively low interest rates," said Rivlin. "The reason for being nervous is that may not last. It's almost certainly not going to last forever, and as your debt gets to be a larger and larger ratio to your economy, you're more and more vulnerable."

University of Texas economist James Galbraith, a former Democratic staffer on the congressional Joint Economic Committee who is even less concerned than Rivlin, notes that several factors -- the dollar's status as the reserve currency abroad, the United States' ability to borrow money in its own currency, and the Federal Reserve's operations -- make the U.S. deficit fundamentally different from deficits in other countries.

"The term 'deficit' presupposes and implies something bad that should be filled in or made up for," Galbraith said. "It suggests that the right norm is a deficit of zero, and all of this is completely without meaning in economics. Zero is not the middle number. ... There's no presumption that zero is better than some other number, and in the case of the U.S., it's absolutely the wrong number. The U.S. provides reserve assets to the rest of the world, so it has to run a deficit and it would be a bad thing if it did not."

Deficit concerns are usually raised as a proxy for unpopular ideological preferences, Galbraith notes. Instead of demanding cuts to Medicare because it constitutes what Ronald Reagan once called "socialized medicine," conservatives now insist that such programs must be cut to avoid the supposedly greater pain caused by fiscal trauma.

"The deficit is a front issue for a different agenda of rolling back the New Deal, Social Security, Medicare and Medicaid," Galbraith said. "It's frustrating to have to shadow-box on this."

And indeed, staunch proponents of dramatic deficit reduction like the arch-conservative Club for Growth accompany their calls for tighter budgets with anti-government ideology. In an interview with The Huffington Post, Club spokesman Barney Keller suggested eliminating the Department of Commerce, the Department of Education and the Department of Housing and Urban Development to close the deficit. Paul Ryan's most famous budget proposal included a plan to privatize and cut Medicare benefits, while also cutting taxes so severely that it would have actually expanded deficits.

Total deficit failure in the U.S. isn't likely to end the way it has in other countries, like Greece, that can't borrow money in their own currency. When Greece gets in trouble, it is at the political mercy of the European Union. The United States, in contrast, is at the mercy of the Federal Reserve, which can always print more dollars to finance American debt. Eventually, printing money can result in inflation. But inflation isn't likely to get too out of hand thanks to the dollar's status as the international reserve currency. So the U.S. faces the prospect of mild long-term inflation if it doesn't get its fiscal house in order. That's very different from the bank runs in Argentina during the '90s, or the current humanitarian crisis in Greece.

If Obama can emerge from the looming policy battles with the bulk of his priorities in place -- and secure sufficient savings to satisfy the financial markets -- he'll have nearly his full second term to try to prove that progressive-leaning economics are not just good for people, they're better for the economy.

Public attitudes on the deficit are muddled. Two-thirds of respondents to a new HuffPost/YouGov poll said it was either "extremely important" or "very important" to "drastically reduce the federal budget deficit through either spending cuts or tax increases," and a narrow plurality -- 43 percent -- favored reduction through spending cuts alone, compared to 39 percent who favored both spending cuts and tax increases.

But when asked to specify what programs should be cut -- Social Security, Medicare, Medicaid, Defense, or "Something Else," respondents overwhelmingly favored Defense and Something Else, registering 39 percent and 34 percent each. Just 2 percent said Medicare, and 3 percent said Social Security. When asked which program is the biggest contributor to the deficit, a small plurality, 28 percent, said defense spending. The next most popular response was "foreign aid," at 22 percent.

The polling sentiment doesn’t square with the spending reality. Social Security, health care programs and defense spending each account for roughly 20 percent of the federal budget, according to the Center on Budget and Policy Priorities. Foreign aid accounts for about 0.1 percent of the budget. All "non-defense discretionary spending" -- everything but defense, Medicare, Medicaid and Social Security -- amounts to about 40 percent of the total deficit. Even if the U.S. cut every item under "something else," most of the deficit would remain. Many of those programs are popular or essential government functions -- like veteran's benefits, transportation funding and public education.

Obama's high approval rating and the actual state of the budget then give him a strong hand in the upcoming showdowns. He has been arguing for a "balanced approach" -- raising some taxes and making some cuts -- to find the remaining $1.5 trillion in his planned deficit reduction. Republicans have insisted that no revenue be raised, and that further reductions come from cuts alone.

But they lost in their bid to stick to that formula on New Year's Day, and had to swallow some $600 billion in tax hikes on the wealthy in the fiscal cliff deal. There has been no change in the public mood since. That suggests that whatever the GOP stance, the White House and Democrats are likely to continue seeking their balance.

Indeed, the deal that Obama and House Speaker John Boehner (R-Ohio) nearly cut in December could have come very close to the overall $4 trillion target for deficit reduction.

Similar proposals are likely to emerge in the coming months. The largest pieces would curb tax breaks for the wealthy, perhaps limiting how much they can write off mortgage interest and other common deductions. That could bring in some $500 billion to $600 billion. There are also numerous other tax law loopholes -- such as oil subsidies and tax breaks for private jets that add up to hundreds of billions more.

The White House also has floated some $300 billion in health care cuts, and hundreds of billions in cuts to Social Security and mandatory spending programs.

There is a path to get such a plan passed -- especially, Democrats note, since Boehner nearly backed such a scheme in December and back in 2011.

“Everyone knows that the tax code is riddled with giveaways for the wealthiest Americans and biggest corporations, and those should certainly be on the table as we work toward a balanced and bipartisan budget deal," said Sen. Patty Murray (D-Wash.) the chair of the Senate Budget Committee. "Speaker Boehner proposed to raise $800 billion by closing these loopholes during the last negotiation, so I am certainly going to fight to make sure that middle-class families and seniors aren’t being asked to bear the burden of the next round of deficit reduction alone.”

Republicans' leverage to demand cuts is essentially to threaten catastrophe -- a strategy that is increasingly unpopular, except with the GOP base in very red districts.

That schism has all-but paralyzed the House, dividing the Republicans into a Tea Party camp and a more realistic anti-tax group led by Boehner. The solution to the cliff standoff was to have Senate Minority Leader Mitch McConnell (R-Ky.) work out compromises with the White House and then leave them on Boehner's doorstep.

The GOP protested loudly. But once Boehner put the measures up for votes, they passed easily with support from Democrats and a minority of Republicans. Faced with both public pressure and the reality that shutting down the government or defaulting would be more harmful, that same scenario is likely to play out again and again.

If it does, it leaves the White House in an enviable position for the rest of Obama's administration. If bipartisanship takes root, it could open up the possibility of doing better still on spending, including on the real long-term driver of America's future debts: the high cost of health care.

The problem with focusing on health care, however, has always been that one side or the other invariably politicizes it. Finding health care savings doesn't have to mean slashing benefits. Strategies such permitting Medicare to negotiate with prescription drug companies could save billions without hitting seniors. But when Obama extracted such savings with the Affordable Care Act, Republicans demagogued the issue by saying he'd "cut Medicare," and Democrats lost control of the House.

Facing no reelection, and with the debt stabilized, Obama could wind up with the clout to start dealing with that root problem of health care costs, not to mention other priorities such as education and immigration.

Let us know what you think about the federal budget deficit below:

This article is part of a series produced by The Huffington Post that closely examines the most pressing challenges facing President Obama in his second term. To read other posts in the series, click here.

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