The new budget President Obama proposed last week is no less than another American revolution, an economic revolution that changes the very fundamentals of the country. Rarely in our history has any president tried to use his budget to shape the economy in such magnitude. The budget deficit of $1.75 Trillion dwarfs the already colossal deficit George Bush left behind, and federal expenditures, a measure even more critical than the deficit, will be at 27% of GDP, higher than any time since World War II.
The Obama budget plan is indeed a radical departure. Before we all join the Gadarene rush headlong into financial abyss, let me tamper the enthusiasm a bit. Here are a few points to consider:
Debt and Taxes: Paying back this new debt we are taking on will necessarily mean a combination of future spending cuts, tax increases and inflation (which is tantamount to a surreptitious tax increase, bypassing Congress). The tax code will become more progressive, and perhaps that's good. It certainly seems to be what the country wants. But the tax burden will be shared by everyone, not only the economic upper echelon.
The top 2% of income earners in this country, about three million people, currently pay approximately $500 billion in income taxes, or an average of roughly $167,000 per person. To cut the deficit in half as the President promised to do, we will have to raise the tax burden of the top 2% by another $167,000. That is simply not feasible, if only because human nature dictates these new tax levels are going to adversely impact the incentive of people to work and produce.
Once government is on the advance, it rarely yields its power and authority, and it will be exceedingly difficult to cut back expenses. So either taxes are going up for everyone, or very large deficits are here to stay. And you have to wonder how long the Treasury will be able to keep borrowing that much money before people lose faith in our ability to pay back our obligations.
Stimulus: Monetary policy has been exhausted, and Keynesian fiscal policy stimulus is all that's left. The President believes that massive amounts of borrowed money can be spent effectively by the federal government to get us out of a recession. I think that is unlikely to work. The stimulating effect, borrowing unprecedented amounts of money to spend on a variety of projects at least some of which are dubious and wasteful, will be offset by anticipated higher taxes and the escalating cost to finance these expenditures.
Moreover, I believe the private sector is not buying and investing because the economy is uncertain, not because of some random, unreasoning whim. Among other things, people don't know what government will do next, as the Obama administration is making the rules up as they go.
The way to get people buying again is to give them back their own cash to spend as they see fit, and let markets adjust to the new reality of lower housing prices. Only then will economic activity resume and unemployment ease. Keynesians are using meretricious economic theory in pursuit of their policy goals, but I understand it is a philosophical difference and depends on one's view of government's role. We are in the midst of an outsized experiment and the jury is still out.
Meanwhile, Washington is seizing control of entire industries, in a manner reminiscent of leftist governments in the spirit of Lenin. Major industries such as auto, insurance and banking now depend on the Federal government. Usurping private industry is an expensive process that might trigger a vicious cycle, with dreadful unintended consequences. Once a few banks are nationalized, shareholders will ditch all others, fearing that their stock would soon be worthless as well. These banks would then also need government support. This is already happening.
Bipartisanship is out: Political parties have fissiparous tendencies for a reason. Lincoln, Obama's role model, was not bipartisan. In fact, it is said that in his 1864 reelection, Lincoln did not get a single vote in five southern states--- not even one crank voted for him. He refused to negotiate or compromise and was a polarizing figure like no other we know today. Faced with a moral and military crisis, Lincoln did what he had to do, and stood for what he believed rather than talk of bipartisanship. In turning hard left, Obama is certainly following that model, and people should have no illusions about it.
Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at aschram@wellcappartners.com.