Obama’s new budget is more of the same

Alan Viard Resident Scholar, American Enterprise Institute
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In today’s partisan atmosphere, it was predictable that President Obama’s fiscal 2013 budget plan would sidestep the tough choices required to address the long-run imbalance between entitlement spending and tax revenue. Sure enough, the budget plan includes no fundamental restructuring of the big entitlement programs and no broad-based tax increases. Instead, the plan sticks to the president’s longstanding approach of raising taxes only on a small group of high-income households, placing further tax burdens on the saving and investment that fuel long-run economic growth. The president even doubles down on this strategy, proposing a far larger dividend tax hike than in his previous budgets.

The budget plan does very little to cut entitlement benefits. There are no changes at all to Social Security. The plan does outline a few measures to trim Medicare, including higher premiums for high-income beneficiaries and expanded patient cost-sharing. Although modest, these measures are steps in the right direction.

The president’s plan relies far more heavily on raising taxes than on cutting entitlement benefits. On the tax side, President Obama continues to narrowly target the top 2 or 3 percent of the income distribution, those making more than $200,000 ($250,000 for married couples). One sensible proposal, carried over from previous budgets, would limit high-income households’ tax savings from the mortgage interest deduction, other itemized deductions, and the tax breaks for health insurance and municipal bonds. This proposal would scale back misdirected tax preferences, particularly the incentive for wealthy taxpayers to buy larger houses.

As before, President Obama proposes letting most of the 2001 and 2003 tax cuts expire for high-income households while permanently extending them for everyone else. In one important respect, though, this year’s plan abruptly changes course from the president’s previous proposals.

The president now proposes that the 2003 dividend tax cut fully expire for high-income taxpayers, pushing the top dividend tax rate up from 15 percent to 39.6 percent. In earlier budgets and during his 2008 campaign, the president called for raising the dividend tax rate only to 20 percent, based on the recognition that dividend tax relief partly offsets the extra burden that the corporate income tax imposes on stock-financed investment. This week’s plan would eliminate that much-needed offset.

The dividend tax hike is not the only measure that would increase the tax burden on saving and investment. The budget plan also talks about a 30 percent minimum Buffett tax on millionaires, although it doesn’t spell out the details. These proposals would come on top of a new 3.8 percent tax on the investment income of high-income households already slated to take effect next January, to help pay for health care reform.

Commentators across the ideological spectrum agree that raising taxes on the top 2 or 3 percent of the population will not be enough, by itself, to close the long-run fiscal gap. So, it’s hardly a surprise that the president’s narrowly focused plan falls short on the fiscal front, with the debt projected to weigh in at a staggering 76 percent of annual GDP in 2022 and poised to rise further in subsequent decades.

Still, it is hard to fault President Obama for failing to outline a comprehensive solution to the fiscal imbalance. Neither political party can be expected to tackle this daunting issue without cooperation from the other side of the aisle. The fiscal solution will ultimately come through bipartisan agreements that include both entitlement benefit cuts and tax increases. Some of the tax increases will undoubtedly fall on the top 2 or 3 percent, preferably through measures less damaging to saving and investment than a steep dividend tax hike. But, some of the tax increases and nearly all of the benefit cuts will fall on a broader segment of the population.

Bipartisan agreement seems unlikely in 2012. But, we must overcome partisan gridlock and move toward agreement soon if we are to resolve the fiscal imbalance and lay a foundation for long-run economic growth.

Alan Viard is a resident scholar at the American Enterprise Institute (AEI). Prior to joining AEI, he served as a senior economist at the Federal Reserve Bank of Dallas and taught economics at Ohio State University. He has also worked for the Treasury Department’s Office of Tax Analysis, the White House’s Council of Economic Advisers, and the Joint Committee on Taxation of the U.S. Congress.