Obama's Budget and Its Discontents

President Barack Obama's first two budgets were reflexive, emergency-care responses—spending and more spending on stimulus, bailouts, and jobless benefits—to an historic economic bust. He did what he says he had to do. With the budget Obama sent to Congress on Feb. 14, his third, he's grasping hold of the country's fiscal levers to shape the U.S. economy according to his vision for the early decades of the 21st century. In other words: He's doing what he wants to.

The President's budget is informed by his belief that government has a strategic role to play in guiding the economy. That means in some cases picking winners and losers and directing capital to individual industries and technologies that have a shot at delivering jobs and economic prosperity. His Republican opponents believe it's better to let private investors keep more of their money, so they can allocate capital to where they think they'll get the highest returns.

So this year's budget debate in many ways harks back to the 1930s intellectual rumble between academic economists John Maynard Keynes and Friedrich Hayek. Democrats take their cues from Keynes, the Depression-era British economist who championed government intervention to correct economic imbalances. Republicans hew to Hayek and his free-market Austrian School of Economics, which views government intrusion into an economy as counterproductive at best, outright socialist at worst.

In his 2012 blueprint, Obama picks out the comparative advantages the nation should build up to compete globally. Chief among them is education: K-12 programs would get almost 7 percent more. Clean-energy technologies (electric vehicles, especially) get a Presidential thumbs up. So do high-speed rail and broadband Internet. Oil and gas companies, which stand to lose billions in subsidies, do not.

Of course, Obama's budget is a political as well as an economic document. With independent voters concerned about the size of the deficit, his budget would gradually reduce this year's shortfall from a projected record of $1.6 trillion, or 10.9 percent of the economy, to $607 billion in 2015. That's considered sustainable because, at 3.2 percent of gross domestic product, it will bring the growth of the national debt down to the economy's long-term growth rate. To get there, Obama must persuade Republicans to agree to $1.1 trillion in tax increases over the next decade, including $807 billion from rolling back Bush-era estate and income tax cuts for the wealthy.

While that may be optimistic, Obama is less rosy with his economic assumptions. He assumes jobless rates will average 9.3 percent this year and not drop below 6 percent until 2015. He also assumes the economy will grow at a modest 2.7 percent this year and build to 4.4 percent by 2013 before slowing slightly to 3.8 percent in 2015. Inflation is expected to remain tame at 1.3 percent this year and not to exceed 2.1 percent for the next decade.

Republicans consider the deficit a prime culprit for the lackluster economy. House Budget Committee Chairman Paul Ryan (R-Wis.) argues for $61 billion in spending cuts over the final seven months of the current fiscal year as the best way to boost growth. "Continued uncertainty about our economic future is hindering job creation today," Ryan said at a Feb. 9 House Budget Committee hearing. "The explosive growth in our federal debt is by far the biggest source of this uncertainty."

The idea that a government should live within its means resonates with much of the American public, after many families had to make sacrifices during the recession. While the financial crisis may have cast doubt on the wisdom of markets, persistent high unemployment and a record budget deficit have undermined confidence in the government's capacity to deliver prosperity. In a Bloomberg National Poll in October, 51 percent of respondents said Obama's stimulus either weakened the economy or made no difference.

To win back independents and executives, Obama, along with emphasizing education, would boost spending on transportation so manufacturers can move goods more quickly and cheaply. There's also a $1 billion expansion of health research that would assist biotechnology and pharmaceutical companies. "Now that we're out of the depths of the crisis," Obama said at a Feb. 15 news conference, "we have to look at these long-term problems and these medium-term problems in a much more urgent and a much more serious way."

At the moment, the White House and Republican budget sparring is confined to domestic discretionary programs, or about 12 percent of overall spending. The rest is for defense, interest on the national debt, and entitlement programs such as Social Security and Medicare. Obama and Senate Republican Leader Mitch McConnell of Kentucky on Feb. 15 signaled they would be open to negotiations to put entitlement programs on a sounder footing. A bipartisan group of six senators, including four who were on the President's deficit reduction commission, also has been exploring turning that panel's recommendations into legislation.

Over the coming months it will be clear that the White House and the GOP have deep differences, ranging from how fast to bring down the deficit to which domestic programs to cut. Some of these differences will come to a head soon. The temporary resolution funding the government expires on Mar. 4. Soon after, the government will reach its legal debt limit, requiring Congress to prevent a default. In each case, Republicans, especially newly elected Tea Party members, are hoping to use the occasions as leverage to reopen the debate on the appropriate size and scope of government. When they do, Keynes and Hayek, both now long deceased, will be there in spirit.

The bottom line: The 2012 budget debate could be a prelude to a bigger confrontation—or a grand bargain—over entitlements and the tax code.

Before it's here, it's on the Bloomberg Terminal.