Will deficits trim Obama's agenda?

Democrats had hoped to launch the budget debate on Capitol Hill this week with a focus on their priorities: cleaner energy, healthcare reform, and education. Instead, they’re embroiled in a game-changing debate with Republicans over whether government – the White House, Congress, the bureaucracy, even the Federal Reserve – has what it takes to manage the financial crisis.

Between the AIG bonus debacle and prospects for $1 trillion annual deficits into the next decade, the likelihood is fading that President Obama’s first budget will survive with its key elements intact. The historic deficit numbers, in particular, make a tough sell on the budget even tougher, though some Democratic lawmakers say it’s not out of reach.

“The reality is we are going to have to make adjustments to the president’s budget if we want to keep the deficit on a downward trajectory,” said Sen. Kent Conrad (D) of North Dakota in a statement Friday, after the Congressional Budget Office (CBO) released projections showing federal red ink would total $9.4 trillion over a decade.

Sen. Charles Grassley of Iowa, the top Republican on the Senate Finance Committee, was more blunt.

“People can afford only so much government spending, even for the worthiest-sounding causes,” he said in a statement. “The White House should take a break from the heavy sales job on the budget.”

How much the government should do to try to buttress the weak financial system and spur a flagging economy is the germane question before Congress – and the news from last week may serve to point out the limits of government oversight and financial acumen to date.

First came word that Congress itself had inserted language into a bill that would allow $165 million in retention bonuses at insurance giant American International Group (AIG), rescued from bankruptcy by $170 billion in US taxpayer dollars.

“Congress ... entered a state of self-inflicted wounds,” says John Pitney, a political scientist at Claremont McKenna College in Claremont, Calif. “They themselves voted for legislation that explicitly approved the bonuses. I doubt many of them even knew, because they didn’t read the bill.”

Then, from the CBO, came another blow: The US budget deficit this year would reach $1.8 trillion – and the Obama forecast for the next 10 years would produce deficits totaling $2.3 trillion more than the White House had predicted in its budget blueprint.

The federal budget deficit in fiscal year 2008 was $455 billion (3.2 percent of gross domestic product), up from $162 billion (1.2 percent of GDP) in fiscal 2007. The deficit as a share of the US economy is expected to climb to 11.9 percent this fiscal year, the highest level since World War II, as the government spends on banks and stimulus measures. Next year, the budget gap will be 7.9 percent of GDP, the CBO said.

“It’s just beginning to sink in what the long-run effect of stimulus spending will be – from the audacity of hope to the gravity of reality,” says Mr. Pitney.

Pressure for adjustments will come on both the revenue and the spending sides. Some deficit hawks are already calling for faster elimination of more of the Bush tax cuts, set to expire in 2010.

Those tax cuts “cost $1.9 trillion over 10 years. Almost $2 trillion of the cost of [Obama’s] budgetary proposals are due to the extension of the Bush tax cut,” says Diane Lim Rogers, chief economist at the Concord Coalition.

Some economic analysts worry that lawmakers, in a bid to look more responsible on federal deficits, will cut into spending intended to revive economic growth.

“To the extent you do that, it undercuts the goods and services that the government is buying and will make the economic situation worse,” says James Horney, director of federal fiscal policy at the Center on Budget and Policy Priorities here. “What Congress should do to cut deficits is close tax loopholes, cut back on unnecessary Medicare spending, and [make] other cuts that will kick in over the next few years and reduce deficits in the longer run.”

At the same time, congressional Democrats are battling to restore credibility in the face of a firestorm over the AIG bonuses.

Within hours of disclosure of the AIG bonuses, House and Senate lawmakers proposed fixes to get the money back. Many said the furor over these payments was more intense than anything they had experienced in years in public life.

First to a vote, the House on Thursday passed a bill to “claw back” bonuses at firms receiving at least $5 billion in US aid. If the bill clears Congress (and passes constitutional muster in court), the government will tax back 90 percent of bonuses to employees who make more than $250,000 in gross income. The bill passed 228 to 93, with half of the GOP caucus voting with most Democrats in favor.

A Senate version of the bill, which Republicans are proposing to delay, would tax back 70 percent of bonuses. The provisions would apply to individuals who work at companies receiving government funds via the Troubled Assets Relief Program (TARP), as well as firms in which the government holds an equity interest, including mortgage giants Fannie Mae and Freddie Mac.

Increasingly, public anger isn’t directed just at bailed-out company bonuses. It’s also aimed at Congress, which voted language in last month’s $787 billion stimulus to enable the bonuses – either by intent or by failure to read the bill.

Last week, Sen. Christopher Dodd (D) of Connecticut said that he, at the behest of the Obama Treasury Department, proposed the legislation. Republicans are demanding to know why the Obama administration requested this fix and are blaming Democrats for not giving members enough time to read the bill.

“We have to make sure that we not only win the confidence of a majority of the Congress, but that the American people see that this is being managed well,” says Sen. Richard Durbin (D) of Illinois, who as majority whip was responsible for drumming up votes for the stimulus bill. “It’s hard, when you see the excesses of these folks at AIG. I find this incredible to think that they believe they’re deserving of million-dollar bonuses for what they’ve put this country through.”