Obama, Congress to wrangle over budget, taxes, entitlements

President Barack Obama must spend a second term confronting — once again — joblessness, anemic growth, stagnant incomes and a large, growing mountain of debt — not to mention a sick European economy and erratic oil prices.

As he does, the president will — once again — confront the limitations of his office. They include the need for congressional cooperation, the critical influence of the Federal Reserve and the unpredictable global economic forces that are beyond his control.

“There is a lot of magical thinking about what the president is really capable of doing,” said Philip Wallach, fellow in governance studies at the Brookings Institution. “When it comes to getting economic growth or not, I’m pretty skeptical about how much power he has.”

Not that there is consensus on what he ought to be doing.

Some economists argue that the best route to long-term growth is cutting the tax and regulatory burdens on business.

Others, concerned about the more immediate problem of joblessness, argue that the federal government should spark more growth by spending more to fill the gap left by an anemic private sector.

A similar set of strategies helped Ronald Reagan bring the country out of a deep recession in the early 1980s. He cut taxes, poured money into military spending, ran up the deficit – at the same time the Federal Reserve was cutting interest rates – and the economy surged.

But today, with a national debt of $16 trillion, there is much less political support for priming the economy’s pump through deficit spending, even though growth remains weak. In Georgia, for example, the unemployment rate is 9 percent and it’s been around that level or higher for nearly four years.

Despite the limits on his power to improve the economy, a president does matter when it comes to:

— The budget. He proposes the federal budget – $3.8 trillion covering everything from paying interest on the debt to paying for the Pentagon – which accounts for roughly 24 percent of the economy. He never gets the budget he submits to Congress without significant changes, but he starts the discussion. He can try to boost some sectors of the economy – like alternative energy or education – or chill others, like defense.

For example, Obama’s proposal last year included $30 billion to modernize schools and $30 billion to help local government pay teachers and firefighters. The budget added $850 million for Race to the Top, a program aimed at education reform. Obama proposed a 5 percent cut in Pentagon spending.

But Congress never passed that budget. Instead, there were months of wrangling. The pact that kept the government running expires at the end of the year and leads – without another deal – to the “fiscal cliff” of spending cuts and tax increases that could drive the economy back in recession.

Unfortunately for the president, the political balance hasn’t changed much in Congress. Any future Obama budget is near-certain to face resistance.

— The Fed. While the Federal Reserve operates independently, the president names its members and chairman. Ben Bernanke’s term is up in 2014 – and naming a chairman could be the president’s most important economic decision, according to Bruce Bartlett, former senior economist at the White House under Reagan and George H.W. Bush. When contacted to elaborate, he cited a column he wrote for the Financial Times.

“Changes at the central bank are likely to have far more influence on the economy than the presidential election,” wrote Bartlett. “With politicians unable to hammer out an agreement on fiscal policy, it has been left to Ben Bernanke and his Federal Reserve colleagues to pilot the economy through monetary policy alone.”

Bernanke has engaged in a tempered aggressiveness, often keeping the Fed in the game while the president was sidelined by politics. While the president was quarreling with Congress about how to spur the economy, Bernanke’s Fed drove interest rates virtually to zero and poured tens of billions of dollars into the economy each month by purchasing securities.

Bernanke, named by George W. Bush, serves a six-year term. So the president’s pick for chairman can reverberate long after the Oval Office has a new occupant.

— Taxes. The president sets the agenda, but cannot dictate changes. Consumers account for roughly 70 percent of the economy and anything that raises their taxes threatens that spending – especially if their pay is not rising. Anything that lowers their taxes is good for growth.

The president could support tax reform – that is, closing loopholes, raising taxes at the higher income levels and perhaps cutting others. Of course, he must negotiate any proposed changes with Congress.

That is a recipe for conflict. President Obama on Friday said any deficit reduction must include higher taxes on the wealthy. Republicans leaders responded that the idea was unacceptable.

Some recent studies argue that the dramatic increase in income and wealth inequality over the last generation has been bad for economic growth. Tax changes could close the gap a little and boost the economy, argues Heather Boushey, senior economist at the Center for American Progress. “The president should make sure we are investing in the productive capacity of the United States instead of (boosting incomes) at the top.”

Others argue that the president should beware of higher taxes on the wealthy, which could chill their spending, hurt entrepreneurs and the reduce job creation that’s desperately needed.

The Bush-era tax cuts reduced the top marginal rate for high-income households – from 39.6 percent to 35 percent – while also trimming rates for those with lower incomes. But all the cuts are set to expire at year’s end. The president has called for locking in the lower rates for middle class taxpayers, while allowing the top marginal rate to rise back to 39.6 percent.

A struggle over tax policy seems to be a given. Republicans have adamantly opposed letting any tax rates rise. Perhaps buoyed by his re-election victory, Obama on Friday renewed his call to extend tax cuts for 98 percent of taxpayers and argue later about taxes for the wealthiest Americans.

“If you combine the president’s desire for higher marginal tax rates and the gridlock of Washington, we could end up with something very bad,” said Matthew Jensen, economic researcher for the American Enterprise Institute. “To me, it’s misguided to raise tax rates when the economy is still so sluggish.”

— Entitlements. Spending on Medicare, Medicaid, and Social Security accounts for 62 percent of the budget – double what it was five decades ago, according to the Heritage Foundation, which calls it “unsustainable.”

But the worst of the problems is in healthcare, experts said. Social Security needs relatively minor changes – perhaps a higher ceiling on incomes that pay into the system or possibly an older retirement age or maybe some means testing. The hardcore problems center on the rising costs of Medicare and Medicaid.

Still, to the chagrin of many liberals, the president last year flirted with a “grand bargain” in which he agrees to cutting entitlements in exchange for higher taxes, at least on the wealthy.

Expect the president to be under pressure again to make some kind of deal, said Jensen of the American Enterprise Institute. “Every dollar you cut short-term (in entitlements) does a lot in the long-term for the deficit.”

Entitlement reform would also reassure investors about the federal government’s long-term solvency – which should help keep interest rates low. On the other hand, big cuts could undermine household finances.

Forces beyond the president’s control

Unlike changing entitlements or reforming taxes, much of the president’s power stems from actions he can take without seeking Congressional assent.

For example, there are ways to advance trade without a formal pact that requires an endorsement on Capitol Hill. There are also trade restrictions and sanctions that a president can impose. For example, Mitt Romney campaigned partly on a promise to name China a currency manipulator – something Obama has shied away from, apparently worried about escalating tensions.

And since the president runs the executive branch, it is his agencies who write and enforce thousands of regulations that guide – or restrain – businesses on everything from oil drilling to managing a hedge fund.

Some of the president’s power is indirect, such as whether he encourages consumers to feel more confident or less. Higher confidence can have a feedback effect. As consumers spend more, they boost the economy – and often the stock market — which in turn makes them feel more confident and more inclined to spend.

But for all the rhetoric about a president’s performance, the U.S. economy is buffeted by forces that are often beyond any administration’s control. When it comes to the economy, there is no commander is chief. Presidents often get too much credit for the good times and too much blame for the bad.

“The underlying trend rate of growth of the U.S. economy is a function of two things politicians can’t do much about: productivity and demography,” Bartlett wrote.

The president also has little control over the volatile price of oil or the trajectory of the European economic crisis.

When those unexpected, unruly winds howl, a smart president remembers that more than anything else, he can command attention, said Boushey of the Center for American Progress.

“The president does have the scope to define the economic conversation,” she said. “The labor market is still not good enough. And if he is not focused on it, there’s really nobody else who will be.”

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