Obama’s trillion dollar question

It was only a month ago that America narrowly escaped a Federal government shutdown, caused by the intense difficulties of reaching a consensus on the 2011 budget. But if that skirmish seemed significant, it is nothing compared to the battle that is erupting between Democrats and Republicans over Obama’s 2012 budget proposals, and his accompanying plans for how to take $4 trillion out of the deficit over the next decade.

In a speech last month, hailed by many as a return to his more combative form of 2008, the President pushed back hard against the ongoing Republican commitment to the $1.3 trillion tax breaks introduced by George Bush. In contrast to the conciliatory position he adopted in December’s negotiations about tax cuts, he cast the debate about deficit reduction as nothing less than a clash of visions for America’s future. The Republican proposals – of swingeing cuts to public programs while maintaining the Bush tax cuts – would cut the deficit, said Obama, but at a price that is not worth paying:

         ‘This vision is less about reducing the deficit than it is about changing the social compact of America. It is a vision that says 50 million Americans must lose health insurance to pay off the deficit, at the same time as saying that we can afford more than $1 trillion of tax cuts for the wealthy… that’s not right. That’s not a vision of the America I know.’

The Bush tax cuts may be a totem for Democrats and other progressives for the GOP’s refusal to address growing inequality. But if Obama wants to challenge the way in which the current US tax regime distributes resources unfairly, he has to look beyond the Bush tax cuts alone. He will need to zone in on the dense thicket of tax expenditures, labelled by academic Suzanne Mettler as America’s ‘submerged state’.

The tax expenditures of the submerged state are not the familiar policies that function through sending cheques or offering in-kind supports such as Medicare or Social Security; instead they are manifest as incentives, built into the tax code, and designed to encourage – or nudge people towards – certain behaviours such as saving or home ownership.

Like an iceberg, this submerged state is significant. Jacob Hacker estimates that adding tax expenditures and other private welfare spending to traditional public social programmes pushes America’s welfare spending from 17.1 per cent of GDP to 24.5 per cent – slightly above the OECD average.

Nearly all these policies redistribute money – but unfortunately not always proportionately to those who need it most. Instead the benefits frequently flow upwards, to the richest in society. Furthermore the sums involved often dwarf the government spending programs that are designed to help poorer families. This hidden welfare state may have been designed with good intentions, but it now swallows up revenues that might otherwise be better targeted. For example:

• $60 billion is spent on providing healthcare for families unable to afford insurance, but a further $1.25 trillion goes towards subsidising employer-based health insurance – which low-paid, part-time and temporary workers are much less likely to be offered.

• The Federal government spends $400 billion on encouraging saving and asset-building, most of which is channelled through the tax system. The Corporation for Enterprise Development has shown how half of this money goes to the top 5 per cent of tax payers.

• $69 billion is spent on mortgage interest deduction for homeowners – 23 times the amount that is spent on supporting mortgage subsidies for low earning families.

At a cost equivalent to 2 per cent of GDP, America is unique in the scale of its tax expenditures. But even after reductions over the last decade, tax breaks remain a significant part of the British system, covering a wide range of things including pensions saving, charitable donations and employer-supported childcare vouchers.

Given that tax breaks are no more or no less than discretionary expenditure – money that could be spent elsewhere – the ongoing existence of such spending in Austerity Britain begs a question about fairness. Is it right to give richer families tax breaks on savings when both the Child Trust Fund and the Savings Gateway – major saving schemes benefitting those on low incomes – have been abolished? Is it fair to give middle class working families tax breaks on childcare when the childcare element of the Working Tax Credit has been cut back?

These are the sorts of questions that Obama is now beginning to ask. The real question is whether or not his desire to tackle the unfairness in some of these measures will win him the support he needs to make such major changes. Three things stand in the President’s way.

First, economic inequalities have bred political inequalities. The vested interests that would prefer to keep the status quo are far more powerful in America today than those who would benefit from it changing. From the student loan companies to the massive health insurance corporations, altering the regime of tax breaks involves defeating rich and entrenched interests who have profited from them in recent years. Those who stand to lose most exert the most political clout and they would fight these changes hard.

Second, by virtue of its imperceptibility, those who are losing out most from the submerged state are rarely aware of what is at stake in the President’s attempt to reform it – an important insight for anyone wondering how to make sense of the buoyancy of the UK government’s popularity ratings, despite the major cuts they have made to tax credits.

Pushing welfare through the tax code undermines the links people make between certain benefits and government action: 47 per cent of Americans benefiting from the US version of the Working Tax Credit, and 52 per cent of people receiving the Child Tax Credit do not believe they have received support from the federal government. If the figures are similar in Britain, this may well explain why the price paid by the coalition for cuts is not as high (so far) as some predicted.

And third, addressing the costs of the hidden welfare state may be central to targeting limited spending towards those who need it most. But it lacks the clarion call of FDR’s New Deal or Lyndon Johnson’s War on Poverty. It has none of the chutzpah of Clinton’s goal to ‘end welfare as we know it’. Instead, it is technical, complex, and about restructuring what exists rather than creating something new.

For a nation clamouring for the charismatic leadership it went wild for in 2008, Obama may be doing the right thing, but it will not be as easy as it should be to earn broad-based public support for his stance. Can he do it? That’s the real trillion dollar question. It is not yet clear what the answer will be.