Obama's Plan to Reduce the National Debt: If the reports are correct, President Obama will propose budget cuts in his speech today, and the proposal will involve both increases in taxes and reductions is spending.
There is no doubt that we have a long-run budget problem, and the problem is driven mainly by expected increases in health care costs. Thus, to the extent that the president's proposal focuses on the health care cost growth problem, it will be a step in the right direction.
But there are also worries that come with budget reduction, especially when the economy is struggling to get back on its feet.
First, and foremost, the road back to full employment looks like it will be long and bumpy. Short-run budget cuts -- even cuts that help us address the long-run budget problem -- work against an already highly sluggish recovery. By themselves, the immediate budget cuts are unlikely to send the economy back into a recession. But a slower recovery is entirely possible.
The real danger comes if the economy is hit by a large, unexpected shock. A large oil price shock, for example, that is expected to persist could, along with the budget cuts, certainly be enough to cause the economy to go back into recession. A large financial shock could do the same thing.
Second, the steps needed to address the long-run problem are politically unpopular. No matter how the problem is resolved, one of the two sides of the political divide will be unhappy. In fact, there's a good chance both sides will be unhappy with the result. Thus, there will be a temptation to implement policies that look as though they are making headway on the deficit problem without actually facing the need to make the difficult decisions associated with reducing health care costs. If this type of deceptive avoidance is the outcome, and I expect it will be, the budget reductions will come with the risks above, but have little long-run payoff.
Ideally the president will propose a set of policies that would become effective down the road when the economy can handle it better, and directly address the health care cost issue. But no matter what is proposed the actual budget cuts -- constrained as they are by the political reality that what needs to be done is highly unpopular -- are likely to come too soon, and fall well short of what is needed to make progress on the long-run budget problem.