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In defense of Obama's budget

It's astronomical, all right, but here are four reasons that it makes a lot of sense.

Anthony Karydakis, contributor
Last Updated: March 3, 2009: 1:16 PM ET

NEW YORK (Fortune) -- Since its announcement last week, President Obama's budget has been savagely attacked by the Republican side on the grounds that it projects massive deficits and, as such, it represents the apotheosis of recklessness and fiscal irresponsibility. However, framing the debate in such terms, which are transparent in their political motivation, is a gross misrepresentation of some basic realities that are impossible to ignore. Here are four of them:

1.) The admittedly astronomical budget deficit numbers projected for the current and next fiscal years ($1.75 trillion and $1.17 trillion respectively) are not exactly the new administration's doing. Beyond stating the obvious fact -- that the current fiscal year's budget was prepared by the Bush Administration -- the lion's share of these deficits is the result of an unprecedented convergence of an uncharacteristically deep global recession and a near-meltdown in this country's financial system.

Both of these calamities, which starkly define the backdrop against which Obama's budget was submitted, are in desperate need of massive government assistance to help contain a very unstable situation. To put it differently, these are not exactly elective deficits but borne largely out of extenuating circumstances which conspired to cause a deficit blow-out early on the new Administration's watch.

2.) The budget-deficit projections for both the current and upcoming years are not to be taken too literally at this point. The current fiscal year's estimated deficit would represent a staggering 12% of GDP, courtesy of a pre-existing disintegration of the banking system and a steadily deepening recession.

In fact, this is a number totally beyond the Administration's control and it is completely unrelated to any of the purported, and widely criticized "tax and spend" measures, which would only kick in next year (when the deficit is actually projected to start coming down and total almost $600 billion less than in the current year).

But more to the point, given the sheer size of the numbers involved and the highly volatile and uncertain environment we are in, it is no exaggeration to argue that shifts of $300 billion to $500 billion in the deficits in either direction represent almost a rounding error. The needs of the banking system and the duration of the recession are impossible to predict with anything approaching credibility. So these estimates are, for all intents and purposes, simple placeholders.

In fact, while most people's first instinct would be to assume that the officially projected deficits probably underestimate their ultimate size, history paints a somewhat different picture: the official projections often tend to overestimate the size of the final deficit, and the sitting administration tends to take a short "victory lap" afterwards, on the grounds that it managed to get better-than-expected results.

With regard to the current environment, a somewhat sooner and stronger than anticipated rebound in economic activity in the first half of 2010 could cause a quick improvement in tax revenues and easily help reduce the projected deficit by $200 billion to $300 billion.

3.) The budget Obama submitted shows considerable political courage in the midst of a highly precarious environment, the crashing demands of which could have cowed the new administration into a defensive, crisis-management mode. The crisis would have easily provided political cover for the President to shelve the rest of the ambitious agenda upon which he was voted in office just four months ago.

Obama's budget not only rises to the unprecedented, combined challenges posed by a severe recession and a financial system in disarray but also incorporates the key elements that fulfill his pre-election commitments to those who elected him. Essentially, he is being attacked for doing what he said he would do, under economic conditions that were already clear on election day.

4.) In an unmistakable nod that he remains mindful of the need to rein in these deficits once the storm has passed, Obama's budget forecasts a $533 billion deficit in fiscal 2013, which although still a fairly sizable number, would represent a relatively benign percent of GDP (around 3%), which is generally considered as acceptable among industrialized countries.

The path he is planning to pursue to achieve that objective is broadly consistent with his pre-election promises of raising taxes on wealthier individuals and cutting them for most households below the $200,000 a year mark.

Further projected spending cuts via the streamlining of the government bureaucracy and the winding down of the Iraq war are also part of the broader plan. In general, the stronger overall tax revenue from these budgets should be viewed as a more effective and reliable tool to decrease the deficit in the next few years, vs. proposed spending cuts, given the affinity that members of Congress (from both parties) have for a wide array of spending projects.

These are extraordinary times and require extraordinary measures. Preaching in a robot-like fashion the principle of fiscal responsibility in the midst of the biggest crisis the U.S. economy has experienced in 75 years sounds pretty irresponsible itself, particularly when all that the critics have to offer as an alternative is tax cuts.

Anthony Karydakis is a former chief U.S economist with JP Morgan Asset Management and currently an adjunct professor at New York University's Stern School of Business.  To top of page


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