Spend. Cut. Obama's tough spot on debt

By Jeanne Sahadi, senior writer

NEW YORK (CNNMoney.com) -- President Obama's State of the Union address will raise the curtain on how he plans to tackle the unsustainable growth in U.S. debt over the next decade.

At the same time, he'll be engaged in a tough balancing act: Laying out how he'll close the gap while making proposals to boost hiring and help the middle class.

Obama is set, for instance, to offer a number of sweeteners such as nearly doubling the child care tax credit.

How can he square the circle?

For one thing, the expectation is that most deficit-related measures he proposes wouldn't be implemented before the economy regains a stronger footing.

"Economically, to pull greatly back at a time of enormous economic uncertainty and recession ... could possibly have a very negative impact on the continuing recovery," White House spokesman Robert Gibbs said Monday.

But the administration still has a long way to go to pare deficits.

From the start of his administration, Obama promised to cut the $1 trillion deficit he inherited in half by the end of his first term. Gibbs on Tuesday indicated that that is still a realistic goal.

In addition, White House budget director Peter Orszag last fall said the administration was considering a range of proposals to reduce annual deficits to 3% of gross domestic product at some point in the next decade.

The administration hasn't been specific about when it would try to reach the 3% goal. But it's possible it would aim for 2015, said Sean West, U.S. policy analyst for Eurasia Group.

A 3% goal would be well below the Congressional Budget Office's projection that annual deficits would be more in the range of 4% to 5.5% between 2015 and 2019.

Getting from here to there

How Obama would get to 3% is still a question mark.

He is set to propose a freeze on non-defense discretionary spending, which is currently $447 billion, or less than 20% of the overall federal budget. The estimated total savings: $250 billion over 10 years. But that's a mere fraction of the $9 trillion in debt the CBO projects the country will incur over the same time period.

And he's likely to reiterate his support for a bipartisan fiscal commission that would be charged with making recommendations to Congress for how best to address the looming fiscal shortfalls facing Uncle Sam. A proposal for just such a commission was voted down by the Senate on Tuesday, leaving the door open for the president to create his own commission by executive order.

But any credible long-term solution to the country's fast-growing debt puts Obama in a tight political spot. It would have to involve a combination of tax increases (sure to rankle Republicans) and spending cuts (certain to disturb Democrats).

To use just one would be economically prohibitive.

Just how prohibitive?

Suppose Obama and Congress wanted to rely solely on individual income tax increases to get the annual deficit down to 3% of GDP. If they just raised taxes on high-income households -- something Obama has promised -- they'd have to more than double the top two tax rates.

And that would push the top rate above 75%, according to research by the Tax Policy Center.

If they relied only on spending cuts, they would have to slash the federal budget to the bone. That means they would have to cut discretionary spending by well more than half.

Experts' wish list

So what are Obama's options? There's no shortage of fiscal wonks and commissions offering ideas.

To make serious inroads in the country's debt predicament, a commission of leading budget experts recently recommended that the administration and Congress aim to stabilize the national debt at a ratio of 60% of gross domestic product by 2018. That would mean reducing average deficits to 2% of GDP between now and 2018.

Getting to 3% will be a big stretch as it is.

But shy of that, there are still things the president and Congress can do to improve the long-term fiscal outlook and demonstrate a strong commitment to addressing the debt issue.

CNNMoney asked two leading deficit experts what they think Obama should propose on Wednesday.

Greater transparency about the long-term obligations of the government is top of the list for Stuart Butler, vice president for domestic and economic policy at the conservative Heritage Foundation.

"He can say, 'We're going to make your federal budget like your kitchen-table budget,'" Butler said. "The purpose is to confront Americans with what is really happening in the future."

He wants Medicare and Social Security included in lawmakers' annual consideration of the federal budget. Right now, money allocated to both entitlement programs is considered mandatory spending and therefore annual spending increases are on autopilot and the future financial commitment to the programs is uncapped.

"We've got to lay down a real, total cap on spending [across the federal budget]," Butler said.

In terms of specific policies, the permanent extension of the 2001 and 2003 tax cuts for all but the highest-income households doesn't sit well with most deficit experts.

"What I'd love to see different from last year is for Obama not to propose making the Bush tax cuts permanent," said Len Burman, a former deputy assistant Treasury secretary who is writing a book about the prospects for catastrophic budget failure.

Burman doesn't think it's a good idea to raise taxes when the economy is still weak. But he'd prefer Obama only temporarily extend the tax cuts through 2012.

Beyond that, he'd like to see the president make "a lock-solid commitment to tax reform and a process that gets the budget under control."

For instance, Burman thinks Obama should direct the Treasury Department to present a serious plan for tax reform by the end of 2012.

Many experts believe tax reform is a key ingredient to getting the country's fiscal house in order. The tax code needs to be made simpler, tax breaks need to be streamlined, and the base from which Uncle Sam gets revenue made broader.

-CNN Senior White House Correspondent Ed Henry contributed to this report. To top of page

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