Americans demand higher unemployment!

Politico reports that the Obama Administration is planning to pivot toward deficit control, which could mean the end (for now) of cap-and-trade. This is worrisome if true:

1. We have a serious long-term budget problem; that is, after 2020 or so, the numbers look really ugly. The key to getting a handle on this is reducing health care costs. Hopefully whatever is passed this year will help, or at least give future governments tools to address these problems.

2. In the medium term there's no real budget crisis. Deficits are expected to stabilize at around 3% of GDP once the economy recovers (2013 or so), which is about the level under Bush II and lower than what we had under Reagan and Bush I. Tackling the long-term issues would be easier if we had a better medium term balance (or a better balance now), but reducing the deficit in the medium term should not be considered absolutely necessary in and of itself.

3. Roosevelt began taking aggressive actions to fight the Great Depression in 1933. In 1937, thinking the economy had recovered sufficiently, the Fed tightened monetary policy and FDR pushed through some budget cuts. The economy immediately sank into another severe recession. The Japanese began a massive fiscal expansion to stimulate their economy in the early 1990s. By 1937, they thought the economy had stabilized sufficiently to withdraw some of the stimulus. Taxes were raised; the economy sank into another recession. It would be a huge mistake for the Obama Administration to start tightening fiscal policy in 2011. Huge.

4. The Obama Administration knows this, so it looks like they're being careful to say that they are trying to tackle the medium term issues without cutting deficits in the near term. But politically, apparently, the American people (independents at least) want higher unemployment now. I worry about political pressure to reduce budget deficits too soon. In this environment, it turns out that running big budget deficits is the politically courageous move!

5. Cap and trade should be a net revenue enhancer, or at worst budget neutral. Initially under Waxman-Markey 85% of emissions permits are given away, but the percent that is auctioned rises over time. Budget concerns should not be an impediment to cap and trade (though I too see huge political hurdles at this time). If I were Obama, I'd propose a sweeping overhaul of the tax code designed to (a) eliminate loopholes, equalize rates for different types of income, and otherwise make the code more efficient; (b) increase revenues in the medium term enough to make a dent in budget deficits, while (c) preserving the current level of progressivity. A key element of this tax reform would be a carbon tax and/or cap and trade system.