The big news today is that Obama plans to propose a freeze on domestic discretionary spending in Wednesday's State of the Union address. For what it's worth, I talked to some administration officials about the thinking behind this in December, not long after the idea was first floated. Here's the gist of what I found:
Within the administration, White House budget director Peter Orszag appears to have settled on another solution. Last month, Orszag raised eyebrows when word leaked that he’d asked most cabinet agencies to prepare two budgets: one that freezes spending, the other that cuts it by 5 percent. Many congressional liberals were livid, and, according to multiple sources, Larry Summers’s National Economic Council reacted negatively to the emphasis on the deficit. (“The economic team has a healthy debate about most major issues,” says an administration official. “Getting people back to work is central to addressing the deficit. Similarly, putting the country back on a fiscally sustainable path is vital to confidence in the economy.”) The concern among wonks outside the administration is that clamping down on domestic discretionary spending without touching entitlements would take money out of the economy in the short term while doing nothing to close the long-term deficit.
These same liberals and wonks rejoiced when Obama backed job creation. But there is a logic to Orszag’s gambit, which runs roughly as follows: It’s almost certain that Congress will pass, and the president will sign, a jobs bill early next year, probably in the neighborhood of $100 billion to $200 billion. Given that, and given the difficulty of doing anything about the long-term deficit next year, the administration needs some signal to U.S. bondholders that it takes the deficit seriously. Just not so seriously that it undercuts the extra stimulus.
The Orszag approach just might accomplish that. Given the amount of domestic discretionary spending in the federal budget--about $700 billion this fiscal year--we’re talking about cuts of, at most, several tens of billions of dollars if Orszag holds the line on spending (and probably less once Congress weighs in). Which means the cuts wouldn’t come close to offsetting the likely stimulus. But they just might buy some credibility in the bond market, which could defer the day when the real deficit cutting has to start. “It’s a little bit of form over substance,” says Michael Granoff, a money manager who served on the advisory council of the Brookings-based Hamilton Project when Orszag ran it. “But, if you show resolve, that you care about this stuff, it gets into the psychology of bond traders.” The laws of psychology may prove easier to finesse than the laws of economics.