President Barack Obama suggested Wednesday that a new value-added tax on Americans is still on the table, seeming to show more openness to the idea than his aides have expressed in recent days.

Before deciding what revenue options are best for dealing with the deficit and the economy, Obama said in an interview with CNBC, “I want to get a better picture of what our options are….”

After the interview, White House deputy communications director Jen Psaki said nothing has changed and the White House is “not considering” a VAT.

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Washington is gearing up for a big debate: What to do about the exploding national debt, the unsustainable annual budget deficits and what to do about the Bush tax cuts that expire at the end of the year.

Alarm bells are ringing over the size of the national debt, now equal to 84 percent of the country’s gross national product — the highest level since after World War II. The credit-rating agency Moody’s is hinting that the federal treasury’s Triple A bond rating is in jeopardy and Fed Chairman Ben Bernanke is warning that China, the United States’ largest foreign creditor, may start charging higher interest rates.

“The arithmetic is, unfortunately, quite clear,” Bernanke said. “To avoid large and unsustainable budget deficits, the nation will ultimately have to choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above.

“These choices are difficult, and it always seems easier to put them off — until the day they cannot be put off any more.”

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How big a government do we want — and what can we afford? In closing deficits, what’s the best mix between tax increases and spending cuts? What programs are outmoded, ineffective or unneeded? How much should we tax the young and middle-aged to support the elderly? Should wealthier retirees receive skimpier benefits? Should eligibility ages for benefits be raised?

The basic budget problem is simple. For decades, the expansion of Social Security, Medicare and Medicaid — programs mostly for the elderly — was financed mainly by shrinking defense spending. In 1970, defense accounted for 42 percent of the federal budget; Social Security, Medicare and Medicaid were 20 percent. By 2008, the shares were reversed: defense, 21 percent; the big retirement programs, 43 percent. But defense stopped falling after Sept. 11, 2001, while aging baby boomers and uncontrolled health costs keep retirement spending rising.

Left alone, government would grow larger. From 1970 to 2009, federal spending averaged 20.7 percent of the economy (gross domestic product). By 2020, it could reach 25.2 percent of GDP and would still be expanding, reckons the Congressional Budget Office’s estimate of President Obama’s budgets. In 2020, the deficit (assuming a healthy economy with 5 percent unemployment) would be 5.6 percent of GDP. To cover that, taxes would have to rise almost 30 percent.

A VAT could not painlessly fill this void. Applied to all consumption spending — about 70 percent of GDP — the required VAT rate would equal about 8 percent. But the actual increase might be closer to 16 percent because there would be huge pressures to exempt groceries, rent and housing, health care, education and charitable groups. Together, they account for nearly half of $10 trillion of consumer spending. There would also be other upward (and more technical) pressures on the VAT rate.

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The next day, at a breakfast with reporters in Washington, Douglas Elmendorf, the head of the Congressional Budget Office, confirmed that his economists have begun studying how to write a value-added tax, a form of national sales tax, because of growing congressional interest in drafting such a measure.

Elmendorf reminded the journalists of the grim news contained in his agency’s analysis of President Obama’s budget proposals. Agreeing with Bernanke that the current course is “unsustainable,” he said that unless something changes, the U.S. will emerge from the Obama years spending one-quarter more than it collects in revenue — 25 percent compared to 19 percent of the gross domestic product.

Closing the gap “can’t be solved through minor changes,” he said. Revenues projected under current laws would barely be sufficient to pay for Medicare, Medicaid, Social Security, defense and interest on the national debt. Everything else would depend on finding new revenues — or borrowing.

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The danger now is red ink, not Redcoats.

In recent years, a modern-day Paul Revere has been found in David Walker, the former U.S. Comptroller General, who has been visiting every state to warn of the consequences of the nation’s fiscal course.

The majority of our representatives have, so far, closed their ears to the message.

But on Wednesday, Mr. Walker’s warnings were echoed by the chairman of the Federal Reserve Board, Ben Bernanke, who stepped out of character to alert Americans in plain language:

“To avoid large and ultimately unsustainable budget deficits, the nation will ultimately have to choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above….”

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The U.S. must start to prepare for challenges posed by an aging population with a credible plan to gradually reduce a soaring public debt, Federal Reserve Chairman Ben Bernanke said Wednesday.

Health spending is set to increase over the long term as the U.S. population grows older, posing challenges to the country’s already strained finances, the Fed chief warned.

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The United States should consider raising taxes to help bring deficits under control and may need to consider a European-style value-added tax, White House adviser Paul Volcker said on Tuesday.

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With ferocious speed, the financial crisis, recession and efforts to combat the recession have swung the U.S. debt from worrisome to ruinous, promising to handcuff the administration. Lost amid last month’s passage of the new health care law, the Congressional Budget Office issued a report showing that within this decade, President Obama’s own budget sends the U.S. government to a potential tipping point where the debt reaches 90 percent of gross domestic product.

Economists Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University have recently shown that a 90 percent debt-to-GDP ratio usually touches off a crisis.

This year, the debt will reach 63 percent of GDP, a ratio that has ignited crises in smaller wealthy nations. Fiscal crises gripped Canada, Denmark, Sweden, Finland and Ireland when their debts were below where the United States is shortly headed.

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Obama administration officials on Friday ramped up their attempts to help struggling homeowners, announcing major changes to the government’s much-criticized $75-billion program to modify mortgages to avoid foreclosures.

The most significant change is a set of complex new incentives for banks and investors to reduce the principal on so-called underwater mortgages — loans for homes now worth less than what is owed.

In addition, the administration announced that many unemployed homeowners could receive three to six months of reduced mortgage payments while they look for a job.

Together, the revisions are designed to spur the Home Affordable Modification Program to reach its target of helping 3 million to 4 million homeowners avoid foreclosure through 2012.

While the changes are significant to a year-old program that so far has helped just 170,000 homeowners receive permanently lowered mortgage payments, administration officials stressed they would only make a dent in the projected 10 million to 20 million foreclosures expected in the next three years.

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The bursting of the real estate bubble and the ensuing recession have hurt jobs, home prices and now Social Security.

This year, the system will pay out more in benefits than it receives in payroll taxes, an important threshold it was not expected to cross until at least 2016, according to the Congressional Budget Office.

Stephen C. Goss, chief actuary of the Social Security Administration, said that while the Congressional projection would probably be borne out, the change would have no effect on benefits in 2010 and retirees would keep receiving their checks as usual.

The problem, he said, is that payments have risen more than expected during the downturn, because jobs disappeared and people applied for benefits sooner than they had planned. At the same time, the program’s revenue has fallen sharply, because there are fewer paychecks to tax.

Analysts have long tried to predict the year when Social Security would pay out more than it took in because they view it as a tipping point ”” the first step of a long, slow march to insolvency, unless Congress strengthens the program’s finances.

Read it all from the front page of yesterday’s New York Times.

But Pimco’s Bond King and Barron’ s Roundtable member Bill Gross contends the relatively high yield on a 30-year bond (compared to a less than 1% on a two-year note) reflects the mounting unfunded obligations taken on by the U.S. government.

In his latest monthly missive, Gross notes the discounted present value of future social-insurance expenditures, mainly Social Security and Medicare, total $46 trillion. The passage of health-care reform will only add to that entitlement.

“No investment vigilante worth their salt or outrageous annual bonus would dare argue that current legislation is a deficit reducer as asserted by Democrats and in fact the Congressional Budget Office,” Gross writes. “Common sense alone would suggest that extending health-care benefits to 30 million people will cost a lot of money and that it is being ‘paid for’ in the current bill with standard smoke, and all-too-familiar mirros that have characterized such entitlement legislation for decades.”

In that regard, Gross cites an op-ed piece in Sunday’s New York Times by former CBO director Douglas Holtz-Eakin, who wrote that rather than reducing the budget deficit by $138 billion over the next 10 years, health-care reform will add $562 billion to the deficit over that span. “Long-term bondholders beware,” he warned.

—Buyer’s Remorse in Bond Market? in last night’s Barrons

Two-year notes sold by the billionaire’s Berkshire Hathaway Inc. in February yield 3.5 basis points less than Treasuries of similar maturity, according to data compiled by Bloomberg. Procter & Gamble Co., Johnson & Johnson and Lowe’s Cos. debt also traded at lower yields in recent weeks, a situation former Lehman Brothers Holdings Inc. chief fixed-income strategist Jack Malvey calls an “exceedingly rare” event in the history of the bond market.

The $2.59 trillion of Treasury Department sales since the start of 2009 have created a glut as the budget deficit swelled to a post-World War II-record 10 percent of the economy and raised concerns whether the U.S. deserves its AAA credit rating. The increased borrowing may also undermine the first-quarter rally in Treasuries as the economy improves.

“It’s a slap upside the head of the government,” said Mitchell Stapley, the chief fixed-income officer in Grand Rapids, Michigan, at Fifth Third Asset Management, which oversees $22 billion. “It could be the moment where hopefully you realize that risk is beginning to creep into your credit profile and the costs associated with that can be pretty scary.”

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On Thursday, the Congressional Budget Office reported that, if enacted, the latest health care reform legislation would, over the next 10 years, cost about $950 billion, but because it would raise some revenues and lower some costs, it would also lower federal deficits by $138 billion. In other words, a bill that would set up two new entitlement spending programs ”” health insurance subsidies and long-term health care benefits ”” would actually improve the nation’s bottom line.

Could this really be true? How can the budget office give a green light to a bill that commits the federal government to spending nearly $1 trillion more over the next 10 years?

The answer, unfortunately, is that the budget office is required to take written legislation at face value and not second-guess the plausibility of what it is handed. So fantasy in, fantasy out.

In reality, if you strip out all the gimmicks and budgetary games and rework the calculus, a wholly different picture emerges: The health care reform legislation would raise, not lower, federal deficits, by $562 billion.

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Read it all and follow the links as you are inclined.

The forced march to pass ObamaCare continues, and all that matters now is raw politics. But opponents should go down swinging, and that means exposing such policy debacles as President Obama’s 11th-hour decision to apply the 2.9% Medicare payroll tax to “unearned income.”

That’s what savings and investment income are called in Washington, and this destructive tax wasn’t in either the House or Senate bills, though it may now become law with almost no scrutiny.

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The United States, Germany and other major economies could see their top-notch credit rating come under pressure if the recovery in the global economy stalls, Moody’s Investors Service warned Monday in a report.

The ratings of the Aaa governments ”” which also include Britain, France, Spain and “the less fiscally challenged Denmark, Norway, Finland and Sweden” ”” “are currently well positioned despite their stretched finances,” Moody’s said in its quarter Sovereign Monitor report.

But the agency noted that “the recovery that has taken hold across the global economy remains fragile in several of the large advanced economies, most of which have also implemented the most aggressively expansionary fiscal and monetary policies.”

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The United States, Germany and other major economies could see their top-notch credit rating come under pressure if the recovery in the global economy stalls, Moody’s Investors Service warned Monday in a report.

The ratings of the Aaa governments ”” which also include Britain, France, Spain and “the less fiscally challenged Denmark, Norway, Finland and Sweden” ”” “are currently well positioned despite their stretched finances,” Moody’s said in its quarter Sovereign Monitor report.

But the agency noted that “the recovery that has taken hold across the global economy remains fragile in several of the large advanced economies, most of which have also implemented the most aggressively expansionary fiscal and monetary policies.”

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The Democrats have not been completely irresponsible. It’s just that as the health fight has gone on, their passion for coverage has swamped their less visceral commitment to reducing debt. The result is a bill that is fundamentally imbalanced.

This past year, we’ve seen how hard it is to even pass legislation that expands benefits. To actually reduce benefits and raise taxes, we’re going to need legislators who wake up in the morning passionate about fiscal sanity. The ones we have now are just making things worse.

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A new congressional report released Friday says the United States’ long-term fiscal woes are even worse than predicted by President Barack Obama’s grim budget submission last month.

The nonpartisan Congressional Budget Office predicts that Obama’s budget plans would generate deficits over the upcoming decade that would total $9.8 trillion. That’s $1.2 trillion more than predicted by the administration.

The agency says its future-year predictions of tax revenues are more pessimistic than the administration’s. That’s because CBO projects slightly slower economic growth than the White House.

The deficit picture has turned alarmingly worse since the recession that started at the end of 2007, never dipping below 4 percent of the size of the economy over the next decade. Economists say that deficits of that size are unsustainable and could put upward pressure on interest rates, crowd out private investment in the economy and ultimately erode the nation’s standard of living.

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As always with the Obama compromise offers, this offer seemed to be both sincere and insincere. Embodying the core contradiction of the Obama presidency, the president seemed both to want to craft a new package and also to defend the strictly Democratic approach. I think he’s a bipartisan man stuck in a partisan town, but maybe he’s an iron partisan fist in a velvet postpartisan glove.

Fourth, you got to see how confident Republicans are. Obama’s compromise offer is one the Republicans can happily refuse. In their eyes, he is saying: If you don’t make some concessions now, I’m going to punch myself in the face. If you don’t embrace parts of my bill, I will waste the next three months trying to push an unpopular measure through an ugly reconciliation process that will probably lead to failure anyway.

Fifth, you got to see at least one area of bipartisan agreement. Neither side was willing to be specific about how to cut costs and raise revenue. The Republicans continued to demagogue efforts to restrain Medicare spending. The Democrats (and the Republicans) conveniently neglected to mention the fact that they had just gutted the long-term revenue source for their entire package, the excise tax on high-cost insurance plans. That tax was diluted and postponed until 2018. There is no way that members of a Congress eight years from now are going to accede to a $1 trillion tax increase to pay for a measure that the 2010 Congress wasn’t brave enough to pay for itself.

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With uncharacteristic bluntness, Federal Reserve Chairman Ben S. Bernanke warned Congress on Wednesday that the United States could soon face a debt crisis like the one in Greece, and declared that the central bank will not help legislators by printing money to pay for the ballooning federal debt.

Recent events in Europe, where Greece and other nations with large, unsustainable deficits like the United States are having increasing trouble selling their debt to investors, show that the U.S. is vulnerable to a sudden reversal of fortunes that would force taxpayers to pay higher interest rates on the debt, Mr. Bernanke said.

“It’s not something that is 10 years away. It affects the markets currently,” he told the House Financial Services Committee. “It is possible that bond markets will become worried about the sustainability [of yearly deficits over $1 trillion], and we may find ourselves facing higher interest rates even today….”

“We’re not going to monetize the debt,” Mr. Bernanke declared flatly, stressing that Congress needs to start making plans to bring down the deficit to avoid such a dangerous dilemma for the Fed.

“It is very, very important for Congress and administration to come to some kind of program, some kind of plan that will credibly show how the United States government is going to bring itself back to a sustainable position.”

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So all is coming right. Sales of existing homes in the final quarter of last year were 27.2% above the 2008 level. Home construction jumped 2.8% in January, to its highest level in six months. The mining, manufacturing and utilities sectors also grew at satisfactory rates as did retail sales.

So confident is the Federal Reserve in the recovery that it has raised a key interest rate.

Alas, every silver lining has a cloud ”” in the case of the American economy, several. For one thing, the fiscal deficit, which is fuelling some of the growth, is clearly unsustainable. Even under the rosy scenario posited by the president ”” economic growth at about twice the rate the non-partisan Congressional Budget Office is predicting ”” the deficit will still be unsustainably high, and rising, in 2020.

Congress knows this, the president knows this, and the opposition knows this. But the Democrats want to fill the gap by raising taxes, anathema to Republicans, who fear such a move would stifle growth by reducing entrepreneurs’ incentive to create new businesses and jobs. The Republicans want to cut spending, a move the Democrats say would stifle growth by prematurely withdrawing a prop from a fragile recovery.

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After decades of warnings that budgetary profligacy, escalating health care costs and an aging population would lead to a day of fiscal reckoning, economists and the nation’s foreign creditors say that moment is approaching faster than expected, hastened by a deep recession that cost trillions of dollars in lost tax revenues and higher spending for safety-net programs.

Yet rarely has the political system seemed more polarized and less able to solve big problems that involve trust, tough choices and little short-term gain. The main urgency for both parties seems to be about pinning blame on the other, before November’s elections, for deficits now averaging $1 trillion a year, the largest since World War II relative to the size of the economy.

Mr. Bayh, the centrist Democrat from Indiana, lodged his complaint about excessive partisanship and Congressional gridlock on Monday by way of explaining his decision not to seek re-election. But he is hardly alone in sounding an alarm about the long-term budgetary outlook, which has Medicare, Medicaid and Social Security costs growing at unsustainable rates and an inefficient tax system that cannot keep up.

“I used to think it would take a global financial crisis to get both parties to the table, but we just had one,” said G. William Hoagland, who was a fiscal policy adviser to Senate Republican leaders and a witness to past bipartisan budget summits. “These days I wonder if this country is even governable.”

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What we in the western world are about to learn is that there is no such thing as a Keynesian free lunch. Deficits did not “save” us half so much as monetary policy ”“ zero interest rates plus quantitative easing ”“ did. First, the impact of government spending (the hallowed “multiplier”) has been much less than the proponents of stimulus hoped. Second, there is a good deal of “leakage” from open economies in a globalised world. Last, crucially, explosions of public debt incur bills that fall due much sooner than we expect

For the world’s biggest economy, the US, the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the “safe haven” of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008.

Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase “safe haven”. US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.

Even according to the White House’s new budget projections, the gross federal debt will exceed 100 per cent of GDP in just two years’ time. This year, like last year, the federal deficit will be around 10 per cent of GDP. The long-run projections of the Congressional Budget Office suggest that the US will never again run a balanced budget. That’s right, never.

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So though the remarkable decline in the annual Social Security surplus from 2008 to 2009 qualifies as surprising news, the inevitable bottom-line debacles awaiting it and Medicare do not. Anyone capable of doing simple arithmetic — and willing to face the hard truths of a protracted, persisting drop in the workers-to-beneficiaries ratio — could long ago see that those massive federal entitlement programs were unsustainable without comprehensive transformations.

Those needed makeovers grow more costly with every passing year of inaction. Something’s got to give, likely on both sides of the funds collected/funds dispersed equation, or the system will go bankrupt.

That dire outcome will occur even if Washington stops robbing the Social Security trust fund. Nor has that regular raiding kept the regular federal budget deficit from rising to record levels, and the White House budget plan predicts another $1.6 trillion in red ink.

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Social Security’s annual surplus nearly evaporated in 2009 for the first time in 25 years as the recession led hundreds of thousands of workers to retire or claim disability.

The impact of the recession is likely to hit the giant retirement system even harder this year and next. The Congressional Budget Office had projected it would operate in the red in 2010 and 2011, but a deeper economic slump could make those losses larger than anticipated.

“Things are a little bit worse than had been expected,” says Stephen Goss, chief actuary for the Social Security Administration. “Clearly, we’re going to be negative for a year or two.”

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Mr Obama’s budget reduces the projected deficits between now and 2020 by just over $2 trillion, mainly through reductions in planned spending on overseas military operations and proposed tax changes. The concern is that many of the recommended tax changes may not stick. Mr Obama’s Financial Crisis Responsibility Fee (the so-called bank tax) will probably survive, but other items, including reform of the international tax system and repeal of fossil-fuel subsidies, were proposed last year and failed to make it through Congress. Measures boosting taxes on upper-income households (those earning above $250,000 a year) should fare better, but the decision to sustain George Bush’s tax cuts for everyone else is short-sighted.

If Congress balks, as expected, at some tax provisions, then deficits will prove larger than budgeted for. But even the president’s proposals fail to cut deficits to the 3% target. To make up the difference, Mr Obama will create a deficit commission by executive order, charged with making recommendations for long-run budget sustainability. Yet Congress had earlier failed to pass its own proposal to create a bipartisan deficit commission, which would at least have been able to force a yes-or-no vote on its recommendations. Republicans who had praised the idea cynically reversed themselves when the president signalled his support. And even before its defeat, the Senate voted 97-0 to shield Social Security from the commission’s purview.

The aversion of Congress to hard decisions is no small obstacle for the president. But Mr Obama has done himself no favours by fudging the hard budget choices which must ultimately be made. It could be a costly failure. The American government has room to continue supporting the weak economy, but only for as long as markets believe that the United States will eventually make good on its obligations. In this budget proposal, Mr Obama has not done anything to reassure them.

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The US economy is in a mess ”“ even if growth has resumed, and bankers are once again receiving huge bonuses. More than one out of six Americans who would like a full-time job cannot get one; and 40% of the unemployed have been out of a job for more than six months.

As Europe learned long ago, hardship increases with the length of unemployment, as job skills and prospects deteriorate and savings gets wiped out. The 2.5-3.5 million foreclosures expected this year will exceed those of 2009, and the year began with what is expected to be the first of many large commercial real-estate bankruptcies. Even the Congressional Budget Office is predicting that it will be the middle of the decade before unemployment returns to more normal levels, as America experiences its own version of “Japanese malaise….”

Three things can make a difference: a second stimulus, stemming the tide of housing foreclosures by addressing the roughly 25% of mortgages that are worth more than the value the house, and reshaping our financial system to rein in the banks.

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Don’t get confused by the size of the numbers at stake. Pay attention to the ratio of cumulative debt to the size of the national economy. That will tell you how easily we can manage the debt.

The debt-to-GDP ratio right now is close to 53%””still in the manageable zone. But after the boomers hit retirement, it will soar. One of the most telling figures in the president’s budget document is the Congressional Budget Office’s projection that by 2020 the debt-to-GDP ratio will be 77%, assuming no entitlement reforms. That’s bad news. The ratio is moving in the wrong direction. At some point, the dollar could tank and interest rates explode.

—Robert Reich in today’s Wall Street Journal

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