Economics

US
abc
Global Research

The Obama Budget  Expanded health care coverage and

extension of most Bush tax cuts…
What’s ahead for fiscal policy and the
economy?  …partly paid for by higher top-income
tax rates and Iraq withdrawal

 New fiscal stimulus coming as well;

budget deficit to remain large for a while

As a result of the recession and ongoing financial crisis, the

FY2009 budget deficit is on track to hit around USD800bn, or
5½% of GDP, assuming a USD250bn fiscal stimulus is enacted,
which is increasingly likely, perhaps sooner rather than later.
Once off-budget items such as the Troubled Assets Relief
Program (TARP) and Supplementary Financing Program (SFP)
are included, the “cash deficit” is likely to be around
USD1.8trn, taking the public debt to GDP ratio up to 52% from
37% before the crisis.

Looking further ahead, we take a stab at what the budget

outlook may be under a Barack Obama presidency, knowing
that once his proposals actually get through Congress, things
may look somewhat different. The main initiatives are tax cuts
for the “middle class”, higher tax rates on the two top marginal
tax rates, a phased withdrawal from Iraq, and expanded health
care coverage. Energy initiatives are expected to be deficit-
5 November 2008 neutral.

Ian Morris Obama’s policy proposals, which we assume would be

Economist
effectively up and running in 2010, is likely to mean deficits in
HSBC Securities (USA) Inc.
+1 212 525 3115 ian.morris@us.hsbc.com the order of USD650bn in 2010, partly because unemployment
is still expected to be high. The deficits are then expected to
decline gradually towards USD400-450bn in 2013. In the latter
period, these deficits would represent a structural budget gap of
2½% of GDP, and if achieved, would at that time act to
stabilize the public debt to GDP ratio at around 54%. If the SFP
is unwound and if the TARP is selling mortgages back into the
market by 2012, the debt ratio might be somewhat lower at 50%
at that time.
View HSBC Global Research at: http://www.research.hsbc.com
This report also updates our economic forecasts. The main
Issuer of report: HSBC Securities (USA) Inc.
change is that we now expect Q4 GDP of -3%, versus -2.2%
previously, due to the plunge in October auto sales. We still
Disclaimer & Disclosures expect the Fed funds rate to fall to zero by the second quarter of
This report must be read with the next year, as the unemployment rate rises sharply towards 8%.
disclosures and the analyst
certifications in the Disclosure
appendix, and with the Disclaimer,
which forms part of it
 Economics
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5 November 2008

The Obama budget

 Expanded health care and extension of most Bush tax cuts…
 …partly paid by higher top-income tax rates and Iraq withdrawal
 New fiscal stimulus coming as well; budget deficit to remain large

Fiscal outlook in the months and quarters ahead. Nevertheless,

With Barack Obama winning the US Presidential
election, what does fiscal policy and the budget
outlook look like over the next few years under an
Obama administration and stronger Democratic
majorities in Congress? And what are the
implications for the economy? This article can only
be considered a first rough stab as the final programs
could look much different and have different costs
after the negotiating process with Congress is done
some broad outlines have been clear for sometime.
Based on his campaign, Obama’s major policy
initiatives that will widen the budget deficit relative
to the Congressional Budget Office (CBO) base case
scenario under current policy legislation are: tax cuts
for the middle class (effectively an extension of the
Bush tax cuts for the bottom 95% of income earners
that are due to expire in 2011), and expanded health
care coverage.

1. Summary of Obama’s fiscal policy proposals: impact on budget balance relative to CBO baseline

2013 impact, 2013 impact,

USDbn USDbn
Extend most of the 2001 and 2003 tax cuts -294 Implement a cap-and-trade system +100
Increase income taxes on higher earners +48 Provide tax rebates and transition assistance -85
Raise capital gains and dividend taxes +28 Invest in green technology -15
Reinstate a smaller estate tax +49 Total Obama energy policy 0
Patch the alternative minimum tax -106
Make the R&E tax credit permanent -9 Initiate a phased withdraw from Iraq +156
Create a universal refundable mortgage credit -13
Create a "Making Work Pay" tax credit -72 Increase pre-K-12 education spending -18
Eliminate income taxed for many seniors -7 Create infrastructure reinvestment bank -6
Expand the earned income tax credit -5 Increase spending on basic research -15
Modify the saver's credit and implement auto-saving -21 Expand support for higher education -9
Create a new college tax credit -13 Reduce and reform government contracting +40
Expand the child and dependent care tax credit -3 Reform government spending +17
Close tax loopholes and shelters +77 Eliminate the federal education loan program +4
Cut corporate taxes -13 Double foreign aid -25
Increase the future payroll tax on high earners 0 Increase the size of the military -20
Total Obama tax policy -354 Reduce wasteful spending +20
Other Obama spending/savings -12
Expand health care coverage -115 to -144
Close "Doughnut Hole" in Medicare Part D -43 GRAND TOTAL -262 to -316
Find savings to finance Part D reform +43
Reduced overall health care costs +24 to +41
Cut Medicare and Medicaid costs +14 to +22
Total Obama health care policy -52 to -106
Source: Committee for a Responsible Federal Budget; we have left out the social security tax surcharge of 2-4% for high-income earners, as the Obama campaign has suggested that will not be
implemented for many years, perhaps ten years.

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5 November 2008

Meanwhile, the key measures that are likely to plans from his campaign that Obama said he
reduce the deficit relative to the CBO base case planned to pursue.
are tax increases for the top two marginal tax
However, the incoming Administration will also
rates, affecting the top-5% of income earners, and
wrestle with the ongoing financial crisis, which is
the money saved through a phased withdrawal of
now guaranteed to oversee a dramatic
the US military from Iraq.
deterioration in the federal budget over the next
2. Income tax brackets for married couples few years.
Taxable income Current marginal tax Marginal tax rate
(based on 2007 tax rate under Obama plan Our latest estimates suggest that the FY2009
schedule) less than:
deficit is likely to come in at around USD800bn,
USD15,650 10% 10% or about 5½% of GDP. This assumes a new
USD63,700 15% 15%
USD128,500 25% 25% USD250bn fiscal stimulus, enacted under either
USD195,850 28% 28%
USD349,700 33% 36%* Obama shortly after his inauguration on 20
no limit 35% 39.6%* January 2009 (with the aim of boosting GDP in
Source: Internal Revenue Service, Obama campaign
* We think Obama proposed increases could be delayed until 2010 due to current weak late Q1 or early Q2), or President Bush in the next
economy. Obama intends to adjust thresholds of rates slightly so that married couples
making less than $250,000 are not affected. few weeks (with the aim of boosting GDP in late
Q4, or more likely early Q1).
Energy policy, as currently envisioned, is
The USD800bn deficit assumes that Obama
expected to be deficit neutral, with revenue from
delays introduction of a new health care policy
the introduction of a cap-and-trade system for
until 2010 (given the likely length of time it will
carbon emissions used to pay for various green
take to get broad support, even with a Democratic
energy initiatives. These are the medium term
Congress), while also delaying the income tax

3. Budget projections under Obama

USDbn 2008 2009 2010 2011 2012 2013
CBO baseline -438 -438 -431 -325 -126 -147

Budgetary impact relative to CBO baseline:

Obama tax proposals -10 -84 -230 -309 -332
Obama health plan -91 -94 -97 -100
Iraq withdrawal 50 100 130 156
Other, net -9 -10 -11 -12

Estimated Obama budget -448 -565 -559 -413 -435

New fiscal package -250 0 0 0 0

Impact of weak economy -100 -100 -50 -25 0

Budget balance (HSBC forecast) -798 -665 -609 -438 -435

Financing needed for Troubled Assets Relief Program -700 0 0 0 0

Financing needed for Supplementary Financing Program* -299 -301 0 0 0 0

Cash deficit -737 -1799 -665 -609 -438 -435

Debt held by the public 5809 7608 8273 8882 9320 9755

Nominal GDP, CBO estimate 14210 14719 15473 16390 17253 18036
Budget balance (HSBC forecast), % GDP -5.4 -4.3 -3.7 -2.5 -2.4
Debt held by the public, % GDP 40.9 51.7 53.5 54.2 54.0 54.1
Source: HSBC, using Obama policy initiatives as estimated by the Tax Policy Center and the Committee for a Responsible Federal Budget
* The Supplementary Financing Program (SFP) provides cash for use by the Federal Reserve for its lending and liquidity initiatives.

3
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5 November 2008
increases until 2010, given the recession.
On top of the USD800bn deficit, the USD700bn
Troubled Assets Relief Program (TARP) needs to
be funded. Meanwhile, the Treasury has also
issued debt to fund the Supplementary Financing
Program (SFP) that provides cash to the Fed.
Treasury bill issuance related to the SFP has
increased from USD299bn in fiscal year 2008
(end-September 2008) to about USD600bn in FY
2009 so far, a rise of about USD301bn.
This takes the expected “cash deficit”, the amount
that the public debt will rise by in FY2009, to
about USD1.8trn (USD800bn deficit +
USD700bn TARP + USD300bn increase in SFP).
Bear in mind that the SFP could rise by a much
larger number than what we have assumed, so the
“cash deficit” could end up being a lot higher,
depending on the length and severity of the
banking crisis.
Looking at 2010 and beyond, when the Obama
programs are expected to be mostly fully up and
running, we expect the economy to still be
operating well below full employment so that the
FY2010 budget deficit will be around USD650bn,
falling towards about USD450bn in 2013.
The estimates here are largely based on estimates
provided by two non-partisan groups who have
provided costs of the Obama measures, the Tax
Policy Center and the Committee for a
Responsible Federal Budget.
Under these conditions, the public debt to GDP
ratio rises from 37% before the financial crisis hit,
to just under 52% in FY2009 and then stabilizing
at about 54% in 2011-13. This is of course a huge
jump, but in a banking crisis this is to be
expected. For instance, during the Swedish
banking crisis in the early 1990s, the public debt
to GDP ratio jumped from about 40% to 80% in
the space of three years. The US outlook is not
4
abc
nearly as dire, but does warn that there may be
some upside to our 54% estimate.
The upside risk exists because the analysis takes
at face value Obama’s promise to make spending
cuts (e.g., Medicare cost reductions, reduce
wasteful spending, reform government
contracting, to name a few) which may prove
difficult to implement.
Moreover, some increased spending on defence
may prove unavoidable, even if an Iraq
withdrawal saved money as planned. The reason
is that Obama has committed to doing more in
Afghanistan, which, if followed through, may
require a larger “boots on the ground” strategy
that ends up being more expensive than currently
envisaged. All of these elements provide some
risk that the budget deficit ends up being larger
still in the next few years.
The gaping deficit may not be much of an issue in
a recession, but questions about longer-term fiscal
sustainability cannot be too far away, especially
when the unprecedented Treasury issuance runs at
full steam over the next year.
The best way to increase confidence about
medium-term fiscal responsibility would be for
the new Administration to commit to gradually
reducing the deficit to 2½% of GDP by 2013, and
hopefully a little earlier if the economy can return
to full employment earlier. Under these
conditions, the public debt to GDP ratio should
stabilize at under 55%. Although much higher
than the 37% before the crisis, there is still a
crumb of comfort from the fact that such debt,
relative to the size of the economy, will still be
lower than many countries in Europe (although
not all) and Japan.
On the more optimistic side, the Treasury could
unwind the SFP program, and if credit conditions
normalize in three or four years, perhaps the
Treasury could start selling some of the toxic
 Economics
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5 November 2008
mortgages (say, around $100bn or so in 2012),
that will be bought under TARP in the next few
years.
If that were to happen, then the public debt could
be USD700bn or so smaller in 2013 relative to
that shown in table 3 (-USD600bn SPF and
-USD100bn or so in TARP). This would take the
public debt ratio down a bit to 50% by 2013,
instead of 54%.
4. Debt held by public as a percentage of GDP
% GDP % GDP
60 F 'cas t
50
40
30
20
60 64 68 72 76 80 84 88 92 96 00 04 08 12
Federal debt held by the public, % GDP
With SFP unw ind and som e T ARP as set s ales
Source: Haver Analytics, HSBC
Forecast update
The recent economic data pertaining to October
has so far been miserable. The October Senior
Loan Officer Survey made for, once again, grim
reading, as lending conditions tightened again.
Still, this was “in the price” given the earlier
deterioration in credit markets through September
and October, and hence should not be seen as a
major surprise. The collapse in the October ISM
manufacturing index, meanwhile, was lower than
market expectations but, in reality, about
consistent with falling GDP in the fourth quarter.
The collapse in October auto sales, however, had
not been fully factored into our forecasts, and we
have cut our Q4 GDP forecast from -2.2% to
-3.0% as a result. Our consumption forecast for
Q4 has been cut from -0.5% to -2.5%. With
headline PCE inflation expected to be around
-5%, thanks to the drop in energy prices, nominal
abc
consumption is apparently on track to fall 7.5%
annualized, the largest nominal quarterly decline
since 1951.
The decline in Q4 prices is set to boost Q4 real
personal disposable income by 7.3%. This should
result in quite a sharp rise in the personal saving
ratio from 1.3% in Q3 to 3.5% in Q4. We
envisage a continued increase to 5% by the end of
2009 and probably higher in 2010.
Our forecasts through 2009 and 2010 are
essentially unchanged from when we last
60 published our forecasts in our 20 October report,
50 Zero Bound. We continue to expect three quarters
40 of falling GDP, a sharp rise in the unemployment
30
rate to 8% and the Fed to cut rates to zero in the
second quarter of 2009. We assume that a
20
USD250bn fiscal stimulus will start to hit the
economy in the second half of 2009, which
explains the higher growth rates in H2, but we
note that a package could come a lot earlier,
which might boost Q2 growth, and perhaps even
Q1. If it becomes clear that the political
machinations are heading in that direction, we
will make adjustments to our forecasts.
Our forecasts are based on the set of financial
conditions assumed in table 5. We assume the oil
price stays around USD65 in the forecast period,
corporate spreads gradually decline, the 30-year
mortgage rate fall from 6.4% now to under 5% by
end-2009, real estate values continue to decline
and stock prices rise slowly. Given unsettled
conditions, big moves in financial conditions
away from what we are assuming, would trigger
forecast revisions too.
5
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5 November 2008

5. HSBC US economic forecasts

Yr avg A A F F F F F F Q4/Q4 Q4/Q4 Q4/Q4
2008 2009 2010 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 2008 2009 2010
Real GDP 1.4 0.2 1.8 0.9 2.8 -0.3 -3.0 -0.8 1.5 2.6 2.8 0.1 1.5 1.6
Nonfarm payrolls (mo average, '000) -121 -119 36 -82 -71 -100 -231 -176 -183 -102 -16
Unemployment rate 5.7 7.4 8.0 4.9 5.3 6.0 6.5 6.9 7.3 7.6 7.8
Headline PCE inflation 3.4 0.4 1.2 3.6 4.3 5.4 -5.0 0.1 1.0 1.0 1.0 2.0 0.8 1.3
Core PCE inflation 2.3 1.7 1.4 2.3 2.2 2.9 1.9 1.5 1.2 1.2 1.2 2.3 1.3 1.6

Fed funds (end period) 2.25 2.00 2.00 1.00 0.50 0.00 0.00 0.00
10-year Treasury (end period) 3.7 3.9 3.9 3.9 3.7 3.5 3.3 2.9

Consumption 0.4 -0.8 1.1 0.9 1.2 -3.1 -2.5 -1.0 0.2 1.0 1.0 -0.9 0.3 1.2
Real personal disposable income 1.7 2.1 2.4 -0.7 11.9 -8.7 7.3 1.6 1.6 2.3 2.9 2.2 2.1 2.5
Personal saving ratio 1.9 4.6 5.8 0.2 2.7 1.3 3.5 4.1 4.4 4.7 5.1
Employment cost index 3.1 3.8 4.0 3.0 2.6 3.0 4.0 4.0 4.0 4.0 4.0 3.2 4.0 4.0
Residential investment -21.0 -10.0 3.1 -25.0 -13.3 -19.1 -20.0 -10.0 -5.0 5.0 5.0 -19.5 -1.5 3.0

Business fixed investment 2.4 -6.2 0.5 2.4 2.5 -1.0 -13.0 -10.0 -6.0 0.0 0.0 -2.5 -4.1 1.5
Inventories (ppt contribution) -0.3 0.0 0.3 0.0 -1.5 0.5 -0.1 0.0 0.2 -0.3 0.5 -0.3 0.1 0.5
Productivity, nonfarm business 2.6 1.3 1.9 2.6 4.3 1.2 -2.0 0.2 3.0 3.7 3.3 1.5 2.5 1.4
Unit labor costs 1.1 2.5 2.0 1.2 -0.5 1.8 6.0 3.8 1.0 0.3 0.7 2.1 1.5 2.6
Profits after tax -8.0 -17.7 -5.7 4.5 -19.9 -21.9 -17.8 -30.4 -8.8 -1.2 -3.9 -14.4 -11.9 -5.2

Government spending 2.9 4.0 4.3 1.9 3.9 5.8 2.0 1.6 4.1 8.0 8.0 3.4 5.4 2.5

Net trade (ppt contribution) 1.4 0.9 -0.3 0.8 2.9 1.1 0.5 1.0 1.1 0.4 -0.2 1.3 0.6 -0.5
Exports 8.2 2.5 3.3 5.1 12.3 5.9 -1.5 -1.7 4.3 4.9 4.9 5.3 3.1 3.3
Imports -2.4 -3.2 4.8 -0.8 -7.3 -1.9 -3.8 -7.1 -2.9 1.8 5.7 -3.5 -0.7 5.6
Current account balance, % GDP -4.7 -3.1 -3.4 -4.9 -5.1 -5.1 -3.6 -3.3 -3.1 -3.0 -3.0

Financial conditions assumptions:

Spot oil price, WTI ($/barrel) 102.5 65.0 65.0 98.0 124.0 118.0 70.0 65.0 65.0 65.0 65.0
Farmer agricultural prices received index 149.3 136.3 135.0 145.0 151.0 156.3 145.0 140.0 135.0 135.0 135.0
Moody's Baa corporate rate less 10-year Tsy (ppt) 3.71 4.33 2.88 3.09 3.10 3.34 5.30 4.80 4.50 4.20 3.80
30-year mortgage rate 6.19 5.40 5.02 5.96 6.08 6.34 6.40 6.00 5.60 5.30 4.70
30-year mortgage rate less 10-year Tsy (ppt) 2.37 2.05 1.42 2.29 2.19 2.48 2.50 2.30 2.10 2.00 1.80
Nominal broad trade-weighted dollar index 99.6 108.2 108.2 97.3 95.8 97.9 107.5 108.2 108.2 108.2 108.2
S&P500 index 1184 1002 1062 1323 1280 1166 966 980 995 1009 1024
U. Michigan 5 to 10-year inflation expectations 3.1 2.8 2.7 3.0 3.3 3.1 2.9 2.8 2.8 2.7 2.7
Household real estate wealth (annualized % change) -3.8 -2.8 3.0 -6.3 -4.5 -5.0 -5.0 -3.0 -1.0 0.0 0.0
Notes: Quarterly forecasts are Q/Q annualized unless stated otherwise.
Source: HSBC

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Disclosure appendix
Analyst certification
The following analyst(s), who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject
security(ies) or issuer(s) and any other views or forecasts expressed herein accurately reflect their personal view(s) and that no
part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained
in this research report: Ian Morris

This report is designed for, and should only be utilised by, institutional investors. Furthermore, HSBC believes an investor's
decision to make an investment should depend on individual circumstances such as the investor's existing holdings and other
considerations.

Analysts are paid in part by reference to the profitability of HSBC which includes investment banking revenues.

For disclosures in respect of any company, please see the most recently published report on that company available at
www.hsbcnet.com/research.

* HSBC Legal Entities are listed in the Disclaimer below.

Additional disclosures
1 This report is dated as at 05 November 2008.
2 All market data included in this report are dated as at close 04 November 2008, unless otherwise indicated in the report.
3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its
Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research
operate and have a management reporting line independent of HSBC's Investment Banking business. Chinese Wall
procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or
price sensitive information is handled in an appropriate manner.

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Disclaimer
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Global Economics Research Team

Global Emerging Europe, Middle East and Africa
Stephen King Juliet Sampson
Global Head of Economics +44 20 7991 5651 juliet.sampson@hsbcib.com
+44 20 7991 6700 stephen.king@hsbcib.com Alexander Morozov
Stuart Green +7 495 783 8855 alexander.morozov@hsbc.com
+44 20 7991 6718 stuart1.green@hsbcib.com Murat Ulgen
Europe +90 21 2366 1625 muratulgen@hsbc.com.tr

Janet Henry Simon Williams

Chief European Economist +971 4507 7614 simon.williams@hsbc.com
+44 20 7991 6711 janet.henry@hsbcib.com Latin America
Astrid Schilo Jonathan Heath
+44 20 7991 6708 astrid.schilo@hsbcib.com Chief Economist, Latin America
Germany +52 55 5721 2176 jonathan.heath@hsbc.com.mx
Lothar Hessler Argentina
+49 21 1910 2906 lothar.hessler@hsbctrinkaus.de Javier Finkman
France Chief Economist
Mathilde Lemoine +54 11 4344 8144 javier.r.finkman@hsbc.com.ar
+33 1 4070 3266 mathilde.lemoine@hsbc.fr Ramiro D Blazquez
United Kingdom Senior Economist
Karen Ward +54 11 4348 5759 ramiro.d.blazquez@hsbc.com.ar
+44 20 7991 3692 karen.ward@hsbcib.com Brazil
North America Andre Loes
Chief Economist
Ian Morris +55 11 3371 8184 andre.a.loes@hsbc.com.br
+1 212 525 3115 ian.morris@us.hsbc.com
Mexico
Ryan Wang Juan Pedro Treviño
+1 212 525 3181 ryan.wang@us.hsbc.com Chief Economist
+52 55 5721 2179 juan.trevino@hsbc.com.mx
Stewart Hall
+1 416 868 7523 stewart_hall@hsbc.ca Lorena Dominguez
Economist
Global Emerging Markets +52 55 5721 2172 lorena.dominguez@hsbc.com.mx
Philip Poole
+44 20 7992 3683 philip.poole@hsbcib.com
Wietse Nijenhuis
+44 20 7992 3680 wietse.nijenhuis@hsbcib.com
Asia Pacific
Qu Hongbin
+852 2822 2025 hongbinqu@hsbc.com.hk
John Edwards
+61 2 9255 2744 john.k.edwards@hsbc.com.au
Robert Prior-Wandesforde
+65 6239 0840 robert.prior-wandesforde@hsbc.com.sg
Frederic Neumann
+852 2822 4556 fredericneumann@hsbc.com.hk
Seiji Shiraishi
+81 3 5203 3802 seiji.shiraishi@hsbc.co.jp
Prakriti Sofat
+65 6230 2879 prakritisofat@hsbc.com.sg
Christopher Wong
+852 2996 6917 christopherwong@hsbc.com.hk
Sophia Ma
+86 10 5999 8232 xiaopingma@hsbc.com.hk
Yukiko Tani
+81 3 5203 3827 yukiko.tani@hsbc.co.jp