President Barack Obama has set the ambittous goal of reducing the federal deficit by half in four years. He will file a budget this coming week that seeks to begin that process, and is hosting a “fiscal responsibility” summit this week as well. In this area the President faces what I consider to be his greatest challenge.

As we look at deficit numbers it is important to realize that as enormous as they are they are in fact grossly understated. The “unified accounting” approach allows the federal government to count the surplus in social security against the governmental deficit. This accounting sham produces a “lower” federal deficit, with the United States government replacing the Social Security surplus with Treasury I.O.U’s. The problem is that the Social Security Trust Fund will soon need to begin redeeming those bonds, as the SS system turns to deficit. Those Republicans now pining for fiscal responsibility are, in many cases, the same ones who made fun of Al Gore for promoting the Social Security lockbox! With that in mind lets look at the Washington Post description of numbers:

Even before Congress approved the stimulus package this month, congressional budget analysts forecast that this year’s deficit would approach $1.2 trillion — 8.3 percent of the overall economy, the highest since World War II. With the stimulus and other expenses, some analysts say, the annual gap between federal spending and income could reach $2 trillion when the fiscal year ends in September.

Those are some real ugly numbers. The Post talks about Obama reducing some spending, in particular on our overseas committments in Iraq and Afghanistan.

Obama proposes to dramatically reduce those numbers, said White House budget director Peter Orszag: “We will cut the deficit in half by the end of the president’s first term.” The plan would keep the deficit hovering near $1 trillion in 2010 and 2011, but shows it dropping to $533 billion by 2013, he said — still high but a more manageable 3 percent of the economy.

To get there, Obama proposes to cut spending and raise taxes. The savings would come primarily from “winding down the war” in Iraq, a senior administration official said. The budget assumes continued spending on “overseas military contingency operations” throughout Obama’s presidency, the official said, but that number is lower than the nearly $190 billion budgeted for Iraq and Afghanistan last year.

Obama also plans to let the Bush tax cuts expire in 2011 as he deals with the revenue side.

Obama also seeks to increase tax collections, mainly by making good on his promise to eliminate some of the temporary tax cuts enacted in 2001 and 2003. While the budget would keep the breaks that benefit middle-income families, it would eliminate them for wealthy taxpayers, defined as families earning more than $250,000 a year. Those tax breaks would be permitted to expire on schedule in 2011. That means the top tax rate would rise from 35 percent to 39.6 percent, the tax on capital gains would jump to 20 percent from 15 percent for wealthy filers and the tax on estates worth more than $3.5 million would be maintained at the current rate of 45 percent.

Obama also proposes “a fairly aggressive effort on tax enforcement” that would target corporate loopholes, the official said. And Obama’s budget seeks to tax the earnings of hedge fund managers as normal income rather than at the lower 15 percent capital gains rate.

Overall, tax collections under the plan would rise from about 16 percent of the economy this year to 19 percent in 2013, while federal spending would drop from about 26 percent of the economy, another post-World War II high, to 22 percent.

The Obama budget will also begin the process of dealing with health care. There will be some tweaks to medicare and medicaid, which in combination cost $561 billion per year.

Administration officials and outside experts say the most likely path to revamping the health system is to begin with Medicare, the federal program for retirees and people with disabilities, and Medicaid, which serves the poor. Together, the two programs cover about 100 million people at a cost of $561 billion in 2007. Making policy changes in those programs — such as rewarding physicians who computerize their medical records or paying doctors for results rather than procedures — could improve care while generating long-term savings, experts say.

One of the things that Obama is doing is to undo Bush era accounting practices, which left disaster relief and the two wars largely off book in the hopes of masking the true size of the deficit. Obama will end that practice.

It is very clear that in order to truly attack the deficit some deeply unpopular actions will need to be taken. Whether this President has the stomach for that is yet to be seen. Congress has shown itself as incapable of dealing with this problem. Without Presidential leadership on this issue we will be doomed to failure on restraining deficits, and such a failure may bring additional disaster to the U.S. The latest Pete Peterson Foundation ad is below. These are the folks that brought us I.O.U.S.A.