Recently in defecit Category

Cutting Our Way to Balance

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Now, we'll begin to look at where we spend all that money. Below, please find two pie charts, blending a bunch of lower-level categories, and showing how the Federal outlays breakdown. On the left, you'll see the 2011 budget; on the right, the "Alternative" projection from the CBO, which assumes mainly that stuff like the "doc fix" continue to get passed every year, and that the Bush tax cuts never actually expire.

The first thing to note is that, if you hover over the segments, you'll find the percentage of GDP (not the budget) that each expenditure is. Remember that our goal should be for those expenditures to total to 19%, or less - yet in the 2021 budget, it's nearly 26%.

Next, let's think about the process of cutting spending, especially in light of how things went over the summer. After tremendous histrionics, Congress has sort-of agreed (through the failure of the "Super Committee") to cut 0.186% of GDP from the budget, annually.

This year, we'd need to cut a total of 5.1% to hit our target of 19%. These came 50/50 from the category of "Other" and "Defense". The reason they did is because the other categories are essentially uncuttable. I am also skeptical those cuts will actually happen.
However, this year is a bit odd, and it's not worth a lot of effort to try to make our plans based on it. In a decade, the picture looks a lot different, for a number of reasons:
 
  1. Defense drops a lot as we (hopefully) stop fighting in Iraq and Afghanistan (and Libya)
  2. Social Security and Healthcare increases. Frankly, I think OMB's estimate on this is optimistic - they're forced to work in a world where Obamacare's projected savings actually happen. Unfortunately, I don't have a good basis for changing it, so I'm leaving it as-is.
  3. Interest payments on the debt are now a noticeable item (4.4% of GDP). In fact, because of this, we now only really have 14.6% of GDP to spend on things that actually do things. This number may be optimistically small, but we'll leave it there for the moment.
Shooting for the 2021 budget then, let's imagine we take all the stuff everyone in Washington loves to argue about. Funding for the Energy Department; Education; Health and Human Services - heck, let's toss a bunch of Veteran's benefits, and EITC, and Unemployment, and everything out the window. Let's cut the "Discretionary" budget to zero. What's the rest add up to?

18.8% of GDP. That's right, if we cut Defense spending from its current 4.7% of GDP to 2%; and eliminate everything else (and raise taxes 25%, but that's for tomorrow), we just barely get the Federal budget in balance.

In other words, all of the arguing in Washington can't possibly address the problem. And, I reiterate, we're imagining we've had a substantial tax raise, too - if you want to keep taxes where they are, you need to cut this thing even more.

What haven't we looked at? "Social Security and Healthcare". They're 12.4% of GDP in 2021. We're spending 4.4% of GDP on Interest, and that's basically non-negotiable. That means 85% of our sustainable spending that we can do anything about is going into this bucket. It breaks out like this:

As you can see, it's mostly Social Security and Medicare - both programs for the elderly. The way our elections work, it's basically impossible to cut these - there will always be enough voters who will swing on this issue that they'll be able to kick out anyone who tries. There's maybe 1% of GDP you could get in there by repealing Obamacare. Remember, if you're opposed to it - you expect it to cost a lot of money. The CBO, officially, doesn't, so it's scoring the cost in 2021 as being very small. If you think Obamacare is going to be very expensive, then you need to adjust these numbers up, accordingly (which means you need more cuts from elsewhere to bring it into balance).

As long as the parties have split power in Washington - as long one party doesn't have the Presidency; 2/3 of the Senate, and 1/2 + 1 of The House - no progress will be made on significant cuts. That much has been obvious for a while now. What's no so obvious is that, even if one party or the other took over, it is still not going to solve things. The Republicans, for all their talk, are not going to take on Social Security reform at the level of cuts that will be needed - it would be political suicide. The Democrats would prefer to concentrate on tax hikes; but, even if they accepted the need for spending cuts, they would be even less likely than the Republicans to take on the entitlement monster.

What's the bottom line? Making enough cuts to bring the budget into balance is going to be political suicide. As we've seen from other countries, politicians don't commit political suicide. The only way the budget will get significantly cut is when we lose the easy alternative of "just borrow more money."

Tomorrow, we'll discuss what the alternatives are for raising taxes instead of cutting things.  Sneak preview: not good.

Government Spending as a Percent of GDP

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Much of the past seventy years in the United States has seen a debate about "how big" government should be.  Should we have a small government that intrudes little on our lives ("that government is best which governs least"), or should it provide a broad safety net to smooth out the shocks and problems of life?

While I have a philosophical opinion on which of these extremes I'd prefer, it isn't particularly relevant to the situation in which we find ourselves.  Both Democrats and Republicans have done nothing but expand the scope of government for scores of years.  One thing that has not been well-analyzed by either side is the theoretical limit of the size of the government.  While Republicans have tended to chant doom-and-gloom about the growth of government, it has tended to be in vague "someday this is going to cause a problem" terms.

One thing that is becoming very clear is that we are nearing the limit of how big government can get (again, leaving aside any question of how big it should) - and we have probably already exceeded it.  My personal opinion is that a much smaller government than this would mean higher growth and greater net human happiness; but such a thing is so far from the political reality that it seems unlikely to be worth much time analyzing.

What are the limits to government growth?

In the United States, from 1950 - 2010, Federal tax receipts have never exceeded 21% of GDP.  As the economy grows and shrinks, revenues grow and shrink with them.  There seems to be a natural governor on the economy and taxes - as taxes exceed that rate, people become better (and more motivated) at tax evasion; or earn less; or do less; or some combination of those items.  Over the long haul, the average rate has been more like 18% - and it's never exceeded 19% for any length of time.

We therefore can set a theoretical sustained maximum size for income of 19% of GDP.  In 2011, that's about $2.8T.  Again, I'll reiterate - I think it would be better for us to take less money from our citizens.  However, we are talking here about the real world, and the natural constraints on how big the Federal government possibly can get.

We can borrow money to increase what the government can spend.  If our borrowing is in line with GDP growth, in fact, it might be essentially infinitely sustainable.  3% seems like a reasonable guess as to a long-term GDP growth rate.  It might be a little bit on the conservative side (if things go at all well, we'll grow faster), but when we're thinking about borrowing against future earnings it seems reasonable to be conservative about them.

Taking 2011 as an example year, if we take expected GDP of $14.7T, and we figure it'll grow 3% (which I frankly find unlikely in these particular circumstances, but we're building a model, here), we'd expect to add $441B to the economy next year and have a total GDP next year of $15.14.  So, if we borrowed 19% of that this year, we could add another...$80 billion to the Federal expenditures for 2011 in a fairly sustainable fashion.  It's not a lot of money, but it could help smooth things out a bit.

We also can borrow unsustainably.  There is a limit to how much we can do.  How much of a limit?  Frankly, no one knows.  Clearly it's more than 70% of GDP, since we're there and we're still borrowing money just fine.  Japan is currently at nearly 200% - but they have a uniquely stable economy, and, as recent credit ratings downgrades have shown, the markets will not have infinite patience with them.

A reasonable limit for us to imagine for ourselves - given the market's horror at the continuing political strife in Washington - is 120% of GDP.  Maybe the real number is lower; maybe it's higher, but that gives us a good, reasonable target for the point at which interest rates begin to rise.

Putting all this together, for a long-term sustainable US government, the Feds need to spend no more than $2.8T/yr, but they can borrow up to a total of $17.6T total on top of that to spend more.  As of November, 2011, total debt outstanding is $10T, so we have another $7.6T of headroom. Of course, we're not currently taxing at 19% of GDP - we're only going to bring in something like $2.2T, this year in reality.  We're going to spend $3.8T, meaning we'll need to borrow approximately $1.6T, so we'll only have $6T left on our account, this time next year.  We'll (hopefully) increase that by about 3% per year, too, but we're running out of funds to borrow at an alarming rate.  A trivial model would show this running out in a little under four years; the more complex model actually gives us ten, assuming some GDP growth and some short-term cuts in spending as we finish up TARP and pull out of the Middle East.

It is theoretically simple to chart a path through this that isn't terrible for the country.  If we slowly lower expenditures, while slowly raising taxes, we could get the two to cross at $2.8T/year.  That would require a roughly 25% cut in expenditures, coupled with a roughly 25% increase in taxes, all relative to the economy that would be growing at the same time (thus making it easier).

Phased in over a decade - even two, as the initial reductions would buy us more time - this could be done with a relatively small disruption to the economy. However, the lesson we learned from Europe is that the incentives are not there for the politicians to do either of these things.  

In summary - the biggest government the US can sustain indefinitely is about 19% of GDP, which was $2.8T in 2011.  To do that, we'll also need to increase taxes from $2.2T (15% of GDP) to $2.8T (19% of GDP).  If you desire lower taxes, expenditures need to be lowered further, as well.  If you desire more spending, you're going to be long-term stuck, because we haven't yet been able to raise more than 19% of GDP over the long haul.

Finally, we have about $7.6T left on our "credit account" before the bank (probably) starts refusing to lend us more.

Tomorrow, we'll look at ways we could improve this situation by cutting spending - and why, regardless of who is in power, this isn't going to happen.

Messes, Foreign and Domestic

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When I first began to read about politics, in the late 1980s, I read a number of books that had been written in the late 1970s and early 1980s that were extremely pessimistic.  In a nutshell, they argued that we were running unsustainable deficits, and that eventually the government was going to was going to have to face the music that unsustainable spending was...well, unsustainable.

As my personal economic situation improved along with the country's, in the mid-90s, I began to feel more optimistic. Conservative pundits had been preaching doom for fifteen years, and yet things continued to improve - despite the compelling gut-level logic, as the Dow soared past 10k, the evidence seemed to indicate that things weren't so bad, after all.

Since then, most of my thinking about the deficit has revolved around a few core concepts:

  1. It's not that big a deal because the economy is growing; if we're borrowing about as fast as the economy grows, that's not really a practical issue.
  2. It's not that big a deal because the demographic time bomb that is Social Security isn't going to really explode (i.e., become insolvent) until ~2037.  In the year 2000, that was nearly 40 years off - and we'd had previous deadlines we'd managed to move by tweaking things.  In 1960, who could've begun to predict the economy in 2000?  Clearly there's no sense worrying too much about something so far away.  However, given that 2035 is when I would personally be eligible for Social Security, I did resolve not to base my retirement plans on its availability.
A few things have happened to change this thinking:

  1. The economy stopped growing.  For the first time in fifty years, from 2007 - 2010, GDP growth has been essentially flat, and it's looking like 2011 isn't going to be much of an improvement.  This graph is instructive.
  2. The slowed economy has caused a lot more people to enter forced retirement early.  Additionally the payroll tax holiday of 2010 reduced how much was being paid in.  That has significantly pulled in when Social Security begins to draw from the treasury instead of paying into it - from ~2037 ten years ago to...gulp...now.
  3. The Federal government is spending a lot more money now than they were ten years ago.  In 2000, we spent $1.8T, from an economy making $10T (GDP).  In 2010, we spent $3.5T from an economy making $14.7T.  We went from spending 18% of our GDP to spending 24%.
We are not yet completely doomed.  Right now we're adding about 1/15th of GDP to our standing debt every year.  There is some reason to be mildly optimistic this will drop a bit in the next few years (as we wind up wars and neglect to deploy new TARPs), but our long-term commitments have only gone up in the past few years.

In the midst of this, though, there is a crisis in Europe.  Europe will not survive this crisis in anywhere near its current form - and what happens there has both lessons for us, and direct effects upon us.

I intend this to be the first of a many-part series on what's going on in the world, and what the next decade will look like. The next piece will give my views on the short-term future for Europe, and perhaps something of what that will mean for us.

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