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Our Dangerous Budget and What to Do About It

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Georges de la Tour/Louvre, Paris

The December budget deal, worked out between Representative Paul Ryan and Senator Patty Murray, has been widely greeted with relief. Since the first days of the Obama Administration in 2009, Washington has been in a pitched battle over the budget, with endless fights over stimulus packages, temporary tax cuts, spending limits and sequestration, fiscal cliffs, debt ceilings, and government shutdowns. Who would not welcome a moment of bipartisan calm, especially when the economy still needs to break out of its prolonged torpor?

Yet the budget battles have never been quite what they’ve seemed, and the new bipartisan agreement is not a victory of bipartisan reason. Despite all of the budget turmoil over the past five years, the long-term trajectory of the US budget has remained remarkably and dangerously unaltered. With this new agreement, the US takes another step toward a diminished future.

The long-term budget trajectory is the combination of three trends. First, ever since Ronald Reagan’s successful assault on government, beginning in 1981 (“Government is not the solution to our problem; government is the problem”), federal tax revenues in a normal year have stabilized at around 18–20 percent of the Gross Domestic Product (GDP). Adding in state and local governments, the total tax take in the US is around 30 percent of GDP. In Canada, Europe, and Japan, the total tax take (national, state, and local) is at least several percentage points of GDP higher than in the US. Canada averages 38 percent, Germany 45 percent, and social democratic Denmark 55 percent. (Supporters of supply-side economics may be interested to learn that Denmark ranks as the happiest country in the world in the Gallup International polling of life satisfaction.)

Democrats are called the tax-and-spend party, but Bill Clinton, Barack Obama, and the congressional Democrats have consistently opposed proposals for any marked increase in federal revenues as a share of GDP. When Democrats fight their perennial battles to close loopholes and raise taxes on the rich, their proposals typically add up to around 1 percent of GDP at the maximum. Obama’s budgets since 2009 have consistently called for federal revenues below 20 percent of GDP as of 2020, not more. Remember that Obama called for making George Bush’s temporary tax cuts permanent for 98 percent of Americans, allowing possible increases only for the top 2 percent of income earners. In the deal made for the budget in January 2013—in response to the “fiscal cliff”—the Bush-era tax cuts were in fact made permanent for approximately 99.5 percent of households.

Second, outlays on major mandatory programs like Social Security, Medicare, and Medicaid have continued to rise relative to GDP. (These programs are called “mandatory” since the benefits are fixed by law rather than by annual appropriation.) Other notable mandatory programs include food stamps and unemployment insurance. In 1980, the mandatory programs cost 9.6 percent of GDP. By 2013, they had risen to 13.6 percent of GDP. (Note that all budget data refer to the fiscal year, or FY, rather than the calendar year.)

The rise in mandatory spending relative to GDP has resulted from the increased coverage of these programs (e.g., the expansion of the population reached by Medicaid), as well as the increased costs of health care and the aging of the population. Rising health care costs and aging will lead to further increases in outlays relative to GDP unless there are changes in coverage, benefits, or costs. The Congressional Budget Office projects that spending on health programs (including Medicare, Medicaid, and Obamacare) will rise from 4.7 percent of GDP in 2013 to 5.9 percent of GDP in 2023, and to 8.1 percent of GDP in 2038 under current legislation and cost trends.

Third, health care and military spending have so far resisted reforms that could save vast amounts of money. The excessive costs of US health care are notorious, but neither party has dared to grapple with the lobbying power of the private health care industry, which is after all the single largest industry in the entire country. America spends around 18 percent of its GDP on health to obtain what other high- income countries get for around 12 percent of GDP. The difference is around $765 billion of waste, fraud, and abuse each year, roughly 5 percent of GDP, as described in a recent major study by the authoritative, government-sponsored US Institute of Medicine. Americans vastly overpay for medicines, hospital stays, outpatient visits, and countless procedures.

Bloated military spending is also notorious, with many billions spent on useless wars, hundreds of superfluous military bases, unnecessary nuclear weapons systems to fight a Soviet enemy that no longer exists, and high-cost conventional weapons systems that the generals often don’t want but that congressmen crave to create jobs in their districts. All of this waste, plus the bloated intelligence budgets (now estimated to be around $53 billion per year, roughly 0.3 percent of GDP), has added up to military outlays of around 5 percent of GDP in recent years.

Combine these three long-term trends, and the underlying fiscal problem is clear. Revenues amount to around 19 percent of GDP; mandatory programs require around 13.6 percent of GDP and rising; and security-related spending runs at around 5 percent of GDP. There is no room to fund civilian discretionary programs, a vast category that includes education, job training, protecting the environment and regulating land use, infrastructure such as roads, community development, housing, agriculture, and the technologies of the future, including advanced biomedical research, nanotechnology, information technology, renewable energy, and more.

The result is chronic budget deficits, and a chronic squeeze on the part of the economy associated with America’s future, the part where we invest to remain prosperous and globally competitive. These budget deficits in turn bring us to the fourth category of the budget (in addition to the mandatory, security, and civilian discretionary programs): interest payments on the growing public debt.

Currently the interest costs on the debt are around 1.5 percent of GDP, yet they will rise significantly in the coming few years. The public debt stands at around 75 percent of GDP, and the interest rate paid by the government is around 2 percentage points; hence the level of debt servicing (1.5 percent of GDP equals 75 percent of GDP times 2 percent per annum). Yet almost all observers believe that when the Fed ends its quantitative easing program—when it begins to “taper,” to use the new catchphrase—interest rates will rise to 4 percent or higher. The interest costs would then rise to 3 percent of GDP or more. This will further increase the budget deficit, either accelerating the rise of public debt or forcing some other adjustments, such as further cuts in spending.

The reader will by now see the fundamental problem, one that is far deeper than the repeated episodes of shutdowns, sequesters, and threatened defaults. There are simply no federal revenues available under the current tax laws to fund the civilian discretionary part of the budget. With total revenues set below 20 percent of GDP, and the sum of mandatory programs, interest servicing, and military spending amounting to around 20 percent of GDP or even more, all discretionary spending is destined to be financed through deficits or to disappear in budget cuts and spending limits.

Despite the endless budget skirmishes, the short-term stimulus packages, and all of Obama’s heartening speeches about investing for the future, the fact is that America is on a path of gutting critical public investments in education, job training, science, technology, and infrastructure. This dark secret has been true since Obama’s original run for the White House in 2008. His campaign pledge to make the Bush-era tax cuts permanent for almost all Americans meant that there never was an Obama plan (or a plan by the congressional Democrats other than a few dozen progressive members) to fund the public investments needed for America’s future.

It is worth looking at Obama’s first budget in 2009 to recall these hard truths, which have been obscured by mountains of rhetoric. In the budget sent to Congress in August 2009, Obama foresaw federal revenues at 19.2 percent of GDP in 2019, the last year of the ten-year budget. Thus, he put himself squarely in line with the political consensus that allows no increases in long-term revenues relative to GDP. To accommodate that position, Obama already had his eye on reducing the share of national income allocated to civilian discretionary programs. The August 2009 budget has civilian discretionary programs falling to just 3.1 percent of GDP, compared with an average of 4.5 percent of GDP in the 1970s, 4.1 percent of GDP in the 1980s, 3.5 percent of GDP in the 1990s, and 3.6 percent in 2008, the last budget of the Bush administration. In other words, Obama’s much-vaunted plans to invest in our future were never in the budget. By July 2013, Obama’s own budget plans called for civilian discretionary spending to decline to a mere 2.5 percent of GDP in 2023, the final year of the updated ten-year period.

The new budget agreement announced on December 10 cements these draconian and ill-judged cuts. In fact, according to the budget ceilings in the agreement, both military and civilian spending are now on track to decline to around 2.5 percent of GDP by 2023. The Republicans have accepted steep declines in military spending as a share of national income, while Democrats have acceded to the gutting of the civilian discretionary budget.

What is to be done? Consider four possible courses of action. The first is to continue to sleepwalk into the future, as we’ve been doing now for three decades. As public investments in science, technology, the environment, and education continue to shrink, US technological prowess will decline; the physical environment will continue to deteriorate (as our energy policy remains defined by drilling now and forever); and at least half of our children will never get the skills they need for decent jobs in the twenty-first century.

A second course would be to fund the civilian budget through more deficit spending. This would be a possible outcome, for example, if the Democrats regained control of the House. This has also been Paul Krugman’s well-known advice, and for many progressives it has become the standard position. Several arguments are made for it: that large deficits will lead to more employment and tax revenues in an underemployed economy (the Keynesian “stimulus” argument); that today’s very low interest rates will persist; and that there is no serious problem with the debt–GDP ratio rising to high levels in the future. In this view, we’ve been at high debt–GDP ratios in the past (such as after World War II—the debt–GDP ratio was 80 percent in 1950) without evident harm to long-term growth.

I do not agree with this position. I am worried about the rising ratio of debt to GDP, which has already doubled since 2007, from 36 percent of GDP to 71 percent of GDP. Most importantly, when interest rates return to more normal levels the burden of debt servicing will be quite steep. At 3.1 percent of GDP in 2023, as projected by the Congressional Budget Office, the interest costs would be larger than the projected defense budget and the civilian discretionary budget. Debt servicing will eventually crowd out vital areas of spending. There are also unbudgeted future burdens—in health and retirement programs—that will further exacerbate the debt problems.

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