Wednesday, July 27, 2011

Nobody is proposing actual spending cuts

When the history of the Great Debt Limit Debate is written, one of the key villains will be the definition of "cut." For everyone who lives outside the halls of Congress, "cut" means to reduce. But inside Congress, "cut" means to spend less than your baseline projection of future spending. Since spending always tends to rise by at least the growth of nominal GDP, which has averaged about 5.5% for the past 30 years, the baseline that everyone compares their budget proposals to tends to project increased spending of about 5-6% per year.

Over the past 12 months the federal government has spent $3.56 trillion. A typical baseline would project spending to increase about 5.5% a year, reaching some $6 trillion a year by 2021 (budget scoring generally focuses on what happens over the next 10 years). That would equate to total expenditures of $48.4 trillion over the next decade. So when one party proposes to "cut" spending by, say, $4 trillion, what they really mean is that they propose to spend $44.4 trillion over the next 10 years instead of $48.4 trillion. The $4 trillion "cut" they are proposing actually works out to a 4% annual increase in spending, instead of a 5.5% annual increase in spending.

So even the most radical of "cuts" that are being proposed today would still allow government spending to increase by 4% a year. How hard or draconian is that?

I suspect the great majority of Americans would be stunned to realize that if we allowed government spending to increase by only 2% a year, then we could probably balance the budget in about 7 years, without any need to increase tax rates or actually cut anybody's spending. No real cuts and no real tax hikes are needed to balance the budget within a reasonable time frame. Why is there so much sound and fury surrounding this debate?

(My calculations assume that tax revenues as a percent of GDP rise naturally to about 18% of GDP over the next 7 years, which is close to the long-term average and the same level that was achieved a few years after the Bush tax cuts. Tax revenue as a % of GDP always rises during the expansion phase of a business cycle, and we know that the current level of tax rates can generate 18% of GDP if the economy is healthy.)

UPDATE: Prompted by reader "William" as to why it seems so hard for Congress to do something simple like cutting the growth rate of spending to 2% instead of 5.5%, I offer this explanation: The problem with cutting the growth rate of spending is that CBO scores this as a "cut", and the "cut" that would result from a 2% growth rate in spending would be on the order of $8.6 trillion. My guess is that no congressman or senator would want to be labeled as the guy who "cut" such a gigantic amount of spending. Think of all the kids who would starve, the old folks who would die from lack of medicine, etc. In short, it would be too easy for political opponents to brand the cutter as an evil madman, when in fact he was just trying to be reasonably prudent.

10 comments:

Benjamin said...

I concur with the sentiments of this blog.

I also add that in real terms, defense-homeland security-VA outlays have more than doubled in the last 10 years, despite the fact that we face no military opponents of note. Nevertheless, we will spend $10 trillion in the next 10 years on "defense."

How much is $10 trillion? Scott Grannis has noted that our national debt, if you eliminate double-counting, is less than $10 trillion.

If we only reduce defense spending to levels of ten years ago (in real terms) we could save $5 trillion in next 10 years.

But agency spending is not a topic under discussion in DC. You see, Congressmen use agency spending to reward campaign contributors and flow money into their states and districts.

William said...

Totally shocking information!
Thank you for clarifying this.

What then is the real problem in cutting the projected growth to 4%, instead of the average 5.5% do you suppose? The promises to the elderly of Social Security benefits and Medicare?

Medicaid? Defense? All of the above, one would guess.

The US government is broken if they can't figure this out and reach an agreement. Global markets are not going to give the US until the end of 2013 to resolve this issue and make serious progress on the budget deficit. JMHO

Scott Grannis said...
This comment has been removed by the author.
Ms Peru said...

http://www.federalreserve.gov/releases/z1/Current/z1r-1.pdf

Scott - enjoy your work it's very good. But, I wish you would inform your readers of the real truth on the deficit. Check out the 2 nd page of the Federal Reserve flow of funds statement. Is it a pure revenue or spending problem. No country in the world can increase spending at this rate. 20 percent spending increases yr over year and then asking tax payers to subsidize a majority of a permanently higher spending level is economic sucicide. Also, agree that revenues will go back to 18 per cent of GDP when the economy normalizes. However, also point out that the US taxpayer has one of the highest per capita tax rates in the world. Taxpayers more than pay their fair share.

W.E. Heasley said...

“My calculations assume that tax revenues as a percent of GDP rise naturally to about 18% of GDP over the next 7 years….”.

Or merely point to Hauser’s Law:

http://online.wsj.com/article/SB10001424052748703514904575602943209741952.html

“Prompted by reader "William" as to why it seems so hard for Congress to do something simple like cutting the growth rate of spending to 2% instead of 5.5%, I offer this explanation: The problem with cutting the growth rate of spending is that CBO scores this as a "cut", and the "cut" that would result from a 2% growth rate in spending would be on the order of $8.6 trillion. My guess is that no congressman or senator would want to be labeled as the guy who "cut" such a gigantic amount of spending. Think of all the kids who would starve, the old folks who would die from lack of medicine, etc. In short, it would be too easy for political opponents to brand the cutter as an evil madman“.

Maybe not so much a “madman” as it is breaking ranks with the remainder of the politicos who depend on the other peoples’ money to fund their political constituency building exercises through the mechanism of government.

Houston Advisor said...

Where are the politicians and talking heads with their white boards on TV actually describing this for the American people? "Cuts" and "Default" are thrown around by all on CNBC, FOX, etc. which spooks my clients. Rating agencies need to be outlawed. The market will properly price the risk of default without the help of a bean counter at a rating agency.

Mark Gerber said...

Hi Scott. Of course I agree with you. This is what I have been arguing with you going back to 2001: the federal government is on an unsustainable path based on simple actuarial math of the baby boom retirement wave that will ultimately be such an enormous burden on our economy that a depression will occur. I believe you have argued that we as a society will deal with this problem, but I have been doubtful. Now that the the problem is here, we are not dealing with it! If we don't deal with it now, when will we? I am ever more doubtful that we ever will.

Mike Eliason said...

Looks to me like legislation ending baseline budgeting would be a more effective and realistic deficit reduction tool than a balanced budget amendment.

CDLIC said...

Scott,

Excellent interactive map of USA state-by-state per capita debt. Note blue states are far more deeply in debt than red states.

http://money.cnn.com/news/storysupplement/economy/state_debt/index.html

gardner said...

Excellent piece to help guide us through the hall of smoke and mirrors. Scott estimates spending of $48.8T for the ten years through 2021. The actual CBO baseline budget published in January has a number of $46.055T for the nine year period 2012-2021 so his estimate looks a tad low.