No topic is more fraught with misunderstanding than one about fiscal responsibility and the Federal Government. We outline several areas of misunderstanding, and some perspective and a framework to be used to guide the discussion.
Where Does the Money Go?
There is a lack of understanding of where our Government spends its (our) money and the tough choices that will need to be made to reduce the deficit. I will never forget when Jillie and Marko (the names are changed) came up the driveway and upon seeing their Trump sticker, I asked why they supported him. “Because I’m tired of our Government spending all it’s money on foreign countries!” When informed that spending on other governments, including foreign aid, military assistance and humitarian aid is less than 1% of Federal spending and therefore well under .25% of GDP, Jillie was surprised. (Despite her surprise, her mind was not changed by mere facts.)
Another misunderstanding is how much money goes to “welfare” defined narrowly as money provided to the non-working poor (but without Medicaid included). In 2015, about $235BN (<6%) of a $4.11 TN dollar budget could have been classified as welfare under this definition. About a third of this ($75BN) went to food stamps which support a broad cross-section of the population (44MM at the peak of the Great Recession). Many who get food stamp assistance are not poor, for example many young people collect food stamps.
For political reasons, the definition of “welfare” is elastic and conservatives classify much more of the Federal budget as “welfare” spending. Some research is required to unpack these claims. Conservatives lump Medicaid into welfare, which in 2017 added an additional $348 BN to the Federal budget. But it must be noted that many non-poor Americans, once they retire, utilize Medicaid to pay for prescription drugs and long-term care (nursing homes, etc.). The vast majority of Medicaid does not go to the non-working poor.
Welfare is not insignificant, but it is not nearly as significant as spending for Social Security, Medicare and the Military. In 2015, Military spending was $598BN, Social Security $895BN, Medicare and Health was $985BN, and Interest on the Debt was $229 BN, for a combined total of $2.707TN, or 71% of $3.789TN in total spending. Remaining expenditures (30% or so of the budget) are for items such as veterans benefits, education, transportation, energy and environment. All are worthy items that no one wants to cut, and some will lower future productivity because they are forms of investment.
Key Takeaways About Federal Spending
Here are the key takeaways regarding Federal spending:
- Reducing spending is going to cause pain, which is why neither Republicans or Democrats have been willing to tackle the issue since adjustments were last made in the 1990’s. The choices to be made are all challenging, and will hurt a substantial portion of the public.
- Reducing welfare will not solve our budgetary problems.
- Reducing waste in Federal spending will not solve our budgetary problems. It is not significant enough to make a dent.
In terms of making our budget sustainable, only tackling the large ticket items, spending on the military (where we spend more than the next 17 largest military spenders combined) and entitlements (social security and health insurance for the elderly – Medicare and Medicaid), will enable substantial progress to be made towards putting the Federal budget on a sustainable path.
The Need for Counter-Cyclical Spending and Taxes
A key component needed to understand the Federal Budget is Keynesian economics. The rhetoric about having to have a “balanced budget” is just that – rhetoric which ignores the countercyclical nature that spending and taxes should play to keep economies afloat and to protect the populace in hard times. There is no good alternative to Keynesian theories (modernized with “rational expectations” theory) which prescribe that Government spending should increase when unemployment is high, even if budget deficits increase as a result. TARP spending in 2007, 2008, and 2009, effectively saved the US economy during the Great Recession, and cost the US Treasury far less than initial outlays (cost of $70 billion in total after paybacks), . Americans complained about the slow pace of recovery and Conservatives claim the expenditures were all wasted, but the long cycle of recovery reflected the dire state of the economy. The vast majority of economists agreed that these counter-cyclical expenditures were needed to avoid collapse and to achieve a faster recovery than would have occurred without intervention.
That said, running extreme structural deficits year after year, which is where the US finds itself now even at full employment, is not sustainable in the long run, especially when these deficits exceed the growth trajectory of the economy (now roughly at or slightly higher than 2%). In addition, our deficits are now almost 50% foreign held, which represents a drain on US resources down the road. This is a segway to the final key component of the deficit picture, needed to understand the current crisis and to develop policy for the future.
We Are On An Unsustainable Course; In-Action Will Cause a Crisis
The US Federal Budget is on an Unsustainable Course Due to Recent Deficits and Entitlement Outlays Set to Balloon Over the Next 10 Years. Some history is in order. The US deficit used to be 1% or less prior to Reagan. Reagan was bent on reducing government, but instead of reducing spending first, he cut taxes. His advisors (outside of David Stockman) predicted that the tax cuts would unleash such productivity they would pay for themselves. On the spending side, Reagan found that Congress, including Republicans, had no appetite to reduce spending. Reagan also increased military spending. The result was the beginning of significant Federal deficits of 4 – 5 % of GDP, not seen since World War II.In the 1990’s both under Herbert Walker Bush and under Clinton, bi-partisan deals lowered some spending, and raised some taxes, eventually, despite the howls of Conservatives, leading to surpluses in the US budget in the later 1990’s and early 2000’s that briefly brought the economy back to a sustainable course.
Then George W Bush lowered taxes for the rich, fought two unpaid for wars, and added a prescription drug benefit. Then the Great Recession reduced the tax take to 15% of the economy, a low level not seen in decades. The deficit ballooned.
Under Obama the Federal Deficit climbed to 10% of GDP at the height of the Great Recession, and then fell back down to 3% by the end of the Obama Presidency. Even this is unsustainable, given high levels of cumulative deficits we now see, and more concerning, the projections of ever-increasing entitlement payments, primarily Medicare, projected to bring deficits to unsustainable levels. Even without future Medicare expense, the current deficit, with the latest tax cuts from Trump and Congress, and the recent spending increases accompanying the increase in the debt ceiling, will likely reach $1TN in 2018.
These are levels of deficit which will require such high interest payments that they will choke off normal government expenditures in the near future. No one knows when the markets will react with such vehement resistance to increased debts that a market crisis occurs during which there is deterioration of US credit in world markets, making future US Treasury borrowing too expensive to incur. When this occurs, it will adversely affect the well being of US citizens, even if the business sector is somehow shielded from the impact.
ACTION IS NEEDED NOW
The recent tax cuts by Congress, which primarily benefit the wealthiest 1% (see my prior blog on the recently passed Tax Cuts, ), are occurring at an extremely inopportune time during which both Democrats and Republicans, having kicked fiscal responsibility down the road, need to get together and put everything on the table to reach a bi-partisan compromise to put the Country’s books in order. With full employment, now is the time for our Federal Government to accomplish this task. There will be unhappiness across the Country as this occurs, as taxes will need to rise somewhat, and not just on the rich, given the magnitude of the deficit. Objective, centrist analysis shows that spending cuts alone will not accomplish the needed balance.
To be fair, this crisis is decades in the making as partisan politics and ideology prevent an objective look at how to achieve balance. Look for a crisis if the unstable, inconsistent economic policy-making of the Trump Administration continues.
To be discussed in a future blog, and related to excessive deficits:
Destructive trade policies will threaten the role of the US as a Reserve Economy, exacerbating the ability of the US to survive a fiscal crisis unscathed and limiting its ability to project its power.