In the second week of November 2010, the co-chairs of
the President’s deficit reduction Commission put out a
report in which they recommended supposedly
draconian cuts in about all Federal expenses and
material increases in tax revenue. Even then, their
recommended actions do not eliminate the deficit; but
rather bring it down to under 3% of the GDP by 2015.
Immediately thereafter, the Speaker of the House, a
Democrat, as is the President, declared the proposal a
“non starter.”(The final report is materially unchanged
from the draft report.)
About every thinking person, who is not a politician, recognizes that the Federal debt crisis cannot be solved without addressing entitlements. But, last week, a congress woman, Jan Schakowsky, who is on the deficit commission, countered her co-chairmen on national television with an alternative proposal that left entitlements untouched, reduced Defense by 10% (which is only modestly more than the recommendation of the co-chairs), increased taxes and reduced the deficit by less than $500 billion. In short, without being overly specific, her view apparently was that it was ok to continue running deficits of more than a half trillion dollars a year. Moreover, her model, known as the primary balance model, does not include the interest paid on the national debt, which we ignore in this argument at our own peril.
What the hell is going on here?
About every thinking person, who is not a politician, recognizes that the Federal debt crisis cannot be solved without addressing entitlements. But, last week, a congress woman, Jan Schakowsky, who is on the deficit commission, countered her co-chairmen on national television with an alternative proposal that left entitlements untouched, reduced Defense by 10% (which is only modestly more than the recommendation of the co-chairs), increased taxes and reduced the deficit by less than $500 billion. In short, without being overly specific, her view apparently was that it was ok to continue running deficits of more than a half trillion dollars a year. Moreover, her model, known as the primary balance model, does not include the interest paid on the national debt, which we ignore in this argument at our own peril.
What the hell is going on here?
Some Facts
Are there facts? I am not sure that the answer is an
unequivocal yes. Remember, the subject is about
economics. Economics is a behavioral discipline, not a
physical discipline, such as physics. So most numbers
you read are indications of trends, not accomplished
realities. The only real realities are about what has
already been spent. Also, when it comes to such large
numbers- trillion dollar deficits – it is difficult to pin
point accuracy. For example, if you want accurate
deficit numbers you may have to go back to 2008 to
address numbers from books that actually have been
completely closed. So, one needs to be a little humble
when we discuss this subject.
I felt a need to start this discussion with a review of some macro economic data regarding where the U.S. sits with respect to other world economies because if you don’t get that right, you’ll not understand the full scope of this issue. So please bear with me for a few paragraphs.
Let’s start with a little sense of the bigness of the USA economy. These numbers are from the IMF, for 2009, and are approximate actuals. I cross checked these numbers against a 2011 set of forecasts found in a special issue of the Economist, December, 2010, for comparison purposes. The narrative only refers to the 2009 actuals. This is a little cluttered – sorry about that – but it will give you some very relevant information, which is not easily available.
The US GDP in 2009 was over $14.1 trillion annually (2011 Economists forecast (fc) is $14.9). Japan, the country of the “lost decade,” was still #2 at $5.1 (fc is $5.6). (In 1992, Lester Thurow, the MIT economist, in a book called Head to Head, predicted that Japan’s economy would overtake the U.S. before the start of the 21st century. Not to be.) China was still # 3 in 2009, at $5.0 (fc is $6.4), but has since over taken Japan on a current basis, and the media simply assume that China will be larger than the U.S in fifteen or twenty years.
Germany, even after many years since reunification, was a laggard 4th, at $3.3 (fc is $3.1), but may be the only European country that has its economic house in order. #5 was France ($2.7, fc to be $2.5), # 6 was UK ($2.2, fc is $2.4), # 7 was Italy ($2.1, fc is $1.8), and # 8 was California ($1.8). Ops, I guess California is not a country. The other three BRICs, Brazil ($1.6, fc is $2.0), India ($1.2, fc is $1.8), and Russia ($1.2, fc is $1.7) almost followed in that order. At $1.5 (fc is $1.3), Spain’s economy in 2009 was bigger than Russia’s or India’s. In fact, Canada, at $1.3 (fc is $1.6), was also bigger than Russia’s or India’s. Of note, Australia was about $1.0 (fc is $1.2) and Mexico was about $.9 (fc is $1.1). These numbers are related to actual dollarized foreign exchange rates. Some lists attempt to rank by purchasing parity, factoring in a lower cost of goods, one country to another. But, I think that this just takes the guessing to another degree.
If you examine and compare the 2009 actuals and the 2011 forecasts you can see that there are major shifts taking place among these major economies. In effect, the big European economies are getting smaller relative to the BRICS and even Australia and Mexico. But also notice that, if you can believe the data, the United States isn’t exactly shrinking. Comparing 2009 actuals and 2011 estimates, Germany, France, Italy and Spain got smaller, suggesting that they were hit harder by the economic crisis than was the U.S. All of the other larger countries are forecasted to get bigger.
Let’s address the U.S./China economic relationship briefly. While all assume that China will eventually surpass the U.S., as a function of population size, and indeed the fad is articles praising the Chinese economy, its education system, its workers, etc, an interesting look might be this: If the U.S. grows at 2.5% from its 2011 forecast for the next ten years and China grows from its forecast at 8%, at the end the U.S. economy will be $19 trillion and China’s will be $13 trillion. Both countries would probably be very happy with these numbers. It would probably be a good thing for the world if China’s economy, given its population, were larger than the U.S. – and India’s as well – but Lester Thurow has now taught us that nothing is pre-ordained. The U.S. has proven that it can drive a $14 trillion economy at 2.5-4% growth per year (more or less). Can China, with a different legal structure and a different constitution, drive a $13 trillion economy at even that rate? Only time will tell.
Why are these numbers important as a starting point?
First, what happens in the U.S. affects the whole world. I pulled some data, according to several objective sources, which ranked the world’s economies for exports and for imports. (I think the data is useful from a relative standpoint, but probably not accurate from an absolute standpoint.) The U.S. buys $1.6 trillion worth of goods from the world every year (approximate 2009 data). We export about $1.1 trillion. (Another source had services adding another $500 billion to U.S. exports. There seem to be many competing sources and interpretations of these global trade numbers.) We can be sure of this. We have been buying a lot more than we have been selling for a long time. We are clearly the world’s largest importer. Many economists fret about the U.S. trade deficit. (The problem is not as obvious to me because of the confusion regarding services.) Clearly, our imports will decline as our purchasing power declines and our exports would likely increase. Are not these the rules of economics? But, just as clearly, much of the world does not want to see our imports decline. Exports make up over 7% of the U.S. economy. Within China’s economy, exports make up about 24%, as it exports $1.2 trillion worth of goods a year. China is clearly now the world’s largest exporter of manufactured goods. But, China also appears to be the second largest importer, at about $1.0 trillion. Japan, incidentally, imports about as much as it exports, at somewhat less than $600 billion. Germany exports $1.16 trillion, almost as much as China, but materially more as a percentage of the size of its economy, or 35%. It imports about $950 billion. India exports less than $200b per year. To the extent that U.S. consumer debt grows or declines it can affect these numbers. To the extent the U.S. consumer is over leveraged, as it has been, a period of de-leveraging will hurt the world economy.
The U.S. trade deficit dropped by about 50% between 2008 and 2009, to about 25% of exports. By the way, as mentioned above, the most typical reports on the trade deficit do not include services, or are very fuzzy on this subject. Services probably add about 1/3 to U.S. exports and reduce the deficit by about 1/3. If you give general business and the consumer credit for that 1/3, then, the U.S. trade deficit can be almost entirely attributed to petroleum related product imports, the greatest amount of which come from our North American neighbors, Canada (20%) and Mexico (12%). (Saudi Arabia is 9%. This particular statistic is for the month of May 2010. )
A second reason is that it is useful to begin a conversation with facts, or at least near facts, because so much of what we hear in the major media is misleading. These huge numbers for GDP and trade are hard to get and the data appear to be a moving target. But this fuzziness, as with the U.S. deficit numbers, makes the relative importance of this data no less important. Our search is for relative truth, not ideological purity.
I felt a need to start this discussion with a review of some macro economic data regarding where the U.S. sits with respect to other world economies because if you don’t get that right, you’ll not understand the full scope of this issue. So please bear with me for a few paragraphs.
Let’s start with a little sense of the bigness of the USA economy. These numbers are from the IMF, for 2009, and are approximate actuals. I cross checked these numbers against a 2011 set of forecasts found in a special issue of the Economist, December, 2010, for comparison purposes. The narrative only refers to the 2009 actuals. This is a little cluttered – sorry about that – but it will give you some very relevant information, which is not easily available.
The US GDP in 2009 was over $14.1 trillion annually (2011 Economists forecast (fc) is $14.9). Japan, the country of the “lost decade,” was still #2 at $5.1 (fc is $5.6). (In 1992, Lester Thurow, the MIT economist, in a book called Head to Head, predicted that Japan’s economy would overtake the U.S. before the start of the 21st century. Not to be.) China was still # 3 in 2009, at $5.0 (fc is $6.4), but has since over taken Japan on a current basis, and the media simply assume that China will be larger than the U.S in fifteen or twenty years.
Germany, even after many years since reunification, was a laggard 4th, at $3.3 (fc is $3.1), but may be the only European country that has its economic house in order. #5 was France ($2.7, fc to be $2.5), # 6 was UK ($2.2, fc is $2.4), # 7 was Italy ($2.1, fc is $1.8), and # 8 was California ($1.8). Ops, I guess California is not a country. The other three BRICs, Brazil ($1.6, fc is $2.0), India ($1.2, fc is $1.8), and Russia ($1.2, fc is $1.7) almost followed in that order. At $1.5 (fc is $1.3), Spain’s economy in 2009 was bigger than Russia’s or India’s. In fact, Canada, at $1.3 (fc is $1.6), was also bigger than Russia’s or India’s. Of note, Australia was about $1.0 (fc is $1.2) and Mexico was about $.9 (fc is $1.1). These numbers are related to actual dollarized foreign exchange rates. Some lists attempt to rank by purchasing parity, factoring in a lower cost of goods, one country to another. But, I think that this just takes the guessing to another degree.
If you examine and compare the 2009 actuals and the 2011 forecasts you can see that there are major shifts taking place among these major economies. In effect, the big European economies are getting smaller relative to the BRICS and even Australia and Mexico. But also notice that, if you can believe the data, the United States isn’t exactly shrinking. Comparing 2009 actuals and 2011 estimates, Germany, France, Italy and Spain got smaller, suggesting that they were hit harder by the economic crisis than was the U.S. All of the other larger countries are forecasted to get bigger.
Let’s address the U.S./China economic relationship briefly. While all assume that China will eventually surpass the U.S., as a function of population size, and indeed the fad is articles praising the Chinese economy, its education system, its workers, etc, an interesting look might be this: If the U.S. grows at 2.5% from its 2011 forecast for the next ten years and China grows from its forecast at 8%, at the end the U.S. economy will be $19 trillion and China’s will be $13 trillion. Both countries would probably be very happy with these numbers. It would probably be a good thing for the world if China’s economy, given its population, were larger than the U.S. – and India’s as well – but Lester Thurow has now taught us that nothing is pre-ordained. The U.S. has proven that it can drive a $14 trillion economy at 2.5-4% growth per year (more or less). Can China, with a different legal structure and a different constitution, drive a $13 trillion economy at even that rate? Only time will tell.
Why are these numbers important as a starting point?
First, what happens in the U.S. affects the whole world. I pulled some data, according to several objective sources, which ranked the world’s economies for exports and for imports. (I think the data is useful from a relative standpoint, but probably not accurate from an absolute standpoint.) The U.S. buys $1.6 trillion worth of goods from the world every year (approximate 2009 data). We export about $1.1 trillion. (Another source had services adding another $500 billion to U.S. exports. There seem to be many competing sources and interpretations of these global trade numbers.) We can be sure of this. We have been buying a lot more than we have been selling for a long time. We are clearly the world’s largest importer. Many economists fret about the U.S. trade deficit. (The problem is not as obvious to me because of the confusion regarding services.) Clearly, our imports will decline as our purchasing power declines and our exports would likely increase. Are not these the rules of economics? But, just as clearly, much of the world does not want to see our imports decline. Exports make up over 7% of the U.S. economy. Within China’s economy, exports make up about 24%, as it exports $1.2 trillion worth of goods a year. China is clearly now the world’s largest exporter of manufactured goods. But, China also appears to be the second largest importer, at about $1.0 trillion. Japan, incidentally, imports about as much as it exports, at somewhat less than $600 billion. Germany exports $1.16 trillion, almost as much as China, but materially more as a percentage of the size of its economy, or 35%. It imports about $950 billion. India exports less than $200b per year. To the extent that U.S. consumer debt grows or declines it can affect these numbers. To the extent the U.S. consumer is over leveraged, as it has been, a period of de-leveraging will hurt the world economy.
The U.S. trade deficit dropped by about 50% between 2008 and 2009, to about 25% of exports. By the way, as mentioned above, the most typical reports on the trade deficit do not include services, or are very fuzzy on this subject. Services probably add about 1/3 to U.S. exports and reduce the deficit by about 1/3. If you give general business and the consumer credit for that 1/3, then, the U.S. trade deficit can be almost entirely attributed to petroleum related product imports, the greatest amount of which come from our North American neighbors, Canada (20%) and Mexico (12%). (Saudi Arabia is 9%. This particular statistic is for the month of May 2010. )
A second reason is that it is useful to begin a conversation with facts, or at least near facts, because so much of what we hear in the major media is misleading. These huge numbers for GDP and trade are hard to get and the data appear to be a moving target. But this fuzziness, as with the U.S. deficit numbers, makes the relative importance of this data no less important. Our search is for relative truth, not ideological purity.
WHAT THE HELL IS GOING ON?
The debates about the U.S. deficits are not only about
economics. They are about who wins and who loses in
our diversified society. In the final analysis, the debate
is about the defense budget and entitlements.
Entitlements – cash transfers to individuals – are the
heart of the welfare state – and all about who gains and
who loses. Most cash transfers involve social security,
Medicare (health care for the aged non poor) and
Medicaid (healthcare for the poor).
Working to understand what the U.S. spends and where it spends it is not easy. If you Google the 2010 U.S. Budget or go to www.budget.gov to get a copy of the President’s budget message for 2010, entitled A New era of responsibility. I challenge you to come away with 100% confidence that you know how the money is going to be spent. But, in general, with allowance for error, it looks something like this. The 2010 plan is to spend about $3.6 trillion. National defense will consume about $725 billion (20%), which presumably includes the supplemental war funding which for the 2010 calendar year, not the budget year, is $171 billion. Social Security will consume $695 billion (19.3%). Medicare is $453 billion and Medicaid is $290 billion (jointly 21%). Interest on the national debt, the cost of our borrowing paid as surely as your home mortgage, will consume only $175 billion (5%) because interest rates are at record lows. It is exceedingly unlikely that the current cost of funds will stay this low in the future, but who knows. (If you just follow the math in this essay, and raise the cost of borrowing by the Federal Government to 3%, the cost to service the national debt alone will be over $500 billion in ten years. Most estimates I have seen are far more alarming. The commission sees $1 trillion cost of funds ten years out.) Then there is a category called other mandatory spending, which is over $600 billion (16%), which is very difficult to break down, but seems to be dominated by cash transfer programs: food stamps, unemployment, child nutrition, and I am going to leap to an assumption, probably the cost of federal government pensions. (They have to be somewhere.) We have now arrived at 81% of the costs of running the Federal Government. Add in Homeland Security, at $79 billion (2%) and we are up to 83%. The other 23 major agencies (DOJ, Education, Transportation, Dept of State, Energy, etc.) consume only 17% of the budget. Moreover, the other 23 are not the problem. The problem is about, first, the promises made with respect to social security and Medicare/Medicaid, unemployment insurance, pension obligations, and to our lenders who fund our debt; second, the extent to which the military industrial state drives our defense spending; and, third, the general growth of the Federal government, in both absolute size and in compensation, which has been out of step with the times.
With an allowance for wide variation in estimates, apparently the world spends about $1.5 trillion on its military. We account for 43% of that amount (Data I have seen ranges from 40-48%). Our possible enemies – China ($99 billion), Russia ($61 billion), Iran ($9 billion), and Pakistan – account for 11% combined. Our allies: France, U.K., Germany, Japan, Italy, Saudi Arabia account for 19%. So, six of our allies spend almost twice as much as our enemies. Why do we spend four times as much as our enemies? It has become an importantly relevant question. At the same time, it should be mentioned that the percentage of our GDP that goes to U.S. Military expenditures has remained pretty constant since the end of World War II.
So what does all of this mean? Simply put, if you are worried about the deficit you must address the areas that consume 83% of the budget. This comes from the basic analytical tool, cost sensitivity analysis, which I learned at the RAND Corporation in 1968. Assuming that government expenditures have purpose, that there are important beneficiaries for all government expenditures, if you have an expense problem you must attack the big items. Why? Because relatively small changes in big items might get you to a solution. But, even very large changes to the small items will never get you to a solution. There is no possible way to address the U.S. Government deficit problem without fundamentally changing the promises that define these programs, primarily future promises, and even some of those already made, unless you are willing to fundamentally redefine how U.S. Society works.
This year, according to the Deficit Reduction Commission, the U.S. Budget deficit is about 10% of GDP. Our total debt is 62% of GDP. If we continue on our current course, that is, if we continue with all of the promises we have made in those five major areas listed above, by 2020 our debt will be 90% of the GDP forecasted for 2020. There seems no exception to the conclusion that the impact on the global community would be tumultuous if the U.S. Debt reached 90% of its GDP. The Commission uses words like reckoning and devastation to describe what this outcome would mean. The Commission report says that the interest payments on our debt by 2020, ten years from now, will be about $1 trillion per year, twice the number that I modeled above. That number is half again larger than our total expenditures on national security today. They predict that such a trend, carried out to 2035 would reduce per capita income in the U.S. by 15%. They point out that 50% of our public debit is held by non- Americans, the largest of which is China. Admiral Mullins has stated that the number one threat to the national security of the United States is our public debt. In the final analysis, the Commission states that continued inaction is not viable. But, none of the sitting Congress people on the Commission voted for the report. Pelosi declared it a non-starter. Gingrith called it a non-starter. President Obama has said next to nothing.
One might assume from this that the recommendations of the Commission report must have been very harsh. In fact, some in the press referred to them as draconian. Well, you draw your own conclusions from what follows.
Working to understand what the U.S. spends and where it spends it is not easy. If you Google the 2010 U.S. Budget or go to www.budget.gov to get a copy of the President’s budget message for 2010, entitled A New era of responsibility. I challenge you to come away with 100% confidence that you know how the money is going to be spent. But, in general, with allowance for error, it looks something like this. The 2010 plan is to spend about $3.6 trillion. National defense will consume about $725 billion (20%), which presumably includes the supplemental war funding which for the 2010 calendar year, not the budget year, is $171 billion. Social Security will consume $695 billion (19.3%). Medicare is $453 billion and Medicaid is $290 billion (jointly 21%). Interest on the national debt, the cost of our borrowing paid as surely as your home mortgage, will consume only $175 billion (5%) because interest rates are at record lows. It is exceedingly unlikely that the current cost of funds will stay this low in the future, but who knows. (If you just follow the math in this essay, and raise the cost of borrowing by the Federal Government to 3%, the cost to service the national debt alone will be over $500 billion in ten years. Most estimates I have seen are far more alarming. The commission sees $1 trillion cost of funds ten years out.) Then there is a category called other mandatory spending, which is over $600 billion (16%), which is very difficult to break down, but seems to be dominated by cash transfer programs: food stamps, unemployment, child nutrition, and I am going to leap to an assumption, probably the cost of federal government pensions. (They have to be somewhere.) We have now arrived at 81% of the costs of running the Federal Government. Add in Homeland Security, at $79 billion (2%) and we are up to 83%. The other 23 major agencies (DOJ, Education, Transportation, Dept of State, Energy, etc.) consume only 17% of the budget. Moreover, the other 23 are not the problem. The problem is about, first, the promises made with respect to social security and Medicare/Medicaid, unemployment insurance, pension obligations, and to our lenders who fund our debt; second, the extent to which the military industrial state drives our defense spending; and, third, the general growth of the Federal government, in both absolute size and in compensation, which has been out of step with the times.
With an allowance for wide variation in estimates, apparently the world spends about $1.5 trillion on its military. We account for 43% of that amount (Data I have seen ranges from 40-48%). Our possible enemies – China ($99 billion), Russia ($61 billion), Iran ($9 billion), and Pakistan – account for 11% combined. Our allies: France, U.K., Germany, Japan, Italy, Saudi Arabia account for 19%. So, six of our allies spend almost twice as much as our enemies. Why do we spend four times as much as our enemies? It has become an importantly relevant question. At the same time, it should be mentioned that the percentage of our GDP that goes to U.S. Military expenditures has remained pretty constant since the end of World War II.
So what does all of this mean? Simply put, if you are worried about the deficit you must address the areas that consume 83% of the budget. This comes from the basic analytical tool, cost sensitivity analysis, which I learned at the RAND Corporation in 1968. Assuming that government expenditures have purpose, that there are important beneficiaries for all government expenditures, if you have an expense problem you must attack the big items. Why? Because relatively small changes in big items might get you to a solution. But, even very large changes to the small items will never get you to a solution. There is no possible way to address the U.S. Government deficit problem without fundamentally changing the promises that define these programs, primarily future promises, and even some of those already made, unless you are willing to fundamentally redefine how U.S. Society works.
This year, according to the Deficit Reduction Commission, the U.S. Budget deficit is about 10% of GDP. Our total debt is 62% of GDP. If we continue on our current course, that is, if we continue with all of the promises we have made in those five major areas listed above, by 2020 our debt will be 90% of the GDP forecasted for 2020. There seems no exception to the conclusion that the impact on the global community would be tumultuous if the U.S. Debt reached 90% of its GDP. The Commission uses words like reckoning and devastation to describe what this outcome would mean. The Commission report says that the interest payments on our debt by 2020, ten years from now, will be about $1 trillion per year, twice the number that I modeled above. That number is half again larger than our total expenditures on national security today. They predict that such a trend, carried out to 2035 would reduce per capita income in the U.S. by 15%. They point out that 50% of our public debit is held by non- Americans, the largest of which is China. Admiral Mullins has stated that the number one threat to the national security of the United States is our public debt. In the final analysis, the Commission states that continued inaction is not viable. But, none of the sitting Congress people on the Commission voted for the report. Pelosi declared it a non-starter. Gingrith called it a non-starter. President Obama has said next to nothing.
One might assume from this that the recommendations of the Commission report must have been very harsh. In fact, some in the press referred to them as draconian. Well, you draw your own conclusions from what follows.
ESSENTIAL PRINCIPLES OF THE COMMISSION'S REPORT
- America better off tomorrow than today
- Protect the fragile economic recovery
- Don’t just cut expenses. Also, increase investment on educations, R&D, transportation, basic infrastructure
- Protect the truly disadvantaged
- Cut all spending we cannot afford
- Reform and simplify the tax code
- Stop making promises that we cannot keep
- The solutions will be painful for everyone
- Protect the solutions over the long run
I would argue that the essential principles look pretty sound and they should be given the experience, cross section of views and knowledge of the people who sat on the commission.
GOALS
Now let us examine the goals. One would expect the
commission’s goals to be very extreme, given the
across the board negative reaction by elected
politicians and major political leaders. One would
expect that social security would be slashed, the
economic recovery would have been ignored, that our
military would have been materially reduced, that
boatloads of civil servants would be fired, and all sorts of other horrible things. Why not? When GM went
upside down, pension promises were broken, boatloads
of people were fired, factories were closed, and major
auto brands were disbanded. It was horrible. This is
true whenever the leadership of a private sector
company fails its market. It then fails its employees.
And then, its owners. Well, let us examine the goals and
discern for ourselves whether they are draconian.
First, wipe out $4 trillion of the deficit between now and 2020. This is the estimated deficit, sort of the baseline, from the most probable economic plan put forward by the government which, incidentally, includes maintaining the tax cuts for families with incomes below $250,000, but does not include maintaining the Bush tax cuts for families above that level. (Of course, congress and the President recently approved the full package of tax cut retention, plus another bundle of millions for unemployment.) The goal of the Commission is to reduce that plan by $4 trillion, a goal that has already been compromised.
Second, reduce the deficit to 2.4% of GDP by 2015. Not eliminate it in five years, reduce it.
Third, reform the tax code.
Fourth, cap revenue (essentially, taxes) at 21% of GDP by 2015. Taxes are currently running at under 15% of GDP, significantly depressed because of the great recession. Cap spending at below 22% of GDP by 2015.
Fifth, ensure lasting solvency of the social security system.
Sixth, stabilize the debt (i.e., stop the increasing flow of blood) by 2014; reduce the debt to 60% of GDP by 2023, and 40% of GDP by 2035
If these goals are accomplished the results will be these:
First, wipe out $4 trillion of the deficit between now and 2020. This is the estimated deficit, sort of the baseline, from the most probable economic plan put forward by the government which, incidentally, includes maintaining the tax cuts for families with incomes below $250,000, but does not include maintaining the Bush tax cuts for families above that level. (Of course, congress and the President recently approved the full package of tax cut retention, plus another bundle of millions for unemployment.) The goal of the Commission is to reduce that plan by $4 trillion, a goal that has already been compromised.
Second, reduce the deficit to 2.4% of GDP by 2015. Not eliminate it in five years, reduce it.
Third, reform the tax code.
Fourth, cap revenue (essentially, taxes) at 21% of GDP by 2015. Taxes are currently running at under 15% of GDP, significantly depressed because of the great recession. Cap spending at below 22% of GDP by 2015.
Fifth, ensure lasting solvency of the social security system.
Sixth, stabilize the debt (i.e., stop the increasing flow of blood) by 2014; reduce the debt to 60% of GDP by 2023, and 40% of GDP by 2035
If these goals are accomplished the results will be these:
- The deficit will go up in 2011, higher than the government’s current plan.
- In 2012, the deficit will be $949 billion, but it will be $52 billion better than the baseline plan.
- In 2015 the deficit will still be $421 billion, but $357 billion better than plan.
- In 2020 the deficit will still be $333 billion, but $817 better than plan.
- In 2010, the year now ended, outlays (expenditures) will be 23.8% of GDP, revenue 14.9%, and the total national debt 62% of GDP.
- In 2015, outlays will be 21.6 % of GDP, revenue 19.3%, and the national debt will have grown to 70% of GDP.
- In 2020, outlays actually increase slightly to 21.8%, revenue moves up to 20.6%, and the debt for the first time starts to recede, to 65%.
- In 2025, outlays are stable at 21.8%, revenue is up to 21%, and the national debt has been reduced to 57%.
- The debt held by the public (not the U.S. Treasury) is currently $9 trillion.
- In the commission plan, public debt will be $13 trillion in 2015.
SO, WHAT ARE WE LEARNING HERE?
First, while the Commission’s recommendations will
reduce the debt estimated by the government’s
current plan by $4 trillion, the national debt will still rise by $4 trillion in the next ten years. This does not seem
very draconian to me. So if this is a non-starter, what is
the starter? We will come back to this question. For
now, let’s go inside the Commission’s plan and examine
how they get to where they got. My goal is to supply
very representative examples, the major moves, not all
of the fine detail. For that you need to read the
Commission’s report.
The Commission works in six areas:
The Commission works in six areas:
- Discretionary spending cuts
- Corporate tax reform
- Health care cost containment
- Mandatory savings
- Social security
- Governmental process
DISCRETIONARY SPENDING CUTS
As near as I can tell, discretionary expenses are all of
those that do not entail a formal promise by the
government to pay a pension or a health benefit. Social
Security and Medicare/Medicaid are clearly not part of
this category. There may be other government cash
transfer programs that are not included here. But, the
significant point is that 100% of Security spending and
100% of all the major government agencies are
included. Security is defined as Defense, nuclear
weapons, Homeland security, and International Affairs.
The rest of the list includes all of the major government
agencies: Justice, Education, Transportation,
Commerce, Energy, etc.
According to the Commission, security spending is about 2/3 of all discretionary spending. Recall, I said above, that the President’s budget is a really hard read and organizing the data to get an answer to a question like “what is the size of entitlements” is difficult, at least for me. But, if the baseline federal budget is about $3.5 trillion, and if Security is roughly $900 billion (Defense + Homeland Security + nuclear weapons, + foreign affairs), then non-security discretionary expenditures are about $470 billion. Add those two numbers and you get to a little under $1.4 trillion. Therefore, if this is in the range, entitlements + debt service must be in the order of $2.2 trillion, and if you add back in security, the package then totals $3.1 trillion, or 86% of the budget. Which is even more than the 83% estimate discussed above. (Who knows what are the real security expenditures of the U.S. One study I examined estimated that the security expenditures found outside the defense department in other agencies could be over one half billion dollars.)
Democrats don’t want to cut or change the rules governing entitlements and Republicans don’t want to cut Defense. Good luck!
Now, remembering that we are in the middle of a huge crisis, and reflecting for a moment on what happens to private sector companies like GM – which of course was spared an even worse outcome by the government – here are the major recommendations:
According to the Commission, security spending is about 2/3 of all discretionary spending. Recall, I said above, that the President’s budget is a really hard read and organizing the data to get an answer to a question like “what is the size of entitlements” is difficult, at least for me. But, if the baseline federal budget is about $3.5 trillion, and if Security is roughly $900 billion (Defense + Homeland Security + nuclear weapons, + foreign affairs), then non-security discretionary expenditures are about $470 billion. Add those two numbers and you get to a little under $1.4 trillion. Therefore, if this is in the range, entitlements + debt service must be in the order of $2.2 trillion, and if you add back in security, the package then totals $3.1 trillion, or 86% of the budget. Which is even more than the 83% estimate discussed above. (Who knows what are the real security expenditures of the U.S. One study I examined estimated that the security expenditures found outside the defense department in other agencies could be over one half billion dollars.)
Democrats don’t want to cut or change the rules governing entitlements and Republicans don’t want to cut Defense. Good luck!
Now, remembering that we are in the middle of a huge crisis, and reflecting for a moment on what happens to private sector companies like GM – which of course was spared an even worse outcome by the government – here are the major recommendations:
- Three year pay freeze on all federal employees and civilian members of the Defense Department. No headcount cuts. A freeze. Currently, 10% of the American work force has no jobs.
- Between now and 2015, for every three employees who leave their jobs, only two replacements will be allowed. In short, the government must begin to show the productivity improvements that the private sector has delivered since the Reagan recession thirty years ago. This is how the commission wants to get to a 10% reduction in the work force. Government employees are not getting fired. They are being asked to work smarter.
- No earmarks. Eliminating earmarks will not put much of a dent in the deficit. But, it is an attitude thing!
- Add to the funding of federal transportation goals and requirements through a 15-cent increase in the gasoline tax. From that point forward, limit transportation funding to the funds collected by the Transportation Fund. Oh, and in case this might be viewed too painfully by Americans, don’t begin to phase in this additional tax revenue until 2013, and take until 2015 to fully phase it in.
- The expenditures in the year 2012 must be equal to what we spend this year, 2011.
- But, by year 2013 we need to have backed off to the expenditure level of 2008, the year the Great Recession hit, and the year before the government did everything it could to stimulate the economy in 2009 and 2010 and 2011.
- After 2013, allow discretionary expenditures to increase at 1/2 the rate of inflation.
TAX REFORM
Recall that in the plan the revenue collected by the
government will increase by over 6 percentage points
from what it will collect in 2010 to what it hopes to
achieve when it hits the new base line of under 22%. In
other words, tax reform is not about reducing anyone’s
taxes. It is about making the tax system more efficient.
Let’s pause on this for a moment. As we all know, the tax system has been used for a long time to implement specific social agendas. Many times, the public doesn’t even understand the social purposes behind these programs. Every tax break is a social agenda. So the Commission refers to this as a tax expenditure and regards these expenditures as no different from other governmental expenditures. Tax expenditures add up to $1.1 trillion dollars a year. The Commission wants to see a material reduction in the use of tax breaks to engineer social policy because it is confusing, inefficient, and frequently duplicitous. In addition, many tax breaks simply serve the interests of very small groups of people who have significant influence in Washington, and spend a great deal of money every year making sure that their side of any argument is heard. In and of itself, this is not a bad thing. I fact, I would argue that these groups provide essential information. Elected representatives are not experts at very many things. The world is very complex. Officials need quality information. And, more times than not, these people who work the fourth estate in Washington do educate, and do contribute to better decision making. But, the Congressional response to the lobbying process is not always so enlightened.
Let me add a word on inefficiency. There are three legs of economics: growth, allocation, and distribution. Economic growth determines the size of the pie. Basic government policy ought to be to maximize economic growth within the constraints of the culture. Resource allocation is where capital moves to find its greatest return, between sectors, among individuals, and so forth, and growth is the result of that allocation. Distribution is where the wealth falls among sectors and individuals, be it income or assets. (I suspect an economist might not favor my simplicity but I think it is close enough to being accurate to make my point.) Now, what has happened in the U.S. for years is that public officials, unhappy with the way resources end up being distributed, but unwilling to be honest with the public about its intentions, have used the tax system to cause a non market based allocation of capital in order to cause a different distribution outcome. This causes an inefficient allocation of capital and therefore, it follows, a smaller absolute pie. Now, I have no issue with the need in modern society to balance out the share of wealth among its citizens. But, it would be better in terms of maximizing the size of the pie if this were done directly, through actual transfers, than indirectly and disguised, through the tax system. The question is, could the public handle such honesty, such transparency? In any case, this is the inefficiency pointed to by the Commission, though the report does explain it this way.
So, below are the major things the Commission wants to do:
Let’s pause on this for a moment. As we all know, the tax system has been used for a long time to implement specific social agendas. Many times, the public doesn’t even understand the social purposes behind these programs. Every tax break is a social agenda. So the Commission refers to this as a tax expenditure and regards these expenditures as no different from other governmental expenditures. Tax expenditures add up to $1.1 trillion dollars a year. The Commission wants to see a material reduction in the use of tax breaks to engineer social policy because it is confusing, inefficient, and frequently duplicitous. In addition, many tax breaks simply serve the interests of very small groups of people who have significant influence in Washington, and spend a great deal of money every year making sure that their side of any argument is heard. In and of itself, this is not a bad thing. I fact, I would argue that these groups provide essential information. Elected representatives are not experts at very many things. The world is very complex. Officials need quality information. And, more times than not, these people who work the fourth estate in Washington do educate, and do contribute to better decision making. But, the Congressional response to the lobbying process is not always so enlightened.
Let me add a word on inefficiency. There are three legs of economics: growth, allocation, and distribution. Economic growth determines the size of the pie. Basic government policy ought to be to maximize economic growth within the constraints of the culture. Resource allocation is where capital moves to find its greatest return, between sectors, among individuals, and so forth, and growth is the result of that allocation. Distribution is where the wealth falls among sectors and individuals, be it income or assets. (I suspect an economist might not favor my simplicity but I think it is close enough to being accurate to make my point.) Now, what has happened in the U.S. for years is that public officials, unhappy with the way resources end up being distributed, but unwilling to be honest with the public about its intentions, have used the tax system to cause a non market based allocation of capital in order to cause a different distribution outcome. This causes an inefficient allocation of capital and therefore, it follows, a smaller absolute pie. Now, I have no issue with the need in modern society to balance out the share of wealth among its citizens. But, it would be better in terms of maximizing the size of the pie if this were done directly, through actual transfers, than indirectly and disguised, through the tax system. The question is, could the public handle such honesty, such transparency? In any case, this is the inefficiency pointed to by the Commission, though the report does explain it this way.
So, below are the major things the Commission wants to do:
- Simplify the tax code, broaden the base, and lower tax rates
- Continue the practice of progressivity in our tax code, that is, the more money you make the higher percentage of your income you pay to the government. This is called fairness, and I for one, agree. (Note: While about 40% of all the people who file Federal income taxes pay zero federal tax, we must acknowledge that the FICA tax is just another way to pull revenue into the general fund and it is a highly regressive tax. Let’s relax and accept the view that this probably balances out the fairness score.)
- Lower tax rates from the current three tiers of 15%, 28%, and 35% to 12%, 22%, and 28%
- Complete the phasing in by 2012. (In other words, don’t threaten the fragile recovery.)
- Deductions would go down, but so would everyone’s tax rate
- Reform corporate tax rates to make America the best place to start a business and create jobs
HEALTH CARE COST CONTAINMENT
I cannot do a very good job of representing the
Commission’s views on this subject. In fact, this is an
extraordinarily difficult subject. Even people like Pete
Peterson, the ultimate insider with a resume too heavy
to lift, former secretary of Commerce, Co-Chairman of
Blackstone Group, and author of Running on Empty,
who has paid enormous attention to the government’s
fiscal problems, does not have a simple answer for the
containment of the cost of health care. In the end,
health care delivery is probably plagued by about
everything that could go wrong with a budget:
excessive consumer expectations, no purchasing
discipline, no supplier discipline, a fundamentally
broken pricing system for such a large sector of private
enterprise, overuse of expensive technology, systemic
structural inefficiency, over promising by the
government, and so forth. Wow, that’s a long list.
But, at the same time, the usage and cost trends lead to an unmistakable conclusion. Something has to change because health care costs will just about crowd out any proportionality with other needs within twenty years if we do not do some things differently. The Commission, comprised about equally of Democrats and Republicans seems not to believe that the new health care bill will reduce costs.
Their macro recommendations point toward:
But, at the same time, the usage and cost trends lead to an unmistakable conclusion. Something has to change because health care costs will just about crowd out any proportionality with other needs within twenty years if we do not do some things differently. The Commission, comprised about equally of Democrats and Republicans seems not to believe that the new health care bill will reduce costs.
Their macro recommendations point toward:
- More cost sharing among all of the participants: suppliers, patients, governments, providers, employers, etc.
- Reform of malpractice laws, viewed to be way excessive, in order to reduce the cost of the practice of medicine
- Reforms to how physician payments are defined, processed and approved
- Reforms to prescription drug costs, undoubtedly involving again all of the players.
MANDATORY SAVINGS
The Commission is very direct in telling the Country
that we spend money on things we don’t need and
cannot afford.
- Agriculture subsidies haven’t been necessary for any social purpose for years. They need to be greatly reduced if not eliminated.
- The civilian and military retirement systems need to be modernized. Defined benefit programs are a relic of the past when public employers were not able to pay a competitive wage – the politicians knew that the voters would reject their social policies if they had to pay the full price – so enticed people to come to work because of the retirement packages which were hidden from the public. The politicians made the social policy they wanted and the public never knew it because the real costs were all back loaded.
- Caveat. Jerry Brown just submitted his $86 billion budget for California, which increase taxes by $12 billion and reduces expenditures by $12 billion. But a recent study done by Stanford University estimates that the unfunded pension obligations of just the State government of CA are now almost six times the annual budget, or about one-half a trillion dollars.
- These are just the obvious highlights. The Commission makes countless recommendations.
SOCIAL SECURITY
The Commission wants social security reformed for its
own sake. In effect, social security is supposed to be a
self-funded operation. Whether it is or isn’t, the term is
a mathematical model, not a banking model. There is
no money in the social security trust fund. Taxes from
social security are used on a cash basis to help fund all
of the government, including current obligations of the
Trust Fund. These realities are all calculated into the
narrative so I would not wish to waste a lot of time with
it. The bottom line is that the mathematical model of
solvency must be enforced and we are getting closer
and closer to the point where even that will not be true.
Every thinking person knows the reality here. Life expectancy has increased enormously in the past seventy years. The initial idea, which was to help people throughout the last five or so years of their life, is now an idea to help people for fifteen or twenty years. A later idea, which was to annually increase social security benefits to keep them constant with rising real costs became, in later years, an idea to give recipients an annual raise in real dollars. That specific policy adjustment of more than a decade ago destroyed the solvency of social security.
The Commission points to what is obvious if people would just face the facts and incur a shockingly small amount of disappointment:
Every thinking person knows the reality here. Life expectancy has increased enormously in the past seventy years. The initial idea, which was to help people throughout the last five or so years of their life, is now an idea to help people for fifteen or twenty years. A later idea, which was to annually increase social security benefits to keep them constant with rising real costs became, in later years, an idea to give recipients an annual raise in real dollars. That specific policy adjustment of more than a decade ago destroyed the solvency of social security.
The Commission points to what is obvious if people would just face the facts and incur a shockingly small amount of disappointment:
- By 2027, sixteen years from now, move the retirement age up to 67
- By 2050, thirty-nine years from now, up it to 68
- By 2075, sixty-four years from now, up it to 69
- Align the COLA increase (cost of living) with the chained CPI (consumer price index) which is known to be a more accurate measure of cost increases that the indexes used today, which are much more aligned to income indexes. In short, keep recipients in alignment with increased costs. Do not give recipients a raise. Their pension payments are determined by how much they earned and are very progressive to make sure that lower earners get a higher percentage of their earnings in retirement than do higher earners.
- Make it more progressive
- Stop double dipping. If you receive governmental retirement benefits of a certain type you cannot also receive social security.
PROCESS
Explaining this is easy, doing it will be hard. The short
explanation is that Congress and the President need to
decide on a plan and they also need to define the enforcement process that will keep the plan from
unraveling at the urging of the next Congress, or the
one after, where memories are short and political
needs are great.
ONE READER'S CONCLUSION
- I think the Commission report was a great start. It is adult, it is honest, and it is gradual. It seems to be fair. It is loaded with evidence. If it were I, I would probably adopt it as is.
- I think that the politicians cannot be allowed to ignore this report. There are no more rocks to look under. There are no simple answers if we want to have a society that is a close approximation to that which we have had since our origin. Do we??
- In effect, Brazil monetized their national debt. They ran an annual inflation rate of greater than 2500% between 1980 and 1994. In 1981 it was 100%. In 1984 it was 192%. In 1988 it was 629%. In 1990 it was, hold your breath, 30,377%.
- They defaulted on their sovereign nation debt.
- They couldn’t import many goods because their currency had little value. They actually had to learn how to build automobiles, airplanes and computers because they could not buy these goods from abroad.
- Per capita GDP barely grew during those years. The country stood still for almost twenty years.
- The poor became worse off
- Eventually, the Country survived.
But,
- The world economy did not depend on Brazil
- World stability did not depend on Brazil’s military
- For the United States, for whom much has been given, much is expected. Charlie Munger, Warren Buffett’s partner, has consistently spoken out over the past couple years about the moral obligations of the United States to get its house in order. The United States wanted the role of world leader. Now it must live up to that role. Any other option is morally bankrupt according to Charlie.
ACTION
Perhaps instead of being bored by a useless debate, we
should encourage the Democrats to propose a
Congressional resolution to approve all of the tax
increases of the Commission’s report (years 2012-
2020, these add to $1.170 trillion), and to reject all of
the expenditures reductions. Then we will know where
they stand. Next, we should encourage the Republicans
to approve all of the expenditure reductions in the
report (same time period = $2.218 trillion) and reject all
of the tax increases. Now we should ask each, have you
solved the problem? If not, what are you prepared to
walk away from? The Commission tried to balance the
pain. Does Congress have the ability to improve on
their model and get at least as strong an outcome?
Does the White House? Inaction cannot be tolerated!
I have been struck by the simplicity of the reporting in the press and the media on the Commission’s report. Facts are reported selectively. Headlines are created that cannot be defended by the story. Passion has been absent. The media doesn’t seem to want to educate. Maybe it doesn’t know how to do that.
If you found this essay helpful perhaps you ought to route it onward. Maybe we would be served well if more and more people actually had the facts that surround this essay.
It is now up to you.
I have been struck by the simplicity of the reporting in the press and the media on the Commission’s report. Facts are reported selectively. Headlines are created that cannot be defended by the story. Passion has been absent. The media doesn’t seem to want to educate. Maybe it doesn’t know how to do that.
If you found this essay helpful perhaps you ought to route it onward. Maybe we would be served well if more and more people actually had the facts that surround this essay.
It is now up to you.
