A value-added tax, a soda tax, a gas tax, banning earmarks, freezing a portion of federal spending at "pre-stimulus" levels - there’s no shortage of ideas being thrown out to fix the country’s disastrous balance sheet, which threatens not just near-term economic recovery but the possibility of long-term growth. Like last week's report from the president's Commission on Fiscal Responsibility and Reform, most of the current plans to fix the country's finances rely more on increases in revenues than on cuts in spending. In part due to its heavy reliance on revenue hikes, the commission, charged with balancing the budget by 2020, failed to win enough votes of its own members to present its recommendations to Congress.
Which raises the question: Can America really reduce its debt and deficit without raising taxes to job-killing rates or cutting essential services to developing-world levels? The answer is not simply yes, it's that we have to.
Raising government revenue - taxes - substantially is not only bad policy, it has proven difficult and ultimately unsustainable for any length of time in the past 60 years. Since 1950, annual government revenue, as a percentage of Gross Domestic Product (GDP), has averaged just below 18 percent despite every attempt to jack it up or tamp it down. Our post-World War II experience shows that if the government is going to live within its means, it can't spend much more than 18 percent of GDP. Period.
Which is one reason to be happy that the debt commission's recommendations won't be presented to Congress anytime soon. The report assumes revenue equal to 21 percent of GDP and struggles to get spending to "below 22% and eventually to 21%" of GDP. That’s a recipe for disaster that would guarantee deficits and red ink.
Similarly, former Sens. Bill Bradley, John Danforth, and Gary Hart, working with the Committee for a Responsible Budget, have offered up a plan to balance the budget by 2020 that relies on revenue hitting 20.8 percent of GDP, a level that hasn't been achieved once in the past 60 years. Republicans have not advanced any realistic near-term plans. Rep. Paul Ryan's (R-Wisc.) Roadmap to the American Future does not balance the budget until 2063. The pre-election GOP’s Pledge to America is worthless since it fails to provide specifics (and to the extent it does, it is no good).
The current situation is a bipartisan disaster that requires immediate action. Since Bill Clinton left the White House in 2001, total federal spending has increased by a massive 60 percent in inflation-adjusted 2010 dollars. In fiscal year 2010, which ended September 30, the federal government spent $3.6 trillion, or 25 percent of Gross Domestic Product. That’s the most spending, in terms of percentage of GDP, since 1946. Likewise, last year’s $1.5 trillion deficit, as a percentage of GDP, was the largest deficit since 1945.
Most economists talk about a debt-to-GDP ratio of 60 percent as a trigger point that makes investors very nervous about a country's ability to pay its obligations. The debt to GDP ratio was 63 percent this year and the Congressional Budget Office (CBO) projects it will be 87 percent in 2020. Just three years ago, it was 36.5 percent. Not good signs.
So, what would it take to bring federal spending into line with plausible levels of revenue?
The CBO, the non-partisan agency charged with estimating the effects of legislation on government costs, has produced a long-term budget outlook in which Bush-era tax rates remain unchanged. Their conclusion is that over the next decade, "government revenues would remain at about 19 percent of GDP, near their historical averages." That's actually a bit higher than the historical average, but is within the bounds of reason.
A balanced budget in 2020 based on 19 percent of GDP would mean $1.3 trillion in cuts over the next decade, or about $129 billion annually out of ever-increasing budgets averaging around $4.1 trillion. Note that these are not even absolute cuts, but trims from expected increases in spending.
To get a more concrete sense of what getting to 19 percent means, here is a table of projected major budget expenditures in total dollars, followed by the amount that needs to be cut each year from the expected budget to get an annual 3.6 percent decrease across the board.
Looking at the chart below, the question becomes: Could you, say, find $129 billion dollars of cuts in a 2016 budget that squeezes through the door at $4.3 trillion?
Congress hasn’t even begun real work on the 2011 budget, even though the fiscal year started in October (the government is currently being funded by short-term continuing resolutions; the next one expires on December 18). If they want to get serious about staving off the uncertainty, tax increases, and unrestrained spending that are sure recovery killers, they could put us on a path to a balanced budget right now.