Here’s an appalling snapshot: During fiscal year 2010, which ended on September 30, the government spent around $3.6 trillion, or 25 percent of gross domestic product (GDP), while collecting $2.1 trillion in tax revenue, or 14.5 percent of GDP. The resulting deficit was $1.5 trillion. The total debt held by the public—the sum of all accumulated annual deficits and interest payments—reached 63 percent of GDP.
You have to go back to 1946, in the immediate aftermath of World War II, to find spending that was as large a percentage of GDP. You need to return to 1945 to find a deficit that big on a percentage basis as well. Just a few years ago, in 2007, the debt was 36.2 percent of GDP. If current trends continue, the Congressional Budget Office (CBO) projects, the number will reach 87 percent in 2020. Most economists talk about a debt equal to 60 percent of GDP as a trigger point where investors become very nervous about a country’s ability to pay its obligations.
Given all this, it’s good that all sorts of people—even the politicians responsible for the problem—are beginning to take spending seriously and even tentatively propose some action. The animating message of the unexpectedly successful Tea Party movement has been to stop the spending. In 2010 Rep. Paul Ryan (R-Wis.) unveiled his “Roadmap for America’s Future,” which seeks to eventually balance the budget by reducing entitlement spending. Weeks before the November midterm elections, the presumptive speaker of the House, Rep. John Boehner (R-Ohio) released the GOP’s “Pledge to America,” which declared that “the need for urgent action to repair our economy and reclaim our government for the people cannot be overstated.” President Barack Obama convened a National Commission on Fiscal Responsibility and Reform that in December recommended ways to eliminate the primary spending gap—the difference between revenues and total government outlays minus interest payments on the federal debt—by 2015 and actually balance the full budget by 2020. Esquire magazine pulled former Sens. Bill Bradley (D-N.J.), John Danforth (R-Mo.), and Gary Hart (D-Colo.) out of retirement to gin up a package that would balance the budget by 2020. The liberal Center for American Progress, chaired by Clinton administration Chief of Staff John Podesta, has weighed in with a proposal of its own.
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Unfortunately, the plans produced to date are severely lacking. The Tea Partiers’ hearts may be in the right place, but the decentralized movement has yet to deliver any specifics. The GOP pledge is a laughable and already forgotten document, explicitly ruling out cuts in military spending (one of the biggest budget items) and implicitly taking other big-ticket items such as Medicare and Social Security cuts off the table as well. Under the best of circumstances, Paul Ryan’s plan, pilloried by detractors as “radical,” does not balance the budget until 2063. Radical, that ain’t.
John Podesta believes cutting $255 billion—the primary spending gap—from a projected 2015 budget over $4 trillion would “eviscerate the middle class.” So his group’s plan features major tax hikes instead, coupled with relatively small spending cuts. The Esquire program opts for tax hikes too. The presidential debt commission’s final report called for serious cuts to defense and other programs but increased gas taxes and raises the amount of salary subject to payroll taxes. More problematically, its plan depends on hiking federal revenue as a percentage of GDP to at least 21 percent, a level that has never been sustained at least since World War II. A majority of commission members endorsed the plan but not the requisite number needed to present its recommendations to Congress for action. You can almost feel the conventional wisdom hardening like an old man’s arteries. “Conservatives must accept that tax increases need to be on the table to achieve fiscal stability,” wrote Washington Post columnist Ruth Marcus in November. “Liberals must accept that promised entitlement benefits are not affordable and must be pared.” This formulation may sound sensible, but any plan that relies on significantly raising average annual federal revenue is based on fantasy. Since 1950 annual federal revenue has averaged 17.8 percent of GDP, fluctuating within a relatively narrow range (see Figure 1). Despite endlessly creative attempts to squeeze more dollars out of taxpayers, the feds haven’t been able to pull in much more than that on a regular basis.
There’s a better way to balance the budget, one that wouldn’t raise revenue levels above historic averages or “eviscerate” anything other than bloated spending. To get there, though, we’ll need to lay out the basic facts without flinching, especially when it comes to realistic projections of revenue.
Giving Washington yet more money will grant it more power over the economy, but it won’t guarantee anything resembling a balanced budget. That’s because federal spending has little connection to revenue levels. The feds can spend more than the available revenue by literally printing money or by taking on massive levels of debt that future generations of Americans will have to pay off.
The federal budget (see Figure 2) has two basic parts, each accounting for about half of total outlays. “Mandatory” spending includes entitlement programs, such as Medicare and student loans, whose funding is automatic under current law. Some major entitlement programs—most notably Social Security—are “off budget,” meaning they are not included in the official spending numbers, making it that much more difficult for taxpayers to understand what’s going on. Politicians like to call such outlays “mandatory” because it implies they have no control over that part of the budget, but they can always change the laws that govern the entitlement programs.
The second part of the budget is “discretionary” spending, which includes things such as homeland security, most military spending, and programs such as farm subsidies and aid to schools. Discretionary spending is what the president and Congress decide to spend each year through appropriations bills. Because items come up for annual votes, they are theoretically easier to increase or decrease than programs in the mandatory part of the budget.
In fiscal year 2010, the federal government spent 25 percent of GDP, well above the historical average. Since 1950 annual expenditures have averaged just under 20 percent of GDP. According to the CBO’s “alternative scenario” budget projection—which assumes the most likely policy changes, including legislators’ concessions to interest groups such as doctors and senior citizens—spending at its current trajectory will increase to 26 percent of GDP in 2020 and to 32 percent in 2030.
The costs of Medicare, Medicaid, and Social Security are an important force behind this growth (see Figure 3). According to the CBO’s alternative scenario, the combined cost of these three programs was roughly 10 percent of GDP in 2010 but will reach 12.4 percent in 2020 and 15.7 percent in 2030.