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The main driver of the growth, however, is interest spending—the bar tab for our binge. The CBO projects that in the next 70 years, public money spent on interest will grow from 1.4 percent of GDP (or $204 billion in 2010 dollars) to almost 41.4 percent of GDP (or $27.2 trillion in 2010 dollars). In the short term, the cost of our debt will reach 3.8 percent of GDP by 2020 and 7 percent of GDP by 2030. Today spending on interest represents about a third of the cost of Social Security; in 20 years it is expected to exceed the cost of that program.
The 19 Percent Solution
As noted, annual federal revenue since 1950 has averaged just under 18 percent of GDP. Sometimes the percentage is a bit lower, and sometimes it is a bit higher. In 2010, for instance, due to the weak economy, revenue was only 14.5 percent of GDP. Under Bill Clinton, revenues reached 19.9 percent, 19.8 percent, and 20.6 percent between 1998–2000, helping to produce surpluses. Such upticks are typically short-lived, and to the extent that they produce surpluses, political pressure inevitably builds to reduce revenue levels or return the money to taxpayers in one form or another—through rebates, tax cuts, or increased spending. It’s worth remembering that both major-party candidates campaigned on tax cuts during the 2000 election.
Under the CBO’s basic projection, which amounts to little more than running numbers supplied by politicians, federal revenue will rise to 20 percent of GDP in 2015 and then climb even higher, reaching 21 percent in 2020 and 22.3 percent in 2030. If history is any guide, such estimates are pure fantasy. Under the CBO’s more realistic “alternative scenario,” federal revenue will equal about 19 percent of GDP within a few years and then stay around that level. Even that projection is a bit of a stretch, to judge from the last 60 years, but it is far more plausible than the basic projection. For the purposes of this budgeting exercise, we are willing to give the alternative forecast the benefit of the doubt.
So as a starting point, we assume that federal revenue will be about 19 percent of GDP in any given year. To put that into plain numbers, the GDP in 2010 was about $14.6 trillion. If the government spent 19 percent of GDP, it would have spent no more than $2.8 trillion, as opposed to the $3.6 trillion it actually shelled out. (We use fiscal year 2010 figures because, as of this writing, no federal budget has been passed for fiscal year 2011.) Federal spending will vary from year to year, especially in response to such unpredictable events as natural disasters, recessions, and acts of war. But like a family that dips into savings or lives on credit cards during short downturns, the government can survive such swings from time to time.
In absolute dollars, getting to 19 percent immediately would mean cutting $829 billion out of the budget, which isn’t a politically realistic target at the moment. Getting to 19 percent within a few years, though, would require a series of far smaller cuts because of the expected economic recovery. One of the tasks assigned to Obama’s debt commission was finding ways to close the primary spending gap (the deficit excluding interest payments) in 2015. That would mean cutting about $243 billion from a budget projected to be $4.1 trillion.
That’s a 5.9 percent reduction, the sort of cut that many businesses and households have managed relatively easily during the recession. In its “A Thousand Cuts” study, the Center for American Progress lays out (with reservations) a series of spending cuts that total $255 billion in current dollars. The trims include a 75 percent reduction in farm subsidies (saving $11 billion), a 12.5 percent cut in military spending (saving $96 billion), and $53 billion in terminated “tax expenditures”—spending done through the tax code such as the child tax credit or the home mortgage interest deduction.
The president’s debt commission suggested $200 billion in discretionary cuts for 2015, including closing a third of America’s overseas bases ($8.5 billion), freezing noncombat pay for three years at 2011 levels ($9.2 billion), freezing federal pay at nonmilitary agencies for three years at 2011 levels ($15 billion), and eliminating 250,000 nonmilitary contractors ($18 billion). They also suggested reductions in mandatory spending, including the use of a lower-cost “chained Consumer Price Index” to adjust entitlement spending and a plan to fix cost-of-living adjustments for military retirees. All told, they came up with about $56 billion in cuts to mandatory spending for 2015. It should be noted, though, that these cuts are only cuts in name, as the final Deficit Commission plan increases spending by $1.6 trillion in the next 10 years. (The CBO assumes $2 trillion in increases.)
In a related exercise, the Committee for a Responsible Federal Budget, a bipartisan nonprofit housed within the left-leaning New America Foundation, has called for balancing the budget in 2020, when revenue is expected to equal 19.3 percent of GDP under the CBO’s alternative scenario. GDP that year is projected to be $19.5 trillion, which means federal outlays should not exceed $3.8 trillion in a balanced budget. To reach that goal would require cutting about $1.3 trillion from projected spending increases during the next decade, or about $129 billion annually out of budgets projected to average around $4.1 trillion. Due to variations in individual budgets and various effects of compounding, that works out to reductions of about 3.6 percent a year. To give you a clearer sense of what getting to 19 percent of GDP means, Figure 4 shows how much needs to be cut each year from six areas of the budget.
On its face, freezing spending at 2010 levels in nominal dollars would also create a balanced budget in 2020. But it would not prepare the country for the explosion in Medicare spending expected after 2020. Furthermore, using 2010 spending levels as a starting point means locking in the spending increases of the last decade. That’s true too of using 2008 spending levels, which the GOP House leadership pushes for in its Pledge to America.
The spending increases since Bill Clinton left office have been gigantic. Under George W. Bush and Barack Obama, in constant 2010 dollars, military spending during the last decade increased by 75 percent, Medicare by 75 percent, and Social Security by 37 percent. Some of the increases reflect demographic changes: As the country ages, the number of retirees will increase, and the payouts for old-age entitlements will rise. But the last decade saw no demographic shifts that justify anything like the spikes in spending shown in Figures 5 and 6. More to the point: Precisely because the country is aging, we need to seriously reform entitlement spending lest it swamp every other aspect of government. In 2030, with the baby boom fully in its dotage, the U.S. Census Bureau projects that nearly 20 percent of the country will be 65 or older.
If we were going to peg future outlays to a budgetary baseline from the past, we would do far better to use the 2000 federal budget as a guide. The final year of the last century was a pre-recession year, and it is recent enough to dismiss any complaints that everyday life has changed dramatically since then. Few people were complaining at the turn of the century that our federal spending was at a dangerously low level that did not support the needs of the nation.
Figure 7 compares projected spending in 2020 under the CBO’s alternative scenario to what 2020 levels would be if they were based on 2000 spending as a percentage of GDP. In 2000, for instance, military spending was $294 billion, 3 percent of that year’s GDP. In 2020 GDP is expected to be $19.5 trillion, so military spending based on 2000 levels would equal 3 percent of $19.5 trillion, or $585 billion.