May 9, 2011
Glide Path to Federal Budget SustainabilityBy Greg Richards
A glide path for federal spending to return the federal budget to break even, which is the same thing as long term sustainability, is possible. One must look at the budget in terms of percents of GDP. We are not looking at programs piece by piece but rather at what resources the country can provide for those programs.
The reason why using percents of GDP to analyze the federal budget is so powerful is that whatever your policy preferences, there is only so much money -- there is only 100% of GDP at the limit. And on a practical level, if the US of A is to remain a free enterprise country, with all that implies, federal spending has to be a small subset of 100% -- about 19% according to Hauser's Law, which is based on the country's historical experience of the amount of GDP raised through various different tax structures over a long period of time. If you accept 19%, and the logic of the situation is that it must be close to 19% if the economy is going to be free to grow...then all you have to spend is 19% X GDP. That's it! No matter how much arm-waving you do, that is all there is.
In 2011, the federal government will spend 25.4% of GDP, a non-war all-time record. The arithmetic to get from where we are, 25.4% of GDP, to where we want to be, 19.0% of GDP, is:
25.4% - 19.0% = 6.4%
So, we want to reduce federal spending by 6.4% of GDP. Let's think in terms of 1% per year. We have more than 6 years -- more than 6% to reduce -- so let's take the time frame of 7 years, cutting spending as a percentage of GDP by 0.9% per year. This is our "glide path" to sustainability and is shown in Chart I:
If I were to be asked what we should try to get out of the bargaining over raising the debt ceiling, it would be Chart I. We should get the other side to agree to a glide path back to 19% of GDP and enforce it by only agreeing to raise the debt ceiling by the amount of debt the model requires for each year. I.e., raise the debt ceiling for only a year to assure that we are, each year, on the glide path agreed to.
Chart II shows assumptions for GDP over this period, and the consequent federal budget when those GDP figures are multiplied each year by the percents in Chart I:
Right away, the reader sees that under our glide path of reducing the percent of GDP spent by the federal government each year, even with growing GDP there is not much growth of the federal budget in dollar terms over this seven year period. In point of fact, there is some growth in the federal budget.
In 2011, the federal budget is an estimated $3,825 billion and in 2018 it is an estimated $4,025 billion, or growth of $200 billion. That is not $200 billion per year, but $200 billion over seven years. Doubtless, experts on federal spending in Washington will say that such restraint is not practical. But the point of this exercise is that this is what the numbers say needs to be done if we are to save the country. I am not offering my personal opinion so much as showing the inescapable logic of the numbers. Of course, after we have federal spending back to 19% of GDP in 2018, federal spending can resume growth at the same rate as GDP.
Chart I was not constructed by reviewing all the programs the federal government is engaged in. Rather it shows what the constraints on federal spending have to be if we are to return the country to solvency. But let's just take a quick look at how the major categories of federal spending look on this glide path (the top line in Chart III, the line at the top of the Social Security category, is exactly the same line as in Chart I):
This chart may look cool and calm, but it is a revolution. It means that every major spending category except for defense needs to be restructured to get federal spending back down to 19% of GDP. For instance, in a previous AT essay ("Cutting the Federal Budget"), we cut "Other" (most of what you think of as government) to fit this model by cutting out entirely the Departments of Education, Energy (non-nuclear), and Housing and Urban Development and cutting federal civilian employee compensation by 10%.
Left unchanged, the entitlement categories would explode way beyond the limits shown here. This problem is what Paul Ryan is wrestling with. The point of doing this chart is to show what these programs need to look like if we are not going to financially ruin the country. These are not "my" numbers; these are "the" numbers; they cannot be escaped. And this is a crisper way of showing what the solution has to look like than vague statements of trillions of dollars of "savings" (from projected spending) over a decade. After the mumbo jumbo, the numbers have to look something like this.
Chart III is in percent of GDP. Chart IV shows how this looks in dollars (the top line in Chart IV, the top line of the Social Security category, is the same line as the red line in Chart II):
Note the constraints on spending growth of major programs with the exception of defense and interest over the next seven years, according to the glide path model. Whether this is politically realistic I cannot say, but it is what the logic of the numbers requires if we are going to bring the budget back into balance. And note that we have allowed for a seven year glide path, meaning that we are using a relatively long period, particularly given the danger that out-of-control spending poses to the future of the country.
The reader might like to see what the federal deficits would look like over the next seven years according to the glide path model. This is shown in Chart V:
Even with what experts are going to call our "extreme" control of spending, we still have budget deficits of over $1 trillion until 2015!
In our model, the federal deficit goes from $1,645 billion this year to zero in 2018. There is one element here the reader doesn't see. Apart from our exercise in bringing spending down from 25.4% of GDP to 19.0% of GDP, we have brought tax receipts up to 19% of GDP over the same period. That is, after all, where the 19.0% comes from -- it is the historical level of tax revenues that we have achieved over time, and it is actually a rounding up of that number. That is why the deficit goes to zero in 2018: we have not only brought spending under control but "off-stage" we have also brought revenues up to 19% of GDP. That process is not included in this paper, except for its results.
Chart VI shows what changes in net federal debt created by the deficits in Chart V -- our glide path -- would look like:
Net debt in 2011 is estimated to be 11.0 trillion and even with our program, still grows to an estimated $16.1 trillion in 2018. And that's with our very aggressive limiting of the growth of federal revenues!
One of the very dangerous elements of net federal debt is that because of the economic environment and Federal Reserve policy, the federal government is paying unusually low interest rates. The estimated interest rate on net federal debt this year is only 1.8%.
We estimate that interest rates will increase over the next seven years to 3.5%. Given the risk of inflation from current monetary policies, this is not that aggressive an assumption.
Chart VII shows our estimates for interest payments by the federal government over the next seven years, given the estimates for net federal debt in Chart VI. These interest payments are also included as the bottom category in Charts III (in percent of GDP) and Chart IV (in billions of dollars). Chart VII is an expanded view of the interest category in Chart IV:
We have already calculated above that the federal budget can only grow by $200 billion during the glide path period. Chart VII shows interest expenses are estimated to grow by $350 billion over this period, meaning that some other categories of spending have to decline during the glide path period.
The other way to look at the load that net federal debt is putting on the country is to consider it as a percent of GDP. This is shown in Chart VIII:
In this model, net federal debt starts at 72.0% of GDP in 2011, it peaks as a percentage of GDP at 82.1% in 2015, and then starts back down, finishing at 76.2%. There is a lot of dynamism here, in that both GDP and net federal debt are growing, but we do get net federal debt / GDP under control.
Federal expenditures this year, 2011, (for which the Dems -- both president and Congress -- blew off their responsibility to the country for this problem by not passing a budget) will grow by $365 billion. That is in one year. In the glide path model, we are talking about growth of $200 billion over seven years, not $200 billion a year for seven years, but $200 billion all in over seven years, or about $30 billion a year. I am sure you can hear, as can I, the screams of agony coming out of Washington if its denizens contemplate these numbers. I am sure they will say there is no way federal obligations can be stuffed into growth of "only" $200 billion over the next seven years.
Well, that is the point of this exercise. Even if you want to fiddle with the numbers, you are going to get a result that looks pretty much like the one here if we are going to save the financial future, and thus the future, of the country. Yes, the kids have been living large off daddy's estate, but that cannot go on forever. That is why S&P has flagged U.S. debt for downgrade. We are borrowing $1.6 trillion this year and the Congressional Budget Office contemplates borrowing essentially $750 billion - $1 trillion a year for the foreseeable future. And we cannot afford that.