Could Federal Spending Reach 20% of GDP by 2016?

Some on the left have assailed a Wall Street Journal op-ed by top Romney economic adviser Glenn Hubbard claiming that Mitt Romney's economic plans set the goal of having federal expenditures be 20% of GDP by 2016.  They currently stand at 24% of GDP.  As John Cassidy writes:

Is this credible? As far as the immediate future goes, Romney is promising austerity. Hubbard reiterates that he would aim to reduce federal spending from roughly twenty-four per cent of G.D.P. in fiscal 2012 to twenty per cent by 2016. Romney hasn't spelled out how he would reach this target, but simple arithmetic suggests he would need to impose about five hundred billion dollars in annual spending cuts, which is equivalent to more than three per cent of G.D.P.

I think it's a little more complicated than Cassidy lets on, however.

Historically, the last time government spending as a percentage of GDP was cut by about 4 percentage points in four years or less was in the 1950s, when government expenditures went from 20.4% of GDP in 1953 to 16.5% of GDP in 1956.  The end of the Korean War played a considerable role in that decline in spending.  So such a decline over a short time is not unprecedented, though declines of that kind usually take place after a war has drawn down.  This magnitude of decline is usually accompanied by a recession (as happened after World War II and Korea), an outcome Romney may want to avoid.

One way it is possible to get near 20% of GDP for government spending by 2016 is to factor in economic growth.  Unadjusted for inflation, economic growth averaged around 4% in 2010 and 2011 (factoring in inflation, the growth is much lower).  Let's say that Romney's economic policies are effective and that growth starts to take off.  Rather than 4% unadjusted growth a year, let's estimate 6% growth.  Six percent annual GDP growth is a very attainable number.  The second term of the Clinton administration matched that number, and the first term also came close.  Reagan's presidency also saw about a 6% annual GDP growth per year.  Even the second Bush administration saw growth above 6% some years.  (Again, factoring in inflation leads to lower growth rates, but we'll work with non-inflation-adjusted dollars for the moment.)

The Office of Management and Budget estimates that the 2012 GDP is $15.6 trillion.  At 6% growth, GDP would be $19.7 trillion by 2016.

Currently, government spending is around $3.8 trillion.  If government spending were $3.8 trillion in 2016, it would be only 19.2% of GDP.  So with decent economic growth, not a single dollar would have to be cut from the federal budget to bring government expenditures to under 20% of GDP.

This claim is partially deceptive, however, because a certain level of growth is factored into government spending, and not keeping up with this growth would operate as de facto cuts.  For example, as more people retire over the next four years, Social Security spending would have to grow; not having it grow would mean benefit cuts for beneficiaries.

With a $19.7-trillion economy, government spending at 20% of GDP would be $3.94 trillion.  So if government spending is going to stay under 20% of GDP, the U.S. could afford to spend only $140 billion more than what it currently spends.  The OMB estimates that Social Security will grow from $778 billion to $976 billion, a nearly $200-billion increase.  That would be politically very difficult to cut, especially over the short term.  Medicare is also expected to grow from $484 billion to $626 billion, a $140-billion increase.  Meanwhile, interest payments are also expected to increase $260 billion, from $224 billion to $482 billion.  So new mandatory entitlement spending and interest could climb $540 billion or so -- and that's if no other part of the budget increases at all.

If the government can spend only $140 billion more before cracking 20% of GDP and mandatory entitlement and interest spending can't go above $540 billion, that leaves a $400-billion hole to be made up for by cuts.

Where could these cuts come from?  Part of them might be able to come from these seemingly mandatory sectors.  If the U.S. can get its fiscal house in some level of order and the economy stabilizes, there's no guarantee that interest payments will climb to $482 billion.  Say they climb to $300 billion instead, which is only an $80-billion increase -- not a $260-billion one.  That shaves off $180 billion of the $400-billion hole.

Now we're down to $220 billion.  Income security spending (for unemployment benefits, etc.) rocketed from $365 billion in 2007 to an estimated $580 billion in 2012.  Much of this increase in spending is due to the Great Recession.  Unemployment benefits from the federal government alone climbed from $35 billion in 2007 to $160 billion in 2010, settling to around $110 billion in 2012.  If the economy turns around, a considerable portion of that new growth could be cut.  Let's be conservative and say that, by 2016, income security spending will have dwindled to $500 billion (though it could be much less).  So, another $80 billion in savings, which leaves us with $140 billion to make up for.

Trimming this $140 billion is trickier.  There are a few options here.

Health care: in part due to the stagnant economy, federal health spending (excluding Medicare) has grown at a considerable rate over the past few years, and it is projected to grow even faster in the years ahead.  Currently, it is around $360 billion (up from $266 billion in 2007).  The OMB projects that it will grow to $588 billion in 2016, a $220-billion increase.  Keeping federal spending on health level over the next four years would be a huge (and perhaps unlikely) accomplishment, even when one factors in the amount that improved economic growth could slow the need for federal health spending.  I'm doubtful many cuts could happen here.  In fact, it seems fairly likely that health care spending will grow over the next four years.  Perhaps market-oriented reforms will help slow down the rate of medical cost inflation.

Defense: defense is a favored Republican spending item.  The current defense budget is $716 billion (over twice what it was in 2002).  The OMB projects that defense spending will decline to $578 billion in 2012, which would net nearly $140 billion in savings.  I don't know how much appetite Republicans will have, though, for defense cuts.

Everything else: everything else in the budget (everything except defense, health care spending, Social Security, income security, and interest payments) comes out to only about $620 billion, and there's only so much room to cut.  The OMB estimates that this portion of government spending will decline to around $440 billion in 2014.  If that spending goes according to schedule, $180 billion could be saved there.

So there does seem to be a route to getting government spending near 20% of GDP, though the calculations above are very much back-of-the-envelope (and it seems very likely that health care spending will rise, making that gap harder to close).

Here's another way of thinking about how we could arrive at federal government spending near 20% of GDP.  The OMB currently estimates that federal spending will increase about $500 billion between 2012 and 2016, from $3.8 trillion to $4.3 trillion.  Say interest payments do not reach $482 billion but rise only to $300 billion (which is still a significant increase).  Now the budget is at $4.12 trillion, or 20.9% of GDP (assuming an average of 6% GDP growth).  Say the improved economy saves $100 billion in income security and Medicaid payments.  Federal spending is now a little over 20.3% of GDP.

I do not know if federal spending will decline to 20% of GDP by 2016, but the above arithmetic suggests, I think, that this goal is imaginable without draconian cuts -- if the economy recovers.  A restored economy would cut deficits through increasing revenue and decreasing the need for government subsidies for the poor.  Shrinking deficits would also keep interest payments from accelerating.

These numbers also suggest the following: if Romney does want to decrease the size of government relative to the rest of the economy without creating profound economic dislocation, there will need to be a huge turnaround in economic growth, and the fruits of this growth will need to be largely shared.  If relatively few benefit from a Romney recovery, tax revenues will not rebound and social welfare spending will increase.  Such a dynamic would increase interest payments and other kinds of government spending, leading to a larger government hand and a more fragile economy.

Making government spending 20% of GDP is a demanding goal; federal outlays never dipped below 20% of GDP between 1975 and 1996.  This number might be especially difficult to reach if Romney intends to maintain current American defense and retirement commitments.  It's perhaps worth noting in passing that, under Reagan, government spending reached its twentieth-century postwar high as a percentage of GDP, cresting at 23.5% of GDP in 1983 (of course, Obama's administration has smashed this Reaganite record).  So government spending is not necessarily incompatible with economic growth.

Would federal spending under President Romney reach 20% of GDP by 2016?  The uncertainties of the future leave that result in doubt.  But the magnitude of government spending in the American economy can be reduced through robust and broadly shared economic growth.

(Note: GDP data comes from the Bureau of Economic Analysis, and all spending data comes from the Office of Management and Budget.)

Fred Bauer blog at A Certain Enthusiasm.

Some on the left have assailed a Wall Street Journal op-ed by top Romney economic adviser Glenn Hubbard claiming that Mitt Romney's economic plans set the goal of having federal expenditures be 20% of GDP by 2016.  They currently stand at 24% of GDP.  As John Cassidy writes:

Is this credible? As far as the immediate future goes, Romney is promising austerity. Hubbard reiterates that he would aim to reduce federal spending from roughly twenty-four per cent of G.D.P. in fiscal 2012 to twenty per cent by 2016. Romney hasn't spelled out how he would reach this target, but simple arithmetic suggests he would need to impose about five hundred billion dollars in annual spending cuts, which is equivalent to more than three per cent of G.D.P.

I think it's a little more complicated than Cassidy lets on, however.

Historically, the last time government spending as a percentage of GDP was cut by about 4 percentage points in four years or less was in the 1950s, when government expenditures went from 20.4% of GDP in 1953 to 16.5% of GDP in 1956.  The end of the Korean War played a considerable role in that decline in spending.  So such a decline over a short time is not unprecedented, though declines of that kind usually take place after a war has drawn down.  This magnitude of decline is usually accompanied by a recession (as happened after World War II and Korea), an outcome Romney may want to avoid.

One way it is possible to get near 20% of GDP for government spending by 2016 is to factor in economic growth.  Unadjusted for inflation, economic growth averaged around 4% in 2010 and 2011 (factoring in inflation, the growth is much lower).  Let's say that Romney's economic policies are effective and that growth starts to take off.  Rather than 4% unadjusted growth a year, let's estimate 6% growth.  Six percent annual GDP growth is a very attainable number.  The second term of the Clinton administration matched that number, and the first term also came close.  Reagan's presidency also saw about a 6% annual GDP growth per year.  Even the second Bush administration saw growth above 6% some years.  (Again, factoring in inflation leads to lower growth rates, but we'll work with non-inflation-adjusted dollars for the moment.)

The Office of Management and Budget estimates that the 2012 GDP is $15.6 trillion.  At 6% growth, GDP would be $19.7 trillion by 2016.

Currently, government spending is around $3.8 trillion.  If government spending were $3.8 trillion in 2016, it would be only 19.2% of GDP.  So with decent economic growth, not a single dollar would have to be cut from the federal budget to bring government expenditures to under 20% of GDP.

This claim is partially deceptive, however, because a certain level of growth is factored into government spending, and not keeping up with this growth would operate as de facto cuts.  For example, as more people retire over the next four years, Social Security spending would have to grow; not having it grow would mean benefit cuts for beneficiaries.

With a $19.7-trillion economy, government spending at 20% of GDP would be $3.94 trillion.  So if government spending is going to stay under 20% of GDP, the U.S. could afford to spend only $140 billion more than what it currently spends.  The OMB estimates that Social Security will grow from $778 billion to $976 billion, a nearly $200-billion increase.  That would be politically very difficult to cut, especially over the short term.  Medicare is also expected to grow from $484 billion to $626 billion, a $140-billion increase.  Meanwhile, interest payments are also expected to increase $260 billion, from $224 billion to $482 billion.  So new mandatory entitlement spending and interest could climb $540 billion or so -- and that's if no other part of the budget increases at all.

If the government can spend only $140 billion more before cracking 20% of GDP and mandatory entitlement and interest spending can't go above $540 billion, that leaves a $400-billion hole to be made up for by cuts.

Where could these cuts come from?  Part of them might be able to come from these seemingly mandatory sectors.  If the U.S. can get its fiscal house in some level of order and the economy stabilizes, there's no guarantee that interest payments will climb to $482 billion.  Say they climb to $300 billion instead, which is only an $80-billion increase -- not a $260-billion one.  That shaves off $180 billion of the $400-billion hole.

Now we're down to $220 billion.  Income security spending (for unemployment benefits, etc.) rocketed from $365 billion in 2007 to an estimated $580 billion in 2012.  Much of this increase in spending is due to the Great Recession.  Unemployment benefits from the federal government alone climbed from $35 billion in 2007 to $160 billion in 2010, settling to around $110 billion in 2012.  If the economy turns around, a considerable portion of that new growth could be cut.  Let's be conservative and say that, by 2016, income security spending will have dwindled to $500 billion (though it could be much less).  So, another $80 billion in savings, which leaves us with $140 billion to make up for.

Trimming this $140 billion is trickier.  There are a few options here.

Health care: in part due to the stagnant economy, federal health spending (excluding Medicare) has grown at a considerable rate over the past few years, and it is projected to grow even faster in the years ahead.  Currently, it is around $360 billion (up from $266 billion in 2007).  The OMB projects that it will grow to $588 billion in 2016, a $220-billion increase.  Keeping federal spending on health level over the next four years would be a huge (and perhaps unlikely) accomplishment, even when one factors in the amount that improved economic growth could slow the need for federal health spending.  I'm doubtful many cuts could happen here.  In fact, it seems fairly likely that health care spending will grow over the next four years.  Perhaps market-oriented reforms will help slow down the rate of medical cost inflation.

Defense: defense is a favored Republican spending item.  The current defense budget is $716 billion (over twice what it was in 2002).  The OMB projects that defense spending will decline to $578 billion in 2012, which would net nearly $140 billion in savings.  I don't know how much appetite Republicans will have, though, for defense cuts.

Everything else: everything else in the budget (everything except defense, health care spending, Social Security, income security, and interest payments) comes out to only about $620 billion, and there's only so much room to cut.  The OMB estimates that this portion of government spending will decline to around $440 billion in 2014.  If that spending goes according to schedule, $180 billion could be saved there.

So there does seem to be a route to getting government spending near 20% of GDP, though the calculations above are very much back-of-the-envelope (and it seems very likely that health care spending will rise, making that gap harder to close).

Here's another way of thinking about how we could arrive at federal government spending near 20% of GDP.  The OMB currently estimates that federal spending will increase about $500 billion between 2012 and 2016, from $3.8 trillion to $4.3 trillion.  Say interest payments do not reach $482 billion but rise only to $300 billion (which is still a significant increase).  Now the budget is at $4.12 trillion, or 20.9% of GDP (assuming an average of 6% GDP growth).  Say the improved economy saves $100 billion in income security and Medicaid payments.  Federal spending is now a little over 20.3% of GDP.

I do not know if federal spending will decline to 20% of GDP by 2016, but the above arithmetic suggests, I think, that this goal is imaginable without draconian cuts -- if the economy recovers.  A restored economy would cut deficits through increasing revenue and decreasing the need for government subsidies for the poor.  Shrinking deficits would also keep interest payments from accelerating.

These numbers also suggest the following: if Romney does want to decrease the size of government relative to the rest of the economy without creating profound economic dislocation, there will need to be a huge turnaround in economic growth, and the fruits of this growth will need to be largely shared.  If relatively few benefit from a Romney recovery, tax revenues will not rebound and social welfare spending will increase.  Such a dynamic would increase interest payments and other kinds of government spending, leading to a larger government hand and a more fragile economy.

Making government spending 20% of GDP is a demanding goal; federal outlays never dipped below 20% of GDP between 1975 and 1996.  This number might be especially difficult to reach if Romney intends to maintain current American defense and retirement commitments.  It's perhaps worth noting in passing that, under Reagan, government spending reached its twentieth-century postwar high as a percentage of GDP, cresting at 23.5% of GDP in 1983 (of course, Obama's administration has smashed this Reaganite record).  So government spending is not necessarily incompatible with economic growth.

Would federal spending under President Romney reach 20% of GDP by 2016?  The uncertainties of the future leave that result in doubt.  But the magnitude of government spending in the American economy can be reduced through robust and broadly shared economic growth.

(Note: GDP data comes from the Bureau of Economic Analysis, and all spending data comes from the Office of Management and Budget.)

Fred Bauer blog at A Certain Enthusiasm.