Federal Budget Primer

I found this budget primer as a comment to an article I read on the Internet. It seemed like a nice follow up to yesterday's blog on our spending problem.


Current State
Defense, Social Security, and Medicare/Medicaid are about 20% of our spending each. So that is 60% of total federal spending. Interest is another 10%. So about 70% of our budget is tough ground politically to address. The remaining 30% is the big departments (Education, Transportation, etc.) which have some turf guardians as well. In fiscal year 2008, before the economic crisis the government spent $3.5 trillion with tax revenues of $2.5 trillion, leading to a national debt increase of $1 trillion. In fiscal year 2009, the government spent $3.9 trillion with tax revenues of $2.0 trillion, leading to a national debt increase of $1.9 trillion. For various technical accounting reasons, the deficit far understates the actual increase in the national debt, so watch the debt number instead.

Pre-crisis and pre-Obama, we spent between $1.30 and $1.40 for every dollar in tax revenue. In fiscal year 2009, we spent $1.90, due primarily to tax declines caused by the crisis and the TARP bailout program. So if our economy returns to a pre-crisis level of vigor, it would take an across-the-board 40% reduction in every federal spending category to balance the budget without tax increases.

Social Security and Medicare are mandatory programs, meaning the spending is on autopilot in accordance with certain laws and those laws must be changed to reform them. Defense is discretionary; Congress decides each year how much to spend on it technically. The Constitution has a two year limit on Army appropriations, deferring to state militias, so our large standing military is not what the Founders intended. Not paying interest would be defaulting on our debt; about half the debt is owed to foreign countries and about 75% of new debt is issued to foreign countries.

So far, Social Security and Medicare have more than paid for themselves with dedicated payroll taxes. The Social Security Trust Fund, the sum of annual surpluses since the early 1980's, is over $2.5 trillion. However, Congress chose to spend this surplus on other things, the largest two categories of which are defense and interest on the debt, giving I.O.U.'s to the program.

So the $12 trillion debt we have today is driven by defense and related interest, the largest remaining budget categories, followed by the discretionary department categories.

The Short-Term Problem
We have a short-term problem, which is a $1.5 trillion "hole" in our (pre-crisis) $14 trillion GDP economy. There are short-term and long-term aspects to the solutions. President Obama has enacted a $787 billion stimulus program to address this, spread over three years, while the Fed has lent $1.3 trillion, printing dollars in the process. Getting the economy back to $14 trillion in a sustainable way (i.e., without borrowing like we did over the past 10 years) requires us to learn how to compete with developing countries that can produce goods at a global wage that is much lower than our own.

The Long-Term Problem
The long-term problem is primarily health care (Medicare and Medicaid), which represent five-times as big a funding challenge as Social Security. According to the Government Accountability Office (GAO), sometime between 2030-2040 Medicare, Social Security and interest will absorb the entire federal tax revenue amount, which has historically been around 18% of GDP. We face a demographic/volume problem with the ratio of workers to retirees dropping from: 5.1:1 in 1960 to 3.3:1 today to 2.1:1 in 2040. We also face a rate or spending per capita problem, with health care costs rising 8% per year and Social Security annual cost of living adjustments that average about 2% above inflation. In other words, the purchasing power of Social Security increases each year, although it may not feel that way to seniors.

Fallacies
No experts argue that we can outgrow this problem, as we would be fortunate to have sustainable real growth of 2-3% going forward. However, many politicians on the right argue that is not the case. GAO estimates the U.S. would have to grow at 10%+ for the next 75 years to outgrow our entitlement problem.

Further, economists from the far left to center right argue tax cuts increase deficits. Any boost to the economy from tax cuts is not sufficient to offset the loss of revenue to the Treasury.


Why Congress Hasn't Acted
Congress is paralyzed on this issue because Americans are not informed enough yet to understand the shared sacrifice that is required to address these issues. So far, they have chosen to place the burden on future generations, consuming now irrespective of future consequences, driving the debt to levels not seen since WW2. Until Americans are willing to demand tax increases and spending cuts across the board (remember--we spent $1.40 for every dollar we paid in taxes, borrowing from future generations--Before the crisis), we will have a major deficit problem.

How You Can Make a Difference
Get informed. Sources are below. Start writing your Congressman demanding tax increases and spending cuts over the next 10 years. Further, demand an economic strategy and partnership between government and industry so we can compete more effectively with developing countries and make more of what we consume here. If our economy doesn't grow, the budget problem is magnified dramatically.

Here are great sources for more information:
http://www.pgpf.org/
http://en.wikipedia.org/wiki/United_States_federal_budget
http://www.gao.gov/cghome/d08446cg.pdf