EconomistMom.com
…because I’m an economist and a mom–that’s why!

EconomistMom.com

More on That Very Basic Budget Math

May 13th, 2008 . by economistmom

To elaborate a bit on the points in that “Mastercard commercial” I posted yesterday…

Some policymakers who oppose using revenue increases to address our short- and long-term deficit problems argue that taxes are already high enough, or even too high.  They argue that tax cuts can’t be responsible for our deficit situation because the current level of federal revenues as a share of the economy (at 18.8%) is higher than the 40-year (1968-2007) average (of 18.3%).  In fact, even if the Bush tax cuts were permanently extended, and even if relief from the Alternative Minimum Tax (AMT) was permanently extended, revenues as a share of GDP would rise to the 19-20% range over the next few decades.  (Yes, that fact is a fact; see CBO’s Analysis of the President’s Budget or their Long-Term Budget Outlook… I will have to do a post soon called something like ”Why Revenues Rise”…) 

I have several problems with this argument that a historical perspective proves our current revenue levels (and path of revenues under extension of current tax policy) are adequate.  It goes back to that basic math in the “commercial”… 

There is nothing significant about the historical average of revenues/GDP as a guide for whether revenue levels are adequate today or in the future.  In fact, there’s nothing significant about it as a guide for whether revenue levels were adequate in the past.  The 40-year historical average of federal government spending/GDP is 20.6% (below where it is currently, at 20.0%).  If we were to hold to those historical norms, that would imply a goal of achieving permanent budget deficits of 3.1% of GDP, year after year.  That’s not sustainable, but we should be so lucky if that’s all we were facing…

Fiscal responsibility means the ”right” level of revenues is that which is sufficient to pay for the government programs we desire–not that which we’ve averaged over the past 40 years.  We decide what are our priorities as a society, and then we figure out how much of those priorities we can afford.  Ideally this decision process is not a “first come, first served” one, but is based on some sort of cost-benefit analysis that accounts for both how much benefit our society gets from the spending, as well as how large are the costs associated with the taxes that pay for that spending.

So here’s the problem going forward, and why the future budget calculus can’t be anything like the past.  We face two huge challenges in terms of federal government spending, given that our major entitlement programs provide income support and health care to older Americans:  (i) the changing demographics that will give us more older, retired people per younger, working person (that’s the going from 3.3 to 2.1 math where we lose more than one working person per retiree!), and (ii) the fact that for each of those older people, the costs of their health care will continue to rise faster than the economy grows (if historical trends continue, more than 2 percentage points faster), so that our economy cannot keep up.   It’s impossible for us to change (i), and at this point we don’t understand enough about how we can counter (ii).  With (i) and (ii) we face a distressingly-steep upward path of government spending as a share of our economy.  CBO’s long-term outlook shows that by 2050 under current policies, the federal government’s spending on Social Security, Medicare, and Medicaid alone will be 18.6% of GDP, and total federal spending will reach 41.8% of GDP. 

This distressing outlook for entitlement spending means that of course, entitlement reform is necessary, and that of course, policymakers will have to find ways to damp down health costs if the ”fiscal train wreck” is to be avoided.  But even under wildly optimistic assumptions of how successful we will be at containing health care spending, given the demographics, there is just no way we could possibly “flat line” government spending–that is, no way we could keep spending as a share of the economy anywhere close to the 20% it is now.  That spending path will continue to move upward, even if we are able to keep it from rising as steeply as under the current policy trajectory.  To assume anything other than a continued upward path means we are basically counting on implementing a policy which would “cut the old people off.”  Probability that would happen?  Zero.   (I’d hope.)

So that leads us back to that 40-year historical average of revenues as a share of GDP as looking pretty silly and meaningless.  CBO’s long-term outlook shows that under current tax policy extended (which is not the same as current tax law, some of which expires each year but a lot of which will expire at the end of 2010), revenues as a share of GDP will reach 19.4% in 2050.  To some that seems like “plenty,” and it’s more than a full percentage point above that 40-year average.  But given that spending in that year would reach 41.8% of GDP and that the possibility of cutting that by more than half is extremely bleak, 19.4% just aint gonna cut it.

And even worse news for our noble pay-go supporters in Congress (but please don’t let this dissuade you from your continued support):

Even if we were to stick to current-law revenue levels, either allowing the Bush tax cuts to expire, or paying for any extended tax cuts with offsetting revenue increases elsewhere, CBO shows that revenues as a share of GDP would be 23.5%.  That’s more than 4 percentage points higher than if tax cuts are permanently extended by increasing the deficit, but it still only covers about half of the projected spending costs.

So, what’s the lesson here?  In terms of the federal budget, history teaches us nothing about how to handle where we are going–because we have never started from here before.  

We’re not only going to have to work on entitlement reform, but we’re going to have to work on fundamental tax reform as well.  Because it’s just basic math to see we’re going to need to raise revenues as a share of the economy, and we’re going to want to do it in ways that minimize economic harm–or ideally in ways that might even encourage a more efficient economy.  I happen to believe that’s very possible.          

….Someone remind me to relate this “we haven’t started from here before” story to my family finances and how we’ll be facing college costs for the first time a couple years from now…  

2 Responses to “More on That Very Basic Budget Math”

  1. comment number 1 by: Jeffrey

    Why haven’t we started here before? You mention the 2 key reasons, health care and entitlements. And why are they an issue? Because of the decisions by the Roosevelt Democrats to institute a Ponzi scheme called Social Security and to decouple health care expenditure from the ultimate consumer by allowing tax deductions for employers only. I don’t believe health care has to continually rise on it’s current course. If we treat health care like any other economic good. it will be subject to the normal economic market factors. HSA’s, portable insurance and deductions for consumers would be a start. Funny, whenever the gov’t is heavily involved in a good (health care, education) it’s price rises well above the inflation rate.

    As for Social Security, a movement to the private market and a reduction in benefits (phased in) would be a start as well. This would not cut off any older people. Actually, a strong case can be made that Social Security is a rip off as the historical returns for “donated” money is well below the return to capital in the private market.

    The US has been the greatest generator of wealth in history due to many factors of which compartively low taxes and low regulations have been a major reason. Higher taxes may just kill the golden goose. Higher taxes will never satisfy the appetite of the government; it just fosters creeping socialism. And we see how well socialist economies perform (Soviet Union, China pre Deng, Cambodia, Western Europe). A perfect example of the unending appetite is the Pay-Go rule. This rule perpetuates a ratcheting up of taxes. When the original tax hike does not result in the taxes expected do we cut some expenditures as a result? Of course not, we raise taxes again.

    One final point, you are trying to tie a household budget to the government budget. Well, if I’m in debt because of my lavish lifestyle, I don’t go to my boss and demand a raise to fund my lifestyle (he would rightfully laugh me out of his office). First, I learn to live within my means.

  2. comment number 2 by: Anandakos

    Jeffrey,

    I bet you dollars to doughnuts you don’t know that the original Social Security proposal by President Roosevelt included a significant portion of the trust fund really being a trust fund. That is, it would own non-governmental securities, the majority AAA bonds, but even a little bit of equity,

    The people in your party screamed SOCIALISM !!!! and “government control of business” and Congress ducked, removing the ownership of non-governmental securities, which did indeed make the system dependent on an ever-growing labor force.

    Your first paragraph essentially marks you as one of those people who DO want to kill off the old folks — at least those who aren’t fortunate to be blessed with as good a brain as you have.

    I was an NMSQT Finalist, so I have a “good brain” too, but I know I did NOTHING to get it. Ningun. Zero. My path through life has been bulldozed by my white skin, Y chromosome, and fluent speech. As has yours.

    Use that good brain to do some introspection and struggle with your greed.