Contrary to a lot of propaganda being espoused by certain political groups, the US does not have a discretionary “spending problem!” The solution to the US budget deficit is, in fact, quite straightforward if not entirely easy.
The Great Lie of Our Generation
The solution to the US budget deficit issue is not just discretionary “spending cuts.” This notion is a lie that has become an illusion among lots regular folks who have unnecessarily become concerned about all the wrong things. This is what lies do; they mislead – and they often lead to inappropriate action.
US government spending may be broken into two pieces; discretionary and entitlement. For a more detailed explanation and breakdown, head over to my article The US Budget Explained: Discretionary vs. Entitlement Spending. For 2013, discretionary spending is proposed by President Obama as 31% of the total US budget. Of this amount 57% is proposed to be allocated to the military. This leaves 43% x 31% = ~13% of the total US budget.
Discretionary Spending is Not a First Order Effect
Before we get into long-winded debates and gnashing of teeth about which fractional percent of discretionary spending to cut from which budgets, let’s note that discretionary spending is a component, but not by far the most important component to solving the US budget deficit issue.
Here is a chart of US government spending as a percent of GDP:
One thing we can see from this chart is that decisions made as a society to enact Social Security, Medicare and Medicaid – that is, “to take care of our own” – were largely responsible for creating the majority of the growth in spending from around 15% of GDP in the 1950’s to the present level of around 23% of GDP as seen in the chart below:
But this chart alone, of course, does not explain the US debt. For this we have to also look at receipts as shown in the following chart:
Two Things are Happening at Once
There are always two things that can be observed in charts like the one above. One we may refer to as tax/spend or budget policy, while the other is an economic phenomenon.
Different administrations have exercised different policies. From the end of WWII all administrations, regardless of party, exercised policy that was characterized by receipts (taxes) in excess of expenditures. During the administrations of presidents Reagan and Bush, policy was oriented toward decreasing taxes while increasing spending. Deficits grew significantly during this period resulting in increases in US debt.
President Clinton’s policies were more fiscally conservative as observed by increases in tax rates and decreases in spending. Deficits plummeted and indeed a surplus was observed, and debt was decreased again following the conservative approach of administrations prior to president Reagan.
During the administration of president Bush II, taxes were again reduced while spending was increased. Deficits were again quickly observed and debt rose again. During the latter part of the Bush II administration we faced The Great Recession. Entitlement spending surged as demands of unemployed hit Social Security, Unemployment Insurance as well as Medicare and Medicaid. The unprecedented surges were not the result of budget policy per se, though many criticize decades of financial deregulation (carried on under the administrations of both parties) as the primary cause of The Great Recession.
Most recently (even before the sequester), discretionary and indeed overall spending has been decreasing under the Obama administrations, and receipts have been increasing due to policy favoring increased taxes primarily on the wealthiest earners.
Policies of Republican administrations since president Carter have generally decreased tax rates while increasing spending, adding to the US debt. Policies of Democratic administrations, in contrast, have favored increased tax rates (weighted toward the wealthiest earners) while decreasing spending. This is somewhat ironic as public perceptions of the policies of the two parties is generally opposite of this reality.
Uh-hmm; There is a Gorilla in the Room
Did anyone notice any patterns in the last chart showing expenditures and receipts? Hmmmm?
Did anyone notice how often expenditures and receipts move in opposite directions?
Can it be possible that our politicians are so brilliant that they can actually consistently do the all the wrong things at all the wrong times?
Take a second look:
Do you notice how frequently expenditures and receipts move in opposite directions?
If our goal is to reduce US debt, these figures, at times, extraordinarily complement one another. At other times they pull in quite opposite directions? How can this be? What is the cause of this?
Psst…Here is a Hint (Employment)
When people are employed, THEY PAY TAXES!
When people are unemployed: THEY DON’T PAY TAXES!
Furthermore, when people are unemployed: THEY GO ON THE DOLE!
They retire early and jump onto Social Security. They look to Unemployment Insurance. They think about their health and dip into government benefits for a check-up or to take care of lingering concerns. They are worried, and they get while the getting is good!
The chart below shows US budget deficits as percent of GDP compared to percent unemployment.
Deficits track unemployment like clockwork!
Taxes, Spending, and Unemployment: The Catch 22 of Macroeconomics
The following facts should be plainly obvious at this point:
- Reducing unemployment puts more people into the economy and generates more tax revenue thereby reducing deficits
- Raising taxes, closing loopholes and so on brings more revenue into government accounts thereby reducing deficits
- Reducing spending reduces deficits
But there is a catch…unemployment is to a significant degree related to taxes and spending. Raising taxes can be a drain on the economy, especially in times of recession, downturn, stagnation or periods of slow growth. The same is true of reducing spending.
If increased taxes and/or reduced spending negatively impacts the economy, unemployment may rise (or may reduce more slowly) thereby working to increase deficits in contradiction to the intended impacts of increased taxes and reduce spending.
The Psychological Component
Furthermore, unemployment generally behaves in non-linear ways. In other words, 3% reduced spending may not cause a 3% increase in unemployment. In some scenarios, reduced spending (or increased taxes) may be ignored by unemployment. In other scenarios unemployment may strongly overreact to reduced spending (or increased taxes). This is because there is a psychological component.
If businesses and consumers feel the economy is doing well and have high confidence, then small changes in government policy (for taxes and spending) may be unnoticed. That is to say that during good economic times, the government can increase taxes and reduce spending in modest increments with little to no impact on the economy.
But the opposite is also true! During times of weak economy, the effects of contraction by government are magnified such that they actually may have effects opposite of what was intended.
Austerity: Lessons Learned?
Europe (and most of the world) experienced a deep recession starting around 2008. Their response was to increase taxes and reduce spending. The result has been, in a word, catastrophic. As a direct result of economic policy, unemployment soared, further drying up government coffers and in fact creating the opposite effects of those intended. Unemployment has hit level around 25% in some countries with both young and elderly workers hit much harder. The economies of Europe are by and large in much worse shape than they were in 2008. This is direct and predictable result of the failed austerity policies they enacted.
China in contrast followed the economic lessons learned since WWII and enacted strong stimulus. Guess what? China is doing fine.
US policies were in between those of Europe and those of China – in other words modest stimulus. The result is that we have seen modest improvement in unemployment and are seeing reductions in deficits as a direct result.
Fixing the US Budget Deficit
Near the beginning of the The Great Recession, the US implemented modest stimulus. It is widely believed by mainstream economists that:
- The stimulus had at least a moderating effect on the recession and brought about modest improvements
- The magnitude of the stimulus was not large enough
In my opinion, the keys to success seem pretty clear.
- Increase government spending preferably in investments that create ROI and future benefit while at the same time creating jobs and injecting cash into the US economy to bring down unemployment and deficits
- After unemployment drops to more normal structural levels, increase taxes and reduce spending.
This approach will help tremendously to get our economy back on track so that we can use our global leadership role to the much more important global sustainability issues.
You can read more about the history of the US budget deficit and debt here: Why the US Budget Deficit is Not the Biggest Issue.
Learn More Here: http://greenplug.nu/category/learning-center/us-economy/
CEO Rain8 Group LLC
Joe Weisenthal, Business Insider: There’s Only One Way To Fix The Deficit — And Actually It’s Totally Painless
Joe Weisenthal, Business Insider (Charts): Sorry, Folks, We Don’t Just Have ‘A Spending Problem’
Jason Linkins, The Huffington Post: http://www.huffingtonpost.com/2013/04/11/grand-bargain-punditry_n_3063963.html
United States Office of Management and Budget: OMB Website