Look at the budget for a while.
If one saw a train wreck coming, one would probably feel a strong urge to warn the engineers of either or both trains. It’s a part of our human nature to want to help others avoid danger, injury or catastrophe.
It is somewhat baffling that politicians refuse to see the coming entitlement problem. Or, if they do see it, they refuse to act. Some talk about it and acknowledge that it is unavoidable, but it is always described as something that we should really get serious about in the near future.
Let’s take it down to the basics.
A series of laws, passed in the last 70 years created the Social Security, Medicare and Medicaid entitlement programs. Social Security and Medicare taxes have been collected for decades and have generally had a surplus – more taxes collected than benefits paid out. Recently though, Medicare and Medicaid have paid out more than the revenue taken in, so they are operating in a deficit mode. Social Security is about to go negative cash flow in the near future.
Traditional accounting rules say that you recognize bad news now, but you don’t recognize good news until it actually happens. This is known as accounting conservatism and is designed to keep companies or entities from financial crisis. When it comes to our national finances, we don’t practice what we preach.
The federal budget is calculated largely on a cash basis. That is, revenues and outlays are recognized when transactions are made. Things that happen in the future are ignored, at least in a budget sense. The long-term costs of entitlement programs such as Medicare, Social Security, and the federal portion of Medicaid, are not reflected in the federal budget. By contrast, many business and some foreign governments have adopted forms of accrual accounting, which recognizes obligations and revenues when they are incurred. To exacerbate the problem, the costs of some federal credit and loan programs, according to provisions of the Federal Credit Reform Act of 1990, are calculated on a net present value basis which reduces the value of future dollars to account for the effects of interest and inflation. This understates futures obligation. In plain English, using cash basis accounting means that future obligations are not shown as budget items because they have not yet occurred. While we have an enormous obligation to Social Security and Medicare/Medicaid, but we do not show them as a future liability.
Administrations play other budget tricks. Some don’t show the cost of wars financed though special of supplemental appropriations. Other administrations omit the cost of running the Legislative or Judicial branches of government, avoiding having to include the cost on the same piece of paper as administrative branch expenses.
Said another way, expenditures for Social Security and Medicare are growing at a faster rate than the economy. In the past, potential problems in the budget were able to hide behind growth in the economy. If congress passed a spending bill that was not currently supported by revenue, increasing income due to growth in future years was enough to hide the cost of the program. Most spending is covered this way. However, with the economy in the tank these days, there is not enough current income to cover the new expenses and increases from growth won’t be enough to cover it next year.
In terms of solutions, there are only three.
The first is to increase tax revenues. This is hard to do in a recession when business and individual profits are squeezed and unemployment and lower wages reduced the income form Social Security and Medicare taxes paid. Those who favor tax rate reductions point out that tax cuts have a positive effect on business and actually increase tax revenues. The political party that is in power now is philosophically opposed to tax cuts.
The second solution is to change the obligation. This means redesigning Social Security and/or Medicare. The main problem with this is that no politician wants to be associated with or responsible for a reduction in entitlements, especially when people paid it over the years with money out of their own wallets. Said another way, people feel that they have paid for and have been guaranteed certain benefits and are entitled to receive them. That’s why they’re called entitlements.
Third, and the most straight forward way to bring revenues and expenses in line with each other, is to cut expenses. Discretionary spending is a mixture of very important budget items, like National Defense, and truly discretionary items, like providing Broadband Internet Services to rural America. One is “need to have” and the other is “like to have”. To give perspective to the size of the problem over the next 50 years, consider this:
- To solve the budget problem with more revenue, production of goods and services in the US would have to increase three times. Under the current economic conditions, this is difficult to imagine.
- To solve the budget problem with tax rates increases, we would have to increase the personal tax rate to 60% to cover increases. Currently, revenues run about 20% of production.
- To solve the budget problem with cuts in spending, discretionary expenses would have to be cut by 30% or so.
The practical solution to the problem is probably a combination of two or three of the above. Any of the above is probably not palatable by itself mainly because people would consider it too harsh or unreasonable. A 300% is production is not reasonable. High tax rates are too harsh. Cutting expenses 30% affects too many people’s pet projects or vested interest.
Another point that people often miss is that letting private enterprise produce some of these goods and services puts people to work, lowers government spending and typically delivers these goods and services more efficiently (at a better price). We should privatize a number of functions and services that are now a part of the bureaucracy.
But still, a train wreck is coming and action is required! We need to ensure continued growth in the economy. At the same time, we will probably need some increase in tax rates unless decreased tax rates increase productivity enough to bring revenues up significantly. Probably, the most practicable action will be the significant reduction of discretionary expenses by a hefty percentage, even if only for a few years.
Many people have the viewpoint that congressional spending is out of control. Many of the “expenses” are for superfluous things that are “social spending” or “pork” projects intended to reward supporters or gain reelection support.
Using the personal budget example, we can see to options available to our government. If you make $1,000 and have taxes of $300, then you have $700 to cover expenses. If your expenses are $600, then you have $100 of discretionary income to spend, give away, save or invest. If your expenses are $800, then you need to find another $100. You can work longer, get a raise in pay, get someone to give it to you or borrow it form the bank. If you borrow the money without paying down the balance, then you have a new (and growing) expense called interest.
It’s no more complicated than that. The economics of the federal government are just the same.
A major problem with the federal budget is the deficit spending we are doing. It is analogous to the example above where we spend increasingly more than we bring in, so we keep borrowing money and racking up interest expenses without ever bringing the balance (debt) down. If the US continues to spend as planned, annual interest on the debt will grow dramatically and soon become the largest single (mandatory) expense in the budget. Interest on the debt and required payments to Social Security, Medicare and Medicaid make up 83% of our spending and cause the problems described above. Sometime between 2030 and 2040, mandatory spending will exceed government revenues as shown above.
So, to summarize:
- It is obvious that there is a train wreck coming.
- Congress and administrations have buried their heads in the sand for years.
- The solutions are to:
- Increase productivity which increases profits and then taxes.
- Change tax rates to increase tax revenues.
- Change programs to reduce benefits
- Reduce discretionary expenses so there is money left to pay for entitlement benefits.
- Some combination of all these actions.
The most practical solution is to reduce discretionary spending by 30% (an estimate) until the problem is behind us. Raising tax rates to 60% or reducing entitlements are not popular remedies. Cutting discretionary spending is not more popular, but (with pain) is the most practical path to follow.
It is possible that a runaway great economy would provide a suddenly convenient solution to the budget problem. The more likely scenario is that, without changes, revenues will be around 20% of goods and services produced and that mandatory spending will exceed 20% sometime after 2030.
A train wreck. Time to do something about it!
Some people believe in past lives. Some people are curious about it. Some people reject it completely.