Budget Debate Primer...

One of my past-times is following the national debt (I know, NERD!). In recent weeks, thanks to a Congressional budget standoff which almost shut down the government, we saw Paul Ryan (R – Wisconsin) take the first step and a huge swing at the budget deficit ($6 Trillion reduction proposal), and then received a retort from President Obama with his own budget cutting attempt ($4 Trillion reduction proposal). What we have on our hands is a good ole’ fashioned budget fight in full swing in the nation’s capital.

This is pretty much all you’re going to hear from now until the elections next year (if you don’t, you better find a new candidate to back as this is a serious issue facing our country)…so I thought I’d prime the pump and visually give you some illustrations to help lay the groundwork so you’ll be ready to understand what all will be referenced and challenges ahead.

To begin with, here’s what the government spends our money on (see below illustration) - four things:

1. Mandatory (Social Security, Medicaid, and Medicare are in this)
2. Defense (Military spending)
3. Non-defense (Education, Health, Benefits/Transfer payments)
4. Interest (Interest payments to all the holders of our debt per the continual issuance of government bonds).

Next, here’s the breakdown of what’s in each category and where the money further goes within each category.

Now, let’s slice the budget another way. Here’s a look at how the biggest individual components from the different categories take up the budget.

And yet again, another way of looking at the largest budget contributors…

Finally, follow this link for a clever look at the national debt broken down. While the information discussed is actually from 2009, the concept of "scale" is what's important and what the video cleverly points out (thanks Pop for sending to me!).  Contrary to a previous post about education and the startling statistics about students not learning anything, this student in the link seems to have actually applied himself and learned something…

A couple of notes I find interesting:

Social Security: Long gone are the days when the Social Security trust fund – where payroll taxes not needed for current payouts are held – actually had ANY funds. That’s right, currently the trust fund consists of $2.6 trillion in IOUS from the U.S. Treasury. The funds needed to pay current benefits have been borrowed over the past two decades to pay for other federal programs (remember Al Gore’s “Lockbox” in 2000? This is what he was talking about – no more raiding the SS trust fund to pay for other programs). Current taxes paid in by today’s workers aren’t held for their future use in the trust fund, but are used for today’s retirees.

Net Interest on Debt: It’s calculated that we will spend about $250 billion in interest to the owners of U.S. Treasuries (both U.S. owners and those abroad). This is a BIG DEAL. Let’s stop and think for a moment. As of right now, we have historically low interest rates. This has allowed the Treasury to keep a lid on how much we pay out to the holders of our debt. But – what happens when interest rates rise almost certainly in the near future? The cost of those payments increase as the interest rate rises! That $250 billion will increase dramatically. Ouch. Much more of the budget will end up going to interest payments in the future instead of to the other categories. Not a good thing…

Now for my two cents:

The following are the underlying problems that the U.S. government will buck up against during the coming budget fights (these are probably obvious, but worth keeping at the forefront of our minds as politicians will do their best to divert your attention):

1. Regardless of your political affiliation, we all need to agree that something needs to be done to reduce the deficit (obviously the “how” is what’s up for debate – stay tuned: soon to follow is a post about “the national debt and why you should care…”).
2. The problem is that doing what needs to be done is not politically popular and the party that flinches and really does what should be done is effectively putting a gun in their mouth and pulling the trigger. Why? See #3…
3. Cutting entitlements, military spending, and raising taxes will not score a political party any points in elections (side question: is this the democracy we want to live in where our representatives are more concerned about re-elections than solving problems?). The American people like having a “full service” government, feeling safe, and receiving entitlements. We might as well make this into a universal law…people want a “free lunch”. Gone are the days of “ask not what your country can do for you; ask what you can do for your country…” We now only ask “what our country can do for us…” and demand not to pay for it.
4. Thus we (the U.S. government) have a spending problem because of wars and the demand for entitlements.
5. To further the problem, cutting spending is much more difficult – not just because of drawn out wars and the demand for entitlements – but because of the dependency that has been created by adding them over the past century (e.g., nobody wants to reduce the social security benefits that the retired population receives and that so many are planning on having as part of a fixed income) – thus many expenses have to be slowly reduced instead of an all at once cut (something that will be fought every step of the way and has the possibility of being overturned).
6. We (the U.S. government) also have a taxing problem. Obviously no one likes to pay more taxes. But over time, tax rates have been cut back and back and back.
7. We will have to come to grips with the fact that, to aid in reducing the deficit, we may have to cut spending AND increase taxes. There…yes, I said it. That’s painful. Man, it’s even painful to type. But getting out of our mess WILL require sacrifice.

Historically, what you’ll see (and what is currently playing out in D.C.) are Democrats fighting tooth and nail to not cut entitlements but willing to raise taxes (especially on “the rich”). On the other side of the aisle you have Republicans not wanting to raise taxes but are willing to cut entitlements. Thus we are left with an impasse because neither group will do what’s necessary (albeit it unpleasant) – a combination of both. I like to call this the “beef or chicken” conundrum and was able to find a picture that expresses my sentiments nicely (below). Label each animal whatever party or view you want, they are interchangeable. The point is, neither option (cutting entitlements and raising taxes) is pretty. But for the good of the country, we need to choose BOTH.

I’d also like to take a minute and highlight two theories related to entitlements and economic growth as we’re on this subject.

One school of thought, which much of our government programs are built on (whether we realize it or not) is the economic theory of a “zero sum game.” Simply put, “a zero-sum game is a mathematical representation of a situation in which a participant's gain or loss is exactly balanced by the losses or gains of the other participant(s). If the total gains of the participants are added up, and the total losses are subtracted, they will sum to zero.” Read more about game theory here if interested.

To illustrate: I have a pie with 8 slices. You take 1. I now have 7 slices and you have 1. The total amount of pie is still 8 slices…but the balance of who has what changed. This is a zero sum game.

The second school of thought revolves around growth economics. Read here if you want more. Simply put, if you “grow the pie” everyone gets a little more. So if we have a pie that is 10 inches in diameter, what we really want is to get a pie that is 12 inches or 14 inches or 16 inches in diameter – so everyone can have more pie.

If we dig a little deeper, we’ll notice that our government seems to operate in both of these theories.

Applied to government programs, we treat entitlements as a zero sum game. The employed population has taxes taken out of their earnings. Some of those taxes go to Medicaid, Medicare, Social Security, unemployment benefits, etc. Others are now a recipient of our earnings. The employed population’s loss is another’s gain.

Government spending and the national debt; however, are based in growth economics. The government assumes that our economy will always be growing (after all, this is America, right!?!?). If we have more economic output, businesses make more in profit, people get raises, and more wealth is in the system – tax receipts go up and consumers pump more money into the economic system (or so the story goes…stay tuned for a post on wealth inequality in America). You’ll also hear that “tax cuts will help spur growth.” So why not spend in excess…there’s no time like the present, right? “Sure spend more now and go in the hole because our economic growth will make up for it and one day we’ll use the surplus tax receipts to cover the debt.”

I hope you realize it, but “one day” is not coming. The problem, as you may have already observed (other than the fact that economic growth does not equal wealth and prosperity for everyone) is that our government increases spending as the economy grows. Government spending does NOT stay flat. As the economy grows, we increase entitlements, create more programs, add more agencies; A.K.A. “increase the size of government.” And yes, just to be clear, cutting taxes can help spur economic growth. But the increase in government spending negate the growth (most of the time the government outspends the growth…imagine that).

Keep these two concepts of a zero sum game and growth economics in mind over the next year and a half as we lead up to elections.

Much of the discussion related to budget cutting will revolve around the concept of a zero sum game. There will be emotional ploys about cutting entitlements and certain groups of people receiving less. Of course, the reality of cuts will be painful to many – there is no escaping it. This is a red herring; however, and a way to divert your attention from the real problem.

The real problem stems from the government’s inability to curtail growth in spending during the good times. Just like the good consumers that we are, in good times we go out and spend. In the bad times, we pinch every penny. The government is no different as they spend more in the good times (except that they have a credit card with no limit to use in both the good and the bad times). We are in this spot because they couldn’t stop spending. The problem with using growth economics as a basis for spending is the issue of fiscal discipline; i.e., disciplined controlled spending. And our government CAN’T DO IT. Think I’m joking? How many of you want to bet that the government won’t vote to raise the debt ceiling yet again? Not likely. It’s easy to say economic growth with make up for spending sins, but if spending increases in tandem with that growth, you don’t realize a gain. And we have need for some BIG gains to overwhelm a BIG debt.

Thus we are left with the following (albeit it simple) list of necessary solutions (in an ideal world):

• Stop the spending hemorrhaging and roll back big government (yes, it’s going to hurt).
• Increase taxes (yes, I said it again and it pains me to write it just as much as before) to balance the budget and be able to pay for spending and live within our means.
• Have a growing economy and bank the growing tax revenues instead of spending it – to reduce the debt.

Notice I mentioned “in an ideal world”. Now, if you can find a politician in the next year who will say all of the above, he/she should be your candidate! Cheers!