The Nature of the Deficit

There have been numerous stories about the first meeting of the Debt Commission last week.  My of my state's Democratic Congressman recently celebrated that taxes were at their lowest since 1950.  He seems to think that if we just cut defense spending by 15% and freeze discretionary spending, we'll be good to go.  I'd like him to look at the attached charts.

What you'll see is a number of things that you won't hear among the conventional elites in DC as they blather about the deficit and the need to cut entitlements. 

Look at Figure above first - You'll see that we don't have a spending crisis as much as we have a general revenue crisis.  It's great that people are realizing that the budget crisis is most easily managed by tackling the spending in Social Security and Medicare - but note that they're getting the blame for the deficit, which isn't fair.  In fact, the so- called Social Security Crisis that pre-occupied so much of DC's time in the Bush II era has always really been a general revenues crisis.

The next image, SS and Medicare spending as a percent of GDP, shows that Social Security (the blue line) isn't really slated to rise much in terms of spending as a percent of GDP.  What growth you see is probably a function of demographics and an aging population.  But it's hardly indicative of a problem in runaway entitlements' spending.

What you do see in this second attachment is that runaway Medicare spending (the red line) is a problem we have to get a hold of.  We've only just touched the surface of the kinds of things we'll need to do to control Medicare spending in the health care reform bill.  Nothing in the health care debate leads me to think this society and polity are prepared to discuss end of life issues and shaping benefits coverage to match tests of reasonableness for treatments and procedures.  Continually cutting payments to doctors and hospitals for certain procedures will only take us so far.  I'm skeptical that the deficit debate (and the Debt Commission) will ever go there, despite their political insularity.

But most importantly, the top most graphic shows that General Revenues as a percent of GDP have fallen off the cliff.  This is where our real budget problems lie.  Yes, in the last 10 years spending as a % of GDP has risen substantially above historical levels - we have GWB to thank for that.  And much of the last two years growth is directly related to the bailouts and stimulus so they are temporary (see the purple line below).

However our structural problems lie fundamentally on the revenue side.  We've cut taxes repeatedly for the middle class, so that only the highest earners or those without homes and children pay substantial amounts of tax on their income.  The tax base itself is so dependent on the wealthy that it's extremely prone to economic fluctuations.  Much of the deficit would disappear if growth would simply return.  Sadly, what is needed is a broad tax base that can also be fair and progressive.  But the Debt Commission, the President, the Congress and the public seem unwilling to acknowledge or discuss this fact.  Maybe in 10 years Bruce Bartlett thinks.  I think he's optimistic.

There have been three periods of significant declines in general revenues - two times under Bush II and once early in the Reagan years.  There was also a modest decrease in general revenues under Bush I.  But otherwise, general fund revenues rose under most of Reagan's and Clinton's terms - most likely because economic growth was so robust. 

However we don't have a Social Security crisis.  We don't really have an entitlements crisis.  We don't even have a spending crisis once we get past the stimulus spending.  If we had preserved the Clinton era surpluses we'd have some savings to tap for the time (in the next 5-10 years) when entitlement outlays exceed entitlement revenues -- which is what we were supposed to do with the 1986 fix to Social Security - save those funds for the rainy day when our General funds needed to subsidize elderly entitlements.  Yet the heart of the US fiscal crisis - like all historical fiscal crises dating back to the English Revolution that cost King Charles his head - is at heart a revenue crisis.  We simply refuse to raise the general funds to pay for our general funded program appetites.