Previous posts in this Budget Basics series have shown that the U.S. federal budget deficit and debt are on an unsustainable path. It is easy to say how to close the budget gap--cut spending or raise revenues. Why, then, is doing it so hard?
As a working estimate of the budget gap, we will use the cyclically adjusted primary budget deficit, which was about 7 percent of U.S. GDP in 2009. Some estimates are smaller by a percentage point or two, and some, especially those that assume delays before starting to tighten policy, are larger. It is also necessary to take into account that tightening policy too soon could slow the recovery, and make the gap larger.
Politically, the easiest promise to make is to eliminate waste, fraud, and abuse. Often such political rhetoric is vague about just what programs should be targeted. The first place many people look for wasteful programs is in nondefense discretionary spending, but that part of the budget is surprisingly small, only 19 percent of all federal spending in the 2010 federal budget, or just 4.7 percent of GDP. Adding defense gives total discretionary spending of about 9 percent of GDP. At least a few areas of spending, like federal courts, U.S. embassies abroad, and operations of the Treasury would have to be protected in any program of cuts. It follows, as a matter of simple arithmetic, that any attempt to eliminate the budget gap through cuts in discretionary spending alone would have to cut defense spending by more than half, and eliminate most nonessential departments--HUD, agriculture, commerce, NASA, EPA and many others--entirely.
Long-term projections show that growth of entitlement spending is more important than discretionary spending in explaining growth of the budget gap in coming decades. To some extent, this is due to aging of the US population. The other big factor is excess growth of medical costs, which have been growing at a rate about 2.5 percent faster than the general price level. Bringing the growth of medical costs down to the rate of increase of other prices could by itself eliminate most of the budget gap. However, doing so would be politically difficult. Many cost-cutting proposals, ranging from malpractice reform to a public insurance option to removing tax preferences for employer-paid health plans were considered, but rejected, during the recent health care debate in Congress.
The budget gap could also be closed by raising revenues, but there are constraints here, as well, as shown in recent research by the Urban Institute-Brookings Institution Tax Policy Center. It would be difficult to close the gap simply by raising tax rates within the existing income tax system--essentially impossible if rates were raised only for higher tax brackets. Closing tax loopholes and preferences could make a substantial contribution, up to 5 percent of GDP. However, many tax preferences serve public policy purposes, so that eliminating them would have opportunity costs. New taxes like a VAT could also raise much of the revenue needed to close the gap, but there seems to be solid political resistance to a VAT for the time being.
The bottom line: Simple arithmetic suggests that no single approach can close the budget gap. A combination of spending cuts and revenue increases will be needed. However, it must be kept in mind that every line in the federal budget has its political supporters--otherwise it would not be there in the first place. Eliminating the budget gap and restoring fiscal sustainability will be very hard work.
Follow this link to download a free, classroom-ready set of slides that present graphs and tables showing options for closing the budget gap. Three earlier posts in this Budget Basics series appeared on this blog during June, 2010.
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