Back to the Budget

One of the least remarked upon aspects of the President’s State of the Union address last week was that it made no reference to the federal budget or to the deficit. Nor, for that matter did any of the seven – yes seven! – official or quasi-official Republican rebuttals.

Why has the budget become a non-issue?

Well, because the deficit has shrunk at a rapid rate. This is what it looks like expressed as a percentage of the economy as a whole:

 

Fed Deficit

In terms of dollars the deficit was $483 billion in 2014 and is expected to shrink slightly to $467 billion in 2016. As a percentage of GDP the deficit is now down to 2.8% in 2014, which compares with an average of 2.7% for the past fifty years. So after its extraordinary run-up because of the crisis of 2007/2008 the Federal deficit is pretty much back to normal.

A couple of days ago the Congressional Budget Office released its latest long range forecast for the Federal budget, and announced that the red ink will begin to swell again in the not too distant future, with deficits inching back up towards between 3% and 4% of GDP over the next decade.

A consequence of this is that the amount of Federal debt owned by the public will also start to rise again, from its current level of about 74% of GDP towards close to 80% by 2025. Just for reference that ratio was around 37% before the crisis began.

Why is this worthy of comment right now?

Because the President will submit his annual budget to Congress next week and rumor has it that he looking for an increase in spending somewhere in the range of $70 billion. This will undoubtedly bring the deficit back into focus, and will cause the usual rumpus from the GOP.

So as we set the stage for the next round of budget battles we ought to reflect on a few significant points:

First, let me remind you of the famous comment by Dick Cheney: “deficits don’t matter”. This was standard Republican thinking back in the 1980’s when Reagan tax and spending policies caused outlays to grow much faster than revenues. You can see this effect clearly in the cart above, where the 1980’s are a decade of large deficits – much larger than anything seen since those of the wartime economy of the 1940’s. It is always fun to poke Cheney’s line at any Republican who now claims that it is Democratic policy making that created the deficits.

Second, as the chart also shows, apart from the recent post-crisis years the only period of consistent reduction in the deficit was during the Clinton era. I don’t count the Bush administration for the simple reason that the reduction in later years was from a larger deficit that was a deliberate consequence of profligate tax policy at the onset of the Bush era. I realize that some Bush apologists will claim that deficit increase of 2001/2002 was in reaction to the recession around that time, but I don’t buy it: the Bush administration’s early policy was built around reducing revenues, and the infamous tax cuts of that era reflect, not a Keynesian style stimulus, but a Grover Norquist driven attempt to “starve the beast”. Those of us enamored with Clinton, however, would do well to remind ourselves that the deficit reduction during the 1990’s and more to do with the dot-com bubble than it did with intentional policy.

Third, a significant factor in driving the recent reduction in the deficit has been the notorious sequester of 2011 [aka: The Budget Control Act].  This legislation imposed strict spending guidelines on Congress, which, after a so-called Super-Committee failed to find any common ground for cuts, kicked in with full force in 2013. So sequester is still driving budget policy and the two sides in Congress both tear their hair out over the damage being done to pet projects – the defense budget is now down to about 3.3% of GDP and is expected to fall further to about 2.8% over the next couple of years. The effect of the sequester will be to drive discretionary spending – i.e. that part of spending not mandated by specific legislation – down to levels unheard of since records were first established for such spending in 1940. We are already back to levels not seen since 1962. Obviously this untenable: it leaves no room at all for increases in infrastructure spending, which has been moribund for years now.

Fourth, this all leaves the field open for continued war over the mandatory part of the budget which largely consists of Social Security, Medicare, and Medicaid. These programs together comprise a large majority of total Federal spending and are due to increase gradually over the next decade as the baby boom generation ages and retires. According to the CBO, Social Security spending will rise to about 5.7% of GDP by 2025 [from around 4.9% in 2015 and 4.2% in 1990], while spending on the various health care programs will rise to about 6.2% of GDP [from around 5.1% in 2015 and 2.3% in 1990]. Only a couple of weeks into the new Congress and the groundwork has been set for the next battle over Social Security: the House GOP leadership changed the rules covering the way in which internal transfers between the two Social Security accounts are agreed to by Congress. The account covering the disability portion of the program was set up at a different time from the main account, and is expected to need replenishment in 2016. In that past votes to authorize such a replenishing move were pro-forma and perfunctory. Now the new rule allows a single member of Congress to veto them. So instead of being routine, as they have been in the past, they will become hostage to right wing attack.

Fifth, the CBO’s forecasts of a renewed deterioration in the budget in the years beyond 2020, are heavily affected by interest rates. The CBO expects interest rates to return to ‘normal’ levels quite quickly. This will, inevitably, raise the cost of the accumulated debt, so that it gets back to about 3% of GDP by 2025 up from around 1.3% now. This is, however roughly what interest costs were in the early 1990’s before the Clinton era reduction in debt.

Overall lamentable tax policy over the past thirty years – and especially under Reagan and Bush –  has seen Federal revenues drop to only 17.5% of GDP. Whilst this is around the average for the past fifty years it is well below the level of spending, which, at around 20% of GDP, is also right at its fifty year average. In other words we have arrived, accidentally rather than deliberately, at a budget whose income and expense components reflect long term attitudes. The net result being a return also to the long term amount of deficit.

What throws this into the political battleground is that spending on social programs is mandated to increase simply because of the aging of the population. We are thus confronted with a dilemma: do we fund that increase? Or do we cut into spending – essentially reneging on the deal we made with future retirees when they were working and contributing to the programs?

So, although the budget wars might seem to have faded from view, they will assuredly pop right back up. Perhaps as early as next week’s Presidential budget proposal.

Stay tuned.

 

 

 

 

 

 

 

 

 

 

 

 

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