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In the Nation's Interest

“We Have a Spending Problem”? OR “Everything on the Table”?

Is the federal budget problem caused solely by overspending?  Or does it have roots on both sides of the ledger?  And what does the answer to that question say about a potential remedy going forward?

There are people who believe in, and want, bigger government.  And there are people who believe in, and want, smaller government.  But that is a different issue.  It is the gap between spending and revenues today which equals the deficit, which is the annual increment to our potentially unsustainable debt.  What is the cause of that gap?  To see, it might be worth taking a look at the numbers.

To the extent that this claim is analyzed, it is generally in reference to the historical average of spending as a percentage of the GDP.  So, for example, federal spending now – actually 24.1 percent of GDP in both fiscal years 2010 and 2011 – is higher than its post-World War II (1946-2011) average of 19.8 percent.  QED, to some.

But what about revenues?  And is the entire post-War average a reasonable historical standard?  Using a benchmark of all of our post-World War II history could be misleading, because that would include the years in which we borrowed ourselves into the trouble we now face.  Instead, a more reasonable approach might be to look at the recent years when our finances were unquestionably in order: the balanced budgets of fiscal years 1998-2001.

Here is a brief summary of those years, looking at both spending and revenues as percentages of the GDP, compared with the last three years of large budget deficits:

Then, for purposes of analysis, let’s look at the range of receipts and outlays – both the lowest and the highest, in the balanced budget years and the last three years:

So in our balanced budget years, federal outlays ranged from a low of 18.2 to a high of 19.1 percent, whereas in the last three years outlays were between 24.1 percent (in 2010 and 2011) and 25.2 percent (in 2009) – clearly higher.

However, receipts in the last two years also differed from the balanced budget years.  When the budget was in balance, receipts ranged from a low of 19.5 percent to a high of 20.6 percent.  But in the last three years of high deficits, receipts ranged from 15.1 percent to 15.4 percent of GDP – much lower than when the budget was in surplus.

So how far off from our best recent budget years were these last three years?  Here is how the numbers stack up:

Clearly, our budget has been substantially off from its most reasonable historical benchmark, but on both sides of the ledger.  Spending has been anywhere from 5.0 percent to 7.0 percent of GDP higher than in our best recent years.  But revenues have ranged from 4.1 percent to 5.5 percent of GDP lower – nearly the same gap.

Some might question this comparison, on the ground that revenues in the last three years have been lower because of the weakness of the economy, and will recover.  But spending has been higher because of the weakness of the economy as well, and it will decline.  Revenues have been reduced because of stimulus initiatives.  But spending has been increased because of stimulus initiatives, too.

At 25.2 percent of GDP in 2009, spending was at its highest since 1945, the last year of World War II.  But at 15.1 percent of GDP in 2009 and 2010, revenues were at their lowest since 1950.

In sum, a simple historical view of recent federal government spending and revenues does not by itself indicate that our budget problem is caused 100 percent on the spending side of the ledger.  Revenues have been lower than history would endorse, just as spending has been higher.

But choices for our future should not be made solely on the basis of historical norms.  Any public finance textbook would say that every public initiative must justify itself according to the benefits it would yield relative to the cost to fund it.  Our elected decision makers owe us their careful analysis of the value of national security, food safety, the education of our next generation, and the health of our elders (among other things) against the economic cost of raising the funds necessary to accomplish those objectives.  (And that relative balance will change over time.)  Anything short of such careful analysis does not do justice to the trust of public office that we, the voters, have vested in our representatives in Washington.

As a quick first cut at such analysis, let’s consider two factors.

“Draining funds from the private sector.”  Some argue that budget deficits are an inherent drag on economic growth, because the excess government spending drains resources from the private sector into government.  They believe that this reduces private investment and replaces it with invariably wasteful government spending.

There is one big problem with this argument.  In an economy such as today’s with massive unemployment and idle private-sector productive capacity, budget deficits do not reduce private-sector activity.  If anything, they increase it, because when households and businesses receive payments from the government, they turn around and spend that money in the private sector, thereby pulling idle capital and workers back into use there.

The aging of the population.  Second, looking forward, the elderly will be a growing share of our population – not only because of the widely heralded retirement of the baby-boom generation, but also because of the underlying trend of longer lifespans and smaller families.  The growing elderly population will increase government outlays for Social Security, Medicare, and Medicaid.  That will increase federal government outlays, and will require higher revenues to compensate.

Beyond population aging itself, rapidly rising healthcare costs for each elderly beneficiary will drive federal outlays still higher, and are the major cause of projected long-term budget deficits and unsustainably growing debt.  There is no question that the healthcare system must be restructured to reduce cost growth.  However, no one yet knows precisely by how much any healthcare strategy can reduce cost growth.  Most every healthcare analyst would be driven to bliss if he or she found a policy that could stop excess cost growth in its tracks.  But to assume that such success could be achieved, in the absence of any evidence, would be imprudent.  And even if such total success were attained – and we are nowhere near that assurance – aggregate health costs still would increase because of the growth of the elderly population.  So prudent budget planners must prepare for increasing outlays for programs for the support of the elderly; and if the budget is to become sustainable again, those greater outlays will have to be paid for.

There is no clear-cut case that all of the budget problem arises from spending; and looking forward, there is strong evidence that the problem cannot be solved only with spending cuts.  It seems that the best guide toward a solution is the oft-repeated aphorism:  Everyone at the table, and everything on the table.