Tuesday, November 15, 2011

Latvians, Homework and Budget Balancing


I went to a Latvian wedding last weekend and the dog ate my homework. Anyway, because of this or that my usual blog post may be a little shorter than usual. But I have been wanting to do this with or without the excuses anyway. This post is just a little data exercise to provide some perspective on what the so-called special committee is doing. Politics aside, their assignment is not really that difficult. One takeaway is that there is too little attention given to the fact that we are trying to create one solution for two very different problems. It’s like trying to find one shirt for Dolly and Gary Coleman. One size just won’t fit all.

The special committee is supposed to find roughly $1.2 trillion in deficit reduction over a time period of 10 years. In looking at spending and revenue possibilities everything gets lumped in and examined together – the Bush tax cuts, loopholes, spending on the military, etc. As a result we have an economic and ideological debate about what is and what isn’t a fair change. But the truth is that we really have two issues. The first one has to do with the short-run. We have a recession followed by a slow growth economy. The second one is the longer term issue of how to deal with an aging population. Separating these issues might help create some simple insights – and some simple remedies.

Let’s take the short-run first. The data is very clear. We jumped from having a very reasonable deficit of $161 billion in 2007 to one of about $1.3 trillion in 2010. That’s a 8-fold increase. The data is very clear about the source of that increase – between 2007 and 2010 government spending increased by $727 billion and taxes decreased by 406 billion. But that’s not the best measure of what happened. If government spending had grown at its normal rate (average rate since 1971) it would have increased in those years by $661 billion. Thus, only about $66 billion was an extraordinary increase in spending. It tax revenue had grown at a normal pace from 2007 to 2010, tax revenues would have increased by $602 billion. A tax decrease of $406 billion means that tax revenues were $1.008 trillion off their normal pace. It is absolutely clear that 2007 to 2010 was different from normal because: spending rose $0.066 trillion more than normal and tax revenues increased $1.008 trillion less than normal.

You spending clippers do not like this result because it focuses our attention away from cutting government spending to raising taxes. But you are wrong for two reasons. First, the spending issue has more to do with the long-run and I will get to that soon below. Second, I cannot tell you we need to raise specific taxes or tax rates because the tax reductions came from two very different sources – those that came from policies (e.g. Bush tax cuts, Obama tax cuts, etc) and those that came automatically as households, firms, and investors had less incomes and capital gains to claim. I can tell you that the fall-off of taxes was shared. Between 2007 and 2010 personal income taxes declined by $268 billion while business taxes decreased by $179 billion. Social Security taxes declined by only $5 billion.

Let’s move on to the longer-run. I am defining the long run as the 10 years from 2010 to 2020. Over those years government spending under existing law will increase by a total $1.705 trillion. This is, total federal government spending will go from $3.456 trillion in 2010 to $5.161 trillion in 2020. The changes in government spending over those years are projected to be:
               
Total                      $1,705 billion
                Social Security         502
                Medicare                 383
                Medicaid                 247
                Net Interest             436
                Everything else        137

Notice that if we don’t change any of those programs – and we cannot change net interest – we will need to raise taxes in 10 years by $1.7 trillion to cover spending. There isn’t much to cut from “everything else” and we can’t touch net interest. But we do have a nice hunk of future spending equal to $1.132 trillion that shows some promise.

Let’s emphasize now what is and what is not a cut. For example, Social Security spending is going to INCREASE by $502 billion. Just imagine that your check goes up by $502 billion by 2020. I would be pretty happy with that. But now, let’s say we decide to reduce the increase by 10% or by $50 billion. You would still find yourself $452 billion ahead of where you were in 2010. That will still buy a few nice prunes!  That is NOT a cut. It is an increase of $452 billion.

Speaking of Social Security, Medicare, and Medicaid if we slowed the increase by 10% we could save ourselves tax increases of $112 billion. If we cut the increase by 20% we would save $225 billion.

This short-run/long-run breakdown suggests that we have two different problems. The first one is to try to improve the tax system to offset reductions in taxes accruing from two recessions in the last decade and the tax cut policies that treated the recessions. As the temporary tax programs automatically are rescinded and as economic growth improves, much of that tax problem will disappear without any policy whatsoever. Of course, some attention to tax loopholes and attention to reversing temporary spending increases could hasten that short-run problem even more. 

With respect to the longer run the only game in town is spending. No program has to be cut. And tax revenues will increase. But reining in spending growth is necessary if we are to address our debt and deficit issues. Right now the baseline estimates have the deficit declining by a large amount in 2013 as temporary tax changes end with the deficit declining to 1.2% of GDP by 2010. I wouldn’t trust that number but it does show with some marginal attention to Social Security, Medicare, and Medicaid, all this is within reason.

I have not said a word about optimal spending and tax policies for long-term growth. I have not said anything about flat taxes or tax reform in general. Those are issues very worth addressing in another post. But what I am saying here is that we can do something about our worst debt and deficit problems. The solutions are not as impossible as our politicians make out.

If the European debt mess doesn’t send us a signal I don’t know what will. Our growth and our employment are dangling precariously as our leaders drink martinis and tell war stories. Boehner calls Obama a goof ball and ReidPelosi calls the Republican candidates worse names. They have within them to power to play political games that will soon seriously damage our country or they can wear big person clothes and address the humdrum but very doable task of letting the world know that we can handle our financial messes. From what I see in the news it sounds and looks more like continued political posturing and less attention to simple solutions. We should send all our government officials Barbie Dolls!



6 comments:

  1. Currently (today) the FED announced that spending rose for cars and electronic goods. Well if buying cars that are really needed at discount pricing to replace the old worn out clunkesr and wanting and buying Apple equipment is the savior of our economy then we are doomed for this cycle forever. At the same time Warren buffet stated that the underlying issue is the large inventory of vacant and foreclosed homes and commercial buildings....which are not paying taxes as well as the people who either developed them or may have lived in them.

    Tax revenue always increases when times are good ...unless there is a system that has so many loopholes that it falters along the way. So the short and long term goals are intertwined..1. in the short term the Government do what is necessary to set the stage for the long term where the economy will get good and a more honest tax system will generate the needed revenue without raising the %.

    It is refreshing to hear the word long term...I thought that type of thinking went away in the late 80's when corporate raiders and saviors thought only in the short term because they were paid by stock and cost cutting. Slicing businesses up produced instant short term earnings and they got their names in Fortune Magazine and brilliant businessmen.

    Then there is the other problem: The Boomers and the supporting generations under them. That is worth several blogs.

    What to d?. Ffocus on cutting unnecessary spending...and there is a lot of it.
    Unfortunately, the politicians have created all kinds of gifts and favors to keep their job and neither party can neatly get themselves out of this web.

    Stimulate spending but not give away funds to save government jobs....like the past stimulus where less than 30% every reached its target...or underwrote businesses that would make the president look good....for the short term.

    Dr. D brings up some good points. Until we solve the long and short term and admit they are married together in terms of cause and affect then it will be like our mutual friend Crashmore stated.."watching the D's and The R's negotiate the cutting of the $1.2T is like watching two gentlemen trying to discuss who will pay the bar bill on the Titanic as the band played on".

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  2. Your analysis is spot on, Perfesser! I suggest you forward it to the "Ever So Special Committee." They seem to be about as effective as the negotiators were in ending the Korean Police Action. I imagine the august committee has spent more time trying to decide the shape of their table and other such important issues than taking any meaningful action toward the debt problem. Wonder if they've decided on a $16-muffin supplier.

    First of all, $1.2T over 10 years is like spitting in the ocean. Second, the Ds don't want to cut spending anywhere, and the Rs don't want to raise taxes. Thirdly, the Ds don't want to touch entitlement programs, and the Rs don't want to touch defense and are afraid to touch entitlements. Fourth, the Ds want a more "progressive" tax structure, and the Rs want a more "fair" tax structure.

    Folks, what we have here is...sorry for the political incorrectness...the proverbial Mexican standoff. Nothing will happen. Automatic cuts will kick in and the Ds, supported by the mass media, will blame the Rs. The Rs will blame the Ds, but nobody but FNC watchers and non-traditional media users will hear about it. It's a silly game played by people who have only their own best interests at heart. To assume this group even owns any "grown-up clothes" is dangerous.

    Welcome to Itgreeportspausa.

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  3. Dear LSD . . . a blog a little shorter than usual?

    Yes . . . AEM and J . . . . good words all . . . . but at the end-0-the-day . . . . and also to Dr. D . . . . . the especialé cummitte on self flagilation will simply pass de ol bole down the field to their respective subcummittees to self-fondle (can we say PS?) until the ol electorate rufferee on Nov. 6, 2012 declares the decision will “stand as called on the field” or turn de ol bole over to de odder side.

    Mexican standoff in the U.S.?

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  4. Charles -- it started out shorter but then I kept adding...and adding. I guess it isn't possible for me to write a shorter one. Ain't it the truth about the standoff. But what should we expect from our politicians? They are paid handsomely to hand out favors. We should not expect them to take away their only weapons easily.

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