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Mindless Yes, Austerity No: The Real Budget Problem

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Mindless Yes, Austerity No: The Real Budget Problem

February 19, 2015

When his budget proposals were recently released, President Obama stated, “I want to work with Congress to replace mindless austerity with smart investments that strengthen America.” That quotation neatly summarizes how the White House is framing the basic trade-off faced in federal budgeting: between “austerity” (i.e., severe cuts in spending and deficits) and “investments” (i.e., spending on things needed to support future prosperity). The real trade-off we face, however, is fundamentally different.

It should be recognized up front that the president makes an important point. To see this, let’s put aside for a moment the semantic battle between right and left over whether to call government outlays “spending” (with its negative connotations) or “investments” (with its positive ones). Let’s also put aside important policy questions such as the relative efficiency of public vs. private investments in areas ranging from transportation infrastructure to education. The president is correct to suggest there has been a protracted decline in the share of our economic output going toward this type of federal expenditure.

The graph below shows total federal domestic appropriations as a percentage of GDP. This essentially includes (among others) the categories of spending described in the president’s budget as “investing in America’s future,” among them education, manufacturing research, and transportation infrastructure. This does not include mandatory “auto-pilot” spending such as Social Security, Medicare, and interest payments on the debt. The long-term trend for appropriated non-defense spending has indeed been down, at least as a share of our economic output, despite surging after President Obama took office. Under current Congressional Budget Office projections, this downward trend will continue: less of our output will be going toward such federal expenditures than was formerly the case.

This is not because we have been shifting our resources from domestic needs to fight wars. Spending on defense did increase in the 2000s after the 9/11 attacks, but overall the relative decline in defense spending has been even steeper than for domestic appropriations. In other words this has not been a shift of butter to guns; quite the opposite, as the next graph shows.

Is it correct, then, to say that our ability to spend/invest in the areas favored by the White House has been constrained by the practice of fiscal austerity? Decidedly not. Federal deficit spending has instead risen persistently, soaring to a post-WWII high in the first years of the Obama Administration. It has abated in the last few years but CBO finds it will resume rising in the years ahead.

These historically large deficits have produced historically large debt. Federal indebtedness to the public is now 74 percent of GDP, over twice the share of our economy that it was just seven years ago. CBO projects it will rise to roughly 79 percent of GDP by 2025, a level not seen this side of a world war. 

Taken together, these graphs reveal that the fundamental trade-off we face is not between spending on education/innovation/infrastructure on the one hand and “mindless austerity” on the other. To the contrary, prioritization of such federal spending has declined during the same period that federal indebtedness has soared to historic highs. 

Is this happening because Americans, specifically rich Americans, aren’t being taxed enough? No. In 2014 federal revenues equaled 17.5 percent of GDP, a little above the average (17.4 percent) over the last fifty years. Looking forward to when various current-law tax increases fully kick in, CBO projects revenue collections will reach 18.3 percent of GDP, well above historical norms. In other words, federal debt will be at historic highs while appropriated spending is lower than historically normal and taxation is higher than historically normal. Clearly these variables alone don’t explain what is going on. 

Our debt has exploded because total federal spending, beyond those areas many define as “investments,” is rising faster than our economic output or our revenue base can sustain. 

This unsustainable spending growth occurs because we continue to increase spending on Social Security, Medicare, Medicaid, and now on the massive expansion of federal health spending embodied in the Affordable Care Act. Growth in these four categories of federal entitlement spending accounts for our whole fiscal imbalance.

This last graph shows the essence of our budget problem. It reveals that the barriers confronting those who want to see more federal spending on education and infrastructure have little to do either with austerity or with insufficient taxes paid by rich people. Both taxation and debt are heading to historic highs despite the relative declines in the aforementioned spending. The reason we are spending relatively less on defense, education, and highways is purely because we are continually spending more on Medicare, Medicaid, Social Security, and the ACA.

A dialogue between left and right will not change this dynamic because the areas of strongest disagreement between left and right—taxation and alleged austerity—are not at the root of the problem. The dynamic will only change if the conversation within the political left changes; specifically, when left-of-center thinkers decide that rising entitlement spending is a problem because it steadily degrades our capacity to spend on other priorities. This would not require those on the left to abandon their philosophical commitment to Social Security, Medicare, Medicaid, or the ACA: only that they recognize these programs cannot perpetually grow faster than our ability to finance them, without undesirable consequences for the rest of the budget. 

To date this conversation has yet to be seriously engaged. Certain narrative fictions persist, for example that the only thing preventing us from having enough money to spend on highways and community colleges is that the rich aren’t paying enough taxes. Though this fiction may suit certain political interests, it does not serve the interests of those serious about addressing other societal needs. Even if one believed this narrative, the fact remains that our abilities to tax and to issue debt are not unlimited. Plus, there are practical limitations that the political center will impose which the political left, left to its own devices, would not. It is not realistic to believe that our untenable entitlement spending growth path can remain in place, and that we will also find more money to invest in roads and bridges.

The evidence of these dynamics is clearly visible. In 2011, Democrat and Republican negotiators both well understood that entitlement spending growth was driving our fiscal imbalance. Still they could not agree on even modest corrections. Raising taxes on the rich, as President Obama succeeded in doing in early 2013, has not meaningfully changed the long-term trend. Even with these tax increases in hand, the burden of meeting fiscal targets under the Budget Control Act is falling primarily on the discretionary spending accounts, especially defense. This has meant across-the-board spending cuts (sequestration), mostly in appropriated spending, while entitlement spending continues to rise unchecked.

As long as spending growth in Social Security, Medicare, Medicaid and the ACA continues unabated, we can expect the share of national resources devoted to other federal government priorities to continue to decline. As former President Clinton might say, “it’s arithmetic.”

 

Charles Blahous is a senior research fellow for the Mercatus Center, a research fellow for the Hoover Institution, a public trustee for Social Security and Medicare, and a contributor to e21.

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