A Plan to Cut Spending

April 2011

Introduction
Reducing Spending over 10 Years
Spending Cut Details
Subsidies to Individuals and Businesses
Aid to State and Local Governments
Military Expenses
Medicare, Medicaid, and Social Security
Privatization
Conclusions
 

Introduction

Federal spending is soaring, and government debt is piling up at more than a trillion dollars a year. Official projections show rivers of red ink for years to come unless policymakers enact major budget reforms. Unless spending is cut, the United States is headed for economic ruin.

The results of the 2010 elections made clear that Americans want an end to the spending spree in Washington. People fear that today’s spendthrift policies may lead to large tax increases and a lower standard of living for themselves and their children. The public has given Congress marching orders to start cutting spending and rein in debt.

Policymakers should implement an emergency plan of cuts to defense, domestic, and entitlement programs. This essay proposes spending cuts of more than $1 trillion annually by 2021, which would balance the budget without resorting to damaging tax increases. Federal spending would be reduced to 18.0 percent of gross domestic product by 2021 under the plan, which compares to President Obama’s projected spending that year of 24.2 percent of GDP.

Each of the spending cuts proposed here would make sense whether or not the government was running deficits. That’s because many federal programs reduce individual freedom and cause economic distortions. If these programs were cut, resources would flow from lower-return government activities to higher-return activities in the private sector.

In recent decades, the federal government has expanded into hundreds of areas that should be left to state and local governments, businesses, charities, and individuals. That expansion is sucking the life out of the private economy and creating a top-down bureaucratic society that is alien to American traditions. Cutting federal spending would enhance civil liberties by dispersing power from Washington.

The need to cut spending and debt is urgent. Numerous committees, think tanks, and members of Congress have proposed plans to tackle ongoing deficits, including the House Budget Committee, the House Republican Study Committee, Senator Rand Paul (R-KY), and President Obama’s National Commission on Fiscal Responsibility and Reform. The various plans are not in agreement about the role of taxes in reducing deficits, but there is fairly broad support for substantial spending cuts, particularly cuts to entitlement programs.

The plan presented here does not include tax increases. Official budget projections show that federal debt is exploding because spending is at abnormally high levels. With the 2001 and 2003 tax cuts in place, and with continued relief from the alternative minimum tax, federal revenues are expected to rise to at least 18 percent of GDP in coming years, which is about the average over recent decades. By contrast, it is federal spending—currently at more than 24 percent of GDP—that is above normal levels. During the last two years of the Clinton administration a decade ago, federal spending was just 18 percent of GDP.

Some analysts claim that cutting government spending would hurt the economy, but that idea is based on faulty Keynesian theories. In fact, federal spending cuts would shift resources from often mismanaged and damaging government programs to the more productive private sector, thus increasing overall GDP. Consider Canada’s experience. In the mid-1990s, the country faced a debt crisis caused by runaway government spending—similar to our current situation. The Canadian government changed course and slashed total spending 10 percent in just two years and then held it roughly flat for another three years.¹ The Canadian economy did not sink into recession, but was instead launched on a 15-year economic boom.

Policymakers shouldn’t think of spending cuts as a necessary evil needed to reduce debt. Rather, the government’s fiscal mess is an opportunity to make reforms that would spur growth and expand individual freedom. The plan below includes a menu of spending cut options for Congress, and further reforms are described at www.DownsizingGovernment.org.
 

Reducing Spending over 10 Years

This section illustrates how a reduction in spending could eliminate the federal budget deficit over 10 years. It shows projections of revenues and spending as a share of GDP based on the March 2011 Congressional Budget Office estimates.² My projections for revenues assume the extension of the 2001 and 2003 income tax cuts, extension of alternative minimum tax relief, and repeal of the tax increases in the 2010 health care law.³ My projections for spending adjust the CBO baseline to include more realistic assumptions regarding troop reductions in Iraq and Afghanistan and the extension of the Medicare “doc fix.”⁴

In Figure 1, the bottom line shows that federal revenues with tax relief in place are expected to rise to 18.0 percent of GDP by 2021 as the economy recovers and resumes normal growth. The top line shows President Obama’s proposed spending based on his fiscal 2012 budget.⁵ As a share of GDP, spending is expected to dip the next few years as funding from the 2009 “stimulus” bill peters out and war costs fall, but spending is expected to start rising again after that. That high spending path would lead to higher taxes, higher debt, or both.

Figure 1.
Projected Federal Revenues and Spending Percent of GDP

The middle line in the chart shows spending under the balanced budget plan. Under this plan, spending cuts of more than $1 trillion annually by 2021 would be phased in over 10 years.⁶ Those cuts would generate substantial interest savings by 2021, and total federal spending would fall to 18.0 percent of GDP—the same level as federal revenues that year. With those cuts, federal public debt would peak at 75 percent of GDP in 2013 and then fall to 64 percent of GDP by 2021.
 

Spending Cut Details

Table 1 lists the proposed annual cuts for the balanced budget plan. By 2021, these include $150 billion in defense cuts and $490 billion in cuts to Medicare, Medicaid, Social Security, and the 2010 health care law. The table also includes other discretionary and entitlement cuts valued at $445 billion in 2011. With the assumed revenues, all these spending cuts would be saving the government $260 billion in annual interest costs by 2021.⁷All in all, total spending in 2021 under this plan would be about $1.4 trillion lower than under either the CBO baseline or the president’s budget.

As a technical note, most of the figures in Table 1 are outlays for fiscal 2011 from President Obama’s fiscal 2012 budget.⁸ These cuts are expressed in 2011 dollars, but I’ve assumed that the value of these cuts would grow over time at the same rate as discretionary spending in the CBO baseline. The cuts in Table 1 marked with an asterisk are expressed in 2021 dollars and are generally based on CBO estimates.

The reforms listed in the table are deeper than the “duplication” and “waste” items often mentioned by federal policymakers, such as earmarks. The reality is that the nation faces a fiscal emergency, and we need to cut hundreds of billions of dollars of “meat” from federal departments, not just the obvious “fat.” If the activities to be cut are useful to society, then state governments or private groups should fund them, and those entities would probably be more efficient at doing so.

The cuts in Table 1 are illustrative of how to begin getting the federal budget under control. Further reforms are needed in addition to these cuts, particularly structural changes to Medicare. But the important thing is to start cutting right away because the longer we wait, the deeper the pile of debt we will have to dig out from.

Table 1 includes cuts to individual and business subsidies, cuts to state aid, cuts to military expenses, cuts to the growth in entitlement programs, and privatization of federal activities. The sections following the table discuss these various types of cuts, and further analysis of the cuts is available at www.DownsizingGovernment.org.

Subsidies to Individuals and Businesses

The federal government operates more than 2,000 separate subsidy programs, a doubling of subsidy programs since the mid-1980s.⁹ The scope of federal activities has greatly expanded in recent decades, along with the sizeof the federal budget. The federal government subsidizes farm businesses, retirees, school lunches, rural utilities, the energy industry, rental housing, public broadcasting, job training, foreign aid activities, foreign purchases of weapons, urban transit services, and many other types of activities and people.

Each subsidy program costs money, generates a bureaucracy, spawns lobby groups, and encourages more people to demand freebies from the government. Individuals, businesses, and nonprofit groups that become hooked on federal subsidies essentially become tools of the state. They lose their independence, they have less incentive to innovate, and they shy away from criticizing the government.

Table 1 includes cuts to subsidies in agriculture, commerce, energy, housing, foreign aid, and other areas. These cuts wouldn’t eliminate all of the unjustified subsidies in the federal budget, but they would be a good start. Government subsidies are like addictive drugs, undermining America’s traditions of individual reliance, voluntary charity, and entrepreneurialism.
 

Aid to State and Local Governments

Under the Constitution, the federal government was assigned specific limited powers, and most government functions were left to the states. To ensure that people understood the limits on federal power, the Framers added the Constitution’s Tenth Amendment: “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.” The amendment embodies federalism, the idea that federal and state governments have separate areas of activity and that federal responsibilities are supposed to be “few and defined,” as James Madison noted.

Unfortunately, policymakers and the courts have mainly discarded federalism in recent decades. Congress has undertaken many activities that were traditionally reserved to state and local governments through the mechanism of “grants-in-aid.” Grant programs are subsidies that are combined with federal regulatory controls to micromanage state and local activities. In fiscal 2011, federal aid to the states will total $625 billion, which will be distributed through more than 1,100 separate programs.¹⁰

The theory behind grants-in-aid is that the federal government can operate programs in the national interest to efficiently solve local problems. However, the federal aid system does not work that way in practice. Most federal politicians are consumed by the competitive scramble to maximize subsidies for their states, regardless of efficiency, fairness, or any appreciation of overall budget limitations.

Furthermore, federal aid stimulates overspending by state governments and creates a web of complex federal regulations that destroy state innovation. At all levels of the aid system, the focus is on regulatory compliance and spending, not on delivering quality public services. The aid system destroys government accountability because each level of government can blame the other levels when programs fail. It is a “triumph of expenditure without responsibility.”

The federal aid system is a roundabout funding system for state and local activities. It serves no important economic purpose. By federalizing state and local activities, we are asking Congress to do the impossible—to efficiently plan for the competing needs of a diverse country of more than 300 million people.

The grants-in-aid system should be dramatically cut. Policymakers need to revive federalism and begin to terminate grant programs. Table 1 includes cuts to grants in the areas of agriculture, education, health care, justice, and transportation. The justice grants, for example, are for funding such items as bulletproof vests for local police.¹¹ There is no reason why such activities should not be funded at the city or county level.
 

Military Expenses

Cato Institute defense experts Christopher Preble and Benjamin Friedman have proposed a lengthy list of cuts to U.S. military spending totaling $1.2 trillion over 10 years.¹² Within 10 years, their proposal would reduce spending by about $150 billion annually, based on a strategy of restraint and reduced intervention abroad.

In proposing their plan, Preble and Friedman argue that the United States would be better off taking a wait-and-see approach to distant threats, while letting friendly nations bear more of the costs of their own defense. They note that U.S. policymakers support many extraneous missions for the military aside from the basic requirement to defend the nation. There is no doubt that America’s military budget is bloated. Even aside from the wars in Iraq and Afghanistan, Department of Defense spending roughly doubled between 2001 and 2011.¹³
 

Medicare, Medicaid, and Social Security

The projected growth in Medicare, Medicaid, and Social Security is the main cause of America’s looming fiscal crisis. Budget experts and policymakers across the political spectrum understand the need to restructure these programs. The reforms listed in Table 1 include repealing the 2010 health care law and some initial efforts to control health care and Social Security costs.

For Social Security, the growth in initial benefits would be indexed to prices rather than wages, which would slow benefit growth over time. The proposal would save $41 billion annually by 2021 and growing amounts after that, according to the CBO.¹⁴ The plan also includes a CBO option to modestly raise the program’s normal retirement age.¹⁵

Medicaid should be converted from an open-ended matching grant program to a block grant, which would provide a fixed amount of funds to each state but allow state policymakers more program flexibility. That was the successful approach used for welfare reform in 1996. Converting Medicaid to a block grant would reduce federal costs, while encouraging innovation and cost reductions by the states. Setting the Medicaid block grant at the 2011 level of Medicaid spending would result in saving more than $200 billion annually within a decade.

The plan includes some modest Medicare changes based on CBO estimates, including increasing deductibles for services and increasing premiums for Part B to cover 35 percent of the program’s costs.¹⁶ The plan would repeal the 2010 health care law, including the higher revenues and spending. It further assumes that the Medicare improper payment rate, which is at least 10 percent, would be cut in half.

However, much larger reforms to the program are needed. Cato scholars have proposed moving to a system based on individual vouchers, personal savings, and consumer choice for elderly health care.¹⁷ The House Budget Committee has similarly proposed a plan to convert Medicare into a consumer-driven health system.¹⁸ Such reforms would create strong incentives for providers and patients to improve system quality and efficiency.
 

Privatization

In recent decades, governments around the world have sold off state-owned assets to private investors.¹⁹Airports, railroads, electric utilities, post offices, and other assets have been privatized. Privatization generally leads to reduced costs, higher-quality services, and increased innovation in formerly moribund government industries.

There are many federal assets that should be privatized. Table 1 includes the privatization of Amtrak, the air traffic control system, and the Army Corps of Engineers. Such reforms would reduce federal budget deficits and help spur economic growth.

Consider the nation’s air traffic control system, which is run by the Federal Aviation Administration.²⁰ The FAA has struggled to expand capacity and upgrade its technology, and its modernization efforts have often fallen behind schedule and gone over budget. A series of incidents in 2011 indicated that the agency has serious workforce management problems. The air traffic control system needs major improvements to meet rising travel demands, but the FAA may not be capable of meeting the challenge.

The good news is that a number of countries have restructured their air traffic control systems and provide good models for U.S. reforms. Canada privatized its air traffic control system in 1996, setting up a private, nonprofit corporation, Nav Canada. The company is self-supporting from charges on aviation users. The Canadian system has received high marks for sound finances, solid management, and investment in new technologies.²¹ Aside from those advantages, a privatized system in the United States would save about $6 billion a year in general fund taxpayer costs.
 

Conclusions

Official projections show that without reforms federal spending will soar to more than 40 percent of GDP by 2050, and even higher after that. State and local spending comes on top of that, with the result that governments would consume more than half of the entire U.S. economy.

However, it seems inconceivable that voters and taxpayers would let the government grow to anywhere near that large. Indeed, the results of the 2010 elections indicate that there is already widespread disapproval of big government. It is also unlikely that the government would be able to raise taxes much above current levels to support higher spending because of our increasingly globalized economy.²²

The upshot is that we will have to make major spending cuts sooner or later, and it would be better to make them sooner before we accumulate even more debt. Policymakers can start with the menu of cuts presented here, and then they should pursue other reforms such as restructuring Medicare. Leaders of other industrial nations have pursued vigorous cost-cutting when their government debt got out of control, and there is no reason why our political leaders shouldn’t do the same.