A Plan to Cut Federal Spending

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Chris Edwards

May 2014

Introduction
Spending Cut Overview
Spending Cut Details
Subsidies to Individuals and Businesses
Aid to States
Military Expenses
Medicare, Medicaid, and Social Security
Privatization
Conclusions
 

Introduction

Federal spending has soared over the past decade and government debt has piled up. The budget situation has recently improved as the economy has strengthened, but federal deficits are expected to start rising again after 2015. Over the long term, official projections show endless rivers of red ink unless policymakers enact major budget reforms.

Policymakers should downsize every federal department by cutting or eliminating the most harmful programs. This essay proposes phasing in spending cuts that would reach almost $1 trillion annually by 2024. That would bring spending down from 20.4 percent of gross domestic product (GDP) today to 17.6 percent, which was the level the last time the budget was balanced in 2001.

Spending cuts would make sense whether or not the government was running deficits. That is because cuts would spur economic growth as resources moved from lower-valued government activities to higher-valued private activities. Spending cuts would also expand freedom by giving people more control over their lives and reducing the regulations that come with federal programs.

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 Congressional Budget Office (CBO) projects that under current law federal spending will rise from 20.4 percent of GDP in 2013 to 22.1 percent by 2024.1 Over the same period, federal tax revenues are expected to rise from 17.6 percent of GDP to 18.3 percent. Despite the growing revenues, the government would continue to run large deficits because spending would remain at high and rising levels.

Policymakers should change course and cut spending, eliminate deficits, and reform the most damaging parts of the tax code. The plan presented here would balance the budget in nine years and generate growing surpluses after that. Spending would be reduced to 17.6 percent of GDP by 2024, or one-fifth less than the CBO projection for that year. Spending cuts would create budget room to repeal the tax increases in the 2010 health care law and pursue other tax reforms.

Some economists 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 more productive private sector activities, thus increasing overall GDP.

Consider Canada’s experience. In the mid-1990s, the federal government faced a debt crisis caused by overspending, which is similar to America’s current situation. But the Canadian government reversed course and slashed spending from 23 percent of GDP in 1993, to 17 percent in 2000, and to just 15 percent today.2 The Canadian economy did not sink into a recession as Keynesians would have expected, but was instead launched on an extended boom.

The lesson is that policymakers should not think of spending cuts as a necessary evil needed to reduce deficits. Rather, the U.S. government’s fiscal mess is an opportunity to make reforms that would spur growth and expand individual freedom. The plan considered here includes a menu of spending cuts for policymakers to consider. These and other reforms are discussed further in essays at www.DownsizingGovernment.org.
 

Spending Cut Overview

This section illustrates how a reduction in spending could eliminate the federal deficit in nine years and generate growing surpluses after that. The starting point for the plan is the baseline projection from the Congressional Budget Office in April 2014.3 Figure 1 shows the CBO projections for revenues (black line) and spending (red line) as a percent of GDP. The gap between the two lines is the federal deficit, which is expected to grow after 2015 unless reforms are enacted.

Figure 1. Projected Federal Revenues and Spending
Percent of GDP

Figure 1. Projected Federal Revenues and Spending  Percent of GDP

The green line in the figure shows projected spending under the reform plan proposed here. Under the plan, spending would decline from 20.4 percent of GDP today to 17.6 percent by 2024. The deficit would be eliminated by 2023 and growing surpluses would be generated after that. Under the plan, spending cuts would be phased in over 10 years and would total $965 billion annually by 2024. Those cuts would generate interest savings of $228 billion annually by 2024.4 All in all, federal spending would fall to 17.6 percent of GDP by 2024, which was the level the last time the budget was balanced in President’s Bill Clinton’s final year in office.

Under the CBO baseline projection, federal revenues rise to 18.3 percent of GDP by 2024, which is higher than spending would be under the reform plan. That would allow room for tax reforms, such as repealing the tax increases in the 2010 health care law (“Obamacare”), which are expected to raise about 0.7 percent of GDP in revenues annually.5

Policymakers can also reform the tax code in ways that would not reduce federal revenues. One high-priority change is to cut the federal corporate income tax rate from 35 percent to 25 percent or less. Such a cut would not decrease revenues over the long term because it would reduce tax avoidance and increase economic growth.6 Canada provides a real-world example of these dynamic effects. It cut its federal corporate tax rate from 29 percent in the 1990s to just 15 percent today, but corporate tax revenues as a percent of GDP are about the same today as in the 1990s.7

In sum, the best fiscal policy would be to cut spending while reducing the most economically harmful taxes, such as the corporate income tax. That approach would not only reduce budget deficits but also create broad-based benefits for all Americans from an expanding economy.
 

Spending Cut Details

Tables 1 and 2 below list proposed cuts to reduce federal spending to 17.6 percent of GDP by 2024. Table 1 shows the cuts for health care and Social Security. These reforms would be implemented right away, but the value of savings would grow larger over time. The figures shown are the estimated annual savings by 2024, based on CBO projections.8

Table 2 shows cuts to discretionary programs and entitlements other than health care and Social Security. 9 These cuts would be valued at $429 billion in 2014, but the plan assumes that they would be phased in one-tenth each year over the next decade. Also note that the value of these cuts would be greater in 2024 than in 2014.10

The reforms listed in Tables 1 and 2 are deeper than the savings from “duplication” and “waste” often mentioned by federal policymakers. 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 proposed cuts are illustrative of how to begin getting the federal budget under control. Further reforms are needed in addition to these cuts, particularly major structural changes to Medicare. The important thing is to start cutting as soon as possible because the longer we wait, the deeper the debt hole that we will be in.

After the tables, sections below discuss proposed cuts to subsidies, aid to the states, military expenses, and entitlement programs. The final section discusses the privatization of federal activities. Further analyses of the cuts listed here are available in the related essays at www.DownsizingGovernment.org.
 

Table 1. Proposed Federal Budget Cuts
Health Care and Social Security
Agency and Activity  
Annual Savings
     
$Billions, 2024
Department of Health and Human Services    
   Repeal 2010 health care law   125.0
   Block grant Medicaid and grow at 2%   132.0
   Increase Medicare premiums   55.0
   Increase Medicare deductibles   17.0
   Cut non-Medicaid state/local grants by 20%   17.4
   Total cuts   346.0
Social Security Administration
   Price index initial Social Security benefits   45.0
   Raise the normal retirement age for Social Security   16.0
   Cut Social Security Disability Insurance by 20%   43.0
   Cut Supplemental Security Income by 20%   13.0
   Total cuts   117.0
   
Total annual spending cuts in 2024   $463.0

 

Table 2. Proposed Federal Budget Cuts
Discretionary Programs and Other Entitlements
Agency and Activity  
Annual Savings
     
$Billions, 2014
Department of Agriculture    
   End farm subsidies   25.1
   Cut food subsidies by 33%   35.4
   End rural subsidies   5.2
   Total cuts   65.7
Department of Commerce
   End telecom subsidies   0.7
   End economic development subsidies   0.5
   Total cuts   1.1
Department of Defense
   Reduce overseas contingency operations (CBO option)   68.0
   Enact Selected Cato reforms   43.0
   Total cuts   111.0
Department of Education
   End K-12 education subsidies   28.2
   End all other programs   37.4
   Total cuts (terminate the department)   65.6
Department of Energy
   End subsidies for energy efficiency   2.6
   End loan programs   1.0
   End fossil/nuclear/electricity research   3.3
   Privatize the power marketing administrations   0.2
   Total cuts   7.1
Department of Homeland Security
   Privatize TSA airport screening   5.3
   End FEMA state/local grants   9.3
   Total cuts   14.6
Department of Housing and Urban Development
   End rental assistance   29.2
   End community development subsidies   14.6
   End public housing subsidies   6.4
   Total cuts (terminate the department)   50.2
Department of the Interior
   Cut net outlays by 50% through spending    
   reductions, privatization, and user charges   6.4
Department of Justice
   End state/local grants   3.8
Department of Labor
   End employment and training services   3.5
   End Job Corps   1.4
   End Community Service for Seniors   0.3
   End trade adjustment assistance   0.8
   Total cuts   6.0
Department of Transportation
   End urban transit grants (federal fund savings)   3.8
   Privatize air traffic control (federal fund savings)   3.2
   Privatize Amtrak and end rail subsidies   2.6
   Cut highway aid to match trust fund revenues   14.0
   Total cuts   23.6
Department of the Treasury
   Cut earned income tax credit by 33%   19.3
   Cut refundable part of child tax credit by 33%   7.2
   Total cuts   26.5
Other Savings    
   Cut foreign aid by 50%   10.2
   Cut federal civilian compensation costs by 5%   16.0
   Privatize the Corps of Engineers (Civil Works)   7.2
   Privatize the Tennessee Valley Authority   0.9
   Repeal Davis-Bacon labor rules   9.0
   End EPA state/local grants   3.8
   Total cuts   47.1
     
Total annual spending cuts   $428.7

Subsidies to Individuals and Businesses

The federal government operates more than 2,200 separate subsidy programs, more than twice as many as in the 1980s.11 The scope of federal activities has expanded in recent decades along with the size of the federal budget. The federal government subsidizes farmers, retirees, school lunches, rural utilities, the energy industry, rental housing, public broadcasting, job training, foreign aid, urban transit, and many other types of people and activities.

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, have less incentive to innovate, and likely shy away from criticizing government problems.

Table 2 included cuts to subsidies in agriculture, commerce, energy, housing, foreign aid, and other activities. These cuts would not eliminate all of the unjustified subsidies in the federal budget, but they would be a good start. Government subsidies are like an addictive drug, undermining America’s traditions of individual reliance, voluntary charity, and entrepreneurialism.
 

Aid to the States

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 “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 2014 federal aid to the states will total more than $600 billion, which will be distributed through more than 1,100 separate programs.12

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 preoccupied by the competitive scramble to maximize subsidies for their states, regardless of efficiency or an 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 315 million people.

The grants-in-aid system should be dramatically cut. Policymakers should revive federalism and begin to terminate grant programs. Tables 1 and 2 include cuts to grants for education, health care, highways, justice, transit, and other activities. There is no reason why such activities should not be funded at the state and local levels.
 

Military Expenses

Cato Institute defense experts Chris Preble and Ben Friedman have proposed a lengthy list of cuts to U.S. military spending.13 By the end of 10 years, their proposal would reduce spending by more than $100 billion annually, based on a strategy of restraint and reduced intervention abroad. For the current plan, I assume that a portion of those cuts would be enacted. I also assume that CBO’s estimated reductions to overseas contingency operations would be put in place.14

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 our nation. As such, the military budget should be cut in a prudent fashion as part of an overall plan to downsize the government and balance the budget.
 

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 trims to Medicare, Medicaid, and Social Security. The table also includes the repeal of the 2010 health care law, which would save about $125 billion annually by 2024.15  

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 and allow the states 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 by the states. Creating a block grant and capping annual spending growth at 2 percent would save about $132 billion annually by 2024.16

Table 1 includes modest Medicare changes based on CBO estimates.17 Reforms include increasing Medicare deductibles and increasing premiums for Part B to cover 35 percent of the program’s costs. However, larger Medicare reforms are needed than just these cuts. Cato scholars have proposed moving to a system based on individual vouchers, personal savings, and consumer choice for elderly health care.18Such a reform would create strong incentives for providers and patients to improve system quality and reduce costs.

For Social Security, the growth in initial benefits should be indexed to prices rather than wages to slow the program’s growth. That reform would save about $45 billion annually by 2024 and growing amounts after that.19 The plan also includes a CBO option to modestly raise the program’s normal retirement age.20 In addition, the fast-growing Social Security Disability Insurance and Supplemental Security Income programs would be trimmed 20 percent under the plan.
 

Privatization

In recent decades, many governments around the world have sold state-owned businesses and assets to private investors.21 Airports, railroads, electric utilities, post offices, and other items have been privatized. Privatization usually leads to reduced costs, higher quality services, and increased innovation.

In the United States, there are many federal activities that should be privatized. Table 2 includes the privatization of Amtrak, the air traffic control system, airport security screening, electric utilities, and the Army Corps of Engineers. Such reforms would reduce budget deficits, improve management, spur quality improvements, and generate economic growth. The savings listed stem from the elimination of annual subsidies to these activities.

Consider the nation’s air traffic control (ATC) system, which is run by the Federal Aviation Administration. The FAA’s modernization efforts have often fallen behind schedule and gone over budget.22 The ATC system needs major improvements to meet rising travel demands, but the FAA may not be up to the challenge. Also, the political squabbling over FAA budget cuts under the sequester in 2013 illustrated the problem of tying ATC to the federal budget.

The solution is to privatize the ATC system and separate it from the government. Canada privatized its ATC in 1996, setting up a private, nonprofit corporation, Nav Canada.23 The company is self-supporting from charges on aviation users. It is one of the safest systems in the world, and has won international awards for its efficient and innovative management.24 Britain also privatized its ATC system in the form of a nonprofit corporation.
 

Conclusions

Official projections show that without reforms federal spending will soar to nearly 40 percent of GDP by 2050.25 State and local spending comes on top of that, with the result that governments would consume half of the entire U.S. economy.

However, it seems inconceivable that American voters and taxpayers would let the government grow to anywhere near that large. 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.26

The upshot is that policymakers will have to make major spending cuts sooner or later, and the sooner the better to avoid accumulating even more debt. Policymakers can start with the menu of cuts presented here, but they should also pursue other reforms such as restructuring Medicare. Leaders of other nations have pursued vigorous cost cutting when their debt started getting out of control, and there is no reason why our political leaders cannot proceed with similar reforms.


1 Congressional Budget Office, “Updated Budget Projections: Fiscal Years 2014 to 2024,” April 2014.

2 Chris Edwards, “We Can Cut Government: Canada Did,” Cato Policy Report, Cato Institute, May-June 2012. For the latest data, see www.budget.gc.ca/2014/.

3 Congressional Budget Office, “Updated Budget Projections: Fiscal Years 2014 to 2024,” April 2014.

4 I modeled interest costs using the CBO baseline projections for interest rates. I adjusted for the fact that federal debt held by the public is projected to grow faster in coming years than indicated by the accumulation of annual deficits.

5 Congressional Budget Office, Letter to Speaker John Boehner regarding H.R. 6079, July 24, 2012.

6 Chris Edwards, “Corporate Tax Laffer Curve,” Cato Institute Tax and Budget Bulletin no. 49, November 2007.

7 Chris Edwards, “Canada’s Corporate Tax Cuts,” Daily Caller, March 13, 2012. Canada’s federal corporate tax revenues are expected to be 1.9 percent of GDP in 2014, which compares to an average of 1.7 percent of GDP during the 1990s.

8 The health care and Social Security savings were based on options in Congressional Budget Office, “Options for Reducing the Deficit: 2014 to 2023,” November 2013.

9 The figures for this table are mainly sourced from the Budget of the U.S. Government, Fiscal Year 2015, Analytical Perspectives (Washington: Government Printing Office, April 2013), Table 29-1. The figures are estimates for fiscal 2014.

10 I’ve assumed that the value of these cuts would grow over time at the same rate as discretionary spending in the CBO baseline.

12 The number of programs is discussed in Chris Edwards, “Fiscal Federalism,” Cato Institute, June 2013, www.downsizinggovernment.org/fiscal-federalism.

13 Benjamin H. Friedman and Christopher Preble, “A Plan to Cut Military Spending,” Cato Institute, November 2010, www.downsizinggovernment.org/defense.

14 Congressional Budget Office, “The Budget and Economic Outlook: 2014 to 2024,” February 2014. See the option on page 74.

15 Congressional Budget Office, Letter to Speaker John Boehner regarding H.R. 6079, July 24, 2012. This is CBO’s value of savings in 2022 roughly extrapolated to 2024.

16 This figure does not include the Medicaid savings from repealing Obamacare, which are included in the Obamacare repeal estimate.

17 Congressional Budget Office, “Options for Reducing the Deficit: 2014 to 2023,” November 2013.

18 Chris Edwards and Michael Cannon, “Medicare Reforms,” Cato Institute, September 2010, www.downsizinggovernment.org/hhs.

19 Congressional Budget Office, “Options for Reducing the Deficit: 2014 to 2023,” November 2013.

20 Congressional Budget Office, “Options for Reducing the Deficit: 2014 to 2023,” November 2013.

21 Chris Edwards, “Privatization,” Cato Institute, February 2009, www.downsizinggovernment.org/privatization.

22 Chris Edwards and Robert W. Poole, Jr., “Airports and Air Traffic Control,” Cato Institute, June 2010, www.downsizinggovernment.org/transportation.

24 Chris Edwards, “Privatize the FAA,” Daily Caller, April 24, 2013. And see Glen McDougall and Alasdair S. Roberts, “Commercializing Air Traffic Control: Have the Reforms Worked?” Suffolk University Law School, February 17, 2009.

25 Congressional Budget Office, “The 2013 Long-Term Budget Outlook,” September 17, 2013. See the “extended alternative fiscal scenario.”

26 This theme is explored in Chris Edwards and Daniel Mitchell, Global Tax Revolution (Washington: Cato Institute, 2008).