A Plan to Cut Federal Spending

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Chris Edwards

July 2013

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 in recent years and government debt is piling up. The budget situation is currently improving as the economy strengthens, 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 about $1 trillion annually by 2023. That would bring spending down from 21.5 percent of gross domestic product (GDP) today to 18 percent, which was the level of spending the last time the federal budget was balanced in 2001.

Spending cuts would make sense whether or not the government was running deficits. That’s because cuts would spur economic growth as resources moved from lower-return government activities to higher-return private activities. Spending cuts would also expand freedom by giving people more control over their lives and reducing the regulations that usually come with federal spending 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 21.5 percent of GDP in 2013 to 22.6 percent by 2023.1 Over the same period, federal tax revenues are expected to rise from 17.5 percent of GDP to 19.1 percent. Despite the growing revenues, the government would continue to run large deficits because spending would remain at abnormally high levels.

Instead, 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 five years and generate growing surpluses after that. Spending would be reduced to 18.0 percent of GDP by 2023. The 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 the more productive private sector, 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 less than 16 percent today.2 The Canadian economy did not sink into a recession as Keynesians would have expected, but was instead launched on a 15-year economic 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 below 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 five years and generate growing surpluses after that. The starting point for the plan is the baseline budget projection from the Congressional Budget Office in May 2013.3 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 21.5 percent today to 18.0 percent by 2023. The deficit would be eliminated by 2018 and growing surpluses would be generated after that. Under the plan, spending cuts would be phased in over 10 years and would total $972 billion annually by 2023. Those cuts would generate interest savings of $230 billion annually by 2023.4 All in all, federal spending would fall to 18.0 percent of GDP by 2023, which was about the level of spending the last time that the budget was balanced in President’s Bill Clinton’s final year in office.

Under the CBO baseline projection, federal revenues rise to more than 19 percent of GDP. That is above the average level of recent decades as a result of the tax increases in the 2010 health care law (“Obamacare”) and the 2013 income tax increases on high earners. These tax increases are harmful to the economy and should be repealed. Repeal is not modeled here, but it would reduce revenues to just under 18 percent of GDP by 2023.5 To ensure that the budget stayed in balance, further spending cuts could be pursued.

There are also opportunities for policymakers to make the tax code simpler and more efficient that would not reduce revenues. One high-priority change would be to cut the federal corporate income tax rate from 35 percent to 25 percent or less. That would not reduce revenues over the long term because it would cut tax avoidance and stimulate greater economic growth.6

In sum, the best fiscal policy in the years ahead 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 from an expanding economy.
 

Spending Cut Details

Tables 1 and 2 below list proposed cuts to reduce federal spending to 18 percent of GDP by 2023. 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 2023, based on CBO projections.7

Table 2 shows cuts to discretionary programs and entitlements other than health care and Social Security. 8 These cuts would total $496 billion in 2013, 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 2023 than in 2013.9

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 discuss the proposed cuts to subsidies, aid to the states, military expenses, and entitlement programs. The final section discusses the privatization of federal activities. Further analysis of the cuts listed here is 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, 2023
Department of Health and Human Services    
   Repeal 2010 health care law   119.0
   Block grant Medicaid and grow at 3%   92.0
   Increase Medicare premiums   40.0
   Increase Medicare deductibles   13.0
   Cut non-Medicaid state/local grants by 33%   27.4
   Total cuts   291.4
Social Security Administration
   Price index initial Social Security benefits   41.0
   Raise the normal retirement age for Social Security   31.0
   Cut Social Security Disability Insurance by 10%   21.0
   Cut Supplemental Security Income by 10%   7.0
   Total cuts   100.0
   
Total annual spending cuts in 2023   $391.4

 

Table 2. Proposed Federal Budget Cuts
Discretionary Programs and Other Entitlements
Agency and Activity  
Annual Savings
     
$Billions, 2013
Department of Agriculture    
   End farm subsidies   30.1
   Cut food subsidies by 33%   36.5
   End rural subsidies   3.5
   Total cuts   70.1
Department of Commerce
   End telecom subsidies   1.5
   End economic development subsidies   0.5
   Total cuts   2.0
Department of Defense
   Enact Cato reforms   128.0
Department of Education
   End K-12 education subsidies   28.4
   End student aid   41.8
   End other program   33.1
   Total cuts (terminate the department)   103.3
Department of Energy
   End subsidies for energy efficiency   3.1
   End subsidies for vehicle technologies   1.1
   End fossil/nuclear energy research   2.4
   Privatize the power marketing administrations   0.4
   Total cuts   7.0
Department of Homeland Security
   Privatize TSA airport screening   3.2
   End state/local grants   7.2
   Total cuts   10.4
Department of Housing and Urban Development
   End rental assistance   29.0
   End community development subsidies   11.2
   End public housing subsidies   6.6
   End housing finance programs   11.3
   End other programs   2.4
   Total cuts (terminate the department)   60.5
Department of the Interior
   Cut net outlays by 50% through spending    
   reductions, privatization, and user charges   5.2
Department of Justice
   End state and local grants   4.8
Department of Labor
   End employment and training services   3.6
   End Job Corps   1.8
   End Community Service for Seniors   0.5
   End trade adjustment assistance   0.6
   Total cuts   6.4
Department of Transportation
   End urban transit grants (federal fund savings)   4.9
   Privatize air traffic control (federal fund savings)   4.6
   Privatize Amtrak and end rail subsidies   2.6
   Total cuts   12.1
Department of the Treasury
   Cut earned income tax credit by 50%   27.6
   Cut refundable part of child tax credit by 50%   11.6
   Total cuts   39.1
Other Savings    
   Cut foreign aid by 50%   12.3
   Cut federal civilian compensation costs by 5%   15.3
   Privatize the Corps of Engineers (Civil Works)   5.5
   Repeal Davis-Bacon labor rules   9.0
   End EPA state and local grants   4.8
   Total cuts   46.9
     
Total annual spending cuts   $495.8

 

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.10 That indicates that 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 the government.

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 2013, federal aid to the states will total $561 billion, which will be distributed through more than 1,100 separate programs.11

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 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 need to revive federalism and begin to terminate grant programs. Tables 1 and 2 included cuts to grants for agriculture, education, health care, justice, transportation, 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 totaling $1.2 trillion over 10 years.12 By the end of 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.

Even aside from the wars in Iraq and Afghanistan, military and security spending have soared over the last decade. There is no doubt that America’s defense budget is bloated, and it is time to start cutting.
 

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 an estimated $119 billion annually by 2023.13

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 spending growth at 3 percent a year would result in saving about $92 billion annually by 2023.14

Table 1 included modest Medicare changes based on CBO estimates.15 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.16 Such 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 $41 billion annually by 2023 and growing amounts after that.17 The plan also includes a CBO option to modestly raise the program’s normal retirement age.18 In addition, the fast-growing Social Security Disability Insurance and Supplemental Security Income programs would be trimmed 10 percent under the plan.

 

Privatization

In recent decades, many governments around the world have sold state-owned businesses and assets to private investors.19 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 government activities that should be privatized. Table 2 included the privatization of Amtrak, the air traffic control system, airport security screening, 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.20 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.21 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.22 Britain has also privatized its ATC system in the form of a nonprofit corporation.
 

Conclusions

Official projections show that without reforms federal spending will soar to 40 percent of GDP by the 2040s. 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.23

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 are not capable of similar reforms.




1 Congressional Budget Office, “Updated Budget Projections: Fiscal Years 2013 to 2023,” May 2013.

2 Chris Edwards, “We Can Cut Government: Canada Did,” Cato Policy Report, Cato Institute, May-June 2012.

3 Congressional Budget Office, “Updated Budget Projections: Fiscal Years 2013 to 2023,” May 2013.

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

5 Repealing tax increases in the 2010 health care law would reduce revenues by about 0.7 percent of GDP in 2022. Repealing the 2013 income tax increase on high earners would reduce revenues by about 0.5 percent of GDP in 2022.

6 Chris Edwards, “Corporate Tax Laffer Curve,” Cato Institute Tax and Budget Bulletin no. 49, November 2007. See also Chris Edwards, “Canada’s Corporate Tax Cuts,” Daily Caller, March 13, 2012.

7 The health care and Social Security savings were based on options in Congressional Budget Office, “Reducing the Deficit: Spending and Revenue Options,” March 2011.

8 The figures for this table are mainly sourced from the Budget of the U.S. Government, Fiscal Year 2014, Analytical Perspectives (Washington: Government Printing Office, April 2013), Table 33-1. The figures are estimates for fiscal 2013.

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

11 Chris Edwards, “Fiscal Federalism,” Cato Institute, June 2013, www.downsizinggovernment.org/fiscal-federalism.

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

13 Congressional Budget Office, Letter to Speaker John Boehner regarding H.R. 6079, July 24, 2012. This is CBO’s value of savings in 2022, which would be about the same as the savings in 2023.

14 This estimate does not include the Medicaid savings from repealing Obamacare, which are listed separately.

15 Congressional Budget Office, “Reducing the Deficit: Spending and Revenue Options,” March 2011.

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

17 Congressional Budget Office, “Reducing the Deficit: Spending and Revenue Options,” March 2011.

18 Congressional Budget Office, “Reducing the Deficit: Spending and Revenue Options,” March 2011.

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

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

22 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.

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