A Plan to Cut Federal Government Spending

  • Chris Edwards
April 4, 2016
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Federal government spending is rising, deficits are chronic, and accumulated debt is reaching dangerous levels. Growing spending and debt are undermining economic growth and may push the nation into a financial crisis in coming years.

The solution to these problems is to downsize every federal department by cutting the most harmful programs. This study proposes specific cuts that would reduce federal spending by almost one-quarter and balance the budget within a decade.

Federal spending cuts would spur economic growth by shifting resources from lower-valued government activities to higher-valued private ones. Cuts would expand freedom by giving people more control over their lives and reducing the regulations that come with spending programs.

The federal government has expanded into many 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. So cutting federal spending would enhance civil liberties by dispersing power from Washington.

The Congressional Budget Office (CBO) projects that federal spending will rise from 21.1 percent of gross domestic product (GDP) this year to 23.1 percent by 2026 under current law. 1 Over the same period, tax revenues are expected to remain flat at about 18.2 percent of GDP. As a consequence, rising spending will produce increasingly large deficits.

Policymakers should change course. They should cut spending and eliminate deficits. The plan presented here would balance the budget within a decade and generate growing surpluses after that. Spending would be reduced to 17.7 percent of GDP by 2026, or almost one-quarter less than the CBO projection for that year.

Some economists claim that cutting government spending would hurt the economy, but that notion is based on faulty Keynesian theories. In fact, spending cuts would shift resources from often mismanaged and damaging government programs to more productive private activities, thus increasing overall GDP. Markets have mechanisms to allocate resources to high-value activities, but the government has no such capabilities. 2

It is true that private businesses make many mistakes, but entrepreneurs and competition are constantly fixing them. By contrast, federal agencies follow failed and obsolete approaches decade after decade.3 So moving resources out of the government would be a net gain for the economy.

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 by 2000, to just 15 percent today. 4 The Canadian economy did not sink into a recession from the cuts as Keynesians would have expected, but instead grew strongly during the 1990s and 2000s.

Thus policymakers should not think of spending cuts as a necessary evil 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 proposed here includes a menu of spending reforms for policymakers to consider. These and other reforms are discussed further at www.DownsizingGovernment.org .

Spending Cut Overview

This section describes how cutting spending would eliminate the federal deficit within a decade and generate growing surpluses after that. The starting point for the plan is the CBO's baseline projection from March 2016. 5 Figure 1 shows 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 steadily without reforms.

The blue line shows projected spending under the reform plan proposed here. Under the plan, spending would decline from 21.1 percent of GDP today to 17.7 percent by 2026. The deficit would be eliminated by 2024 and growing surpluses would be generated after that. Under the plan, spending cuts would be phased in over 10 years and would total $1.5 trillion annually by 2026, including about $250 billion in reduced interest costs that year. 6

Falling spending and deficits would allow room for tax reforms. One reform would be to repeal the tax increases under the 2010 Affordable Care Act. 7 Another reform would be to slash the federal corporate tax rate from 35 percent to 15 percent, which would match the reformed Canadian rate. Such a cut would spur stronger economic growth and lose little revenue over the long term. 8

In sum, the best fiscal approach would be to cut spending and reform the most damaging parts of the tax code. That would end the harmful build-up of debt, expand personal freedom, and generate benefits for all Americans from a growing economy.

Spending Cut Details

Tables 1 and 2 below list proposed cuts to reduce federal spending to 17.7 percent of GDP by 2026. 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 2026, generally based on CBO projections. 9

Table 2 shows cuts to discretionary programs and entitlements other than health care and Social Security. 10 These cuts would be valued at $458 billion in 2016, but the plan assumes that they would be phased in one-tenth each year over the next decade. 11

The reforms listed in Tables 1 and 2 are deeper than the savings from "duplication" and "waste" often discussed by federal policymakers. We should cut hundreds of billions of dollars of "meat" from federal departments, not just the obvious "fat." If the activities cut are useful to society, then state governments or private groups should fund them, and those entities would be more efficient at doing so.

The proposed cuts are illustrative of how to start getting the federal budget under control. Further reforms are needed in addition to these cuts, such as major structural changes to Medicare. The important thing is to start cutting as soon as possible because the longer we wait, the deeper will be the debt hole that is dug.

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

Table 1. Proposed Federal Budget Cuts
Health Care and Social Security
Agency and Activity Annual Savings
$Billions, 2026
Health Care

Repeal ACA exchange subsidies 103

Repeal ACA Medicaid expansion 122

Block grant Medicaid and grow at 2% 128

Increase Medicare premiums 63

Increase Medicare cost sharing 20

Cut Medicare improper payments by 50% 78

Cut HHS non-Medicaid state grants by 50% 47

Total cuts 561



Social Security Administration

Price index initial Social Security benefits 39

Raise the normal retirement age for Social Security 10

Cut Social Security Disability Insurance by 25% 54

Cut Supplemental Security Income by 25% 18

Total cuts 122



Total annual spending cuts in 2026 $683



Table 2. Proposed Federal Budget Cuts
Discretionary Programs and Other Entitlements
Agency and Activity Annual Savings
$Billions, 2016
Department of Agriculture

End farm subsidies 29.3

Cut food subsidies by 50% 53.5

End rural subsidies 6.5

Total cuts 89.3



Department of Commerce

End telecom subsidies 0.6

End economic development subsidies 0.4

Total cuts 1.0



Department of Defense

End overseas contingency operations 59.0

Total cuts 59.0



Department of Education

End K-12 education grants 25.3

End all other programs 53.8

Total cuts (terminate the department) 79.1



Department of Energy

End subsidies for renewables 2.2

End fossil/nuclear/electricity subsidies 1.9

Privatize power marketing administrations 0.8

Total cuts 4.9



Department of Homeland Security

Privatize TSA airport screening 4.9

Devolve FEMA activities to the states 16.6

Total cuts 21.5



Department of Housing and Urban Development

End rental assistance 30.5

End community development subsidies 11.0

End public housing subsidies 5.8

Total cuts (terminate the department) 47.3



Department of the Interior

Reduce net outlays by 50% through spending

cuts, privatization, and user charges 7.0



Department of Justice

End state/local grants 6.7



Department of Labor

End employment and training services 3.6

End Job Corps 1.6

End trade adjustment assistance 0.8

End Community Service for Seniors 0.4

Total cuts 6.4



Department of Transportation

Cut highway/transit grants to balance trust fund 12.0

Privatize air traffic control (federal fund savings) 2.1

Privatize Amtrak and end rail subsidies 3.6

Total cuts 17.7



Department of the Treasury

Cut earned income tax credit by 50% 30.7

End refundable part of child tax credit 21.6

End refundable part of AOTC 4.4

Total cuts 56.7



Other Savings

Cut foreign aid by 50% 8.0

Cut federal civilian compensation costs by 10% 32.9

Privatize the Corps of Engineers (Civil Works) 6.7

Privatize the Tennessee Valley Authority 0.5

Repeal Davis-Bacon labor rules 9.0

End EPA state/local grants 4.1

Total cuts 61.2



Total annual spending cuts $457.8

Subsidies to Individuals and Businesses

The federal government funds more than 2,300 subsidy programs, more than twice as many as in the 1980s. 12 The scope of federal activities has expanded in recent decades along with the size of the federal budget. The federal government subsidizes farming, health care, school lunches, rural utilities, the energy industry, rental housing, aviation, passenger rail, public broadcasting, job training, foreign aid, urban transit, and many other activities.

Each subsidy causes damage to the economy through the required taxation. And each subsidy generates a bureaucracy, spawns lobby groups, and encourages even more people to demand government hand-outs. 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 shy away from criticizing the government and its failures.

Table 2 includes cuts to subsidies in agriculture, commerce, energy, housing, foreign aid, and other activities. Those cuts would not eliminate all of the unjustified subsidies in the 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. Through "grants-in-aid" Congress has undertaken many activities that were traditionally reserved to state and local governments. Grant programs are subsidies that are combined with federal regulatory controls to micromanage state and local activities. Federal aid to the states totals more than $660 billion a year, and is distributed through more than 1,100 separate programs.13

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 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 program 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 undermine 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 blames the other levels when programs fail. It is a triumph of expenditure without responsibility.

Federal aid 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 320 million people.

The grant-in-aid system should be eliminated. Policymakers should revive federalism and begin terminating grant programs. Tables 1 and 2include 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 numerous cuts to U.S. military spending. 14 They 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 defenses. They note that U.S. p olicymakers support extraneous missions for the military aside from the basic role of defending the 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. The current plan assumes that spending on overseas contingency operations-which will be $59 billion in 2016-would be reduced to zero over the decade.

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 generally agree on the need to restructure these programs. The reforms listed in Table 1 include cuts to Medicare, Medicaid, and Social Security.

Policymakers should repeal the 2010 Affordable Care Act (ACA). That would reduce spending on Medicaid and end spending on the exchange subsidies. In addition, policymakers should convert Medicaid from an open-ended matching grant to a block grant, while giving state governments more program flexibility. That was the successful approach used for welfare reform in 1996, which encouraged state innovation. Changing Medicaid to a block grant and capping annual spending growth at 2 percent would save about $128 billion annually by 2026. 15

Table 1 includes modest Medicare changes based on CBO estimates. 16 Reforms include increasing deductibles and increasing premiums for Part B to cover 35 percent of the program's costs. It also assumes that the Medicare improper payment rate would be cut in half to six percent. 17

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. 18 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 about $39 billion annually by 2026 and growing amounts after that. 19 The plan also includes a CBO option to modestly raise the normal retirement age. 20 In addition, the fraud-plagued Social Security Disability Insurance and Supplemental Security Income programs would be trimmed 25 percent compared to current spending projections.

Privatization

A privatization revolution has swept the world since the 1980s. Following Britain's lead, governments in more than 100 countries have transferred thousands of state-owned businesses to the private sector. More than $3 trillion of railroads, energy companies, postal services, airports, and other businesses have been privatized.21 Governments of both the political right and left have sold off state-owned businesses.

Privatization helps spur economic growth. It allows entrepreneurs and business leaders to reduce costs, improve service quality, and increase innovation. It also benefits the environment by reducing the wasteful use of resources.

Despite the global success of privatization, reforms have largely bypassed our own federal government. There are many activities that have been privatized abroad that remain in government hands in this country. That creates an opportunity for U.S. policymakers to learn from foreign privatization and enact proven reforms here.

Table 2 includes the privatization of Amtrak, the air traffic control system, airport screening, electric utilities, and the Army Corps of Engineers. Such reforms would reduce budget deficits and improve management. The savings listed in the table stem from the elimination of federal 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 overbudget.22 The ATC system needs major improvements to meet rising travel demands, but the FAA is not up to the challenge.

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

Conclusions

Without major reforms, official projections show that federal spending will soar to more than 30 percent of GDP by the 2030s.25 State and local government spending of 11 percent or more of GDP would come on top of that.

It seems inconceivable that American voters would let the government grow 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

Policymakers will have to make large spending cuts sooner or later, and the sooner the better to avoid accumulating more debt. They should begin reforming the government with the menu of cuts presented here. 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 do the same.


1 Congressional Budget Office, "Updated Budget Projections: 2016 to 2026," March 2016.

2 Chris Edwards, "Central Planning and Government Failure," DownsizingGovernment.org, Cato Institute, September 2015.

3 Chris Edwards, "Bureaucratic Failure in the Federal Government," DownsizingGovernment.org, Cato Institute, September 2015.

4 Chris Edwards, "We Can Cut Government: Canada Did," Cato Policy Report , Cato Institute, May-June 2012. For the latest data, see www.fin.gc.ca.

5 Congressional Budget Office, "Updated Budget Projections: 2016 to 2026," March 2016.

6 As the deficit was reduced, interest costs would fall. I modeled interest costs using CBO 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.

7 ACA tax revenues are expected to be about 0.7 percent of GDP annually. See Congressional Budget Office, Letter to Speaker John Boehner regarding H.R. 6079, July 24, 2012.

8 Chris Edwards, "Corporate Inversions, Tax Rates, and Tax Revenues," Cato@Liberty, Cato Institute, August 5, 2014. And see Chris Edwards, "Canada's Corporate Tax Cuts," Daily Caller , March 13, 2012.

9 Some of the Medicare and Social Security savings were based on options in Congressional Budget Office, "Options for Reducing the Deficit: 2015 to 2024," November 2014.

10 The figures for Table 2 are mainly sourced from the Budget of the U.S. Government, Fiscal Year 2017, Analytical Perspectives (Washington: Government Printing Office, February 2016), Table 29-1. The figures are estimates for fiscal 2016.

11 Note that the values of cuts would be greater in 2026 than in 2016. I have assumed that the values would grow at the same rate as discretionary spending in the CBO baseline.

12 Chris Edwards, "Independence in 1776; Dependence in 2014," Cato@Liberty, Cato Institute, July 3, 2014. For the most recent count, see www.cfda.gov.

13 The number of programs is discussed in Chris Edwards, "Fiscal Federalism," Cato Institute, June 2013, www.DownsizingGovernment.org/fiscal-federalism.

14 Benjamin H. Friedman and Christopher Preble, "A Plan to Cut Military Spending," Cato Institute, November 2010, www.DownsizingGovernment.org/defense.

15 This figure is in addition to the Medicaid savings from repealing the ACA.

16 Some of these are described in Congressional Budget Office, "Options for Reducing the Deficit: 2015 to 2024," November 2014.

17 The current improper payment rate is about 12 percent. See Centers for Medicare and Medicaid Services, Comprehensive Error Rate Testing. Data for 2015.

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: 2015 to 2024," November 2014.

20 Congressional Budget Office, "Options for Reducing the Deficit: 2015 to 2024," November 2014.

21 Chris Edwards, "Options for Federal Privatization and Reform Lessons from Abroad," Cato Institute, forthcoming, 2016.

22 Chris Edwards, "Reforming Air Traffic Control," Tax and Budget Bulletin no. 74, Cato Institute, February 17, 2016.

23 www.navcanada.ca.

24 Chris Edwards, "Reforming Air Traffic Control," Tax and Budget Bulletin no. 74, Cato Institute, February 17, 2016.

25 Congressional Budget Office, "The 2015 Long-Term Budget Outlook," June 2015. See the "extended alternative fiscal scenario."

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

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