America's Spending Crisis

January 17, 2013

Despite four years of annual budget deficits of over US$1 trillion and the most sluggish economic recovery since World War II, voters have rewarded President Barack Obama with a second term. The president has supported a huge growth in federal spending and deficits, believing it to be an economic stimulus. But while there is little evidence that such Keynesian policies actually work, electoral ratification of the president’s approach has further engrained the idea in Washington that higher spending is beneficial.

Sadly, this pro-spending mindset is leading America into a deep fiscal hole that will damage the economy for decades to come. The recent “fiscal cliff” negotiations illustrate how the Democrats resist even the slightest trims to social programs and the Republicans block any reductions to military spending — even though both areas of the budget have expanded greatly in recent years. Overall federal spending as a share of gross domestic product (GDP) jumped from 18 percent when President George W. Bush came to office in 2001 to 23 percent today under Obama.

Congressional Budget Office (CBO) projections show where the federal spending juggernaut is headed. With no changes in policy, spending will rise from 23 percent of GDP to more than 40 percent by the mid-2040s, causing federal debt held by the public to soar from 70% today to about 250% by that time. The situation is even worse than that because the CBO’s basic projections don’t take into account the negative effects of rising spending and debt on GDP growth. As spending and debt rise, GDP growth will fall, and these ratios will rise even faster in a sort of fiscal death spiral. How that death spiral ends — in a catastrophic financial crisis or a long-term economic recession — nobody knows for sure.

The situation is even more disturbing because of the Obama administration’s completely unserious approach to fiscal reform in the past four years. Budget analysts almost universally agree that the main “entitlement” programs — Social Security, Medicare, and Medicaid — are the major drivers of the coming fiscal disaster, yet the Obama administration has proposed no serious restructuring of these programs to reduce costs. The administration has generally ignored the bipartisan Simpson-Bowles fiscal reform plan, and some Democrats in Congress fight even the smallest reductions to entitlement programs.

The administration’s main response to the looming debt crisis has been to campaign non-stop to raise marginal tax rates on high-income earners. Sadly, imposing higher tax rates on entrepreneurs, doctors, angel investors, and other highly productive people will suppress GDP growth in coming years, and thus will not help the situation, but instead accelerate the fiscal death spiral.

Even if raising tax rates on high-income earners didn’t damage the economy, it would make only a small dent in federal deficits. In the recent fiscal cliff deal, President Obama was able to get his pound of flesh from the wealthy in the form of higher income tax rates on those earning more than $400,000 (single) and $450,000 (married). However, the president’s long-sought victory for income redistribution is only expected to raise about $600 billion over the next decade, which is tiny fraction of otherwise previously expected deficits of about $10 trillion over that period.

The lack of seriousness in the Obama administration’s fiscal approach was exemplified by the president’s initial proposal to Republicans to avoid the fiscal cliff. It included $50 billion in new spending to supposedly stimulate the economy, which comes on the heels of more than $5 trillion in deficit-spending over the last four years. At the same time, the administration seems to ignore that its own Treasury Department publishes estimates showing that the long-term unfunded liabilities of Social Security and Medicare are in the tens of trillions of dollars.

For their part, many Republicans acknowledge that spending must be cut substantially if the United States is to avoid a debt crisis. Unfortunately, the actual proposals put forth by the GOP to address overspending have fallen far short. Even the supposedly radical budget proposal by House Budget Committee chairman Paul Ryan (R-WI) is short on details and has few actual program terminations.

Furthermore, despite the 2010 congressional elections that put dozens of “Tea Party” fiscal conservatives in the House, the Republicans have shied away from trying to actually end programs or downsize federal agencies. Indeed, on the few House votes taken on eliminating specific welfare-state programs in the past two years, large numbers of Republicans have joined the Democrats in blocking cuts.

The message to a Canadian audience is that the image of American Republicans as a band of budget-cutting zealots with chainsaws is, unfortunately, far off-base. Jean Chretien and Paul Martin had far more success at cutting budgets in the 1990s than Republicans have ever had. Meanwhile, American Democrats share the same big-spending philosophy as Canada’s New Democratic Party.

The upshot is that the US fiscal situation is very grim. Most members of Congress and the Obama administration support increased spending in the face of the ongoing flood of red ink. The huge deficits combined with a highly-skewed tax code that exempts about half of the public from paying income tax means that many people don’t feel the direct pain of big-government spending. At the same time, the government is able to finance its more than $16 trillion in debt held by the public at very low interest rates, which encourages policymakers to borrow even more.

And yet the American public does occasionally rise up and revolt against big government excesses, as it did in 1980, 1994, and 2010. It is also true that Republicans forced through the 2011 Budget Control Act, which put legal caps on non-entitlement spending for the next decade. It is true as well that growing numbers of policymakers are thinking about America’s place in the global economy and are realizing that the country may go the way of Greece if it isn’t careful. There has also been growing interest in Washington regarding successful foreign reforms, including Canada’s impressive fiscal reforms of the 1990s.

However, balanced against those points of optimism are numerous risk factors to the US fiscal outlook that are often overlooked. Even if the economy recovers in the next couple of years and federal revenues rise, policymakers will likely find new reasons to spend more money and keep deficits high. Another economic downturn would bring forth demands for more Keynesian spending stimulus. A new military conflict would push up the already bloated defense budget. And as we’ve seen in the wake of Hurricane Sandy, every unexpected natural disaster is an excuse to open the spending floodgates for infrastructure and aid payments. The fiscal reality is that policymakers have no choice but to sharply reduce spending if the US is to head off the looming fiscal train wreck. Unfortunately, it does not appear that they are prepared to make the necessary spending cuts at this time. Unfortunately, the longer they wait, the more difficult will be the reforms.

This article appeared in the Fraser Institute’s The US Election 2012: Implications for Canada on January 17, 2013.

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