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Balanced budgets and national security

In the hit TV series Game of Thrones the Machiavellian Lannister family takes great pain to accumulate power.   Because of the  relationship between credit and power, their family motto is:  “Lannisters always pay their debts.”  For much of American history federal leaders sought to balance budgets in order to  preserve credit for true  emergencies.   Debt-financed peacetime military spending was viewed as being unsustainable and profligate borrowing was tantamount to disarmament.

After World War II Senator Robert Taft–the conservative “Mr. Republican”–opposed permanent military alliances such as NATO because he sought to lower tax rates.   No mainstream leader  in either party supported financing routine defense spending with debt, since excessive debt itself could endanger long run national security.

Today most Republicans support higher Pentagon spending than allowed by the Budget Control Act of 2011, which limits outlays by sequestering all amounts above annual ceilings.   Yet they also support lower tax revenues and a level of domestic spending–as set forth in this year’s House Budget resolution–that would absorb every dollar of existing tax revenues, before defense spending.   Call it what you wish, but that policy is far from what was once called “fiscally conservative”

Medicare and the GOP Debt Dilemma

Today the House passed a bill that increased the amount of Medicare reimbursements allowed after  April 1.   As a result,  debt will even faster than projected earlier this year.

An earlier blog post explained that phony projections had been used in order to depict  lower federal borrowing.    On April 1 the fees paid to Medicare providers were set to drop by 24 percent, an April fool’s joke that should have fooled no one.   Congress could, of course, have decided to either cut other spending by an offsetting amount or to raise revenues.   But it was easier to borrow.

Republican leadership passed the measure by a voice vote, so voters could not tell who voted for and against it.   For more on this strained definition of “conservative,”  see my article today in The Washington Monthly.   The GOP Debt Dilemma


A New Analysis of the Fiscal Gap

Any challenge can be minimized simply by assuming that someone, someday will solve it.     Official projections of future borrowing–such as those by the Congressional Budget Office–are required by Congress to assume that future federal leaders will reduce curb the growth in medical spending occasioned by the retirement of Baby Boomers.

Economists Alan  Auerbach and William  Gale  have recently published a paper giving a more realistic view of what some call “the fiscal gap,”  i.e.,  federal spending in excess of available revenues.     The long term fiscal imbalance

A rough summary of some important points:

(1) Most people agree that the should be  some limit on the share of national income in the public sector–state, local, and federal.   That, in turn, implies a ceiling on tax revenues available to each level of government.  But current federal spending is higher than can be supported by historical levels of federal revenues.

(2)   If the federal government consistently spends more than available revenues, it will runs the risk of compounding interest.   Compound interest rises at an accelerating rate.

(3)  Rising federal medical costs and debt service will crowd out funding for defense and all domestic programs except for trust-funded financed Social Security pensions.  Any form of “tax relief” will also add to debt and ultimately debt service.

Timothy Taylor also provides a good analysis of the magnitude of the gap between federal revenues and spending. Taylor’s analysis of fiscal gap

There is one straightforward way to slow the growth of interest expense:  discontinue borrowing.   That will require a new alignment of tax and spending policies.   My book–to be released April 1–chronicles how federal elected officials from across the political spectrum once  understood and acted on that basic insight and still managed to get re-elected.

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Federal Debt and US Employment

Officials in each party claim that balancing the budget in the near future would reduce long term employment.   Republicans say that substituting tax revenue for debt  would be a “job killer,”   while Democrats refer to spending cuts as “austerity.”

Yet consider the most important factors that contribute to total employment–the size of the working age population and the willingness of  working age people to actively seek paid employment.    These factors contributed mightily to US economic growth in the last  half of the twentieth century,  when the vast Baby Boom generation and a soaring percentage of females joined the workforce.

As the economy has recovered from the Great Recession of 2008,  the number of people employed has grown more slowly than predicted.   Put another way,  employment did not rise as fast as the official rate of unemployment of those seeking work declined.  Economist John Cochrane recently reviewed the debate among economists about the reason for the changes in the employment/population level and ratio.

My own interpretation of these statistics:   The retirement of almost 80 million Baby Boomers has and will dampen growth in employment.    In addition, some workers in that generation retired earlier after losing their jobs and had difficulty finding employment without either retraining or relocation.   Some initially lost their jobs because of the recession and others were casualties of the changes in the demand for US labor in a world of global competition.   (Statistics show clearly that a disproportionate number of males left the workforce earlier than predicted.)

People can debate a variety of proposals about how to boost employment–better training and retraining of  workers, higher rates of lawful immigration,  reduction in any assistance that makes work an option rather than necessity,   better various state and local economic redevelopment efforts in areas of persistent high unemployment, etc.

So what do demographic changes contributing to slow growth in employment have to do with the issue of whether the federal government should balance its budget?   The answer is simple:  In the short term, little to nothing.  That conclusion alone is important. 

As described in Ch. 22 of my book,  both economic theory and US economic history undermine the notion that economic growth depends on   spending more than available tax revenues (or imposing taxes insufficient to pay for routine spending. )

Rather than rationalizing continued borrowing as a means of sustaining employment,   elected officials should focus on one fundamental reality:  debt service that rises faster than national income will tend to leave less of each tax dollar to pay for valued services.   For that reason,  a nation with an aging and slowly growing  population should be especially wary of high levels of public debt.

Budget Gimmicks and Fraud

Late March heralds a new  college basketball tournament,  the first glimpse of spring, and a another round of  fraudulent federal budget accounting.

Official budget projections now assume something no one in D.C. believes–that fees paid to doctors serving Medicare patients would will drop by over 20 percent on April 1.  That drop is mandated by a formula for calculating reimbursement of fees–the “Sustainable Growth Rate” or “SGR”–enacted as part of the Balanced Budget Act of 1997.

The SGR was intended to limit the  rise in Medicare costs to the growth in national income.  That goal makes sense:  any large expense that rises each year faster than national income could eventually absorb every penny of federal revenues.  The SGR seemed to work for awhile.   In 1997-2002 spending for  Medicare Part B grew at less than its historical rate.

That progress could not last without other reforms, however.  If fees had to be raised to offset the rise in costs borne by physicians and avoid rationing, then there would be some cuts in services in order to restrain total Medicare spending.   And since  Congress was unwilling to cut services,  Medicare costs began escalating when it  suspended application of the SGR in 2003.   And rather than raise taxes to pay for that amount, Congress cut taxes that year and used debt to finance higher Medicare costs.

Congress did not, however, repeal the SGR itself.   Congressional leaders maintained the illusion that fees would drop in the future, which allowed official projections to understate the level of future borrowing.   And that brings us to the imminent budget fraud.

Leaders in both parties know it is unreasonable to lower fees paid to physicians by over 20 percent in one month.   Allowing that to happen would radicalize the medical profession and prompt some providers to drop their Medicare patients.   However, neither party wants to be blamed for increasing the rate of borrowing that already troubles many Americans.

That leads to budget tricks.  The Committee for a Responsible Budget has described how each party is trying to fabricate “savings” that would “offset” the cost of raising the  fees for Medicare above the level allowed by existing law.   Replacing one gimmick with another.   House bill increases deficits.

The Democratic alternative–winding down spending for foreign wars–is not a savings at all, since spending for those wars will decrease with the end of combat, and has nothing to do with Medicare reimbursement rates.   The GOP alternative–suspending  a portion of the Affordable Care Act for 5 years– would lower federal  spending in the short run, if enacted, though analysis reveals that those savings will not be as much as the cost of the higher Medicare fees.   Moreover,   higher Medicare fees will require extra borrowing for one simple reason:  the federal government could take spending in Iraq and Afghanistan to zero and repeal the Affordable Care Act entirely and each incremental increase in federal spending will still far exceed available tax revenues and have to be funded with debt.

There is one honest and straightforward way to pay for a change in the law preventing a draconian cut in Medicare fees:   raise the Medicare tax rate by a few tenths of one percent and tell the public why.   Those who support “entitlement reform” should welcome the opportunity to explain what Medicare service must be cut in order to avoid paying the price with higher taxes.

The potential power of presidential budgets

On Tuesday, March 4, President Obama will release his budget.   Most observers consider the White House budget to be largely symbolic, since Congress has the sole authority to craft spending and tax bills.

But history shows how presidential leadership can be critical in forcing congressional leaders in both parties to align their tax and spending policies.

The federal government ramped up spending and taxation rapidly after the US entered World War I.  It had difficulty reducing spending and taxation after the war ended abruptly, 20 months after the declaration of war.   That led to a public backlash.   In response, Congress centralized its own control over spending and, in 1921,  required the president to submit a budget before each fiscal year.    In the 1920s conservative Republicans, such as Budget Director Charles Dawes and Treasury Secretary Andrew Mellon,  used that budget to pay  down debt by creating a surplus of revenues over spending.

During the next spike in debt, at the close of World War II,  Democratic President Truman submitted budgets that contained surpluses.    Republicans in Congress sought to reduce wartime taxes at a faster rate than the administration,   but the principle of a balanced budget forced them to specify spending cuts.   Then, as now, no one enjoyed paying taxes.  However,  a majority of voters were also concerned about excessive cuts in spending for national security or domestic programs.   By 1950 the “pay as you go” principle forced federal leaders in each party to forge a new consensus on the use of income and payroll taxes needed to fund the Pentagon and social insurance.

Today’s GOP leaders are quite vocal in criticizing the level of federal borrowing, but neither Republican nor Democratic leaders have proposed to balance the budget during the balance of President Obama’s term.     If the president himself did so,   congressional leaders in each party encounter greater pressure to bring their spending and tax policies more in line.




House of Cards, Federal Debt, and Ted Cruz

So we’ve been watching  Netflix’s House of Cards. I’ve known members of the House and Senate in both parties over last 40 years, and–in reality–most members are too busy meeting with constituents and raising money to plot murder and blackmail.  And their spouses do not encourage affairs with journalists.

Sadly, one aspect of the show is realistic. In  Season 2, episode 3, Frank helps pass an “entitlement reform” that raises the eligibility age for some undefined benefit. Democrats win politically because a Tea Party favorite, Senator Curtis Haas, fears that he will lose part of his outsider appeal by being part of a solution.

One aspect of that drama played out in “real life” over the last five months. The House passed a budget resolution that cut many categories of federal spending to levels less than those favored by the Senate (and, as it turns out, many House Republicans).   Republicans had excellent bargaining power, because the Budget Control Act of 2011–negotiated by President Obama–capped spending at the House level. It would take a majority vote of both houses of Congress to amend that ceiling.

Enter from stage right Ted Cruz. People already knew that Republicans in Congress opposed the Affordable Care Act, but Cruz wanted everyone to know that he opposed it the most, or something like that. So he sought to filibuster legislation that would allow the federal government to function until  . . . well, Congress repealed it or he grabbed more headlines. The gambit raised some public doubts about whether the GOP knew how to govern.

That put congressional GOP leaders on the defensive, and they agreed to raise spending to levels $100 billion more during the next two fiscal years than would be permitted by federal law. And they increased the debt ceiling to cover both that spending and the spending in their earlier budget resolution. What’s more, Cruz forced fellow Senate Republicans to gather ten more votes to raise the ceiling, an action that the conservative Wall Street Journal branded as “kamikaze.”

Many of us  admire politicians who stand on principle, even when we don’t agree with them. In America’s Fiscal Constitution I chronicle the tale of many leaders in both parties who defended the principle of balanced budgets. If Mr. Cruz or others want to defend fiscal discipline, there is a time-tested way to do so: Release a plan that shows exactly how much you would spend next year on every federal function, and not a penny more than estimated tax revenue, and then begin lining up support.

Geo. Washington on Federal Debt

General Washington implored Congress to pay debts due to Revolutionary War soldiers and other creditors when the colonies obtained independence in 1783. Congress, however, had no power to tax and states refused to pay. Washington–who had returned to private life–wrote three years later that “we have probably had too good an opinion of human nature when forming our confederation.” He compared the situation to a “house that was reduced to ashes” while people debated “the most regular mode of extinguishing” the fire.

In 1787 he agreed to return to public life by attending and then presiding over a meeting to decide what to do next, a meeting that produced a Constitution that included a Congress with the power to tax.

On leaving office Washington asked his fellow citizens to “discharge the debts” rather than “ungenerously throwing upon posterity the burden that we ourselves ought to  bear.”   In the next dozen years Congress, and the Jefferson and Madison administrations, devoted much of federal revenues to debt reduction, and paid down debt by almost 50 percent  even though they borrowed to make the Louisiana Purchase.

Today balanced budgets, much less debt reduction, would be called “austerity,” but the United States grew  in its early decades while paying down debt. Debt repayment freed savings for use in private enterprise and reserved credit for use in emergencies. The nation needed every last penny of that credit during the War of 1812, which ended just days before the US was scheduled to default on its debt service.


Budget Myth No. 3

Myth: “Social Security is, of course, the real problem.

Until 2011-2012, the Social Security trust funds never borrowed a dime.  The Social Security pension system is in good financial condition compared to the budget known officially as “the federal funds budget”–that is spending and revenues apart form revenues dedicated to trust funds and a corresponding amount of expenses.

No one has ever seriously argued that debt should be used to fund Social Security pensions.   That would make no sense, because Social Security was designed to be a form of form of savings–paying today for the right to receive a basic pension sometime in the future.

Between the Social Security Act of 1935 and the Social Security Act Amendments of 1950 federal leaders debated whether to maintain a large trust fund reserve to keep the system in long run actuarial balance.   Today people  may be surprised to learn that most Democrats supported a reserve for actuarial balance and some Republicans argued for a “pay as you go” system.   In 1950 they compromised with a hybrid system:  tax rates would be set at a level creating only a modest reserve.  But those estimated reserves were understated, because the actuaries were asked to assume that wages and salaries–and therefore payroll revenues–would not rise with future rises in worker productivity.

That system created an adequate cushion until Congress, with almost no dissent, indexed benefits for inflation in 1972, shortly before inflation increased faster than payrolls.   By 1983, the trust funds  were depleted, and the Reagan administration and congressional leaders in both parties rescued the system by enacting reforms.   They raised the payroll tax and applied income taxation to benefits of retirees with other source of income.   Contrary to widespread belief, in 1983 federal leaders also accurately predicted the impact of the retirement of the Baby Boom generation, and responded by creating a reserve for their pensions and gradually extended the age at which beneficiaries could receive a full pension.   (The pension system does have some unfunded liabilities down the line, because the 1983 reforms indexed the wage base to increases in average rather than median incomes.   Congress and Social Security experts did not anticipate that the incomes of workers in the top 10 percent  would rise so much faster than the other 90 percent.)

Myths about Social Security have become common in the twenty-first century.  Republicans publicized two myths and Democrats publicized another. 

  •   First, when challenged by Al Gore,  Governor George W. Bush claimed that he had no intention of using Social Security reserve to fund his tax cuts, while resisting efforts to remove Social Security–which was then building reserves for Baby Boomers–from the overall federal budget.  After his election, the Bush  administration subtracted increasing amounts borrowed from the trust funds when reporting the level of deficit spending.
  • Second, when attempting to persuade Congress to convert Social Security into a system of government-guaranteed private accounts, President George W. Bush claimed that the trust fund did not exist and dramatized this point by visiting an accounting office where there was no cash reserve.   The trust fund investments, however, did exist in the form of  legally binding ledger entries showing investment in Treasury obligatons;  that is the same manner in which other investors hold most US bonds.  From its inception the trust fund has invested funds in the safest possible security, Treasury obligations, in order to avoid the loss of interest on cash reserves.  Investment of trust fund reserves does not in the least alter the Treasury’s obligation to pay.  The Social Security trust fund is no more or less secure than other holders of Treasury debt.
  • Third, Democrats  insisted on a reduction in payroll tax contributions in 2011-2012, in an effort to stimulate the economy.   While it is technically true that the Treasury credited the trust fund with an amount equal to those lost revenues, it  had to borrow more money in order to make those payments.  So, in substance if not form, the US borrowed for the Social Security system.

There are things that must be fixed to retain a self-sustaining Social Security pension system.  The adjustments needed to bring the system into long run actuarial balance, however, are minor in comparison to reforms needed to fund Medicare, national security, and debt service without incurring  debt.



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