Defusing the Debt Bomb Part 1: Cutting Spending

Based on the feedback from my first blog post, it would appear that most agree that we have a very serious debt and economic problem on our hands with our exploding federal debt. In contrast to the current political rhetoric, dealing with this problem will require both substantial cuts in ALL types of spending AND increases in tax revenues. I will have more about increases in tax revenues in a future blog (though increasing tax revenues in the US should and can be  mostly be accomplished through tax reform rather than just raising personal marginal tax rates).

This post will address cutting federal spending which at the end of fiscal year 2011 (9/30/2011) totalled some $3.6 trillion- an incredible $0.9 trillion above FY 2007 levels.

Understanding what and how to cut the current federal budget requires understanding more about the nature of our expenditures. Accordingly, I have divided our $3.6 Trillion FY 2011 budget into four categories:

• 1. “Benefit” programs($1.85 trillion or 51% of total) – includes Social Security($0.8 trillion), Medicare/Medicaid($0.8 trillion), Unemployment and VA Benefits ($0.25 trillion).
• 2. Defense–($0.95 trillion or 26% of total)–includes Defense dept ($0.74 trillion) , Iraq/Afghanistan Wars ($0.16 Trillion) and Homeland Security ($0.05 trillion)
• 3. Domestic programs (Non-Core/Subsidy) ($0.50 trillion or 14% of the total)–includes Agriculture ($0.15 trillion), Transportation ($0.08 trillion), Energy ($0.05 trillion), HUD($0.06 trillion),Tax Expend.($0.12), Labor/Small Bus./Commerce/Other ($0.09 trillion)
• 4. Federal programs (Core)($0.32 Trillion or 9%) includes HHS, State and Intl. Prog., Justice, Interior , EPA, Treasury, Education, and NASA.

The last two categories bear some explanation. Category 3 includes programs and federal spending which are generally for goods and services that could be produced by the private sector. This ranges from everything to subsidizing crop production, Amtrak, energy production, housing or small businesses. Thus, category 3 in business parlance is a “non-core” part of the federal government’s charter. It is not essential to running the country and largely serves to subsidize various commercial activities or various interest groups.

Category 4 Federal Programs (Core) includes agencies/departments that  generally produce “public” goods which the government needs to provide. This ranges from Health and Human Services, international relations, managing federal lands, environmental protection, public school education and managing the treasury.

Please note that for simplicity these categories are intended to be rough approximations. There are some agencies or departments within Categories 3 and 4 that could be moved between categories or for which some of its activities are “core” and others are not. For example, I would argue that public school education could in fact be significantly privatized (though a voucher system or other means) though this would still end up being a significant (albeit smaller) budget item so I left this in the core.

I have assumed that we must cut the total budget by an average of $1.0 trillion per year over the next ten years achieving this level of cuts in the next 3-5 years. This coupled with tax revenue increases through tax reform and some tax increases should get us to a balanced budget by mid-decade. Note, $1 trillion per year is a much greater number than has been discussed in last year’s aborted budget debates (i.e. about $1-4 trillion over 10 Years). However, with a current $1.4 trillion deficit and the near certainty that interest payments will be increasing significantly, this amount of cuts are essential to bring the US debt problem under control.

Given the size of these cuts, and the nature of our current spending, we need to get MOST of these cuts from the first two areas — Categories 1 and 2. (i.e. Benefit Programs such as Social Security, Medicare, Medicaid and National Defense) since they account for more than 3/4 of our current budget. However, it is also important to make sizeable cuts in Categories 3 and 4, because social security, medicare and Medicaid are growing rapidly due to inflation and greater numbers of retirees, so it will be even harder to cut these expenditures below current levels.

As an initial starting point at least, I would recommend that the following cuts which would equal $1 trillion in total:

(1) Reduce Category 2 (Total Defense) from $0.95 to $0.65 trillion or by $0.3 Trillion Per Year. This is a little more than a pro-rata share of the cuts that will be needed across the budget, and should largely come from phase down or elimination of Afghanistan war spending ($0.16 trillion) and some significant down sizing of Americas troop strength home and abroad as well as cutbacks in some weapon systems.

(2) Reduce Category 3 (Domestic Non-Core Spending) from $0.5 to $0.2 Trillion or by $0.3 Trillion Per Year. This can largely be accomplished by taking aim at the most egregious and largest subsidy producers (i.e.Agriculture, Transportation and Energy) and by eliminating the tax expenditures (i.e. subsidies under Treasury) entirely (as part of  Tax reform) of $0.12 trillion per year.

 (3) Reduce Category 4 (Federal Core) Spending from $0.32 trillion to $0.22 trillion or by $0.1 Trillion per Year. A key part will be reforming our Education spending (injecting more competition into the public school system) so that the dollars generated at the state and local level from property taxes can be mostly used to fund education. In addition, we should be focusing on cuts in aid to foreign countries  which aren’t good friends of the US (e.g Pakistan).

(4) Reduce Category 1 (Benefit) Spending from $1.85 to $1.55 Trillion or by $0.3 Trillion Per Year . This may be the toughest to do, because it will require some substantial changes in Social Security and Medicare in particular and as noted before, these programs are growing rapidly as the ranks of retirees grow. (This will be a topic of future blog posts.) On Social Security at least, the answer would appear to be some combination of (1) raising the retirement age to 70 phased in over this decade (2) reducing the annual inflation adjustment by 1 or 2 percent (3) phasing out benefits (or taxing benefits) to a greater extent for middle to upper income seniors. Also, we probably will see some declines in unemployment benefits as the ranks of the unemployed (hopefully) continues to fall.

While these changes will be difficult, they certainly are doable in my opinion. Note that our total budget in FY 2007 was $2.7 Trillion or $0.9 trillion below today’s levels, so I refuse to believe that we can’t get $1 trillion in cuts in the next few years. 

However, these cuts will be very unpopular with many American citizens. In fact, when you combine these cuts with the tax revenue increases needed through broad tax reform and some tax increases, it is fair to say that almost everyone will be unhappy to some degree. More details and specifics in future blogs. Thoughts?