Assuming President Barack Obama and congressional leaders do reach a deal on the debt limit, taxpayers should carefully assess both the spending and revenue sides of the resulting federal budget.
Politicians will likely herald the revenue “enhancers” in the agreement as the most significant. But that’s the wrong way to look at a problem that’s fundamentally a product of the federal government spending too much, not taxing too little.
Since 1960, federal spending as a percentage of gross domestic product has averaged 20.3 percent while federal revenue averaged 18 percent. A 2.3 percent gap between revenue and outlay is not ideal, but it’s manageable over time. The federal government is experiencing historic budget deficits now because, thanks to the recession, federal revenue dropped to 14.8 percent of GDP, while federal spending under Obama soared to 24.7 percent. That is an unsustainable 10-point gap between what the politicians are spending and what the people pay in taxes.
If Congress leaves tax rates as they are today, revenue will likely rebound to its historic 18 percent average by 2018. But over the same period, federal spending is set to increase to 26 percent of GDP, six points higher than the historical average of 20 percent of GDP. That would still leave an eight-point gap between spending and revenue. Unless the government increases taxes to collect far above the record high of 20.6 percent of GDP in 2000, the U.S. will have to get serious about cutting spending. And the cuts that are being floated by the Obama White House are not serious cuts.
Obama claims to have a plan that would reduce the debt by $4 trillion over 10 years. At least $1 trillion of that is expected to come in higher taxes, leaving $3 trillion in spending cuts. But at least $1 trillion of the reductions come from decreases in defense spending that assumed no end to the wars in Iraq and Afghanistan. Another trillion of Obama’s spending cuts stems from savings on interest payments that might never materialize. Obamacare-like cuts to Medicare, tweaks to how Social Security measures inflation and other discretionary-spending reductions are expected to round out the package.
This isn’t good enough. Most of this Iraq and Afghanistan spending was never going to happen anyway. Medicare and Social Security are in need of fundamental reform, not minor adjustments. And, as former Federal Reserve Governor Lawrence Lindsey has amply demonstrated, we will likely end up paying far more, not less, in interest on our existing debt.
And don’t forget that the prospective deal will not extend the Bush tax cuts from 2001 and 2003 that are scheduled to expire next year, so Obama has a built-in $5 trillion tax hike in store for the economy after the 2012 election. Thus a vital question remains: Where are the spending cuts?