Twelve members of Congress have been asked to come up with a way to reduce the federal budget deficit by $1.5 trillion over the next decade, an average of $150 billion per year. How much is this, and how can it be done?
The federal budget deficit was $1.3 trillion in the last fiscal year, down 8 percent from 2009 but still a greater share of our economy than anytime since WWII. That share was a hefty 37 percent of total outlays of $3.5 trillion.
The Great Recession was a major factor: From 2002 to 2008, the average deficit was only 12 percent of outlays, and by 2015 it is projected to return to 14 percent. We can attribute the current deficit to both falling revenues and rising expenditures. Adjusting for population and inflation, tax receipts fell by 16 percent over the last four years, while federal spending rose by 15 percent.
To better understand why the deficit has grown, it is helpful to divide the federal budget into two parts. The first part consists of Social Security and Medicare, which have dedicated revenues from payroll taxes. This first part makes up more than a third of total federal spending and, until recently, usually ran surpluses except during recessions. These surpluses were saved in federal bonds, and subtracted from the actual deficit to make it seem smaller.
Now, however, this first part has a deficit of $300 billion - and it is expected to keep rising. Partly, this is due to rising health care costs and an aging population, both predictable trends. Partly, this is due to reduced contributions from the underemployed and unemployed, and to payroll tax cuts intended to stimulate spending, both of which are temporary. But this deficit was also made worse by Medicare Part D, which was enacted in 2003 without providing for any funding. We need to deal with this part of the budget separately.
Everything else makes up what should be considered the actual federal budget. This actual budget had a $1 trillion deficit in 2010, on outlays of $2.3 trillion. The Office of Management and Budget (OMB) currently projects that this actual deficit will fall to $300 billion by 2016, once the damage done by the recession has passed.
More than half of this actual budget in 2010 went for three components that the federal government is generally obligated to provide: income security (the largest part of which financed state unemployment benefits), health care services, and interest on the national debt. National defense and associated costs for veterans' benefits accounted for a third of this actual budget. While spending on income security and national defense is expected to fall, the cost of debt interest, health care services, and veterans' benefits is expected to grow significantly.
Everything else the federal government spends money on - from agriculture to education, justice to international affairs - totals only $300 billion per year, 13 percent of the actual budget and 9 percent of the combined budget. Achieving the target level of deficit reductions by going after this last portion is simply unrealistic, unless we plan to fire every other border guard, FBI agent, and federal judge.
But federal spending is responsible for only half of the deficit. Tax revenues have gone down significantly. This is partly because our incomes fell due to the recession, and incomes will eventually recover. But mostly it was because federal income tax rates fell.
According to IRS data, taxpayers who claimed more than $1 million in adjusted gross income in 2000 paid an average of 28 percent of it in federal personal income taxes. By 2008, these wealthiest taxpayers paid only 23 percent of their income in taxes, even though the average income of this group had risen by 30 percent. Had this top 0.2 percent of taxpayers paid the same tax rate in 2008 as they did back in 2000, when there was a surplus, the deficit would have been $50 billion less.
But it wasn't just the rich who paid less - it was everybody. Almost all Americans are now paying a lower share of their income in federal income taxes, either personal or corporate, than anytime since before Eisenhower was elected president. Taxpayers making $30,000 went from paying 9 percent in 2000 to 7 percent in 2008, while taxpayers making $60,000 went from 11 percent to 9 percent. If all taxpayers had paid the same rates in 2008 as they had in 2000, the budget deficit would have been almost $300 billion smaller. This is almost precisely equal to the projected deficit for the actual budget in fiscal year 2016, the budget that excludes Social Security and Medicare.
The OMB projects that the combined federal budget will grow by $1trillion by 2016. This seems like a lot, but it isn't really. Population growth and predicted price inflation explains almost 80 percent of this increase, and if the economy returns to normal growth it will be a falling share of Gross Domestic Product.
This budget increase goes almost entirely toward rising interest on the national debt, a growing number of Social Security recipients, and skyrocketing health care costs. Those who say they can cut the growth of the combined federal budget without cutting Social Security or Medicare are playing games with the numbers.
What should the supercommittee propose? While there are almost certainly areas of wasteful federal spending that should be cut, and other areas that might safely be cut once the economy recovers, they don't add up to a large share of the total. To expect that real headway can be made on the budget deficit without raising tax rates back to where they used to be is sheer partisan fantasy. To try to do so without increasing Social Security and Medicare contributions once the recession is over, or setting more realistic limits on benefits, is equally foolish.
Both issues are divisively partisan. Will the committee lean to one side or the other, compromise or deadlock? We'll find out on Nov. 23.
• Elliott Parker, Ph.D., is an economics professor and chairman of the economics department at the University of Nevada, Reno. He was the only academic economist invited to participate in a congressional conference last week in Washington, D.C., dealing with the jobs bill and the deficit.