Percentages sometimes shed more light on events than absolute numbers do.
House Speaker John Boehner is proposing deficit reductions, done in two stages, of a total of about $3 trillion over 10 years, while Senate Democratic leader Harry Reid is offering a plan that would cut deficits by $2.7 trillion over 10 years.
According to what the Congressional Budget Office has forecast, both of these proposals would be inadequate to keep the debt from growing above the level it will reach by the end of this fiscal year, about 70 percent of gross domestic product, or GDP.
Publicly held debt is now at its highest level than at any time in American history other than the period after World War II when all those aircraft carriers and bombs were being paid for.
The debt level has the bond rating agencies sounding the alarm, partly because the Baby Boomer-driven surge in spending on Medicare and other entitlements has only just begun.
Sounds like a lot, but...
Assume that $3 trillion in cuts over ten years would actually occur.
That might sound like a lot. But $3 trillion in cuts over 10 years would be a 6.5 percent reduction in cumulative spending and about a 45 percent reduction in cumulative deficits.
But that’s only if you measure based on the budget baseline which the Congressional Budget Office is required by law to use.
That baseline assumes some quite improbable things will happen, such as reverting to the 2000 income tax rates and making the cuts in Medicare’s payments to doctors under what’s called the Sustainable Growth Rate (SGR). Congress has circumvented those SGR cuts for the last several years, not allowing them to take effect.
If you use CBO’s more plausible “alternative fiscal scenario,” deficits will total $12.8 trillion over the next ten years.
A $3 trillion cut would be about a 23 percent reduction in cumulative deficits over the ten years.
In a recent report, CBO said that in order to keep the debt from rising above the level it will reach by year end, cumulative deficits over the next ten years would need to be roughly $7.6 trillion less than what’s forecast to occur under CBO’s alternative scenario.
In other words, what’s needed is about $5 trillion in cumulative deficit reductions over ten years — far more than what either Boehner or Reid is seeking.
Boehner and Reid are setting goals, but the failed SGR is a good lesson in why one should be wary of how real the proposed cuts might turn out to be.
When federal spending dropped
Over the past 40 years, only once has federal spending declined in dollar terms: that was last fiscal year, FY 2010, when it dropped by about $62 billion.
And here's why economic growth matters so much: measured as percentage of national income, or GDP, there have been 19 years in the past 40 years when federal spending declined.
It can happen. And it happens when — as in the nine-year run from 1992 to 2000 — the economy is growing at a rate of three to four percent a year. (And in the final years of that period, tax revenues were growing despite, or because of, tax cuts enacted in 1997.)
In the past, there have been some parts of the budget that have been cut by very big amounts, both in nominal dollar terms and as a percentage of total federal outlays.
For instance, from 1992 to 1999, defense spending was cut from $298 billion to $274 billion. As a percentage of total federal spending, defense fell from 21.6 percent to 16.6 percent.
One of the House Republicans’ leading thinkers on debt and deficits, Budget Committee chairman Paul Ryan put the issue in clear percentage terms when he said last week, “The key is you bring the government (spending) down to 18, 19, or 20 percent of GDP.”
Last year, federal spending amounted to nearly 24 percent of GDP.
To force spending down to where Ryan and other Republicans say they want it, two things are needed:
- The first, obviously: cuts in spending.
At the economy’s current size, a cut of four percentage points of GDP would equate to $600 billion.
If Congress were to cut that amount in one year — and of course it won’t — it would be equivalent to eliminating all Medicare spending for a year, plus another $30 billion or so.
- The second thing needed is a bigger national income, or GDP.
One reason federal spending measured as a percentage of GDP is so extraordinarily high — and so worrisome to the bond ratings agencies — is that the denominator in that equation, GDP, is smaller than it would be if the economy were healthy.
Anemic GDP growth
GDP didn’t grow at all in 2008, it shrank in 2009, and grew last year by less than three percent.
Here’s the dangerous dilemma which the CBO report presents: Deficit reduction would be healthy for the economy in the long term.
But in the short term, the spending cuts or tax increases that would produce smaller deficits “would decrease the demand for goods and services even further and thus reduce economic output.”
And if you’re looking for a job, that’s the last thing you need.
Of course, as of Monday night, the proposed spending cuts were very far from being enacted. Substantial cuts do seem closer than probably at any time since the 1997 budget deal between President Bill Clinton and congressional Republicans.
But much hinges on the 2012 election, which will be a mandate both on deficit reduction and on economic growth.