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Deficit spending: Part 2 how to balance the budget

March 10, 2013

It is usually helpful to understand how we got to where we are before trying to fix it. So we left the story with spending at 3.5 Trillion dollars in 2009. Now, 5 years later, spending is at 3.5 Trillion dollars?!

Total government spending per person in constant 2005 dollars

Has there been a time in modern history when US federal spending has held constant for 5 years? There has not. Not since 1973 (as far back as the CBO/OMB data linked above goes).

This is an astounding thing, and not one our media has mentioned. There are in fact a few nominal dollar spending CUTS 2009 to 2010 and 2011 to 2012 – but that isn’t as important as just holding government spending constant and allowing the economy to grow – a fantastic way to cut deficits.

The impact of this has been to lower government spending as a percentage of GDP from the high of 25.2% to the 2013 percentage of 22.2% – which turns out to be as low or  lower of a percentage of GDP than SIX of the years Reagan was President.

So the path to reducing (and ending!) the deficit is to keep a lid on spending. Obama has done that (with some help from slow Medicare spending growth (to his credit that was what Obamacare was designed to do)). If Obama’s 2nd term is EXACTLY like his first term, we can expect to see 12% economic growth, which translates to (conservatively) another 500 billion reduction in the deficit through growth alone. If we can get Congress to keep a lid on spending, that would put the deficit at 345 billion just by doing “nothing”. Indeed efforts to cut spending (ie auserity) tend to have the contrary effect of increasing government outlays and shrinking revenue.

While there is nothing wrong with shrinking areas of government that are too large, where you do it in the business cycle is hugely important. Bush added government stimulus to a roaring economy and brought on the Great Recession. Removing stimulus now (ie cutting spending) would be to apply a headwind to the still-too-small recovery. An OK policy applied at the wrong time.

So how do we get rid of the last 345 billion? Going back to Part I of this post, defense skyrocketed 356 billion between 2000 and 2009. Should we simply undo that run-up in spending? It may be tempting to the peace/fiscal responsibility crowd. But a more useful approach is to look at where defense was as a percentage of GDP in our last balanced budget.

2000 3% of GDP

2009 4.7% of GDP

2013 4.3% of GDP

So while a growing economy and frozen spending is bringing the big picture back in line (deficits down by 40% already) – defense took a disproportionate share of the doubling of government spending in the 2000s. So just holding it constant doesn’t fix the over spending on defense.

Working from the reasonable stance that the year 2000 balanced budget 3% of GDP is a reasonable approximation of the correct amount of spending on defense, the United States would spend 470.5 billion (15,681b X .03) on defense. The 2013 projected defense spending is 701.5 billion – so to return to a balanced budget, defense should be cut by 231 billion dollars per year.

That leaves the deficit at 104 billion dollars. Less than 1/10th of the deficit we had in 2009 – just by growing the economy and spinning down from a decade of foreign adventuring.

We finally turn to increasing taxes. And not just any taxes. The most wealth inequality boosting taxes of them all. “Death” taxes and capital gains taxes.

It is an economic truism that you tax what you don’t want. In the United States, payroll taxes are about 25%. And capital gains taxes are 15% (for the vast majority of us – 20% over 400k).

Raising taxes on non-earned income is appropriate for three reasons: It lowers the deficits, it shrink wealth/income inequality and it has the lightest touch on the economy overall (and of course rates have been MUCH higher historically)

40 billion from raising the capital gains rate from 15/20% to 20/25%

14 billion from estate taxes

Leaving us 50 billion in deficit spending – finally something small enough to drown in a bathtub!

Closing tax loopholes is almost cliche at this point. But it is discussed so often as it is a relatively painless way to both restore fairness and simplicity to the tax code AND reduce deficits.

Regardless of how often it is brought up, their is wide agreement that at least 50 billion is available from closing loopholes.

Note – lowered interest expense due to the eliminated deficit (and thus debt is lower than expected) is ignored. Let’s use THAT money to start paying down the debt!

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From → Economics, Political

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