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Archive for the ‘Deficit’ Category

Since it is the single-largest government program, not only in the United States but also the entire world, it’s remarkable that Social Security isn’t getting much attention from fiscal policy wonks.

Sure, Obamacare is a more newsworthy issue because of the repeal/replace fight. And yes, it’s true that Medicare and Medicaid are growing faster and eventually will consume a larger share of the economy.

But those aren’t reasons to turn a blind eye toward a program that will soon have an annual budget of $1 trillion. Especially since the tax-and-spend crowd in Washington is actually arguing that the program should be expanded. I’m not kidding.

If nothing else, the just-released Trustees Report from the Social Security Administration demands attention. As I do every year, I immediately looked at Table VI.G9, which shows the annual inflation-adjusted budgetary impact of the program.

Here’s a chart showing how the program has grown since 1970 and what is expected in the future. Remember, these are inflation-adjusted numbers, so the sharp increase in outlays over the next several decades starkly illustrates that Social Security will be grabbing ever-larger amounts of money from the economy’s productive sector.

It’s also worth noting that the program already is in the red. Social Security outlays began to exceed revenues back in 2010.

And the numbers will get more out of balance over time.

By the way, some people say that the program is in decent shape since the “Trust Fund” isn’t projected to run out of money until 2034. That’s technically true, but utterly meaningless since it is nothing but a pile of IOUs.

You don’t have to believe me. A few years ago, I quoted this passage from one of Bill Clinton’s budgets.

These balances are available to finance future benefit payments and other trust fund expenditures–but only in a bookkeeping sense. …They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury, that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures.

Amen.

This is why annual cash flow into and out of the program is what matters, at least if we care about the Social Security’s economic impact.

And for those who want to know about the gap between the inflow and outflow, here’s a chart showing how deficits are going to explode in coming decades. Again, keep in mind these are inflation-adjusted numbers.

That’s not a typo in the chart. The total shortfall between now and 2095 is a staggering $44.2 trillion. Yes, trillion.

Remarkably, there’s an even bigger long-run problem with Medicare and Medicaid. Which helps to explain I relentlessly push for genuine entitlement reform.

But let’s focus today on Social Security. The answer to this looming fiscal nightmare is to copy one of the many nations that have shifted to “funded” retirement systems based on real savings. I’m a big fan of the Australian approach. Chile also has a great system, and Switzerland and the Netherlands are good role models as well. Hong Kong and Singapore also rely on private savings for retirement, and both jurisdictions demonstrate that aging populations and falling birthrates aren’t necessarily a fiscal death sentence. Heck, even the Faroe Islands and Sweden have jumped on the bandwagon of private retirement accounts.

P.P.S. You can enjoy some Social Security cartoons here, here, and here. And we also have a Social Security joke if you appreciate grim humor.

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Back in April, I shared a new video from the Center for Freedom and Prosperity that explained how poor nations can become rich nations by following the recipe of small government and free markets.

Now CF&P has released another video. Narrated by Yamila Feccia from Argentina, it succinctly explains – using both theory and evidence – why spending caps are the most prudent and effective way of achieving good fiscal results.

Ms. Feccia covers all the important issues, but here are five points that are worth emphasizing.

  1. Demographics – Almost all developed nations have major long-run fiscal problems because welfare states will implode because of aging populations and falling birthrates (Ponzi schemes need an ever-growing number of new people to stay afloat).
  2. Golden Rule – If government spending grows slower than the private sector, that reduces the relative burden of government spending (the underlying disease) and also reduces red ink (the symptom of the underlying disease).
  3. Success Stories – Simply stated, spending caps work. She lists the nations that have achieved very good results with multi-year periods of spending restraint. She points out that the U.S. made a lot of fiscal progress when GOPers aggressively fought Obama. And she shares the details about the very successful constitutional spending caps in Hong Kong and Switzerland.
  4. Better than Balanced Budget Amendments or Anti-Deficit Rules – The video explains why policies that try to target red ink are not very effective, mostly because tax revenues are very volatile.
  5. Even International Bureaucracies Agree – Remarkably, the International Monetary Fund (twice!), the European Central Bank, and the Organization for Economic Cooperation and Development (twice!) have acknowledged that spending caps are the most, if not only, effective fiscal rule.

I touch on some of these issues in one of my chapters in the Cato Handbook for Policymakers. The entire chapter is worth reading, in my humble opinion, but I want to share an excerpt echoing Point #4 that I just shared from Ms. Feccia’s video.

There’s a very practical reason to focus on capping long-run spending rather than trying to balance the budget every year. Simply stated, the “business cycle” makes the latter very difficult. …when a recession occurs and revenues drop, a balanced-budget mandate requires politicians to make dramatic changes at a time when they are especially reluctant to either raise taxes or impose spending restraint. Then, when the economy is enjoying strong growth and producing lots of tax revenue, a balanced-budget requirement doesn’t impose much restraint on spending. All of which creates an unfortunate cycle. Politicians spend a lot of money during the good years, creating expectations of more and more money for various interest groups. When a recession occurs, the politicians suddenly have to slam on the brakes. But even if they actually cut spending, it is rarely reduced to the level it was when the economy began its upswing. Moreover, politicians often raise taxes as part of these efforts to comply with anti-deficit rules. When the recession ends and revenues begin to rise again, the process starts over—this time from a higher base of spending and with a bigger tax burden. Over the long run, these cycles create a ratchet effect, with the burden of government spending always reaching new plateaus.

It’s not that I want to belabor this point, but the bottom line is that it is very difficult to amend a country’s constitution (at least in the United States, but presumably in other nations as well).

So if there’s going to be a major campaign to put a fiscal rule in a constitution, then I think it should be one that actually achieves the goal. And whether people want to address the economically important goal of spending restraint or the symbolically important goal of fiscal balance, what should matter is that a spending cap is the effective way of getting there.

P.S. The narrator is from the soccer-mad country of Argentina, which has a big rivalry with the soccer-mad nation of Brazil. Like most Americans, I don’t quite get the appeal of that sport. That being said, I will cheer for Brazil the next time it plays against Argentina for the simple reason that it just adopted a constitutional amendment to cap government spending. If Ms. Feccia wants me to cheer for her country’s team, she needs to convince her government to do something similar.

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It’s both amusing and frustrating to observe the reaction to President Trump’s budget.

I’m amused that it is generating wild-eyed hysterics from interest groups who want us to believe the world is about to end.

But I’m frustrated because I’m reminded of the terribly dishonest way that budgets are debated and discussed in Washington. Simply stated, almost everyone starts with a “baseline” of big, pre-determined annual spending increases and they whine and wail about “cuts” if spending doesn’t climb as fast as previously assumed.

Here are the three most important things to understand about what the President has proposed.

First, the budget isn’t being cut. Indeed, Trump is proposing that federal spending increase from $4.06 trillion this year to $5.71 trillion in 2027.

Second, government spending will grow by an average of almost 3.5 percent per year over the next 10 years.

Third, because the private economy is projected to grow by an average of about 5 percent per year (in nominal terms), Trump’s budget complies with the Golden Rule of fiscal policy.

Now that we’ve established a few basic facts, let’s shift to analysis.

From a libertarian perspective, you can argue that Trump’s budget is a big disappointment. Why isn’t he proposing to get rid of the Department of Housing and Urban Development? What about shutting down the Department of Education? Or the Department of Energy? How about the Department of Agriculture, or Department of Transportation?

And why is he leaving Social Security basically untouched when taxpayers and retirees would both be better off with a system of personal retirement accounts? And why is Medicare not being fundamentally reformed when the program is an ever-expanding budgetary burden?

In other words, if you want the federal government to reflect the vision of America’s Founders, the Trump budget is rather disappointing. It’s far from a Liberland-style dream.

But for those who prefer to see the glass as half-full, here are a couple of additional takeaways from the budget.

Fourth, as I wrote yesterday, there is real Medicaid reform that will restore federalism and save money.

Fifth, domestic discretionary spending will be curtailed.

But not just curtailed. Spending in the future for this category will actually be lower if Trump’s budget is approved. In other words, a genuine rather than fake budget cut.

I’ll close with my standard caveat that it’s easy to put good ideas (or bad ideas) in a budget. The real test is whether an Administration will devote the energy necessary to move fiscal reforms through Congress.

Based on how Trump was defeated in the battle over the final spending bill for the current fiscal year, there are good reasons to be worried that good reforms in his budget won’t be implemented. Simply stated, if Trump isn’t willing to use his veto power, Congress will probably ignore his proposals.

P.S. You may have noticed that I didn’t include any discussion of deficits and debt. And I also didn’t address the Administration’s assertion that the budget will be balanced in 10 years if Trump’s budget is approved. That’s because a fixation on red ink is a distraction. What really matters is whether the burden of spending is falling relative to the private sector’s output. In other words, the entire focus should be on policies that generate spending restraint and policies that facilitate private sector growth. If those two goals are achieved, the burden of red ink is sure to fall. Whether it happens fast enough to balance the budget in 2027 is of little concern.

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I expressed pessimism yesterday about Trump’s tax plan. Simply stated, I don’t think Congress is willing to enact a large tax cut given the nation’s grim fiscal outlook.

In this Fox Business interview, I elaborated on my concerns while also pointing out that the plan would be very good if it somehow got enacted.

We now have some preliminary numbers that illustrate why I’m concerned.

The Committee for a Responsible Federal Budget put together a quick guess about the revenue implications of Trump’s new plan. Their admittedly rough estimate is that federal revenues would be reduced by close to $6 trillion over 10 years.

Incidentally, these revenue estimates are very inaccurate because they are based on “static scoring,” which is the antiquated notion that major changes in tax policy have no impact on economic performance.

But these numbers nonetheless are useful since the Joint Committee on Taxation basically uses that approach when producing official revenue estimates that guide congressional action.

In other words, it doesn’t matter, at least for purposes of enacting legislation, that there would be substantial revenue feedback in the real world (the rich actually paid more, for instance, when Reagan dropped the top tax rate from 70 percent to 28 percent). Politicians on Capitol Hill will point to the JCT’s static numbers, gasp with feigned horror, and use higher deficits as an excuse to vote no (even though those same lawmakers generally have no problem with red ink when voting to expand the burden of government spending).

That being said, they wouldn’t necessarily have that excuse if the Trump Administration was more aggressive about trying to shrink the size and scope of the federal government. So there’s plenty of blame to go around.

Until something changes, however, I don’t think Trump’s tax cut is very realistic. So if you want my prediction on what will happen, I’m sticking to the three options I shared yesterday.

  1. Congress and the White House decide to restrain spending, which easily would create room for a very large tax cut (what I prefer, but I won’t hold my breath for this option).
  2. Congress decides to adopt Trump’s tax cuts, but they balance the cuts with dangerous new sources of tax revenue, such as a border-adjustment tax, a carbon tax, or a value-added tax (the option I fear).
  3. Congress and the White House decide to go for a more targeted tax cut, such as a big reduction in the corporate income tax (which would be a significant victory).

By the way, the Wall Street Journal editorialized favorably about the plan this morning, mostly because it reflects the sensible supply-side view that it is good to have lower tax rates on productive behavior.

While the details are sparse and will have to be filled in by Congress, President Trump’s outline resembles the supply-side principles he campaigned on and is an ambitious and necessary economic course correction that would help restore broad-based U.S. prosperity. …Faster growth of 3% a year or more is possible, but it will take better policies, and tax reform is an indispensable lever. Mr. Trump’s modernization would be a huge improvement on the current tax code that would give the economy a big lift, especially on the corporate side. …The Trump principles show the President has made growth his highest priority, and they are a rebuke to the Washington consensus that 1% or 2% growth is the best America can do.

But the WSJ shares my assessment that the plan will not survive in its current form.

…the blueprint is being assailed from both the left and the balanced-budget right. The Trump economic team acknowledges that their plan would mean less federal revenue than current law… Mr. Trump’s plan is an opening bid to frame negotiations in Congress, and there are plenty of bargaining chips. Perhaps the corporate rate will rise to 20%… Budget rules and Democratic opposition could force Republicans to limit the reform to 10 years.

For what it’s worth, if the final result is a 15 percent or 20 percent corporate tax rate, I’ll actually be quite pleased. That reform would be very good for the economy and national competitiveness. And regardless of what JCT projects, there would be substantial revenue feedback.

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Based on new 10-year fiscal estimates from the Congressional Budget Office, I wrote yesterday that balancing the budget actually is very simple with a modest bit of spending restraint.

If lawmakers simply limit annual spending increases to 1 percent annually, the budget is balanced by 2022. If spending is allowed to grow by 2 percent annually, the budget is balanced by 2025. And if the goal is balancing the budget by the end of the 10-year window, that simply requires that spending grow no more than 2.63 percent annually.

I also pointed out that this wouldn’t require unprecedented fiscal discipline. After all, we had a de facto spending freeze (zero percent spending growth) from 2009-2014.

And in another previous column, I shared many other examples of nations that achieved excellent fiscal results with multi-year periods of spending restraint (as defined by outlays growing by an average of less than 2 percent).

Today, we’re going to add tax cuts to our fiscal equation.

Some people seem to think it’s impossible to balance the budget if lawmakers are also reducing the amount of tax revenue that goes to Washington each year.

And they think big tax cuts, such as the Trump plan (which would reduce revenues over 10 years by $2.6 trillion-$3.9 trillion according to the Tax Foundation), are absurd and preposterous.

After all, if politicians tried to simultaneously enact a big tax cut and balance the budget, it would require deep and harsh spending cuts that would decimate the federal budget, right?

Nope. Not at all.

They just need to comply with my Golden Rule.

Let’s examine the fiscal implications of a $3 trillion tax cut. If you look at CBO’s baseline revenue forecast for the next 10 years, the federal government is projected to collect more than $43 trillion during that decade. If you reduce that baseline by an average of $300 billion each year, receipts will still grow. Indeed, they’ll rise from $3.4 trillion this year to $4.8 trillion in 2027.

And since CBO is forecasting that the federal government this year will spend more than $3.9 trillion, we simply have to figure out the amount of spending restraint necessary so that outlays in 2027 don’t exceed $4.8 trillion.

That’s not a difficult calculation. It turns out that the American people can get a substantial $3 trillion tax and a balanced budget if politicians simply exercise a modest amount of fiscal discipline and limit annual spending increases to 1.96 percent annually.

In other words, if the crowd in Washington does nothing more than simply have government grow just a tiny bit less than the projected rate of inflation, lots of good things can be achieved.

P.S. I can’t resist pointing out yet again that we shouldn’t fixate on balancing the budget. The real goal should be to shrink the burden of federal spending so more resources are allocated by the productive sector of the economy. That being said, if lawmakers address the underlying disease of excessive spending, that automatically solves the symptom of red ink.

P.P.S. Higher taxes, by contrast, generally lead to higher deficits and debt.

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The Congressional Budget Office, as part of The Budget and Economic Outlook: 2017 to 2027, has just released fiscal projections for the next 10 years.

This happens twice every year. As part of this biannual exercise, I regularly (most recently here and here) dig through the data and highlight the most relevant numbers.

Let’s repeat that process. Here’s what you need to know from CBO’s new report.

  • Under current law, tax revenues over the next 10 years are projected to grow by an average of 4.2 percent each year.
  • If left on autopilot, the burden of government spending will rise by an average of 5.2 percent each year.
  • If that happens, the federal budget will consume 23.4 percent of economic output in 2027 compared to 20.7 percent of GDP in 2017.
  • Under that do-nothing scenario, the budget deficits jumps to $1.4 trillion by 2027.

But what happens if there is a modest bit of spending restraint? What if politicians decide to comply with my Golden Rule and limit how fast the budget grows every year?

This shouldn’t be too difficult. After all, even with Obama in the White House, there was a de facto spending freeze between 2009-2014. In other words, all the fights over debt limits, sequesters, and shutdowns actually yielded good results.

So if the Republicans who now control Washington are serious about protecting the interests of taxpayers, it should be relatively simple for them to adopt good fiscal policy.

And if GOPers actually decide to do the right thing, the grim numbers in the CBO’s new report quickly turn positive.

  • If spending is frozen at 2017 levels, there’s a budget surplus by 2021.
  • If spending is allowed to grow 1 percent annually, there’s a budget surplus by 2022.
  • If spending is allowed to grow 2 percent annually, there’s a budget surplus by 2025.
  • If spending is allowed to grow 2.63 percent annually, the budget is balanced in 10 years.
  • With 2.63 percent spending growth, the burden of government spending drops to 18.4 percent of GDP by 2027.

To put all these numbers in context, inflation is supposed to average about 2 percent annually over the next decade.

Here’s a chart showing the overall fiscal impact of modest spending restraint.

By the way, it’s worth pointing out that the primary objective of good fiscal policy should be reducing the burden of government spending, not balancing the budget. However, if you address the disease of excessive spending, you automatically eliminate the symptom of red ink.

For more background information, here’s a video I narrated on this topic. It was released in 2010, so the numbers have changed, but the analysis is still spot on.

P.S. Achieving good fiscal policy obviously becomes much more difficult if Republicans in Washington decide to embark on a foolish crusade to expand the federal government’s role in infrastructure.

P.P.S. Achieving good fiscal policy obviously becomes much more difficult if Republicans in Washington decide to leave entitlement programs on autopilot.

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What could be more fun than to spend the day before Christmas reading about fiscal policy?

I realize there are probably endless ways to answer that question, particularly since normal people are probably more concerned about the rumor that the feds are going to arrest Santa Claus.

But America’s fiscal future is very grim, so hopefully some of you will be interested in some relevant new research on spending caps.

My buddy Sven Larson has a scholarly article about deficits and the Swiss Debt Brake that has just been published by the Journal of Governance and Regulation.

The first half of his article is a review of the academic debate on whether deficits are good (the Keynesians) or bad (the austerity crowd). This literature review is necessary for that sort of article, though I think it’s a distraction because deficits are merely a symptom. The real problem is excessive government.

Sven then gets to the meat of his article, which considers whether the Swiss Debt Brake (which imposes a cap on annual spending increases) is a better approach because it isn’t focused on annual budget deficits (which are susceptible to big swings because income tax revenues can dramatically increase or decline based on the economy’s performance).

…the Swiss Debt Brake…focuses primarily on the non-cyclical, i.e., structural part of the deficit in Switzerland (Geier 2011). By focusing on the long-term debt outlook rather than the short-term or annual ebbs and flows, the debt brake allows the economy to move through a business cycle without disruptive fiscal-policy incursions. …Since it was introduced in 2003 it appears to have worked as intended. Beljean and Geier (2013) present evidence suggesting that the brake has ended a long period of sustained government deficits.

Sven then cites my Wall Street Journal column on the Debt Brake, which is nice, and he then shares some new evidence about the economic benefits of the Swiss spending cap.

The Swiss economy grew faster in the first decade after the brake went into effect than in the decade immediately preceding its enactment.

And, in his conclusion, he speculates that the United States could reap similar economic benefits with a spending cap.

Should Congress manage to pass and comply with an adapted version of the Swiss debt brake, it is reasonable to expect…stronger economic growth. As an indication of the potential macroeconomic gains, a real growth rate of three percent as opposed to two percent over a period of ten years would add more than $2.3 trillion in annual economic activity to the U.S. GDP.

The degree of additional growth that would be triggered by a spending cap is an open question, of course, but if we could get even half of that additional growth, it would be a boon for American living standards.

Let’s now shift to an article with a much more hostile view of spending caps.

I wrote very recently about the adoption of a spending cap in Brazil. This new system will limit government spending so that it can’t grow faster than inflation. Sounds very reasonable to me, but Zeeshan Aleem has a Vox column that is apoplectic about the supposed horrible consequences.

Americans worried that Donald Trump will try to shred the nation’s social welfare programs can take some grim comfort by looking south: No matter what Republicans do, it will pale in comparison with the changes that are about to ravage Brazil. On Thursday, a new constitutional amendment goes into effect in Brazil that effectively freezes federal government spending for two decades. Since the spending cap can only increase by the rate of inflation in the previous year, that means that spending on government programs like education, health care, pensions, infrastructure, and defense will, in real terms, remain paused at 2016 levels until the year 2037.

Since the burden of government spending in Brazil has been rising far faster than the growth of the private sector (thus violating fiscal policy’s Golden Rule), I view the spending cap as a long-overdue correction.

Interesting, Aleem admits that the policy is being welcomed by financial markets.

As far as inspiring faith from investors, the amendment appears to be working. Brazil’s currency and stocks rose during December in part because of the passage of the measure.

But the author is upset that there won’t be as much redistribution spending.

…the spending cap…places the burden of reining in government spending entirely on beneficiaries of government spending — all Brazilians, but especially the poor and the vulnerable.

Instead, Aleem wants big tax increases.

…the amendment does a great deal to limit the expenditure of government funds, it doesn’t do anything to directly address how to generate them directly: taxes. “The major cause of our fiscal crisis is falling revenues,” Carvalho says… Carvalho says taking an ax to spending is coming at the expense of discussing “taxing the very rich, who do not pay very much in taxes, or eliminating tax cuts that have been given to big corporations.”

Wow, methinks Professor Carvalho and I don’t quite see things the same way.

I would point out that falling revenues in a deep recession is not a surprise. But that’s an argument for policies that boost growth, not for big tax hikes.

Especially since the long-run fiscal problem in Brazil is a growing burden of government spending.

And it’s worth noting that overall impact of the spending cap, even after 10 years, will be to bring the size of the public sector back to where it was in about 2008.

Let’s close by reviewing an article by Charles Blahous of the Mercatus Center. Chuck starts by noting that we have a spending problem. More specifically, the burden of government is expanding faster than the private economy.

…to say we have a problem with deficits and debt is an oversimplification. What we have instead is an overspending problem, and the federal debt is essentially a symptom of that problem. …federal spending has grown and will grow (under current projections) faster than our Gross Domestic Product (GDP).

The solution, he explains, is a procedural version of a spending cap.

To solve this, future federal budgets in which spending grows as a percentage of GDP from one year to the next should require a congressional supermajority (e.g., three-fifths or two-thirds) to pass. Only if spending in the budget does not rise as a percentage of GDP from one year to the next could it be passed with a simple majority.

Chuck explains why there should be a limit on spending increases.

…we cannot permanently continue to allow federal spending to grow faster than America’s production. …as government spending growth exceeds GDP growth, we all lose more control over our economic lives. As individuals we will have less of a say over the disposition of each dollar we earn, because the government will claim a perpetually-growing share.

And higher taxes are never a solution to a spending problem.

…this problem cannot be solved by raising taxes. Raising taxes…does not avoid the necessity of keeping spending from rising faster than our productive output. Raising taxes may even have the downside of deferring the necessary solutions on the spending side.

The last sentence in that abstract is key. I’ve written about why – in theory – I could accept some tax increases in order to obtain some permanent spending reforms. In the real world of Washington, however, politicians will never adopt meaningful spending restraint if there’s even the slightest rumor that higher taxes may be an option.

He concludes that current budget rules need to be updated.

…budget rules apply no procedural barriers to continuing unsustainable spending growth rates, while legislative points of order protect baseline fiscal practices in which both federal spending and revenues grow faster than the economy’s ability to keep pace.

I certainly agree, though it would be nice to see something much stronger than just changes in congressional procedures.

Perhaps something akin to the constitutional spending caps in Hong Kong and Switzerland?

Now that would be a nice Christmas present for American taxpayers.

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