Here, You Fix the Budget

By next Wednesday, a group of politicians dubbed the "supercommittee" has to come up with a plan to slash federal deficits by at least $1.2 trillion over the next decade. If they don't, or if Congress rejects their plan, an automatic sequester cuts deficits by $1.2 trillion over eight years, split evenly between defense and non-defense spending cuts.

Some are holding out for a megadeal that cuts deficits by as much as $4 trillion over a decade. Others are less optimistic -- maybe more realistic -- and don't expect the supercommittee to reach an agreement at all.

But why wait for them? Here's a simple question: How would you fix the budget?

The Congressional Budget Office forecasts deficits out to 2022, but so much guesswork goes into 10-year forecasts that their significance is questionable. The Office of Budget and Management, however, forecasts specific line items of the federal budget going out to 2016 -- probably as far out as you can realistically project. The figures are still reliant on assumptions, but they're a decent estimate of future spending based on current law. Have a look:


Source: Office of Budget and Management.

Those are the numbers. How would you fix them? A few things to keep in mind before you make your changes: First, the most bloated areas of the budget are also the most popular with voters. According to the Tax Policy Center:

Three-quarters of Americans believe that entitlement programs such as Medicare and Social Security "will create major economic problems" over the next 25 years. But two-thirds are opposed to addressing these challenges by reducing benefits, and 56 percent are against raising taxes.

In other words, voters have a strong message for their politicians: Entitlements are going to wreck the budget, but don't you dare touch them.

Then there's defense. One of the biggest obstacles to making cuts at the Pentagon is how concentrated the defense industry has become. Just five companies -- Lockheed Martin (NYS: LMT) , Boeing (NYS: BA) , Northrop Grumman (NYS: NOC) , General Dynamics (NYS: GD) , and Raytheon (NYS: RTN) -- have defense contracts worth more than $100 billion. As New York Times columnist Joe Nocera wrote, "the Pentagon simply can't allow them get into serious financial difficulty; there are just too few of them." Furthermore, these five spent more than $60 million lobbying in 2009. The result: When the Pentagon does find the will to make cuts, the savings usually find their way back into other defense projects. Last year, former Defense Secretary Robert Gates announced he was cutting $100 billion in waste out of the defense budget but that almost all the cuts would be reinvested into "higher priority systems." Net impact on the federal budget: nil.

Finally, tax revenue is expected to be a healthy 19.3% of GDP by 2016 -- about what it was in the late 1990s -- but that relies on two assumptions: that all of the 2001/2003 tax cuts will be allowed to expire, and that the unemployment rate will drop to around 5%. Both are unlikely. For the unemployment rate to hit 5% by 2016, we'd need to add roughly 500,000 jobs a month going forward, compared with 150,000 a month so far this year. The odds are high that tax revenue will be lower, and hence deficits larger, than these forecasts show.

Those are a few constraints, but don't let them hold you back. How would you make the budget more efficient and sustainable? Tell us your plans in the comment section below.

And if you haven't already, check out my new e-book. It's currently one of the best-selling investment books on Amazon's Kindle bookstore.

Check back for Morgan Housel's columns on finance and economics every Tuesday and Friday.

At the time this article was published Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter, where he goes by @TMFHousel. The Motley Fool owns shares of Lockheed Martin, Raytheon, General Dynamics, and Northrop Grumman. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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