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Feb 04 2011
Perspective, candor, inspiration PDF E-mail
Written by Stew Goodwin   
February 04, 2011

Last month, I stated the belief in these pages that this country is gradually coming together to address its most pressing financial challenges. Families, municipalities, and states are beginning to recognize the actual scope of their difficulties. Remedies are emerging that take the longer term into account. Leaders are increasingly urging actions that bridge ideological boundaries. How such a convergence can eventually restore fiscal health is the subject of this discussion.

Our country's economy (GDP) is around $14 trillion annually. The federal budget is just under $4 trillion, and it will produce a deficit slightly shy of $1.5 trillion. Federal debt equals the GDP, and state indebtedness adds another $6 trillion. (Debt in all facets of the nation is about $45 trillion.) Interest and rollover costs (at current low interest rates) for the federal debt are $1 trillion per year. This is a figure to keep in mind when evaluating various proposals for cuts in spending. The figures clearly indicate that a restoration of fiscal integrity by learning to live within our means will require trillions, not billions, in adjustments. I estimate that the adjustment will have to be near the top of the $5 trillion to $10 trillion range over five years.

Economic growth won't come close to meeting this target. Each percentage point of growth is only worth $140 billion. If the economy should produce 20 percentage points of growth over the next five years (well above the most optimistic predictions), even allowing for escalation and multpliers, the result would be $3 trillion. But growth acceleration cannot take place until most of the debt and deficit overburden has been cleared away.

Tax cuts are counterproductive at this stage of the economic cycle. (The last round is being financed with borrowed money.) Between 2000 and 2010, taxes as a percentage of GDP have dropped from 20 percent to 15 percent while government spending has risen from 20 percetn to 25 percetn. Both taxes (upward) and spending (downward) will need adjusting.

The extremes of our political spectrum are still focusing upon relatively insignificant areas of spending while the center is starting to understand where the real cuts will have to be made. Earmarks ($15 billion), foreign aid ($30 billion), and the Department of Education ($47 billion) may be satisfying candidates for some, but they will yield minimal amounts. Defense spending could probably be trimmed by $100 billion a year, but in the current world environment it is hard to see how its several sectors: military ($700 billion); wars ($155 billion); homeland security ($50 billion); and intelligence ($40 billion) could yield more. Combined, all the elements of the defense sector total less than one year's interest on the federal debt. Reducing the size of government is a laudable exercise, but may not be overly productive. If 250,000 non-military government contractors were fired, if the federal work force were reduced by 10 percent, and if all federal government employees had their pay cut by 5 percent, the cumulative savings would be only $47 billion.

Looking to reduce pension benefits begins to touch on the big money, but the savings impact would be mostly at the state level. Government pensions are underfunded by $5 trillion, and many states have legislated that pensions be paid prior to any other expenses.

    Social Security, which has a trust fund largely made up of U.S. Treasury IOUs, is a really big money area that is obligated to pay out at least $40 trillion (in current dollars) over the next 50 years. Raising the retirement age to 70, putting all cost of living increases on hold, and reducing payments to the top 40 percent of income earners by 10 percent would save $400 billion a year. Increasing the Medicare eligibility age from 65 to 70 and capping the program's annual expansion to GDP growth plus 1 percentage point would save another $665 billion annually. Medicaid (a federal-state program for the indigent) might be reduced by 25 percent, which would save $37 billion at the federal level. If non-Medicare health care costs could be shaved by 10 percent, the annual savings would be $150 billion (although not all going to the federal government).

Combining the cuts to Social Security, Medicare, and Medicaid would generate $1.1 trillion in annual savings. Adding $300 billion of miscellaneous reductions would create $1.4 trillion of annual and $7 trillion of five-year spending savings. A trillion of federal tax increases could bring the five-year figure close enough to $10 trillion to restore our financial health.

Putting the country on a sound financial footing that reduces deficits significantly and cuts federal debt to 60 percent of GDP would provide a good platform for an extended period of growth. A five- to 10-year perspective is a requirement. Candor about the figures involved is mandatory. Inspiring our citizens to invoke wartime-like sacrifices in order to live within the national means will be harder, but not impossible. The process is under way. I believe fiscal responsibility is visible on the horizon.


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