Budget Myths November 20, 2012

As Congress and the President work together to avoid the looming fiscal cliff during the lame duck session of Congress, a more intransient problem remains in the background: the United States’ structural budget deficit. In our recent Weekly Economic Commentary: Budget Debate (10/29/12), we wrote about how often the budget was mentioned during the campaign season, and we pointed out that the economy and the labor market got more attention than the longer term budget issues facing the country. In late 2010, three different non-partisan organizations released plans that would put the U.S. budget on a path toward a balanced budget, using a combination of revenue/tax increases and spending cuts to achieve that goal. These organizations are:

• The President’s National Commission on Fiscal Responsibility and Reform (commonly known as Bowles-Simpson);
• Bipartisan Policy Center (commonly known as Rivlin-Domenici); and
• Pew-Peterson Commission on Budget Reform.

While each plan differed on certain aspects of the longer term fix for our budget woes, they all generally agreed that there are no easy answers and no quick fixes. Both Democrats and Republicans populated the three commissions. Some hold (or once held) elected office, while others served in the federal government or were on the boards of the many think tanks in and around Washington. All were focused on finding bi-partisan solutions to the problem. In general, the three commissions concluded that in order to successfully tackle the longer term deficit problem, formerly politically untouchable areas must be on the table in any serious negotiation. These areas include:

• Social Security;
• Defense spending;
• Farm subsidies;
• Medicare;
• Medicaid;
• Personal and corporate tax rates; and

„„ So-called tax expenditures, more commonly known as personal and corporate tax deductions ( e.g., home mortgage interest, state and local real estate tax, or charitable contributions).

The plans did vary on the amount of revenue increases (via some combination of higher tax rates, fewer deductions, and more income subject to taxation) relative to spending cuts (across all categories of federal spending) needed to achieve a long-term path toward fiscal stability. The outcome of the November 6 election suggests that the ultimate mix of revenue increases and spending decreases that will set the country on that path is likely to be more reliant on revenue increases than spending cuts than if Governor Romney won and/or the Republicans took control of the Senate.

Absent from the list above are several budget items that receive a great deal of attention in the media, but are not a significant source of the nation’s long-term budget woes. For example, both the Bowles-Simpson plan and the Rivlin-Domenici plan noted that budgets cannot be balanced by eliminating waste or earmarks, by just cutting domestic discretionary spending, by growing our way out of the deficit, or by only raising taxes or cutting foreign aid — or all of these together. To illustrate why this is the case, we focus on the impact of waste, fraud, and abuse, domestic discretionary programs, and foreign aid have on our budget. In future commentaries, we intend to tackle some of the other items in the budget.

 

 

 

 

 

 

 

 

 

 

 

 

 

Waste, Fraud, and Abuse: Impact
The libertarian Cato Institute, a Washington, D.C.-based think tank, estimates waste, fraud, and abuse in the federal budget at between $100 billion and $125 billion per year. On an absolute basis, this is an enormous amount of money, and taxpayers and the financial markets would welcome any and all steps to eliminate this from the budget. However, the annual outlays of the U.S. federal government in fiscal year 2012 were $3.5 trillion. So even if somehow the federal government were able to eliminate every dollar of waste, fraud, and abuse in the budget, federal outlays in fiscal year 2012 would still have been well over $3.3 trillion, and the federal deficit in fiscal year 2012 would have been $960 billion instead of $1 trillion.

Domestic Discretionary Spending: Impact
Let us now examine domestic discretionary spending. The federal budget can be sliced and diced several ways. One way to look at the budget is by function or cabinet post, i.e., Department of Labor, Department of the Interior, Department of Defense, etc. Another way is to group the spending categories together by legislative mandate. For example, all mandatory spending (regardless of function) is grouped together, and all non-mandatory spending (also known as discretionary spending) is grouped together. Mandatory spending is all spending that is not controlled through Congress’ annual appropriation process. For the most part, mandatory spending is based on eligibility criteria and benefit of payment rules set into law. Examples include Social Security, Medicare, Medicaid, and interest on the public debt. In recent fiscal years, mandatory spending has accounted for nearly two-thirds of all federal spending, and this slice of the pie is set to rise dramatically in the coming decade.

Discretionary spending is what Congress agrees to spend each year on things like national defense, education, Veterans Affairs, the national park system, etc. In recent fiscal years, discretionary spending has accounted for about one-third of federal budget outlays. Nondefense discretionary outlays ($528 billion in fiscal year 2011) alone account for only 10 – 15% of total outlays. Thus, even if we eliminated all nondefense discretionary spending — which would literally wipe out whole Cabinet level departments and hundreds of politically sensitive programs championed by both Republicans and Democrats — it would only make a small dent in the overall deficit.

Foreign Aid: Impact
Although not a single line item in the budget, foreign aid receives a great deal of attention in the media. A 2010 poll conducted by the University of Maryland’s Program on International Policy Attitudes found that Americans thought that the United States spends 25% of its budget on foreign aid. Foreign aid is mostly part of discretionary spending, but at around $40 – 50 billion per year accounts for roughly 1% of federal budget outlays, far less than the 25% of the budget the public thinks is spent. These outlays are found in the budgets of the U.S. Treasury, the Department of Agriculture, the State Department, and even the Department of Defense for items such as:

• Embassy security;
• The Peace Corps;
• Disaster assistance;
• Peacekeeping;
• Direct economic support to foreign nations;
• The World Bank, IMF, and United Nations; and
• Global health initiatives.

 

 

 

 

 

 

Putting It All Together
All together, waste, fraud, and abuse, non-defense discretionary spending, and foreign aid amount to a sizable portion (more than $700 billion), roughly 20% of total federal outlays. But 80% of the budget lies outside of these three areas of the budget. Although there is certainly some merit in taking a hard look at each of these categories as part of a longer term budget reform, the real task lies in the 80% of federal outlays that are growing at an unsustainable pace and will contribute the most to our medium- and long-term budget woes in the coming decade.

 

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* Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

^ Federal Funds Rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis.

† Private Sector – the total nonfarm payroll accounts for approximately 80% of the workers who produce the entire gross domestic product of the United States. The nonfarm payroll statistic is reported monthly, on the first Friday of the month, and is used to assist government policy makers and economists determine the current state of the economy and predict future levels of economic activity. It doesn’t include:
– general government employees
– private household employees
– employees of nonprofit organizations that provide assistance to individuals
– farm employees

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