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The 20 Percent Solution

April 20, 2015

On April 15th, Congressional Republicans missed their deadline for the fiscal year 2016 budget resolution. Nevertheless, and despite their differences on defense spending and the voucherization of Medicare (absent from the Senate bill), the GOP conferees aim to balance the budget in 10 years by slashing over $5 trillion in social programs and safety net spending, including the repeal of Obamacare. (Their plans are also magically aided by $2 trillion in mythical revenues and mystery savings.) During a recent floor speech, Senate Budget Committee Chairman Mike Enzi (R-WY) described their objectives this way:

"A balanced budget approved by Congress will help make the government live within its means and set spending limits for our nation. Hard-working families are fed up with [President Obama's] spend-now, pay-later policies and are closely following our effort [on] a balanced budget."

Unfortunately, there is little evidence in support of Enzi's argument. As the nonpartisan Congressional Budget Office (CBO) recently forecast, there is no near-term debt problem. Adjusted for inflation, federal spending is lower now than when Barack Obama first took the oath of office. As the economy has recovered, the yearly deficit has been reduced by almost two-thirds since President Obama first entered the White House. And while the national debt as a percentage of the economy has plateaued, projected yearly deficits through 2025 under President Obama's proposed budget remain at or below the 50 year historical average of 2.7 percent. That stable picture explains both why Americans' concern about the budget deficit has eased and why the Fitch rating agency this week reaffirmed the USA's Triple A credit rating.

But there's an even bigger problem for Republicans so eager to swing a heavy budget ax. Since 1965, federal spending has exceeded revenue by that 2.7 percent of GDP. Yet polls consistently show that outside of foreign aid, there is no area of government spending a majority of Americans wants to decrease. And with the inescapable requirements to provide 21st century education and infrastructure even as the population grows older, the U.S. will need to invest more money in its people, not less. All of which means that to the degree that the United States even needs to "live within its means" right now, it should do so not by spending less, but by raising more revenue.
Call it the 20 Percent Solution.
The CBO chart above tells an important part of the story. Since 1965--the year Medicare and Medicaid health care programs were signed into law--federal spending has averaged 20.1 percent of America's total economic output. During the same five decade time frame, Uncle Sam's revenue has averaged 17.4 percent of GDP per year. But across that span, Washington produced a balanced budget in only five years. In 1969, a booming economy and LBJ's Vietnam surtax filled the Treasury's coffers to 19 percent of GDP. Uncle Sam was also in the black from fiscal years 1998 through 2001, as the Clinton expansion and the dotcom boom (with its large capital gains paydays) brought in a tax revenue haul that reached 20.0 percent in 2000.
(Tax cuts and recessions produced the opposite effect. Ronald Reagan's massive 1981 tax cuts were followed by the deep recession of 1982, a double-whammy which tax revenue did not recover until 1985. George W. Bush's tax cuts, combined with a brief downswing in 2001 and the later financial meltdown produced oceans of red ink, and by FY 2009, the lowest percentage tax haul since 1950.)
Now, Americans could shrink the size of government to what they've actually been paying for, if they actually wanted to shrink the size of government. But when pressed to explain where they would chop the budget, poll after poll shows pretty much the same thing: nowhere. In 2008, not even a quarter of conservatives surveyed by the American National Election Study would cut any of the 12 programs listed. A 2010 CBS/New York Times poll of Tea Party members found that 92 percent said they wanted smaller government and fewer services, yet 62 percent said current Social Security and Medicare expenditures were worth it. That same year, an Economist/YouGov poll found that respondents preferred cutting spending to raising taxes to reduce the deficit by a margin of 62 to 5 percent. But as Ezra Klein noted at the time:

The only program that more than a third of the public wants to see cut is foreign aid. Bummer, then, that it accounts for less than a single percent of the budget.

A 2013 survey by the Pew Research Center (above, right) gave an even clearer view of the degree to which Americans want the scope of the federal government preserved or even expanded. Again, foreign aid ("Aid to the World's Needy") was the only area of federal spending where the percentage wanting to decrease funding (48 percent) even approached those wanting to maintain (28 percent) or expand it (21 percent). Huge majorities wanted to keep or increase current investments in education, Social Security, Medicare and infrastructure. The survey said, simply, that all of the biggest ticket items in the budget are off-limits. (Interestingly, the military is ranked lower as a spending priority.)

It is often said of that the United States government is an insurance company with an army. As the CBPP analysis of the $3.5 trillion FY 2014 budget above shows, defense, Social Security, health care (of which Medicare was $511 billion) and interest on the national debt accounted for 73 percent of federal spending. Total non-defense discretionary spending, which among other things includes education, transportation, research and infrastructure is roughly $1 trillion a year. And thanks to the 2011 Budget Control Act (sequestration) and subsequent budget agreements, those very areas so essential to American global competitiveness in the 21st century now represent their smallest share of GDP in over fifty years.
But while President Obama and Congressional progressives want to make the needed investments to secure Americans' standard of living in the future, House and Senate Republicans are heading down a path to a much different end. Under the emerging GOP budget plan, the United States would be an army with a not-very-good insurance company.

The comparison above from the New York Times helps tell the tale. Under President Obama's proposal, tax revenues over the next decade would average 19.0 percent of GDP a year, compared to 17.5 percent in FY 2014. The President raises $1.55 trillion in additional revenue, much of it from a one-time tax on businesses' foreign income and by capping deductions and exclusions for high earners. While spending--including new investments in universal pre-K education, free community college and expanded infrastructure--would reach 22.1 percent of GDP by 2025, that level would still be less than the Reagan and Obama era highs. The 2025 deficit of 2.7 percent of GDP would be in line with the current 50 year average dating back to 1965. (The People's Budget proposed by Congressional progressives would raise significantly more revenue --21.2 percent of GDP over 10 years--while spending more--22.8 percent--to fund major new infrastructure and jobs initiatives as well as new education programs and expanded Social Security benefits.)
But if President Obama and his more aggressive Democratic allies in Congress are closer to adopting the 20 percent revenue solution, their Republican opponents are going in the opposite direction. Revenues plateau around 18 percent over the next decade. But with over $5 trillion in spending reductions starting almost immediately, federal outlays quickly drop to that same share of the economy by 2025. That isn't just two percentage points lower than the historical average; Uncle Sam's spending as a share of GDP hasn't been as low as 18.5 percent since 2002. That was the year before the Iraq War.
And how do Congressional Republicans manage to "balance the budget" by 2025? Aside from their mystery $2 trillion Paul Krugman rightly mocked, they do it by repealing Obamacare, slashing Medicaid spending by a third and gutting outlays for poor and working Americans.

Their to-be-determined tax reform and health care plans are left for the House and Senate appropriations folks to figure out later. Despite the continued slowdown in the growth of Medicare costs and the substantial cost advantage that the federal government provides over private insurers, House Republicans nevertheless want to proceed with their "premium support" voucher scheme designed to dramatically shift health care costs to future seniors.
At the end of the day, setting any target for federal spending and/or revenue as a percentage of the American economy has limited utility or meaning. After all, the Simpson-Bowles commission established by President Obama sought to reduce the deficit to three percent a year by pegging outlays at 21 percent of GDP and revenue at 18. (Republicans members of the commission like Paul Ryan voted against the final Simpson Bowles plan because it called for raising taxes.) Yet, by the end of FY 2014 those targets had been met and exceeded. The government was spending less, but it was raising less, too.
Ultimately, the real question American should ask first before planning any budget, setting any revenue and spending benchmarks or reforming the tax code is this: what do we want the government to do? In his book We Are Better Than This, USC Professor Edward Kleinbard poses that question and provides one answer. If in an era of record-high income inequality, constrained social mobility and stagnant incomes our objectives are still to enable all Americans to enjoy "life, liberty and the pursuit of happiness" in a "more perfect Union" that promotes the "general Welfare," then "we need more government, not less." Looking at the history of the United States and comparable economies around the world, Kleinbard says there is no real mystery to "the secret sauce":

It turns out that progressive fiscal outcomes do not require particularly progressive tax systems -- just big ones, to support substantial government investment and insurance programs.

There is no magic answer to how big our federal revenue engine needs to be. But 20 percent of the American economy is a good place to start.


About

Jon Perr
Jon Perr is a technology marketing consultant and product strategist who writes about American politics and public policy.

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