Federal Budget Deficit

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Mr. Chairman and members of the Committee, thank you forinviting me to testify today on the topic of federal budgetdeficits.

Budget projections that include continuation of current revenueand spending policies show large amounts of red ink as far as theeye can see.1 The Bush administration is downplaying theimportance of the deficit, and it supports a modest reduction, notelimination, of the deficit in coming years.

I would agree with the White House that today's high deficitsare not a serious problem if these were normal times and the budgetcould be expected to balance as the economy expanded. But we aremoving into an extraordinary time for the federal budget in theyears ahead. As this committee knows, the baby boom generationbegins retiring in 2008, putting enormous and increasing stress onthe budget every year thereafter.

To illustrate the coming entitlement budget squeeze, considerthat combined Medicare, Medicaid, and Social Security spending iscurrently rising at roughly $50 billion every year. But 10 yearsfrom now, spending on these three programs without reforms will berising by more than $100 billion every year.2 Regardlessof when the Social Security and Medicare Trust Funds run out, orwhen these programs start running cash-flow deficits, the financialsqueeze begins just a few years from now when the entitlementsstart consuming ever larger shares of the budget and the nation'sgross domestic product.

Neither Congress nor the administration has moved forward with asolution to the coming entitlement crisis. But I think the WhiteHouse, in particular, needs to take the lead and propose seriousbudget cuts to offset the large spending increases it has supportedin recent years. While I strongly support President Bush's tax cutprogram, his tax and spending policies have been hugelyinconsistent. The president has cut government on the revenue side,but has consistently supported Big Government on the spendingside.

Indeed, President Bush's big spending is headed for the recordbooks. Bush has presided over three of the top five largestincreases in real discretionary outlays in the last 40years.3 President Bush rarely even talks about the needto restrain spending. By contrast, when faced with a $200 billiondeficit, President Clinton argued in his FY1995 budget message that"except in emergencies, we cannot spend an additional dime on anyprogram unless we cut it from another part of thebudget."4

I'd love to hear President Bush lay down such a challenge in hisnew budget, but it does not look like he is going to. Indeed, thepresident does not seem to "get it" with respect to today's fiscalrealities. Last week, he announced new plans to go to the Moon andMars, which could cost tens or hundreds of billions of dollars overthe long term. He continues to tout wasteful new proposals such asa $1.5 billion federal marriage initiative.

Bush Administration Has Not Set Priorities

Even excluding the recent Iraq supplemental bill, total federaloutlays have risen 24 percent in the past three years.5The administration argues that high spending has been driven bydefense and national security needs. That was a good excuse forawhile, but Congress and the administration should now be movingahead with reforms to cut domestic spending and find costefficiencies in the huge Pentagon budget.

Big defense spending is Big Government just like other types ofspending. Defense outlays have risen by about $150 billion in justthree years, sucking resources out of the private sector economyand ultimately reducing U.S. living standards. I don't know whatthe correct level of defense spending is, but the Pentagon doesseem to be one of the most waste-prone agencies in the government.For example, the GAO says that the Pentagon has "serious financialmanagement problems … that are pervasive, complex,long-standing, and deeply rooted in virtually all businessoperations throughout the department."6 The Pentagonloses track of assets, wastes billions of dollars on excessinventory, and makes billions of dollars in erroneous contractorpayments.7 We cannot afford that sort of waste withtoday's huge deficit.

Defense is a high-priority, but the Bush administration hasidentified few, if any, low-priority programs that could be cut.While Ronald Reagan also presided over a large defense spendingincrease, he managed to partly offset it with a 13 percent cut inreal discretionary nondefense spending in his first threeyears.8 Whether you agreed or not with Reagan's fiscalapproach, he clearly had a more consistent position regarding thebudget and the role of government.

Bush's budget director, Joshua Bolten, has been arguing thatnon-entitlement, nondefense, non-homeland security spending has notbeen rising very much. Thus, the administration claims that it hasrestrained spending in less than one-fifth of the entire budget.Shouldn't the administration be looking for savings in the otherfour-fifths of the budget? Aside from possible defense savings,reforms are needed in the Medicaid program, for example. Medicaidspending is out of control with outlay increases averaging morethan 10 percent annually the past three years.9Entitlements are often said to be on autopilot, as if nobodycontrolled them. But, of course, Congress does control entitlementspending and can pass laws at any time to cut spending or reducespending growth.

Are Future Deficits Caused by Revenue Shortfalls orSpending Increases?

Projections of large future budget deficits are based on rapidlyrising spending, not a shortage of revenues. Assuming that the Bushtax cuts are made permanent and the alternative minimum tax isfixed, federal revenues as a percentage of GDP will steadily risefrom 16.2 percent in FY2004 to about 18 percent byFY2013.10 Since 1970, revenues as a percentage of GDPhave averaged 18.2 percent.11 Thus, the Bush tax cuts donot starve the government for funds, and revenues will slowly andsteadily rise over time due to "real bracket creep" under theincome tax.

Looking at the spending side of the budget, outlays haveincreased from 18.4 percent of GDP in FY2000 to 20.5 percent today.Recent spending increases are higher than usually recognized. Thatis because interest costs have fallen substantially since the late1990s, which has partly offset increases in program spending. Forexample, total federal outlays rose $147 billion in FY2002, butoutlays excluding interest, or actual spending on programs, rose$182 billion.

Looking far ahead to 2040, outlays will rise from 20.5 percentof GDP today to more than 28 percent, given the CBO's currententitlement projections and assuming that the rest of governmentstays at the same size relative to the economy.13 Thatmeans that without spending reforms the government will claim atleast a 37 percent greater share of the average American's incomeby 2040 than today.

Long-Term Solution: Cut Spending

Congress has some very tough fiscal decisions to make in theyears ahead. It would have been much easier being a member ofCongress in the 1990s when revenues were pouring into federalcoffers than later in this decade when the entitlement spendingexplosion begins. The extraordinary budget pressures caused by thebaby boomers retiring will hopefully cause Congress to reconsiderwhether the government really needs to do many of the things it hasdone in past decades. As David Walker, comptroller general, hastestified to Congress: "Government cannot accept as 'givens' all ofits existing major programs, policies, and operations. Afundamental review of what the federal government does, how itsdoes it, and in some cases, who does the government's business willbe required, particularly given the demographic tidal wave that isstarting to show on our fiscal horizon."13

I'm glad to see that other groups are starting to focus onfundamental changes to the federal government. Last week, theBrookings Institution released a study that included various plansto balance the budget by 2014. The Institute's "Smaller Government"plan generally moves in the right direction, but the study arguesthat tax increases are needed to balance the budget. However, Ithink that Congress can and should balance the budget without taxincreases. Using Brookings' methodology, my Smaller Government planwould balance the budget by reducing spending by $562 billion by2014 (compared to Brookings' $400 billion), by cutting businesssubsidies, devolving programs to the states, and trimmingentitlements.14

Cato Smaller Government Plan to Balance theFederal Budget
(All figures are for 2014 using Brookings Institutionmethodology)
Spending cuts proposed in the Cato Handbook for Congress $488 billion
Entitlement spending cuts proposed by Brookings $74 billion
Total proposed cuts $562 billion
Cuts needed to balance the budget per Brookings $534 billion

Such a program of substantial spending cuts would likely beopposed by current benefit recipients. But it should be noted thatAmericans will be substantially wealthier in the future than in thepast, which will provide greater scope to make the needed cuts toentitlements and other programs. For example, real per-capita GDPis expected to grow at at least 1.7 percent during the next fewdecades, a rate that would double U.S. living standards in the next40 years. As income levels rise, there should be less need forgovernment transfers for retirement, health care, housing,education, and other programs.

Conclusion

In closing, let me challenge both parties to revisit some oftheir budget restraint efforts from the mid-1990s. The Republicansshould live up to their pledge in the 1994 Contract with America to"restore fiscal responsibility to an out-of-control Congress,requiring them to live under the same budget constraints asfamilies and businesses."15 And I'd like to see allpolicymakers take to heart President Clinton's 1995 State of theUnion message: "Let's change the government-let's make it smaller,less costly and smarter."16

Thank you for holding hearings on this important topic.


  1. For example, a new projection by the Brookings Institution thatincludes the Medicare prescription drug bill, increases indiscretionary spending by inflation and population, and theextension of the Bush tax cuts, shows the budget deficit rising to$687 billion by 2014. See Brookings Institution, "Restoring FiscalSanity: How to Balance the Budget," January 2004, p. 5.
  2. Congressional Budget Office, "The Budget and Economic Outlook:An Update," August 2003, p. 9.
  3. Real discretionary outlay increases for FY2001, FY2002, andFY2003 have been the largest since FY1965 except for FY1966 andFY1967. FY2004 is a CBO estimate. See CBO, August 2003.
  4. Budget of the United States Government, Fiscal Year1995, "The Budget Message of the President" (Washington: GovernmentPrinting Office, February 1994), p. 4
  5. CBO, August 2003. Spending increase from FY2001 to FY2004.FY2004 is an estimate.
  6. General Accounting Office memo in the "Financial Report of theU.S. Government 2001," U.S. Treasury Department, March 29, 2002, p.26
  7. GAO, "Major Management Challenges and Program Risks-DOD,"GAO-01-244, January 2001. See also, GAO, "High-Risk Update,"GAO-01-263, January 2001.
  8. Veronique de Rugy and Tad DeHaven, "On Spending, Bush is NoReagan," Cato Institute Tax & Budget Bulletin no. 16, August2003.
  9. CBO, August 2003, p. 9. Measured from FY2001 to FY2004.
  10. CBO, August 2003. Using Table 1-6 estimates of the impact ofAMT reform and making the Bush tax cuts permanent (but ignoringinteractive effects), revenues in 2013 would be 18.2 percent ofGDP. Brookings puts 2013 revenues at 17.6 percent of GDP underthese policies. See Brookings, January 2004, p. 5.
  11. Measured FY1970 to FY2004.
  12. Chris Edwards and Tad DeHaven, "War Between the Generations,"Cato Institute Policy Analysis, September 16, 2003. Updated basedon CBO's long-range budget projections from December.
  13. David Walker, "Federal Budget: Opportunities for Oversight andImproved Use of Taxpayer Funds," General Accounting Office, June18, 2003, p. 4.
  14. For a detailed list of cuts, see Cato Handbook for the 108Congress at www.cato.org/pubs/handbook/hb108/hb108-23.pdf.I inflated the Handbook's FY2002 cuts to 2014 using Brookings'methodology.
  15. www.house.gov/house/Contract/CONTRACT.html.
  16. William J. Clinton, "State of the Union," Washington D.C.,January 24, 1995, www.thisnation.com/library/sotu/1995bc.html.