“The Penny Plan” to Eliminate the Federal Deficit

four cents
Creative Commons License photo credit: Robert Couse-Baker

We all know that Uncle Sam’s trillion plus dollar budget deficits are unsustainable. Debt is now larger than Gross Domestic Product and we are well on our way to Greece-level debt (and that excludes our “off the book debt,” see sidebar for our true debt levels . . . around $77 trillion). Adding insult to injury, the states are running huge debts of their own.

At some point, Uncle Sam is going to have to sober up and face reality. The reality is that the budget deficit needs to eliminated and budget surpluses must become the norm (American households need to listen up as well).  One solution that I recently came across was “The Penny Plan.” They describe the plan as thus:

The One Cent Solution is beautifully simple: If the government cuts one cent out of every dollar of its total spending (excluding interest payments) each year for six years, and then caps overall federal spending at 18 percent of national income from then on, we can:

  • Reduce federal spending by $7.5 trillion over 10 years.
  • Balance the budget by 2019.

Moreover, instead of using inflated budget “baselines” to claim nonexistent spending “cuts” a common practice in Washington, the One Cent Solution calls for real cuts.  Under the One Cent plan, the sum of all discretionary and entitlement spending will have to go down from one year to the next, by one percent or more.

Another cool feature of the Penny Plan is that it comes with anther great Remy video shown below.

But alas, I fear even this attempt may be too little too late. Even with a balanced budget by 2019, we will still add trillions of dollars to the national debt. Thanks to President Obama’s policies, the national economy will still be struggling to recover over the next few years. This is a recipe for an explosion in our debt-to-GDP ratio. Check out this history of recent debt ceiling increases to see how unsustainable our path already has become.

And if it all becomes too depressing, turn to Remy again for some more amusement with “Raise the Debt Ceiling.”

Cut Federal Spending, Don’t Raise Taxes

Creative Commons License photo credit: SOGKnives

In my previous blog blasting Nouriel Roubini for suggesting that Uncle Sam should raise taxes to close the budget deficit, I made this statement: “Tax increases will only hamper the ability of the economy to recover and worsen our fiscal condition in the long-run.”  Of course, you don’t have to take my word for it . . . so I thought I would review some pieces in the academic literature (at the international, national and state-level) that make the same arguments.

First, Harvard economists Alberto Alesina and Silvia Ardagna examine the economic effects of fiscal policy (pdf) in countries the constitute the Organization for Economic Cooperation and Development (OECD) from 1970 to 2007.  They find that:

“As for fiscal adjustments those based on spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based on tax increases.  In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.”

Second, UC Berkely economists David Romer and Christina Romer (former Chair of the Council of Economic Advisors to President Obama), examine the economic effects of U.S. fiscal policy (pdf) since 1947.  The find that:

“The resulting estimates indicate that tax increases are highly contractionary.  The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes.  The large effect stems in considerable part from a powerful negative effect of tax increases on investment.”

Finally, economists Stephen Brown, Kathy Hayes and Lori Taylor examine the economic effects of fiscal policy of the U.S. states (pdf).  They find that:

“If anything, most public services do not appear to justify the taxes needed to finance them . . . this finding would seem to imply that other state and local public capital has been increased to the point of negative returns, perhaps because a growing stock of other public capital is indicative of an increasingly intrusive government.”

You decide . . .

Nouriel Roubini Says Raise Taxes to Fix Federal Deficit?!

I have long been a fan of Nouriel Roubini, but some recent comments of his made from Leen’s Lodge in Grand Lake Stream, Maine has me reconsidering my fan-hood. (Note: Due to conflicts, I was unable to attend this year’s event where, one year ago, the idea for this blog blossomed).

In this interview with Bloomberg, Roubini states that taxes should have been raised in order to tackle the deficit problem and avoid the recent S&P credit downgrade (clip around the 13 minute mark). He went on to say that the deficit can not be reduced “only on the spending side.”  Really?!

Of course, that is an empirical question, so let’s now turn to the data to see where the source of the deficit is coming from–lack of revenue or run-away spending. The charts below are all created from the data from the Congressional Budget Office.

Chart 1 shows federal outlays and revenue from Fiscal Year (FY) 2007 to 2021.  The chart basically shows that we are being lied to in the sense that the so-called stimulus package, which by definition are supposed to be temporary, is in fact a permanent increase in federal spending (red line). Between FY 2008 and 2009, federal spending jumped by $535 billion, but never does it decline by the same amount.

To look at it another way, in FY 2007 federal spending represented 19.6 percent of Gross Domestic Product (GDP). In FY 2009, federal spending jumped to 25 percent of GDP.  One would expect that over the next 10+ years that the share of federal spending would fall by back to around 20 percent. You’d be wrong.  Federal spending will hit a low of 23 percent of GDP in 2014 and then CLIMB up to 24 percent by 2021.

In contrast, the green line shows federal spending if spending were fixed at pre-recession, FY 2007 levels (19.6 percent of GDP). The gap between the green and red lines represents the permanent increase in spending–some from the stimulus, some from Obamacare some from who-knows-where. The blue shows federal revenue in which I assume that Bush tax cuts will be made permanent (this is to better show that the deficit is due to spending and is not attributable to the Bush tax cuts).

Chart Showing Federal Revenues and Outlays Between FY 2007 and FY 2021

Chart 2 zooms in on just the difference between federal revenue and federal outlays, i.e., the budget deficit. There are a couple of interesting things that pop-out of this chart.

First, even with federal spending held at 19.6 percent of GDP (green line), there still would have been a strong stimulative environment from the federal government due to the revenue drop-off due from the recession and, to a lesser extent, the Bush Tax Cut extension. The spending stimulus package was an add-on (red line) to the natural stimulus that automatically occurs when revenue drops but spending stays the same. So the real question was not whether or not we needed a spending stimulus (we get one anyways), but whether or not we needed additional spending stimulus.

Second, holding federal spending at 19.6 percent would also create an automatic path toward reducing the federal deficit. As shown in Chart 2, by FY 2021, the federal deficit is not only nearly back to zero, but would already be at a sustainable rate (relative to GDP growth) by FY 2014-ish. In contrast, the current projection of federal spending shows that the federal deficit will actually be growing in FY 2021! Overall, between FY 2011 and FY 2021, the current path will create another $11.8 trillion in debt (nearly doubling our current debt load) whereas spending at 19.6 percent of GDP would create only 1/3 of that debt ($3.5 trillion)–again, assuming Bush Tax Cuts are extended.

Chart Showing Federal Budget Deficit Between FY 2007 and FY 2010

So, Nouriel Roubini is flat wrong . . . federal spending is THE problem and only CUTS to federal spending will solve this deficit/debt crisis. Tax increases will only hamper the ability of the economy to recover and worsen our fiscal condition in the long-run. But, wait a minute, this is similar to what was proposed by the Cut, Cap and Balance folks. Although even that plan wasn’t enough since they only cut federal spending down to 19.9 percent of GDP and take until FY 2018 to phase-in to that level. What a bunch of big-spending liberals . . .

Was Quantitative Easing A Plot to Save the Federal Budget?

I’ve never been satisfied with Ben Bernanke’s rationale for Quantitative Easing as a way to save the economy.  Did he totally forget the 1970’s where economists had to invent a new term for recessionary inflation now known as stagflation.  To me, Quantitative Easing is a recipe for stagflation.

Drawing from my GMU/public choice roots, I’ve had this hypothesis that Ben Bernanke was under political pressure to keep interest rates low no matter the costs.  In particular,with these unprecedentedly large budget deficits, the federal budget is becoming extremely sensitive to the interest rate.  The chart below, from the Mercatus Center, shows how the interest costs on the debt will absolutely explode if interest rates rise.

Chart of Federal Interests Costs Under Different Interest Rates

But, what is the direct transmittal mechanism for higher interest rates leading to higher interest payments?  That would ultimately be determined by the term schedule on federal bonds, i.e., how much debt is short-term needing to immediately rolled-over versus debt that is long-term with no immediate need for roll-over.  The shorter the term schedule, then the more at-risk is the federal budget to a higher interest rate.

Unfortunately, I did not know where to find the data on the term schedule for federal bonds.  So today I found over at No Money, No Worries a blog post with the term schedule of federal bonds.  And here we find the smoking gun.  Nearly 38 percent of the $9 trillion in marketable federal debt must be rolled-over this year and the next year (2011 and 2012)!  If interest rates were to spike over the next 18 months, it could make the Mercatus chart look downright rosy.

So for all the folks wondering if there will be a QE III they should not be looking at the health of economy.  Rather, they should be looking at factors that would otherwise force the Federal Reserve to raise interest rates . . . like a plummeting dollar for instance.  Ironically, failure to get a grip on the ballooning federal deficit is exactly the kind of event that could trigger a falling dollar . . . which would then spark QE III to lower interest rates to keep interest costs from further ballooning the federal deficit.  Does anyone see anyway off this hamster wheel?  Argh!