Decoding the federal budget
Part of a weekly series on the economic choices facing the United States and its relations with the rest of the world. For previous entries, click here.
THERE IS NOTHING more important for our economic future — or less understood — than the federal budget. It allocates around 20 percent of our national output to such crucial priorities as health, education, science, the environment, and national defense. It determines, to a large extent, the extent of suffering from poverty and even the extent of inequality in incomes. And yet our national debates on economics, and the positions of Hillary Clinton and Donald Trump, obscure more than they reveal about the choices facing the nation.
Here’s why. While people have a reasonable sense of their own budgets, they have little sense of how Washington taxes and spends. And most policy debates are designed to obscure rather than reveal the truth. We may know well what an extra $1,000 might mean for our own standard of living or ability to pay the bills. But what does $1 billion mean at the national level? (Here’s a hint: With 320 million Americans, $1 billion is a mere $3 per person).
Clinton, like Barack Obama before her, champions an activist role for the government in addressing problems like health, education, poverty, and infrastructure. So do I. She has announced grand plans to invest in the future. But what do her budget numbers really mean?
Take a headline example. Clinton proposes to raise taxes by around $1 trillion over 10 years, mainly from the rich and from corporations, to fund increased outlays for education, health care, child care, infrastructure, and other investment priorities. It sounds like a lot of money, a bold plan of action. But let’s parse it in steps.
Over 10 years, $1 trillion is $100 billion per year. During the coming decade, the national income of the United States will average around $20 trillion per year. Therefore, the tax increase will amount to around 0.5 percent of GDP, or just one-half of one percent of GDP. If tax revenues were going to average 18 percent of GDP, under Clinton’s “bold” plan they will average around 18.5 percent of GDP.
If this seems a fairly trivial change compared to the gargantuan needs facing our country, it is. And in fact, the trivialization of budget policy is even worse for two reasons. First, Clinton would be likely to get only a part, perhaps half or less, of the tax changes she has advocated. We’d be down to around one-quarter of 1 percent of GDP. And then we must recognize that the budget deficit during the coming decade on existing policies is likely to average around 4 percent of GDP, according to the Congressional Budget Office.
The bottom line is that Clinton’s “bold” program to raise taxes on the rich and invest in our future is close to a rounding error, likely to be swamped by budgetary red ink.
This is certainly not to say that Donald Trump’s plans are more realistic. They are the opposite: utterly irresponsible calls for massive tax cuts in the face of looming budget deficits and unmet critical investment needs.
To solve our economic problems, we need to overhaul our understanding of the budget, the role of government, and the nature of fiscal policy. Neither party offers a solution. The Democratic Party candidate offers the slow drip of gradual decline, rising debts, and stagnation. The Republican Party candidate offers a fantasyland.
Our starting point should be the pithy observation of Vice President Joe Biden: “Don’t tell me what you value, show me your budget, and I’ll tell you what you value.” The federal budget is an expression of what we value as a nation, because it shows how we choose to allocate our national resources.
HERE IN BRIEF, is how the federal budget works. On the one side we have the revenues raised by federal taxes and, on the other side, the outlays. Federal taxes take in about 18 percent of GDP, mostly from income taxes and payroll taxes (for Medicare and Social Security). Together with state and local taxes, the total tax collection of all levels of government amounts to around 32 percent of GDP. Let’s keep that number in mind.
On the federal spending side, we have four main categories to keep in mind. The first is national security. That entails the Pentagon, intelligence agencies, homeland security, the Energy Department’s nuclear weapons programs, other international security programs in the State Department, and the Department of Veterans Affairs (the delayed costs of past wars). In total, annual outlays now total around $900 billion per year, or roughly 4.9 percent of GDP.
The second category covers so-called “mandatory” programs, including health (Medicare, Medicaid, other health), Social Security, and income support programs (such as food stamps). These total around 12.6 percent of GDP. Their costs have been rising as a share of the national income (or Gross Domestic Product) in recent years because of the aging of the population and the soaring costs of health care. The rising outlays due to aging will of course continue.
The third category is interest payments on the government (public) debt. With the ratio of public debt to national income now around 75 percent, and the average interest costs on the debt around 2 percentage points per year, the interest charges are around 1.5 percent of GDP. These costs will rise when interest rates return to more normal, higher levels.
The fourth category of spending, sometimes called “non-security discretionary programs,” includes the federal government’s investments in the future, including biomedical research; other science and technology; low-carbon energy R&D and deployment; education and job skills; fast rail and other public infrastructure; the courts and penal system, and a small amount (a meager 0.2 percent of GDP) for helping the world’s poorest countries to fight hunger, illiteracy, and disease.
THE ASTUTE READER will have already spotted the problem. Tax revenues total around 18 percent of GDP. Yet outlays for the first three categories (national security, mandatory programs, and interest on the debt) total around 19 percent of GDP! Revenues do not even cover the first three categories, much less the crucial fourth category. Borrowing, rather than tax revenues, must therefore pay for the entire non-security discretionary budget, a dreadful and unsustainable situation.
The simple truth is that America doesn’t raise enough tax revenues to finance the key public investments for our future. Instead of investing federal funds adequately in higher education, we pile a trillion dollars of student debt on the backs of our young people. Instead of upgrading our infrastructure, we drive on crumbling highways and bridges. Instead of building a low-carbon energy system, we continue to rely on coal, oil, and gas, endangering the entire planet as a consequence.
Clinton says she will solve these problems, but with what funds? Obama said the same in 2008, and ran into a dead end. Instead of investing in our future, Obama has presided over cuts in the non-security discretionary programs, with budget allocations declining from around 2.6 percent of GDP in 2008 (just before Obama came to office) to a meager 2.3 percent of GDP in 2016. The projections are even more ominous, with non-security discretionary spending on a trajectory to decline below 2.0 percent of GDP by around 2020. Crucial federal programs remain on life support as budget outlays for key public investments continue to fall.
What is the way forward if we want to invest in a 21st century future rather than suffer from continued stagnation and decline? Most importantly, we will need to think out of the box, since neither Clinton nor Trump offers realistic answers.
The first strategy should be to cut back on wasted federal outlays. The biggest saving should be on the military side. Despite the reflexive call to boost military spending, we should instead end the perpetual Middle East wars, cut back sharply on America’s overseas military bases, and negotiate sharp global limits on nuclear arms rather than invest in a new, costly round of the nuclear arms race. In a later article in this series, I will also detail the ways that our nation can save on total health outlays, albeit by shifting part of the today’s private health spending onto the federal budget with big offsetting reductions in private health spending.
The real budget action, however, will have to come on the revenue side. We have refused, since Ronald Reagan became president in 1981, to fund the federal government adequately despite the realities of an aging population and the urgent need to invest in advanced skills, education, infrastructure, and environmental sustainability. Reagan told us in 1981 that government was the problem not the solution; Democratic Party presidential candidate Walter Mondale got buried in Reagan’s 1984 landslide after Mondale said that he’d raise taxes. Since then, both parties have simply faked it, denying the need for more revenues and building up public debt instead. We are now running on fumes, funding the entire non-security discretionary budget on a bulge in public debt.
For a while, the so-called “progressive” idea was simple: Instead of calling for higher taxes, progressives would proclaim that borrowing was just fine. Paul Krugman told us time and again not to worry about the public debt, that it’s actually good for us, by stimulating demand while not adding much to future tax burdens.
That was then. In 2007, the debt-GDP ratio was 35 percent; now it’s 75 percent; in 2025 it will be around 86 percent on current trends; and in 2036, a staggering 110 percent of GDP on current policies. Today, interest rates are low; in the future, when they’re back to normal, at around 4 percent per annum, the debt burden will hit very hard indeed, requiring at least 3 percent of GDP to pay for interest payments, if not more.
SO HOW DO other countries manage their budgets? Simply, they tax more as a share of national income. The US taxes around 32 percent. Canada, with its highly successful public-sector programs in health and education, taxes at around 39 percent (and it’s still thriving!). The Scandinavian social democracies — Denmark, Norway, and Sweden — tax around 50 percent of GDP. And yes, they get great value for money, with smaller budget deficits; lower debt-GDP ratios; at least a month per year of paid vacations; free public health care; free college tuitions; guaranteed maternity leave and quality child care; modern infrastructure; and much greener economies.
Despite their higher tax rates (or more accurately, because of the social services these taxes purchase), the Scandinavian countries and Canada rank much higher than the US on overall national happiness. In the 2016 rankings of national happiness, the top six countries were: Denmark, Switzerland, Iceland, Norway, Finland, and Canada, with the US coming in 13th. All of the top leaders in national happiness collect more in tax revenues as a share of GDP than the US; they thereby pay for an ample array of public investments and public services that contribute to prosperity, greater equality, and higher self-declared happiness.
So how can the US fund its future and collect more revenues without damaging the incentives to save and invest? Part of the answer lies in ending absurd tax giveaways, like the gimmicks that have allowed Apple Inc. and others to keep their profit stashed abroad in tax havens. Ending corporate abuse could garner around 1 percent of GDP. Another 1-2 percent of GDP could come from taxes on the super wealthy and super rich.
Yet, as in Scandinavia, I would also recommend a value-added tax (like a national sales tax), enough to raise another 3-4 percent of national income. The total federal revenues would thereby reach around 24 percent of GDP and around 38 percent for combined federal, state, and local government. This would be roughly equivalent with Canada and still well below the revenues of northern Europe. At least the United States would be in a position to think about investing in our future once again.
Such ideas are currently outside of the political mainstream, but I believe that they will return to the center of national politics as the American people realize that both parties are shortchanging their futures. Senator Bernie Sanders ran his campaign on mobilizing vastly more revenues for much greater public investments. He decisively rallied the young. I believe that this message will soon come to the fore of our national politics; it is vital for our economic future.
Jeffrey D. Sachs is University Professor and Director of the Center for Sustainable Development at Columbia University, and author of “The Age of Sustainable Development.”