PART I - How the United States Created Its Fiscal Crisis
The diagnosis will be broken down by topic: Federal spending, the level and composition of taxes, the history and projected growth of budget deficits and overall government debt, the ticking time bomb of entitlements, and finally the disturbing trend toward greater centralization of government power in Washington, D.C. away from state governments. The picture painted is grim, but not entirely unlike Canada in the early 1990s.
chapter 1
First, Admit There’s a Problem: The United States’ Unsustainable Fiscal Trajectory
Before offering prescriptions to cure the US government’s fiscal problems, we need to first accurately diagnose the condition. This first chapter breaks the analysis into five components: Federal spending, the scope and composition of federal taxation, budget deficits and debt, entitlements, and finally, the centralization of government in the United States.
Federal Spending
When it comes to diagnosing a government’s fiscal problems, it is ultimately spending that is the great driver. It is true that government must administer tax policies sensibly as well, and this is the topic of the next subsection. Yet the only reason government needs taxes in the first place is to finance its spending decisions. There is always the temptation that a democratic government will cater to the general public by delivering apparently “free” gifts: Nobody likes taxes, but spending per se is quite popular indeed.
Regardless of how it is financed, government spending diverts real resources away from the private sector and into channels decided by the political process. For example, if the government decides to spend billions of dollars putting a space station into orbit, then there is less steel, computing power, fuel, and engineers’ and scientists’ time available for other purposes.
To observe that government spending redirects resources away from uses chosen by consumers and producers doesn’t by itself prove that all government programs are a waste of money; it does, however, underscore the need to be very cautious with government spending. At the very least each spending program should be subject to some fairly stringent tests to ensure that the damage it does to the economy’s wealth-creating capacity is outweighed by the benefits it creates.
The United States is currently in the midst of an alarming and almost unprecedented level of federal government spending. As figures 1.1 and 1.2 illustrate, federal spending as a share of the overall economy is currently at a level not seen since the height of World War II. Figure 1.1 shows nominal federal expenditures in such a way that the slope of the line reflects the rate of increase. As you can see, it is a very steep rise.
Figure 1.1 US federal government spending, FY 1901–2011 (semi-logarithmic scale)
Source: Office of Management and Budget (OMB).1
The figure shows that federal spending exploded during the two World Wars, but that these bulges were temporary. Laid on top of these wartime surges, however, has been a secular growth in federal spending from the pre-Depression era, even under the Hoover Administration. (This may surprise some readers, who have been taught that Herbert Hoover was a “do-nothing” president. On the contrary, he oversaw what was at the time an unprecedented peacetime expansion of federal government in reaction to the Great Depression.) Not until the Bill Clinton years in the 1990s do we see a noticeable slowdown in the growth of spending, a deceleration reversed under first the presidency of George W. Bush and then that of Barack Obama, culminating in a staggering $3.6 trillion expenditure in FY 2011.
Nominal spending figures can be somewhat misleading, however, because of changes in the price level, growth in population, and general economic growth. A much more telling statistic is federal spending as a share of the economy, shown in figure 1.2.
Figure 1.2 US federal government spending, as a share of nominal GDP, FY 1930–2011
Sources: White House, American Presidency Project.
Here the trend is upward from the early 1930s, with another huge bulge during World War II. The slowdown in absolute spending growth shows up here as a leveling off and then a sharp decline during the Reagan-Clinton era, dropping from 23.5 percent of GDP in 1984 to 18.2 percent in FY 2002. Yet within the first Bush Administration the trend quickly reversed again, steadily rising until hitting a peak of 25.2 percent in FY 2010 (under Barack Obama) and falling to 24.1 percent in FY 2011. Note that this slight pullback still places federal spending as a share of the economy at the highest level (save the prior year) since 1946.
In addition to surveying the general growth of federal spending, it is also instructive to look at a detailed breakdown by major spending category. Figure 1.3 shows the evolution of federal spending since 1972.
Figure 1.3 US federal budget by major spending category, FY 1972–2011 (billions nominal USD)
Source: CBO Historical Budget Data, tables F-3 through F-5.
As figure 1.3 illustrates, since the 1970s there has been growth across all major components of federal spending. The massive surge in federal spending cannot be blamed simply on “mandatory” spending programs such as Medicare, Social Security, and interest on the federal debt, nor can it even be blamed on military spending, which many would view as necessary because of the US role in world affairs. No, even “nondefense discretionary" spending has steadily risen throughout the decades. Figure 1.3 makes it clear that the US federal government has a widespread, systemic spending problem that cannot be explained away by particular factors beyond the control of legislators.
Later we will specifically discuss the problem of entitlement spending, but here we point out their growth as a fraction of the federal budget. In 1972, Social Security, Medicare, Medicaid constituted 23 percent of total federal spending. By 2011, they had risen to 43 percent. According to the 2012 Congressional Budget Office (CBO) forecast, by the year 2050 Social Security and other health care spending (which includes the legislation popularly known as “ObamaCare”) will absorb 67 percent of the federal budget.2 Clearly, to solve the federal spending problem in the long term, the explosive growth in entitlements must be addressed.
Federal Taxation: Level and Composition
When it comes to the burden of taxation, both the level and the composition or “mix” of taxation matter. In other words, it’s not merely the amount of resources extracted by the government, but also the manner in which it is extracted. We examine each issue in turn.
Figure 1.4 shows total money collected by the federal government as a share of the economy.
Figure 1.4 US federal government receipts, as a share of nominal GDP, FY 1930–2011