How to Balance the Federal Budget Without Spending Cuts

Balancing any budget is “simply” a matter of making sure revenues in any period of time cover expenses.  A deficit for a relatively short period of time can be covered by borrowing.  But over a long period of time, the debt level is raised to a level that borrowing becomes increasingly more expensive and more difficult and in time may be impossible.  Historically this has proved true for governments as well as private organizations and individuals.  When this occurs, the resulting pain can be severe.  There is no reason to believe that the U.S. is an exception to this rule.

In previous blog posts, I have addressed some of the difficulties with cutting government expenditures.  But there are two pieces to this puzzle.  The other way to balance a budget is to increase revenue.  In the case of the government this means to increase tax revenue.  Notice that I didn’t say tax rates, but tax revenue.  It is important, I think, to remember that those are not the same thing.  When we, or the media, or the politicians, talk about raising taxes we really mean tax rates.  But it’s possible to raise revenue without raising rates.  Tax rates are a percent of something – e.g. income or sales or some other variable directly tied to economic activity.  So if the level of economic activity goes up, tax revenue increases automatically without the need for any congressional action.  If the level of economic activity increases enough, we could conceivably balance the budget without any other action.  For those of us who believe that Keynesian economics has some validity, the approach to balancing government budgets through austerity programs presents a dilemma.  For those keeping up with some of the European debates this is not new news.  For example, the EU has struggled for more than a year now (particularly with Greece) with how hard to push austerity programs to reduce budget deficits.  Because cutting government spending has the potential to hurt economic growth, it could, in turn,  reduce revenue and make deficits worse.  Increasing tax rates also has the potential to decrease economic growth rates.  But if there was some way to increase economic growth, the resulting increase in tax revenue might provide a way out of the deficit dilemma with a minimum of pain.

There is a recently published book, The 4% Solution, that is based on the fact that even at current government expenditure levels, a 4% growth in the economy would not only eliminate the deficit, but over the next few years could significantly reduce the total national debt.  The currently projected long-term growth rates are in the neighbor hood of 2.5% and since WWII our average growth rate has been an annual 3%.  We have grown at 4% over short periods of time, but not routinely or consistently over long periods.   Given our historical numbers and some specific headwinds that we are faced with today, it would be difficult, but probably not impossible, achievement.  The book contains a collection of 21 essays from some 21 different people with some impressive sounding credentials including 3 or 4 Nobel Prize winning economists and an author/theologian who has served in both Democratic and Republican administrations.  The one theme that seems to be common to all these ideas is that while this would not be easy, it could be done.  But none believe that it would happen without some changes (but no changes in tax rates or Federal Government spending).  At the same time, each author brings a different perspective.  Not all identify the same important factors and suggestions differ among them.

Two of the headwinds that we face in this endeavor that I believe  to be significant are the demographic of a numerically declining work force, and the fact of an increasingly competitive world-wide economy.  At the end of WWII, the developed countries of  Europe were torn up by the war, as was much of Asia.  We were clearly the leading manufacturer in the world,  were in the best financial shape, and had a rapidly growing, well-educated work force.  Signs of change were first seen in the 1970s with the Japanese product invasion.  Starting with motorcycles, then cars and TV sets, etc., they became the dominant manufacturers of much of what had been primarily American products.  Today we hear a great deal about off shore outsourcing.  Many things are now manufactured overseas in what are now developing countries.  There is good news and bad news to this.  The good news is that it tends to hold prices down keeping inflation – even in the face of significant deficits – from being a serious problem.  The bad news, of course, is that what had been U.S. manufacturing jobs are now done elsewhere.

There are other head winds to be concerned with – particularly what seems to be a decline in the U.S. education system.  But the point is that in a world-wide economy it is important for us to be able to stay competitive if we are to maintain a robust rate of growth.  The good news is that if we can remain competitive, and the current 3rd world countries continue to improve, the demand for goods and services can also grow rapidly.  So if we can stay competitive, we could get our share of that.  There are some ideas in the book about how we might do that.  But there are also other articles that are appearing in other places concerning things that affect our competitive position in the world.  For example, the Wall Street Journal had a fairly long article recently and there have been syndicated editorial page pieces in our local paper.

I have some mixed emotions concerning the possibility of not having an austerity program.  As I mentioned in a previous post, most organizations – the government included – tend to develop inefficiencies over time.  For private companies, a required austerity program provides a reason to do something that will improve its efficiency, but it is not fun and might not otherwise get done.  If we were successful in raising our growth rate to the point that a look at government efficiency would not be necessary, it would be a lost opportunity to figure out how to do more good with less money.  On the other hand, it would probably be more beneficial to more things to raise the growth rate and certainly less painful.

If you find any of this interesting, I would encourage you to read the book.  In the meantime, in the next post I will attempt to tell you what are the most important things that I think need to be done.