The 17% Budget Solution

"federal government spending can be no more than 17% of GDP"

We have waited for politicians to propose a viable solution to our debt problem, yet all we hear is rhetoric. The deficit commission issued its report in December 2010, but it was promptly ignored by those who had called for the commission. President Obama (D), who established the commission, has been silent. Representative Frank Wolf (R), who has been suggesting a similar commission for five years, has also failed to take any action on the proposals, despite his seat on the Appropriations Committee. It is now clear that this was just a delay tactic. The Republican Pledge is not any better - it does not even return us to "sustainable" deficit levels, yet the Democrats refuse to accept even these limited cuts. Even the most "extreme" proposals, such as the deficit commission report and Rand Paul's recent proposal, fail to ever pay off the debt. If these are the best leaders our country has to offer, we are surely doomed.

Luckily, there are those who are willing to propose serious solutions, but if we are to be successful, we must first start with a common understanding of a common goal.

What is a fiscally responsible budget?
One of our biggest challenges is that we no longer have a clear vision of a common budgetary goal. I take my principles seriously. My first principle is "Integrity." When I ask myself what is a responsible budget, I find but one answer: we have a moral responsibility to pay off the national debt; if we fail to do so, we will condemn our children to live with the consequences of our irresponsible spending. If our country is to have integrity, we must eliminate the national debt and save our children from this fate.

Are we really surprised that people are now realizing that our children will not have the lifestyle that we have had? The fact is, we have been living beyond our means and stealing money from our children for decades to fund our lifestyle. The good news is that there is still time to change course; but we must accept responsibility and embrace the words of Midnight Oil:

The time has come
To say fair's fair
To pay the rent
To pay our share

The time has come
A fact's a fact
It belongs to them
Let's give it back

I call upon the country to return the money that we have taken from our children. Thus, our goal should not be a "sustainable" deficit,nor should it be a balanced budget; rather, it must be what our founding fathers called for - a country free from a national debt. How do we get there? By developing a realistic budget that is focused on achieving our goal and implementing it. I understand that this will not be easy, but the alternative is immoral and will eventually lead to financial collapse.

Higher taxes, less spending, or something else?
Our debt is too serious a problem to play politics with. If we are to be serious, we must thoughtfully consider all proposals and make responsible decisions based on known information. While some may suggest defaulting on our debt or printing our way out of the problem, these are not serious solutions. Not only are such policies morally bankrupt, they would destroy the credibility of the American government and the American business environment; the result would be highly destructive for our economic system.

In fact, there are only two viable options: either increasing revenues or decreasing spending. Increasing revenues sounds easy. One might think that we just need to raise taxes, and the rich will be forced to give us their money; however, history demonstrates that this is not the case. Figure 1 shows federal government revenue versus the top individual income tax rate over a 65-year period. (Revenue data from Government Printing Office (GPO) Access and tax rate data from Tax Foundation)

Figure 1: Total Federal Revenue since World War II

The data reveal two interesting anomalies. The first is that government revenues have been remarkably stable at roughly 18% of Gross Domestic Product (GDP) over the last 65 years, despite drastic changes in tax policy. The second is that if there is any variance at all, the maximum return occurs at a top tax rate of roughly 40%; tax rates above this are counter-productive. Further, it is widely accepted that higher tax rates result in reduced economic activity; thus, the peak revenue in dollar terms would be to the left of the peak shown in this graph. If one were to consider all government revenue (e.g., including local and state revenue), the peak of the curve would move even further to the left. While there are economic theories that try to explain such relationships, our proposals need to be based on real-world evidence. Any objective analysis of the historical evidence has to conclude that long-term federal government revenues are unlikely to exceed 18-19% of the economy as measured by the GDP.

Unfortunately, we must also realize that tax revenues are currently in the range of 15% of GDP, among the lowest rates in recent history. This is partially due to the recession, but partly due to changed policies (e.g., Bush tax cuts and Obama payroll tax holiday). While I will work for a smaller government, we must accept responsibility for the spending that we have incurred and continue to approve. This will likely require increasing government revenues back to 18%, at least until we eliminate the debt. While there are multiple tax reform proposals that I could support, my preferred solution is to greatly simplify the tax code while making America more business-friendly. Nonetheless, we will still need to significantly reduce reduce spending if we are to balance the budget.

How deep do we have to cut?
If revenues are likely to be in the range of 18% of GDP, we cannot claim to have a responsible budget unless expenses, including interest on the debt, are less than 18% of GDP - with the remainder given to debt reduction. While I would like to see us eliminate the debt within 20 years, this would require devoting roughly 3% of GDP to debt reduction. At a minimum, I believe it is our responsibility to pay off the debt within "our generation." In other words, those who have benefited from the 30 years of deficit spending should pay it off before retiring (at roughly 70), which means no more than 40 years to eliminate the debt. Currently, this can be achieved by devoting about 1% of GDP to debt reduction. Thus, at the extreme, federal government spending can be no more than 17% of GDP, if we are to claim that our plan is fiscally responsible.In fact, even if we are able to increase revenues to 20%, I would still believe that we should not spend any more than 17% of GDP; the additional revenue would simply allow us to eliminate the debt in the time frame recommended by Thomas Jefferson.

Our current spending is roughly 25% of GDP, 2% of which is devoted to interest payments, which we cannot cut without destroying our credit rating. Therefore, we need to cut the remaining federal budget by 35%. 

This is not a right-wing perspective or a left-wing perspective. It represents an honest look at the math while holding firm to the principle of integrity.

Can we phase these cuts in over a multi-year period?
We will not be successful at curing our spending addiction if we adopt the attitude that we can postpone cuts. The first act of any sensible financial advisor dealing with a heavily indebted client is to cut up the credit cards. We must do the same thing. We must implement these cuts as soon as possible, after we clearly explain our goals to the country.

Where do we make these cuts?
Just like a family with an out-of-control budget, our country needs to sit down at the table and seriously look at our expenses. In order to reach our goal, we have to come to that table with a willingness to compromise during detailed negotiations. Ideally, we would be able to identify what we really need to spend money on while cutting out the extras and discover that we have money left over. However, we have grown so accustomed to so many programs that I do not think this approach will work. Further, we need an approach that will not allow for infinite delays during negotiations. Therefore, I propose that we establish a set of simple ground rules.

Once again, this is not a right-wing perspective or a left-wing perspective. It merely provides an honest approach while holding firm to the principle of integrity. Once we agree on these two ground rules, I would propose an additional set of rules as follows: 

  1. As a starting point, we apply across-the-board cuts to all non-interest programs (mandatory and discretionary) to reach the 17% spending cap.
  2. Each subsequent proposal that reduces cuts in one area must be coupled with a proposal to make offsetting cuts in other areas.
  3. Cuts to programs that are designed to be self-funded2 should be designed to put the program into a long-term budget balance with its funding stream. 
  4. The federal government has the unique and primary responsibility to provide for the national defense. I would hesitate to cut this program any more than 35%, which would put defense spending at its lowest level since the start of World War II.
  5. Subsidies of virtually any sort should be among the key targets for deeper cuts or elimination.
  6. Federal government bureaucracies that duplicate the responsibilities of state and local governments should among key targets for deeper cuts or elimination.
  7. Tax increases should only be considered as an option to accelerate the payoff of the federal debt (i.e., they should not be used to justify spending more than 17% of GDP) and should only be considered when the historical evidence suggests that they have a potential to raise additional revenues (i.e., certainly no tax rates above 40% under the current tax code).

Using these ground rules, we will pay off the debt in my lifetime, but we can only achieve this goal by keeping the discussion focused on our moral responsibility. The bulk of the American people understand that this is the right thing to do; we simply need leaders with the courage to implement these policies. I have prepared a sample budget that follows these principles; however, to be clear - this is just one sample budget that I could support. My non-negotiable is that we balance the budget; I am willing to negotiate on where we make the necessary cuts, but cuts of this magnitude must be made. 

1Assuming an average growth in GDP of 3% per year
2 For example, the U.S. Postal Service, Social Security, Medicare, and transportation are all programs that are designed to be self-funded. Each of these programs should be modified to ensure a net balance of funds over the long term.