A Look At the Federal Budget

I was emailing with some friends about what to do about the federal budget. Below are my thoughts and analysis, which should be classified as "back of the envelope" thinking.

Let's look at the problem.

First, according to the Bureau of Public Debt, the US has been increasing its total debt load by a minimum of $500 billion per year since 2003. This means the gap between spending and revenue is consistent and systemic.

According to the CBO the total US budget was 2.7 trillion in 2007. Of this 1.6 trillion was mandatory and 1 trillion was discretionary. The mandatory spending of 1.6 trillion is about 60% of the total US budget and includes SS, Medicare and Medicaid. A closer look reveals the following spending increases. Since 2000, SS spending has increased from $406 to $581 billion (a 43% increase), Medicare spending has increased from $216 to $487 (a 125% increase) and Medicaid spending has incresed from $117 to $190 billion (a 62% increase). In other words, the mandatory spending has spiked really hard.

At the same time, discretionary spending has spiked as well. The big increase here is from defense spending which increased from $295 to $549 billion (an 86% increase). Other domestic spending increased from $298 to $457 billion (a 52% increase)

And here's where the big screw-up comes in. Revenue from individual income taxes increased from $1 trillion in 2000 to $1.16 trillion in 2007 -- a 16% increase. This is the biggest source of funds for the federal government.

So, we have the following situation.

1.) A systemic problem of outlays outstripping revenues by at least $500 billion/year

2.) Nearly stagnant revenues

3.) Massive increases in spending.

Let's overlay the current economic environment on this situation. We're in a recession and we're not getting out of it anytime soon. That means that tactically, this is a terrible time to increase taxes. Clinton did raise the top rate, but only after the economy had been growing for a few quarters.

In addition, recessions usually mean increased government spending. The stimulus checks are a good example, as is the possibility of increased unemployment benefit spending. There is also talk at some level of a federal bail-out of the housing market, although the exact plan is still vague. But if it happens, it's going to be very expensive. Freddie and Fannie are going to need a ton of cash.

So, let's sum up everything so far just to make sure we're on the same page.

1.) The budget process is screwed and has been for the last 7 years.

2.) The budget is already a giant mess.

3.) Because the economy is in a recession, this is tactically the worst time to try and fix the budget.

All that being said, what do I advocate doing.

1.) Get us the hell out of Iraq. That's at least $150 billion a year and probably more.

2.) Let the Bush tax cuts expire. According to the Tax Policy Center, 57.6% of the 2001 - 2003 changes in tax law went to people with incomes over $100,000. At that level of the game, they can take care of themselves. The expiration will happen naturally because of the built-in sunset provisions. I have not seen an estimate of the amount of money this will bring into the Federal government. Let's be conservative and say an addition $150 billion year. That means between an expiration of the tax cuts and getting out of Iraq we've got $300 billion in savings.

That means we've got $200 billion more to go. I would advocate at least another $100 billion from the Pentagon. They've had a nice run of budget increases, but enough is enough. In addition, there have been several studies that say the Pentagon's accounting system is, well, fucked. That means all the increases we've seen in spending probably mean a ton of graft and corruption that needs to be investigated thoroughly.

So, now we've got an additional $100 billion. Frankly, if we get $400 billion in savings we'll be heroes. That would be enough from the markets perspective. If you want to get the extra $100 billion, I think there are plenty of places to get it from.

However -- and here's a big caution -- note the massive increases in mandatory spending over the last 7 years. Those increases are very real and will eventually eat our economic lunch if we don't deal with them now.