Understanding the Deficit
George H. Blackford © 2010
There is much confusion over the budget struggle taking place in Washington today. It may help to clarify the issues if we step back from ideology and take a look at the actual budget to see what our options are.
When we look at the history of the federal budget we find that Defense, Social Security, and Net Interest dominated the budget from 1980 through 2000, and since 2001 the budget has been dominated by Social Security, Defense, Medicare, and Health. All the rest of the top 10 expenditures—Federal Retirement, Transportation, Veterans Benefits, Food Assistance, and Administration of Justice—have played a relatively minor role in the budget since 1980. Each was less than 5% of total outlays, and each had a smaller share of the budget in 2007 than it did in 1980, save Administration of Justice which increased its share by about 80%. (Chart 1)
By 2000, the size of the federal budget had fallen to only 18% of the entire economy measured as a percent of GDP—25% below the Reagan high of 24% in 1983, 10% below what it was in 1980, and comparable in size to the government in the early 1960s before the Viet Nam defense buildup began in 1965. After the Bush tax cuts and military buildup for the Iraq and Afghan wars, but before the crash in 2008, the budget was back to 20% of GDP but still 10% below what it was in 1980 in spite of the buildup in defense. Then came the Crash of 2008. Since then, the budget grew to 24% of GDP by 2010 as a result of the ensuing economic crisis and the emergency measures taken to mitigate its effects.
When we look the revenue side of the budget we find that both the 1981 Regan tax cuts and the 2001 Bush tax cuts were followed by substantial decreases in federal revenue. Following the Reagan tax cuts, receipts fell from 20% of GDP in 1981 to 17% in 1984 and did not regain their 1981 level as a percent of GDP until 1998. Following the Bush tax cuts, receipts fell from 19% of GDP in 2001 to 16% in 2004, increased to 18% in 2007 before the crash, and fell to 15% by 2010 after the crash. In 2010, total federal Receipts as a percent of the economy were less than they were at any point since 1950. (Chart 2)
This is where we stood at the end of 2010: As a percent of our total economy, federal outlays were 25% of GDP in 2010, the highest they had been since World War II. On the revenue side, receipts were at 15% of GDP, the lowest they had been since 1950, and the deficit (the negative Surplus) was equal to 9% of GDP in 2010, the highest it had been since World War II. Social Security and Defense each comprised 20% of the total budget, Medicare 14%, Health 11%, and Net Interest 6%. Each of the other items in the top 10 was less than 4% of the budget, and the all the rest of the government stood at 17%. (Chart 3 Six other Charts for comparison.)
When we look at the rest or the budget—total outlays excluding the top 10 listed above—we find its share of the total budget was cut by 44% from 1980 through 2007 and was responsible for only 13% of total outlays in 2007. Since 1982, the rest of the budget has been less than either Defense or Social Security, except in 2009 when the emergency expenditures authorized to mitigate the effects of the recession raised the rest to 23% of total outlays. By 2010 the rest of the budget had fallen back to 17%.
What is particularly interesting about the rest of the budget in the 2000s, however, is that it is in the same relationship to the deficit that it was in the mid 1980s. After the Reagan tax cuts and anti Soviet defense buildup the deficit was greater than all of the rest of the government combined beyond the 10 items listed above. Similarly, after the Bush tax cuts and defense buildup the deficit was again greater than all of the rest of the government combined in 2003 and 2004. It fell to 44% by 2007 as the economy recovered from the 2001 recession, but after the crash in 2008 the deficit increased dramatically and rose to twice the size of the rest of the government by 2010. (Chart 4)
It should be obvious from these numbers that we cannot fix this situation by cutting the budget without increasing taxes. The deficit was 37% of the budget in 1010. Even if we eliminated everything in the budget except Defense, Social Security, Medicare, and Health—including not paying interest on the National Debt—we would only reduce the budget by 36%. We would still have a deficit.
The fact is that federal budget and taxes have been cut to the bone over the past 30 years. It took 9 tax increases and a reduction in government spending by 20% of GDP to eliminate the deficits caused by the Reagan tax cuts and defense buildup. It also took 14 years, and we didn’t have a worldwide economic crisis to deal with while this was being done. A dramatic reduction of the budget in the midst of the current crises would be a disaster. It would throw millions of people out of work and cause our economic system to implode.
The only way we can solve our economic problems today is by creating jobs. Cutting government expenditures does not create jobs. It destroys jobs as people are laid off in the government sector of the economy. And cutting taxes on businesses and upper-income individuals also does not create jobs. Businessmen do not hire additional people or invest in more plant and equipment because their taxes are cut. Businessmen hire additional people when they can sell the output that additional people can produce, and they invest in more plant and equipment when they believe they can sell the additional output investment makes possible. Cutting their taxes does not allow businesses to sell more. Nor does it give them hope for the future when jobs are destroyed in the public sector and unemployment grows as a result. And they can’t sell more when taxes are cut on the wealthy.
Cutting taxes increases the amount of after tax income people have to spend, but it doesn’t guarantee that those who receive the extra income will actually spend it. Among those who live hand to mouth, it most certainly will be spent, but the further you go up the income scale the less likely this is to be the case. A substantial portion of the extra income will be saved by the higher income groups, not spent, and the ultra wealthy will spend what they will spend whether their taxes are cut or not.
If we are to solve the deficit, debt, and unemployment problems we face today we must 1) increase taxes on those who can afford to pay—and that does not mean just the top 2% of the income distribution, though it certainly does include that top 2%, and 2) use the proceeds to put people to work rebuilding the public infrastructure we have allowed to decline over the past thirty years as we cut the size of the rest of the government by 44%—that is to say that we must increase government expenditures.
If we do not do this it is going to be almost impossible to deal with our deficit, debt, and unemployment problems, and our economy is going to deteriorate. Millions more people are going to find themselves in desperate straits, and there is a serious possibility the deficit, unemployment, and the national debt will get out of control.
For an analysis of the kinds of policies that are necessary to deal with our deficit, debt, social insurance, and employment problems see Understanding the Deficit, Understanding the Social Security Crisis, The Simpson-Bowles Solution to the Deficit Problem, and On International Finance and Trade. Where Did All the Money Go and The Rise of Utopian Capitalism and the Crash of 2008 explains how we got to where we are today, and for an explanation of why our government is not pursuing the kinds of sensible policies recommended above, see It Makes Sense if You Don't Think About It.
