The long term budget problem begins now

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I am comparing the past 50 years with the next 50 years under President Obama’s proposed policies.

The dotted red line shows us that, over the past 50 years, federal government spending averaged just over one-fifth of the economy (20.2% of GDP).  The dotted blue shows us that, over the past 50 years, federal revenues averaged just over 18% of GDP.  The small yellow double arrow between the dotted red and blue lines shows the average deficit over the same period: 2.1% of GDP.

The vertical white line at 2011 separates the past from the projected future of the President’s policies.

You can see the assumption of the economy recovering as the blue revenue line recovers from an extraordinary low share of GDP.  As more people get jobs, the government will get more income and wage revenues.  You can also see spending declining from the 2009-2011 phase which spiked principally because of TARP and stimulus.

Three things should jump out at you from the future portion of this graph:

• The red and blue lines diverge enormously, and the gap grows over time.
• The blue line is flat while the red line slopes upward.
• Both the red and blue lines shift upward significantly.

Let’s take each in turn.

The red and blue lines diverge enormously, and the gap grows over time.

The gap between the red and blue lines is the budget deficit.  A deficit of 3% of GDP will hold debt constant relative to the economy.  Under the President’s policies the deficit would dip in 2018 to 2.9%, and would otherwise forever be at or above 3%.  Our government debt burden will increase forever.

In a crisis our economy can handle an enormous temporary budget deficit.  Our deficit problem is that future deficits are large, sustained, and projected to grow forever.  Our little yellow double-headed deficit arrow will grow into a monster and keep growing.

The blue line is flat while the red line slopes upward.

Taxes grow as a share of the economy very slowly.  The blue line is basically flat for two decades.

I’d like the solid blue line to be below the dotted blue line.  Most Congressional Republicans argue to match the historic average of about 18%.  The President proposes just below 20%.  Reverting the tax code to pre-Bush policies (“repealing all the Bush-Obama tax cuts”) would bring us to the high 20s.  In each case the line is basically flat.

The red spending line grows steadily as a share of GDP.  That’s because three enormous spending programs are growing at unsustainable rates:  Social Security, Medicare, and Medicaid.  A better way to think about it is that there are three underlying forces driving spending growth:  demographics, unsustainable benefit promises by elected officials, and per capita health spending growth.

At any point in time, the gap between the red and blue lines can be narrowed by lowering the red line, raising the blue line, or both.  Over time, however, the red line must be flattened, no matter what level you pick for the blue line. If it’s not, any downward red shift or upward blue shift only temporarily narrows the gap.  If you don’t flatten the red line, your solution is only temporary.  It’s the slope of the red line that’s killing us.

Both the red and blue lines shift upward significantly.

We care not just about the gap between the red and blue lines, but also about their absolute levels.  A higher red line means we are devoting more of society’s resources to federal government control.  That leaves less for the private sector (and for state & local governments).

I’m a small government guy, so I want the red line to be as low as possible.  Whatever your policy preference about the size of government relative to the private sector, two things are undisputable:  bigger government comes at the expense of a smaller private sector, and at some point that growth in government has to stop.  This second point is just another way of saying that eventually we have to flatten that red line.

This size-of-government metric is often ignored.  Washington fights about whether a policy (like the new health care laws) widens or narrows the gap (the deficit) without asking whether the policy shifts the lines up or down.  Both things matter.

You can see that President Obama proposes long-term revenues of about 20% of GDP over the next decade.  Other than a brief tick above 20% during the tech stock bubble in the late 90s, that would put federal taxes at an all-time high share of GDP.  That difference, between 18.1% of GDP and almost 20%, is enormous.

Those higher taxes are an explicit policy proposal from the President.  While the new health laws shifted the red spending line up, most of that long-term path long predates him.  The path of entitlement spending has changed over the years, but the shape of this graph has not changed in decades.  Pre-crisis and pre-Obama, the spending line would have bumped around 20% for another several years and then would have begun its steady upward growth.

What has changed is that we used to say this was a long-term problem.  The financial crisis, economic recession, and the President’s policies have eliminated this small amount of breathing room.  This graph makes clear that the long-term problem begins now.

I’ll end with a clean version of this same chart which removes all the explanatory chartjunk.

Sources:  This graph combines three tables from the President’s budget – historical data are from, surprise, Historical Table 1-2; the next ten years are from the principal short-term table (summary table S-1); the rougher long term numbers  are from (table 5-1 on page 51 of Analytical Perspectives), which provides shares of GDP every 10 years.  I combined the streams (the data match in 2020) and interpolated the long run data for intervening years.