From Deficit to Debt to Disaster?

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Jul 20, 2018 3:13:01 PM

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deficit to debtIn recent posts, we have looked at the deficit over the next 10 years, according to the nonprofit Congressional Budget Office (CBO), and the debt over that same period. Now, we are ready to take a look at what that problem might mean for us as a country. It is certainly a problem, but is it solvable? And if so, what would it take to solve it?

What the most recent data tells us

We closed yesterday's post with the conclusion that, with the deficit adding to the debt every year, we will need to find $600 billion over the next 10 years just to stay even with the current deficits. I was originally going to analyze what would need to be done to get us closer to balance in 2028.

Stepping back a bit, though, doing anything in 10 years is speculative. It makes much more sense to see what it would take to bring us to balance now—and then use that to try to project the future. We will still be guessing but, hopefully, from a more solid foundation. So, let’s look at the most recent available data, for 2017, and see what that tells us.

According to the CBO, revenue in 2017 was $3.3 trillion, divided as $1.6 trillion in individual income taxes, $1.2 trillion in payroll taxes that fund social security and Medicare, $297 billion in corporate income taxes, and $270 billion in other taxes and revenue sources. Spending overall was $3.7 trillion, leading to a $400 billion deficit in 2017 before considering interest payments; these payments added $270 billion for a total spend of $4 trillion and a deficit of almost $700 billion. 

Balancing the budget

To balance the budget, there are two possibilities: more revenue and lower spending. Let’s take a look at what each option would entail to eliminate the actual $700 billion deficit and balance the 2017 budget.

More revenue. To balance the 2017 budget by raising revenue, we would have to raise tax rates and charges by 21 percent across the board. In other words, the tax bill of every person and company would have to rise by 21 percent. Failing that, we could decide to focus on revenue increases. 

  • If we focused on individual taxes, including both income and payroll, we would have to increase them by 25 percent.
  • If we focused on corporate taxes, we would have to increase them by 236 percent, or more than triple them.

From a revenue perspective, it would take massive tax hikes to eliminate the deficit based on 2017 numbers. Remember, the current budget—with more spending and lower revenues—would require even bigger increases.

Lower spending. The 2017 budget has $2.5 trillion in mandatory spending, including social security, Medicare and Medicaid, and other benefit and retirement programs. The balance of the budget is $1.2 trillion in what is known as “discretionary spending,” roughly evenly divided between defense and literally everything else the federal government does. The total federal budget was therefore about $3.7 trillion. To balance the 2017 budget by cutting spending, there are two options. 

  • First, we could focus on discretionary spending. This would mean either eliminating the Defense department and cutting $100 billion (16 percent) from everything else or eliminating every single federal expense except for defense and then cutting $100 billion (16 percent) from defense.
  • Second, since discretionary spending is only one-third of the budget, we could take on mandatory spending requirements and eliminate Medicare or cut social security by two-thirds.

Note that the second option would require legislation; those items are required by law, which is why they are called “mandatory spending.” Note also that these have traditionally been the third rail of American politics.

Spoiler alert!

These are all bad choices. But this is what we have to do if we want to balance the budget: massive tax hikes or massive spending cuts. On the face of it, this doesn’t necessarily look like a solvable problem, which is the question we started with several days ago. As I said then, we have been through this once before, fairly recently. Next week, we will take a deeper look at how we can solve the problem. Spoiler alert—it involves both options.

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