Conclusion

This blog turned out to be a much larger project that I initially envisioned. I would love to get any feedback on what people thought. If there is anything that you have questions about or feel like I left out please let me know and I will look into it.

 Thank you for taking the time to read all of this, I hope you found this blog interesting and informative.  My initial plan was to end the blog with my opinion on how to best deal with the national debt problem, base on what I learned through my research. But now that I have finished, I realize that the problem is not so much that there is a "right" solution that we have not found. But that there are several solutions to the federal debt crisis and they all boil down to the simple answer that the federal government either needs to spend less money, collect more revenue, or some combination of the two, until budget is balanced. It is not what we need to do that the country is hung up on, it is how we need to do it and honestly I do not think there is right or wrong choice here. No matter how we do it there will be consequences. We just need to decide as a nation which consequences we can live with. So in the end it is more about our values and our perspectives, then a right or wrong way to do it.

So I decided to scrap my opinion piece at the end of the blog, because after reading though all these figures and delving though government policy. I am no more equipped to tell someone what to value or what perspective to take on the world than before I started.

Now the question is, "where do I go from here?" and this is what I have settled on. I want to do something about this problem, but I do not think I can do much by myself.  At this point I would like to ask all of you out there to help. First of all, if you have not read through my blog, please read through it (and if you do not mind this shameless plug if you know anyone who might find this interesting please share a link to my blog with them). When you are done, ask yourself how you think the country needs to go about balancing the budget. Then write up your what you think in a letter and send a copy to the your Congressman, both of your Senators, and the President you can email them all through this site:

http://www.usa.gov/Contact/Elected.shtml

This may seem small thing to do, but there is power in writing your elected representatives. One letter does not get much notice, but fifty, or one hundred, or a thousand causes these people to take notice. It easy for us to be anger at our elected officials for not doing enough, but ultimate we have no one to blame but ourselves. Politicians want to be reelected and ultimately they pursue the issues that will get them reelected, and if we do not let them know that the debt matters to us or what we think they need to do about it, then they are not likely to make the issue a priority, let alone take action in a way that we are likely to agree with.

I would encourage you all to do this and with that said thank you all again for reading. I enjoyed putting this all together and I hope you found it interesting.

Part XIII

Health care is one of the governments biggest costs and almost all of the money spent in this area goes to two major programs: Medicaid ($272 billion) and Medicare ($451 billion). So what are these programs? Medicare is public insurance program that is available for all citizens who are 65 years old or older and the severely disabled. It is broken up into four parts: A, B, C and D. Part A and B were part of the original Medicare program and are an insurance program that covers hospital care (part A) and medical care (part B). Part C was added in 1997, which allows recipients of Medicare to have their benefits administered through private insurers. Part D was added in 2006 and it covers the cost certain prescription drugs. It is important to remember though that Medicare is not “free” healthcare, it is a subsidized insurance program that collects co-pays and has premiums. In 2010 $65 billion was collected from Medicare beneficiaries or about 12.7% of the cost of Medicare. This means the average Medicare enrollee pays about $1,380 per year for their care, though it is worth noting there is support for people who cannot pay their co-pays and premiums. Medicaid is a very different program. It covers the cost of medical care for the poor and the disabled, and their children. It is not administered by the federal government, but by state governments and the criteria for eligibility varies between states, within a mandate set by the federal government. The funding comes from the general federal budget and which is given to the States in the form of grants. The states also contribute funds to cover the cost and can expand coverage within their own states (most states pay roughly half the cost). Additionally there are co-pays for Medicaid but they are minimal and are often as little a few dollars and even that  can be waived by state programs.

 Together these two programs made up 20.9% of the federal budget in 2010. Medicaid is funded out of the general fund and Medicaid is partially funded with a special payroll tax. Every wage earner pays1.4% of their taxable income and employers pay 2.9% of the wages they pay their employees, to Medicare. In 2010 the Medicare payroll taxes collected $180 billion meaning that Medicare had a $271billion short fall (yikes!). So why was there not a drop in benefits? First of all Medicare has never been fully funded by its own payroll taxes. It has always needed some funds from the “general fund” to cover it (the general fund in turn makes up its short falls by selling securities, AKA debt).

 Like Social Security, Medicare has a trust fund, which as of the end of 2010 had $71.4 billion in it. But this trust fund is a bit of a false sense of security because if Medicare were not able to rely on the general fund the trust would have been wiped out long ago and would not even last one year if the general fund could not be accessed.

 But the concern is not that Medicare and Medicaid need to rely on the general fund but that the general fund is already unable to cover all the expenses it needs to as it is, and cannot take the extra burden without selling securities. So why did the federal government create such a large program but not the means to fund it? The answer is complicated because at the time that Medicare and Medicaid  were created the country could afford it to fund it, but that has changed.

So why can we no longer afford to fund these health care programs without borrowing? It is because these programs have got much more expensive then when they were created. This is because as America’s average age has increased and medical care has gotten more expensive, Medicare and Medicaid premiums and pay roll taxes have not kept pace with the increased costs. In 1970, when the oldest of the baby-boomers were 35, Medicare received 24.6% of its funding from the general fund (or about $2 billion). In 2000, when the oldest of the baby-boomers were 55 years old and Medicaid received 27.6%of its funding from the general fund (or about $71 billion). So far so good right? Well the first decade of the 21st Century was rough on Medicare.  In 2010,when the oldest of the baby-boomers were 65 Medicare received 44% of its funding from the general fund (or about $214 billion). That was a big jump in a short time.

 Why the jump? First of all as the average American gets older he or she will need more medical care and often more expensive medical care. In addition the cost of medical care is increasing at a rapid rate. You know how the old timers like to talk about the price of a gallon gas? Well gasoline has nothing on your doctor’s bill. In 1976 the average cost of a gallon of gas was 60¢, by 2010 the average cost was $2.73,or another words the price increased 455% with inflation and increased demand. Sounds bad doesn’t it? Compare that to cost of a standard doctor's appointment that cost on average $49.70 in 1976. In 2010 the average cost is $382.68 or an increase of 769%!

 So how do we tackle the cost of public health care and in end help balance the budget? There are three primary schools of thought on the topic. Either we raise more revenue to cover the costs, or we reduce benefits and increase premiums and co-pays, or we reduce the overall costs of health care so we can cover the care we need with the money we have.

Let's look at these one at time, first raising revenue. To cover the cost of these health care programs the federal government needs to raise an additional $543 billion dollars. We could do this based on an increasing income taxes, cooperate taxes, Medicare taxes or come up with an excise tax that would cover the cost.

 If we did it by increasing income taxes we would have to raise rates by 60.4%, that would mean that a family that made $50,000 to $199,000 a year would have to had paid 25.98% of their income in taxes in 2010, up from the current average rate of 16.2%. If we tried to cover the cost by raising cooperate taxes we would need to raise cooperate tax rates by 284% or in other words tax cooperation at 106% of their profits, which is not mathematically possible.

If we try to cover the cost by an increasing the payroll Medicare tax, we would need to increase the tax rate by 400% or in other words increase wage earners taxes by from 1.45% to 5.8% for individuals and for 2.9% to for employers to 11.6%. Self-employed individual would have to pay 16.8% of their income as opposed to the current 4.2%.

If we came up with a new excise tax (like a new federal sales taxes on gasoline, cigarettes or some other product or service) it would have to have every household in America pay on average $402 a month, so if the excise tax rate was set at 25% (pretty high for an excise tax) it would have to tax something the average American household pays $1,608 a month on. The only thing I could can think of that would achieve this would be a federal property tax could.

The other option would be reduce the cost of health care programs by cutting coverage an increase premiums and co pays. But if we were to cover the cost of these programs based solely on the current payroll tax revenue we increase patient premiums and co-pay sufficiently to cover 77% of their own care. Though it is unlikely that many people in need of federal assistance for health care would  be able to afforded this.

On the other side of the coin we could increase the age requirement. Currently there are 39.6 million people enrolled in Medicare based on their age (there is another 7.6 million based on being disabled). The average enrollee receives $11,762 per year in benefits, for a total of 465.7 billion of benefit played out in 2010. To trim things up to a point where we can afforded both Medicare and Medicaid we would need to raise the age limit enough to remove 6.8 million people from eligibility or about one out of every seven current enrollees. However this might have a similar effect as rising the Social Security retirement age in that it might only push more people into Medicaid until they reach the age requirement for Medicare. So the overall savings might be less than projected.

 Lastly the option is to take steps to reduce the cost of health care. But that is easier said than done. On the one hand if the government stepped in and regulated or deregulated aspects of the medical industry that resulted in a reduction in the cost of providing health care (of which there is no guarantee of). An actual price drop for consumers may not even happen because medical care providers and insurers could simple maintain their current prices as it has already been shown that costumers are willing to pay those prices, and simply increase their profit margins.  Other, more extreme options, such as price controls or a nationalization of health care could be enacted. But these are philosophies that would be extremely radical in American politics and in the end may or may not be very effective. Either way it would certainly be uncharted waters for our country.

 A simpler (if not extreme) option would be to simple eliminating federal funding for Medicaid, and leave support of medical care for the poor solely to the States. If we cut Medicaid out of the federal budget we could just barely cover the Medicare cost of $451 billion. But this would dump a large burden on the State budgets, and even such a drastic action would not solve the root problem of the increasing cost for Medicare.

Ultimate even if we could have balanced the budget in 2010 we would still have a problem looming in the background. In 2010 Medicare cost of $451 billion. In 2012 it is expected to cost $492 billion(so we need to scrounge up another $51 billion by then) and in 2013 it will cost $543 billion so we will need another $58 billion that year. It only gets worse and worse, and by 2021 (only nine years from now)it is estimated that we are going to need $848 billion or almost twice the amount we cannot seem to afford today. So any solution for covering the cost of health care must not only address the current shortfall but also be able to keep up with the rising costs.

 The Verdict:

So what do these options mean? Since we cannot reliable reduce the cost of medical care without taking extremely radical steps (and even then it is not necessary a sure thing) we are left with a complex problem that has a simple, yet difficult, solution. Medical care is expensive and the government has created programs to assist certain people to pay for it. However we are cannot afford to fund these programs as the budget currently stands. So the government needs to raise revenue or reduce benefits, or a mixture of the two, and then the government must continue to adjust the revenue/expense formula to keep up with the increasing cost.

Since increasing revenue is covered in other sections of my blog (Part V, Part VII and Part VIII), what remains is to look at what could be cut or what Medicare or Medicaid recipients could pay for themselves.  As this is more a matter of opinion than anything else I will not weigh in on what is the best way to do this. However, I will provide this information and you can make your up you own mind. Here is a breakdown of Medicare’s and Medicaid's costs in 2009, the most recent year’s records that have been publicly published .Please note that the costs were higher than in 2010 because these figures are the total program costs, not how much it cost taxpayers after premiums and co-pays were collected.

Though these are not the 2010 statistics I assume the break down in cost (and the overall numbers) are similar:

Medicare	Cost in Billions	Percentage of Total
Hospital Care	$220.40	43.80%
Physician and Clinical Services	$109.40	21.70%
Prescription Drugs	$54.80	10.90%
Home Health Care	$29.80	5.90%
Nursing Care Facilities and Continuing Care Retirement Communities	$28	5.50%
Net Cost of Health Insurance *****	$24.10	4.70%
Other Professional Services*	$13.70	2.70%
Durable Medical Equipment***	$7.40	1.40%
Government Administration	$7	1.30%
Other Health, Residential, and Personal Care**	$4.60	0.90%
Other Non-Durable Medical Products****	$2.80	0.50%
Dental Services	$0.30	0.01%
Total cost:	$502.30	100%
Medicaid	Cost in Billions	Percentage of Total
Hospital Care	$136.10	36%
Other Health, Residential, and Personal Care**	$64.40	17.20%
Nursing Care Facilities and Continuing Care Retirement Communities	$45	12%
Physician and Clinical Services	$39.90	10.60%
Home Health Care	$24.30	6.40%
Prescription Drugs	$20	5.30%
Government Administration	$18.20	4.80%
Net Cost of Health Insurance *****	$10.10	2.70%
Dental Services	$7.10	1.80%
Other Professional Services*	$4.50	1.20%
Durable Medical Equipment***	$4.30	1.10%
Other Non-Durable Medical Products****	$0.00	0%
Total cost:	$373.90	100%

*Services provided other than physicians and dentists. These professional services include those provided by private-duty nurses, chiropractors, podiatrists, optometrists, and physical, occupational, speech therapists, etc.

** Care provided in residential care facilities, ambulance services, school health and worksite health care, community centers ,senior citizens centers, schools, and military field stations and mental health and substance abuse facilities

*** Items such as contact lenses, eyeglasses and other ophthalmic products, surgical and orthopedic products, hearing aids, wheelchairs, and medical equipment rentals.

**** Non-prescription drugs and medical sundries

***** Money played to private insurance companies who provided coverage to individual enrolled in Medicare.

Part XII

Welcome back! It has been a while. I added a new tax deduction to my family and I have had little free time. But I am eager to finish what I started. Today I am going to take a look at what Social Security reform would do for the budget. This topic is being widely discussed across the country, which is good, but it is also widely misunderstood, which is not so good. Before we start let me clear up some common misconceptions.

 Social Security is going bankrupt.

 This is completely false. Social Security is funded by a special payroll tax. You can look on your paystub and see it. Congress is required to spend this tax revenue on Social Security and only on Social Security. After the government pays all its Social Security obligations if there is any money left over is goes in the Social Security trust fund. In 2010 the government had a surplus in Social Security tax revenue, or in other words more was collected in Social Security payroll taxes then the government had to pay out. In fact Social Security has had a surplus every year since 1982 and the trust has grown to $2,608 billion.

Social Security won’t exist in 30 or 40 more years.

 This one is mostly false but there is a kernel of truth to it. According to the Social Security Agency projections, in the next few years the revenue from Social Security payroll taxes will not be able to cover the costs of the Social Security program. At that point we will need to start drawing on trust fund instead of putting into it, and according to the Social Security Administration current estimations the Social Security trust fund will run out in about 30 to 50 years. Now that does not mean that Social Security payments will stop, it just means that the short fall can no longer be made up by the drawing on the trust fund. So in 2061 if there is a 5% short fall that would mean that either Social Security payments would have to be cut by 5% that year or taxes would need to go up to make up the difference but it is not like the checks would just stop going out.

You might be wondering if Social Security is not going anywhere, then what it all the worrying about? The problem is Social Security will get more and more expensive over the next several decades we don’t how we are going to pay for it in the long term.

So why is Social Security getting more expensive? It is because our country’s average citizen is getting older so we have less people working (paying into Social Security) and more people are retired (drawing out of Social Security). In 1999 5.3% of the population was over 65 years old. In 2009 13.9% of the population was over 65 years old. This number is expected to rise even more over the next few decades as the baby boomers retire and people’s life expectancy increase.

So what do we do? We have to reform Social Security policy so it can function in the long term, even with an aging population.

 There are three schools of thought on how to reform Social Security

1. Privatize the trust fund

The idea behind this reform is that instead of putting the surplus from Social Security taxes into in the Social Security trust fund to buy securities, the government would use it to buy private stocks. The benefit of this is that investing in stocks generally has a much higher rate of return then securities (A decent return on a security is 5% over anywhere from 5 to 30 years, a good stock portfolio can grow about to 7% to 8% in a single good year).

What is good about it:

We could generate a lot more revenue for Social Security without raising taxes. In 2010 the Social Security trust fund produced 118 billion in interest (or about a 4.5% rate of return). The S&P 500 (an index of important American stocks) grew by 11.2%, so if Social Security trust had been moved to the private market on December 31, 2009 it would have generated by $292 billion. In other word Social Security would have generated $174 billion more without raising taxes by a single penny.

What is bad about it:

Social Security invests in securities because it is stable and extremely safe. If the government invested in the private market there would be no guarantee that the market would grow and there would be a very really possibility that the stock market could go down and the government would lose money. If the Social Security trust fund had been invested in the private market in 2008, when the market crashed, it would have shrunk by 38.5% that means that not only would have the trust fund produced no interest that year, the trust fund would have lost $1,340 billion! That is the equivalent of losing all the surplus revenue from Social Security from the year to 2000 to the date of the crash, or in other words 8 years of savings down the drain. So there is a chance that privatizing the trust fund could make things much worse.

2. Increase the retirement age

What is good about it:

Is would reduces the cost of Social Security because it would reduce the amount of time that a person would be receiving benefits and increase the amount of time that people would work (and pay taxes into Social Security). To calculate how much money would be saved you can look at Social Security's most recent demographic data. In December 2009 there were 33,514,000 people receiving Social Security retirement benefits. Out of these 12,227,000 are under the age of 70. The average monthly benefit for a retiree under 70 is $1,122.15 a month. If we had risen the retirement age to 70 in 2010 it would cut the cost of Social Security by about $13.7 billion. As for how much more would be generated in taxes. If we take the median annual salary for people over the age of 65 in 2009, which was $28,952* and use that as our yard stick for how much taxable income this group could make. That means the amount that the current retirees under 70 would be contributing in taxes to Social Security would be about $15.9 billion.

*It is worth noting that annual salary for people over the age of 65 is a little hard to figure. It is true that the median annual salary was $28,952, but that includes people on Social Security. So it is hard to say whether that number would be higher or lower if people would have to wait to 70 to get benefits. On the one hand the age group of 55-64 make considerably more ($41,269 annually) so it is debatable how much of that drop is due to people who choose to quite working because the can receive Social Security and how much is due to a people physical needed to retire.

What is bad about it:

For most people there is a noticeable difference in physical ability from 65 years old and 70 years old. Odds are many of the people who would be no longer be on Social Security and those who would have to wait longer to get on Social Security would become physical unable to work before turning 70. Especially people whose education or work experience would limit them to physically demanding jobs. So inevitably there would be an upswing in people who would file for disability insurance (so not solving the problem). Additionally, it is hard to know how much more money would be generated in taxes because if we raised the retirement age. Because people could just stop working at an earlier age and live off of savings or a pension until Social Security to kicks in when they turn 70. So the savings of $13.7 billion and extra revenue of $15.9 billion might be overly optimistic.

3. Lift the cap on taxes for Social Security

Social Security is funded by a payroll tax. You pay 6.2% of your income to Social Security and your employer pays the equivalent of 6.2% or your salary (if your are self employed you pay the whole 12.4% yourself). But there is a catch; you only pay Social Security taxes on the first $106,800 you make annually. So you can never pay more than $6621.60 in Social Security taxes a year ($13,243.20 if you are self-employed). So whether you make $106,801 or $10 billion a year you will never pay more than $13,243.20 a year (though they do adjust the cap for inflation from time to time). So if you lifted the payroll tax cap you would have to pay your 6.2% on your whole income and not just the first $106,800.

What is good about it:

It would raise a lot more money. As you may recall from Part VII the vast majority of money made in the country is made by people who make more than $200,000 a year. So most of the money being made in the county is not taxed for Social Security. So how much more revenue would be raised if they lifted the cap? Considering that in 2010 there was $7,991 billion paid to employees in the US and self employed individuals made another $1,055 billion. If we taxed the total amount at the current rate without an income cap it would gross about $1,121 billion, or about $256 billion more than was actually raised in 2010.

What is bad about it about it:

 Given the current way the Social Security calculates how much a person gets in retirement benefits, the tax cap is taken into account. To actually raise revenue we would need to eliminate the cap on the tax and keep the cap on benefits. This would mean that the Social Security benefits would be capped at about $2,366 per month (how much you would receive if you made more than $106,800 every year for 35 years. That means that a small group of Americans who make more than the cap (about 12% to 13%) would have a lower benefit to tax ratio than the rest of the country, which essentially means that they are paying more for the same level of benefits.

So which one should we do to help balance the budget?

Well, since Social Security was solvent in 2010 (it collected more in revenue that it paid in benefits) none of these plans would have much of an immediate effect (though they would help save us from a long term budget crisis 30 or 40 years from now. With that said let’s revisit each plan and see what these plans would do.

Plan number one, the plan to privatize the Social Security trust fund would be the cheapest as it would not require any tax increases and would no doubt help the economy because of the increased investment. But, there are a couple of hiccups. First we cannot just transfer the whole trust fund to the private market at once. It would have to be done gradually as the existing securities mature, so there would not be much of an immediate effect. Secondly there is no guarantee that the markets will perform well enough to cover the rising expenses of Social Security as the baby boomers retire. So it is a more risky choice.

Plan two is probably the least effective as it would push many people from receiving on form of Social Security to another and even if that was not the case would not save enough money to make much of a difference.

Plan three, eliminating the tax cap, would raise the most money, about $256 billion more a year. This would not do anything in the short-term because all the extra money would go into the Social Security trust fund. But in the long term, the Social Security trust fund would larger, so it would produce more interest and last longer. Maybe even long enough to ride out the Baby Boomers retiring, and that way Social Security may never add to the debt.

The Verdict:

None of these plans would reduce the deficit in the short term. But in the long term lifting the cap of taxable income for Social Security would be the most likely plan to raise enough money for Social Security to make a significant difference.

Part XI

Introducing a “flat tax” is a popular idea among some Libertarians as an idea to increase revenue, reduce costs and reduce government interference in private life. I won’t go into the pros and cons of a flat tax system as it would stray too far from the topic at hand. But the general idea is, if one was implemented, that the government would eliminate all current income taxes (the standard income tax, the Medicare tax, Social Security taxes, employment insurance, etc.), all deductions and all tax credits and would replace it with a single tax rate for all taxpayers that applies to their total annual income, regardless of the sources (no taxing capital gains differently than wage income).

A “flat tax” would be very different because the rich would pay the same percentage as the poor and there would be no tax loopholes for anyone to use (or abuse).  If the tax rate was 15%, instead of the current forms we use the tax return for a family of four who made $50,000 a year would look like this:

• Tax rate for 2010: 15%
• Income: $50,000
• Taxes owned in 2010: $7,500
• Taxes paid from payroll deductions: $7,500 ($625 per month)
• Balanced owed: $0

It would be a lot simpler and it would ensure that every American pays at the same rate but would it raise more money than the current system?

In 2010 the federal government collected $1,782 billion in various forms of individual income tax and payroll taxes. The total amount of personal income from all sources (but not including income from government assistance programs) in the US in 2010 was $10,089 billion (keep in mind this income includes previously untaxed sources of income such as employer contributions to retirement programs). To raise the same amount of money we would have to have a flat income tax of 17.6%. A flat income tax of 18% would raise more than the current system. So if we had such a system would you pay more or less in taxes? Here is a list of the average taxable incomes in different tax brackets and the percentage each paid in taxes in 2008 (these numbers include payroll taxes as well).

Annual Income	Current Average Tax Rate
$12,509	14.4%
$61,470	16.1%
$284,735	23.25%
$1,207,751	26.6%
$6,841,677	25.25%
$29,671,274	22.45%

Now consider that 77.2% of Americans have a taxable wage lower than $75,000.  Under a flat tax system, about 77% of Americans would have to pay more taxes than they do now if we were to maintain our current levels of revenue.  We would have to raise taxes on most people to keep the deficit from getting any larger, so the argument that a flat tax could reduce the deficit without raising taxes does not hold water. Now a supporter of a flat tax would argue there are some hidden savings, because if we had a simpler tax system we could reduce the size of the IRS and that would save money. This is true but it would not save that much. The IRS budget was 12.2 billion or 0.3% of the total budget in 2010.  Even if we could disband the IRS all together it would not make much of a dent in the budget deficit.

So what is the verdict? Despite what some supporters of a flat tax would argue, the system would not raise revenue without raising taxes. Nor would it increase government efficiency to a point that would save enough money to make an impact on the deficit. Ultimately, there are some good arguments out there for implementing some form of a flat tax, but the argument that it will help balance the budget is not one of them.

Part X

Another idea that is popular Liberals to balance the budget is to reduce military funding. This is a controversial topic and a difficult one to address because the core of the argument is how big does our military need to be? The answer will vary depending on what you think the purpose of the military should be. Should it be just to protect our borders from aggression? Or should it be able to protect our allies as well? Do we want a military that is capable of applying diplomatic pressure or even be able to intervene in other nations? Do we want a military that can overthrow other governments? I am not going to argue what our military should or should not be able to do. But we need to think about what we can afford. Think about it like this; what is the point of having a state-of-the-art security system for your home if you cannot afford the system and your house payment at the same time? If we are serious about balancing the budget we have to go where the money is and the military is one of the governments most expensive programs. So any discussion about balancing the budget will have to look at military spending.

It is important to note that the government spends a huge amount on the military ($691 billion or 19.9 % of the entire budget). That is a lot, but it is not as much as some people think. Cutting military spending or even eliminating it would not balance the budget (we would still be $602 billion in the hole even if we did not spend any money on defense. It is worth noting that three out of four times the federal government has reduced overall government spending in the 20th century has been by cutting military spending after a war (The budget shrunk after World War I, one year during the Great Depression, after World War II, and after the Korean War).

So what do we cut from military spending? If you look at the Departments of Defense’s budget there are no big surprises, the top five expenses are:

1. Operation and maintenance: $275 billion
2. Military personnel $151 billion
3. Procurement (buying stuff) $133 billion
4. Research, development, test and evaluation $76 billion
5. Military construction: $21 billion

It seems that an overall reduction would be more appropriate than targeted cuts. But how much should be cut? It is worth noting that the US military is far and away the most expensive military on earth. As I stated earlier we spent $691 billion on our military in 2010 and we spent another 2 billion on other security agencies (like the CIA and the FBI), so we spent a grand total of $693 billion on defense. Compare that with the country that spent the second most on its defense, China, who spent $119 billion on its military and national security agencies. In fact in 2010 42.5% of all the money that was spent on militaries world wide was spent by the US. Why is our spending so high? You might think it is because we are at war, but oddly enough the wars in Iraq and Afghanistan do not have much to do with it. In 2000, before the wars, we spent about 16.6% of our budget on the military (It is 19.9% today). Even if we were spending at pre-war levels we would be spending $573 billion dollars or $418 billion dollars more than China, who has the second most expensive military in the world.

So why do we spend so much? There are two reasons. First, because we are an extremely wealthy nation so we can afford an expensive military. Second, we spend a higher portion of our national wealth than most nations on the military. So what portion of our wealth do we spend on the military compared to other countries?

To make this comparison accurately it is best to compare what percent of nations total wealth was spent on their military. The wealth of a nation is tracked by a measurement called a Gross Domestic Product or GDP. The GDP of a country is the amount of money that is the equivalent of all the goods and services generated in a country each year. In 2010 the GDP of the US was 14,660 billion dollars. Of all that wealth the US spent 4.7% of it on the on the military. How does that compare with the 15 most expensive militaries in the world in 2010? Let’s take a look:



So out of the top 15 militaries in the world only Saudi Arabia spent a higher percentage of its wealth on it military than us (but since we have a lot more money, we still spend more than 15 time what they do).

So with that in mind how much could we realist really cut from defense spending? Of course it all depends on how big you think the military needs to be. A good base line would be to compare how much other nations with comparable military needs as us spend a year. Here is list of nations that in one way or another are similar to us (in no particular order):

Russia: A large nation with a history of current conflicts (Georgia, Chechnya)
United Kingdom: NATO member, large navy and second highest military involvement in the conflicts in Iraq and Afghanistan
China: Large nation, aspiring super power and world’s second most powerful military

Currently we are spending $693 billion on defense. So how much would we spend if we matched these countries' GDP percentage of spending on the of military spending?

Same GDP percentage as Russia: $586 billion
Same GDP percentage as United Kingdom: $395 billion
Same GDP percentage as China: $307 billion

For kicks if I took the average GDP percentage of the world’s top 15 militaries we would spend $422 billion.

So how much should we cut? Like I wrote earlier it all depends on what you think our military should be capable of. But for the purposes of this analysis I am going to assume that it would be possible to reduce our military spending to the average GDP percentage of the world’s top 15 militaries, which is 2.88% this is still a higher percentage than all but two of the nations on that list and we would still be spending $422 billion three and half-time half which is still three and half times higher than any other military in the world.

So what is the verdict?

This would actually make a decent dent in the deficit. These cuts would be drastic, but not unreasonable, because the percentage of our wealth is still above any other western nation and our total amount spent would still be 31.1% of all military funding in the world (compared to our closest rival China, which would only be up 8.8%)

By the numbers:

Percentage this idea could reduce the federal budget deficit by: 20.9%

Total dollar amount this idea could cut the deficit by: $271 billion

Part IX

The flagship issue for many conservatives in our country right now is to reduce cost and size of government. So let's take on this issue and see how effective cutting government spending would be at reducing the deficit. As you have seen in the previous posts we cannot balance the budget by increasing revenue alone. Government spending will have to be reduced. Now the simple answer would be to cut cost by 62% and viola the would problem solved, but unfortunately it is not that simple. Congress cannot simply cut certain spending because it is mandatory spending (see part IV for explanation of this). To reduce mandatory spending there would have to be major reforms to current programs. So for my analysis I am going to take a few issues off the table because they are issues that cannot simply be “cut” they would have to be “reformed” which is a whole other issue (and I will address them in separate post). Additionally, since I will look at cutting military in a separate post I will not address the military budget at this time. I felt like it was appropriate to draw a distinction between defense spending and nondefense spending because many conservative politicians that talk about cutting the budget but very few are enthusiastic about reducing the size of the military. So I wanted to take their point of view and see how the numbers pan out.

So before I take an ax to the federal budget here is a list of the funding I will consider off limits:

Social Security: $754 billion
Medicare and Medicaid $719 billion
Department of Defense: $691 billion
Interest on the national debt: $413 billion*

Now it is worth nothing that I am not considering all mandatory spending off limits just these issues. Some mandatory spending can be cut rather easily, for example the cost of living pay increase was suspended for civilian federal employees in 2010 and there was not much negative reaction to it because it effects a relatively small part of the population. But you can imagine the reaction if the congress tried to reduce Social Security payments or Medicare coverage because it effects millions and millions of people.

All right let's get cutting! With the above issues off the chopping block we could balance the budget with an across the board cut of 119.1%. Again we butt up against a mathematical impossibility. So if we eliminated the entire federal government except the programs listed above and the national debt payment we would still be in the hole $404 billion.

Ouch! So what does this mean? It means that any politician who tries to sell you that a smaller government is the answer to the deficit and is not willing tackle Social Security, Medicare and Medicaid reform or is unwilling to touch Department of Defense, they are either pandering to you or are uniformed. That is not to say that the government should not or cannot reduce spending in other areas, on the contrary it will be a necessary part of balancing the budget. But shrinking the size of government without going after these larger issues will produce little results in regards to balancing the budget.

But let's not put that ax away yet! Despite the fact that the majority of government spending is tied up in a few major programs that does not mean that cutting spending in other areas would not add up and play a significant role in balancing the budget. But the hard question is what do we cut?

It is popular for the media to target politician’s salaries or pensions or pet projects that affect a very specific area. But realistically this would accomplish almost nothing when it comes to balancing the budget. If we are going reduce the deficit we are going to have make cuts to programs that are big enough to make a difference on the balance sheet. So lets take a look at the top ten most expensive programs in 2010 other than Social Security, Medicare and Medicaid, the Department of Defense and interest on the national debt (It may surprise you):

1. Unemployment Insurance programs: $156 billion (though it is worth noting that in 2007 before the recession it was $35 billion)

2. Food stamps: $70 billion

3. The Earned Income Tax Credit (a tax credit to employed people with low wages): $54 billion

4. Disability Compensation and Pensions for veterans $47 billion.

5. Hospitals and medical care for veterans: $41 billion.

6. The National Institutes of Health: $32 billion.

7. Building and maintaining highways: $30 billion

8. GSE purchase programs (this is part of the Housing and Economic Recovery Act of 2008, it is to help the banks offer mortgages during the recession): $30 billion

9. Financial assistance for students pursuing higher education: $30 billion.

10. Section 8 rental assistance (Subsided rent for people with low income) $27 billion.

These programs along with Social Security, Medicare and Medicaid and the Department of Defense make up 83% of the federal budget and of the remaining 17% there is not a single program that is larger than $23 billion or 0.6 percent of the total annual budget.

So what do we cut? The popular response by politicians and the media is “pork barrel” or wasteful spending but if look at the top ten most expensive programs outside of Social Security, Medicare and Medicaid and the Department of Defense, 68% of money spent goes to assisting those who lost their jobs, the poor and the disabled. Not exactly pet projects. The problem with targeting specific programs is that we often determine the value of a program based on how much it impacts us. I think this is why Congress has had such a hard time balancing the budget over the years. The debate always gets bogged down with which programs should be targeted for cuts and inevitably either nothing gets done or they go after minor programs everyone can agree on leading to penny wise and pound foolish policies are adopted. Public Radio is a good example of this. Recently there has been a lot of debate about whether or not the federal government should fund public radio. Now it is a valid discussion to question whether or not the government should be subsidizing a radio station. But the fact of the matter is that in 2010 National Public Radio received about 11 million dollars in federal funds or in other words 0.00031% of the federal budget and if the issue was really about the budget there would be bigger fish to fry. To put things in perspective lets go back to my example of the US government as a middle class household. Let's think of Congress as the adults of this household, they are $341,064 in debt and have $2,588 in bills they cannot pay each month. The 26 cents that one spouse donates to NPR each year is the least of their concerns.

But let's look at this from a more goal-oriented perspective. To save the bickering on what should be cut, what would happen if Congress just instituted a 10%** budget reduction to every agency equally (except Social Security, Medicare, Medicaid and the Department of Defense) and let the chip fall where they may?

By the numbers:

Percentage this idea could reduce the federal budget deficit by: 8.4%

Total dollar amount this idea could cut the deficit by: $109.6 billion

So what is the verdict? Without tackling the major expenses of Social Security, Medicare, Medicaid and the Department of Defense cutting spending would only have a mild effect. I would look at it like this, let's say you are leasing a really nice car for $500 a month and you spend $50 a month eating at restaurants. It is true that you will save money if you stop eating out, but that is not the source of your problem.

*Technically only $196 billion of taxpayer money went to paying off the national debt. The rest was covered by the investment from the Treasury Department. Since in my example the Treasury Department was closed due to lack of funds there was no one to buy and sell these investment bonds the $217 billion in interest was not made.

** If 10% does not seem high enough it is important to note that the overall federal budget has not decreased by one cent since the end of the Korean War, so a 10% reduction would be huge by historical standard.

Part VIII

I have written a lot about raising taxes to increase revenue but there is another school of thought on the topic of raising revenue and it is best explained by talking about pie.

Governments like revenue and people like pie. If you want to get your hands on more pie your options are very similar to the options a government has to get more revenue. You either have to cut bigger slices (like cutting the pie into fourths as opposed to eights), or bake a bigger pie (each of the eight slices are bigger). Some politicians and economists argue that the best way to raise more revenue is not to tax people more (take a bigger slice), but rather to help people make more money. The government is still taking the same percentage but it is getting more because people have more money (bake a bigger pie so your share is bigger).

So how does the government “bake a bigger pie?” To do this the government has to encourage economic growth. This is a tricky business for our government because we live in a capitalist nation were the government has limited control over the economy. A good way to think about it is like doctor who is treating a patient with medication. The doctor knows that the medication will most likely help but the doctor cannot say exactly how effective the medication will be or how long it will take to be effective because not all patients respond the same way. So doctors will often try different medications at different doses to get the desired effect with the least amount of side affects. This is very similar to how a government would try to boost its national economy. The government knows that certain actions will encourage economic growth, for example lowering taxes, but there is no formula that shows if the government lowers taxes by "X" than it will grow the economy by "Y".*

But assuming that the government could consistently grow the economy could it balance the budget by doing it? Lets look at couple of factors to determine what is realistically possible.

So how fast can we grow the economy?

It is hard to say but we can use some historical benchmarks. From 1993 to 2000 the US experienced huge financial growth with only minimal inflation. The economy was booming and unemployment steadily dropped and the federal government was able to have a huge increase in tax revenue and balanced the budget for the first time in decades. From 1993 to 2000 there was a 56.9% increase in tax revenue. That is an average of 7.1% a year. When you factor in inflation the Federal government’s revenue was increased by 4.5% on average a year. Given that the 1990’s were considered a boom time, lets use this rate as yard stick for excellent economic growth.

So how does this growth balance the budget?

If we keep making more money and do not spend any more, eventually we will balance the budget. So it is not a matter of if it would work how long would it take?

So can we do it? Can we “out grow” the deficit?

Sadly no. Assuming that starting in 2011 the American economy starter growing at the rates comparable to the 1990’s (4.5% a year) it would take 11 years to balance the budget. That is 7 years longer than the actual 90’s boom (which was the longest period of economic expansion in US history) and that is not to pay off the debt, that is simply to start paying down the debt. To make matters worse this figure assumes that the government would never raise spending levels for 11 years. If the government continues to increase spending at the same rates that it has from 2000 to 2010 (an average of 19.3% per year) we would never balance the budget, even if the economy grew at 90’s boom levels forever.

But what if we freeze spending completely and did not adjust it for inflation?

In a way this be the equivalent to a 2.6% decrease in the federal budget each year and it would take 7 years to balance the budget, all the while, the deficit would be growing. Also keep in mind that the 7 year period of growth was the largest in history and would be difficult to reproduce.

So what is the verdict?

By the numbers:

How many years would we need of 1990’s level economic expansion to balance the budget:

Freezing the budget at 2010 and adjusting for inflation: 11 years
Freezing the budget at 2010 and not adjusting for inflation: 7 years
Budget increasing at the average rate from 2000 to 2010: Never

The verdict

If we could maintain 11 years of 1990’s level economic expansion and Congress limited all spending increases keeping up with inflation, along with some reductions in spending to counter balance an increase in the interest rates from the national debt, it could be done in 11 years. Is this possible? I would argue no because even if we could manage an unprecedented 11year economic boom we could not freeze spending for that long. Congress’s financial restraint aside we would need a major cuts to Social Security to keep spending from increasing because the first of the baby boomers will be 65 in 2012 and will be eligible for full Social Security retirement.

*Welcome to the bonus topic!

There are probably dozens if not hundreds of theories on how to grow the economy but for simplicity's sake let's just look at one of the most popular theories, cutting taxes. Can cutting taxes increase tax revenue? Lets look at the numbers.

Let's pretend we are looking a fictional country so that we are dealing with smaller round numbers. Let’s imagine there is a nation called Taxcutistan whose citizens and businesses have $100 in taxable income and a government that collects 20% of that income in taxes giving the government $20 in revenue. Now let's say that Taxcutistan elected a new president who wants in increase revenue to $21 by cutting taxes, so he proposes reducing over all rates from 20% to 19% in the hopes of growing the economy. To collect the extra $1 in revenue by reducing taxes the taxable incomes would need to grow to $110.6 or by 10.6% annually (remember that 4% to 5% is considered really good). If the president was really ambitious and was wanted to increase revenue by $5 by reducing taxes to 18% taxable incomes would need to grow to $138.8 or by 38.8% annually.

Whether you are dealing with Taxcutistan or the US these same ratios hold true. So could you have balanced the budget in 2010 by cutting taxes? No, and the reason is that we would need to increase tax revenue by 67.2%. That means that a tax cut of 5% would need to grow the economy by 524% and based on how fast the economy has historically grown this is impossible (remember that 4% to 5% is considered really good).

Now this does not mean that tax cuts cannot be used to increase revenue it just means that it is not a short-term solution. For example, it would it may be unlikely that the US economy could grow 10.6% in a year, but it could do it in two or three good years. Based on these numbers I would say that tax cuts are not a good way to deal with the deficit, but after the budget is balanced they could potentially be a good way to pay down long-term debt.