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The Deficit Problem
The gap between government revenues and government spending is now about 10% of GDP.
Government spending is approximately 25% of GDP, while government receipts are approximately 15% of GDP.
The following chart shows the history of the gap between government spending and receipts since the year 2000.
- Income taxes: $1,179 billion
- Corporate taxes: $281 billion
- Payroll taxes: $904 billion
All other taxes combined total just $227 billion. This includes excise taxes, estate taxes, customs duties, Federal Reserve earnings ($80 billion), and a variety of other small sources.
This leaves the three major components of receipts as the only potential sources for increased tax revenues.
It should be immediately obvious that raising taxes alone cannot solve the deficit problem.
If individual income taxes are viewed as the solution, the taxes would have to be doubled. If this were possible, the deficit of $1.2 trillion could be closed.
But it would be politically impossible to double tax receipts, particularly since such a move would certainly harm the economy, and perhaps drive total revenues much lower than current levels, leading to a failure to collect the full doubled tax.
Even an increase of 50% in individual taxes would raise just $600 billion, filling only half of the deficit problem. But a 50% increase is politically impossible.
At best, approximately 20% of current revenue could be raised by increased taxes, or approximately $200 to $300 billion of income taxes. This would still leave a deficit of $1 trillion.
Corporate taxes are even less of a help in closing the deficit gap, since they are just 1/4 of the individual income tax totals. Even if these were increased by 50%, it would only raise an additional $140 billion, leaving still large shortfalls.
The payroll tax, which is primarily the social security and medicare tax (93% of all payroll tax receipts), is also a difficult tax to increase.
In fact, the social security payroll tax has already been lowered by two hundred basis points, from six percent to four percent, in an unsuccessful effort to stimulate the economy.
Raising the payroll tax would almost certainly frustrate economic growth, as it would directly decrease the amount of take-home pay in everyone’s paycheck.
While this makes raising the payroll tax unlikely, it is also clear that the payroll tax is not a strong resource for solving the deficit problem, simply due to its size.
The total amount received is smaller than the individual income tax, which means even if politically possible, an additional 20% from increased payroll taxes would leave a deficit of nearly $1 trillion.
Since raising current tax revenues by politically impossible levels of 50% still leaves the deficit problem unsolved, spending cuts are necessary.
Cutting Spending Does Not Solve The Deficit Problem
If tax revenues are not raised, the only alternative is drastically cutting government spending. However, this approach is also impossible for solving the deficit problem.
Total government spending, projected for fiscal year 2012 in the White House Budget, is $3,717 billion.
Of this category, mandatory spending is almost twice as large as discretionary spending. When net interest (which could also be considered mandatory) is added to mandatory spending, the total is $2,477 billion. Discretionary spending is just $1,319 billion. (The difference between the sum of these two numbers and the total government spending given above lies in off-budget accounting. For the purposes of this argument, the difference is small enough to ignore.)
In discretionary spending, security spending is almost double that of non-discretionary spending, at $868 billion versus $450 billion.
Even cutting both of these by 50% would only generate about $650 billion in savings, or half of the deficit. However, cutting either by 50% is politically impossible.
Social Security, Medicare, and Medicaid spending are the elephants in the room for government spending.
These three programs combined account for more than $1.5 trillion in government spending.
The White House Budget for fiscal 2013 projected fiscal 2012 spending for these three categories as shown below:
- Social Security: $773 billion
- Medicare: $478 billion
- Medicaid: $255 billion
All three of these categories spend more than they receive in payroll taxes, as shown below.
| 2012 Forecast, $B | Spending | Revenue, Payroll Tax | Deficit |
|---|---|---|---|
| Social Security | $773 | $635 | -$138 |
| Medicare | $478 | $203 | -$275 |
| Medicaid | $255 | 0 | -$255 |
The total deficit of these three programs combined is $668 billion, or roughly ½ the size of the total deficit.
It is virtually impossible to tackle the deficit problem without addressing the deficit spending of these three programs.
This bears repeating: It is virtually impossible to tackle the deficit problem without addressing the deficit spending of these three programs.
Can spending on these programs be curtailed? Is it politically possible?
Is the upcoming Obamacare program going to increase the costs of medical coverage? Or decrease them? One can find studies that argue both ways; we confess to being uncertain about the actual impact, or even whether Obamacare will ever be enacted as planned.
Certainly, the very first steps of Obamacare, the mandated insurance rebates, is a net-cost program, with no offsetting revenues.
Even if these spending programs were cut by 50%, the net savings would only be $300 billion.
Only A Combination Of Spending Cuts And Raising Revenue Is A Solution
As we have illustrated, in a back-of-the-envelope style analysis, there is no simple approach to solving the deficit problem.
However, even a dramatic approach of 10% increases in taxes and 10% cuts in government spending is not enough.
The following table illustrates this.
| Category | Current | 10% Change |
|---|---|---|
| Receipts | $2,590 | $2,850 |
| Outlays | $3,717 | $3,345 |
| Deficits | $1,127 | $495 |
This simple analysis shows that adjusting receipts upward 10% while cutting government spending 10% still only cuts the deficit in half, with a nearly $500 trillion gap still in place.
It should be obvious from even this cursory analysis that a solution to the deficit problem is a far more difficult political problem than most people are realizing.
A increase of 10% in taxes is virtually impossible, particularly with one candidate promising no new tax increases, while a 10% decrease in government spending is virtually impossible, as the other candidate is promising no drastic cuts in current social programs, only cuts in future spending increases.
Where does this leave the US and its financial deficit problems?
The worst part of this situation is that the drastic nature of the US debt situation seems to be trivialized by most of the mass media into a simple Republican versus Democrat polarized argument.
The only meaningful solution on a long term basis is one which requires both political parties to make compromises of a major nature – and the political environment continues to evolve into one where only polar black-and-white opposing arguments are presented.
The concept of a negotiated middle ground being the best result of a two-party system seems to have already died, however, which may make a solution to the US deficit problem an extremely difficult one.
Comments may be emailed to the author, Robert V. Green, at aheadofthecurve@briefing.com
