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Balancing the federal budget hard in the short run; policies will be key

Published: Tuesday, March 5 2013 1:30 p.m. MST

"The National Debt Clock " is displayed on the side of a building near an Internal Revenue Service office in New York, U.S., on Thursday, July 14, 2011.

Scott Eells, Bloomberg

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Fiscal cliffs, sequestration, debt ceilings. How hard is it to balance the federal budget? While conceding that unexpected events do occur that can cause increases or decreases in revenue and expenditures, let's spend this column trying to set a plan that would balance the budget if nothing too unexpected happens.

Trying to accurately forecast expenditures and revenues is notoriously difficult. So I will not try to be too precise. Rather, let’s focus on balancing the budget in very rough terms. As a baseline, let’s take the actual revenues and expenditures from the most recent fiscal year, which ran from October 2011 to September 2012.

During this period, the federal government collected $2,469 billion in taxes and other revenues and spent $3,796 billion for a deficit of $1,327 billion. To balance this budget the federal government would have needed to spend 35 percent less than it actually did, or collect 54 percent more revenue. That’s a pretty big gap no matter how you look at it.

Part of the problem is that the economy is not very sound right now. Unemployment is high and underemployment is even higher. Certainly the U.S. economy is not producing as much income as it is capable of doing. Were we in better economic times, there would be more people earning income and therefore paying taxes. Also, fewer people would be receiving unemployment benefits and other forms of welfare assistance, so expenditures would be smaller. To make the task easier, let’s assume for the sake of argument we only care about having a balanced budget when the economy is doing reasonably well. Suppose that an economy closer to full-employment generated 15 percent more taxable income and cut income assistance spending in half. This is probably way too generous, but let’s err on the side of being able to balance the budget.

Under this scenario, income and payroll taxes rise by 15 percent, yielding $173.7 billion more in revenues and expenses fall by $290 billion, giving us a deficit of $863 billion. This is substantially smaller, but still a very big number. For comparison purposes, note that all federal military spending for the last fiscal year was $716 billion. All non-defense, non-entitlement spending was $882 billion. In other words, we could eliminate all defense spending and still not balance the budget even in good economic times. We could eliminate all other non-entitlement spending, i.e. shut down every federal department except the Social Security administration, the Veterans Administration and welfare assistance, and we would just barely be able to balance the budget

By contrast, spending on entitlement programs — Social Security, Medicare, veterans benefits, unemployment payments and welfare assistance — cost $1,682 billion, even with our assumed 50 percent cut in benefits to the poor and out-of-work. Note that to balance the budget on entitlements alone would require a cut in the neighborhood of 50 percent.

To eliminate our hypothetical $863 billion deficit we would need to cut spending across the board by 25 percent or raise tax revenues by 33 percent. If you think Washington is hyperventilating now over the sequester, imagine the response to either of these. Just for fun, suppose we could reduce entitlement spending by 10 percent and cut all other spending by 25 percent. This would bring the deficit down to $268 billion. This is still a huge number, but much better than what we are facing now.

Balancing the budget is very hard in the short run. The best hope for restoring a sustainable fiscal policy is to experience substantial economic growth. This is not horribly surprising; if tax revenues rise as the economy grows and expenditures can be kept in check so that they do not rise too rapidly, then eventually the budget will balance. This is exactly how the budget was balanced during the last few years of the Clinton administration.

The keys to a restoration of sound fiscal policy are to adopt policies that encourage more rapid growth of the economy and put meaningful and enforceable caps on expenditures, particularly entitlements. If we can’t do that, we are clearly on a long run path that will make us a much larger version of today’s Greek economy.

Kerk Phillips is an associate professor of economics at Brigham Young University. His views do not necessarily represent those of BYU.

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