could federal spending be capped at 20 percent of gdp? should it be?

More Slides fromEd Dolan’s Econ Blog

http://dolanecon.blogspot.com/

Could Federal Spending be Capped at 20 Percent of

GDP? Should It Be?Posted January 13, 2011

Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics

classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishers.


http://creativecommons.org/licenses/by-sa/3.0/us/

http://www.bvtpublishing.com/disciplines.php?Economics

Posted Jan. 13, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

The 20 Percent Solution

One proposal for resolving US budget problems is to cap federal spending at 20 percent of GDP

20 percent is approximately the average level of federal spending during the post-World War II period, up to the beginning of the present crisis

Congressman Mike Pence (R-Ind.) is among the backers of the 20 percent solution, which he has packaged in the form of a proposed Spending Limit Amendment to the Constitutionhttp://mikepence.house.gov/index.php?option=com_content&view=article&id=3946:sla-page&catid=86:sla&Itemid=109


http://mikepence.house.gov/index.php?option=com_content&view=article&id=3946:sla-page&catid=86:sla&Itemid=109

http://mikepence.house.gov/index.php?option=com_content&view=article&id=3946:sla-page&catid=86:sla&Itemid=109


Past vs. Future

Backers of the 20% solution contrast past spending levels with future projections

To understand the proposal, we need to look in more detail at the past and future lines on this graph

Chart source: http://mikepence.house.gov/index.php?option=com_content&view=article&id=3946:sla-page&catid=86:sla&Itemid=109


Disaggregating Past Spending

Not all components of past spending have behaved alike

The discretionary component of spending (defense, education, law enforcement, highways, etc.) has been on a long downward trend for several decades

Unless something else changed, a 20% spending cap would require continued decrease of the discretionary component


Defense vs. Non-defense Discretionary Spending

Within discretionary spending, the defense and non-defense components have played tag over the years

When defense spending has fallen, non-defense spending has tended to rise, and vice versa

Over time, both components have generally trended downward


Net Interest

Net interest on the national debt has averaged around 3 percent of GDP over time

In the mid-2000s, it fell to about half its usual levels due to Unusually low interest rates Brief budget surpluses during the late

Clinton administration During this period, low interest costs

relieved pressure on discretionary spending

However, interest outlays will return to their usual 3% of GDP, or above, in the coming decade


Entitlements

While discretionary spending has fallen as a percentage of GDP, entitlements (mostly social security and Medicare) have grown from 6 percent of GDP in 1970 to over 10% in the mid-2000s.


Aging US Population

Growth of entitlements is largely driven by demographics By 2050, the share of the US

population 65 and older will nearly double compared with 2010

The share 85 and older, heavy consumers of Medicare services, will more than double

In order to cap social security and Medicare spending at their current shares of GDP, benefits per person would have to be cut sharply


Could Spending be Limited to 20% of GDP?

Could spending be limited to 20% of GDP? Probably yes, using some set of measures like this:

Reduce discretionary spending to its pre-9/11 level of 6.3% of GDP

Within discretionary spending, decide between large cuts in defense, with withdrawal from foreign deployments, or else cut deeply into the muscle, not just the bone, of education, law enforcement, research, infrastructure, etc.

Cap entitlements at 10% of GDP by converting social security and Medicare to means-tested programs for only the neediest Americans

?


Should it Be Done?

The bottom line: Holding federal spending to 20% of GDP would be

possible, but it would mean a gradual decline to a pre-1930s level of social safety net and third-world quality of defense, education, and infrastructure

Maintaining approximately the level of government services provided in the late 20th century would require total federal spending to rise well above 20% of GDP

?

Take your choice—but don’t pretend you can have it both ways!

could federal spending be capped at 20 percent of gdp? should it be?

Business