The Super Committee deadline is a week away. But whether the Super Committee succeeds or not is actually not that important. Either way, we’re going to see $1.2 in spending cuts. The real question: Is $1.2 trillion in cuts is enough? This post shows why $1.2 trillion is not enough and just delays an inevitable day of reckoning that is required for the U.S. to avoid becoming like Greece or Italy.
Over the next week, the Super Committee must find a way to reduce the U.S.’s 10-year cumulative deficit by at least $1.2 trillion. The deadline actually is 48 hours before November 23, which gives the Congressional Budget Office (CBO) time to officially score the plan.
If the Super Committee fails, it will not result in a government shutdown as a consequence of hitting the debt ceiling. Automatic spending cuts totaling $1.2 trillion over the next decade will start kicking in beginning January 2013, or cuts agreed upon by the Super Committee will kick in. The big unknown, however, is whether the $1.2 trillion in cuts is enough to put the U.S on a stable fiscal course.
In an unusual news conference Wednesday, House and Senate Democrats and Republicans urged in December 2010 by the Super Committee to go for $4 trillion in cuts. That was the target proposed by the President’s National Commission on Fiscal Responsibility and Reform (the “Simpson-Bowles” commission). Where are they getting these numbers and what’s the magnitude of solution that we should be rooting for?
To get a handle on the numbers the logical place to look is CBO's latest baseline federal revenue and spending projections. Prepared last August, it incorporates the provisions of the Budget Control Act of 2011—the product of the debt-ceiling battle.
There the CBO projects federal revenues and spending looking out through 2021. As the chart below shows, CBO must forecast GDP growth as well.
Noteworthy among CBO’s assumptions in these projections is that nominal GDP will grow at a +4.7% compound annual growth rate in the decade ahead, 2012-2021, compared to +4.0% actual growth over the past decade, 2001-2011. Perhaps it’s a reasonable assumption, but is it too optimistic? This is a key assumption because tax revenues are tied directly to GDP growth, whereas spending is not.
Another key assumption CBO makes on the revenue side of its baseline forecast is that present law is extended forward, which is to say that the temporary extension of the Bush tax cuts terminates (the tax cuts are not further extended), which results in a jump in tax revenues (under a static tax revenue analysis).
Noteworthy among CBO’s baseline spending assumptions, again, pursuant to current law, is that Medicare reimbursement to physicians will be substantially cut. That assumption is clearly unrealistic.
A look behind CBO’s baseline outlays curve shows that all of the growth in spending in excess of GDP growth comes from the entitlements — Medicare, Medicaid and Social Security — all growing well in excess of +5%.
Now take a look at the picture below. It compares CBO’s baseline revenue and outlay projections as a percent of GDP and the projected cumulative deficit looking out a decade is $4.7 trillion. Projected revenues as a percent of GDP trend steadily higher from the 20% mark, compared to the historic average of roughly 18%. In other words, as entitlement spending takes an ever-increasing share of GDP, tax revenues are assumed to simply keep up. And, this is the crux of our nation’s debt and spending problem.
What if, on the other hand, we went with an assumption that tax revenues as a percent of GDP were legislated to revert back to the historic 18% mark, as some have suggested should be done? The chart below shows would result. The cumulative 10-year deficit assumption would hit $8.3 trillion!
Alternatively, what if the tax code were modified to result in tax revenue equal to 20% of GDP, a new, higher plateau, on average than the 18% historic mark? Under this scenario the cumulative 10-year deficit assumption would be more than $4 trillion, as illustrated below.