Budget Battle (Clay Bennett, Chattanooga Times Free Press)

This article is Part II in a series of articles regarding government spending. To read the other related pieces, go to my U.S. Federal Debt: Sources and Solutions page.

Current status

Buoyed by their 2010 election success, the Republicans (who ran on jobs and the economy) have come to Washington to take it down. House Majority Leader, John Boehner (R-OH), has called for $100 billion in cuts to discretionary spending. Ron Paul has suggested not raising the U.S. federal debt limit, which would precipitate a worldwide crisis as the nation defaults on $14.3 trillion in debt. The fervor does not end there: Iowa’s Steve King (R) even suggested we should “kill the government” should Obama fail to kill health care reform – a move that would add up to $1 trillion to the federal debt after 10 years. The cuts that are proposed are standard: Education, unemployment benefits, housing and (oddly) also cuts to entitlements that are not discretionary spending. Social security and Medicare have long raised the ire of Republicans who would love to privatize the systems and transfer the wealth they contain to the private sector. The largest portion of federal discretionary spending, the military, remains largely untouched through all of this.

So where do all of these cuts leave the jobs issue? Well, the “strange” unemployment numbers from January were not strange at all. The current situation is entirely consistent with the viewpoint in which so many people have been unemployed for so long that not only are they no longer eligible for unemployment benefits, but they are also giving up their jobs searches. That is prior to pending federal budget cuts. The forecasts for the currently proposed GOP cuts will involve the layoff of around 650,000 federal employees alone and the decrease in federal spending will bring the total to nearly 1 million jobs after 2011. This clearly does not jive with the Republican platform of helping jobs, but it is entirely consistent with the Republican mantra of “small government” that has been sweeping that nation and is most evident in the events taking place in Wisconsin.

We will take a look at the history of federal spending in order to find new methods to reduce the federal budget deficits in a what that will encourage growth in the national economy.

U.S. Federal Spending

Fig. 1: US Federal Outlays and GDP since 1901 (Wikipedia)

The U.S. Federal Government spent roughly $3.6 trillion in 2010. Big Government, you protest? Figure 1 shows the history of federal spending since the beginning of the 20th Century (please note that this is a logarithmic plot). The spending on the federal budget has grown in rough proportion to the growth of the economy since the time of FDR, though GDP numbers were not taken prior to that time and the rate of growth of government spending was much lower prior to 1900 because government undertook very few social spending initiatives before then. Also note the point of inflection at 1980. Prior to that time, the rate of GDP growth was accelerating as opposed to the deceleration we have seen since Reagan’s election.

Fig. 2: U.S. Spending and Revenue in %GDP (Bureau of Economic Analysis, via Carried Away)

Figure 2 shows the full level of spending by state and federal governments in the U.S. as a fraction of GDP since the beginning of the Great Depression. It clearly demonstrates that while there is growth in spending during the expansion of the military and programs such as Social Security, the overall spending per GDP by states has held roughly steady since the early 1970s and in the federal government since the election of Ronald Reagan in 1980. This essentially means that the cost per person of the federal government would have remained constant since the early 1980s, provided that middle class incomes would have tracked with the growth of the economy. This has not been the case. As a result, federal programs since the time of Reagan have become more expensive for the middle class while the middle class receives fewer services.

Fig. 3a: Total U.S. Spending, 2010 (Congressional Budget Office, via Wikipedia)

Fig. 3b: U.S. Discretionary Spending, 2010 (National Priorities Project)

That last point on the middle class receiving fewer services is doubly demonstrated by the proportion of military spending relative to total discretionary spending. I will discuss that in a moment, but I will first make a side observation. While researching U.S. discretionary spending, I noticed that the spending is usually displayed either of two ways. The first is the “Federal Pie Chart” in Figures 3a and 3b that show the relative sizes of various categories of total and discretionary spending respectively. The second form of presentation can be found in Figure 4. In short, the portrayal of discretionary spending in either mode is almost always the same and it has the effect of creating a politically expedient frame within which to understand the data.

Figures 3a and 3b represent to shares of total and discretionary spending (respectively) that are spent on a number of different budget categories. This is useful if you were concerned about how much money is spent on programs such as entitlements like Medicare, Medicaid and Social Security or how much is spent on paying off interest on the debt. But the pie charts do not indicate what fraction of the “Discretionary Budget” in Figure 3a are actually spent on Homeland Security or other non-Department of Defense national security areas however. So one gets the impression that defense spending is not so large relative to the entitlement programs shown in 3a.

Figure 3b show us a little more detail, essentially expanding the blue and orange sections from Figure 3a. Here we see just how much of the discretionary budget is taken up by the military but it does not include, say transportation programs that are geared to beefing up Homeland Security. This leads one to the conclusion that military spending is somewhat lower than it really is.

Furthermore, the pie charts only represent funding from a single year. It is impossible to tell how much spending might have changed either from the previous year or from a time several decades ago. And if the accounting is done right, then as I mentioned in the previous two paragraphs, it is easy to give the impression that everything is normal and there are no imbalances in the budget.

Nor would we get that that impression if we were to look at the other way in which the data is displayed: Historically. Figure 4 shows the relative proportions of military and non-military spending, with the caveat that the data is broken down in essentially the same way that it was in Figure 3b (the Department of Homeland Security is not part of the Department of Defense). However, the earliest date for the data is very important. It occurs at a time when the U.S. was in an arms race with the Soviet Union and at a time when it was becoming actively involved in the Vietnam War. The center panel of Figure 4 gives the strong impression that defense spending is under control, but only because it ignores the times prior to 1962 (the 1950s and prior to World War II when the fraction of military discretionary spending was about 30%) when spending on defense was much lower. And keep in mind that we are not including all national security spending in the defense sector – a trend that became worse and worse during the 2000’s. In fact current national security spending comprises nearly half of the “non-defense” discretionary outlays.

The bottom panel in Figure 4 drives home another convenient point that mandatory spending is out of control as well, but this is only due to the fact that defense spending has been considered a high priority among neo-conservatives. But the story behind Figures 3a, 3b and 4 is that even among discretionary spending, the military is consuming a larger and larger share even while spending on social discretionary programs becomes more expensive for the middle class and even while the middle class is expected to carry an increasing responsibility for funding these programs.

Fig. 4: U.S. Military and Non-military Discretionary Funding since 1962 (Office of Management and Budget, via Congressional Quarterly)

Another thing to consider is that all of the social programs that make life easier and demonstrably improve the quality of life for people who live in the United States (i.e. Education, Income & Labor Security, the EPA, Transportation and the Federal R&D) make up a very small fraction of the budget overall.

The take away message here is that despite the initial outward appearances, Figure 5 (the misspelling in the Figure is due to the Economist, not me, though the numbers are sound) shows that discretionary social spending has been very squeezed as a fraction of GDP over the past 40 years, ending with a brief and temporary counterpoint that corresponds to President Obama’s stimulus package. This overall decline has been due to the tax cuts that we will discuss later on which have limited the amount of money that can be spent on social discretionary programs, out of deference to mandatory spending and defense and national security.

Fig. 5: Non-defense Discretionary Spending as a function of GDP (The Economist)

Things are no different in either the current Republican or Democratic proposals for the upcoming budget deal. Social discretionary spending, comprising a small fraction of the total budget, will take the biggest lumps in upcoming budget cuts. That means housing programs, unemployment benefits, research and development, infrastructure investments, clean energy and environmental protection are going to lose funding relative to continued spending on the U.S. Military. The Republicans are aiming for broad cuts of $100 billion to the $660 billion non-military discretionary budget but the cuts are not planned to go toward the national security components of that budget.
The Minnesota Independent has a brief summary of some of the expected cuts which correspond to a roughly 30-50% hit to social programs that are used by everyone in the country and the regulatory agencies that protect our physical and fiscal environments, while the military budget of $689 billion will remain virtually untouched even though the U.S. spends the same amount on its military as the rest of the world combined (Figure 6). Feeling safe yet?

Every gun that is made, every warship launched, every rocket fired signifies, in the final sense, a theft from those who hunger and are not fed, those who are cold and not clothed. This world in arms is not spending money alone. It is spending the sweat of its laborers, the genius of its scientists, the hopes of its children. This is not a way of life at all in any true sense. Under the cloud of threatening war, it is humanity hanging from a cross of iron.

–President and Five-Star General Dwight D. Eisenhower, From a speech before the American Society of Newspaper Editors, April 16, 1953

Fig. 6: World military expenditures of every nation in the world, 2009. The tall bar on the far left is the United States, which spends more than 6 times as much as its nearest rival, China. Click to access a larger version. (Global Security, via Think or Thwim)

Impacts of Federal Spending on the Economy

Despite conservative beliefs and mantras, government spending has a legitimate place in the national economy if for no other reason than the fact that, according to the U.S. Census, the U.S. federal government has 2.5 million employees in addition to the military which has 1.5 million active and 1.5 million reserve personnel. That corresponds to nearly 5.5 million total employees, not including part time civilian staff, and that corresponds to more than 3% of the U.S. workforce.

More importantly, Figure 1 shows that current federal spending is at a level of roughly 20% of GDP so it can act as a strong lever arm to encourage economic growth, industrial development, support workers wages and to develop public infrastructure, especially in concert with the government’s regulatory powers. Yet here is what House Speaker John Boehner (R) says about spending:

“This is where cutting spending will create jobs because it is going to bring greater fiscal responsibility here in Washington, DC, end some of the uncertainty, and allow jobs to be created in America.”

Even Cliffs notes will tell you that decreased government spending shrinks the demand for labor in the economy. During times of economic crisis, this can lead to a downward spiral because a smaller workforce leads less consumer purchasing that, in turn, leads to lower corporate profits and less investment and possibly more layoffs which feed back into the system. The Keynesian economic view argues that the Government can borrow money maintain spending levels despite a drop in tax revenue in order make up for the consumer demand that is lost to unemployment.

One could in principle spend money on just about anything, but the most effective approach is to make investments into public infrastructure that essentially build new efficiencies into the national economy that everyone can share in the future. This is the idea behind financial stimulus, but some forms of stimulus are better than others because some forms of spending allow the money to pass through more hands in the economy in a relatively short period of time and that encourages economic growth.

Mark Zandi, Chief Economist for Moody’s, published a study that modeled the effects of various forms of stimulus to see which would provide the greatest impact per dollar invested. You may find the results rather surprising in Figure 7.

Fig. 7: Effective rates of return on each dollar invested in various forms of stimulus (Moody's via Huffington Post)

Surprised? Perhaps it is because the best form of stimulus shown is investing in Food Stamps and Extending Unemployment Benefits! These are anathema to the laissez-faire Trickle Down Economics favored by the Republicans, who tend to be acolytes of Milton Friedman. The Bush Administration, in contrast, strongly favored Capital Gains Tax Cuts, Tax Rebates and Tax Cuts on the wealthy, in keeping with the notion of Trickle Down.

So why would food stamps be better stimulus than tax cuts on the wealthy? The reason is that poor people will spend the money as soon as they get it while wealthy individuals will typically save a windfall for a rainy day. In the latter case money is taken out of circulation so it does not typically provide a positive economic benefit. But there is another important benefit. When people become unemployed and can not feed themselves, they die. When that happens, not only does society lose their productivity, skills and knowledge that those people once had, but society also loses the investment it made to train and educate them. That was the situation in the United States during economic disasters like the Panic of 1893 and the early years of the Great Depression, before Roosevelt’s New Deal. Other forms of stimulus are not listed.

The military, for example returns roughly $0.40 on every dollar because every dollar spent on a bomb is a dollar spent on something that was designed to be wasted. Scientific research provides a quick infusion of cash with a return to the tune of approximately $1.60 on the dollar.

One is forced to wonder why the Bush Administration supported non-stimuli such as tax cuts because, despite the conservative propaganda, Friedmanian economics tends to lead to a reduction in tax revenues over the long term. (This is an indication that the middle class becomes poorer over time.) Nevertheless, the Friedmanians do (rarely) have a point. In the event of too much borrowing, there can be a set of diminishing returns. If the federal debt levels require steep payments on the debt, the government can respond by making money to pay it off. This results in depreciation, which if taken too far can drastically increase interest rates and lead to accelerated depreciation in the value of the dollar and a sticky mess for the economy: Stagflation. That was the situation during the 1970s during an economic slowdown that occurred while the U.S. was balancing the debt it racked up during the Vietnam War. War is expensive.

Another way of looking at this is that, as in Figure 8, various forms of stimulus act on the economy over differing lengths of time and some forms even have a longer lasting impact than others. These factors must be considered in preparing a viable stimulus package.

Fig. 8: Cumuluative Effects of Policy Options on Unemployment (Rachel Maddow Blog)

Obama’s stimulus package was considered by some economists such as Nobel Prize Laureate Paul Krugmanas too small to completely repair the economy, and the U.S. economy is still at risk for a double-dip recession as the stimulus has now worn off while unemployment remains quite high. Part of the reason for this is that the stimulus contained a combination of approaches including non-stimulative tax cuts due to political expediency. While enacting the stimulus package, Obama also failed to raise taxes on the wealthy, which would have given more budgetary cover for a larger stimulus package, but it is also unlikely that would have been accepted by Blue Dog Democrats who were already leery about the federal stimulus package.

Obama’s hands are now tied because of the size of the federal budget deficits due to the wars in Afghanistan and Iraq as well as the reduction in tax revenue due to the Bush tax cuts. Having missed his chance and having failed to include enough stimulus required to fix the economy, the U.S. labor force is now locked in a political game of prisoner’s dilemma. If Obama and the House Republicans can find a compromise, then everyone loses (in this version of the game, this is the best possible scenario), but everyone loses a lot if an agreement is not made soon or if Congress fails to increase the federal debt limit. In that case, the U.S. could eventually be forced to use money locked in the Social Security Trust Fund to pay off existing debt. This is considered a goal by some conservatives because it may force the privatization of Social Security.

What to expect from a short-term federal shutdown

Here we are: In a situation in which the recently elected representatives to Congress care far less about stimulus and investment into the economy than spending money on special interests – especially the anti-stimulative military – and ensuring that “Obama fails”.

So if the current budget impasse continues due to the stark divide between the emerging conservatism of the White House and the bottomless pit of nihilism of the Congressional Republicans, what are we likely to see in a short-term federal shutdown? The Minnesota Independent has summarized a 1999 Congressional Research Service report on past federal deadlocks. (Note, there is a typo in he Minnesota Independent report. The November 2005 shutdown should read November 1995.) A 5-day shutdown caused the furlough of 800,000 federal workers while a subsequent 21-day shutdown led to 284,000 furloughs and 475,000 others were forced to work in critical positions without pay. This of course means lost tax revenue for the government in addition to the extra costs that are incurred by the need to pay additional contract extensions and fees. (Cutting programs often results in similar additional costs.)

The Congressional Research Service also described the impact on the public:

“Health. New patients were not accepted into clinical research at the National Institutes of Health (NIH) Clinical Center; the Centers for Disease Control and Prevention ceased disease surveillance (information about the spread of diseases, such as AIDS and flu, were unavailable); hotline calls to NIH concerning diseases were not answered; and toxic waste clean-up work at 609 sites stopped, resulting in 2,400 “Superfund” workers being sent home.

Law Enforcement/Public Safety. Delays occurred in the processing of alcohol, tobacco, firearms, and explosives applications by the Bureau of Alcohol, Tobacco, and Firearms; work on more than 3,500 bankruptcy cases was suspended; cancellation of the recruitment and testing of federal law-enforcement officials occurred, including the hiring of 400 border patrol agents; and delinquent child-support cases were suspended.

Parks/Museums/Monuments. Closure of 368 National Park Service sites (loss of 7 million visitors) occurred, with local communities near national parks losing an estimated $14.2 million per day in tourism revenues; and closure of national museums and monuments (estimated loss of 2 million visitors) occurred.

Visas/Passports. 20,000-30,000 applications by foreigners for visas went unprocessed each day; 200,000 U.S. applications for passports went unprocessed; and U.S. tourist industries and airlines sustained millions of dollars in losses.

American Indian/other Native Americans. All 13,500 Department of Interior Bureau of Indian Affairs (BIA) employees were furloughed; general assistance payments for basic needs to 53,000 BIA benefit recipients were delayed; and estimated 25,000 American Indians did not receive timely payment of oil and gas royalties.

American Veterans. Major curtailment in services, ranging from health and welfare to finance and travel was experienced.

Federal Contractors. Of $18 billion in Washington area contracts, $3.7 billion (over 20%) were managed by agencies affected by the funding lapse; the National Institute of Standards, was unable to issue a new standard for lights and lamps, scheduled to be effective January 1, 1996; and employees of federal contractors were furloughed without pay.”

Some federal agencies such as those related to defense would continue to operate even under a government shutdown.

Coming soon

In the next segment, we will discuss tax policy in relation to the information that we have covered in Parts I and II. Stay tuned.

References and Links

The Economist: “Outrageous Cuts”

U.S. Census: Federal Government Civilian Employment

U.S. Department of Commerce Bureau of Economic Analysis National Income and Product Accounts

Wikipedia: List of countries by level of military equipment

Wikipedia: United States Federal Budget