$1 Trillion Deficits and the Crisis of the Entitlement State

– August 6, 2018

In case you have missed them since the early years of the Obama administration, the $1 trillion-a-year federal budget deficits are coming back, beginning with Uncle Sam’s new fiscal year for 2019, which starts on October 1, 2018. And they might not be going away anytime soon. Is it something to be worried about? Yes, it is.

Both the Congressional Budget Office in its June 2018, long-term budgetary projections and the Office of Management and Budget in its own budgetary report released in July 2018 forecast that starting in fiscal year 2019, there will be years of $1 trillion annual budget deficits facing the United States.

$1 Trillion Deficits for Years to Come

The OMB estimates that the budget deficit for the fiscal year that ends on September 30, 2018, will be about $890 billion. But for the next three years, the budget deficits go above $1 trillion a year: $1,085 trillion (2019); $1,076 trillion (2020); and $1,011 trillion (2021).

Then the OMB turns “optimistic.” For fiscal year 2022, the federal government’s budget deficit will be a mere $952 billion, and then it gently declines over the years after that; the OMB projects that 10 years from now, in 2028, the budget deficit will still be around $500 billion. (The Congressional Budget Office, on the other hand, forecasts $1 trillion deficits for every year to 2028 and beyond.)

But, of course, the deficits’ descending once again from the $1 trillion levels depends upon various assumptions made by the Trump administration. These include that annual growth in gross domestic product will be close to or greater than 3 percent over the next 10 years, that currently legislated expenditures will not be increased in the future, and that the economy will not experience a recession along the way that will reduce anticipated government revenue streams under current tax law.

“Hope and Change” or “Making America Great Again” = Big Government

The Office of Management and Budget is directly answerable to the president, and not too surprisingly the text accompanying the numbers glows with confidence and incorporates the rhetoric of Donald Trump.

That is, portions of it read like one of his campaign stump speeches: “President Trump will continue to work to ensure that there is free, fair, and reciprocal trade.” “While focusing on the economic health of the Nation, the Trump Administration continues to work toward getting the Nation’s fiscal house in order.” “President Trump’s policies are fostering a growing economy.” “The Administration will continue to work to … further strengthen this Nation.”

One can only wonder, How would America survive and prosper if whoever is the chief executive sitting in the Oval Office was not caring for and guiding us to national economic well-being? All hail the central planner-in-chief!

President Obama’s grand plan was for “hope and change.” President Trump’s grand plan promises “making America great, again.” In two or six years, the next occupant of the White House will, undoubtedly, have his (or her) own uplifting slogans and phrases meant to mark a planned legacy for America. (See my article “A Call for ‘Do-Nothing’ Presidents Without Legacies.”)

Government Spending Continues Out of Control

A constant with all who have been elected to this elevated political position for the last 90 years is that their administrations have left the government’s accumulated debt larger than when they took office (if not always as a percentage of GDP). President Trump is on track to do so too.

The Congressional Budget Office projects that total federal government revenues over the next 10 years, between 2018 and 2028, will rise from 16.6 percent of GDP to 17.5 percent, or a 5.5 percent increase. On the other hand, federal government spending, the CBO estimates, will increase from its present 20.6 percent of GDP to 22.4 percent, or an 8.8 percent increase over the coming decade.

What is and will be driving this increase in government spending and growing debt are the “entitlement” programs. Yes, the Trump administration is planning increases in defense spending, and Congress will, no doubt, go along with a lot of it. But it is the set of domestic redistributive programs — Social Security and the network of federally funded health care spending, and the programs related to them — that is the primary factor for out-of-control government expenditure.

During the coming 10-year period, government spending on Social Security will go up from 4.9 percent of GDP to 5.5 percent, or a 12 percent increase; the major health care spending programs of the federal government will rise even more, from 5.2 percent of GDP to 6 percent, or an increase of 15 percent.

Under the Trump administration’s optimistic forecast for the next decade, the cumulative increase in the federal government’s debt will be an additional $11.75 trillion, amounting to a total national debt by that time of over $33 trillion. (The CBO projects the total addition to the debt to be over $12 trillion during this period.) As a result, the national debt held by the public as a percentage of GDP will rise from 78 percent to 96 percent, according to the CBO.

Uncle Sam’s net interest payments, which now represent only 1.6 percent of GDP because of the artificially low interest rates the Federal Reserve has been maintaining for more than a decade, will go up to 3.1 percent of GDP by 2028, for a 94 percent increase.

The Congressional Budget Office, of course, has its own frequent forecasting misfires. Indeed, if the CBO’s annual and semi-annual budget calculations and projections for future GDP, for the levels of government spending and taxing, and for the sizes of the yearly budget deficits and overall growth in the national debt are looked over for, say, the last 20 years, they almost always have underestimated just how bad, in fact, the direction was going to be for the deficits and debt.

So it is not too much of a stretch to reasonably expect that the growth in government spending, taxing, and debt accumulation will be greater, all around, when the coming 10 years have reached their end than either the CBO or OMB is presently suggesting to the American people.

America’s Former Unwritten Fiscal Constitution

Government spending is out of control, and it has been this way for a very long time. But it has not always been. There was a time in American history when the U.S. government followed what James M. Buchanan (1919–2013) and Richard E. Wagner called in their book Democracy in Deficit (1977) the country’s “unwritten fiscal constitution.”

It was unwritten because there is nothing in the Constitution requiring or mandating that the federal government balance its budget on an annual basis. But for much of the 19th and early 20th centuries, that is what the government followed as its fiscal policy rule.

Why was this considered good governmental policy? A balanced budget meant government could not spend any money that had not been appropriated as taxes. This closely linked benefit with cost because any dollar spent would have to be matched by a dollar taxed from one or more of the taxpaying citizens.

If a politician running for public office offered to increase existing or introduce new government spending programs in some direction in the hope of winning electoral support, it was, at the same time, necessary to specify how much the government program was going to cost, how the tax money to fund it would be raised, and upon whom the tax incidence would fall.

There could be no free lunches. Any dollars of additional government spending meant many fewer dollars were left in some citizens’ private pockets to spend on some personal or business activity that would have been possible if those dollars had not been taxed away.

This required the citizens and taxpayers to make a clearer and more conscious decision as to whether they really considered what that politician was offering to be worth the cost in terms of less private sector financial discretion. Taxpayers might still vote for the policy, but a balanced budget made the government’s taxing and spending nexus far more transparent, similar to how when you pull a box of breakfast cereal off the shelf at the supermarket and know that if you buy it, there will be that much less money left in your pocket to buy something else instead.

You have to weigh (at the margin) whether the benefits from some extra mornings that start the day with a bowl of cereal are worth the cost of what you give up in the form of some alternative purchase you might make if you do not pay for the cereal.

Emergency Deficits and Budget Surpluses

There was one exception to an annual balancing of the budget, Buchanan and Wagner pointed out, and that was a “national emergency,” such as a war when the government might need extra revenues in a short period of time. But when the crisis had passed, it was expected that the government would then run annual budget surpluses to reduce the fiscal burden on the existing and future generations who otherwise would be left having to pay it off.

In the figure below, we can see that up until the Great Depression of the 1930s, the government followed the balanced-budget rule with exceptions for national emergencies. Following the borrowing during the War of 1812, the Mexican-American War of 1846–48, and the American Civil War of 1861–65, the government reduced spending and ran budget surpluses to move the total debt in the direction of zero as a percentage of GDP. In fact, during the presidency of Andrew Jackson in the 1830s, the national debt was practically paid off.

But since the 1930s, government budget deficits practically have been the rule rather than the exception. In the 73 fiscal years since the end of World War II in 1945, Uncle Sam has had budget deficits in 61 and budget surpluses in only 12. The total amount of the debt has been growing dramatically, especially since the beginning of the 21st century, and will not be helped by these forthcoming multitrillion-dollar deficits we are facing once again.

The Keynesian Rationale for Unbalanced Budgets, and Its Consequences

The main theoretical force behind this change was the Keynesian revolution. In his 1936 book, The General Theory of Employment, Interest, and Money, John Maynard Keynes (1883–1946) argued that free markets were open to unpredictable and prolonged periods of economic depressions and high unemployment, which only government fiscal and monetary “stimulus” could set right. (See my article “The Follies and Fallacies of Keynesian Economics.”)

Rather than balance the budget on an annual basis, Keynes argued, the government should balance its budget over the business cycle, with budget deficits in bad years of depressions balanced by budget surpluses in good years of high employment and economic growth. Since the U.S. economy has not been in an economic depression for six of the last seven and a half decades, why has the federal budget been in almost-perpetual deficit?

Buchanan and Wagner argued that by nullifying America’s unwritten fiscal constitution, the floodgates have been opened to unending justifications to never rein in the size and spending of the government. Politicians always want to spend other people’s money as the financial grease to gain campaign contributions and win votes on Election Day.

Special interest groups always want to use government to receive protection from competition and to benefit from redistribution of other people’s money to obtain income and profit margins they may not be able to honestly earn in the free play of the marketplace. Those who man the government bureaucracies always want larger departmental and agency budgets as the means for increased staffing and more promotional opportunities, along with expanded regulatory authority.

Once the annual balanced-budget rule was breached, it became possible for those holding political office or pursuing such office to offer more spending in the present for the voting support of special interest groups without having to either impose all the higher taxes that would be required to fund what is promised to be done or tell when or on whom any future tax burden will have to fall to make good on all the promises.

Budget Deficits and the Illusion of Something for Nothing

What better magician’s hat from which to pick a fiscal rabbit than to be able to spend, say, $1,000 on vote getting and governmental activities but give the impression that it only costs the voter-taxpayers $700 or $800. Who wouldn’t want to only pay $700 or $800 for something they consider worth $1,000? What a deal!

Of course, it still costs $1,000. It’s just that the difference between what the government spends and what it takes in as tax revenues ($200 or $300) is covered by borrowing from lenders in the private sector. They are promised a future interest return on the government loan that is equal to or more attractive than lending that same $200 or $300 to some private enterprisers — private businessmen who would have used that $200 or $300 (and the real resources it represents in the marketplace) to undertake a new investment project, or expand an existing business to increase the supply of consumer-oriented goods and services, or invest in new technologies and labor-saving devices that would lower costs of production so more, better, and less expensive goods could be offered to the consuming public looking to the future.

Government borrowing eats into and cuts down on private sector capital formation and productive use of some of the scarce resources in the society. Instead, resources are shifted to politically motivated employments that have little or nothing to do with what they might have been used for if guided by the entrepreneur’s profit motives of satisfying the actual demands of those same citizens in their role as consumers in the market.

When part of what government spends is done through deficit spending, it becomes an instance of Frédéric Bastiat’s “what is seen and what is not seen.” What is seen are the government activities that are only partly covered by actual taxes collected. That is the illusion of paying in taxes only $700 or $800 but getting in return declared government benefits of one type or another claimed to be worth $1,000. What is unseen are the lost private sector business- or personal-borrowing activities that will not be possible because the needed $200 or $300 is siphoned out of the financial market for government borrowing to make up the difference of what is required to fund the full $1,000 of promised government goodies.

The cost (in real resources and goods) of government activities in the present cannot be transferred from the future. The resources and goods are used now by the government and come from today’s production and supplies, and are transferred into government hands either through taxes or borrowing (or through inflation, which is a separate story). All that can be left to tomorrow is a financial lien on the taxpayers of the future to pay back to lenders in that future for goods, services, and resources that were borrowed and used in the past when the government first took out the loan.

Buchanan and Wagner were not the first to understand the deception created by deficit spending. For instance, an American economist, Dudley Baxter (1827–75), explained the danger from the perverse incentives created from a government’s ability to finance part of its expenditures through deficit spending. Said Baxter in his book National Debts (1871):

When money is raised by taxation within the year for which it is needed, the amount that can be raised is limited by the tax-enduring habits of the people, and must be as small as possible in order not to provide discontent [among the voters]. By the same reason it must be spent economically, and made to go as far as possible.

But when the money is raised by loans, it is limited only by the necessity of the interest [payment] not to be too large for the taxable endurance of the people, or provoking their discontent. Hence the limits of borrowing are about twenty times larger than the limits to taxation, and an amount that is monstrous as a tax, is (apparently) a very light burden as a loan. In consequence, borrowing is freed from the most powerful check that restrains taxation.…

When a loan is obtained the reason for economical expenditure is equally wanting, and borrowed money is commonly expended with much greater profuseness, and even wastefulness, than would be the case with taxes.

Net interest payments on the national debt are, for the current (2018) fiscal year, about 7.5 percent of total government spending, or almost $320 billion. But if interest rates continue to rise, the government continues to issue new annual debt, and it rolls over existing debt when it matures, the percentage of the government budget devoted to net interest payments on the debt will go up to 13 percent by 2028, according to the CBO, and the dollar cost will be close to $1 trillion for that year.

So rather than the government’s total deficit spending being $1 trillion, as expected in fiscal year 2019, that same amount will be just the net interest on the national debt a decade from now.

Restoring Balanced-Budget Rules and Changing Political Direction

This is why various proposals such as a constitutional amendment requiring the federal government to follow an annual balanced-budget rule, with any permitted short-term escape clauses coming with requirements that budget surpluses quickly follow to bring any accumulated debt down to zero as expeditiously as possible, are far more relevant and imperative than many seem to think.

Of course, the more fundamental reason behind this growth in government spending, in which the ability to borrow is one that makes the growth that much easier by hiding its full cost from the immediate view of the citizen-taxpayers, is the drift away from a shared philosophy of individual liberty, self-responsibility, freedom of association, and voluntary exchange.

A change in people’s political philosophy and attitudes is even more difficult to bring about, perhaps, than institutional restrictions on government deficit spending. Yet that longer-term change in America is essential if people are to think about whether it is the role and responsibility of government to redistribute wealth, extend subsidies to crony partners of that government in the private sector, provide a safety net from cradle to grave, and be the political paternalist who guides, prohibits, and commands how and for what people may live their lives.

Serious fiscal crises are coming in the years ahead for the “entitlement” state. The long-run consequences of a host of short-run policies that have accumulated over the many decades are finally facing the American people just over the political horizon.

It would be better if the problems were faced now, rather than when it all becomes noticeably worse. The institutional budgetary-rule changes should be introduced to make the illusion of something for nothing less easy to create. And a serious debate should really begin on the meaning of individual freedom, personal self-responsibility, market solutions to presumed social problems, and the role of government in society before it perhaps becomes too late.

Richard M. Ebeling, an AIER Senior Fellow, is the BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel, in Charleston, South Carolina. Ebeling lived on AIER’s campus from 2008 to 2009.