The table to the right compares the twenty year (2011 through 2030) cumulative Federal spending in trillions of dollars under two different scenarios.  Just Keep Borrowing shows what the government will spend if we stay on our current course.  We Can Fix It shows how spending will change if we implement the three steps outlined above.  Note that the largest single source of savings is the reduction in the Interest on the Debt.

If instead we can grow GDP at a 7% annual rate and keep the deficit to 2%, the Debt shrinks to 40% of GDP in 2030.  We get essentially the same result if we halve the growth rate and run a deficit of 0%.

If we grow GDP at a 7% annual rate and run zero deficit, the Debt will fall all the way to 23% of GDP by 2030.

"Slow and steady wins the race."

- Aesop

In the 60 years from the end of World War II to just before the current economic crisis (1948 thru 2007), the effective annual nominal GDP growth rate (real economic growth plus inflation) was 7% and the effective annual budget deficit ran at 2%.   Let’s take a look at a couple of projections...

We Can Fix It

As Americans, we have been overspending and our politicians have been over-promising for decades.  Like a person who looks in the mirror and finally stops denying that they are seriously overweight, as a country we need to make significant lifestyle changes.  The budgetary equivalent of a crash diet might make us feel better temporarily, but its very likely to do more harm than good in the long run.  Instead we need to slowly and steadily rein in government excess so that we don’t throw a fragile economy into another tailspin.

Over the past 40 years, federal spending has averaged 21% of GDP while revenues have averaged 18.1% of GDP.  This 2.9% gap between revenue and spending has driven the Federal Debt Held by the Public up from $283 Billion in 1970 to $12 Trillion today.  If we don’t take decisive action soon, spending will average 26.2% of GDP over the next 20 years while revenues will  average 18.6%.  By 2030, the debt will balloon to $48 Trillion. 

Step 1:  Reduce the rate of growth in health care spending to match the rate of growth of the overall economy.

The United Stated currently spends twice as much per person for health care as other western democracies (Australia, Canada, France, Germany, Japan, Norway, Sweden, and the United Kingdom) and yet we have the highest infant mortality rate (80% higher than their average) and the lowest life expectancy (2.6 years lower than their average).  We are throwing away a lot of money to get inferior outcomes.

If you look at per capita income plus per capita health care spending in the United States, over the last 50 years, the sum is an amazingly constant 75% of GDP (Std Dev = 1.24%).  Per capita spending on health care has increased by 423% in real dollars while per capita income has only increased by 64%.  If we continue on the current path, real wages will only increase by 7.6% in the next 25 years while health care spending will increase another 163%.  Essentially all improvements in productivity will go to health care and none will go to improve the standard of living of the average American.  That’s if health care grows at the same rate relative (+2.5%) to the overall economy for the next 25 years as it has for the last 40 years.  Even if we limit health care growth to 1%, real wages will only increase by 32% in the next 25 years while health care spending will increase another 85% to $15,567 per person in 2009 dollars.  We can’t compete in a world economy at this rate!

Step 2:  Reduce the rate of growth of all federal spending other than Medicare, Medicaid, and Social Security to the rate of inflation measured in the overall GDP.

Any bureaucracy becomes progressively more inefficient over time unless some outside agency imposes discipline.  Private corporations routinely give their existing operations cost reduction goals to drive improved efficiency.  We need to do the same for the Federal Government.  Current operations should be expected to reduce their budgets every year by the rate of inflation or even inflation plus 5%.  The funding this frees up can be used to drive initiatives that make the United States a more effective global competitor.

Step 3:  Increase federal revenues by 3% to cover the growth in Social Security benefits over the next 25 years.

One way to achieve this would be to collect Social Security Taxes on all Earned Income with the tax rate for earnings over the income ceiling ($106,800 in 2010) set to 50% of the rate below that ceiling.

We Have A Choice

It’s going to take serious action to dig ourselves out of this hole.  We have to make fundamental changes in our expectations of what government will and won’t do and in what we are willing to pay for.  The problem is so large that we must accept that we all have a role to play in solving it.  In the words of Benjamin Franklin, “We must all hang together, or, most assuredly, we shall all hang separately.”  Four things are undeniably clear:

1. We must protect and nurture our economy.  Real economic growth is the only way out of this mess.  This means the creation of productive, well paying jobs.  The longer the current economic slowdown lasts and the deeper it is, the bigger the problem, the greater the danger, and the more painful the cure.
   
2. We must change our health care spending curve.  One option is to enable market forces to work.  The alternative is to ration health care and to limit the treatments to which people are entitled.  As long as consumers are insulated from the true costs, demand will skyrocket beyond our means.  You can’t repeal the Law of Supply and Demand any more than you can repeal the Law of Gravity.
   
3. We must rein in spending.  We can run a small annual deficit - at most about 2% per year - over a long period of time when our economy is growing, but our current trajectory isn’t sustainable and will lead to disaster.
   
4. Some revenue increases may be required, but this must be done very carefully to ensure that any gains aren’t cancelled out by the damage done to employment and to overall economic growth.
   

Keep the graphic at the right in mind when anyone proposes a plan to solve our Debt Crisis.  If they can’t explain how that plan ensures economic growth and controls the deficit, it isn’t a plan, it’s a fairy tale.  Fairy tales are for children.  We all need to start acting like adults to ensure the America that our children and their children deserve.