Blog Department – April 22, 2011 |
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The Blog Department is our occasional expression of opinion. Compared with Timely Topics, the Blog Department ventures into broader topics which may be more controversial. For this writing, we'll amplify on the Standard & Poor's (S&P) warning about the U.S. debt rating and attempt a summary exposition about the very hot topic in our nation's capital, namely how to reduce current and projected Federal deficit spending. Salient background information and observations about the S&P outlook revision to "negative" from "stable" are as follows:
Turning next to the hotly debated subject of deficit reduction, it is clear this topic has interested the Blog Department for quite some time. Last year at this time we suggested the DVD "I.O.U.S.A." as highly recommended watching. It is available from Netflix and we assume many video stores. Though getting slightly dated, this 2008 documentary provides an excellent review of the growth of deficit spending in our country, presents causes, and projects the future, which is truly alarming and unfair to today's young people. This terrain may not be new to you, but the DVD presents its case very clearly and includes, as an added feature, video of a discussion of the film and its content by a panel that included Warren Buffet, the heads of AARP and the Cato Institute, and the filmmakers. The DVD and panel discussion are certainly a call to action that is finally being heard. In a similar vein, a year ago the Blog Department indicated that the Wall Street Journal had recently reported that debt levels of the world's leading developed nations were expanding rapidly. According to the International Monetary Fund, sovereign debt of Canada, the U.S., U.K., Germany, France, Italy, and Japan was up over three times levels in the 1970's as a percentage of GDP. Further, the level projected for 2010 represented the highest debt-to-GDP level since 1950, when war-battered nations were still paying down the cost of World War II and the subsequent rebuilding of Europe and Japan. A global sampling of deficit spending and gross debt as a percentage of GDP is shown below (current sovereign debt ratings are in parentheses; data are from the International Monetary Fund):
It is noteworthy that the U.S. has the highest annual deficit figure and the highest gross debt other than Japan. The estimated 2011 U.S. budget deficit is $1.645 trillion, and the U.S. debt now stands at $14.219 trillion, nearing the currently authorized debt cap of $14.294 trillion. The debt represents a staggering $46,000 each for every man, woman, and child in the U.S. In case there's any confusion about nomenclature, deficits are typically for annual periods and occur when expenditures exceed revenues. Over the past 30 years, only four (from 1998-2001) resulted in surpluses; the peak was in 2000, when revenues exceeded expenditures by about $236 billion. Gross debt is essentially the accumulation of past deficits; it is projected to continue to increase dramatically in future years due to on-going annual deficits in excess of $1 trillion in 2012 and averaging $500 billion every year over the next decade according to projections by the Office of Management and Budget. According to president Obama, in his recent speech on the deficit, "By 2025, the amount of taxes we currently pay will only be enough to finance our health care programs, Social Security, and the interest we owe on our debt. That's it. Every other national priority – education, transportation, even national security – will have to be paid for with borrowed money." So that's the projection unless something is done. And something must be done – we can't continue to live so far beyond our means. This realization is now front and center on both sides of the aisle in Congress and at the White House. That's good, but Democrats and Republicans so far have vastly different action plans to tackle growing deficits. They have major disagreements over tax and health care policy (see below). Before looking at the competing deficit reduction plans, let's quickly review the composition of federal government spending at present. Around two-thirds of our budget is spent on Medicare, Medicaid, Social Security, and national security. Programs like unemployment insurance, student loans, veterans' benefits, and tax credits for working families take up another 20%. What's left, after interest on the debt, is just 12 percent for everything else. That's 12 percent for all of our other national priorities like education and clean energy; medical research and transportation; food safety and keeping our air and water clean. By the way, we're not generally worrying much about who's to blame for this problem of increasingly, dramatically living beyond our means as a nation; the future is what matters. In many respects, we're all to blame, and essentially, no one in particular is to blame for the way this century has begun: the Internet bubble popped, destroying billions in paper profit; September 11 led to a "war" on terrorism, prompting two lengthy, costly wars in Iraq and Afghanistan; and a real estate/financial crisis in the U.S. and Europe precipitated a global stock market crash, both of which in turn led nearly to a repeat of the Great Depression, averted only by massive government deficit spending to prop up the world economy. If there is any specific blame to lay, especially in retrospect, it would be one major contributor to current deficits, namely a major new entitlement program. The Bush administration and Republican Congress acted rather atypically of Republicans by enacting Part D of Medicare, which requires huge and increasingly expensive subsidies of prescription drug costs of senior citizens. Finally, we could blame politicians in general, many of whom have worried more about getting re-elected than making tough decisions unpopular with special interests and just plain regular voters. In the interest of brevity, we'll summarize the competing Republican and Democrat plans to reduce the Federal deficit. Perhaps the Blog Department will go into additional detail in the future. We also warn that we haven't become experts. We'll try to describe and comment as objectively as possible. Finally, we see that each of the competing plans is rooted in the core values and constituencies of each of the parties. The Republican plan was drafted by House Budget Committee Chairman Paul Ryan and subsequently passed by the Republican-controlled U.S. House of Representatives on April 15th. The vote was almost completely along party lines. The plan relies entirely on spending cuts to produce a projected $4 trillion decrease of deficits over 10 years. Major savings are in the area of entitlements. The plan ends fee-for-service Medicare in favor of subsidized private insurance plans. Medicaid also receives a makeover by transforming the federal-state health program for the poor and disabled into a system of block grants for the states. Finally, the plan includes $1 trillion in tax cuts for wealthy Americans to stimulate job creation via "trickle down." In his speech April 13, President Obama's plan became the leading deficit reduction plan for Democrats. He declared it a balanced approach and projected savings of $4 trillion over 12 years. The Obama plan makes no major changes in the existing Medicare and Medicaid framework and builds on last year's Democrat-sponsored health reform legislation. He plans to use purchasing power to cut spending on senior's prescription drugs, to increase efficiency and accountability from Medicaid, and to significantly cut defense spending. Finally, in contrast to Congressman Ryan's plan, the Obama plan would increase income taxes on wealthy Americans for about one-third of the 10-year savings. Criticism of each plan has been loud and partisan as expected. Ryan's plan has been berated as lowering the government's health bills by asking seniors and the poor and disabled to pay them instead (because Medicare premium subsidies are not projected to keep up with medical cost inflation, and block grants will gradually transfer Medicaid costs to states unable to absorb them). The Wall Street Journal described it as "an unapologetically conservative document." The most vitriolic criticism from the blogosphere calls Ryan's plan "reverse Robin Hood." Obama agrees, saying that it "asks for sacrifice from those least able to afford it." Likewise, criticism of the Obama plan abounds. Mitt Romney called the plan "too little, too late" and lacking in "true reform" of federal entitlement programs. Ryan declared the plan full of "dramatic inaccuracies." He also argues that rising health care costs are the most important driver of deficit spending, and that Obama's health reform and budget plan fail to address the problem. Finally, conservative economists argue tax increases will not really lead to higher Federal revenues and will stifle innovation, risk-taking, and job creation. As a quick footnote (because almost all blue-ribbon studies go in the trash bin), President Obama appointed a bipartisan Deficit Commission last year. Its report perhaps represents a middle ground between the current Republican and Democratic plans just described. It did make hard choices, putting many sacred cows on the chopping block of true tax reform and spending reduction. It should be noted the Commission's report did not achieve anything like consensus among its own 18 members. In case either side boasts too much about what its plan accomplishes (they both cut the deficit by $4 trillion), it's important to apply a little perspective. The $4 trillion is indeed a big number, but it amounts to "only" about $350 billion per year versus projected deficits averaging $500 billion. Accordingly, the plans reduce but don't eliminate deficit spending and thus make no dent at all in the gross U.S. Federal debt outstanding, which continues to grow. We can't predict whether ambitious deficit reduction will emanate from a Washington so divided and hyper-political. We hope so, but we're less than optimistic. We hope you will let your voice be heard. Study the Ryan plan, the Obama plan, and that of the bipartisan Deficit Commission. They entail dramatic affects on you and future generations. For example, Obama has couched his presentation as a much different vision for the future of America. We recommend you reflect on your own vision and on the following as you consider how you want to lobby your representatives in Congress:
To conclude, even before the Great Recession, it became clear to our nation's financial planners as a group and those with a similar perspective in the media that the vast majority of older Americans were woefully unprepared financially for retirement. As a corollary, many of the younger generation appeared to be following in their parent's footsteps. This condition is both voluntary (overspending/lack of saving) and involuntary (job loss/sickness/house devaluation/under-education). We believe this condition, this reality, must be considered in any reasonable discussion of deficit reduction. |
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