The Math Is Easy, Doing It Is Hard

Tim Pawlenty got some attention the last few days with his economic plan.  In a nutshell, his plan is to cut taxes in order to rev up the economy to a 5% growth rate and embark on a 6 year plan to cut spending.  The goal in the spending cuts would be trim 1% per year for 6 years.

Governor Pawlenty is on the right track.  First and foremost, we need a growth economy if we are ever going to dig out of the hole.  It is very difficult to ever balance a government budget with spending cuts.  I did a lot of research on this issue in the the late 1980's when President George H.W. Bush proposed what he called the "flexible" freeze" in the 1988 Presidential campaign.  He took a lot of abuse from the liberal left and the mainstream media about the concept but the numbers do work.  However, rarely is there any political will or leadership to even freeze government spending let alone cut it modestly.  The President Father Bush gave up on negotiating what he needed in spending cuts with the Democrats in Congress and cut a deal with them that included tax increases as part of a grand bargain on the federal budget. 

In doing so he violated his "no new taxes" pledge from the 1988 election.  Of course, he never got anywhere near the spending cuts that the Democrats promised but we got the tax increases.  He lost in 1992 and the Republicans learned to never trust Democrats again.  The result-the budget gridlock we have today where Democrats will never agree to any spending cuts and Republicans will never agree to any tax increases.

Let's look at the hole we are facing right now.  We are expected to have $2.2 trillion in revenues in fiscal 2011.  We are expected to spend $3.8 trillion.  That is a $1.6 trillion deficit.

Revenues grew about 10% per year in the 1970's but revenue growth was closer to 7% per year in the 1980's and 1990's.   Let's look at where revenue can realistically be if we can grow revenues at 7% between now and 2018.  This should be easily achievable under the most conservative economic growth calculations based on history.

Revenue growth @ 7%= $3.5 trillion in 2018

To put this into further context, we brought in $2.5 trillion in receipts in 2008 before the current economic downturn.  From this baseline, to achieve $3.5 trillion in revenues in 2018 only requires a 10-year revenue growth rate of about 3.5%-half the historical rate of revenue growth.  This should be realistic.

Since we are spending $3.8 trillion in 2011 we would have to freeze all spending at 2011 levels and find another $300 billion to cut to bring the budget into balance in 2018.  It sounds pretty simple but it means no spending increases on anything.  If gas prices go up on the gas for the government car, find the money somewhere else in the budget.  The same for food prices for food stamp recipients.  Those new entrants to Social Security and Medicare?  We are glad to have you but current recipients are going to have to take a cut to pay for you.  Pay increase for the military-no way.  We are talking about a total freeze.

If you can get the economic growth rate up so that receipts grow at 10% like they did in the 1960's you have the potential to grow federal receipts to the range of $4.3 trillion by 2018.  This makes the job considerably easier but spending still can only increase at around 1.75% per year.   There must be no growth in any programs except for these small inflation adjustments.  Any new programs are out of the question like health care reform or other extensions of the welfare state.  Most likely, the extra spending room under this scenario would be needed to just pay the increasing interest burden on the national debt.

The simplest way to look at the problem is that we are currently only collecting about 60 cents for every $1.00 we are spending.  We are borrowing (more accurately, printing the money, right now) the rest.  The only way to solve the problem is for revenue to grow faster than spending for an extended period of time.  If  revenues grows 10% next year and we hold spending constant, the 60 cents becomes 70 cents and we are now only borrowing 30 cents to cover the annual shortfall. Do it a second year and you have 77 cents of revenue and you are only borrowing 23 cents.  By the fifth year, you are balanced.  Pawlenty is trying to do this over 6 years.  It is a good goal but most economists think it is overly optimistic.  However, the concept is the sound.  Grow the economy and government receipts much faster than spending.

The bottom line is that we need to get the economy going and we need for it to fuel increased revenue growth to get anywhere near a responsible federal budget.  At the same time, we need to cap total spending where it is for the forseeable future or only allow for increases in the very low single digits. For example, if we can get 7% revenue growth and hold spending to 2% (a 5% differential) we can get there but it would take a little more than 10 years of this type of discipline.

Pawlenty has shown us the path.  The math is easy.  Doing it is hard.  However, we better get on it.  It does not get any easier with every passing day.  It just gets harder and more painful.