We don't have a revenue problem. We have a spending problem.
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With the ongoing debate surrounding tax reform, the budget and a potential government shutdown, along with outcries from the left about massive revenue losses, it’s time we remind our policymakers that we don’t have a revenue problem, we have a spending problem.

Using data from the latest Congressional Budget Office (CBO) report on the budget and economic outlook, we can begin to identify the underlying problems behind our federal fiscal imbalances. The projected fiscal shortfall increased to $587 billion in 2016 from $438 billion in 2015. This year, the deficit is projected to fall to $559 billion and again to $487 billion in 2018.

However, as the graph below illustrates, the deficit is set to skyrocket exponentially from 2018 onwards.

 

While fiscal restraint has been increasingly practiced in discretionary spending, growth in spending for Social Security, Medicare and net interest will heavily outstrip any growth in revenues with the deficit set to reach 5 percent of GDP by 2027.

Discretionary spending is projected to continue shrinking to its lowest level since 1962 relative to the size of the economy, while an aging population and rising healthcare costs continue to push outlays for mandatory programs through the roof.

The following chart illustrates how the federal deficit would change over time if, starting in 2017, mandatory spending was increased in line with the rate of inflation. This is based on the assumption made by the CBO and the Federal Open Market Committee (FOMC)  that inflation is expected to increase at a rate of 2 percent over the medium-to-long term, in line with the Federal Reserve’s inflation target.

 

The new administration often attempts to make the case that any increase in the deficit will be counterbalanced by higher rates of economic growth. On the assumption that the U.S. economy grows at a robust annual rate of 3 percent annually over the next 5 years, we can see how such a scenario would impact the size of the federal deficit in the following chart.

 

Even with a robust rate of economic growth at 3 percent, the federal deficit will only be slightly smaller in the long run compared with a growth rate of 2 percent. To illustrate the scale of our fiscal imbalance problem, the final chart depicts what the federal deficit will look like if mandatory spending is tied to inflation and the economy grows at an average annual rate of 3 percent. 

Whoever is in power, closing the federal deficit is a crucial task that should be politically non-negotiable.

The economic impacts of an ever-increasing national debt will be crippling for future generations, with federal debt held by the public due to hit 90 percent of GDP over the next decade.

As federal borrowing reduces national savings over time, the nation’s capital stock will ultimately be smaller, meaning that both productivity and income will be lower than would be the case if the debt was smaller.

Furthermore, with a large and growing debt burden, the likelihood of a financial crisis in the United States is greatly increased as investors become unwilling to finance the government’s borrowing.

Policymakers must recognize this problem for what it ultimately is: a spending problem. Until this problem is properly addressed in a manner that does not undermine the dynamic and competitive nature of the economy, this great political-economic risk will remain. 

 

Jack Salmon is a Washington, D.C.-based researcher focused on federal fiscal policy. Salmon holds an M.A. in political economy with specializations in macroeconomics and comparative economic analysis from King's College London. 


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