Wednesday, January 27, 2010

The Running Joke on the Taxpayer

In the run-up to tonight's State of the Union speech, the media have been reporting that President Obama will call for a "spending freeze" on discretionary spending. In plain English, this means that Obama will call for "freezing" the spending of the portion of the budget that Congress has not already committed to spend (e.g., defense, education, transportation), while allowing entitlement spending (Social Security, Medicaid, Medicare) to continue to grow at unsustainable rates.

Although not a completely meaningless gesture, it will have minimal real effect as illustrated by the chart below. If entitlement spending is allowed to grow as projected, it will consume all federal revenue by about 2052, crowding out all discretionary spending. Of course, federal government will reach a crisis well before then because much discretionary spending is not truly optional. Even The Washington Post has noted that the proposed "freeze would shave no more than $15 billion off next year's budget...barely denting a deficit projected to exceed $1 trillion for the third year in a row." (link)

Substantially raising taxes to cover the increasing spending is not a viable option for at least two reasons. (1) High taxes are already a drag on the economy. Raising them enough to pay for entitlement spending would send the economy into a downward spiral, which would ultimately reduce tax revenue. (2) In the modern world, governments have found it nearly impossible to extract more than 20 percent of GDP from their countries, regardless of how draconian their tax codes. The U.S. tax code has already almost reached that limit.

Adding another dimension to the joke, "spending freeze" in Washington usually doesn't mean the same thing as it does outside the Beltway. In federal budget speak, a "freeze" means increasing spending based on inflation and population growth (or other factors build into the budget baseline), but not adding any more spending on top of the automatic spending increase. In the real world, families cannot automatically increase their spending to account for inflation or a new baby, but then few people would ever claim that Congress lives in the real world.

Chart source:

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