Our Real Deficit Problem Has Nothing to Do With Traditional Government

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We shouldn't be forced into cutting Social Security, Medicare or other social insurance by the delusion that government does one thing, has one size, or that it all must be slashed.

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In last week's column, I discussed the fallacy of focusing on the total size of the federal budget, either as a measure of anything meaningful or as a basis for making policy decisions. This week, I want to talk about how this fallacy is distorting the deficit debate.

The important point to start with is that the government does many different things, ranging from national defense to personal insurance. Each of those things affects people differently, and how much of it the government does--if anything--should be an independent decision, just like businesses make independent decisions about investment opportunities.

To make things simple, instead of looking at every little thing the federal government does, I'll divide it into three parts (excluding interest on the debt): Social Security, Medicare, and Everything Else.

Traditional government is getting smaller. Social Security and Medicare are getting bigger.

In 1960, the last full year of the Eisenhower administration, taxes were 17.8 percent of GDP and primary spending (excluding interest) was 16.4 percent. Social Security took in and paid out 2.2 percent. Medicare didn't exist. So Everything Else had a primary surplus, with taxes at 15.6 percent and spending at 14.2 percent.

In 2010, in the supposed age of "big government," spending on Everything Else was only 14.7 percent of GDP, and that was swollen by the recession and stimulus spending. By 2021, according to the CBO's alternative fiscal scenario (the pessimistic one), spending on Everything Else will be 13.0 percent--less than in 1960. Everything Else tax revenues--that is, everything except the Social Security and Medicare payroll taxes--will be 12.5 percent of GDP, for a primary deficit of only 0.5 percent. And that's assuming that all of the 2001, 2003, and 2009 tax cuts are extended indefinitely.

Now, we can have a debate about Everything Else: some people may want more defense, others may want more environmental protection, and others may want less of both and lower taxes. But the traditional government has been getting smaller and does not have a long-term deficit problem.

Social Security and Medicare, by contrast, are getting bigger and do have problems. In 2021, Social Security is projected to have income of 4.5 percent of GDP and outgo of 5.3 percent, for a deficit of 0.8 percent. Medicare is more complicated because it was never designed to be fully self-funding. But its dedicated revenues in 2021 (mainly the Part A payroll tax and premiums for Parts B and D) come to 2.4 percent of GDP, while gross spending will be 4.3 percent, for a deficit of 1.9 percent. And those deficits will only get bigger.

Fine, you may say, but it's all government, and if you add it back together it's too big. But what does that mean?

Assume with me that 13.0 percent of GDP is a reasonable level for Everything Else. You may not agree, but in that case you need to go argue with Dwight Eisenhower, not with Barack Obama and not with me. The Everything Else budget could be balanced easily, just by letting some of the Bush and Obama tax cuts expire.

Then we need to deal with Social Security and Medicare. Social Security is basically a pension plan combined with old-age insurance. Each person contributes money while working and gets back money in retirement. The government just does the accounting. To balance the Social Security budget, we only have to decide if we want more insurance (higher payments, same benefits) or less insurance (same payments, lower benefits). That's a decision we should make on its own, based on how much risk we want to pool.

Medicare is guaranteed health insurance that you pay for in advance. Eliminating Medicare wouldn't suddenly free us from a burdensome tax: seniors would still want health insurance, and since Medicare is better at cost control than the private sector, they would have to pay more for it. The real question is how much insurance we want and whether we want a guarantee today that we will be insured in old age. The amount we should pay for that insurance has nothing to do with the rest of the government. Instead, it depends on how much we would have to pay for health insurance otherwise--a lot and growing each year.

With both programs, there's no magical budget constraint that limits how much Social Security or how much Medicare we can have. We can have a generous program funded by high contributions or a meager program funded by low contributions or no program at all.

The crucial thing is that with Social Security and Medicare, we're not just hoping the government does something useful with our tax money. We are pooling our money to share specific risks across a large population, and that money comes right back out as pensions and health care payments. The size of these programs should depend on how much risk we want to pool--not on whatever happens with Everything Else.

Given that most Americans don't save enough for retirement and most working Americans with health insurance will lose it when they retire, I think most people will want more insurance, not less. I could be wrong. Maybe people will want to keep more cash now and take their risks later. But we shouldn't be forced into less insurance by the delusion that government does one thing and has one size, let alone that it has to be smaller.

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James Kwak, an associate professor at the University of Connecticut School of Law, is co-author of White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.
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James Kwak is an associate professor at the University of Connecticut School of Law and the co-author of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown. He blogs at The Baseline Scenario and tweets at @JamesYKwak.
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