There’s Good News and Bad News About the U.S. Budget
It’s an old joke, or rather the framework for a whole bunch of old jokes, to start out saying “I’ve got good news and bad news.” So here’s a good one: I’ve got good news and bad news about the budget.
First the good news
None of the United States’ budget problems — not the deficit, not the national debt, not even the underfunding of Social Security and Medicare — is intrinsically insoluble, and I can prove it. It all comes from the magic of compound interest.
Compound interest is actually very easy to understand, although — as Euler, Napier, one of the Bernoullis, and every Calculus 101 student learned — the implications of compound interest are wide and varied indeed. But the basic idea is really simple.
Start with simple interest: if you have $100 in a savings account, and you get paid 5 percent simple interest, at the end of a year, your bank sends you a check for $5. Don’t spend it all in once place.
But now, let’s say you have $100 in a savings account paying 5 percent per year — which is called the principal amount — compounded. Now, the money the bank would have sent you by check in simple interest goes back into the account. After one year, you have $100 × 1.05, or $105. Leave your princely dividend in the account, and next year, you have $105 × 1.05 or $110.25, which is more than the simple interest computed on the principal amount alone. (Twenty-five cents more, in fact. Feel rich yet?) Wait another year, and you have $115.76; you’ve now made 76 cents more than you would have. Another year, it’s $121.55, or $1.55 more. If we lay that out in a table, you can see the differences. Every year the interest compounds, you make a little bit more than you would have from simple interest. But instead of a succession of little fussy numbers, let’s look at a picture:
Over a long enough time, obviously, the compound interest is much more than the simple interest.
Now, thinking about something like this, we need to take into account inflation: over time, a dollar tends to buy less and less. That’s its own problem, but let’s avoid it this time: in this chart, and in all the rest of this article, we’re going to talk about inflation-adjusted dollars.
So now for a second topic. Taxes can be understood as money that comes in from the Gross Domestic Product or some other measure. (Old folks like me will remember when the important measure was called the Gross National Product. A little bit different in precise definition, but pretty much the same for our purposes.) The government, through various mechanisms, takes a cut off the top; this has a number of effects that we don’t need to think about right now; what’s important is that taxes are a percentage of the gross. If the GDP is X, then the total taxes will be some percentage of that — around .29 X in 1998. But the economy is growing, and since there’s no place for the extra to go that growth is compounding too.
In other words, if you leave everything alone, the amount of taxes collected grows and compounds too.
So now we’re ready for the good news: let’s assume that we start with current spending, and since we know there are a bunch of new programs being promised, like doggie treats, for electing the next government, we’ll assume that we actually assume spending of twenty-five percent more than current spending. We also assume that we leave the tax system completely alone; there are reasons you might want to raise them or lower them, but I don’t want to have that argument right now. So we just assume the tax system doesn’t change at all. The kicker is once we decide what the right spending level is — twenty-five percent isn’t magic; it could be any percentage — we leave it alone. From then on, we don’t let spending increase any faster than inflation, or in inflation-adjusted dollars, it stays constant. Then we get this picture:
… which has a magic point at the big red arrow: the break-even point.
Or maybe you think that’s unrealistic, so let’s look at another chart. This time, we’re letting spending grow by some percentage every year, and still starting with the big spending increase of the last example. Then we get this chart:
We can prove this all algebraically — I promise I won’t — but it comes down to this: if we can keep spending constant, or even just keep spending growing slower than the growth in GDP, even if we start at a major deficit, we will eventually break even and even start to accumulate a surplus. Keep that up long enough, and the debt goes away, the Social Security and Medicare underfunding goes away, and we can pay for all sorts of things. Or, better yet, give some of the money back so people can do what they want with it.
We know this is true, because this is exactly what happened in the 90s — the economy grew significantly faster than spending did. It’s not that spending didn’t grow, and in fact it grew faster than inflation; just not as fast as the economy did. Sure enough, in a few years, we had a budget surplus. Of course then we had a recession, which cut revenues temporarily, and a war, which raised spending, but that doesn’t actually matter: wherever you start, so long as spending isn’t growing as fast as the economy on average over a long time, you will eventually come back to a surplus.
Now for the Bad News
The bad news is, basically, that no one will tell you this. All politicians talk about the deficit — but that doesn’t stop each Congress member, from the rawest newly elected one to the speaker and the Senate leadership, from talking about the priority of their special project, which just coincidentally benefits their district and their big contributors. Add in entitlement programs, which seem to grow without bounds because there’s always someone — like AARP, not to name names — who wants to increase the spending on their particular group. The result is that government spending, over time, seems always to grow faster than the economy that supports it. Here’s a picture of that situation:
What’s more, no tax increase can keep this from happening. Tax the relatively few rich; you still can’t tax them more than 100 percent, and if spending grows faster than GDP, it will eventually overwhelm whatever taxes you can levy. Tax the many poor, and you get the same result — except you’ll be voted out of office first, because there are a lot more poor people than rich people. And it still won’t matter, because you cannot make revenues grow faster than the economy forever.
So the real bad news is that this is a mathematical fact: over the long term, government spending cannot grow faster than GDP forever. If you want more money for government programs, you eventually have to make sure the economy is growing faster than spending is. Of course, this has been a part of government programs since John Maynard Keynes: “In the long run, we’re all dead.” Many of the New Deal and Great Society programs depended, essentially, on the assumption that the people making the promises would be safely buried before the real costs came due.
If someone is trying to tell you something else, they either haven’t figured out the arithmetic, or they’re trying to put something over on you.
Republicans are often weak willed and hypocritical about spending. Still, they usually understand that somewhere along the line spending must be curtailed. The Democrats are far worse because they philosophically believe the bizarre notion that everything can paid for if only we tax wealthy folks like Bill Gates a few dollars more. They refuse to admit to themselves that ultimately the middle class will have to pay the growing bills. And sadly the majority of voters prefer believing the con games of the Democrats. It is almost amazing that Republicans even have a chance to win any elections. Americans have essentially turned into dishonest socialists. They may claim to embrace market solutions—but are actually more comfortable with politicians running the economy. Some of this is most assuredly the result of the disgracefully shabby historical work of the late Arthur M. Schlesinger, Jr. concerning the New Deal. His extremely flawed interpretation of that era dominates our culture. It may even now be exceptional to find someone who doesn’t contend that Franklin D. Roosevelt didn’t “save capitalism.”
There are some serious omissions in this piece, Charile. Do we know what they are?
I. e., can we define the economy’s “growth” rate separate from money’s growth rate?
In other words, what’s the unit of growth and how does growth occur? Does it overcome the M3′s rate? If so, why is the M3 going nearly exponential not as a factor of evident growth (non-farm jobs just posted a 22 year low, for but one example, and there’s been some one trillion dollars in global write downs in credit markets over the last 18 months) but as a factor of a crashing dollar? As one might expect?
Against a crashing dollar, why are commodities exploding? Why have we allocated huge new powers to the Fed? Why is the Fed itself in turmoil, with many within it decrying our reckless, “helicopter” monetary policy?
If money is lent into circulation, incurring negative interest that must be paid back, how does that factor against this “growth”, as factor it must?
And so on. Inflation running some 10% and not the 3% the government reports. The national debt breaching $50,000,000,000.00 when you include entitlements.
Of course, the problem is our entire fiscal policy coupled with a reckless DC-based spending policy. That’s the actual bad news here.
Excuse me, I meant $50,000,000,000,000.00 as in $50T. That many zeros is hard to reckon with.
What would have been the repercussions if FDR had instituted a massive government loan program for the impoverished instead of his socialized New Deal handouts?
Looking at this, I think I wish I’d have gone one graph deeper into the subject.
What I really want to make clear, and state as strongly as possible , is that this shows arithmetically that taxes are not the answer. No tax scheme, no matter how onerous or how liberal or how “conservative” or “reactionary” or “confiscatory” or “supply side”, can produce a surplus or reduce the debt unless the economy grows faster than expenditures. Any tax scheme, no matter how fair or unfair, will eventually produce a surplus and buy down debt, so long as the economy grows faster than expenditures. If you want universal health care, or immediately progress to colonies on Mars, or a government-provided pony for every little boy and girl, you have to make sure the economy grows fast enough to cover it. Over the long term, nothing else will work.
“Over the long term, nothing else will work.”
I completely agree—but most Americans fail to comprehend this harsh economic fact. Once again, they prefer believing the scam job that taxing Bill Gates a few more dollars will do the trick. And I am not trying to get a cheap laugh out of you. I am dead serious! The Democratic Party not so subtly conveys this message every election cycle. John Kenneth Galbraith, who once was accurately described by Thomas Sowell as an Archie Bunker like anti-intellectual, would charge you with being mean spirited and a defender of the capitalist bosses. Only a supposedly disgusting low-life would reject the near sacred doctrine of wealth redistribution.
Once again, they prefer believing the scam job that taxing Bill Gates a few more dollars will do the trick. And I am not trying to get a cheap laugh out of you. I am dead serious!
And dead right, I’m afraid.
Good one, Charlie. I agree, mostly, but I have a question. What happens if the economy doesn’t grow, but goes into a long term contraction?
AP
Good one, Charlie. I agree, mostly, but I have a question. What happens if the economy doesn’t grow, but goes into a long term contraction?
Um, it sucks?
It’s an interesting question: there have certainly been good historical examples, like the Soviet Union and the Soveit-dominated Eastern block in history, or for a fictional version, the world of Atlas Shrugged.
Algebraically, the theorem is still a theorem: if the rate of growth of GDP (which is negative in your hypothetical situation) ir greater than the rate of growth of spending (which also now must be negative for this to hold) then you still eventually have a surplus and buy down debt. It doesn’t matter what the values are: as long as d(GDP)/dt < d(SPEND)/dt, you’re in good shape.
Politically, of course, this isn’t really likely: it’s much more likely that a government would attempt to restore a condition in which the economy is growing, while increasing expenditures temporarily to insulate its constituents from the economic contraction.
Oh, and thanks for the kind comments, all.
Dammit. d(GDP)/dt > d(SPEND)/dt. Greater than.
The only source of new money is profit i.e., adding one unit of wealth purchasable with money and one unit of money deriving its value — new incremental value — from the new unit of wealth that the money financed. If the new wealth is worth more to the market than it cost to create it, then that profit is new money. That can be proved mathematically, and that one fact, producing market wealth that is more and more valuable, in greater quantities, with borrowed money or bank-created money. That is the sole source of new money value, whether gold or bank notes or whatever. If we applied that rule to creating money, we could easily pay off the debt — convert bonds at compound interest to stock in government facotories on domestic soil. Sell the produce of the factories and pay the workers with the profits who own 51% and pay off the former owners of the bonds, now retired, with the 49% profits. Profits to replace pork-barrel and government profits to create new money. This is superior to the present system headed for meltdown because taxes and one way gov’t pork barrel spending producing nothing that can be purchased with the money spent to create it, destroys money, as opposed to profit which creates it. This is the answer to paying off the gov’t debt, creating new money, ending porkbarrel spending which destroys our money and creates inflation and if we assign the gov’t profits to the poor in exchange for their cooperative efforts in creating that profit, we can end poverty and reduce to a great extent the maldistribution of wealth. This is actually the answer and the only answer to the basic economic problems create by unbalanced capitalism.
George, it sounds good, but what evidence do you have that the government can run something effectively to make a profit?
Charlie–
Very nicely done. It would be interesting to apply this theory to Europe, where birthrates are falling (have fallen?) to below replacement levels, and where entitlements as a percentage of GDP are already much higher than the U.S. I think you would see they are simply at a more advanced point on the graph than we are currently. And the Democrats think Europe has everything pretty much figured out…
If government is so inept, why trust it to run a counterinsurgency war, one of the most difficult tasks in the world?
Cartman2, the “Silly ass veers into Iraq War complaints” department is down the hall, and to the left. The far left.
Fresh, the thing about European entitlements is that they’re so large it’s making it hard for the GDP to grow, an issue we have (so far) avoided, as you correctly imply. The shrinking population should, over time, improve the situation though… if you can get through the transition.
Charley,
Number One:
Government, an essentially psychological concept (e.g., The Emporer has no Clothes)is what we call a legal fiction. Government does not create profit, though it can create more paper and credit based money easily enough. Workers in the factories create the profit. Just as a slave who shares in none of the output of the plantation, and who will eat nonetheless, regardless of output, is the most unproductive worker on the planet (stands to reason) a factory worker who owns the factory and shares in the profits is the most productive worker on the planet. (Stands to reason). Profit based economies where the productive class owns the capital (e.g., South Korea) are always more productive than slave based economies like Soviet Russia and North Korea where the monopolistic government, ocntrolled by one person, owns all the capital. Stands to reason.
So my idea, as stated, is the workers owne the government factories, competing with private enterprise, not the government bureacrats, who get paid a salary, unless they want to take a promotion to become a factory worker/owner. This of course is hundreds of years in the future, but ultimately, once you understand economics and the only source of new money, or I should say, new money value, it is the only logical answer. Not the photocopy we use now of what the Bourbons did during and after the Sun King. That way lies the Guillotine followed by Bonaparte. Ughhh! There is a book available to explain the whole thing “Not Perish the Fire: The Science of Money, The Science of Peace” by Adam Marx and Karl Smith. It is the story of Quantum Economics which explains the universal means and methods available for Creating, Preserving and Destroying market accumulations of wealth and money. The conclusion of the book is “No Taxation With Representation” since, if the government is busy making a profit and expanding the money supply, it will have no money for war or conquest (or need for it either) since no one ever made a profit out of a war. (Theft is not profit).
George, that’s way too much for me to try to repond to in a comment. Why don’t you write it all up and submit it to PJM?