The Price of Civilization

by Jeffrey D. Sachs

  Table 10.2: Indicators of National Well-Being (Rankings, with 1 = “Best”)

  Source: Gallup, OECD Statistical Databases, World Health Organization.

  CHAPTER 11.

  Paying for Civilization

  In fiscal year 2011, the federal government covered around 39 percent of its spending, roughly $1.4 trillion of $3.6 trillion, by borrowing.1 Each year’s borrowing adds to the total public debt. In 2007, the government debt held by the public amounted to around 36 percent of GDP.2 By 2015 the debt is expected to soar to 75 percent of GDP.3 Some economists try to tell us not to worry as we rack up the debt. They pitch tax cuts today as a demand stimulus (according to the Democrats) or a supply stimulus (according to the Republicans), without telling us about the long-term costs. I have my serious doubts about such shortsighted arguments.

  As the debt rises, the burden of paying the interest on it will rise as well. Today we spend around 1.5 percent of GDP to pay the interest.4 By 2015, it could be around 3.5 percent of GDP. By 2020, it could reach 4 percent of GDP or more. This interest servicing will crowd out other vital spending, for example for infrastructure or help for the poor. Or it will require a hugely contentious tax increase, with revenues that instead should have been used for essential public goods. Or it will cause a future financial crisis as global lenders lose confidence in the capacity and willingness of the U.S. government to honor its debts other than by inflation (printing money to pay them off). It’s better, therefore, to try to stabilize the debt relative to GDP and then begin a process of gradual reduction in the debt-to-GDP ratio.

  This chapter, then, is about our government paying its bills on time through adequate tax collections, rather than borrowing from the future. As the great Supreme Court Justice Oliver Wendell Holmes, Jr., wrote, “I like to pay taxes. With them I buy civilization.”5 It is a sentiment utterly unrecognizable in America today, where an ongoing thirty-year tax revolt predominates. Without adequate taxation, we can’t live in a civilized country. Middle-class Americans are so sure that higher take-home pay is the key to their happiness that they’ve lost track of the need to pay taxes to fund society-wide undertakings and avoid an explosion of public debt. More important, middle-class Americans have repeatedly given the green light to tax cuts for the richest Americans, allowing income and wealth to concentrate among a tiny fraction of the population. The richest then invest a very small fraction of their wealth to dominate the airwaves, enrich members of Congress and their families, and preserve their privileges. Congress needs little cajoling by lobbyists; it has itself become a millionaire’s club, with 261 members, almost half, of today’s Congress holding at least $1 million in assets.6

  Getting the rich to accede to Justice Holmes’s wisdom is a big part of the challenge. Getting the government to plan and implement long-term policies properly and competently is another. The two changes are, of course, inseparable. There is no way to increase the scale of government if the government remains as incompetent and corrupt as it is today. This chapter takes up the challenge of how to pay for a government that does its proper job. The next chapter takes up political reform, how to take government back from the corporatocracy and put it back into the service of public well-being.

  The Basic Fiscal Arithmetic

  America’s peacetime budget deficit is unprecedented: $1.3 trillion in 2010, equal to 9 percent of the national income. And the deficit could well remain above $1 trillion for years to come. The problem with economic reform in America is how to pay for public goods: quality education, college completion, advanced energy technologies, improved roads, safe child care, and decent health care. The quality of life is deteriorating because we refuse to pay for the public goods needed for a civilized society.

  The Tea Party’s answer is to leave the needed investments to the private market. This, as we’ve seen in earlier chapters, will not do. We are required, in one way or another, to address the budget deficit and at the same time address the challenges that we’ve inherited from these market failures and the powerful forces of global capitalism.

  The lack of budget resources is now the fundamental constraint on effective governance and a sustainable recovery. It’s fair to say that all our civilian programs other than the entitlements programs are paid for with borrowed money and borrowed time. The result, as we know, is political paralysis. As much as we’d like to do more and better things, we simply can’t afford them. And the squeeze on civilian discretionary programs has tightened considerably over the years, since Ronald Reagan put the country on the course of repeated tax cuts.

  There is nothing more important today than understanding the basic arithmetic of the budget and of household incomes to understand the predicament.

  This is shown in Figure 11.1. Under the current tax system, the federal government will collect around 18 percent of GDP in 2015, with the breakdown shown in the chart. For this baseline calculation, I assume that the Bush-era tax cuts that were extended at the end of 2010 for two years will be extended again after 2012.7

  Figure 11.1: Revenues and Outlays as a Percentage of GDP in 2015 Budget Projections

  Source: Data from Office of Management and Budget Historical Tables and author’s estimates.

  There are three main sources of federal revenues. Roughly 8 percent or so of GDP in 2015 will come from personal income taxes, around 6.3 percent will come from payroll taxes for Social Security and Medicare, and 2.2 percent from the corporate tax. The rest, around 1.5 percent, will come from a variety of excise and other taxes.

  To prepare a spending baseline for 2015, I divide the budget into six main categories. Under current law Social Security will account for around 5 percent of GDP. On current trends, health care spending (Medicare, Medicaid, and veterans’ health care) will account for around 6 percent. Other mandatory spending, such as unemployment insurance, disability pay, and the Earned Income Tax Credit, will account for another 2 percent. Military outlays will absorb 4 percent, and interest payments on the publicly held government debt will amount to around 3 percent. I assume that discretionary civilian spending will amount to around 4 percent of GDP, roughly the average of 2005–2008, before the crisis and the stimulus package. In total, therefore, a reasonable baseline for 2015 puts total spending at around 24 percent of GDP.

  The single most important point about this accounting is the following: The budget baseline revenue of around 18 percent of GDP will not even cover mandatory spending (13 percent) plus the military (4 percent) plus interest on the debt (3 percent). This means that on the baseline, all civilian discretionary spending, and then some, would have to be paid for with borrowed money.

  It might be wondered how Clinton managed to balance the budget, and indeed run a small surplus, at the end of the 1990s. There were four parts to that. First, military spending fell to just 3 percent of GDP, compared with 5 percent today. That saved 2 percentage points of the budget, a good move that should be repeated. Second, revenues soared to around 20 percent of GDP on the back of a hot economy fueled by the temporary dot-com bubble and with top tax marginal rates slightly higher than today. Unfortunately we can count on tax revenues of only around 18 percent of GDP on the basis of the current tax system. Third, interest payments were only 2 percent of GDP in 2000 and will be close to 3 percent in 2015,8 if not more. Fourth, mandatory programs accounted for only 10 percent of GDP and are likely to be around 13 percent by 2015. This sums to a shift of 6 percent of GDP toward deficit, even assuming that defense spending declines to 3 percent of GDP.

  We must recall, too, that Clinton and the Republican-led Congress of that period deeply shortchanged key public expenditures—on education, infrastructure, energy, foreign assistance, poverty relief, R&D, and other areas. They squeezed spending below the levels needed to maintain U.S. competitiveness and social well-being in order to keep domestic spending at 15 percent of GDP. With our aging population, rising health care costs, and growing needs in infrastructure, education, energy, and other areas, domestic spend
ing by 2015 will have to be far higher than 15 percent of GDP.

  Deficit Cutting Beyond Illusions

  Suppose that we want to close that deficit to zero or near zero (with the more precise target discussed below). We need to find budget cuts plus tax increases that sum to around 6 percent of GDP. Most Americans say that they’d like to do this through spending cuts rather than tax increases. Budget cutting certainly sounds more appealing, as long as there is tremendous waste in the budget. The public indeed imagines that the civilian budget is laden with fat. The problem is that the public’s favorite targets for budget cutting are nowhere close enough to do the job. The notion of closing the deficit through budget cuts alone is a fantasy, though a popular one. Considerably higher revenues as a share of GDP will be needed.

  Consider two of the politicians’ favorite targets for budget cuts: budget “earmarks” for pet projects within congressional districts (such as the famous “bridge to nowhere”) and foreign aid. Earmarks are on the order of $16 billion per year.9 One percent of GDP is $150 billion per year. Hence earmarks account for 0.1 percent of GDP. Foreign assistance is approximately $30 billion per year, or 0.2 percent of GDP.10 Combining the two categories, their complete elimination—warranted or not—would save just 0.3 percent of GDP, compared with a target of 5 to 6 percent in deficit cuts. So we’re at far less than a tenth of the solution, even with a draconian and unwise total elimination of foreign aid (which the public believes should be a larger fraction of the budget than now).11

  The mandatory programs represent additional potential targets for cutting waste, and at first glance much larger and meatier ones. Much of the public believes that the mandatory programs are one giant transfer machine, in which the deserving middle class is taxed in order to transfer income to the undeserving poor, especially to minorities who live on the public dole. In the 1980s, Reagan riffed repeatedly about “welfare queens” who allegedly stole from the public purse by collecting illegally on multiple welfare accounts. That image has stuck in the public mind. Let’s therefore take a closer look at the mandatory programs to see what might plausibly be cut.

  As shown in Figure 11.2, the mandatory programs consist of universal programs such as Social Security and Medicare (for all elderly), social insurance programs such as unemployment compensation, and means-tested transfers for the poor such as food stamps.12 The universal programs make up two-thirds of the mandatory spending, roughly 10 percent of GDP. There is relatively little political controversy over the outlays on those programs. The public strongly supports Social Security, Medicare, federal employee retirement and disability, and veterans’ benefits.13 Any cuts in those programs would inevitably be very gradual and stretched out over decades. There are few if any short-term savings in this category, and with the aging of the population, we can expect an increase in such outlays by around 1 percent of GDP by 2020. Even Tea Party activists strongly support Medicare and Social Security by a wide margin.

  Figure 11.2: Mandatory Spending as a Percentage of GDP for 2015

  Source: Data from Office of Management and Budget Historical Tables.

  The main category of social insurance is unemployment compensation. This program reached around 1.3 percent of GDP in 2010 because of the high unemployment rate in that year, but this will tend to revert to around 0.4 percent by 2015, assuming a gradual reduction of those qualifying for unemployment compensation. That cost saving is already taken into account in the baseline deficit in 2015 of 6 percent of GDP.

  The means-tested category of spending is certainly the most contentious politically, the area where the public believes there is huge waste to trim.14 The public believes that means-tested spending is mainly in the form of welfare payments for the (undeserving) poor. That is simply not true. Medicaid (health care for the poor) constitutes the largest of means-tested programs, 60 percent of the total and equal to around 2 percent of GDP. There is no broad public support for ending health care for the poor. Food stamps constitute the next largest program, roughly 0.5 percent of GDP. Here again, there is no public outcry to take food off the table of the poor. The third program is the Earned Income Tax Credit, which rebates taxes to poor working families. It is widely regarded as an important incentive to work for the poor. It constitutes around 0.3 percent of GDP.

  Finally comes the welfare program that has been most contentious for decades: aid to poor families with dependent children. Welfare, formerly known as Aid to Families with Dependent Children, is now known as Temporary Assistance for Needy Families, or TANF. This program makes up only 3.5 percent of the means-tested programs and just 0.1 percent of GDP.15 America cut back on “welfare” from the 1970s onward. Family income support fell from 0.4 percent of GDP in 1970 to under 0.2 percent in 2010.16 Welfare still looms large in the public’s imagination, but it plays little role in the budget and the deficit. It’s been a long time since America was generous to its poor families with children!

  The upshot is that we could eliminate foreign aid, earmarks, and welfare payments in the TANF program entirely, and the combined effect would be to save just 0.5 percent of GDP out of a structural deficit of 5 to 6 percent of GDP. The hot-button items of the budget are a distraction from real budget balancing. Unless we are willing to slash Social Security, Medicare, Medicaid, veterans’ benefits, or food stamps to the bone, we have to look elsewhere to close the deficit.

  What about waste, fraud, and abuse in civilian discretionary programs? Once again, there is much less than meets the eye. Civilian discretionary spending constitutes everything the government does aside from retirement, health care, social insurance, income support, and the military, yet the total is only around 4 percent of GDP. That modest level of spending is spread out over many areas, including general science, space science (NASA), health science, agriculture, commerce, transportation (including highways), environment (including water resources), energy, regional development, education, training, housing, the justice system (including the judiciary and penal system), public administration, international diplomacy, and international development assistance. Each of these areas of spending constitutes less than 1 percent of GDP. There are no areas of obvious massive waste. A few billion dollars of savings can surely be achieved by ending wasteful agriculture subsidies, but that would barely dent the overall budget deficit. Total spending on public administration—the much-derided “federal bureaucracy”—amounted to just $20 billion, or 0.13 percent of GDP, in fiscal year 2010.17 When it comes to saving vast budgetary resources through cuts in waste, there is simply not vast waste to cut in civilian outlays.

  Here is another way to show the falsity of the idea of vast waste hidden in the civilian budget. Obama established the National Commission on Fiscal Responsibility and Reform with a mandate to find a path to budget balance. The commission was charged with identifying specific areas of budget cutting, yet it couldn’t find large waste to trim. Here is the list that the commission proposed and the estimated dollar savings for the year 2015, when GDP is expected to be $18.6 trillion:18

  Reduce congressional and White House budgets, $800 million.

  Impose a three-year wage freeze on federal workers, $20 billion.

  Reduce the size of the federal workforce, $13 billion.

  Reduce federal travel, printing, and vehicle budgets, $1 billion.

  Sell excess federal real estate, $100 million.

  Eliminate all earmarks, $16 billion.

  Reform Medicare sustainable growth, $3 billion.

  Repeal support for long-term affordable care (the CLASS Act), $11 billion.

  Reduce Medicare fraud, $1 billion.

  Reform Medicare cost sharing, $10 billion.

  Restrict Medicare supplemental insurance, $4 billion.

  Extend Medicaid rebates to “dual eligibles,” $7 billion.

  Reduce excess payments to hospitals for medical education, $6 billion.

  Cut Medicare payments for bad debts, $3 billion.

  Accelerate savings for home health care pro
viders, $2 billion.

  Medicaid savings, $6.3 billion.

  Medical malpractice reform, $2 billion.

  Reform health benefits for federal employees, $2 billion.

  Reduce agriculture spending, $1 billion.

  Eliminate in-school subsidies in student loan programs, $5 billion.

  Other specified saving, $1 billion.

  This is a long list, to be sure, but it is not an impressive one in terms of budget savings as a percent of GDP. It sums to a mere $115 billion, or roughly 0.6 percent of GDP in 2015. And that’s an optimistic assessment. Many of the supposed savings would not really materialize. Others may be ill advised, such as cutting support for long-term health care. The commission also called for other large savings by way of limiting cost-of-living adjustments and other gimmicks, rather than through specified cuts.