In previous posts, I have been illustrating projections in Obama’s 2017 budget out to 2025, and comparing that budget to four alternative scenarios which could put the federal budget on a trajectory toward balance and paying down the national debt. Now let me ask what would happen if the U.S. Congress and the President kick the can down the road again as they have for so many years. What can we predict as far out as 2035? This is 19 years from now. This is the world that a baby born today would face as they enter adulthood. This is potentially my grandchild. What indictment would he or she hand down on the current generation which fails to take action now?
To attempt to answer this question, I took the compound average growth rate (CAGR) from 2015 to 2025 of each category in the federal budget, the discretionary and mandatory spending items we have been discussing, and extended the budget to 2035. This means that defense spending grows at 2.59% per year. Is this sufficient? Not sure, but that is a political question, which is not my intention to answer here. Non-defense spending grows at 2.18% per year.
All mandatory programs grow at 5.69% per year. Interest expense continues to explode at the rate of 14.15% per year. Total tax receipts grow at 4.43% per year. This means that the annual deficit yawns wider at 11.26% per year, while the national debt marches higher at 4.06% per year.
Welcome to the year 2035. Here is the federal budget this year with comparisons to 2025 and 2015. Figures are in billions of dollars.
Extending the Obama 2017 budget out to 2035 means that the total federal budget in 2035 will be $10.2 trillion. This is approximately 3 times the budget in 2015. The annual deficit will be $2.34 trillion. This would be more than the total appropriated budget. Recall that in 2025 the government is projected to borrow 87% of every dollar it appropriates for both defense and non-defense spending. This graph shows how the trend would continue such that, by 2029, the federal government would be borrowing 100% of every appropriated dollar. This ratio would grow to 126% by 2035.
What would it mean to this country if we are 100% dependent on creditors to finance the operations of the federal government and defense of this nation?
By 2035, the federal government would be paying $1.39 trillion per year in interest on $45 trillion in debt. But this is assuming that interest rates on our national debt hold steady at 3.25% per year. Would creditors demand an interest premium as our national debt continues to grow? In a normal world, yes. These graphs correspond to the graphs above, with the additional assumption that interest rates on the national debt grow 0.5% per year from 3.25% in 2025 to 8.25% in 2035.
Such a relatively rational increase in interest rates would mean that the federal government would have to borrow 282% of all appropriated spending in 2035. Interest payments would balloon from $1.39 trillion to $4.3 trillion on $57.5 trillion in debt. The total federal budget in 2035 would have to be $13.1 trillion, while the budget deficit would be $5.26 trillion. Compared to these projections, 2016 will certainly look like the good ol’ days.
How much of the US GDP will be dedicated to the federal budget? Under normal growth rates, i.e. 3.2% per year, we can expect that the federal budget would consume 31% of the US GDP. My alternative scenarios put our federal budget on a path where the ratio holds at 19% to 21%.
A worse scenario occurs if the average growth rate continues at the recently reported annual growth rate of 1.2% per year in 2016. In this case, the federal budget would consume 45% of the US GDP by 2035, while my alternative scenarios hold this ratio at 23% to 25%.
Recall that the only time in our history that the federal government’s budget represented over 30% of the US GDP was during World War II.
Could these scenarios really happen?
Can this nation postpone making the decisions that are necessary to avoid these projections?
But wait a minute! During this entire discussion, I have looked at cutting spending as the only option for eliminating deficits. What about raising taxes in order to maintain current federal spending programs and entitlements without adding to the deficit? Certainly the rich could pay more.
Currently the wealthiest tax payers pay most of the income tax paid. According to the Pew Research Center, in 2014, 2.7% of the individual tax returns filed reported an adjusted gross income of $250,000 or more, and paid 51.6% of the income tax collected. Their average tax rate was 25.7%. By contrast, taxpayers with incomes less than $50,000 accounted for 62.3% of all returns filed, and paid 5.7% of all taxes collected. Their average income tax rate was 4.3%. Given these facts, I challenge anyone to design a tax plan which raises taxes on the rich and produces more revenue.
Undoubtedly the rich will pay more in the future, but raising tax rates is not the way to collect more revenue, according to the Congressional Budget Office report published in March, 1988. This report identified three distinct periods of different capital gains tax rates between 1954 and 1985. From 1954 to 1969, capital gains tax rates were stable and relatively low at 25% to 27.5%. From 1969 to 1978, capital gains rates shot up to 39.875% for taxpayers in the 70% income tax bracket. In 1978, the rate dropped to 28%, and dropped again in 1981 to 20 percent. The impact of these changes is measured by the ratio of long-term gains to the gross national product in percent. The conclusion from this study is that falling capital gains tax rates produce more tax revenue, while increasing capital gains tax rates produce less tax revenue relative to the gross national product.
In conclusion, how do I propose that we solve the problem of our national debt and avoid economic collapse in the very near future? Here is THE ANSWER. Our federal government has to take the following actions as soon as possible.
- Cut non-defense spending by 50% over the next 3 to 10 years, starting by privatizing the U.S. Postal Service, while growing defense spending at a rate of 2.6% per year.
- Reduce the average Social Security benefit such that Social Security tax revenues equal or exceed expenditures.
- Change Medicare and Medicaid entitlements from an insurance program to a health savings account program with account balance rollover, and promote cross-state health insurance markets without federally mandated benefits and without restrictions on premium pricing for different health risks.
If we do these things in the next year, I calculate that the national debt will peak at approximately $21.9 trillion and can start to decline if the federal government maintains spending discipline. Also, the federal budget will consume no more than 19% to 21% of the US GDP which is normal in the post World War II era.
If the citizens and their elected representatives continue to wait before addressing the growing national debt, the problem gets worse, while the inevitable day of economic collapse and social chaos get closer. Would this day also be the end of America?