by David OttI read Where Does the Money Go? – Your Guided Tour to the Federal Budget Crisis by Scott Bittle and Jean Johnson last summer before things went from bad to worse.
The U.S. had entered a recession although we didn’t know it yet. The phrase ‘subprime mess’ was creeping out of our lexicon and was being supplanted with the much more ominous term: ‘credit crisis.’
And although I had intended to write this review in the fall of last year, I was taken far off track when the bear market broke into a panic and we graduated from a credit crisis to a full blown global synchronized financial crisis.
Of course, this doesn’t make the contents of the book irrelevant at all – quite the opposite.
As governments around the world attempt to solve the current crisis with massive monetary and fiscal stimulus, it is obvious that the budget problem that we had when this book was authored in 2008 will be stunningly worse as we try to solve the problem.
It is clear in my mind that we will emerge from the current crisis as we always do. It is also clear to me thanks to the work of Harvard economist Ken Rogoff that the budget problem will become substantially worse in the next few years.
Rogoff and his collaborators have looked at financial crises in industrials and emerging nations over the past thirty years and has found striking similarities between them. For example, they have found that home prices typically fall 35 percent on average and stock markets generally fall by 55 percent. So far, the U.S. is right on target.
The combination of policy responses and substantially lower tax receipts lead governments to double the budget deficit within three years of the crisis. Judging from the budget proposals floating around, it would appear that the U.S. is right on track again as the Congressional Budget Office (CBO) estimate that the budget deficit will be $1.7 trillion in 2009.
Even more startling is that the budget deficit will total almost 12 percent of Gross Domestic Product (GDP) – its largest showing since the end of the Second World War. Granted, the CBO estimates that after a $1.2 trillion deficit in 2010, the budget deficit will decline annually to the $300 billion range, which isn’t great, but a lot better than being in the trillion dollar range.
The point, though, in my mind is that we are expecting deficits as far as the eye can see and while a large nation like ours can support deficits and debt, we do seem to be standing on the edge of the Rubicon, as the demography of our spending problems on Social Security and Medicare look less increasingly abstract.
Social Security has been a known problem for decades – President Reagan set up a Blue Ribbon panel in 1983 that included Alan Greenspan to make changes to improve the solvency of the program. And, they did some things that make sense, like increase the retirement age from 65 to 67 for younger people.
Unfortunately, Social Security is less of a problem than Medicare because Medicare is already in trouble. This isn’t a secret, either. The Medicare Trustees told Congress in their 2007 report that their “financial difficulties come sooner – and are much more severely – than those confronting Social Security.”
Biddle and Johnson report that in the respective trustee reports, it is estimated that to fund Social Security for the next 75 years, we would need to cut benefits by 13 percent, raise payroll taxes by 16 percent or do some combination of the two. Using the same metrics with Medicare, it would require a 51 percent reduction in benefits, a 122 percent increase in taxes or some combination thereof.
As bad as that sounds, it gets worse because the authors point out that Medicare’s costs are not as predictable as Social Security. Social Security is mainly about demography, but Medicare costs add ballooning healthcare costs.
Amid all of the interesting statistics, realistic projections and marvelous examples and sidebars, the authors offer only a few solutions. Of course, this isn’t the fault of the authors – it’s that the solutions are so obvious: entitlements have to shrink, taxes have to rise, or, most reasonably, there has to be some combination of the two.
None of these choices are particularly appealing, but preventative changes are required to keep us out of real trouble down the road.
If we wait until 2040, we would have to cut nearly every other government program since Social Security and Medicare would absorb every tax dollar. While we can agree that there is government waste, we can also agree that we need some programs that maintain our dominating position in the world (the military and National Institutes of Health are two of my favorites).
Since it is unreasonable to cut every ounce of spending but Social Security and Medicare, we could raise taxes in 2040. The magnitude of this kind of tax hike is also untenable since raising taxes always puts a strain on growth and economic progress. As undesirable as it is, raising taxes in small increments now would be far better than choking it all down at once, which , which would be crippling.
Unfortunately, given how difficult it is to cut spending and raise taxes in any dose before there is an emergency, it seems likely that nothing will happen for some time to come. The current financial crisis is also a setback since it makes sense to put out the fire that’s currently raging instead of working on long-term prevention issues.
So, we will sustain the unsustainable until it isn’t possible anymore and deal with the problem when the best options are exhausted and have to accept second or third choice options.
Sadly, that’s in some ways what led to this crisis. The housing bubble itself was no surprise – it has been talked about for years. The problem was with the speed and severity of the reversal and the reverberations that came along with it.
Of course, in retrospect it is obvious that we were going down a bad path, but no one wanted to change course because it was easier to keep doing the same thing, even though we knew it couldn’t be sustained.
The book is well worth the read, although it seems like waiting for a second edition may be worthwhile since the fiscal picture has changed so dramatically since the book was published a year ago.
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Recommendation: Buy
Where Does the Money Go? Your Guided Tour to the Federal Budget Crisis
By Scott Bittle and Jean Johnson
HarperCollins Publishers, New York, New York 2008
ISBN: 978-0061241871
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