The cardinal rule for general interest columns is “Never discuss politics, religion or sex.” This week I will bend the rule a little by attempting to understand some of the economic aspects of our current political upheaval. The one thing about which my polarized friends at both extremes seem to agree is the necessity that we do something about the annual federal deficit and the ballooning national debt, neither of which makes sense to us micro-economists. We agree they are problems, but don’t understand them well enough to have rational solutions, so we leave that to the macro-economists.
We micro-economists make decisions every day that affect the financial welfare of our families, generally compromising our desires when their cost exceeds our resources. To us there is a direct relationship between a day’s wages and the goods and services it can buy at any given time. If you want better “creature comforts”, you must increase your value to an employer or client. The macro-economists live in a different world. They understand concepts that are mysteries to the rest of us — the significance of money supply, how “quantitative easing” can stimulate economic growth, and how tiny changes in the Federal Funds Interest Rate can influence inflation, for example.
Let’s begin by trying to understand the Federal Budget. In fiscal 2023 (October 1, 2022, to September 30, 2023), the federal government spent $6.1 trillion. Mandatory programs totaled $3.8 trillion, subdivided into Social Security ($1.3 trillion), Medicare ($839 billion), Medicaid ($616 billion), Income Security Programs ($448 billion), and Veterans’ Benefits ($502 billion). The Discretionary category was divided between Nondefense ($917 billion) and Defense ($905 billion). Net Interest completed the list with $659 billion. Revenue from the same fiscal year equalled $4.4 trillion. $2.2 trillion came from individual income taxes; $1.6 trillion from payroll taxes; $420 billion from corporate income taxes; and $229 billion from other sources. The shortfall between expenditures and revenus was a deficit of $1.7 trillion. This increased the cumulative federal debt to about $32 trillion. It is obvious to all of us that this situation must be reversed.
It is my understanding that the Social Security System was initially intended to be self-supporting, funded by payroll taxes, and that Medicare was established on the same principle. The Federal Insurance Contributions Act established a payroll tax on each employee of 6.2% to fund Social Security and 1.45% to fund Medicare, and requires each employer to match those totals. Until recently this process provided enough revenue to satisfy requirements for benefits for retired employees, while building up a significant surplus which is currently being depleted to account for shortfalls. The combination of more retirees than usual as the Baby Boomers retire and longer lifetimes for all retirees will soon produce a situation in which the system is no longer self-supporting unless payroll taxes are increased and retirement benefits reduced. It is our opinion that these two programs should be separated from the general federal budget and required to be self-supporting.
Each of the other five major categories (Interest will be discussed separately) should be reviewed independently by the appropriate Congessional committees to confirm their functions are in the national interest and that they are being operated efficiently. The category of “Interest” is a special case, dependent upon the magnitude of the National Debt and the prevailing interest rate. It is our opinion that some debt is acceptable, providing the advantage to the debtor of having this capital is greater than the cost of borrowing it. I would be comfortable with a debt level at 20 % of the Gross Domestic Product (GDP), based on a comparison with successful commercial firms. For fiscal 2023 that amounts to $5.75 trillion (a far cry from the actual amount).
However, the significance of the Federal Debt is not clear cut. In 2023 $7 trillion of the $32 trillion was designated as “Intragovernmental”. For example, the Social Security surplus has been stored there; it amounted to $2.6 trillion in 2023. Intragovernmental debts certainly must be considered differently than conventional ones. Similarly, the Federal Reserve loaned the Federal Government five trillion dollars (by printing money with no backing), the process called “quantitative easing”, to stimulate the economy following the Covid crisis. Recently they have begun to reverse the process, reducing the supply of money by retiring the bonds without redemption. If we consider the Federal Reserve action and intragovernmental transactions as “shifting money from one pocket to another”, the actual debt shrinks to $20 trillion, still much greater than my $5.75 trillion target.
Suppose we commit to balancing the budget by a gradual change. The first step would be to stabilize Social Security and Medicare by making them self-supporting as proposed above. And, suppose we aim for an annual surplus of $500 billion. Let’s deal with 2023 constant dollars and adjust for inflation later. If Social Security and Medicare are self-supporting, we need annual revenue of $4.5 trillion, compared to the actual $2.8 trillion (ignoring payroll taxes) currently being collected, One option is to increase the tax revenue from $2.8 trillion to $4.5 trillion, roughly sixty percent. That is bitter medicine that would have to be administered very gradually, perhaps over eight or ten years. The median tax paying family currently earns $110,000 per year and pays $6,000 income tax. Raising its annual income tax 60 % ($3600) amounts to a 3.28% reduction in its standard of living. The family at the 75th percentile of tax paying families earns $175,000 and pays $11,800. A sixty percent increase is $7,080 and a 4.04% reduction in its standard of living.
If we believe that our current practice is not sustainable, and if we believe the current level of governmental services should be maintained, our only recourse is to increase our tax burden and accept the associated reduction in our standard of living. I am not sure the general public is willing to make that concession.