How to Balance the Federal Budget

Can the US federal budget be balanced? It is obviously physically possible to balance the budget by either lowering spending, raising taxes, or a bit of both. But can the budget be balanced in a manner that is fiscally prudent while maintaining adequate funding for government’s most important operations?

I have attempted to balance the 2008 budget below while obeying the following constraints:

  1. No tax increases
  2. No spending shifts between departments, only spending cuts
  3. All spending, including entitlements spending, is fair game

The actual federal deficit for 2008 was $459 Billion, which forms the goal for the cost cutting exercise outlined in the table below [1].

Category 2008 Spending ($Billions) Proposed Cuts Proposed Spending
Defense 612 Cut by $150 Billion, maintaining US defense spending at a level that exceeds the entire World excluding NATO. [2] 462
Social Security 612 Phase out social security benefits for upper income seniors, cutting roughly $110 Billion annually. [3] 500
Medicare + Medicaid 587 Introduce 20% coinsurance for medical spending above $40,000 per year for Medicare and Medicaid recipients, saving $110 Billion. End Medicare Advantage subsidies, saving $17 Billion. [4] 460
Non-defense Discretionary 508 Make an across-the-board 9% cut in non-defense discretionary spending, saving $46 Billion. [5] 462
Other Mandatory Programs [5] 411 End agricultural commodity subsidies and crop insurance subsidies, saving $15 Billion. Modify student loan programs to cut out private middlemen, saving $9 Billion. [6] 387
Interest Payments 253 This cannot be cut without a US government default. 253
Totals 2,983 459 2523

As the table shows, the US federal budget cannot be balanced without deep cuts in Medicare/Medicaid, Social Security, and the Department of Defense. Roughly 60% of the budget is allocated to these major programs, making a balanced budget impossible without reductions here.

A rationale for each major budget cut is provided in the footnotes below. I invite readers to share their balanced budgets as well, or to suggest changes in the cuts that I’ve suggested. Just make sure that the numbers add up, as cutting $459 Billion from the federal budget is harder than it looks!

[1] The core budget data for the table comes from Table S-3 of the US Budget Summary Tables. The 2010 budget document is used, as actual spending for 2008 is not available in earlier versions. The 2009 fiscal year data is incomplete, and also has significant one-time items like TARP and Stimulus package spending, so I chose to focus on the finalized 2008 numbers instead.

[2] The US defense budget represents almost 50% of the entire world’s defense spending, leaving ample room for cuts without jeopardizing US security. Over time the US defense apparatus has become particularly bloated, and cuts may actually improve the DoD’s efficiency over time. It’s worth noting that the US won the Cold War with much lower defense budgets than today.

[3] Social Security was enacted to ensure that American seniors did not starve in their last years, but later grew into a mandatory retirement program. Cutting Social Security payments to upper income seniors would bring the program closer to its original goal. There are 5 million senior households with income greater than $50,000, and they represent the top 20% of all seniors in income terms. These seniors likely draw maximum social security benefits, around 30k annually if there is slightly more than one senior per household on average.  Phasing out these benefits for the wealthiest 20% of seniors would save around $110 Billion. Gross benefits reductions would be around $150 Billion (5 million * 30,000), with an offsetting loss of tax revenue from the reduction in benefits.

[4] Along with defense spending, Medicare and Medicaid are the fastest growing parts of the federal budget.  Since government resources are limited, government benefits must also be limited. Medicare and Medicaid spending can be contained by requiring individuals to pay 20% of their own health care bills beyond $40,000 per year. This change would affect only 5% of Medicare recipients, but would yield huge savings as many patients would decline expensive treatments once cost became a consideration. 32% of all Medicare spending occurs above the $40,000 line; if requiring coinsurance cut this in half, roughly $110 Billion would be saved. This analysis assumes that the breakdown in Medicaid spending is similar to that of Medicare.  An additional $17 Billion annually could be saved by ending subsidies to Medicare Advantage, which is part of current health care reform proposals under debate.

[5] Non-defense discretionary spending includes almost all other federal departments. A 10% across-the-board cut would force all departments to shrink and increase efficiency. Alternately, targeted cuts could be used to shrink certain programs, but these cuts would still have to total $51 Billion annually. Health care cost growth could be reined in through heavy cuts at the NIH, which heavily subsidizes health care and pharmaceutical research. Cutting NIH’s $30 Billion budget in half would enable other departments to get by with a 6% cut instead. One more alternative would involve eliminating Congressional earmarks, which would reduce spending by $20 Billion.

[6] Other Mandatory Programs includes federal funding for food stamps, unemployment insurance, farm subsidies, student loans, veterans’ benefits, and other miscellaneous programs written into law with automatic spending formulas. Farm subsidies in particular deserve heavy cuts, as they distort the economy while worsening Americans’ health. Eliminating commodity crop payment programs and crop insurance subsidies would save $15 Billion annually (see page 4). An additional $9 Billion in savings is possible through the removal of middlemen in federally-backed student loans. Since the federal government assumes all risk on these loans, there’s no reason to compensate private banks to issue the loans.

16 thoughts on “How to Balance the Federal Budget

  1. I know this is a dead thread, but I wanted to state for the record that for 2008, the target is not $459B, but over $1T! The federal deficit may have been $459B, but the Bush administration’s budget was a dishonest and irresponsible document that left both the costs of Bush’s foreign wars, and the cost of borrowing from the SS trust fund off the balance sheet. So in 2008, the US debt increased by $1T, even though the deficit was ostensibly $459B. In light of this adjustment, I’m sure it will be seen that tax hikes are essential if we are to avoid the fate of the European austerity regimes.

  2. Yeah, something like the QALY is probably the best thing to do in the long run, looking at more and more expensive treatments.

    But since I am already in complaining mode ( 😉 ), let me add this. Assuming that 20% coinsurance for expenses above $40000 would cut those expenses in half is *very* optimistic. A lot of seniors do have savings they would use, some of the expenses would be shifted into the next year or their children would chip in. My point here is: 20% sounds so modest and doable, but it wouldn’t cut it. A lot harsher cuts would be necessary. Also, you can’t require copay from people in medicaid ($200B of the $600B) as the whole reason for them being in the program is that they would not be able to afford them.

    My bottom line here is actually the following:

    In your proposal, it all seem so doable. In practice, it just isn’t.

    But thanks for the discussion. I enjoyed it.

    1. Holger,

      Good discussion, and it has motivated me to write a new post: “What Will Happen When The US Can’t Borrow Anymore?”

      I’m curious to see how it all plays out. There will be some combination of tax increases, benefits cuts, increased inflation due to monetization of the debt (Fed quietly printing a bit of money).

      But what benefits will be cut? And what taxes will be raised? From what we’ve seen in the statehouses (like in California), politicians will resort to limitless gimmicks to pretend to fix a budget until they are up against the wall. So I’m quite curious what will happen when the US really is forced to cut Medicare, Medicaid, Defense, and more, and really is forced to raise taxes.

      What will the public outcry be? Fodder for a speculative blog post.

  3. The proposal is also bad from another perspective. A large part of the cuts is made in social security and medicare. However, those programs are actually financed through dedicated taxes (i.e. payroll taxes for most people) and these taxes actually brought in more money than the programs needed (, section on mandatory spending and entitlement). Given that these programs are still fully financed, there is actually no reason to cut them. This is the whole point of having dedicated taxes for certain programs. Additionally, there is the social security trust fund with $2.2 trillion in it, which can finance social security even if it is running deficits for a while.

    If you cut social security and medicare spending anyway, you would essentially use social security payroll taxes to finance defense spending and other federal budget items. They were not intended for this. Federal medicaid outlays in 2008 were $204 billion. So, you would acutally have to cut $459 billion not from the whole budget, but from the budget- social security – medicare (summing up to approx $1 trillion), leaving the remaining budget at $2 trillion. Of course, interest payments can’t be reduced, so actually the spending that can be cut is only $1.75 trillion.

    The problem seems quite a bit more daunting suddenly – actually pretty much impossible to achieve by cuts only. The budget can only be balanced if you increase some taxes (if you don’t want to misuse social security taxes)

    1. Holger, great comments. I did lump the entire federal budget together for simplicity, but let me break it down and respond by category of spending:

      1. Social Security is indeed fully funded at the moment, and the federal government borrows its surplus revenues to fund other programs. But let’s simply assume that we can’t touch the SSA. Then sometime in the 2040’s its trust fund would be exhausted and it would eventually pay around 70 cents on the dollar from ongoing revenue. That’s actually pretty good, and I think there’s a case to be made that nothing at all should be done with SSA. Just let it pay out what it can, and that’s that.

      2. For Medicare, I stand by my proposal. Why? It’s a form of strict rationing, which is needed to ensure the financial viability of any taxpayer-funded program. Government funds are not limitless, and we can’t give everyone everything. By asking those who want extraordinary treatments to pay more, we are simply recognizing that the government is only responsible for providing care up to a point – after that, if you want the fanciest, newest procedure, pay for it yourself. In contrast to your statement,

      My standard is a less-harsh form of that used by NICE, the body responsible for deciding on treatments covered by the British NHS. NHS does not pay for treatments that cost more than roughly $40,000 per quality-adjusted life year. I am saying that Medicare will pay for a part of those treatments, but seniors will have to chip in if they want expensive, medically inefficient procedures.

      3. With regard to moneys reserved for certain benefits, I have already conceded that the SSA was designed in this way, so let’s leave out my $110B in SSA cuts and assume that the SSA continues to function independently.

      Let’s look at Medicare:

      The Medicare Part A Hospital Insurance fund has a 2010 expected deficit of $20B, rising to a projected deficit of $100B by 2018.

      For Medicare Parts B and D, 75% of revenues come from US general revenues (or deficit borrowing): That’s $185 Billion in 2008, rising every year thereafter.

      So looking at solvency on a per-program basis, Medicare ran a -205B deficit for 2008! If I wanted to balance programs by making them self-funding, I could stick to your proposal and say 0 SSA cuts, and 205B in Medicare cuts, which would pretty much keep my numbers the same.

      But I think the cuts that I’ve advocated are much more responsible. I’m open to the suggestion that we cut SSA less and health care more, however.

      I think this is what will actually happen when the US enters a deep fiscal crisis, which is less than 5 years away by my reckoning. Of course taxes will be raised as well, but make no mistake – cuts are coming, there’s simply no alternative.

      1. Thank you for your reply. Especially your point on medicare financing is good – I did not know that payroll taxes don’t cover part B and D. And I completely agree that in Medicare some cuts will have to be made, especially as expenses are rising so quickly.

        However, you contradict yourself somewhat with your suggestions. In your post, you want everyone to pay 20% of expenses over $40000 a year. As an example of other nations doing this, you cite NICE which does not pay for any treatment costing more than $40000 per adjusted life year. However, these 2 things are vastly different. Under your proposal, a senior getting say a heart transplant costing $200000 would have to pay $32000 out of pocket. However, under NICE guidelines, this would be paid for if he is expected to live more than 5 years. The concept of yearly costs and cost per quality-adjusted-life year are very different.

        Of course I agree that cuts will have to be made, but there is not way the budget could be balanced without tax increases. When discussing this, one should also not forget that the U.S. has one of the lowest tax rates of all developed countries and has repeatedly cut taxes in recent years. The way it looks now, this hasn’t really helped the economy that much, except making a small group of rich people a lot richer. However the federal budget is deep in the red.

      2. Holger, you are correct to point out the difference between QALY and the straight line limit I proposed. In reality I would expect that any such system should be implemented via something like QALY – I analyzed a simpler budget cut to make it, well, easier to analyze. But it would be good to go back and look at how much a QALY based proposal would save, and where the line should be drawn.

        In writing this post, I chose not to propose tax increases in order to look at the specific question, “How do we live within existing revenues?” Note that this analysis is for FY2008 (ended 9/30/08), before revenues went off a cliff due to the fiscal crisis.

        I agree that in the end there will be a combination of tax increases and budget cuts. And though our taxes are lower than most European nations’, many of them are also dealing with 10% of GDP deficits, and will have to cut spending sharply as well. In the last three decades it seems that governments got as addicted to the idea of debt as consumers did, and it looks like they will be the last to wean themselves off. But it will happen one way or another, whether via cuts, hyper-inflation, or something else.

  4. There are several parts of this plan that are completely unworkable.

    For example social security. The proposal is to cut the complete benefit of $30000 per year for the top 20% of earners, which according to him earn $50000 or more. So if I get this correctly, in this plan, people who have $50000 a year and cut their income by $30000, dropping them from the upper income bracket to the middle to lower ones?
    From a practical perspective, it does not work to give people maximum benefit if they earn $49999 and cut their income by 30000 if they have 50000 or more (the income distortion would be huge and very arbitrary – such a rule would certainly not be consitutional). So it has to be phased in over a larger income range. But of course, in order to save 20% of expenses, it would then be necessary to make some cuts to the majority of social security recipients (i.e. by cutting the maximum social security paid out). However, if you want to save 20% of expensens by cutting the maximum benefit, you would have to cut the max benefit down from 30000 to 20000 or less (as not everyone gets 30000, a larger cut than 20% is necessary). A complete cut of social security benefits would also not be possible, as it is an entitlement, meaning people are “entitled” to at least some benefit as they paid in for a long time.

    For the medicare suggestion, the suggestion to have a 20% copay of expenses of $40000 or more puts the whole idea of medical insurance. Most seniors would not have enough money to pay for the 20% copay (that is the only reason they would decline the treatments, as the expensive treatments are mostly live-saving …). So under this proposal, most seniors would not be able to afford live-saving treatment anymore. This proposal is quite cynical, as the savings will only occur if people forgo some really important treatments. In medicare, we should work to cut expenses for the lots of available mostly useless treatments that don’t cost $40000 a year.

  5. The above plan is not aggressive enough to prevent an implosion.

    The interest on the debt has been artificially suppressed by Federal Reserve for years and has accelerated since 2008. This suppression is accomplished by printing hundreds of billions of dollars and using that money to buy debt instruments like mortgages and US Treasuries. The funding channels are obfuscated by sometimes routing funds through foreign central banks.

    This circular process of borrowing (and printing) to buy our own debt is not sustainable. Like a snake eating its tail, it may delay starvation for the short term but will still kill the snake. At some point, interest rates will climb and the debt service costs will overwhelm the federal budget to the point of no retuen

    1. Jayson, cutting the deficit to zero would definitely start to reduce the debt and end the circular debt spiral. The cuts I proposed are for 2008, and so for the upcoming record FY2010 budget, deeper cuts would be needed, since the red ink is now projected at 1.6 Trillion, and not just $459 Billion.

      Hypothetically, if the US were able to reduce its deficits to 0 for a decade, that would be a huge benefit, as inflation would reduce the value of the remaining debt, even if we had to refinance it with new issuance. If the US had its fiscal house at break-even, the demand for Treasuries would be so high as to further reduce interest rates, since people are always looking for a “safe” place to park money.

      Gold bugs may not be amused, but most of the world still regards a US Treasury bill as a lower-risk instrument. That is set to change at the rate we are currently running deficits, of course.

      On your point about monetizing the debt – it shocks me that Japan doesn’t do more of that, literally just print money to buy up their debt. They’re experiencing deflation – if that isn’t the time to print money, then when is?

  6. Who is the benificiary of the interest we pay ($253B) ?
    My suggestion is to pass a law to reduce the interest required on the loan.
    I tend to agree with the plan as stated.

    1. The people who bought all those Trillions of dollars of Treasury bonds: the Chinese, the Japanese, banks, various funds, etc.

      The rates are set by the market.

  7. Cutting agricultural crop subsidies will require raising Commodity Credit Corporation loan rates to reflect the true value of food. CCC loan rates are the farmer’s minimum wage and are the value of the crop for use as collateral on a loan.

    While hourly minimum wage rates over the past six decades have fluctuated around a set point, when measured in constant dollars, CCC loan rates have dropped drastically. This is a result of a decision made in the Nixon White House, when Ag Secretary Earl Butz put American agriculture on an export footing, promoting exports by eliminating production controls and dropping CCC loan rates and making up the loss in farm income by a target price subsidy.

    Measured in true value, the primary flow of subsidy has been from farmer to consumer, through low commodity prices, with a small subsidy back flow from government to farmer. If crop subsidies are removed, crop prices must be allowed to float to their true level by removing a federally set CCC loan rate.

    1. Fred, interesting comments on the business of agricultural subsidies. New Zealand did opt to scrap its subsidies in the 90’s, and since then its farmers have been free to compete on an open market, with generally good success.

      And you’re right, if you remove one subsidy, you have to throw out nonsensical price ceilings and floors to go along with it.

  8. Mostly makes sense to me. The devil is in the details, but we could cut (and SHOULD cut) $450 Billion from the federal budget.

    The government is way to big, way too bloated, way too inefficient.

    We can’t keep spending more than we take in. And we need to start teaching citizens to take care of themselves (rely on themselves or maybe local governments can provide some services more efficiently)

    BUT … none of this will ever happen. The powers that be won’t allow any changes to the status quo.

    Good luck to us all — we’re going to need it.

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