More Slides from Ed Dolan’s
Econ Blog http://dolanecon.blogspot.com/ Could Federal Spending be Capped at 20 Percent of GDP? Should It Be? Posted January 13, 2011 Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics , from BVT Publishers.

The 20 Percent Solution <ul><li>One
proposal for resolving US budget problems is to cap federal spending at 20 percent of GDP </li></ul><ul><li>20 percent is approximately the average level of federal spending during the post-World War II period, up to the beginning of the present crisis </li></ul>Posted Jan. 13, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com Congressman Mike Pence (R-Ind.) is among the backers of the 20 percent solution, which he has packaged in the form of a proposed Spending Limit Amendment to the Constitution http://mikepence.house.gov/index.php?option=com_content&view=article&id=3946:sla-page&catid=86:sla&Itemid=109

Past vs. Future <ul><li>Backers of
the 20% solution contrast past spending levels with future projections </li></ul><ul><li>To understand the proposal, we need to look in more detail at the past and future lines on this graph </li></ul>Posted Jan. 13, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com Chart source: http://mikepence.house.gov/index.php?option=com_content&view=article&id=3946:sla-page&catid=86:sla&Itemid=109

Disaggregating Past Spending <ul><li>Not all
components of past spending have behaved alike </li></ul><ul><li>The discretionary component of spending (defense, education, law enforcement, highways, etc.) has been on a long downward trend for several decades </li></ul><ul><li>Unless something else changed, a 20% spending cap would require continued decrease of the discretionary component </li></ul>Posted Jan. 13, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

Defense vs. Non-defense Discretionary Spending
<ul><li>Within discretionary spending, the defense and non-defense components have played tag over the years </li></ul><ul><li>When defense spending has fallen, non-defense spending has tended to rise, and vice versa </li></ul><ul><li>Over time, both components have generally trended downward </li></ul>Posted Jan. 13, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

Net Interest <ul><li>Net interest on
the national debt has averaged around 3 percent of GDP over time </li></ul><ul><li>In the mid-2000s, it fell to about half its usual levels due to </li></ul><ul><ul><li>Unusually low interest rates </li></ul></ul><ul><ul><li>Brief budget surpluses during the late Clinton administration </li></ul></ul><ul><li>During this period, low interest costs relieved pressure on discretionary spending </li></ul><ul><li>However, interest outlays will return to their usual 3% of GDP, or above, in the coming decade </li></ul>Posted Jan. 13, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

Entitlements <ul><li>While discretionary spending has
fallen as a percentage of GDP, entitlements (mostly social security and Medicare) have grown from 6 percent of GDP in 1970 to over 10% in the mid-2000s. </li></ul>Posted Jan. 13, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

Aging US Population <ul><li>Growth of
entitlements is largely driven by demographics </li></ul><ul><ul><li>By 2050, the share of the US population 65 and older will nearly double compared with 2010 </li></ul></ul><ul><ul><li>The share 85 and older, heavy consumers of Medicare services, will more than double </li></ul></ul><ul><li>In order to cap social security and Medicare spending at their current shares of GDP, benefits per person would have to be cut sharply </li></ul>Posted Jan. 13, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

Could Spending be Limited to
20% of GDP? <ul><li>Could spending be limited to 20% of GDP? Probably yes, using some set of measures like this: </li></ul><ul><li>Reduce discretionary spending to its pre-9/11 level of 6.3% of GDP </li></ul><ul><li>Within discretionary spending, decide between large cuts in defense, with withdrawal from foreign deployments, or else cut deeply into the muscle, not just the bone, of education, law enforcement, research, infrastructure, etc. </li></ul><ul><li>Cap entitlements at 10% of GDP by converting social security and Medicare to means-tested programs for only the neediest Americans </li></ul>Posted Jan. 13, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com ?

Should it Be Done? <ul><li>The
bottom line: </li></ul><ul><li>Holding federal spending to 20% of GDP would be possible, but it would mean a gradual decline to a pre-1930s level of social safety net and third-world quality of defense, education, and infrastructure </li></ul><ul><li>Maintaining approximately the level of government services provided in the late 20 th century would require total federal spending to rise well above 20% of GDP </li></ul>Posted Jan. 13, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com ? Take your choice—but don’t pretend you can have it both ways!