This Ryan Won’t Fly-Part 1

Back in the days when economists had a sense of humor and irony Herbert Stein noted that something that is unsustainable will not continue. This unalterable fact is true of federal finances as currently constructed. The budget has a structural deficit of about 4%+ of GDP and this structural component will grow if the spending/taxing relationship is not changed. The Debt/GDP ratio will have to be reduced and stabilized. Empirical research indicates a ratio of around 60% is necessary for long-run economic stability. We are currently at 80% and moving towards a three digit level within the next few years. The recession is only partially responsible (about 60% of the current deficit can be attributed to the slow economy).

Currently there are three fully formed budgetary proposals designed to put federal finances on a sustainable path and reduce deficits and federal debt. They are : The Bowles-Simpson plan put forward by the President’s Commission on Fiscal Responsibility and Reform, the Rivlin-Domenici deficit reduction plan proposed by the Bipartisan Policy Center and the “Path to Prosperity” fiscal plan proposed by Congressman Ryan. And recently the Obama Late Entry Plan. I take it as a political truth that only bipartisan support will generate a plan that has any chance of legislative enactment, and bipartisan support indicates the public has the stomach for the plan’s distribution of pains and benefits.

This eliminates two extremes: A plan that claims to attack  the fiscal crisis by only cutting spending (The Ryan Plan )or a plan that solves the problem by only raising revenues (I’m speaking of both of these as a share of GDP). The current fiscal gap is roughly 10% of GDP.Under the current structure of taxes and expenditures. This gap would close to around 5% if the economy were operating at a full employment level of output. Any plan must reduce this structural gap to claim it will achieve fiscal sustainability.

The trick is to move toward a sustainable fiscal balance without jeopardizing the recovery. The adoption of a plan will not in itself immediately stimulate the recovery. It will improve the nation’s balance sheet overtime and provide a foundation for more economic stability. It accomplishes this by stabilizing and gradually reducing the Debt/GDP ratio at the 60% range, and reduces the potential “crowding out” effect of increasing federal debt held by the public. This does not assure balancing of the budget, at least not, annually. The ideal solution (I think) involves cyclical balancing of the budget with a virtual balance at around 5% unemployment and surpluses at output levels that generate unemployment a lower levels.

In the real world a politically acceptable solution will involve increased taxes, and program cuts (this will involve actual reductions in the growth rate of entitlement spending, actual reductions in Medicare and Medicaid. Pain for all is the politically acceptable solution.

A balanced plan also implies some growth in the federal share of the GDP. Demographic trends augur for an aging population and this means increased medical care per capita. Demography is destiny.There is no extant evidence that medical costs for the elderly will decline in absolute terms, or for that matter in relative terms. This means that the current and future generations will have to save more (either through increased personal savings or increased taxes) to cover growing medical expenses. Geriatric care is the elephant in the closet, and the elephant is growing. We can offset some of this burden through economic growth but growth is unlikely to offset all of it. We can try and offset the growth in medical federal medical liabilities trend by reducing government expenditures on other programs. That will buy some time but unless you can envision defense spending and non-defense discretionary spending trending to zero, the budget will increase. The interest on the debt is the other item that seems primed for inexorable growth absent serious fiscal discipline.

The Ryan approach throws all the burden of hunting elephants to the expenditure side of the budget. Over time discretionary spending declines by 91% as a share of the budget and Medicare and Medicaid spending are significantly reduced The burden of all these cuts falls on the majority of the population.

Nothing real has changed. The elephant is still growing demography and medical cost trends guarantee this result. The cost is shifted to the consumers of medical services. (Additionally, The Affordable Care Act is also repealed) Let me suggest that all of this is politically impossible, but the fight will slow down the search for real alternatives.

The federal budget deficit is not the real focus of the Ryan Plan. He wants to reduce the share of Federal spending to GDP to its post WW2 average of around 18% and just cuts spending growth to get there. The deficit is not eliminated until 2030 under his favorable economic growth assumptions. A discussion of these assumptions will follow in the next installment of the Ryan flight plan.

These spending cuts and medical cost redistributions will be combined with higher income earners sacrificing pre-Bush tax rates. This is the most regressive fiscal revision in US history.