The budget is the main arena in which the nation as a whole decides on the allocation of resources. What we spend money on and what we don't reflects what we value as a nation. But making those choices isn't at all simple. It is in the federal budget that the breakdown of consensus in America is most vivid and most dangerous. One side of the political divide wants to cut taxes and shrink existing public services (including support for the poor) in the name of cutting wasteful government programs and insisting that the poor solve their own problems. The other side wants to increase public spending on social and economic needs the poor, the unemployed, infrastructure, education and the environment even as it remains unclear on how to fund the outlays.
With these divisions unresolved, we've landed in a first-rate mess. Compared with those in other rich countries, taxes in the U.S. are low. Yet government spending is persistently higher than taxes: the budget deficit is at a record high for peacetime, and Washington is utterly paralyzed when it comes to addressing urgent needs. The only thing that reliably grows in our economy is the public debt.
During the first full budget year of the Obama Administration (fiscal year 2010, which runs from October 2009 to the end of September 2010), both sides "won" yet again: taxes were cut; spending was increased. According to the latest projections by the Administration in presenting the fiscal year 2011 budget, the deficit is now expected to reach $1.6 trillion, an astounding 10.6% of gross domestic product (GDP). Some of that reflects the downturn in the business cycle, which cuts into tax revenue while boosting unemployment compensation, bank bailouts and other spending. Yet there's nothing temporary about the enormous deficits. The Obama budget office projects megadeficits for years to come as high as $752 billion, roughly 4% of GDP, in 2015 despite some rosy economic and budgetary assumptions. Meanwhile, as the Treasury borrows to fill the gargantuan gap between revenue and outlays, the stock of government debt is soaring. In fiscal year 2010, the Obama budget office projects that the public debt will increase by $1.75 trillion. That amounts to roughly $15,000 per household. Through 2015 the cumulative rise in the debt is projected to exceed $6 trillion.
How much does that matter? Some liberals say not to worry. They point out that the New Deal was funded by deficits, claim that interest costs on the debt will be minor and insist that fiscal scolds are putting accounting niceties ahead of economic needs. They exaggerate on all of these counts. When the New Deal deployed deficit spending from 1933 to '36, the deficits were around 5% of GDP, compared with around 10% today. The publicly held debt was rather stable, around 40% of GDP then, but it will soon reach 60% of GDP in 2010, and on the Administration's budget plans will rise above 70% by 2012. What's more, in the 1930s the debt was financed domestically by Americans. Today about half of public debt is held by the rest of the world, much of it by China and Japan. In the New Deal era, taxes could easily rise to cover the increased cost of servicing interest on the debt. Today we have no agreement on how such debt servicing will be paid for. And we face another unprecedented challenge: large increases in entitlement spending as a share of GDP are likely to continue into the 2020s and '30s as the population ages and health care costs mount.
Let's look more closely at budget revenue and outlays. In a normal year, our federal tax system takes in around 17% of GDP less in the current recession and more in years of financial bubbles, when capital-gains-tax collections are high. It's important to understand what that revenue buys us. Military spending accounts for around 5% of GDP. Health spending (including Medicare, Medicaid and veterans' health) is around 5% of GDP, as is Social Security (retirement, disability and veterans' benefits). Interest payments on the debt will soon reach 2% of GDP. In short, the Federal Government collects tax revenue sufficient to cover just four budget items. The rest of the budget is funded by borrowing.