Gross Negligence

The Case Against Washington’s Handling of the Federal Budget

by Alan R. Davis

 

(Written in 01/31/2012, still valid today.) 

Those in Washington aren’t dealing with the budget seriously.  In fact, some in DC are doing their best to convince the country the problem isn’t nearly as bad as it really is.  My concerns fall into five main areas:

-          Washington has invented terms to help ignore the extent of the crisis

      -          The budget includes unrealistic assumptions
      -          There is an oncoming tidal wave of Interest Outlays
      -         The budget is built on legislation that won’t stand
      -         The extent to which individuals depend on the Federal Government

“Invented” Terms:

One of the most frustrating things for me is the fact that rather than face the crisis, Washington has come up with new terms to make the budget crisis look less severe.  Those terms are:

Primary Deficit: The deficit excluding Net Interest Outlays. It allows Washington to claim that they have balanced the budget when they have made little progress in doing so.

Publicly Held Debt:  While this isn’t a new term, using it as the bench mark as opposed to Total Debt is new.  This allows Washington to ignore the fact that it has used intra-government debt (borrowing from the trust funds) as a major source of funds for the general fund.  We’ve seen Non-Public debt grow from ~10% to~ 35% of total debt since WWII.  Comparisons to Post WWII are erroneous for two reasons.  First, we started WWII with relatively low levels of debt compared to the size of our economy.  Second, our current debt was largely built up during times of relative peace, rather than during a major worldwide conflict.  You won’t even find Total Debt in last year’s budget analyses put out by the CBO!

Unrealistic Assumptions:

I first looked at the WH OMB (summary tables) in 2009 after the 2010 budget proposal was released. I was interested in seeing how they calculated Interest outlays.  (Tracking interest rate trends is a hobby of mine.)  I started with the Economic assumptions and was surprised.  The values for each of the five key assumptions appeared to be overly optimistic making the projections meaningless.  I’ve been following the budget ever since.  This year I concentrated on the inflation assumption values.  I found that both the WH OMB and CBO are using assumptions that can’t be supported by historic trending or basic economic principles.  In the original budget projections the WH OMB projected 2.0% and 2.1% as the average and maximum inflation assumption values.

Understating the values for the inflation assumptions has two significant impacts:

Compounding:  Low values compound much slower over ten years than higher values do.  That results in lower “out year” outlays and deficits.

Interest Rates:  Understating inflation allows them to use lower values for interest rates as there is a correlation between the two over the long run.  Each 1% understatement of the “effective rate” (Net Interest Outlays divided by average debt) understates Net Interest Outlays by $200 billion in a year when the National Debt (Total) is $20 trillion.  The original budget included 7 years where debt exceeded $20 trillion.

Interest Rate “Tidal Wave”:

In the early 1990’s we became concerned over the size of the debt as we saw Net Interest Outlays increase dramatically.  This occurred as interest rates decreased to “normal” levels.

90's Average:  $216 billion Net Interest on $4.6 trillion debt (Fed Fund Rate of 5.2%)

In 2010 we incurred less Net Interest Outlays on nearly three times the level of debt. 

2010:               $197 billion Net Interest on $13.4 trillion debt (Fed Fund Rate of 0.18%)

The Treasury Dept. has been utilizing a substantial amount of short term maturity instruments to finance our debt. Even long term maturity instruments have been issued at unsustainably low rates.  Once the FRB increases rates (they have indicated that will occur in 2014) it will dramatically increase the interest we’ll be paying on our Debt.  It means we have a built in “tripling” of Net Interest Outlays at current debt levels that is not being properly considered by Washington.

Legislative Assumptions:

Budget projections are built on current legislation.  The best example of how this distorts the projections is the Medicare “Doctor Fix”.  It is addressed for one year each year so as to allow the cost cutting impact of the law to be used in projections.  But the intention is to not allow the dramatic cut to physician payments to ever take effect.  There are several other items like this that allow the projections to reflect much smaller deficits than would otherwise be shown.

“Individuals” & the Federal Budget:

I ran across a historic schedule on the WH OMB website that broke out Outlays in much different categories than I had previously seen.  That schedule showed the following for 2010 Outlays:

National Defense:                      20.0%

            Net Interest:                                 5.7%
            Payments for Individuals:          66.5%
                          Subtotal                         92.2%
             Other Grants:                               5.8%
             All Other:                                     2.0%
                          Total                            100.0%           

With so much of the Federal Budget going to individuals (directly or indirectly through state and local governments) any serious cuts to the Federal Budget will have serious consequences for towns like Chillicothe. Add in the fact that soon we will see a dramatic increase in Net Interest Outlays and the size of required cuts to balance the budget are staggering!  Yet this isn’t being properly discussed in Washington.

Unless the real extent of our Nation’s financial crisis is brought forward for public debate, we won’t see it properly addressed and financial collapse becomes more likely.  Addressing it appropriately will result in real hardship for many.  But unfortunately hardship comes either way.

 

“There are two ways to conquer and enslave a nation.

One is by sword.  The other is by debt.”

John Adams 1826

“The battle, sir, is not to the strong alone; it is to the vigilant, the active, the brave.”