Lazear's Budget Solution: Deceptively Simple, Or Simply Deceptive?

by: James Bacon

Edward P. Lazear offers a beguiling — and misleading — approach to restoring the United States to a balanced budget. In today’s Wall Street Journal, the former chairman of the President’s Council of Economic Advisors proposes (1) enacting a 2012 budget that brings spending halfway back to where it was in 2008, and (2) limiting spending increases to inflation minus 1% thereafter.

If those rules were applied consistently over 10 years, Lazear suggests, the U.S. would steadily close the deficit. “The inflation-minus-one rule would allow us to grow our way out of our fiscal problems without taxing a higher proportion of GDP. Eventually the deficit would vanish — and with taxes remaining at historic levels, there would be no impediment to economic growth.”

Gosh, Lazear makes it sound so easy. Just put a slow, gentle squeeze on spending, and we’re back to a balanced budget — with a healthier national balance sheet as well — in a mere 10 years.

Thanks for nothing. Lazear’s op-ed is about as profound as saying 1 + 1 = 2. He is expressing little more than a mathematical identity. And in doing so, he makes the job of restoring the country’s fiscal foundations sound deceptively simple: Stop passing new spending initiatives, tweak a little here, show a little discipline there, and, voila, we’re back to a balanced budget. Unfortunately, he doesn’t tell us what to cut. That’s like a man who advises his neighbor that the way to save his house from a flash flood is to lift it up on stilts.

“How do I do that?”

“I did the hard part of thinking up an idea. You figure out how to do it.”

Lazear overlooks the three forces (not to mention an improvident Congress) that will drive spending higher: the age wave, escalating medical costs, and the rising burden of servicing the debt. Meeting his inflation-minus-one formula will be far harder than it sounds.

Next year, the first Boomers become eligible for Medicare. Meanwhile, health care expenses are escalating considerably faster than inflation. Without any changes to legislation, federal Medicare payments will roughly double over the decade ahead, adding another $400 billion a year to spending by 2020. Thus, in addition finding 1% of the budget to cut, Congress will have to find $400 billion a year more to offset rising Medicare costs. (Medicaid will be increasing in lockstep with Medicare, presenting a similar, though somewhat smaller, problem for the federal government.)

Meanwhile, interest rates on the $13 trillion-and-growing debt are expected to increase. The national debt will climb to $17 trillion to $20 trillion even if Congress manages to eliminate the deficit by 2020. Compounding that problem, today’s low interest rates, largely engineered by the Federal Reserve, are not sustainable. By some estimates, the rate in 10-year Treasuries could nearly quadruple to 10% by 2020. Thus, interest on the national debt could shoot up from roughly $200 billion to as much as $1 trillion a year. To meet Lazear’s inflation-minus-one schedule, Congress will have to offset that mammoth growth as well.

Using very rough numbers, Medicare, Medicaid and interest on the national debt will drive spending higher by roughly $1.5 trillion a year in 2020. (As a reminder: The FY 2011 budget will be $3.7 billion.) The interest payments, by the way, are untouchable. They cannot be cut, not without triggering the very financial crisis we hope to avoid. Bottom line: There is no easy way out of our predicament. We need to start thinking now about how to fundamentally reorganize our government and entitlement programs.
Disclosure: No positions