George H. Blackford, Ph.D.
Economist at Large
It ain't what you don't know that gets you into trouble.
It’s what you know for sure that just ain't so. Mark Twain
Figure 1: Total Federal Government Outlays, 1901-2012.
This figure also shows that, in spite of what most people seem to think:
As can be seen in Figure 2, the fall in federal employment since the 1960s is even more dramatic.
Figure 2: Breakdown of Federal Government Employment, 1962-2011
Federal employment fell from 5.2 million in 1965 to 4.1 million by 2007, and when we subtract out those employed in the military and by the post office we find there has been hardly any change at all in the number of non-military, non-postal federal employees over the past fifty years even as the population increased by over fifty percent and the level of total employment in the economy more than doubled. What's more, Figure 2 clearly shows how the fraction of the workforce employed by the federal government has fallen by more than 40% since the 1960s even after taking into account the decrease in the size of the military.
So much for our ever-growing, out-of-control federal bureaucracy!
The fact that Americans are not terribly overtaxed is shown quite clearly in Table 1 which is constructed from the official statistics of the Organization for Economic Cooperation and Development (OECD). This table shows how the United State's ranking among the 34 OECD countries has changed since 1980 in terms the percentage of gross income (GDP) that is paid in taxes.
Table 1: OECD Countries that Pay Less Taxes than We Do
Percent of GDP, 1980-2010.
We have moved from tenth from the bottom on this list to third from the bottom over the past thirty years. Among the advanced countries of the world, only Chile and Mexico paid less in taxes as a percent of their gross income than we did in 2010.
The idea that the federal budget and employment have grown voraciously over the past forty years or that Americans are terribly overtaxed are only three of the fiscal myths people believe today. In a recent survey (February 2013), the Pew Research Center asked 1,504 respondents: "If you were making up the budget for the federal government this year, would you increase spending, decrease spending or keep spending the same" for nineteen different categories of government expenditures. The expenditure categories and results of the survey are given in Figure 3.
Figure 3: Pew Research Center Survey Results, February 2013.
Source: Pew Research Center
These results suggest that the vast majority of the American public is satisfied with the size of the federal government we have, and, if anything, would like to see it increase rather than decrease: For all categories of expenditures, other than the first three, a larger proportion of the respondents would choose to increase rather than decrease expenditures, and for all categories, even the first three, a majority of those who had an opinion would either increase expenditures or keep them the same if given the choice. In addition, the three categories which more respondents would rather decrease than increase—Aid to the world's needy, State Department, and Unemployment aid—sum to just 4% of the federal budget while just five of the categories which more respondents would increase rather than decrease—Social Security, Military defense, Medicare, Health care, and Aid to needy in U.S.—sum to over 70% of the federal budget.
These results stand in stark contrast with those of the Pew Research Center/USA Today survey conducted later that same month in which the respondents were asked if the president and Congress should focus on spending cuts, tax increases, or both in order to reduce the federal budget deficit. The results of this survey are given in Figure 4.
Figure 4: Pew Research Center/USA Today Survey Results, February 2013.
Source: Pew Research Center/USA Today
Here we find that the overwhelming majority of people (73%) would like to see the federal deficit problem solved through only or mostly spending cuts rather than through only or mostly tax increases (19%). In other words, an overwhelming majority of the American people would like to have their cake and eat it to: they want to increase the size of the federal government or keep it the same as they solve the deficit problem through only or mostly spending cuts.
According to the OMB, the federal deficit was equal to 30% of total federal expenditures in 2012. As a result of rescinding some of the provisions of the 2001-2003 tax cuts combined with the expected recovery of the economy and some spending cuts, this deficit is estimated to decline to 10% of total federal expenditures by 2018. It should be obvious that we are not going to be able to eliminate the remaining 10% deficit through mostly spending cuts—as, apparently, 73% of the American people want to do—by cutting the 4% of the budget that goes to Aid to the world's needy, the State Department, or Unemployment aid. If we are to eliminate the 10% deficit estimated for 2018 through mostly spending cuts we are going to have to cut the 70% of the budget where we find Social Security, Military defense, Medicare, Health Care, and Aid to needy in U.S. because that's where the money is.
As can be seen in Figure 5, which shows a breakdown of the entire federal budget with a 10% hole in it, the money is not in the 24% of the budget that is left after we deduct the 6% we must pay in interest on the national debt.
Figure 5: Pie Chart of Federal Expenditures 2012 with a 10% Hole, 2018.
Even a causal examination of this chart reveals that it is impossible to maintain the government the vast majority of the American people seem to want and, at the same time, reduce the deficit by as much as 10% through mostly spending cuts:
Where are these cuts supposed to come from? From eliminating waste, fraud, and abuse? I don't think so. (For an examination of the problems involved in trying to cut the budget through the elimination of waste, fraud, and abuse see Waste, Fraud, and Abuse in the Federal Budget.)
The federal budget has been at the center of the political debate in our country for the past forty years, and, yet, few people seem to understand how the money is spent. As the Pew Research Center and Pew Research Center/USA Today surveys indicate, many, if not most seem to believe that somehow we can cut the budget dramatically, say by as much as 10%, and can thereby save a substantial amount in taxes without having to cut defense or Social Security or Medicare and without cutting those programs that make up our social safety net. At the same time there are those at both ends of the political spectrum who believe we can save a tremendous amount in taxes by cutting defense. (Coburn Sanders) Figure 5 clearly indicates that these beliefs are problematic. Figure 6 and Figure 7 below may help to make this point even more forcefully.
Figure 6 is constructed from the OMB's Table 3.1—Outlays by Superfunction and Function. This figure plots a breakdown of the actual, real-world expenditures of the federal government in terms of its three largest categories (Superfunctions) from 1940 through 2011: Defense, Human Resources, and Net Interest.
Figure 6: Defense, Human Resources, and Net Interest, 1940-2012.
The first thing we see when we look at the graphs in this figure is that even though the size of the federal budget has changed very little relative to the economy since the 1950s, the Human Resources component of the budget—those programs that make up our social insurance system including Social Security, Medicare, and those programs that make up our social safety net—has grown dramatically. It has gone from less than 20% of the budget in the early 1950s to more than 60% in the 2000s.
At the same time, we see that Defense has decreased just as dramatically, going from over 60% of the budget in the early 1950s to around 20% in the 2000s. Meanwhile the third largest category in the budget, Net Interest, has gone from a high of 13.8% of the budget in 1948 to a low of 5.2% in 2009, and it stood at 8.4% of the budget in 2007—the year before the federal budget was distorted by the financial panic in 2008 and the economic crisis that followed. What is most relevant to the point at hand, however, is what has happened to All Other Expenditures and Defense in this graph.
All Other Expenditures is constructed by subtracting the sum of Defense, Human Resources, and Net Interest from the Total Expenditures (Total outlays less Undistributed offsetting receipts in OMB's Table 3.1). It shows us how much the federal government spent on everything other than Defense, Human Resources, and Net Interest. All Other Expenditures consists of such things as expenditures on Energy, Natural Resources and Environment, Transportation, Community and Regional Development, International Affairs, General Science, Space, Technology, Agriculture, Administration of Justice, and General Government—basically, all of the items north of Interest on the National Debt in Figure 5 that do not involve retirement, healthcare, or other social-insurance programs. This residual has gone from a high of 31.6% of the budget in 1940 to a low of 7.4% in 2010. It stood at 9.4% in 2007 before the financial and economic crisis that wrought havoc with the federal budget began and at 10.8% in 2012.
It is obvious—or at least it should be obvious to anyone who looks at the actual, real-world expenditures of the federal government plotted in Figure 6—that there is no reason to believe we can save a substantial amount in taxes by cutting the programs in the All Other Expenditures category in Figure 6, obviously not enough to reduce the total budget by 10%. The expenditures on programs in this category have already been cut by almost 50% since 1980, relative to the budget and GDP, and even if we were to eliminate all of these expenditures completely—which, of course, we can't do and still have a functioning government—we would succeed in reducing the size of the federal budget by at most 11%.
What do we find when we look at Defense?
It is apparent from Figure 6 that there may be room to make additional cuts in the area of Defense. After all, Defense today is barely below where it stood in 1980 when we were still waging the Cold War against the Soviet Union, and with the end of the wars in Iraq and Afghanistan there could be room to maneuver here. Just the same, there is no reason to think we can cut our total tax bill by as much as 10% simply by cutting Defense. Even if we were to cut the defense budget in half—something that virtually no one would be willing to do—it would only reduce the total federal budget by about 10%.
Thus, if we are serious about saving as much as 10% of our total federal taxes, unless we are willing to make draconian cuts in Defense or dismantle a substantial portion of rest of the federal government, we must look to Human Resources. That's where the money is, and that's also where Social Security and Medicare are as well as the other social-insurance programs that make up our social safety net. The question is:
The OMB's Table 11.3—Outlays for Payments for Individuals details the bulk of the expenditures contained in the Human Resources category of the budget. Figure 7 breaks down the items in Table 11.3 into four categories: Retirement/Disability is the sum of all federal expenditures on retirement and disability programs. Healthcare is the sum of all federal expenditures for individuals on healthcare. Other Payments for Individuals is the sum of all federal expenditures on all payments-for-individual programs that are not medical or retirement/disability programs. The final category, Other Human Resources, is the total of all government expenditures on all other Human Resources programs. (For a detailed explanation of each of these categories along with a detailed examination of programs that are included in each category see Understanding the Federal Budget.)
Figure 7: Breakdown of Human Resources, 1940-2012.
The first thing we see when we look at the breakdown in Human Resources in Figure 7 is that Retirement/Disability has been the largest component of Human Resources since 1952.
The second is that while there were significant increases from 1965 through 1975 in all four of the graphs in this figure, only Healthcare has continued to rise after 1975. This component of the federal budget has grown almost continuously from virtually nothing in 1965 to the point where it rivals Retirement/Disability as the largest component of Human Resources today.
Retirement/Disability and Healthcare combined dominate Human Resources and accounted for some 82% of all Human Resources expenditures in 2007 and 80% in 2012. This would suggest that if we are to find ways to make substantial cuts in Human Resources we should begin by looking at Retirement/Disability and Healthcare.
The problem is that when we look at Retirement/Disability we find that it is dominated by Social Security in that fully 76% of the total spent on programs in this category of the budget goes to Social Security while 19% goes to civil service, military, and railroad retirement/disability programs, and only 4% to the Supplemental Security Income (SSI) program. There is no way to make substantial cuts in this portion of the Human Resources budget without cutting Social Security. After all, military, civil servants, railroad employees, and other government employees are just as entitled to their retirement/disability benefits as are Social Security recipients, and, in any event, these programs take up less than 6% of the total budget. (See Understanding the Federal Budget.)
This leaves the SSI program which is 4% of Human Resource expenditures and less than 2% of the entire federal budget. Aside from the fact that SSI is less than 2% of the budget, SSI is the primary social safety-net program that provides for indigent disabled and indigent elderly individuals who are either not eligible for Social Security or whose benefits fall below a subsistence level. Substantial cuts in this program would not only save virtually nothing, it would also tear a hole in our social safety net.
What about Healthcare?
Healthcare accounts for 25% of the federal budget with Medicare and Medicaid accounting for over 90% of this portion of the budget, and Medicare accounting for 70% of this 90%. What about the 30% of this 90% that went to Medicaid?
This program represented 7% of the federal budget and less than 2% of our gross income in 2007 and lies at the very core of our social safety net. According to the Census Bureau's Table 151. Medicaid—Beneficiaries and Payments: 2000 to 2009, some 75% of its beneficiaries were either poor Children, indigent Blind/Disabled individuals, or indigent elderly adults age 65 and over, and over 85% of Medicaid's expenditures went to these individuals. It would appear that there is very little room to cut this 7% of the budget without causing a great deal of hardship and misery through the denial of medical services to poor children or indigent disabled or elderly adults.
That leaves the remaining 10% of the Human Resources budget that went to the other Healthcare programs. Here we are talking about 2% of the entire federal budget and 0.5% of our gross income. Of that 2%, 67% went to veterans (Hospital and medical care for veterans and Uniformed Services retiree health care fund), 11% to Children's health insurance, and 6% to Indian health. Of the remaining 17%, 63% went to Health resources and services (a program that is designed to meet the healthcare needs in underserved, mostly rural areas), 34% went to Substance abuse and mental health services (a program that is severely under funded given the extent of the substance abuse problem in our country), and 3% went to Other federal healthcare programs. (See Understanding the Federal Budget.)
Veterans certainly have as much right to their medical benefits as Medicare recipients, and the rest of these programs play an important role in our social safety net. In addition, since the rest of these programs took up less than 1% of the entire federal budget in 2007 there is virtually nothing to be saved in taxes by eliminating these programs.
The leaves but two categories in Figure 7 to examine: Other Payments for Individuals and Other Human Resources.
Other Payments for Individuals includes the expenditures on all of the federal programs in the OMB's Table 11.3 that are not medical or retirement/disability programs. This is where we find the programs that make up our social safety net.
The first thing that should be noted about this portion of the budget is that we are talking about only slightly more than 9% of the entire federal budget and less than 2% of our gross income in 2007. In addition, it was slightly less than 13% of the budget and 3% of GDP in 2012 in the midst of the worse economic depression since the 1930s.
While there were no programs that dominated this category, the ten largest accounted for some 93% of the total expenditures in the Other Payments for Individuals category in 2007 and 84% in 2012. These ten programs comprise the backbone of our social safety net. We're talking about the Earned Income and Child Tax Credits (1.99% of the total budget in 2007/2.17% in 2012) that are designed to encourage work and assist the working poor who pay over 14% of their earned income in payroll taxes. About food stamps, school lunch and milk programs, and feeding programs for women, infants, and children (1.95%/2.98%) that assist the poor in feeding themselves and their children. About student aid (1.01%/1.39%) and unemployment compensation (1.22%/2.61%). About foster care and adoption assistance (0.24%/0.19). And we're talking about only 9% of the federal budget and less than 2% of our gross income in 2007, and 13% of the federal budget and 3% of GDP in 2012 in the midst of the worse economic crisis since the Great Depression.
There is no reason to think that we can save a great deal in taxes by making substantial cuts in this portion of the budget without dismantling our social safety net and causing a great deal of hardship and misery. The money just isn't in this 9% or 12% of the budget, and it's through the programs in this portion of the budget—combined with Medicaid and SSI—that our war against hardship and misery is waged. (For a comprehensive examination of our social safety net see Chapter 14: Welfare, Tax Expenditures, and Redistribution in Where Did All the Money Go?)
This leaves only Other Human Resources in which to find those elusive programs on which the government is supposedly squandering our federal tax dollars. Other Human Resources is the total of government expenditures on all Human Resources programs that are not included in the other categories in Figure 7. It is calculated by subtracting the sum of Retirement/Disability, Healthcare, and Other Payments for Individuals in Figure 7 from the total of Human Resources given in Figure 6.
This residual can be disposed of rather quickly. It represented only 2.4% of the budget in 2007 (1.4% in 2012) and less than 1% of our gross income, and aside from the fact that 2.8% of the budget is insignificant in the grand scheme of things, as is shown in Figure 7, the programs contained in Other Human Resources have already been cut by almost 50% since 1980. There is no reason to believe additional savings can be found in additional cuts in this 2.8% of the budget.
That's it! That's all there is to the entire federal budget! Everything the government spends money on in financing its ongoing operations is included in one or another of the categories contained in Figure 6 or Figure 7. (See Understanding the Federal Budget for a more complete examination of these two figures. For a somewhat different perspective on the problem of finding ways to cut the budget see Waste, Fraud, and Abuse in the Federal Budget. In addition, a detailed and comprehensive examination of the various kinds of expenditures in the federal budget can be found in Part III The Federal Budget (PDF) of Where Did All the Money Go?)
This is the situation that actually exists in the real world, and this is what Real-World Economics is about. It’s about cutting through the rhetoric, the spin, the propaganda, and all of the other nonsense that exists in the imaginary world many, if not most people have come to believe in, and looking at the facts as they actually exist in the real world, the world in which we actually live. It is hoped that looking at the facts in this way will introduce a degree of rationality into the otherwise hopelessly irrational debate we have been subjected to over the past forty years. After all, facts do matter, or at least they should.
Many of the papers on this website, including this introduction, have numbers in them. I realize that many people have an aversion to numbers, but I make no apology for including them here. For the past forty years we have lived in a world in which one end of the political spectrum has insisted that two plus two is six and demonized anyone who argued otherwise. Those who argued that two plus two is four have been ignored while the vast majority of the population, including our political leadership, has come to the conclusion that this sum must be five. Our nation’s economic policies have been guided accordingly with results that are totally consistent with the logic involved. This is the kind of arithmetic that got us into the mess we are in today, and it is not going to get us out. The time has come for people to look at the numbers and learn how to add.
This is particularly so when it comes to trying to understand our economic system. It is impossible to understand the economy without looking at the numbers. The reason is that no one can actually see the economy. The economy is made up of some 315 million people, 114 million households, 27 million business firms, 89 thousand governments, innumerable goods and services, and it is spread throughout the land and has tentacles that stretch all over the world. All we can actually experience of the economy is the very tiny part we personally interact with, and our personal experiences tell us virtually nothing about the whole.
The only way we can come to grips with the whole is to look at numbers. Output numbers. Employment numbers. Government numbers. Production numbers. Price numbers. Money supply numbers. Income numbers. International numbers. Debt numbers. Numbers! Numbers! Numbers! There are often very real problems in obtaining the numbers needed to understand the economy, and often the numbers we have don't measure what we want them to measure or think they measure, but, in the end, all we can actually know about the economic system is numbers. Everything we think we know about the economic system is just speculation unless it is supported by numbers, and everything we think we know about the economy that is contradicted by the numbers is just hot air in the absence of an explanation as to why the numbers are wrong.
In searching for ways to cut the federal budget it is important to understand that cutting a small amount from a large portion of the budget or a large amount from a small portion of the budget may yield a lot of money in absolute terms, but it doesn't yield a lot of money relative to the size of the total budget. It only reduces the total budget by a small amount. To reduce the total budget by a large amount we have to cut a large amount from a large portion of the budget. That's just grade school arithmetic.
When we look at the actual expenditures in the federal budget over the past forty years we find that it is not possible to cut a large amount from a large portion of the budget without cutting defense, Social Security, Medicare, or the programs that make up our social safety net because that's where the money is. The rest of the budget has already been cut to the bone since 1980, and there simply isn't enough money in the rest of the budget to make a difference even if we cut a large amount from this small portion of the budget.
At the same time, if we were to look at the actual numbers that exist in the real world we would find there is no reason to believe we can reduce the size of the federal government by increasing our efforts to target specific instances of waste, fraud, and abuse, because there simply aren't enough specific instances of waste, fraud, and abuse in the budget that are of sufficient magnitude to make a difference in this regard. (See Waste, Fraud, and Abuse in the Federal Budget.) At best, all we can hope to do by expanding our efforts in this area is cut a small amount from a large portion of the budget, and doing this could actually cost us more to do than we can save by doing it. This does not mean we should ignore this problem. It only means that we should not expect to see a substantial reduction in the size of the budget as a result of our efforts to solve it. Those who think otherwise have a problem with arithmetic. Their numbers just don't add up. (Compare Waste, Fraud, and Abuse in the Federal Budget with Coburn Sanders, MFCU, NYT, and St Luis Fed.)
It is also worth noting that attempting to address deficit problems by simply cutting the budget—which is what we have been trying to do over the past thirty years—is a recipe for disaster. When we do this we risk increasing malnutrition and death rates among poor children or indigent disabled/elderly adults and forcing people who can’t find work—for whatever reason—to become desperate which is what we can expect to happen when we simply cut the funds to those programs contained in Other Payments for Individuals in Figure 7. (Lindert) We also risk impairing the government’s ability to protect the public from poisonous food, dangerous drugs, harmful consumer products, fraud and predatory practices in our financial system, unsafe work environments, potential environmental catastrophes or to maintain our transportation systems and educate our population which is what happens when we arbitrarily cut funds to those programs contained in All Other Outlays in Figure 6. (Amy)
A fundamental, real-world truth that has been almost completely ignored in the otherwise hopelessly irrational debate we have been subjected to over the past forty years is that there are certain things that only the government can do. One is provide a system of national defense. Another is provide legal, law enforcement, and legislative systems that set and enforce the rules in a fair, efficient, and effective way. Another is provide the public education and infrastructure that makes possible such things as an educated labor force and an efficient transportation system. Yet another is to provide a social insurance system that makes possible such things as unemployment insurance, efficient healthcare and retirement systems, and a welfare system, all of which provide ordinary people some insurance against the devastation caused by the vagaries of our economic system. (Amy Lindert)
It seems to me quite clear that these are all things the vast majority of the people want the government to provide for them. (Pew) This does not mean the vast majority of the people expect the government to take care of their every need. It means the vast majority of the people realize that, in the real world, only the government can provide these kinds of economic goods in a fair, efficient, and effective way. These are not the kinds of economic goods that can be provided fairly, efficiently, or effectively by the private sector of the economy. (Amy Lindert)
The response from those who are waging their own private war against the federal government is that we must cut the budget—especially Social Security, Medicare, and the rest of our social welfare system—because deficits and the national debt are out of control.
But if we really do want to balance the budget and, at the same time, provide the government that the vast majority of the American people seem to want, balancing the budget through mostly tax increases makes much more sense than trying to do so through mostly spending cuts. Personal income in the United States amounted to $13,191.3 billion in 2011, and total federal expenditures came to $3,603 billion. This means that the total tax liability created by a 10% hole in the federal budget amounted to only 2.73% of our personal income. Does it really make sense to make dramatic cuts in Social Security or Medicare or to dismantle a major portion of the rest of the federal government rather than pay the extra 2.7% of our income needed to fund the government we have?
If we want the government to provide the essential services that only government can provide we have to pay for those services, and the way we pay for them is by paying taxes. It's just that simple. (Well, not quite. There is the economic crisis to deal with, but since I have dealt with that in excruciating detail in Where Did All the Money Go?, I won't get into it here.)
But we live in a democracy. I don't get to decide. This is something a majority of the American people must decide, and the first thing we as a people must decide is whether we want to keep the government we have, as an overwhelming majority of the people seem to want to do, or dismantle that government in an attempt to balance the federal budget, as an equally overwhelming majority of the people also seem to want to do. We can't do both, and if we want to keep the government we have we must first accept the fact that we have to raise the taxes needed to pay for it.
Finally, I freely admit there is no reason anyone should agree with everything I have to say in the essays on this website, and constructive criticism is more than welcome. If you find a mistake, I will fix it immediately and will be ever so grateful when you point it out to me. If you can convince me I am wrong, I will change my mind. If not, we can agree to disagree. What's important is that we establish the facts as they exist in the real world, not that we agree on the interpretation or meaning of those facts.
I am convinced that it is what people "know for sure that just ain't so" that has brought us to where we are today. I also believe that if we are to find solutions to the seemingly insurmountable political, social, and economic problems we face today we must begin by leaving the imaginary world that is created by rhetoric, spin, propaganda, and all of the other nonsense and face the facts that exist in the real world, the world in which we actually live. Real-World Economics is my contribution toward the effort to make this possible.