Real-World
Economics

 

 

George H. Blackford, Ph.D.

 Economist at Large

 Email: george(at)rwEconomics.com

 

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

 

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[T]he ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. . . . [I]t is ideas . . . which are dangerous for good or evil.

 John Maynard Keynes

About Real-World Economics

 (Last updated: 9/13/2014)

We live in a country in which a large number of people, if not the vast majority, hold a set of beliefs about the federal budget that are demonstrably inconsistent with the facts that exist in the real world. The extent to which this is so is easily seen by considering how many people would be surprised to discover that the size of the federal government as a fraction of our economy—that is, as a percent of gross domestic product (GDP)—in the 2000s was about where it was in the 1970s and was actually smaller in 2000 and 2001 (17.6%) than it was in 1961 through 1964 (17.8%-18.2%). How many people would be shocked to discover that there were more civilian federal government employees in 1967 (2.852 million, 6.265 million if we include the military) than there were in 2013 (2.766 million, approximately 4.3 million with the military)? How many would also be shocked to find that federal employees as a fraction of the civilian labor force has fallen by more than 50% since the 1960s? (Federal employees were 4.3% of the labor force in 1967. They were only 2.0% in 2013, and 20% of federal employees in 2013 delivered our mail!) And how many know that Americans are among the least-taxed people among the advanced countries of the world?

These are all simple and easily verifiable facts that most people would find almost impossible to believe given the deluge of disingenuous, antigovernment rhetoric that is designed to encourage us to believe otherwise. (These facts are examined in detail in the Prologue to Understanding The Federal Budget which can be viewed by clicking on this link.)

The American Fiscal Dilemma

The idea that the federal budget and employment have grown voraciously over the past forty years and 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. For all but three categories of expenditures—Aid to the world's needy, State Department, and Unemployment aid—a larger proportion of the respondents would increase rather than decrease expenditures, and for all categories, even those three, a majority of those who had an opinion said they would either increase expenditures or keep them the same.

These results strongly 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. This is especially so in view of the fact that the three categories which more respondents would rather decrease than increase sum to just 3% 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 to those of the Pew Research Center/USA Today survey conducted later that same month. In this survey 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. An overwhelming majority of respondents (73%) indicated they 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. (These surveys are examined in detail in the Prologue of Understanding The Federal Budget which can be viewed by clicking on this link and scrolling down to Prologue.)

According to the OMB, the federal deficit was equal to 20% of total federal expenditures in 2013. 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 10.6% of total federal expenditures by 2019. It should be obvious that we are not going to be able to eliminate the remaining 10.6% deficit through mostly spending cuts—as, apparently, 73% of the American people want to do—by cutting the 3% of the budget that goes to Aid to the world's needy, the State Department, or Unemployment aidIf we are to eliminate the 10.6% deficit estimated for 2019 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.

Figure 1 shows a breakdown of the entire federal budget with a 10.6% hole in it.

Figure 1: Pie Chart of Federal Expenditures 2013 with a 10% Hole.

Source: Office of Management and Budget (3.2 11.3)

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:

  1. Maintaining our current levels of expenditures on Social Security and Medicareas over 80% of the respondents in the Pew poll say they would chose to doleaves less than 60% of the budget to cut after deducting the 6% of the budget that goes to interest on the national debt. It would require a 18% cut in the rest of the budget to cut the total budget by 10.6% if we were to exempt Social Security and Medicare from cuts.

  2. Maintaining our current levels of expenditures on aid to the needy in addition to those on Social Security and Medicare—as over 80% of the respondents in the Pew poll also say they would chose to doleaves only 40% of the budget to cut after deducting interest on the national debt. This would require a 26% cut in defense and the rest of the budget to cut the total budget by 10%.

  3. And if we were to include maintaining our current levels of defense expenditures as well—as over 70% of the respondents in the Pew poll say they would chose to do—it would leave only 23% of the budget to cut. It would require a 46% cut in this 23% of the budget to cut the total budget by 10%.

Where are these cuts supposed to come from? From eliminating waste, fraud, and abuse? I don't think so! (See Waste, Fraud, and Abuse in the Federal Budget for an explanation as to why this is so. See also, Understanding The Federal Budget.)

The Federal Budget in the Real World

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 1 clearly indicates that these beliefs are problematic. Figure 2 and Figure 3 below may help to make this point even more forcefully.

Figure 2 is constructed from the OMB's Table 3.1—Outlays by Superfunction and Function. This figure plots a breakdown of the actual, real-world outlays of the federal government in terms of its three largest categories (Superfunctions) from 1940 through 2013: Defense, Human Resources, and Net Interest both as a percent of GDP and of Total Outlays.

Figure 2: Defense, Human Resources, and Net Interest, 1940-2013.

Source: Office of Management and Budget. (3.1 10.1)

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 budgetthose programs that make up our social insurance system including Social Security, Medicare, and the programs that make up our social safety net—has grown dramatically. It has gone from less than 20% of Total Outlays 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 Total Outlays 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 Total Outlays in 1948 to a low of 5.2% in 2009. Net Interest stood at 6.4% in 2013. What is most relevant to the point at hand, however, is what has happened to All Other Outlays and Defense in this graph.

All Other Outlays

All Other Outlays shows us how much the federal government spent on everything other than Defense, Human Resources, and Net Interest. All Other Outlays 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 Governmentbasically, all of the items north of Interest on the National Debt in Figure 1 that do not involve retirement, healthcare, or other social-insurance programs. This residual has gone from a high of 32.6% of the budget in 1940 to a low of 7.6% in 1945. It stood at 9.7% in 2007 before the financial and economic crisis that wrought havoc with the federal budget began and at 8.0% in 2013.

It is obviousor at least it should be obvious to anyone who looks at the actual, real-world expenditures of the federal government plotted in Figure 2—that there is no reason to believe we can save a substantial amount in taxes by cutting the programs in the All Other Outlays category in Figure 2, obviously not enough to reduce the total budget by 10%. The expenditures on programs in this category have already been cut by more than 55% since 1980, relative to the budget and to 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 8%. It is also worth noting that, relative to the size of our economy, we have already cut the programs in this portion of the budget to below where they were in the 1950s!

What do we find when we look at Defense?  

Defense

As for Defense, there may be some room to maneuver here with the end of the wars in Iraq and Afghanistan and by realigning our budget priorities away from the military threats we faced twenty-five or thirty years ago and toward those we face today. There is, however, no reason to believe we can solve all of our fiscal problems simply by cutting Defense. Defense was only 18.2% of Total Outlays in 2013 and 3.8% of GDP. Even if we were to cut Defense in halfsomething that virtually no one would be willing to doit would reduce the federal budget by less than 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 and the rest of the federal budget, we must look to Human Resources. That's where the money is, and it'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:

Does it really make sense in the real world to think we can save a lot of money by cutting Human Resources without cutting Social Security or Medicare and without cutting the programs that make up our social safety net?

Human Resources

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 3 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 the expanded discussion of this figure in Understanding The Federal Budget.)

Figure 3: Breakdown of Human Resources, 1940-2013.

Source: Office of Management and Budget. (11.3 3.1 10.1)

The first thing we see when we look at the breakdown in Human Resources in Figure 3 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 increase 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 2013. 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.

Retirement/Disability

The problem is that when we look at Retirement/Disability we find it is dominated by Social Security in that fully 75.9% of the total spent on programs in this category of the budget went to Social Security in 2013 while 19.4% went to civil service, military, and railroad retirement/disability programs, and only 4.7% 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 8% of the total budget in 2013.

This leaves the SSI program which was 4.7% of Human Resource expenditures and less than 1.5% of the entire federal budget 0.3% of our gross income in 2013. Aside from its insignificance, 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

Healthcare accounted for 25% of the federal budget in 2007 with Medicare and Medicaid accounting for over 90% of this portion of the budget, and Medicare accounting for 69% of this 91%. What about the 31% of this 91% that went to Medicaid?

This program represented 9.7% of the federal budget and less than 2% of our gross income in 2013 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 9.7% 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 9% of the Human Resources budget that went to the other Healthcare programs in 2013. Here we are talking about 3% of the entire federal budget and 0.6% of our gross income. Of that 3%, 65% went to veterans (Hospital and medical care for veterans and Uniformed Services retiree health care fund), 12% to Children's health insurance, and 5% to Indian health. Of the remaining 18%, 52% went to Health resources and services (a program that is designed to meet the healthcare needs in underserved, mostly rural areas), 23% 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 25% went to Other federal healthcare programs.

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 only 1.0% of the entire federal budget in 2013 there is virtually nothing to be saved in taxes by eliminating these programs.

The leaves but two categories in Figure 3 to examine: Other Payments for Individuals and Other Human Resources.

Other Payments for Individuals

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 14.5% of the entire federal budget and less than 3% of our gross income in 2013 in the midst of the worse economic depression since the 1930s. These programs comprise the backbone of our social safety net. We're talking about the Earned Income and Child Tax Credits (2.9% of the total budget in 2013 and 0.55% of GDP) 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 (1.0%/0.19%) that assist the poor in feeding themselves and their children. About student aid (1.6%/0.31%) and unemployment compensation (0.48%/0.09%). About housing assistance (1.4%/0.27%) and temporary assistance to needy families (0.78%/0.15%). About foster care and adoption assistance (0.25%/0.05). And we're talking about only 14.5% of the federal budget in all of the programs in Other Payments for Individuals combined, less than 3% of our gross income in 2013 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 14.5% 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 detailed examination of our social safety net see Chapter 4 of Understanding The Federal Budget.

Other Human Resources

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 3. It is calculated by subtracting the sum of Retirement/Disability, Healthcare, and Other Payments for Individuals in Figure 3 from the total of Human Resources given in Figure 2.

This residual can be disposed of rather quickly. It represented only 0.77% of the budget in 2013 and 0.16% of our gross income, and aside from the fact that 0.77% of the budget is insignificant in the grand scheme of things, as is shown in Figure 2, the programs contained in Other Human Resources have already been cut by more than 80% since 1980. There is no reason to believe that additional savings can be found in this 0.77% 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 2 or Figure 3: Defense, Net Interest, All Other Outlays, Retirement/Disability, Healthcare, Other Payments for Individuals, Other Human Resources. (The programs in each of these categories are examined in detail in Understanding The Federal Budget.)

What Real-World Economics is About

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 numbers. The reason is 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, when we were to look at the actual numbers that exist in the real world we 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. 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 doesn't 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 budgetwhich is what we have been trying to do over the past thirty yearsis 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 3. (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 2 (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. (See Amy, Lindert, and Ideology Versus Reality) Simply cutting the budget arbitrarily hinders the the government's effectiveness in performing all of these functions.

It seems to me quite clear that these are all things the vast majority of the people want the government to provide. (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 perform these kinds of economic goods in a fair, efficient, and effective way. These are not the kinds of economic goods that can be performed 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. National income in the United States amounted to $14,543 billion in 2013, and total federal outlays came to $3,456 billion.  This means that the total tax liability created by a 10.6% hole in the federal budget amounted to only 2.3% of our national 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 3% or 4% of our income needed to fund a government that can function?

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.

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