Part 4: Solving the Deficit Step By Step

Takeaway

The steps needed to deflate the deficit are not drastic, but require political willpower and consistency

Your doctor sounds the alarm: Your weight has hit the danger zone. You ask for a miracle drug that could slim you down overnight. His matter-of-fact reply: Eat less and exercise more.

Like losing weight, the steps needed to deflate the federal deficit are not drastic, say faculty at the McCombs School of Business. The chief obstacle is not economic practicality but political willpower.

“We’re a wealthy country with a solid central bank,” says Dean Thomas Gilligan. “We can work through this.”

How much should America restrict its fiscal calorie intake? A reasonable target, say many economists, is to maintain publicly held national debt at its current 62 percent of Gross Domestic Product. With no change in current policies, that number would top 350 percent in 75 years.

To bridge that gap, calculates the Treasury Department, will take spending cuts and revenue hikes that add up to 2.4 percent of GDP. That would amount to $360 billion this year, and larger amounts as the economy grows.

“That’s what it needs to add up to immediately, and it needs to be lasting,” says McCombs senior lecturer Sandy Leeds. “If we can keep our debt-to-GDP ratio constant over 75 years, it would be an amazing feat.”

James Galbraith

Get the conversation focused on the real problems, like unemployment, energy, foreclosures, and financial reform.”

Chair in government/business relations,
Lyndon B. Johnson School of Public Affairs

Here, from McCombs faculty, are some diet tips for the U.S. Government: 

Fix the Recession First. It’s risky to slash spending during a recession. Moody Analytics forecast in February that cutting a mere $61 billion from this year’s budget would cost 400,000 jobs and slow the growth of the GDP by 0.5 percent.

“You can’t solve the long-term problem until you solve the short-term problem,” says Michael Granof, accounting professor at McCombs, “and solving the short-term problem may be counter to the obvious things that have to be done to solve the long-term problem.”

Besides, deficits tend to fall naturally as an economy recovers, points out James Galbraith, chair in government/business relations at the Lyndon B. Johnson School of Public Affairs. “I would try and get the conversation focused on the real problems, like unemployment, energy, foreclosures, and financial reform. Without dealing with those problems, you can’t deal with the deficit. If you dealt with those problems, the deficit would diminish on its own.” 

Cut Spending and Raise Taxes. At least $300 billion could be cut from this year’s budget, says Court Huber, former director of McCombs’ Executive MBA program. “Government is spending wildly too much money on projects that don’t deserve to be pursued. It’s locking up resources that could be used in the private sector.”

But the job can’t be done solely with spending cuts, says Jim Nolen, senior lecturer in finance at McCombs. “They will have to be combined with some tax increases. When the economy starts to recover, then we’ll have to adjust taxes upward.”

He cites the president’s National Commission on Fiscal Responsibility and Reform, which recommended raising taxes by $785 billion and cutting discretionary spending by $1.7 trillion over the next decade.

Invest in R&D. Not all government spending is expendable, says McCombs finance professor Lewis Spellman. Past funding of computer science and transportation laid the foundations of today’s economy. “The only way you can accomplish those objectives of running a surplus or having a balanced budget is to have the economy growing fast. The only way to have that is to have growth industries.”

He recommends targeting research and development in up-and-coming technologies like energy and medical delivery. “Make those investments a full tax write-off, or subsidize research on top of it. If XYZ Corporation puts up $100 million, we’ll put up $100 million.”

Jim Nolen

If you cut everything else in the budget 10 percent, you would still have a deficit if you did not cut Social Security and Medicare.

Senior lecturer in finance, McCombs School of Business

Adjust Entitlements. Social Security and Medicare take 34 cents from every dollar of federal spending. That could rise to 50 cents as baby boomers retire. Says Nolen, “If you cut everything else in the budget 10 percent, you would still have a deficit if you did not cut Social Security and Medicare.”

Stepping on those programs is a political minefield, acknowledges Gilligan. Instead of cutting benefits, he would gradually raise the age at which citizens can start collecting them. He notes, “People today live longer than when the Social Security Act was first initiated.”

Another notion is to reduce benefits for the wealthiest retirees. “We have to have a means test for Social Security and Medicare,” says Huber. “People like me should probably not get anything.”

But Galbraith warns against breaking a promise to workers, who have paid higher taxes since 1983 to build up both programs’ reserves. Both funds are projected to remain solvent for the next two decades. “There’s plenty of time for Congress to alter the law,” he says, “and every reason to say that what they should do now is absolutely nothing.”

Make a Long-Term Plan. Both spending cuts and tax hikes should phase in over several years, to avoid further shocks to the economy, says Gilligan. The good news is that Congress doesn’t have to solve the whole problem overnight. “If there were significant progress made on solving our long-term problem, five to 10 years out, it would have a salutary effect on markets,” he says. “If they saw the Senate coming together with a plan, it would do a lot to resolve the issue of uncertainty.”