Budget Bloodbath

When is deficit reduction, not deficit reduction? When it is the just-finished fiscal year 2010 federal budget. Yes, the fiscal year 2010 deficit fell by $125 billion from the previous year’s record total. The problem is that is only due to the elimination of one-time emergency spending. Beneath the emergency, the federal government went right on growing. This not only leaves us with another trillion dollar deficit, but also lays the groundwork for future deficits.

The government has just closed the books on another budget bloodbath. Red ink that is.

The federal deficit reached $1.291 trillion in 2010, the fiscal year just ended. Only the second trillion-plus deficit in U.S. history—it would be the record, if not for last year’s $1.416 trillion deficit. Putting those eye-popping totals into perspective: total federal government spending did not reach last year’s deficit level until 1991. Now we are over-spending by the same amount we used to entirely spend just 19 years ago!

Never has the government spent, or over-spent, so much. In each of the last two years, the federal government has spent roughly a quarter of all the goods and services America produces. And it has over-spent by an amount roughly equivalent to one-tenth of everything America produces.

Yet in all this budgetary bleakness we are supposed to take comfort that the deficit fell from the year before.

Any time the government saves money is news and should be applauded. However, examine this savings, and the applause may sound more like one hand clapping. As the Congressional Budget Office stated in its October monthly budget report, the savings is due to the absence of last year’s one-time emergency spending. “Excluding those … spending rose by about 9% in 2010, somewhat faster than in recent years.”

Certainly some of the deficit is recession-induced. The dramatic drop in federal revenues is the most obvious example. Some spending too is a result of the recession. However we always knew the emergency would end, economies do not shrink forever. Yet even as emergencies are ending and the economy beginning to recover (albeit slowly), spending continues to increase rapidly.

To understand what has happened, look at 2007. In that last year before the recession, federal spending was $2.729 trillion and receipts were $2.568 trillion, for a deficit of $161 billion. That equated to 1.2% of the economy—about one-eighth of today’s deficit. Just three years later, the government spent $3.453 trillion—$724 billion more. That is roughly the size of last year’s stimulus package, despite there being no stimulus package this year!

As bad as this additional spending is, its worst effect is likely yet to come. This is due to federal budgeting’s baseline concept. Baselines are how future federal spending is calculated. While different programs have different methods, it basically works thusly: Current spending is adjusted upward for inflation and extended outward.

The methodology’s obvious problem is that the baseline becomes a veritable “roach motel:”spending checks in, but it doesn’t check out. It becomes inflated into perpetuity. Even little spending soon becomes big spending under this compounding process.

Unimpeded by “gravity,” spending’s momentum carries it forward and upward. Of course, the “gravity” which restrains spending elsewhere is known as “competition.” In the public sector world of federal spending, competition does not exist. In the private sector, baselines are the antithesis of its operation. There the goal is always to decrease spending. Even if this were not a business’ own desire, it is enforced by others.

While the private sector continually pushes spending down, baselines continually push the public sector’s up. This is why the 9% increase in non-bailout federal spending is so dangerous.

The baseline dynamic is why CBO projects the federal government will spend $3.714 trillion, and run a third consecutive trillion dollar deficit ($1.066 trillion), next year. It is also why federal spending has not fallen from one year to the next since 1965!

Simply, Washington must reverse its baseline. If spending can be programmed up, it also can be programmed down. It need not even be drastic—any more than is the multiplier (usually linked to inflation) fueling prevailing increases. Simply holding spending growth to less than the rate of inflation, while the economy grows (and with the government shrinking,
it will grow more rapidly), will begin government’s deleveraging.

With Washington lacking the dynamic called “competition” to enforce spending declines, it must rely on another dynamic. That other dynamic is called “election.”