Balancing the budget

So here's the facts as they currently stand. Our current take is between 15.5-16.5% of GDP. Our current expenditures are about 23-23.5% of GDP and our current debt level 9s ~100% of GDP (should crest it this year). There are two goals:

1) The most modest goal is to reduce the growth in debt by less then the growth in GDP. That is a bare minimum.
2) For long term health, we will have to pay down the debt which can only come about by running a surplus for at least a few years

Given the current gap (~1.3T dollars) it's a yeoman's task to close that gap. Here's how I'd propose doing it.

1) Let's assume that GDP grows again and we establish our baseline, that will help a lot. If we can hit 2.5% growth for 5 years (and I believe anything higher then this is ambitious at this point in the cycle) then we add about $1.8T to GDP by the end of the 5th year. Assuming the current tax policy, that would be additional revenues of about $300B. It doesn't happen all at once but we do get there. [$1,300B gap - $300B in savings = $1,000B left to go)

2) Wind down war spending and get the Pentagon back under control: Our military in the 90's was operating on $250-300B in cost. Indexing that up at 3% per year would put it at today's budget level of $400B. Given that we will spend ~$650B in 2011 that's a reasonable savings of $250B per year. That won't happen all at once but one presumes by the 2nd or 3rd year into this you could hit that mark. [$1,000B - $250B = $750B]
3) Restructure the corporate tax code: There's a current problem with the corporate tax code. Most corporations pay taxes at a rate of 39% but their EFFECTIVE tax rate (i.e. what they actually pay) is only about 18%. I'd slash the headline rate and level it (currently, there are tax brackets like the personal income tax but they're already NEARLY flat). I'd make it just two tiers. 18% for every C Corp under $1MM in income and 25% for everything above that. The only tax code changes I'd permit would be those related to depreciation acceleration (which is essentially tax deferral) and R&D tax breaks that work similarly to the depreciation acceleration (which essentially creates tax deferral as well). Those are long term neutral and allow companies to retain some of their cash while growing. Current corporate income tax brings in $330B. Assuming we got up to 23% of profits as taxes then that would be an increase of ~$80B per year. [$750B - $80B = $670B]

Okay. Those are the easy three. That got us about 50% of the way there. Now what?

1) Personal Income Tax reform: This is tricky and I can only talk in %'s because it's so convoluted. There's a great deal of distortion in the tax base as it currently stands. The federal tax code is also highly progressive but part of that is to offset the regressive nature of most stateside tax systems (heavily sales and property tax driven). I recognize that there's a chicken and egg issue there too but I'm not about to try to address that. So let's just take the current system as a given. My idea would be to remove all the distortions and then drop the headline rate substantially. Divorce health care from your employer. It should be portable anyways and the only thing keeping it linked in is the tax code. Make group discounts illegal (there's no reason for every policy of an insurer to be "actuarily profitable". The full bundle should be. Small business health care shouldn't subsidize large company health care... This is one of the "lies" that gets mistold about health care). Also wipe out the home mortgage deduction. I'm okay with making certain medical costs deductable (if I spent my entire salary last year on medical expenses it would suck to have to pay taxes to boot!). After having said all that, tweak the tax rates down such that the level of receipts to the federal coffers increases by about 10% (~90B over where it's at now). Given that some of this "cost" will be offset by reduced expenditures on accoutants, lawyers, turbo tax, etc, I see this as a relatively minor increase. I would also scale back the mortgage deduction to be capped at 80% of the value of the average home for the bottom 50% of income earners. I expect that to be somewhere around $150,000. The government will help you but a basic house. But there's no reason for the government to incentivize "McMansions". [$670B - $90B = $560B]

2) Entitltement Fraud. Fraud accounts for ~$40B (possibly more) per year in medicare. It also accounts for about $5B per year in welfare fraud. I couldn't find numbers on SS, SSDI or SSI but let's assume that about 5% holds true for those programs (they're easier to stop then medicare which has a 7% fraud rate but harder then welfare at 2%). That's another $35B so if we spend $5B to fight the fraud we can save about $80B (net $75B). That's not bad. [$560B - $75B = $485B]

3) Ag subsidies (note, with #2 above, all tax subsidies have already been cut): The US currently spends about $20B in direct subsidies to farmers (there are other indirects like crop insurance that I think I can live with). I'd cut every penny of that. [$485B - $20B = $465B]

4) Earmarks: The biggest problem with earmarks isn't the dollar amount (depending on how you count them it's between $2B - $10B per year). It's the compounding affect they have on the federal budget. An earmark in one year is counted in the next year's baseline for an agency. So the result is an ever increasing agency budget due to things that were never intended to be recurring. This is more of a defensive measure to limit future growth but I think it's an important one. [$465B - $5B = $460B]

5) Agency Budgets: Current Agency budgets are $660B. I think we have to take a pretty big swing at that to have any chance of cutting this thing. 20% sounds like a lot but the federal government has been in need of significant modernization for a long time. There are constant stories of 2 people doing the job of 1 now. Granted, these are anecdotal but I feel like between the efficiency cuts and some of the other cuts (like trimming back on a too expansive DOE, for example) we could get to 20% without significant troubles. This would need to be phased in over a couple years but there's no reason we can't get there in relatively short order. [$460B - $130B = $330B]

6) The affect of the above changes on our #1 item: Now that we've tweaked the tax code, we'd expect revenues as a % of GDP to rise from the 16% we're at back to a more normal 18%+. Let's assume we stick with the "tea party approved" 18% because that's probably what's politically palatable at present (how's that for alliteration?). That's another $35B. [$330B - $35B = $295B].

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Okay. So now we're 5 years down the road and we've trimmed our deficit to $295B. That's 1.8% of our projected GDP number of $16.1T. So we've hit our bare minimum goal (slowing debt growth to below the rate of GDP growth). Hurray!

But there's some problems. #1, we had to hold Entitlement spending constant in nominal $ terms. That's not likely to happen. Assuming that they continue to grow at their current rates (8% per annum for medicare and 5% per annum for social security) we're looking at additional expenditures of about $200B for medicare and another $200B for Social Security (this factors in the above cuts). So now we're at $295B + $200B + 4200B = $700B in round numbers. That's about 4.3% of our projected GDP. Given GDP growth rates historically, that's pretty rough.

The other problem is that our interest costs are expected to grow. Both because of increasing debt but also presumed rises in interest rates. I would project that we'll have about a $300B increase in interest costs when comparing today's level to the level in 5 years. So now we're back to [$700B + $300B = $1T] in annual deficits.

So how do we combat this?

1) Hack away at Social Security and Medicare: The fact is, these are absolutely killing us. I apologize to all the people near retirement. I recognize that you based some assumptions on promises that were made to you. As someone who DIDN'T make those promises, I'm here to tell you that we can't afford it. Social Security needs to get re-indexed (the CPI is a terrible measure of inflation) and an extra year of work needs to be required. Let's also agree that elevating the cap to somewhere around $130 - $150k per year would be extremely beneficial. So let's assume that we do all that and not only avoid the $200B increase over 5 years but actually bring down the net expenditures a bit (say $50B). Let's also presume that there's significant curtailments of SSI and SSDI that need to happen (another $50B). [$1T - $200B -$50B - $50B = $700B].

2) Hack away at Medicare: The Dem's sacred cow. Obama's laid out $440B in cuts over 10 years that he could live with. Let's assume that, in the way of all politicians, he's low balled that a bit. Instead of $44B a year let's call it $75B that we could ACTUALLY live with. Let's also incorporate the savings projected to come from generics coming on the market as well (projected to be about $100B - $150B per year... call it $125B). [$700B - $125B - $75B = $500B].

Now we're at 3.1% of GDP and basically all of that is in interest expense. This is a bare minimum sustenance level for the economy. But we're nowhere near a surplus. So how do we bridge the gap?