How to balance the budget by reducing spending.

• Author: Niskanen, William

THE FEDERAL BUDGET can and should be balanced by the end of this decade by reducing spending. The Clinton budget, however, has increases in taxes and fees that are several times the spending cuts and leaves a deficit of about $300,000,000,000 in Fiscal Year 2000.

Most American families, firms, and governments recently have restrained their spending in response to a lower-than-expected growth of income--most, that is other than the Federal government. Real Federal domestic spending during the Bush Administration increased at a higher rate than during any since John F. Kennedy's. The combination of a rapid growth of Federal spending and a slow growth of tax revenues increased the deficit from $153,000,000,000 in FY89 to an estimated $319,000,000,000 in FY93.

Moreover, the long-term projections are even more discouraging. The Clinton Administration forecasts a baseline deficit of $390,000,000,000 in FY98 and nearly $600,000,000,000 in FY2002 in the absence of major changes in Federal fiscal policy or an increase in economic growth. The huge level of Federal borrowing would have to be financed in a world where U.S. private saving is expected to stay low and the net saving by other nations is expected to decline.

One might have hoped that this issue would have been addressed in the 1992 campaign, but that did not happen. Both George Bush and Bill Clinton promised to finance their new proposals by offsetting changes, but neither major party candidate offered any substantial proposals to reduce the baseline deficit. Only Ross Perot made a major issue of the Federal deficit, but he did not defend the specific proposals of the plan that was prepared for him. The issue will not go away. Several new movements are pressing candidates for Congress for a commitment to reduce the deficit, and only a few more votes in Congress are necessary to approve a balanced-budget/tax-limitation amendment for subsequent ratification by the states.

Americans should have learned the following lessons from the economic and fiscal record of the past decade:

* A Federal deficit does not trigger a corresponding increase in private saving. As a consequence, the deficit leads to some combination of reduced domestic investment and increased borrowing from other nations. In effect, the U.S. is placing an unjust tax burden on future generations, who had no role in undertaking the debt. This may be appropriate to finance a major war or temporary increase in public investment, but it is not a viable long-term fiscal policy.

* Economic growth will not be sufficient to reduce the deficit without a major change in current fiscal policies.

* An increase in Federal taxes is likely to be counterproductive, reducing economic growth and inviting an increase in spending.

* Major reductions in the main spending programs are necessary to reduce the growth of total Federal outlays. There is plenty of waste and pork in the budget, but reducing them is neither sufficient nor easier than cutting major programs. For the most part, wasteful expenditures exist because someone in authority wants them.

The primary implications of those lessons is that we can not avoid for long a major reduction and restructuring of the major spending programs. State governments already have made such hard choices. The task will not be very much fun for Federal politicians, but, if they are not willing to make such hard choices, they are part of the problem and should be replaced.

The Federal budget could be balanced by the end of the decade through spending reductions, not tax increases. The program changes and the magnitude of the spending reductions that should be considered to achieve this goal are not unique, and other combinations also would meet the goal. The specific set of reductions we propose is based on the following general criteria:

* Maintain mandatory spending. The only types of spending that should be fixed obligations of the Federal government are interest payments on the debt, payments for other goods and services previously supplied, deposit insurance expenditures, and the real pension benefits of retired Federal employees and current recipients of Social Security.

* Respond to changed conditions. The most important, of course, is the end of the Cold War. That has primary implications for the appropriate size of the defense budget.

* Correct unsustainable conditions. For some years, expenditures for medical care have increased at roughly twice the rate of Gross Domestic Product (GDP). That can not be kept up, and it is better to correct the condition early.

* A significant part of Federal spending generates benefits for higher-income people. These should be reduced.

* Eliminate low-priority programs. This criterion applies to hundreds of unnecessary domestic programs that should be abolished or financed by state and local governments.

Any serious proposal to reduce the deficit should address the implications of each of those criteria. The case for balancing the budget by spending reductions, rather than tax increases, is based on a judgment that the Federal government has grown too large and that most people do not get their money's worth from the current level of expenditures. The popular vote for the presidential and gubernatorial candidates of the incumbent party, for example, generally declines in response to an increase in real per capita spending and taxes since the prior election. Similarly, net migration among the states generally is from high-tax to lower-tax states.

Those two patterns are strongly inconsistent with a belief that an increase in government spending is broadly popular. Total government spending now exceeds $20,000 per household. It is doubtful that most Americans value the benefits of government spending as much as that cost. Moreover, each additional dollar of Federal tax revenue reduces the output available for private use by more than $1.50. Should the budget be balanced by reducing government spending or by increasing taxes? It again is doubtful whether many Americans value most Federal programs enough to support higher taxes. For that reason, it is more logical to balance the budget by scaling down spending to a level that would draw widespread support.

It is important to recognize that the Clinton budget projection probably underestimates future outlays and the deficit. Some of the reductions are dubious; the current budget does not include the upcoming major health policy package; and Congress invariably will add other spending in later years. Moreover, total revenues are likely to be lower than projected because the tax increases probably would reduce economic growth and increase tax avoidance. Assuming that changes in spending do not affect economic growth, inflation, and interest rates, total outlays in FY2000 must be reduced by nearly $300,000,000,000 more than in the Clinton budget to balance the budget by the end of the decade. Total program outlays need not be cut quite that much, because an early reduction of those outlays also would reduce the growth of net interest payments.

Clinton challenged the critics of his budget to be specific about their proposed alternatives. We understand why that is difficult for members of Congress. We are not politicians, however, and are not so constrained.

We propose to balance the budget by the end of the decade by reducing spending to a level consistent with the amount of Federal taxes that Americans have paid for over 30 years, about 19% of GDP. A five-step approach would cut the level of the defense budget in response to the end of the Cold War, reduce the rate of increase of Social Security benefits for future retirees, sequester four percent of the outlays for all other domestic programs in the second half of FY93 and freeze the level of total outlays for them from FY94 through FY98, slash the rate of increase in medical programs consistent with the sequester and freeze, and reduce the level of outlays for other domestic programs consistent with the sequester and freeze.

National defense, medical care, and Social Security

The Cold War is over. America won, and the Soviet Union has collapsed. The U.S. does not now face any substantial military threat to its vital national interests. Nevertheless, the Department of Defense has been busy fantasizing new missions, rather than reducing forces to a level consistent with current realities.

For more than 40 years, U.S. military forces have been designed to deter or...