3 Reasons U.S. Government Costs Will Grow in 2015

Karen Bleier/AFP/Getty Images

Karen Bleier/AFP/Getty Images

Compared with the past several years — which saw the Great Recession, skyrocketing unemployment, 2011’s debt ceiling crisis, the fiscal cliff, sequestration, and 2013’s 16-day partial shutdown of the federal government (and debt ceiling crisis) — 2014 was a calm year, fiscally speaking. Sure, the year dawned with a sizable first-quarter contraction in economic output, but the jobless rate has fallen below 6%, the number of Americans filing new claims for unemployment dropped to a 14-year low in early October, and gross domestic product rebounded in second quarter, hitting a 4.6% annual pace. Meanwhile, a report from the Federal Reserve showed that production at American factories, mines, and utilities grew by a greater-than-expected 1% last month — the largest gain since November 2012. Slowing growth abroad will weigh on the U.S. economy, likely impacting the profits of U.S. retailers and forcing the Fed to postpone a coming increase in interest rates; U.S. consumers — a major engine of economic growth, whose purchases account for nearly 70% of the country’s economic output — have been kept subdued by weak confidence, produced by stagnant wage gains and hiring gains skewed toward low-paying service jobs; yet, overall, economic data offers evidence that the U.S. economy is on stable ground.

But any analysis of the United States economic health must include a look at the state of the country’s finances. Even without the drama that surround the passage of the continuing resolution last year to fund the federal government — made all the more dramatic by the fight over the Affordable Care Act — the question of government spending remains an explosive issue; lawmakers on opposite sides of the have aisle have no more agreed to how much the federal government should allocate to various services or collect through taxes than they have established how much debt is acceptable. Government spending, and its impact on the national debt and deficit, continues to divide Washington, where political rancor impedes Congress from forming any consensus on fiscal policy or sustainability.

The increasing political polarization of Washington has made legislative compromise near impossible, an environment conducive to both political and fiscal crises. Little politically has changed in the past year to make political crises less likely; if anything, last October’s shutdown of the federal government only exacerbated the political dysfunction of Washington. And with U.S. foreign policy questions pressing, from the expansion of ISIL in Iraq and Syria to Russian aggression in Ukraine — fiscal policy has not been as big of an issue as it has in years past. But — with Republicans expected to gain a majority in the Senate and maintain control of the House of Representatives — November’s midterm congressional elections will create a political situation more favorable to putting spending cuts on the political agenda. Republicans want to keep annual limits on spending that would cut funding to programs ranging from transportation to education and research, a plan congressional Democrats will oppose. That disagreement will set off a new round of budget fights. And complicating the Republican case for additional spending cuts is the degree to which the deficit has declined in recent years.

In 2014 — as tax revenues grew thanks to higher rates levied on wealthy Americans and spending cuts tied to sequestration took effect — the U.S. budget deficit fell to its lowest level in six years. A report released earlier in October showed that the United States posted a shortfall of $483 billion in the past fiscal year. After rising to $1.4 trillion at the height of the Great Recession, partly due to economic stimulus, it has fallen by nearly a trillion dollars to pre-recession levels and stands below the annual average recorded over the past 40 years. “This is not only a reduction of the deficit, it’s also a return to fiscal normalcy,” White House budget director Shaun Donovan said after the release.

And even more importantly for the economic health of the United States is that annual budget deficits are making up a smaller and smaller share of the country’s economic output. Over the past five years, budget shortfalls have dropped from 2009’s 9.8% of GDP to the last fiscal year’s 2.8% — what economists deem the acceptable limit for a growing economy. And in one sense, this improvement has put to rest the budget fights that dominated Congress in 2011 and 2013. Yet, this end to fiscal hysteria has not produced much in the way of celebrity fanfare, partly because good news spawns far less hype than bad and partly because the self-proclaimed deficit hawks have claimed this to be a “false victory.” And there are still other matters up for debate, which are likely to push federal spending higher in 2015.

1. Austerity measures seen as the wrong move

A number of economists have highlighted not the political benefits of the falling deficit but the economic problems associated with lower government spending. Sequestration may have contributed to the smaller yearly deficit, but it has been theorized that those immediate spending cuts created a “fiscal drag,” which slowed down economic growth and kept pressure on the Federal Reserve to continue its extraordinary monetary policies to compensate for the austerity measures. And by that logic, if the deficit continues to decreases in line with current projections while the economy remains sluggish, the effects will be harmful to the United States public. When the economy is struggling, in recession, or when unemployment is painfully high, governments should implement so-called counter-cyclical fiscal policies like deficit spending, or so states the Keynesian theory of economics. By comparison, sequestration — the automatic discretionary spending cuts to government spending that began in March 2013 — was designed to lower outlays by $1.1 trillion over a period of eight years.

To the more liberal members of Congress and the Obama administration, hitting and surpassing these key benchmarks of fiscal health not only means there is room to ramp up government spending, but given the possible harm that the lower-than expected spending could have on economic growth, lawmakers will have an argument for increased spending.

During his speech at Northwestern University earlier this month, President Barack Obama declared fiscal victory, noting that the era of “mindless austerity” and Washington’s “manufactured crisis” had ended. And senior White House budget adviser John Podesta tweeted the same day that “a funny thing happened on the way to entitlement explosion,” tacking on a chart the showed how the federal deficit has shrunk. His commentary was obviously aimed at the Republican narrative that warns entitlement programs, specifically Medicare and Medicaid, must be reformed before they bankrupt America.

Proponents of greater spending and of leaving austerity measures behind are not exactly ignoring the problems a huge national debt can bring. The federal government’s debt is approaching $18 trillion, and even those cautioning against shrinking the budget deficit too drastically acknowledge that the debt is likely to because the next focus of fiscal conservative lawmakers. Overlarge federal debt pushes up government spending on interest, restrains long-term economic growth, gives lawmakers less flexibility to deal with unforeseen challenges, and eventually increases the risk of a fiscal crises. Now that the economy is improving, the debt is growing more slowly in proportion to GDP. But debt is still projected to increase over the next 10 years. “Under current law, the gap between spending and revenues would grow again relative to the size of economy, and federal debt would climb,” explained CBO Director Douglas Elmendorf at an August 2014 press conference.

But despite the very real worries about the federal debt, Jared Bernstein — a former chief economist to Vice President Biden and senior fellow at the Center on Budget and Policy Priorities — argued in a recent opinion piece for The Washington Post that the federal government’s “sharp pivot to fiscal austerity” did not boost the recovery. After noting that “as an employee of the fiscally responsible Center on Budget and Policy Priorities, I’m solidly on record that there’s a time for deficit reduction,” Bernstein maintained the past five years of economic recovery were not the right time. He explained that austerity measures created a well-documented fiscal drag, cutting 1.5 percentage points from GDP, worth more than 1.5 million jobs. Austerity “is one of the main reasons our more-than-five-year-old economic recovery is still not reaching nearly enough people,” he wrote.

2. Sequestration

When President Obama met with top Pentagon officials earlier in October to discuss the United States’ strategy for degrading and defeating the Islamic terrorist organization known as ISIL, he also discussed next year’s impending spending cuts to the defense budget. In public remarks he made after the discussion, Obama expressed his desire that Congress avoids “some of the Draconian cuts that are called for in sequestration.” Lawmakers must “make sure that if we’re asking this much of our armed forces, that they’ve got the equipment and the technology that’s necessary for them to be able to succeed at their mission,” Obama told reporters. “That we’re supporting their families at a time when, even after ending one war and winding down another, they continue to have enormous demands placed on them each and every day.”

Obama has seldom spoken about sequestration since a budget compromise relaxed the spending limits for a two-year period. But now that the automatic, across-the-board restrictions are set to recommence in fiscal 2016, the president and Congress will have to begin negotiating a compromise if the deep cuts are to be avoided. It is reasonable to express surprise that lawmakers were able to agree on a deal to mitigate sequestration’s harsh and inflexible cuts to the funding of the military, the Veterans Administration, scientific research, housing programs, and environmental enforcement, to name a few. But because Department of Defense’s spending faced a $20-billion cut in 2014 — a reality prompting Republican Representative Howard P. “Buck” McKeon, chairman of the House Armed Services Committee, to threaten: “You’d better hope we never have a war again” — GOP lawmakers had more chips with which to bargain.

The deal crafted by Senate Budget Committee Chairwoman Patty Murray, a Washington Democrat, and House Budget Committee Chairman Paul Ryan made sequestration unnecessary by using targeted spending cuts (rather than the sequester’s across the board cuts) and raising revenues through higher government fees and sales, not tax hikes — which were a Republican deal breaker. Overall, the plan created $63 billion in so-called sequester relief, or in other words, increased spending caps by $63 billion over two years. If Congress manages to ink another deal offsetting sequestration cuts, it will likely be in the same mold: Avoid the annual automatic spending reductions by increasing spending caps so sequestration will not be triggered. This means more government spending. And if Democrats agree to more defense spending, Republicans must compromise and allow corresponding increases in domestic spending.

3. Public fear: ISIL and Ebola

Survey data suggests the average American voter cares much more about ISIL and Ebola than federal spending. And that preference is only natural; ISIL is a terrorist organization that beheads its prisoners and vowed to exact retribution on the United States for its military bombing campaign in Iraq and Syria; and even though the Centers for Disease Control (and every other leading contagious disease expert) has said Ebola is unlikely to spread in the United States, it is a virus — with no known vaccine — that kills anywhere between half and 90% of its victims by causing hemorrhaging and multiple organ failure. And while the public consciousness may think Ebola is more horrific and more easily transmittable than it really is, that can be seen as a survival behavior. As Massachusetts-based risk perception consultant David Ropeik told NBC that behavior is “not irrational” but “instinctive.” Also, “dying from Ebola does suck,” Ropeik said. “It’s not a good way to go. That makes it scarier.”

Compounding these fears is the fact that the Obama administration’s response to both ISIL and Ebola have been less than effective.

Eighty-two percent of Republicans and 63% of Democrats told Gallup that the federal budget deficit is key to their congressional vote this November, their fourth and tenth most important issue, respectively. By comparison, ”the situation with Islamic militants in Iraq and Syria” is a top concern for 85% of Republicans and 72% of Democrats. Ebola, while not included in Gallup’s poll, has garnered way more headlines in recent weeks than federal spending or even the deficit. After a second case of Ebola was reported among the staff of the Dallas hospital that treated the first infected patient in the United States, an ABC News/Washington Post survey found that only 54% of Republicans were confident the government could respond effectively to Ebola, while 76% of Democrats expressed confidence. And while federal spending is closely related to a number of issues most worrying voters — including the economy, the availability of good jobs, the way the federal government is working, Obamacare, and taxes — the issue is not capturing the public’s attention is it did circa 2011. Still, Ebola and ISIL have a great deal to do with federal spending.

That Ebola has become a political issue means that it will also become a budget issue. The CDC saw hundreds of millions of dollars stripped from its budget during the past four years of austerity. In fact, budget cuts have hit the CDC harder than many other agencies. And Congress has made a bipartisan effort to ensure that the health agency would be prepared to begin training and supplying health care personnel, deploying treatment units in Africa, and collaborating with the private sector health-care companies to develop vaccines. Already, lawmakers have injected $30 million of emergency funds into the CDC, but Democrats continue to criticize Republicans for shrinking its budget and those of other federal agencies needed to stop the spread of Ebola in the United States. Criticism has continued despite the fact a congressional hearing found that CDC funding had been adequate.

Pressure for greater military spending has also grown. Dov S. Zakheim — a senior adviser at the Center for Strategic and International Studies, who worked in the Defense Department in the early 2000s — noted in a piece for Politico that “there is no question that the president and the Congress need to re-examine the implications of the 2011 Budget Control Act, and especially its sequester provision, in light of what is, in essence, America’s latest war.” Even though this “war” is primarily an air war, for now, there are more than 1,000 advisers who do have boots on the ground (and more may be deployed later.) These troops need adequate funding, Zakheim argued. Already, the bombing campaign has eaten up $500 million, and it is not impossible to imagine that there are unforeseen costs yet to crop up. If the administration continues to finance the war on a baseline defense budget, “everything from research, to procurement, to readiness to military construction and family housing” will be short changed, he wrote.

But next year’s increased government spending needs context.

The deficit is projected to continue to fall in 2015; under current spending policies, its share of GDP could remain below 3% through 2018. Yet, budget challenges remain and government spending will continue to spark debates in the new Congress. New York Times columnist Paul Krugman recently opined that deficit scolds (his term for fiscal hawks) were not making more of this year’s significant deficit reduction for political reasons. His theory was based on claims fiscal hawks have made — including on the Washington Post’s editorial page — that this deficit decline is a false victory. The worry being that “trillion dollar deficits are coming back” despite the fact that Obama has said it is time to get past “mindless austerity.” Instead of acknowledging budget problems to be over, Krugman’s deficit scolds continue to make the case for entitlement reform. But beyond January 20, 2017, “anyone looking beyond that date should be alarmed at the satisfaction Obama proclaims despite the prospect of ever-rising government debt,” wrote the Post’s Fred Hiatt. He argued that the deficit decline came thanks to the economic recovery — with tax revenues increasing and spending on unemployment benefits decreasing. He also acknowledged that the Affordable Care Act has also helped keep health care costs rising at a slower-than-estimated rate, helping Medicare’s finances.

Now federal debt stands at 74% of the GDP, “a higher percentage than at any point in U.S. history except a brief period around World War II,” according to the CBO. With no change in policy, that percentage will stay constant or decline modestly over the next several years, before rising to 78% in 2024 and 106% in 2039. That means that by 2039, the government will be paying interest payments equal to 4.5% of the GDP. Plus, as the population ages and health care costs continue to increase, payments to Social Security and health care programs like Medicare and Obamacare will also jump, the CBO has calculated. In 2039, funding those programs will consume 14% of the GDP. Together interest payments and entitlement programs will cost more than what the government spends on its entire budget today. Of course, the economy will likely be growing faster in 2039. As Hiatt noted, faster economic growth would be ideal, “but no one is sure how to do it — and the programs Obama believes might help, namely education, research and infrastructure, are precisely what will lose out in the future he is celebrating.”

Follow Meghan on Twitter @MFoley_WSCS

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