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Why Running Off The Economic Cliff is Inevitable

Today, a bit of a heavy topic.  Economics!

There’s quite a few people out there that are all worried about the fiscal cliff or whatever they’re calling the latest debt limit charade.

I don’t really want to talk about it.  In the end, they’ll raise the limit, just like they always do.  Both sides will probably claim victory, citing numbers and statistics that don’t mean jack to any of us.

They’ll trot out supposed facts and figures, and try to convince us that it’s all going to be fine.

Except it isn’t.  Nobody with any concept of basic mathematics can possibly believe that it will be, unless they’re just not well informed.

And I don’t want anyone to be ill informed, because that leads to a lack of preparedness, mental or otherwise, for what I think will be the biggest impacting event we can see coming.

Boy can we see it coming.  This isn’t an EMP attack, solar flare, or some other Black Swan type event.

The pending economic disaster has been the longest telegraphed punch that I can recall.

Before we go on, let me set the stage a bit.

Federal Spending Categories

There are three categories that all Federal spending falls into.  Entitlements, Interest, and Discretionary Spending.

Entitlements are promises to spend money that the Federal Government is required by law to shell out.  This includes Medicare/Medicaid, Social Security, Military pensions, benefits for Government employees and the military.  That sort of thing.

Interest is pretty straight forward.  Interest payments on the US Debt.  Right now our averaged out interest rate is about 2.8% … this number is important for later on.

Discretionary spending is everything else they spend.  All of the government agencies, handouts, foreign aid, etc fall into this.  These are things that Congress can decide what to spend every year.  Well, assuming they pass a budget anyhow.  There are no laws mandating the levels of discretionary spending.

Democrats and Republicans

We’re all pretty familiar with this breakdown.  Democrats want to raise taxes on “the rich” and cut taxes for “the middle class.”  They want to keep entitlements as is, or increase them.  Cut the heck out of the military because we don’t need them.  We have the UN and Europe to help us!

The Republicans want to lower taxes on “the rich” and let corporations do whatever they want.  They want to axe entitlements and put Granny out on the street.  Guns all around, and lets go turn Iran into a parking lot!  Screw the world, we’ll do what we want.

If you sense a bit of sarcasm and exaggeration in my description of the two parties, you’d be right.  The reality is that both parties are interested in two things.  Staying in power, and kicking the can down the road until past the next election.

The rhetoric that spews from both sides of the aisle is just that.  Rhetoric.  Don’t believe any of it.

The Congressional Budget Office

These are some interesting guys.  They sit there and run numbers on the potential impact of laws and changes to tax rates and whatnot, and publish the numbers.  Quite a few folks look at these numbers as gospel, but they’re really fairly strict about them.

They have specific rules to follow when running those numbers.  They have to assume that whatever is currently law will be in place in the future unless it sunsets.  For example, they have to assume that the AMT will be back in force every year because there’s no long term extension for the AMT sunset.

These rules tend to make numbers bloat up quite a bit, and they don’t often fit reality.

Interestingly, in 2010 the CBO told Congress (and the Nation) that if we don’t do something fast, the total amount of expenditures for the Interest and Entitlements will total up to more than total revenue by 2035.  Keep that in mind.

The Simpson Bowles Commission

These guys are a bunch of politicians from Congress that sit on a committee formed by Obama.  They are supposed to come up with recommendations for medium term fiscal sustainability.  They were formed in early 2010, and in December 2010 they released a report with recommendations on what should be done to prevent fiscal disaster.

These guys were a bit more pessimistic than the CBO as far as Interest/Entitlements vs Revenue goes.  They said that we’d hit that line in 2025, not 2035 like the CBO thought.  Again, keep that in mind.

I’ll Gladly Give You Four Trillion In Ten Years For A Trillion Today!

When we read the news and listen to the policy wonks and politicians talking about spending cuts, and how much they are, inevitably these numbers are huge!

For example, Obama is touting a deficit reduction plan that would reduce the deficit by $4 Trillion.  Sounds great, right?  Our deficit in FY2012 was 1.3 Trillion, so we’re going into surplus, right?

Not so fast.  That $4 Trillion is over ten years, so the actual annual deficit reduction would be $400 Billion.  Not perfect, but a step in the right direction, isn’t it?  After all, that drops the deficit to $900 Billion, right?

Not so fast.  That $4 Trillion is backloaded so most of the reduction happens towards the end of the ten years.  And if you believe that they’ll actually do that, I have some oceanfront property in Nebraska to sell you.

But nobody tells you that.  They spout the top line prediction and never actually tell you those dirty details.

That $4 Trillion in deficit reduction doesn’t look so good when they’re still planning on incurring $11 Trillion more in debt over those same ten years.

When A Cut Is Not A Cut

I could write an entire article about the lies that come out of Washington when they tell us what’s going on.

But for purposes of this post, the bit I want you to understand is what’s called “Baseline Budgeting”

Baseline budgeting is where they establish a certain rate of growth every year, and that becomes the ‘baseline’ for spending on that particular line  item.  For example, they may decide that the USDA budget line item will go up by 4% every year.

In real terms we can understand, let’s say my budget for clothes for our family is $10,000 a year.  I use baseline budgeting, because if it’s good enough for Washington, it’s good enough for me.  So my baseline is 4%.

Next year, my budget goes up a bit because of that baseline spending.  $10,400.  Not bad.  The year after, it’s $10,816. Year three, I’m up to $11,249.

By year ten, I’m up to $14,800 … almost a 50 percent increase.

Basic compounding percentages, right?  No magic there.

But let’s say my income doesn’t go up as fast as that, so I need to cut my budget between year 10 and 11.  Using that 4% baseline, I would be spending $15,400 that year.  I can’t afford that.  Heck, I can’t even afford the current amount because I’m borrowing to cover that.

I have to cut my budget!  So what I’ll do is only spend 3% more instead of 4%.  Since that 4% was already “in the plan” then that’s a cut.

That’s what the government does when they tell you they’re “cutting” the budget.  They’re not actually cutting the budget in real dollars.  They’re simply reducing the rate of increase.  They’re still spending more on that line item than they did last year, but since they’re not spending as much more as they planned, it’s a cut in their eyes.

I don’t know about you, but if I’m spending more next year than I did this year, that’s an increase, not a cut.

Ahh, but that’s not even all!  Remember earlier we talked about how they stack the deck in deficit spending cuts, giving you numbers over ten years that are backloaded?

In most cases the ‘budget cuts’ you hear about are back loaded too, and never actually happen.

They tell us one thing and do something completely different.

They know they can get away with it because the numbers are astronomical and nobody has the time to wade through all the bull to find the truth.

Iceberg, Dead Ahead!

Back to the premise of the article.  Running off that cliff is inevitable.  Mathematically it MUST happen.

Remember those predictions that we’ll be spending more for Entitlements and Interest than we take in?  Ten, fifteen years from now, right?

Recall that what that actually means is that everything we spend in the Discretionary category is on credit via deficit spending.

Well, for better or worse, in FY 2011, that landmark was reached.  We spent about $2.5 Trillion on Entitlements and Interest.  Federal revenues were about $2.3 Trillion.  So we actually blew past that mark, and we spent about $200 Billion more on mandatory spending than we took in via taxes, etc.

In FY 2012 that deficit went up to about $250 Billion.

At this point we’re firmly in the camp of borrowing everything we spend on discretionary expenses.

What this means in reality is that we could shut down every single government agency, stop military spending, kill bailouts, foreign aid, and subsidies and we would STILL be running a deficit.

But hey, we should raise taxes on the rich!  Even if you went with the largest hikes being proposed, that’d get you about $80 Billion.  We borrowed $120 Billion last month.

So that massive tax hike on the rich?  Wouldn’t even cover one MONTH of deficits, let alone a whole year.  This is very clearly a spending problem, not an income problem.

It doesn’t take a rocket scientist to do that math.  Interest keeps going up because we keep borrowing more.  So even if we assume Entitlements stay the same, there’s no way we can attack the debt without putting an axe to Entitlements.  Add in even basic levels of discretionary spending, let alone the bloated spending we see now, and it’s a flat out disaster.

And this is where we back up to the main tenets of the politicians.  Kick the can, and keep power.  They think that if they cut entitlement spending that Granny and Co will kick them out.  And they’re probably right.

So will they ever do it?  Heck no.  They’ll kick the can and hope they’re out of office when the can falls off the cliff.

But That’s Not All, There’s More!

Later this week I’ll talk about what worries me the most … the debt bomb!

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2 Responses to Why Running Off The Economic Cliff is Inevitable

  1. Rudy;
    My stepdad told me along time ago, this saying it is true today as it was then.

    “Figures do not lie, but liars figure”.

    Let’s us call it what it is. Washington cronies who think they are above us, they do not care as long as they get their pay raises even if it is in the middle of the night. The American citizens pays for their bloated expense sheet.

    Military retirees who were career knew they would have a lower pay, then that of the general working force, and so did their families. This is one debt that is owed them and their families for “sacrificing to protect this nation”. It is not an “entitlement” to them or their spouse, it was an earned retirement-the hard way. If anyone should give up their “entitlements to retirement” it those who set on their backsides and call themself Senator or Congressman/women, along with the government employees who have a union to protect them and their pay.

    Where in the world is the lobbist, union representative, or fat cat to speak for those who served this nation as US Army; US Marines; US Air Force; US Navy; US Coast Guard.

    • Entitlements aren’t necessarily a bad thing. Like you said, there’s plenty of folks out there that have worked pretty damn hard for them, and they’re absolutely entitled to their pensions and benefits.

      But there’s plenty of money to pay for them. It’s all the other stuff that kills the numbers.

      We all know that they’re going to threaten military pensions and the like though, instead of anything that might actually make a difference in the grand scheme of things.

      And God forbid they bother touching their OWN benefits or salary.