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Sunday, July 18, 2010

New Data Show the Debt Problem Is Spending (not Taxes) and Obamacare Worsens the Problem

Everyone now seems to agree that the exploding federal debt is a serious problem that must be addressed. But how? The following two charts provide some data to help answer that question. I put the charts together using budget data from CBO’s new Long Term Budget Outlook released on June 30. They take account of the budget effect of latest legislation—including the Obamacare bill.

The first chart presents the outlook for spending (red line) and revenue (blue line) as a share of GDP using CBO’s “alternative scenario,” which assumes that President Obama’s tax increase proposal is passed, including increasing the two top income tax rates. The deficit is the difference between the red and blue lines. Thus the chart clearly demonstrates that the deficit is exploding because government spending is exploding.

The chart also shows (green line) what would happen to tax revenue if tax rates stay at their current level and are not increased as President Obama has proposed. Taxes would average about 18.5 percent of GDP compared with 19.3 percent for CBO’s estimate under the Obama tax rate increase. According to the chart the Obama tax increase would not have a material effect on the very large deficit (the chart even overstates the effect because it assumes static budget scoring). Again the problem is spending growth, not taxes. To me this chart implies that it is far better to leave tax rates where they are and focus on a plan to end the explosive spending growth, especially in a weak economic environment where higher marginal tax rates can severely reduce economic growth and employment.

The second chart looks at the reasons for the explosive spending. It divides non-interest spending into three parts: (1) social security, (2) health care (Medicaid, Medicare, and Obamacare) and (3) everything else. Item 2—spending on health care—is clearly the most important source of the spending explosion. Remember that these data came out after Obamacare was passed. Thus, Obamacare does not address the explosive health care spending problem, which will come as no surprise to its critics, but is clearly contrary to the claims of those who supported it. Moreover, to the extent that Obamacare slowed growth in Medicare it more than offset this with new entitlements, making controlling health care spending even more difficult now. The data are clear: In order to control government spending, you have to start over on health care reform. Whether you call that “repeal and replace” or “repeal and reduce (the deficit)” the message is the same.

In sum, these new budget data show three things: First, the deficit is exploding because government spending is exploding. Second, the tax increase proposed by President Obama would not have a material effect on the exploding deficit. Third, we need a new approach to health care reform if we are to control government spending and wind down the deficit.