The US budget focus

I got hooked up looking at budgets this past week, so now I'll divert my attention to the American budget, or at least a proposal for the American budget. 

Since I didn't go into analyzing the Obama budget as I did with the UK Budget (even though I did refer to it in one post on the US debt and deficit where I call on the Bowles-Simpson report), I decided to give some attention to the Paul Ryan Budget proposal (the Republican chair of the House Budget Committee in Congress). I'll try to draw comparisons with the Obama budget to see which one of these is a pro-growth and pro-reform, if any.

Note: Next year, I'll make sure to give the US budget the equal amount of attention as I gave to the UK one. Also, I'm removing the 'Red book' from the blog and posting it as a link to the post on the budget .

One one side there is President Obama's budget focused on higher taxes (on the rich to lower inequality), higher spending (on entitlements to keep his voter support) and higher deficits (even though the idea was to curb the deficit and debt), while on the other side there is a potential supply side budget calling for reforms in entitlements, spending and taxes.

Let's look at the Ryan budget more closely. It aims to cut total federal spending by 2015 to approx. 20% of GDP. The reductions in taxes (individual and corporate) would follow to restore the revenues to their post war average as well (again around 20%). The deficit by 2015 would amount to 1.7% of GDP, much less than the Obama estimate of approx. 9%. The balanced budget ('holy grail' of 21st century economics) would be achievable by 2017. The CBO has their estimates of the Ryan budget in comparison with their baseline and alternative fiscal scenarios, in the table below (click to get a better view):

Source: Congressional Budget Office 

As can be seen, the main difference between the Ryan budget and CBOs Baseline scenario is that Ryan achieves a balanced budget with a lower size of government in the long run. However, I'm not a big fan of 50 year projections. They can only serve as a type of proxy on today's decision making, but even in that case its prediction power is limited.

Taxation reform 

On the personal income taxes, the Obama budget would introduce a 45% top marginal tax rate, keeping the progressive tax system on all other incomes as it is. Ryan budget would introduce only two rates - 10% for all those families earning less than $100,000, and 25% for all above that threshold. Kind of a double-edged flat tax.

Corporate taxes would also go down in the Ryan budget, to 25% (down from the highest margin of 35% - or as Mankiw puts it from 39.2% including both federal and state taxes), which is still too high and unfavorable for US global competitiveness (note that the UK has just decreased its corporate income taxes to 24% with a pledge for them to drop down to 22% by 2014 - and yet, the UK is still among the highest corporate tax rate countries). To be honest, the current standards of 15% (the lowest corporate tax rate for small businesses) should be applied to all. There is no need to address the inequality among businesses, or is there?

The Ryan budget would also cease taxing overseas earnings of US companies if they invested back in the US. With the current system US firms are greatly discouraged to invest their foreign earnings back in the US, so this reform is absolutely needed.  

On these issues, the proposal is more then welcomed. It aims to decrease the size of government in the economy and provide a boost to businesses and consumers to encourage them to spend more and take on more risks.

Controversy and criticism 

After this, things get tricky. The Ryan budget calls for an immediate repeal of Obamacare and controversial reforms of the Medicare and the social security system. This is a delicate political issue and it takes a lot more than part of a blog post to explain it, so I'll refrain from any deeper analysis for the time being. For now, let me just point out that the current US welfare state is in need of serious reform, not short-term cuts or boosts in spending aimed at achieving political goals. The reform of the welfare state is one of the key issues arising from the current crisis (which has proven its unsustainability) and it needs to be approached carefully. (I plan to write a series of blog posts on welfare state reform). 

But what really bugs me in the Ryan budget is defense spending. Republicans just can't leave it out. I'm supportive of the defense cuts announced by President Obama ($500bn over the next 10 years) and would call for them to go down even further and much more faster. Why can't we be offered a policy that will stop all war funding and all national security spending aimed at making the American people 'safer'? This is a big mistake in the Ryan budget - cutting everywhere else to support a 'military strategy' and prioritizing national security. It is downright hypocritical from Paul Ryan. When he calls for economic freedom, I suggest he starts with individual freedom first.

Esentially, the Ryan budget is a call to cut everything except Social Security, Medicare and defense. Critics of the Ryan budget say that this is out of scope with reality as it disregards all other main functions the government should perform. It has no knowledge of what is needed for a proper functioning of the government. I agree with the critics, but on a different point of view.

The main functions of the government should be to maintain the rule of law, property rights and enforcement of contracts. These institutional prerequisites are the essentials, everything else is optional. They are the guarantee that only the right types of signals are sent to the market, without any distortions. 

I don't mind some basic spending on education or health care, as not everyone can afford schooling or doctors, so keep public schools and keep public hospitals. But the key is to introduce competition among them and enable a high scope of private-based solutions. This is where the process of trial and error will set place and perhaps come up with a better system. It is crucial for this process to develop spontaneously, and not be guided by distorting government subsidies or similar actions. 

In the end, here is the summary of the Ryan budget by the libertarian Republican presidential candidate Ron Paul:

“What is really disappointing is that the GOP budget assumes that the federal government should continue to do everything, or at least almost everything, it is currently doing. We will never have a balanced federal budget, low taxes, economic prosperity, and individual liberty unless Congress stops trying to run the world, run the economy, and run our lives."

Here is Ron Paul's proposal for the US budget if he becomes President - cut a trillion dollars of spending in year 1 along with major regulatory relief, large tax cuts, sound money policies (which include a full audit of the Fed), cuts in defense financing (bringing troops home) and a balance budget by the third year of Presidency. Sounds impossible? Impossible is nothing! 

I would really like to see how that type of rapid and brutal decrease of the government in the economy (down to 15% of the GDP) would react in the system. Even though some initial discrepancies are bound to arise, this budget proposal comes closest to immediately letting market mechanisms instead of government mechanisms send signals of who to hire, in what to specialize in and in what to invest in.