Monday, August 20, 2012

Larry Summers Has Bad News For Obama and Romney

The GOP's campaign is based upon its plans to shrink government.  Obama's budget projection calls for government's share of spending to be about the same as those projected by Romney/Ryan.  Larry Summers' analysis of government spending relative to GDP tells a different story.  He gives four reasons why government spending as a percent of GDP will increase substantially over what it was prior to the financial crisis.

The demographics of an aging population will have a huge impact on government spending.  Prior to the financial crisis, government spending on the elderly was 7.7% of GDP.  The elderly's share the population ( those with 15 years of life expectancy) will increase by 34% by 2020.  If we maintain current programs for the elderly,  the demographics show that government spending for the elderly will rise by 5.6% of GDP.

Federal debt as a percent of GDP was 36.3% prior to the crisis, and debt service as a percent of GDP was 1.7%.  If government implemented the tax increases, and spending cuts, suggested by Simpson and Bowles, which is highly unlikely, government debt to GDP would rise to 65%.  Interest rates will also return to more normal levels during this period. The combination of rising debt to GDP, and higher interest rates will cause debt service as a percent of GDP to rise to 3.2%

Government costs will also rise faster than inflation for many reasons.  Inflation will increase government spending as a percent of GDP to rise by 3.0%

Government will also have more expenses as a result of several structural issues.  Rising inequality will place a greater burden on government. We have also made unsustainable cuts in budgets that have limited the ability of the IRS to monitor tax compliance, and the ability of the SEC and other agencies to regulate commerce.  Moreover, we can't continue to defer maintenance as we have during our current budget crunch.  Increasing globalization of the economy will also expand the role of government.  Defense spending a significant share of GDP.  It is unlikely, however, that significant cuts in defense spending can be made in an era of rising international tensions.

In summary, both political parties have a plan to shrink government's share of GDP, this may be great for running political campaigns, but the realities of the situation suggest otherwise.  Government's share of spending, relative to GDP will have to increase by 2020.

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