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Cutting Federal Government Spending:
Yes We Did
David R. Henderson
Research Fellow, Hoover Institution,
Stanford University
and
Associate Professor of Economics,
Graduate School of Business and Public
Policy Naval Postgraduate School
Me with Former President Reagan,
January 1993
Canada’s Budget Triumph
Federal spending on programs (as a
percent of GDP):

•
•

1992-1993: 17.5 percent
2000-2001: 11.3 percent
Canada’s Budget Triumph (cont)
Federal spending on servicing the federal
debt (as a percent of GDP):

•
•

1992-1993: 5.6 percent
1999-2000: 4.3 percent
What is a “Cut”?
When analysts refer to government budget cuts,
they do not all use the word “cut” the same way. A
cut in government spending can mean one of four
things:
(i) A cut in the dollar amount of spending even
when there is inflation;
(ii) A cut in real spending, that is, an inflationadjusted cut;
(iii) A cut in spending as a percent of GDP;
(iv) A cut in the planned increase in spending.
America’s Budget Triumph
Figure 1
Federal spending as % of GDP
25

% GDP

20
15
10
5
0
1990

1991

1992

1993

1994

1995
Year

1996

1997

1998

1999

2000
Defense Spending as % of GDP
Figure 2
Defense spending as % of GDP
6
5

% GDP

4
3
2
1
0
1990

1991

1992

1993

1994

1995
Year

1996

1997

1998

1999

2000
Net Interest on Debt as a % of GDP
Figure 3
Net interest as % of GDP
3.5
3

% GDP

2.5
2
1.5
1
0.5
0
1990

1991

1992

1993

1994

1995
Year

1996

1997

1998

1999

2000
The Big Three
Figure 7

% of GDP

Social Security, Medicare, and Medicaid Spending as a Percent of GDP.
9
8
7
6
5
4
3
2
1
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Year

Medicare
Social security
Medicaid
Total
Other Domestic Spending
Fell from:
•
•

6.41 percent of GDP in 1990 to
5.40 percent in 2000
Was High Economic Growth in the 1990s
an Important Cause?
Average annual economic growth by decade:
•
•
•

1990s: 3.2 percent
1980s: 3.2 percent
1970s: 3.2 percent
Did Cuts Hurt Growth?
Growth in last half of decade, 1995-2000,
after most of the cuts had kicked in:
•

4.0 percent annual average real GDP
growth
Due to United Legislative/Executive, as in
Canada?
No.
1990-1992: R Pres, D Congress
1993-1994: D Pres, D Congress
1995-2000: D Pres, R Congress
Earlier Evidence: Drop in Post WWII
Federal Spending
Post WWII Growth of Real Private GDP
Moral of the Story
Modest cuts in spending (in real terms),
combined with keeping growth in spending
below growth in GDP, will ultimately balance
budgets and even produce budget
surpluses.
Where Cuts Can Be Made?
Defense spending today, at about 3.8 percent
of GDP, is below where it was at the start of
the 1990s, when it was about 5.2 percent.
There is still room to cut defense spending
substantially.
But the growth in government spending in the
future will be mainly in Medicare, Medicaid,
and Social Security.
The Danger of Our Current Debt
•
•

•

Net interest on the debt is very low.
This is because the interest rate on the
debt is low.
Even a one-percentage-point rise in
interest rates on the approximately $12
trillion in debt held by the public would
increase government spending by a
hefty $120 billion. This is about 0.75
percent of GDP.
Solution: Lock in Low, Long-Term Interest
Rates
•

•
•

Short-term problem: If we lock in longterm rates on, say, $3 trillion of debt, debt
service on this $3 trillion immediately
rises by $90 billion.
Long-term benefit: If interest rates rise by
more than 3 points, feds will save money.
Diversified strategy: That’s why I chose
$3 trillion.
Yes We Can – Cut Federal Spending

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Cutting Spending in the US: Can It Be Done

  • 1. Cutting Federal Government Spending: Yes We Did David R. Henderson Research Fellow, Hoover Institution, Stanford University and Associate Professor of Economics, Graduate School of Business and Public Policy Naval Postgraduate School
  • 2. Me with Former President Reagan, January 1993
  • 3. Canada’s Budget Triumph Federal spending on programs (as a percent of GDP): • • 1992-1993: 17.5 percent 2000-2001: 11.3 percent
  • 4. Canada’s Budget Triumph (cont) Federal spending on servicing the federal debt (as a percent of GDP): • • 1992-1993: 5.6 percent 1999-2000: 4.3 percent
  • 5. What is a “Cut”? When analysts refer to government budget cuts, they do not all use the word “cut” the same way. A cut in government spending can mean one of four things: (i) A cut in the dollar amount of spending even when there is inflation; (ii) A cut in real spending, that is, an inflationadjusted cut; (iii) A cut in spending as a percent of GDP; (iv) A cut in the planned increase in spending.
  • 6. America’s Budget Triumph Figure 1 Federal spending as % of GDP 25 % GDP 20 15 10 5 0 1990 1991 1992 1993 1994 1995 Year 1996 1997 1998 1999 2000
  • 7. Defense Spending as % of GDP Figure 2 Defense spending as % of GDP 6 5 % GDP 4 3 2 1 0 1990 1991 1992 1993 1994 1995 Year 1996 1997 1998 1999 2000
  • 8. Net Interest on Debt as a % of GDP Figure 3 Net interest as % of GDP 3.5 3 % GDP 2.5 2 1.5 1 0.5 0 1990 1991 1992 1993 1994 1995 Year 1996 1997 1998 1999 2000
  • 9. The Big Three Figure 7 % of GDP Social Security, Medicare, and Medicaid Spending as a Percent of GDP. 9 8 7 6 5 4 3 2 1 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Year Medicare Social security Medicaid Total
  • 10. Other Domestic Spending Fell from: • • 6.41 percent of GDP in 1990 to 5.40 percent in 2000
  • 11. Was High Economic Growth in the 1990s an Important Cause? Average annual economic growth by decade: • • • 1990s: 3.2 percent 1980s: 3.2 percent 1970s: 3.2 percent
  • 12. Did Cuts Hurt Growth? Growth in last half of decade, 1995-2000, after most of the cuts had kicked in: • 4.0 percent annual average real GDP growth
  • 13. Due to United Legislative/Executive, as in Canada? No. 1990-1992: R Pres, D Congress 1993-1994: D Pres, D Congress 1995-2000: D Pres, R Congress
  • 14. Earlier Evidence: Drop in Post WWII Federal Spending
  • 15. Post WWII Growth of Real Private GDP
  • 16. Moral of the Story Modest cuts in spending (in real terms), combined with keeping growth in spending below growth in GDP, will ultimately balance budgets and even produce budget surpluses.
  • 17. Where Cuts Can Be Made? Defense spending today, at about 3.8 percent of GDP, is below where it was at the start of the 1990s, when it was about 5.2 percent. There is still room to cut defense spending substantially. But the growth in government spending in the future will be mainly in Medicare, Medicaid, and Social Security.
  • 18. The Danger of Our Current Debt • • • Net interest on the debt is very low. This is because the interest rate on the debt is low. Even a one-percentage-point rise in interest rates on the approximately $12 trillion in debt held by the public would increase government spending by a hefty $120 billion. This is about 0.75 percent of GDP.
  • 19. Solution: Lock in Low, Long-Term Interest Rates • • • Short-term problem: If we lock in longterm rates on, say, $3 trillion of debt, debt service on this $3 trillion immediately rises by $90 billion. Long-term benefit: If interest rates rise by more than 3 points, feds will save money. Diversified strategy: That’s why I chose $3 trillion.
  • 20. Yes We Can – Cut Federal Spending