No one in Washington can agree on how to narrow the budget deficit. Not even balance. Just narrow.
The debate over next year's budget alone has been ongoing for months. Progress is obnoxiously difficult. One person wants this, another calls it "sacred" and says "cut that," any number of thinktanks say both are wrong, and Paul Krugman thinks everyone's a moron.
Tough problems, these. But as Berkshire Hathaway (NYSE: BRK-B) quote machine Charlie Munger said recently, "It's amusing to see someone spend 1 million man-hours on something I can solve with my left hand."
With only partial seriousness, I'm going to do just that, balancing next year's $1.1 trillion budget deficit in three easy steps.
Step one: Return real (inflation-adjusted) defense spending to average 1990s levels
Current projections show that $738 billion will go toward defense spending in 2012. That's one-fifth of all federal spending, and more than twice as much as goes toward the Department of Education, veterans benefits, the Department of Justice, the Department of Energy, and the Department of Agriculture combined.
It wasn't always this way. Adjusted for inflation, an average of $373 billion was spent on defense annually between 1994 and 2000. Reverting to similar levels would cut $365 billion from next year's budget.
Now our deficit's down to $735 billion. Where to next?
Step two: Return tax revenue as a percentage of GDP to average 1980s levels
Tax revenue as a percentage of GDP is now just 14.4% -- a fifth below the long-term average, and the lowest level since World War II.
Returning that figure to the 18.3% average seen in the 1980s would draw in $585 billion in additional tax revenue. In fact, you don't even need to go back to the 1980s. Just returning to 2007 levels would mean collecting more than half a trillion dollars more than we do today.
Now our deficit's down to $150 billion. Progress! What next?
Step three: Rationalize Medicare
I'll let former White House budget director Peter Orszag do the talking here:
Researchers have estimated that nearly 30 percent of Medicare's costs could be saved without negatively affecting health outcomes if spending in high- and medium-cost areas could be reduced to the level in low-cost areas -- and those estimates could probably be extrapolated to the health care system as a whole. With health care spending currently representing 16 percent of GDP, that estimate would suggest that nearly 5 percent of GDP -- or roughly $700 billion each year -- goes to health care spending that cannot be shown to improve health outcomes.
Medicare's 2012 outlays are projected to be $492 billion. Saving "nearly 30 percent," as Orszag suggests could occur without affecting health outcomes, cuts $150 billion from federal spending.
And now the budget's balanced.
Cause and effect
Again, I write this with only half a straight face. It may not be feasible to gut defense spending amid two wars -- and contractors like Boeing (NYSE: BA) and Lockheed Martin (NYSE: LMT) pay taxes, so cutting $1 lowers the deficit by a smaller amount. Tax revenue as a percentage of GDP has fallen so far largely because unemployment is so high. Making the health care system more efficient is the epitome of the phrase "easier said than done." There are also nonmonetary factors. Is the world safe enough to gut the defense budget? It's a question number-crunchers can't answer. I'm not directly advocating any of this.
Still, these exercises drive home an excellent point New York Times columnist David Leonhardt made last month. I've used this quote before, but its importance bears its repeating:
Eventually, the country will have to confront the deficit we have, rather than the deficit we imagine. The one we imagine is a deficit caused by waste, fraud, abuse, foreign aid, oil industry subsidies and vague out-of-control spending. The one we have is caused by the world's highest health costs (by far), the world's largest military (by far), a Social Security program built when most people died by 70 -- and to pay for it all, the lowest tax rates in decades.
Willie Sutton robbed banks "because that's where the money is." Those wrestling over how to attack the deficit would be wise to think the same way.
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.
Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Lockheed Martin. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
