August 6, 2011 – by James W. Schneider:
The Penny Plan, officially known as House bill H.R. 1848, has received a lot of attention lately. Proponents of the plan claim that it will balance the federal budget in six years by cutting federal spending by 1% per year.
Here is an excerpt from the bill:
H.R.1848 -- One Percent Spending Reduction Act of 2011 (Introduced in House - IH)
To prevent a fiscal crisis by enacting legislation to balance the Federal budget through reductions of discretionary and mandatory spending.
When I first heard about the Penny Plan, it sounded a little too good to be true. I wanted to understand how reducing current spending by 1% per year would allow us to whittle-away at a $1.65[1] trillion deficit projected for 2011 and balance the Federal budget in six years. After all, we spend $3.8[2] trillion per year. One percent of $3.8 trillion is a measly $38 billion and six years of that totals only $228 billion. How can a $228 billion reduction in spending eliminate a $1.65 trillion annual deficit and balance the budget in six years? I was unable to find a satisfactory explanation so I went to the actual bill[3] and conducted my own analysis.
Findings:
The Penny Plan is designed to reduce spending to 18% of GDP[4] in seven years. It accomplishes its goal in two phases. Phase 1 begins in fiscal year 2012, lasts for six years and cuts 1% off the previous years’ budget[5]. Phase 2 begins in the seventh year and forces federal spending to 18% of GDP[6] regardless of the amount that may need to be cut from the federal budget that year. Let’s explain what that may mean.
If the economy (GDP) grows by 2.7% per year over the six-years of phase 1, then spending, because of GDP growth, would have been reduced to 18% of GDP by the end of year six and further cuts to spending would not be required. In this case, Phase 2 cuts would be zero. The plan would have been a remarkable success that we should all celebrate. (See Table 1):
If, on the other hand, GDP grows at 3.45% per year, then it only takes 5 years to lower the federal spending to 18%. However, the plan would still require a 1% cut in spending in the sixth year. This cut may cause spending to fall below 18% of GDP. We should all still celebrate, but some may question whether the 1% reduction in year six is worth the fight. (See Table 2):
However, if GDP grows at only 1% per year during phase 1, all else being equal, the bill forces a spending cut during 2018 of $274 billion or 8.6% of the previous years’ spending. A $274 billion cut in federal spending in one year may be difficult to sell to a nation equally split between those who want to stimulate the economy with more government spending and those who want to do so with less. (See Table 3):
If GDP grows even slower than 1% or goes negative, the forced reduction in federal spending in 2018 would be even larger than $274 billion. It may be economically unwise and politically unlikely to cut federal spending by that much in one year if growth remains that anemic.
Conclusion:
Despite the Penny Plan’s stated objective, it does not specifically address revenues and does not therefore provide a mechanism to balance the budget. It does however address federal government spending which represents at least half of the balance budget equation.
From a federal government spending and private sector economic planning perspective, the amount of cuts during phase 1 of the Penny Plan are predictable and as such should help stimulate economic growth by eliminating some degree of business uncertainty so prevalent in our present economy. The size of the spending cuts needed in phase 2 is contingent upon economic growth during phase 1 and as such are inherently unpredictable. The attempt by this Congress to tie the hands of a future Congress with such a large unknown may meet with considerable resistance and raise private sector uncertainty predicated by the mandates in phase 2.
The Penny Plan is an excellent concept that may benefit from one minor adjustment. Instead of two phases, it may be wiser, safer and an easier sell simply allowing Phase 1 to continue its 1% reduction per year until spending reaches 18% of GDP.
Table 1: Penny Plan with 2.7% GDP Growth Rate.
| Fiscal Year | GDP (Billions) | 18% of GDP | Penny Plan Outlay Cap | Penny Plan Cap as % of GDP | GDP Growth Rate |
| 2011 | $15,080 | $2,714 | $3,382 | 22.43% | 2.7% |
| 2012 | $15,487 | $2,788 | $3,348 | 21.62% |
|
| 2013 | $15,905 | $2,863 | $3,315 | 20.84% |
|
| 2014 | $16,334 | $2,940 | $3,282 | 20.09% |
|
| 2015 | $16,775 | $3,020 | $3,249 | 19.37% |
|
| 2016 | $17,228 | $3,101 | $3,216 | 18.67% |
|
| 2017 | $17,693 | $3,185 | $3,184 | 18.00% |
|
| 2018 | $18,171 | $3,271 | $3,152 | 17.35% |
|
| 2019 | $18,662 | $3,359 | $3,121 | 16.72% |
|
| 2020 | $19,166 | $3,450 | $3,090 | 16.12% |
|
| 2021 | $19,683 | $3,543 | $3,059 | 15.54% |
|
| 2022 | $20,215 | $3,639 | $3,028 | 14.98% |
|
In 2011 Spending Excess = $3,382 - $2.714=$668
From 2011 – 2017 GDP increases $2,613 X 18%=$470
From 2011 – 2017 Spending drops $3,382-$3,184=$198
GDP increases + Spending Cuts = $470+$198 = $668
Table 2: Penny Plan with 3.45% GDP Growth Rate.
| Fiscal Year | GDP (Billions) | 18% of GDP | Penny Plan Outlay Cap | Penny Plan Cap as % of GDP | GDP Growth Rate |
| 2011 | $15,080 | $2,714 | $3,382 | 22.43% | 3.45% |
| 2012 | $15,600 | $2,808 | $3,348 | 21.46% |
|
| 2013 | $16,138 | $2,905 | $3,315 | 20.54% |
|
| 2014 | $16,695 | $3,005 | $3,282 | 19.66% |
|
| 2015 | $17,271 | $3,109 | $3,249 | 18.81% |
|
| 2016 | $17,867 | $3,216 | $3,216 | 18.00% |
|
| 2017 | $18,483 | $3,327 | $3,184 | 17.23% |
|
| 2018 | $19,121 | $3,442 | $3,152 | 16.49% |
|
| 2019 | $19,780 | $3,560 | $3,121 | 15.78% |
|
| 2020 | $20,463 | $3,683 | $3,090 | 15.10% |
|
| 2021 | $21,169 | $3,810 | $3,059 | 14.45% |
|
| 2022 | $21,899 | $3,942 | $3,028 | 13.83% |
|
Table 3: Penny Plan with 1% GDP Growth Rate.
| Fiscal Year | GDP (Billions) | 18% of GDP | Penny Plan Outlay Cap | Penny Plan Cap as % of GDP | GDP Growth Rate |
| 2011 | $15,080 | $2,714 | $3,382 | 22.43% | 1% |
| 2012 | $15,230 | $2,741 | $3,348 | 21.98% |
|
| 2013 | $15,383 | $2,769 | $3,315 | 21.55% |
|
| 2014 | $15,537 | $2,797 | $3,282 | 21.12% |
|
| 2015 | $15,692 | $2,825 | $3,249 | 20.70% |
|
| 2016 | $15,849 | $2,853 | $3,216 | 20.29% |
|
| 2017 | $16,007 | $2,881 | $3,184 | 19.89% |
|
| 2018 | $16,167 | $2,910 | $3,152 | 19.50% |
|
| 2019 | $16,329 | $2,939 | $3,121 | 19.11% |
|
| 2020 | $16,492 | $2,969 | $3,090 | 18.73% |
|
| 2021 | $16,657 | $2,998 | $3,059 | 18.36% |
|
| 2022 | $16,824 | $3,028 | $3,028 | 18.00% |
|
Column Definitions:
GDP:
The estimated GDP for the fiscal year 2011 is provided by BEA.gov. The remaining years are increased by the percentage found in the GDP Growth Rate column.
18% of GDP:
The GDP column is multiplied by 18%.
Penny Plan Outlay Cap:
The amount for year 2011-2012 is given in the bill H.R. 1848 http://thomas.loc./cgi-bin/query/z?c112:H.R.1848: ((1) FISCAL YEAR 2012- For fiscal year 2012, the aggregate projected outlays (less net interest payments) for fiscal year 2012 shall be $3,382,000,000,000, less one percent.) [Which computes to $3,348,000,000,000 in 2012]
The remaining years apply the Penny Plan formula as provided in H.R. 1848 Sec 253A
Penny Plan Cap as a % of GDP:
Penny Plan Outlay Cap divided by GDP as a percentage. The percent is less than actual total spending because as mentioned above, the Outlay Cap does not include interest payments made to U.S. Treasury bond holders.
GDP Growth Rate Column:
The assumed annual growth in the GDP.
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