PreFunding Senior Entitlements


How to Save Social Security and Medicare

The Problem:
Congress has promised that our seniors will have health care coverage and retirement income for the rest of their lives. Unfortunately, Congress has failed to pay for all the benefits they have promised. Now our children must deal with the $61.6 trillion shortfall[1]
 
Pay-As-You-Go Funding:
Social Security and Medicare beneficiaries are primarily paid from the payroll and income taxes that are collected today. This type of funding is called Pay-As-You-Go.

Pre-funding at birth:
The greatest criticism of pay-as-you-go funding is that it ignores the wealth accumulation effects derived from the time-value-of-money. The time value of money is defined as the growth of money over time due to the compounding of interest.

The concept of "Pre-funding at Birth" takes full advantage of the time value of money. Pre-funding involves investing a relatively small amount of money at birth that grows unmolested until the beneficiary reaches a certain age – say 70 years old. The accumulated investment is then used to pay the beneficiary for the rest of their life. If you know how much money you want to receive in the future and you know the rate at which your investment will grow, it's a straightforward calculation to determine how much you'll need to invest today to reach your goal.

Compound Annual Growth Rate (CAGR):
Equity markets do not pay interest.  An investor makes money when the value of his or her equities increases or when the company pays a dividend. Because equity values can decline as well as increase, equity value changes are measured by a computation known as the Compound Annual Growth Rate (CAGR). For purposes of this discussion, CAGR and annual interest rate are synonymous.

CAGR History:
Using stock price and dividend yield data for over 100 years, U.S. equities, including reinvested dividends, have delivered a CAGR of 10.4%. The worst 70-year period since 1915 still returned a very respectable CAGR of 9.85% while the best 70-year period returned a CAGR of 11.92%[2]. The site www.moneychimp.com/features/market_cagr.htm allows you to enter a date range and returns the corresponding CAGR.

Risk Mitigation:
There is a widely held but patently false belief that pay-as-you-go-funding for critical programs like Social Security and Medicare is less risky than investing in the stock markets. While it is certainly true that markets can and do fluctuate widely over a five, ten or even a fifteen year period, it is also true that the longer the term, the less the risk in the markets.

Consider a funding plan that was based on the perpetuity of the equity markets. Such a plan could eliminate market risk and beneficiary angst altogether simply by fixing average annual returns for all beneficiaries at a rate that was a few tenths of a percent less than the historic average. The plan could instill confidence further by guaranteeing the benefits through the full faith and credit of the US government.

When you compare the risk realities between Prefunding at birth and pay-as-you-go financing for Social Security and Medicare, the facts are hard to dispute. Even including the Great Depression and the current Great Recession, equity markets have still managed to average a 10.4% return on investment while pay-as-you-go financing has left us with a $61.6 trillion unfunded liability against our children's future. Nice legacy. Which financing strategy would you say is less risky?

A Social Security Example:
In 2007, the average Social Security benefit was $12,972 per year. According to the Bureau of Labor Statistics, a person who turned 70 in 2007 was expected to live another 14 years. Each year Social Security payments were expected to grow 2.8% to cover cost of living increases[3]. The lifetime payout after 14 years was expected to be $218,664[4].

Pre-Funding vs. Pay-As-You-Go:
How would Prefunding at birth compare with Pay-as-you-go financing from an historical perspective? Well, given our 10.4% average return on investment and a 2.8% average annual inflation rate, how much would taxpayers have had to invest one-time in 1937 in order to be able to payout $218,664 over 14 years beginning in 2007? The answer is $121.

You might want to read that last paragraph again – let it sink in.

In other words, if you were born on January 1, 1937 and the Social Security Administration had deposited $121 for you in a fund that grew on average 10.4% per year, at age 70, you could start withdrawing $12,972 per year. Each year you could receive 2.8% more than the year before to cover inflation. You could receive that inflation adjusted payment each year for the rest of your life (estimated at 14 years). At the end of those 14 years, you would have received the same $218,664 that Social Security would have paid you if Social Security had the money, which under current funding law, it would not. Said another way - $121 Pre-Funded at birth is the same as $218,664 Pay-As-You-Go.

Compare the one-time investment of $121 made 70 years ago against the $218,664 that must be taken from workers and employers over the next 14 years. Moreover, that is just one person. Had Social Security and Medicare included pre-funding at their inception, then those programs would be adequately funded today and more importantly, forever.

That's looking at Prefunding from an historical perspective, but what about the future. The BLS.gov forecasts that average life expectancies for a 70 year old will increase from 14 to 18 years. So, how much would it cost today to prefund a newborn’s Social Security account that begins paying benefits 70 years from now? With an average annual growth rate of 10.4%, average annual inflation rate of 2.8% and a life expectancy of 18 years, the answer is $750. 

With roughly 4 million Americans born each year, the cost to fund a program that deposits $750 in an account for every newborn American is about $3 billion per year ($750 X 4 million births).

How much is $3 billion per year? To put it in context, consider that we spend about $2 billion per week in Afghanistan. In other words, the annual cost to prefund Social Security is equivalent to about 10 1/2 days in Afghanistan.

In 2009, Americans paid $805 billion to Social Security. Social Security paid out $680 billion in benefits and Congress spent the remaining $125 billion Social Security surplus on programs unrelated to Social Security. If that surplus had been hidden in a mattress, it could prefund Social Security for the next 40 years ($125 billion / $3 billion per year). But suppose the $125 billion had been invested in non US debt. Any return slightly greater than 2.4% on $125 billion could pay for the prefunding program indefinitely. ($125B x .024 = $3B).

Conclusion:
Pre-funding at birth can resolve the financing problems confronting both Social Security and Medicare. Transitioning from pay-as-you-go to pre-funding would place us on a glide path to eliminate the $61.6 trillion in unfunded liabilities and save Social Security and Medicare from financial crisis. Americans need to be aware of this solution and demand that Congress save our senior safety net and keep the promises they made.

To learn more about how pre-funding can save our Senior Safety-Net programs, please review the position paper ABC – Social Security.



[1] http://www.usatoday.com/news/washington/2011-06-06-us-owes-62-trillion-in-debt_n.htm
[2] http://www.econ.yale.edu/~shiller/data.htm Robert Shiller: The data collection effort about investor attitudes that I have been conducting since 1989 has now resulted in a group of Stock Market Confidence Indexes produced by the Yale School of Management. These data are collected in collaboration with Fumiko Kon-Ya and Yoshiro Tsutsui of Japan. Some of our earlier results are also noteworthy.

Stock market data used in [Robert Shiller] book, Irrational Exuberance [Princeton University Press 2000, Broadway Books 2001, 2nd ed., 2005] are available for download, Excel file (xls). This data set consists of monthly stock price, dividends, and earnings data and the consumer price index (to allow conversion to real values), all starting January 1871. The price, dividend, and earnings series are from the same sources as described in Chapter 26 of my earlier book (Market Volatility [Cambridge, MA: MIT Press, 1989]), although now I use monthly data, rather than annual data. Monthly dividend and earnings data are computed from the S&P four-quarter tools for the quarter since 1926, with linear interpolation to monthly figures. Dividend and earnings data before 1926 are from Cowles and associates (Common Stock Indexes, 2nd ed. [Bloomington, Ind.: Principia Press, 1939]), interpolated from annual data. Stock price data are monthly averages of daily closing prices through January 2000, the last month available as this book goes to press. The CPI-U (Consumer Price Index-All Urban Consumers) published by the U.S. Bureau of Labor Statistics begins in 1913; for years before 1913 1 spliced to the CPI Warren and Pearson's price index, by multiplying it by the ratio of the indexes in January 1913. December 1999 and January 2000 values for the CPI-Uare extrapolated. See George F. Warren and Frank A. Pearson, Gold and Prices (New York: John Wiley and Sons, 1935). Data are from their Table 1, pp. 11–14. For the Plots, I have multiplied the inflation-corrected series by a constant so that their value in january 2000 equals their nominal value, i.e., so that all prices are effectively in January 2000 dollars.
[3] SSA.gov Social Security Administration, Master Beneficiary Record, 100 percent data. SSABenefits2.xls (sheet 2: 12/2007)

If I Wanted America to Fail: Teacher Challenge

On April 20th, 2012, FreeMarketAmerica.org released a four minute video entitled "If I wanted America to Fail"

http://www.youtube.com/watch?feature=player_embedded&v=CZ-4gnNz0vc
I challenge every teacher in America to show this video to their classes and then conduct an open discussion.

But before a teacher can show this video to their students, they should answer the following questions for themselves.

Questions for teachers:
1. Would you be "allowed" to show this in your class?
2. Would you be "concerned" over peer pressure (teachers) to show this in your class?
3. Would you be "worried" about your career if you even asked to show this in your class?
4. Would you "fear" repercussions from the parents?
5. Do you "think" any of the points raised by the video are worthy of discussion?
6. If you belong to a Teacher's Union, do you think your union would support any of the positions raised?

Please submit your answers to these questions and include the zip code where you teach and the grade(s) you teach.

If you know any teachers, please forward this link to them.

Let's have an open and honest discussion for a change.
______________________________________________


James W. Schneider
CEO, Americans United Party

Is America a Nation in Decline?


The evidence to support the case is strong. For starters, we face an unsustainable national debt that continues to grow at an accelerating rate. Our job market has failed to support our population growth for over four years. Our increasing income gap has been eroding the purchasing power of America’s middle class families for decades. These are just a sample of the mounting problems we face as a nation.

Through our Constitution, we empower our political leaders to solve our national problems. Unfortunately, our political leaders have become more of a problem than a solution. Neither the Democrats nor the Republicans have offered anything substantively new from their anemic economic playbooks. Democrats once again want to increase taxes and spending while Republicans want to cut taxes and slow down spending. Both approaches are nothing more than Keynesian band-aids that shift pain from one group to another as we continue our gradual decline.

Neither party has articulated a strategic vision that reverses the decades old policies that are responsible for our protracted economic decay. By pitting American against American and group against group, our political class ensures an equally divided, never-ending tug-of-war among the electorate. Neither side appears capable of offering solutions the other side will accept. How could they? If you despise, distrust and believe your opponent is inherently evil, you are unlikely to accept that they could ever have your best interests at heart.

Confronted with an overly partisan and hopelessly gridlocked government that is either unwilling or unable to solve our nation’s fiscal problems, a concerned electorate has learned that we have been chipping away at our economic foundation since globalization began over forty years ago. While our economy declines against the backdrop of an expanding industrialized world, we are being conditioned by our political leadership and our national press to accept our decline as the “new normal”. Well, this is not the new normal. America’s decline is not a foregone conclusion. Our decline is the result of irresponsible mismanagement perpetrated by both political parties, fueled by an ideologically biased media and funded by the inherent corruption of deep pocket special interest groups that have managed to isolate our elected representatives from “we the people”. As President Kennedy said during his speech at The American University on June 10, 1963,

- Our problems are man made; therefore, they may be solved by man.

Our man made economic decline is fully reversible, but only if Americans can forge a solutions-based strategic plan that unifies the majority of Americans around its implementation and allows us to reject the emotional ploys that keep us a nation divided.

Carting out a retread crop of previously rejected solutions will not be any more palatable to the opposition groups then they were in their previous incarnations. We need a different framework. We need a framework designed to appeal to the majority of Americans. A framework that is so founded in common sense that even the deep-pocket media blitz from the status quo seeking special interest groups will find it difficult to demagogue.

Recognizing that the only positive way forward is through consensus building, the Americans United Party has developed a comprehensive economic road map that addresses the root causes of our economic decline and prescribes a remedy that places America back on the path to prosperity.

The AUP Economic Road map appeals to the financial aspirations and common sense of most Americans. Our solutions based approach was not locked into the rigors of any entrenched ideology nor were we forced to settle for middle of the road mediocrity in order to gain widespread acceptance. On the contrary, our strategy transcends political ideology because our plan puts the financial aspirations of Americans, all Americans, first.

The AUP plan addresses the six economic components whose deterioration is most responsible for our protracted economic decline - Jobs, Debt, Safety Net, Energy, Education and Government. Our Economic Road map presents a plan that coordinates and optimizes these six facets of our economy into a cohesive economic model designed to accomplish one simple and universally acceptable economic goal. Namely;

Continuously improve the standard of living of all Americans.

We invite you to review, comment and support our economic road map.

http://americansunitedparty.blogspot.com/2011/07/executive-summary.html

I look forward to hearing your constructive suggestions.

Jim Schneider
CEO Americans United Party

Eliminate the Job Burden

At the request of the Joint Select Committee, on October 5th, 2011 we passed them our thoughts on the Job Burden.

Eliminate the US Job Burden:
It costs more to create and maintain private sector jobs in the US than it does in any other country. We will continue to lose our best paying private sector jobs to the rest of the global economy until we recognize and correct this job killing and economy killing imbalance.

In this highly competitive global economy, our laws, regulations, taxes and policies have made it increasingly less profitable for employers to create jobs in America than in other countries. The unintended consequences of these actions have been to force investors, entrepreneurs and businesses both large and small to take their capital and their jobs and go elsewhere, and they have – in droves.  To reverse that trend and once again foster U.S. based private sector job creation, Americans must seek out and remove the roadblocks that impede U.S. based employer profitability. We refer to the collection of impediments that inhibit employer profitability, and thereby restrict job creation, as the Job Burden.

We propose that America begin her economic recovery by reversing the forty-year journey that has forced American employers to pay for our nation’s historic social ills and economic inequities at the expense of our jobs. The unintended consequences of these policies have been to undermine the very business climate that was responsible for elevating America to lone economic superpower status and producing the highest standard of living the world has ever known. We argue that by continuously increasing non-business related costs on our job creators, we have forced them to take their capital and their jobs to friendlier shores. We show that by burdening our employers with a host of social safety-net costs, uncompetitive government regulations and the world’s highest business tax structure, the once most job-welcoming nation in history has deteriorated into one of the most job unfriendly counties in the world.

We use Bureau of Labor Statistics data to quantify several of the safety-net programs that contribute to the U.S. job burden. Our analysis reveals that safety-net costs such as Social Security, Medicare, Medicaid, employer-based healthcare, and pension plans add 30% to the cost of U.S. manufacturing labor. A thirty percent labor premium is an unsustainable handicap for American based employers to overcome in an ever-growing global economy that continuously improves in production quality, process efficiency and the education of its labor force. To add insult to injury; we reveal that consumers and not businesses actually pay for these programs by way of increased prices. The sad irony is that the increased prices merely make American made goods less competitive, which costs us our jobs and puts our safety net programs at risk.

While we condemn the job-killing aspects of the job burden, we underscore the critical importance that our safety-net programs have on American society, however; we demonstrate that funding our safety net programs through our businesses not only destroys our jobs but consequently places our job-funded safety-net programs at risk. Keeping both our safety-net programs and our jobs requires an alternate means of funding our safety-net programs. We recommend we address that dilemma through a revenue-neutral National Retail Sales Tax that we have named the Safety-Net Tax. The Safety-Net Tax not only frees U.S. employers from the job-killing ravages of the job burden, but since it allows improvements to overall business efficiency, it will reduce aggregate costs (prices + Taxes) to consumers and taxpayers. All Job Burden costs are passed along to consumers and as such are regressive in that the poor pay a higher percentage of their wages for Job Burden costs then do more affluent consumers.

In any free-market economy, profitable, private businesses are the only economic growth engine we have. The jobs those profitable businesses produce are the most effective way for Americans to contribute to and benefit from that growth engine. In this global economy, American labor must unite and commit to winning the global competition for jobs. American workers must provide employers, both foreign and domestic with reasons to invest their capital in America and create their jobs in America. As a labor force, America must structure an approach designed to entice employers to bring their jobs here not punish them with costs and regulations that reduce their profits and inhibit their success. American labor must assume responsibility for restoring America to the most job friendly country in the world. Our politicians, labor unions, press and special interest groups must unite behind this American self-interest objective. The only way to “jobs-jobs-jobs” is to help business and capital be more profitable here than anywhere else. Americans must demand that our political, business and labor leadership reject the economic destructive strategies that pit labor against business for the purposes of advancing parochial self-serving interests.

Eliminating the Job Burden does not mean we have to relinquish the gains made by organized labor. On the contrary, the AUP wants to protect and even enhance the quality of work-life gains that organized labor has achieved over the years. In fact, we want to take it a step further. We want all Americans, not just a select few, to benefit from the benefits and protections forged by organized labor. Our philosophy in this regard is simple: As a nation, we can have any safety-net program, benefit plan or quality of work-life standard we want! All we have to do is pay for it! And, equally important, we must guard against attempts by our politicians and special interest groups to hide or postpone the costs of our programs in various tax and debt schemes that eventually come back to bite us and put our nation’s financial future at risk.

What we have to do is stop pretending that our businesses pay for any of our safety-net programs – they do not. "There is no free lunch". We must recognize that we pay for them as consumers, taxpayers and employees. Once we realize this fundamental economic truth, we can free our businesses from the job burden, which will allow business to create American based jobs as we continue to pay for our safety-net programs through our purchases.

One way to portray private sector job creators is to compare them to the fabled “Goose that lays the golden eggs”. While the job creators symbolize the goose, the golden eggs denote the jobs they create. Until we unshackle our employers from uncompetitive, non-product related costs, the United States will continue to hemorrhage jobs and industries to the rest of the global economy. It is a simple formula: The more we ask our businesses to pay for our social programs and other non-business related costs, the more jobs we will lose to foreign competitors who are eager to keep their costs down and take our jobs. In essence, we are purposefully killing the goose that lays the golden eggs. Why? Consider recent Congressional actions either passed into law or pending Congressional action e.g. PPACA (Obama Care), Cap & Trade, Financial Regulations. Each of these programs adds to the job burden and will no doubt force more jobs overseas. The question that every American should ask is “why is Congress killing the goose that lays the golden eggs?” Attempts by some in Congress to “shame” American business leaders who outsource or relocate to less costly shores as “un-American” are ridiculous demagoguery. By definition, capital must follow the path of least resistance or risk being lost. It would be a violation of a business leader’s fiduciary responsibility not to do everything in their power to maximize the return on any owner’s capital investment, even if that means going offshore. It is the responsibility of Congress to ensure that investors, entrepreneurs and business leaders do not perceive their best opportunities lie offshore. Any Congressperson who does not understand and accept these fundamental economic truths is not qualified to set economic policy for a country founded on free-market principles.

We conclude by asking the President and both houses of Congress to recognize the job killing nature of the U.S. Job Burden and to issue a “Sense of the Congress” declaration advising the world that the United States is committed to eliminating the U.S. job burden and is once again open for business. The force of this simple declaration would immediately ease the economic uncertainty holding back our business expansion and job creation. That economic expansion and job creation would continue provided Congress actually implements on a timely basis the policies that eliminate the U.S. Job Burden.

Please review our plan to eliminate the Job Burden and the rest of our economic roadmap at http://americansunitedparty.blogspot.com/2011/07/executive-summary.html Thank you for taking the time to read our thoughts and we wish you good luck and great success on your journey to restore our economy.
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The Moral Argument against Unfunded Liabilities


September 13, 2011: By James W. Schneider

According to the National Debt Clock as of September 9, 2011, the U.S. National debt was $14.7 trillion and rising at a rate of over $1.3 trillion per year. The national debt represents money our federal government has borrowed and still owes to others.

Our $14.7 trillion national debt does not include our nations’ unfunded liabilities. Unfunded liabilities represent promises to make future payments for which there will not be enough money to pay those benefits under current law. The obligation to pay those benefits will fall upon the labors of our children. The two programs with the largest amount of unfunded liabilities are Social Security and Medicare. Depending on which future assumptions are used in the various projection models, the dollar value of our nation’s total unfunded liabilities range from $54 to $115 trillion. The National Debt Clock computes our unfunded liabilities at $115 trillion or over seven times our national debt. In August 2011, the USA Today reported that our unfunded liabilities were $61.6 trillion or over $528,000 for every American household. Regardless of which projections are right, if America survives her rapidly approaching fiscal crises, then, unless we make significant changes to our unfunded programs, you will pass your portion of the debt to your heirs.

The financial site www.finweb.com defines an insolvent estate as follows.

Insolvent estates are those where the decedent’s assets are not sufficient to cover debts after death. As a result, there will be no inheritance left to the beneficiaries of the estate, and those beneficiaries may further have a legal obligation to help resolve the debts. Thankfully, less than 10 percent of all estates are insolvent, so it is not likely you will have to face the problem.

In our personal lives, most Americans would be thoroughly disgusted and completely embarrassed at the thought of leaving huge debts to their children. However, in our public lives, we the people of the United States have mandated that 100 percent of our beneficiaries have a legal obligation to resolve our debts. Why is it unacceptable in our personal lives but perfectly acceptable in our public lives? It is not!

The economic history and political conditions surrounding the decisions that led to the inadequate funding of these social programs may have made their enactment understandable; however, with the clarity of 20/20 hindsight, we can now safely argue that the entire category of unfunded future obligations should forevermore be banned as not only fiscally irresponsible but morally reprehensible.

It is time that all Americans stand up and acknowledge that it is wholly immoral to saddle future generations with the greed and poor fiscal management decisions of current generations. If we do not rectify our fiscal malfeasance, our progeny may justifiably cut us off at the knees and leave us without recourse. Considering the profligate mess we have left them, who could blame them? The Baby-Boom generation and the representatives we have elected to do our bidding in Washington have shown our true colors as self-serving, over spenders unconcerned with the condition of the legacy we bequeath to our heirs. Shame on us for destroying the inheritance the Greatest Generation left us. If we wish to restore our honor then we must restore the legacy bequeathed to us and restore the American tradition of leaving the next generation better off then the previous one – not chain them to an unsustainable anchor of debt. It is sad when we recognize that with a little forethought, common sense and moral leadership we could have completely avoided this fiscal problem. The good news is that with a concerted effort we may still have time to correct our profligate mistake without reducing the benefits promised to our seniors.

We the people can have any safety net program or benefit plan we want. All we have to do is pay for it during our time and never expect or allow any future generation to pay for it on our behalf. Just as it will become our children’s job in their time, it is our job in ours to take care of ourselves - and our children. We have no right to borrow against our children’s future. How did we ever let such a notion take hold in America?

Unless the majority of Americans have the courage and moral fortitude to rise up and say “enough”, this generation will be responsible for the greatest undesirable transformation of the American experiment in history and may in fact lead to America’s destruction. What a legacy! We may already be too late, but if we wait any longer, we surely will be.

We need two strategies to deal with the staggering level of our unfunded liabilities. First, the short-term strategy is to enact those remedies necessary to minimize and then reverse the damage caused by our unfunded programs by funding those obligations as quickly as practical. Second, the longer-term strategy is to pass a Constitutional amendment that forever forbids Congress from enacting new or modifying existing laws that would permit unfunded social safety net programs that would once again mortgage our nation’s future.

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Van Hollen Super Committee Appointment

The Americans United Party responds to Maryland Congressman Chris Van Hollen's statement on his appointment to the Joint Select Committee (Super Committee).

Our comments are highlighted in Red

Van Hollen Statement on Joint Select Committee Appointment

FOR IMMEDIATE RELEASE
August 11, 2011

Washington, DC – Today Maryland Congressman Chris Van Hollen, Ranking Member on the House Budget Committee, issued the following statement on his appointment to the Joint Select Committee on Deficit Reduction:

“I am honored to have been asked by Democratic Leader Pelosi to serve on the Joint Committee. I look forward to working with my Democratic and Republican colleagues to address the huge challenge before us.

“Putting America back to work [in the private sector] is the best and most immediate way to reduce our deficit as we also develop and implement a balanced [budget amendment that matches tax revenues and expenditures to 18% of our Gross Domestic Product. These actions will allow us to] establish long-term fiscal discipline and sustained economic growth. Our plan should put [private sector] jobs first, sharpen America's competitive edge [by eliminating the Job Burden], ensure health and retirement security [by replacing the fiscally irresponsible pay-as-you-go funding of Social Security and Medicare with fiscally responsible pre-funding at birth] , and require shared responsibility [ by replacing our economy killing income tax system with a new consumption based tax system that allows our private sector to compete in a global economy.] Together, we can build a prosperous and secure future for all Americans.”

If the Congressman accepts these clarifying changes, then we welcome Congressman Von Hollen's endoresment of the AUP's Economic Roadmap and look forward to working with him to implement these initiatives.

Learn More: http://americansunitedparty.blogspot.com/2011/07/executive-summary.html
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Penny Plan Analysis

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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