Frightful Storm Brewing

June 3, 2008

A reader put me onto a speech by Fed Governor Richard Fisher to the Commonwealth Club of California last week. In it Fisher sounds similar alarms regarding the dangers of runaway entitlement spending that I discussed in my post two days ago….

I see a frightful storm brewing in the form of untethered government debt. I choose the words—“frightful storm”—deliberately to avoid hyperbole. Unless we take steps to deal with it, the long-term fiscal situation of the federal government will be unimaginably more devastating to our economic prosperity than the subprime debacle and the recent debauching of credit markets that we are now working so hard to correct….Were I not a taciturn central banker, I would say the mathematics of the long-term outlook for entitlements, left unchanged, is nothing short of catastrophic.

In my previous post, I discussed what happened to Argentina when it couldn’t get government spending under control. In short, letting the problem go unsolved will lead to economic hardship like Americans haven’t seen in 80 years.

Fisher really gets colorful when he discusses potential solutions. They are totally draconian of course, fitting the scope of the problem….

Suppose we decided to tackle the [entitlement funding issue] solely on the spending side. It turns out that total discretionary spending in the federal budget, if maintained at its current share of GDP in perpetuity, is 3 percent larger than the entitlement shortfall. So all we would have to do to fully fund our nation’s entitlement programs would be to cut discretionary spending by 97 percent. But hold on. That discretionary spending includes defense and national security, education, the environment and many other areas, not just those controversial earmarks that make the evening news. All of them would have to be cut—almost eliminated, really—to tackle this problem through discretionary spending.

I hope that gives you some idea of just how large the problem is. And just to drive an important point home, these spending cuts or tax increases would need to be made immediately and maintained in perpetuity to solve the entitlement deficit problem. Discretionary spending would have to be reduced by 97 percent not only for our generation, but for our children and their children and every generation of children to come.

And similarly on the taxation side, income tax revenue would have to rise 68 percent and remain that high forever. Remember, though, I said tax revenue, not tax rates. Who knows how much individual and corporate tax rates would have to change to increase revenue by 68 percent?

Obama’s universal health care plan would increase health care spending even more. McCain is advocating huge tax cuts without saying how he would pay for them. Clearly neither is showing any leadership on what may prove to be America’s greatest economic challenge of the 21st century.

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