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The U.S. Budget's Tightrope Act

Authors: Sebastian Mallaby, Paul A. Volcker Senior Fellow for International Economics and Director of the Maurice R. Greenberg Center for Geoeconomic Studies Adam Segal, Maurice R. Greenberg Senior Fellow for China Studies Laurie Garrett, Senior Fellow for Global Health Micah Zenko, Douglas Dillon Fellow
Interviewer(s): Deborah Jerome, Deputy Editor
February 15, 2011

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[Editor's Note: This is part of CFR's Renewing America initiative , which examines how domestic policies will influence U.S. economic and military strength and its ability to act in the world.]

President Barack Obama released a budget proposal for fiscal year 2012 yesterday that calls for cutting the country's budget deficit by $1.1 trillion over a decade. Obama said the budget, which seeks to balance federal spending cuts with investment to improve competitiveness, would "ask Washington to live within its means, while at the same time investing in our future."

Four CFR fellows evaluate how well the budget addresses its dual aims. Sebastian Mallaby faults the administration for avoiding tax and entitlement reform and "implausibly optimistic assumptions about growth and borrowing costs." Adam Segal argues that the budget's welcome increases in spending for energy research, science and math teachers, and more are important, but not more so than "the social, political, and cultural institutions that move ideas from lab to marketplace." Laurie Garrett is concerned that the cuts in the FY2012 aid budget will profoundly affect "poor and war-ravaged" populations, while Micah Zenko fears that defense spending is too high and should be cut further.

Sebastian Mallaby, Paul A. Volcker Senior Fellow for International Economics and Director of the Maurice R. Greenberg Center for Geoeconomic Studies

President Obama described his 2012 budget proposal on Monday as a "down payment" on fixing the nation's long-term fiscal problems. But the projections disgorged by his administration amount to the sort of downpayment that over-leveraged home buyers were making half a decade ago. The proposal ducks entitlement reform and does too little on tax reform. To cover up this failing, it relies on implausibly optimistic assumptions about growth and borrowing costs. (Editor's note: For a look at the geoeconomic issues facing this administration, read "Obama's Call for American Renewal.")

According to the administration's own numbers, its plan would gradually reduce the federal budget deficit from 10.9 percent of GDP this year to 2.9 percent by 2018. The math was no doubt tortured to get the deficit below 3 percent because that is the level that economists have traditionally viewed as sustainable. But there are four reasons why this forecast, designed to be reassuring, is the opposite.

First, the administration's forecast is based on expectations of growth that appear optimistic. For 2011, admittedly, the administration is projecting less growth than the private sector. But thereafter the administration throws caution to the winds. In 2013, for example, the administration projects growth of 4.4 percent, whereas the Congressional Budget Office expects 3.1 percent and the consensus among leading private-sector forecasters is 3 percent. In 2014, the administration projects 4.3 percent growth, while the CBO and private sector project 3.5 percent and 2.8 percent, respectively.

Given the frightening state of the longer-term outlook, the administration is wrong to be avoiding the big challenges of tax and entitlement reform.

Second, the administration appears to underestimate the likely cost of servicing the national debt. In 2012, the administration expects the interest rate on ten-year government bonds to be 3.6 percent. The private-sector consensus is a much higher 4.2 percent, implying a significantly larger drain on the budget. For 2013, the administration expects interest rates on ten-year treasuries to have risen to 4.2 percent, but the private forecast is 4.7 percent. The administration's rosy expectations on debt-service costs are particularly odd, since its own forecast of high growth should logically go along with a forecast of high interest rates.

Third, the fact that a 3 percent of GDP deficit has been sustainable in the past does not mean it will be sustainable in the future. This is because the trend rate of growth is probably falling, thanks to slower population growth and a peaking of labor force participation. For much of the past generation, growth was fueled by entry of women into the workforce. Now that revolution has run its course, and meanwhile low-skilled men are increasingly dropping out, depressing the growth rate.

Finally, the administration itself projects that the budget deficit will expand again after 2018 as negative demographics and rising health costs drive up the burden of entitlements. Even on the administration's rosy view, in other words, the budget will fleetingly attain stability and then quickly unravel.

Given the weak state of the recovery, the administration is right to advocate a large budget deficit this year. Given the frightening state of the longer-term outlook, the administration is wrong to be avoiding the big challenges of tax and entitlement reform.

Adam Segal, Maurice R. Greenberg Senior Fellow for China Studies

Three weeks after President Obama's State of the Union call to "win the future," the big winner in the FY2012 budget is spending on innovation and competitiveness.  While almost two hundred federal programs will be cut or trimmed (WashPost), the budget calls for increased funding for energy research, the training of one hundred thousand new science and math teachers, and a high-speed wireless Internet network that will cover 98 percent of the United States.  Spending for the National Science Foundation is expected to rise to $7.8 billion (PDF), an increase of 13 percent above the 2010 enacted level, and the Department of Energy will rise to $29.5 billion (PDF).

This new spending is critical to ensuring that the United States maintains its technological lead over the rest of the world, and a fast rising China in particular, but it would be unwise to fixate on the numbers. They may not survive the budget and appropriations process, and, at any rate, the United States' long term competitiveness depends just as heavily on strengthening the software of innovation--the social, political, and cultural institutions that move ideas from lab to marketplace.

House Democrats and Republicans are already squaring off over whether spending on basic research and development should in fact be immune from budget cuts because they are essential to future competitiveness. On Friday, the House Appropriations Committee announced that it would seek further cuts in the FY2011 budget. In early discussions, it looked as if the Department of Energy and National Science Foundation might be immune, but now the committee is calling for cuts that affect not only proposed increases but also current budgets.

"The budget is good news for American competitiveness, but there is a long battle ahead. Even if supporters of the increase win the political struggle over cuts, there is much to be done to maintaining the United States' competitive advantage."

No matter what levels of spending are finally set, money is only the first step. While the United States now spends about two and a half times more than China on research and development ($395 versus $141 billion in 2010), that gap is shrinking. A more stable competitive advantage rests in the United States' tolerance of risk, ability to manage complex interdisciplinary research, and a culture of tolerance and openness. Strengthening these assets means focusing on technological entrepreneurship and new business creation as well as shifting the debate from the numbers of scientists and engineers the United States is producing to what skills new graduates actually need to compete. The United States must also welcome highly skilled immigrants and create clear paths to citizenship.

The budget is good news for American competitiveness, but there is a long battle ahead. Even if supporters of the increase win the political struggle over cuts, there is much to be done to maintaining the United States' competitive advantage.

Laurie Garrett, Senior Fellow for Global Health

The White House FY2012 budget proposal levies deep cuts on foreign assistance and international health. Overall, foreign assistance drops from being about 1 percent of the federal budget to just over a half percent (depending on the overall reduction in U.S. budgetary spending). Because cuts in overseas programs have a negligible impact on U.S. voting patterns, they are politically painless. But the impact on the ground in poor and war-ravaged parts of the world is profound.

The heaviest budget axe will fall on the Centers for Disease Control and Prevention (CDC), dropping from an FY11 budget of $6.5 billion down to $5.9 billion, a 9.2 percent cut. The budget doesn't stipulate which programs within the CDC will take the heaviest cuts or how these reductions will affect the agency's activities within the Global Health Initiative (GHI). As designed last year by the White House, the GHI operates as a triumvirate of three agencies, including the CDC, the office within the State Department that runs HIV and AIDS programs, and the U.S. Agency for International Development (USAID). Of the three legs of the GHI stool, the CDC will take the greatest cuts.

"Because cuts in overseas programs have a negligible impact on U.S. voting patterns, they are politically painless. But the impact on the ground in poor and war-ravaged parts of the world is profound."

Overall, "Global Health and Child Survival," as the budget line is designated, will increase by 11.54 percent from $7.8 to $8.7 billion. The bulk of that increase fulfills two prior commitments agreed to by Congress in 2009 for modest increases annually in support of HIV/AIDS programs and maternal and infant survival.

USAID's operating expenses are modestly reduced by the White House, while most of its programmatic spending is flat-lined. Among the most challenging flat-lines is President Obama's Food for Peace program, a key outcome of the 2009 G8 Summit in L'Aquila, Italy. The $48 billion effort would under the White House budget realize a roughly $280 million cut. Even a stable food budget is, in real terms, a serious reduction in the numbers of mouths that can be fed worldwide in an age of extraordinary food inflation. In the last six months, rice prices have risen by 12 percent; wheat has soared 66.8 percent; maize has inflated 62 percent. With flat-lined purchasing power for food and seed stock, the USDA and USAID will, in real terms, be compelled to decrease the numbers of farmers provided with seed, and famine-struck households given food to eat.

The House GOP budget proposes a $1.5 billion cut in GHI commitments, including sharp reductions in support of the Global Fund to Fight AIDS, Tuberculosis, and Malaria. House Republicans also want $74 billion cut from the current FY2011 budget, including major reductions in foreign assistance and food aid. For FY2012, Republicans favor a $1 billion reduction in support for the National Institutes of Health--including global health projects--and another $755 million in cutbacks at the CDC, a $327 million virtual elimination of family planning support and a quarter billion dollar slice out of the Food and Drug Administration.

Micah Zenko, Douglas Dillon Fellow

Ten months ago, Secretary of Defense Robert Gates unveiled his Defense Efficiencies Initiative, which instructed the military services to collectively identify $100 billion in budgetary savings over the next five years. This effort to eliminate waste, fraud, and abuse succeeded in identifying extraneous policies and programs. One hundred general and flag officer positions were eliminated; the redundant Joint Forces Command was closed; and there was movement toward a smaller footprint in Europe, where eighty thousand U.S. troops remain permanently stationed. These preemptive cuts will net $78 billion in savings over the next five years.

Still, further Pentagon budget cuts are essential. Defense spending constitutes the majority of federal discretionary spending. Paring it down is necessary to tackle the crippling $3.5 trillion in deficits the United States faces over the next decade. As the Chairman of the Joint Chiefs of Staff, Admiral Michael Mullen, aptly warned, "The most significant threat to our national security is our debt." The challenge for the Obama administration and congressional appropriators is reducing that debt while maintaining the United States' preeminent military force.

"While Secretary Gates has characterized $553 billion as 'the minimum level of defense spending that is necessary,' the proposed budget would represent the fourteenth straight year of increased defense spending."

The White House defense budget request for fiscal year 2012--$553 billion--is a prudent first step toward this objective. But while Secretary Gates has characterized $553 billion as "the minimum level of defense spending that is necessary," the proposed budget would represent the fourteenth straight year of increased defense spending.

Gates can cut even more, and three programs should be further reduced, or eliminated altogether.

First, the strategic nuclear weapons force. The Defense Department should reduce the number of deployed strategic nuclear weapons below the New START Treaty ceiling of 1,550 to 1,000, and eliminate the redundant bomber leg of the nuclear triad before costly new bombers are required to sustain it.

Second, the Airborne Laser (ABL) missile defense platform, of which Gates has correctly noted, "there's nobody in uniform that I know who believes that this is a workable concept." Savings from the ABL would be better dedicated to the urgent and realistic near-term European Phased Adaptive Approach missile defense system, which aims to protect all of Europe from Iranian missile threats.

Third, the Navy and Marine Corps Joint Strike Fighter (JSF). Beset by persistent delays and projected costs that have doubled, the Pentagon has already sharply reduced the number of scheduled purchases of these JSFs. The program should be eliminated and replaced by advanced versions of the cheaper, already available F/A-18 E/F aircraft.

Finally, reforming the entire Pentagon acquisition process is crucial. The Pentagon is responsible for 70 percent of all federal procurement spending. And the Government Accountability Office assesses that two-thirds of all major Pentagon weapons programs face cost overruns, with the cumulative cost growth on Pentagon programs at $300 billion. Correcting this massive imbalance by holding defense contractors and management acquisition officials accountable would go a long way toward reducing defense spending.

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