Government agencies are going to downsize. This statement may seem odd in a year where total federal government spending tops 25% of US gross domestic product (GDP) for the first time since World War II. But reductions are coming.
The pending cutbacks are the result of two factors. The first is the stimulus. The stimulus boosted discretionary spending without resetting the baseline for federal agencies. What this means is that the funding was one-time money. When it is spent, agency budget baselines fall back to their pre-stimulus levels. The second is the growth in mandatory spending — specifically, in the near-term, the cost of interest on the national debt. Interest payments reduce the amount of money available for discretionary spending.
To appreciate what is about to occur, it is important to understand the two main types of federal spending: discretionary and mandatory. They are as they sound. Discretionary programs are appropriated every year by Congress and fund the government’s departments and agencies. They are discretionary because the government is under no legal obligation to fund them at a specified level. Mandatory programs such as Medicare and Social Security and net interest payments on the debt are federal obligations and must be funded at legally established levels.
Discussions of the need to contain the growth of mandatory spending usually focus on Medicare and Social Security. Medicare is one of the fastest growing federal obligations and according the Administration’s budget projections Social Security will be the single largest federal outlay in 2012. However, interest on the national debt is growing faster than both Medicare and Social Security.
The figure below graphs the three programs against US GDP. The blue line is interest on the debt. It is slated to more than double as a percent of GDP between 2010 and 2015.
Looking at a snapshot of the programs in 2010 and 2015 further illustrates the disparity in growth. In 2015, annual interest on the debt is projected to be $383 billion more costly than in 2010. Over the same period annual spending on Social Security and Medicare will grow a relatively modest $179 billion and $202 billion respectively.
Since mandatory programs cannot be cut without changing entitlement laws, the most likely place spending will be reduced is from discretionary budgets. Whatever you think the appropriate size of the federal government, every dollar spent on interest reduces the number of dollars available for discretionary spending. Every deficit dollar we spend today is a dollar with interest we can’t spend tomorrow.