Agencies, get ready to downsize

Richard Russell Contributor
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Author’s Note:  My column uses rpd | ANALYTICS’ Visual BudgetTM program to illustrate its points.  I encourage anyone interested in understanding the federal budget to use it.

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.

Current Administration projections indicate that interest on the debt will climb to $912 billion by 2020.  To give some perspective on that sum, in 2008 the entire discretionary budget for the federal government was $1.1 trillion.  In 2010 interest on the debt consumed 5% of the federal budget.  In 2020 that percentage is slated to increase three fold to 16%.  Such increasingly large fractions of the budget dedicated to interest payments will by necessity significantly reduce funds available for federal discretionary programs.  In fact that is exactly what is forecast.  Discretionary funding falls from 38% of the budget in 2010 to 27% of the budget in 2020.  So despite the total federal budget getting a lot bigger, growing from $3.6 trillion in 2010 to $5.7 trillion (or 58%) in 2020, the discretionary budget is slated to grow by 13% over the next decade – well below the rate of inflation.

In the next five years the impact is even more apparent. If Congress approves the Administration’s spending plans, between 2010 and 2015 the overall federal budget will grow by 21% while the discretionary budget falls.  In absolute terms, the discretionary federal budget is slated to be lower than it is in 2010 in every successive year up to and including 2015.  In the same interval, interest payments on the debt increase by over 200%.

This reality can be seen in the projected out-year (future) departmental spending in the Administration’s 2011 budget.  Compare for example the projected reductions in expenditures for defense (red) with the increase in the cost of interest on the debt (blue).  (The numbers in the chart below are in inflation-adjusted (real) dollars.)

Such decreases are not just happening in the national security budget.  Agencies that were targeted for significant increases by the Administration in the stimulus bill will also see sharp reductions in the future.

The budgets for the Department of Energy’s (DOE) Energy Programs (red) and National Institutes of Health (NIH) (blue) illustrate the point.

In both the case of DOE’s Energy Programs and NIH the significant ramp-up from the stimulus drops off dramatically starting in 2012.

Compared with 2008, the stimulus and the Administration’s first two budgets boosted spending in both program areas. (The chart below shows the change in annual budgetary outlays from 2008 to 2011.)

But the fall-off after 2011 is also significant.  (The chart below shows the change in annual budgetary outlays from 2011 to 2015.)

When you take into account inflation, NIH’s budget is actually $1.5 billion lower in 2015 than it was in 2008. Energy Programs at DOE are above 2008 levels but well below their 2011 levels.  (The chart below shows the change in annual budgetary outlays from 2008 to 2015 in inflation adjusted dollars.)

Such yo-yoing budgets are difficult for any agency.  The projected fall-off in funding for NIH after 2011 is unprecedented in the agency’s history.  What it means is that the very graduate students that benefit from increased grant funding in 2010 and 2011 will graduate into a bleak and grant-starved environment a few years later.

In the end, growing discretionary programs on borrowed money is no different than financing a car for ten years when you know you plan to replace it in three.  You may start out with a Lexus but by the third car you will be paying for a Rolls Royce while driving a Chevy.

Richard M. Russell is CEO and Managing Partner of VIAforward, a technology consulting company.  He is also Managing Partner of rpd | ANALYTICS.