A Plan to Fix the Budget or Blind Faith in Fairy Tales?

By Morgan Housel, The Motley Fool

The first thing you notice when looking at House Budget Chairman Paul Ryan's (R-Wis.) budget proposal -- "The Path to Prosperity" -- is how great it will be if it passes. The plan promises to balance the budget by 2015 with lower taxes, higher employment, and higher wages, and puts us on a path to eliminate the national debt entirely. It presents pictures like this, which, come on, just makes you want to smile and hug the guy next to you:

Source: Ryan Proposal


"Will this be remembered as the Congress that did nothing as the nation slouched toward a preventable debt crisis and irreversible decline?" the plan asks. "Or will it instead be remembered as the Congress that did the hard work of preventing that crisis -- the one that chose the path to prosperity?"

How do you argue with that? Long live the Path to Prosperity!

Yet dig into the details of the proposal, and you realize that it's an exercise in rosy-eyed forecasting, and what can only be described as a blind faith in fairy tales.

The bulk of Ryan's plan rests on two pillars:
  1. A proposal that eliminates Medicare for those turning 65 after 2022, replacing it with a voucher program.
  2. The assumption that the economy will recover at a literally unprecedented rate over the next few years, and remain there forever.
An Unrealistic Rebound

Let's start with the economic recovery. One of the most important variables of any budget forecast is the unemployment rate. When unemployment is low, tax revenue rises as more people pay into the system. When it's high, spending on unemployment benefits and food stamps surges. Today's deficits are largely due to high unemployment, and the surpluses of the early 2000s were largely due to low unemployment. That's how these things work.

Our current unemployment rate is 8.8%. The 60-year average -- what many economists consider close to a "natural" rate of unemployment -- is 5.8%.

Ryan's plan skirts around that average. It assumes that unemployment will fall to 6.4% next year, 4% by 2015, and stunningly, 2.8% by 2021 ... where it will stay forever.


Source: Federal Reserve, Congressman Ryan's proposal, author's calculations



The only time in modern history during which unemployment has fallen to 2.8% was an eight-month period in the early 1950s -- a unique time when the U.S. was one of the only major nations not reduced to rubble by World War II. Ryan seems to have looked back at history, found the lowest unemployment rate, and declared it the new normal.

Here's another interesting note about that 2.8% unemployment figure. When the Heritage Foundation, the conservative think tank tasked with calculating and publishing Ryan's proposal, first released documents outlining the unemployment projection, bloggers and journalists went berserk pointing out how unrealistic the assumption was.

A day later, poof. All references to the 2.8% figure vanished from the Heritage Foundation's documents. Gone. The budget forecast figures didn't change, but an explanation of the unemployment projection used to calculate those figures vanished. Several observers (including myself) saved a copy of the original fact sheet, the source of the chart above.

I called the Heritage Foundation to ask why they purged references to the unemployment projections. They said that while the original unemployment projection "seemed OK," they were reviewing their assumptions after receiving several calls and emails questioning the figure.

Perhaps a 2.8% unemployment rate could be justified if you think the drivers of Ryan's proposal -- lower taxes, lower government spending -- will create unprecedented prosperity. But it's hard to see how this argument fits the plan. Under Ryan's proposal, both spending and taxes as a percentage of GDP will remain above average every year from now until 2021 -- the year that Ryan projects unemployment will fall to 2.8%, or almost half the historic average.

Moving On...

An interesting table appears in a Congressional Budget Office report scoring Ryan's plan. Under current law, the CBO shows that public debt as a percentage of GDP is forecast to hit 67% by 2022. Under Ryan's plan, it would top 70% that year. As Matthew Yglesias of ThinkProgress noted, short-term spending cuts "don't compensate for the tax cuts that Ryan proposes, so relative to current law, debt goes up."

In the long term, Ryan does get serious about reining in spending, putting a bull's-eye on the big budget sinkhole: Medicare.

The plan proposes to tackle Medicare by eliminating it for everyone turning 65 after 2022, while keeping it in place for baby boomers. The younger group would instead receive vouchers to pay premiums on private insurance during their golden years. The vouchers would grow at the rate of overall inflation and age, not premium prices. Since health care costs rise faster than overall inflation (and CBO forecasts they will actually grow faster under a voucher system), the vouchers would eventually fall far short of covering premiums. After that, you're on your own.

This would no doubt cure Medicare's fiscal time bomb. But it's miles away from being politically feasible. Think about it. Ryan's plan would create two groups: Baby boomers with lavish Medicare plans, and everyone else, whose retirement health care will largely be paid out of pocket, and whose taxes would largely support the baby boomers' Medicare. David Leonhardt of the New York Times made a great observation here: Ryan's plan "asks for a whole lot of sacrifice from everyone under the age of 55 and little from everyone 55 and over."

Born one year, and you're set. Born the next, and face a retirement of daunting medical bills. There's no chance voters would put up with that. You thought the "keep your government hands off my Medicare" signs were bad under Obamacare? Wait until Ryancare.

Finally, Ryan's plan proposes to cut non-defense discretionary spending from 12% of GDP today to 3.5% by 2050. Everything from the IRS to the Department of Justice would effectively face a 71% budget cut. How would this work in practice? The CBO wonders, too. "The proposal does not specify the changes to government programs that might be made in order to produce that path," it writes.

As one analyst summed up the proposal, "Their cure for this cancer seems to be just, 'less cancer.'"

And, I'd add, a strong belief in fairy tales.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Conveniently, there weren't any. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.



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16 Comments

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snowbird58

TO ALL KNOW IT ALLS,
I KNOW WHAT I KNOW AND THAT PRESIDENT OBAMA WILLING WALKED INTO THE MESS OF THE PREVIOUS EIGHT YEARS OF BUSH. OBAMA DIDN'T CAUSE ALL YOUR PROBLEMS. IT WAS FIRST WALL STREET THAT SET US ALL UP FOR FINANCIAL MELTDOWN, OH AND THAT'S WHEN BUSH LEFT OFFICE. SO GOLDMAN SACHS SAT QUIETLY SILENT AND BETTED AGAINST THE MORTGAGE INDUSTRY. SWEET! THEN OF COARSE WE HAD TO SAVE THE AMEICAN INSTITUTION, OUR AUTO INDUSTRY. MILLIONS OF MIDDLE CLASS TANKED. YOUR FELLOW CITIZENS LOST EVERYTHING. THEN YOU MEAN PEOPLE BLAMED EVERYONE WHO BOUGHT A HOUSE BOUGHT TO MUCH HOUSE, OF COARSE BLAME THOSE LITTLE PEOPLE NOT THE BROKERS THAT MADE MONEY OFF THE LOANS.
YOU ALL KNOW JUST QUOTING MITCH McCONELL FROM DAY ONE IT'S ALL ABOUT GETTING OBAMA OUT IN 2012, WHAT A AWFUL CYNICAL FEELING TOWARDS OUR PRESIDENT. GUESS WHAT, I VOTED FOR REAGAN IN HIS SECOND TERM AND I VOTED FOR BUSH IN HIS SECOND TERM, HOPING HE WOULD BRING THE WAR TO AN END SINCE HE STARTED IT UNDER LIES.
I'M SO DISGUSTED WITH THE GOP AND RYAN ESPECIALLY TALKING LIKE THEIR WAY IS GOING TO SAVE US. TO USE AN ANALOGY I'VE HEARD WE WERE A CAR IN A DITCH THEN THE TOW TRUCK HAS TO PULL IT OUT, BUT WO THERE THE CAR NOW IT HAS TO GO TO THE BODY SHOP FOR REPAIRS WHICH THEN YOU NEED MONEY TO FIX IT BUT YOU CAN'T AFFORD THE WHOLE BILL NOW SO CAN I MAKE PAYMENTS AND ADJUST SOME OTHER BILLS AROUND OR A SECOND JOB TO PAY IT OFF.
SO YOU SEE THINGS TAKE TIME, DOESN'T MEAN IT WON'T GET DONE JUST HAVE TO BE PATIENT.
SO QUIT BEING SO HATEFUL TO THIS GOVERNMENT.
ABSOLUTELY LEAVE MY S/S DISABILITY ALONE AND MY HUSBANDS FUTURE S/S ALONE.
THE RICH DON'T NEED TO BE GETTING IT , DONATE IT TO YOUR LOCAL FOOD PANTRY OR HOMELESS SHELTER. PUT A LITTLLE LOVE BACK INTO YOUR HEARTS .
SINCERELY, A TRUE AMERICAN

April 17 2011 at 1:58 PM Report abuse rate up rate down Reply
Hoss

Paul Ryan, Yes, I just wish he was the President of the United states.

April 14 2011 at 10:25 AM Report abuse -1 rate up rate down Reply
hlogan1863

give it a rest. his is best yet and all u do is complain!

April 13 2011 at 4:35 PM Report abuse -1 rate up rate down Reply
giogolf

Isn't it great that we are now talking about how much to cut spending instead of how much we should tax and borrow. Even President Obama has finally decided to propose spending cuts. All thanks to Mr. Ryan.

Gino

April 13 2011 at 2:43 PM Report abuse -1 rate up rate down Reply
1 reply to giogolf's comment
kenneth

A good try by Rep. Ryan, but, as this article indicates, much akin to a fairy tale. The sad fact is that we are doomed.
All the attempts I have seen toward balancing our federal government budget call for truly draconian reductions across the board--including Defense, Medicare, Medicaid, Social Security, and the "remainder of government." or unbearable or unacceptable increases in taxes levied "on the rich." This is especially true since, under generally accepted government accounting (which is essentially a cash basis system), future oblications (like promised pensions and the like) are ignored until they are actually paid.
In my opinion, we have to recognize that many costs (such as college tuition and medical care) are largely driven by government intrusion. That is to say, for example, that free or near-free tuition (because it is paid by the government) causes tuition to rise far above what it would be if the consumer had to pay it for him/herself. Similarly, medical care would cost far less if the government did not pay for most of it (via Medicare and Medicaid).
Finally, since almost half of Americans pay NO income taxes, and, in fact, enjoy what is effectively a negative tax (via the EITC), those people have "no skin in the game" and thus vote for people who promise to take care of them. We need to tax EVERYONE for all earnings above the poverty level. And, yes, we probably need to add a couple more tax brackets at the top, say 40% for income over $500K and 50% for income over $1M--maybe even another one of 60% for income over $5M.
Of course, no politician has the courage to confront most of these changes. That is why I fear we are doomed. Anyone know a quick and easy way to learn to read, write, and speak Chinese?

April 13 2011 at 11:46 AM Report abuse +2 rate up rate down Reply
retired2violin

Aynone that believes this tea party congressman is a total fool. Any economy expert will tell you this is a sure plan to failure. We the workers pay into medicare thru our employers, the Fed Gov does not pay anything towards this. The Fed Gov has got to stop taking $ away from Medicare and Social Security to give to their states for people that have never contributed towards either program. Congress needs to be upseated and new (not tea party) people that really care about the working class put into power. We also need to stop supporting other countries, we have enough to do here in our own country. I love being able to live here in the USA, do you? take a stand and write to your congress members of yur state and tell them things will not be tolerated as before, the truth needs to be told not lies.

April 13 2011 at 11:42 AM Report abuse +1 rate up rate down Reply
inasctg56

Boy - look at that unemployment drop under Clinton. And yet the gop is doing the same today as they did when he was in office - attack, attack, attack. Dems policies and legislation work for american families. And that is why the gop has only attacks and no sound ideas but further aid the wealthy.

April 12 2011 at 8:44 PM Report abuse rate up rate down Reply
1 reply to inasctg56's comment
bggdg

Based on the results, It would seem those attacks under the Clinton administration was (and is) just what the doctor ordered!

April 12 2011 at 10:34 PM Report abuse -2 rate up rate down Reply
inasctg56

When the gop wants to bring back the 5.25% tax rate for overseas profits, and more tax cuts for corporations, it sounds a lot like more of gop failed policies. What has been working to turn our economy around? What's Obama and the dems done?
Passed legislation in 2007 that took money away from big oil and steered it toward our auto industry for R&D with mandates for better mileage and now low and behold we have suv's that get 32 mpg as well as waiting lists for chevy volts (almost all US auto workers are back to work)

Electric batteries being built here (500 at just one plant that pays $14 to $18/hour), and charging stations being made in this country.

They eliminated the tax incentives for corporations to go overseas, they eliminated the 5.25% tax rate for those overseas profits

They passed legislation for 100% write offs for improvements made in this country that has demand way up for machinery and equipment

They gave the IRS the resources to go after offshore accounts with over 14,000 coming forward

They passed banking legislation that addresses the problems of the 2002 banking legislation that allowed predatory lending and less govt oversite on wallstreet

They've created 1.3 million jobs in 13 months, manufacturing and export gains for 20 months, and more.

What's the gop done? Cut jobs and wages while handing even more over to corporate tax cuts.

And more good news: Retail sales up again, and unemployment claims continue to decline. All those manufacturing paychecks are coming back into communities and creating demand for goods and services just like the economists said.

And today oil is going back down.

April 12 2011 at 8:40 PM Report abuse rate up rate down Reply
inasctg56

Saying it is a start is putting it mildly. Even conservative economists are laughing at the projections but not laughing at the $4 trillion in corporate tax cuts. The progessive budget plan is the only plan so far that makes cuts across the board in every income level while creating jobs. I'm anxious to see tomorrow how much of President Obama's resembles this and if the cuts to defense he asked secretary of defense to come up with are included. I'm betting they are.

April 12 2011 at 8:37 PM Report abuse -1 rate up rate down Reply
WILLS

While there is great criticism of Ryan's proposal, it remains a bold step. We do need a starting place and SOMEONE had to go first. I don't think much of it either as it depends entirely on "cuts", cuts that are ALL ones that will effect the lower income brackets, and the time frame to "balance" is way too long.

I have my own proposal (and you thought Ryan was bad)(good thing I am not in Congress)
You cannot pay down debt with assumptions - it requires revenue.
I propose an incremental increase in taxes on all over 250000K starting with 3% and topping out at 6% for all over 1 Million. Curtail S.S. COLA increases to every two years Revisit medicare and all those with income levels exceeding 100K (retired) pay an additional 20% premium. Cut Defense - the cold war is over. Impose a national sales tax of 2% - on all retail (except fuel-it's already taxed). Finally, review the tax code. Develop a flat tax with "zero deducks/loopholes and simplfy the form. Throught attrition and retirements we than could close the cost of at least 1/2 of the IRS. Review farm subsidies and remove the "handout" parts. Have Congress agree to "rider/perk earmark" free legislation for at least 2 years.
I am not proposing that we pay off the national debt as this would be economically practical. What I am saying is that a good helping of the above austerity measures will be required to avoid this weak economy slipping into a DEPRESSION.
Since I know none of the above will happen with our present politico's - prepare for the worst! It will include high fuel,food,utility cost and all else that can be passed to the middle class and poor. Viva the investment community and all of the wealthy 20%.

April 12 2011 at 5:28 PM Report abuse rate up rate down Reply