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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