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You’ve been watching the U.S. Presidential debates, and might be wondering how easy it will be for lawmakers to reduce the deficit.

The simple answer: not easy at all.

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There are three ways to reduce a deficit:

  1. Reduce expenses;
  2. Raise revenues; or
  3. Both.

In order to balance the U.S. budget, it’s likely any president would have to follow option 3 as reducing expenses or raising taxes alone could choke the economy.

A gradual change in both sides of the balance sheet could work better without hurting the economy to a large extent.

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Problem is, raising taxes is like poison as such a move could kill your political career. However, it’s not easy to cut expenditures either since there is such a large concentration of spending in Medicare, Medicaid, Social Security and Defense.

If you cut any of the first three severely, there will be a significant backlash, while cutting Defense could easily hurt the U.S. economy through further job losses and lack of investment.

If we look at U.S. federal spending for fiscal 2011, $835 billion (23%) of the budget was spent on Medicare and Medicaid, $725 billion (20%) was spent on Social Security, and $700 billion (19%) was spent on Defense.

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That’s a combined total of 62% of the budget. Net interest payment made up another 6% and other mandatory spending was 13%, while discretionary spending was 18% of the budget. That’s not a lot of room to work with, which means that material reforms may be needed for U.S. social programs.

On the revenue side, 47% of government receipts were individual income taxes while 8% were corporate taxes. One way to get more tax revenue would be to get more people back to work and paying taxes, which is obviously easier said than done.

So politicians don’t have a lot of breathing room to work with and larger structural changes at the government level will be needed to solve the U.S. deficit debacle.

Gareth Watson is the Vice President, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends.
@Gareth_RGMP
Originally published on Advisor.ca

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