What's the Right Size of Government to Avoid Another Credit Crisis-Cut Spending by $800 Billion

The 'Bond Vigilantes" have not hit yet, but most people feel it's a matter of time. Despite the pervasive feeling that we've lost control of our destiny, the biggest headwind to future prosperity is actually something we can control--the federal budget. Through the efforts of our now book touring ex-treasury secrtary, much of the irresponsible private debt has now become public debt, and the current massive spending increases threaten another credit crisis--this time a public one, not a banker driven debt crisis.

The question at hand is, what macro number would be large enough not to bring us back into recession, yet be fiscally responsible given the size of our economy.

To get a sense for what might be practical it might be helpful to take a look at spending levels at the peak of the economic cycle in 2007. In 2007, the government spent about 2.7 trillion. In just a few years spending has shot up to 3.9 and 3.7 trillion in the president's budget. Obviously, the economy has not grown to merit that kind of spending increase, and not even Keynes himself would argue that government should be THAT stimulative in even the worst depression. A trillion dollar increase to almost 4 trillion just isn't practical or reasonable.

It doesn't matter if it's President Bush's fault or President Obama's the number needs to come down.

Really, if we dial it back to about 2.7 trillion as a baseline number, that's at least a starting place of where our spending levels should be. From there, we need about 400 billion in temporary investment and spending programs that invest in our future rather than pork. Examples of things that work include:

• Transition us off of foreign oil onto domestically produced sources like natural gas. This also creates millions of jobs right here at home. More nuclear plants. An modernized energy grid. This also means more US tax revenue and a stronger dollar.
• Modernize our infrastructure. High speed rail has it's problems, but if we make it the best in the world, that will result in more jobs, and also help with fuel dependence.
• Transition assistance for states to the new normal, broadband infrastrucutre, some form of health care reform--ideas like universal preventative care saves money, other priorities by the president.

Right now, even CBO budget estimates assume that we get huge increases in tax receipts ad growth up to 3.5 trillion in a few years that somehow fill the budget gap and bring it down to about half a trillion. This reminds me of the kind of fantasy revenue numbers you often see in startup business plans.

Right now, the government is actually expanding programs and it's workforce then promising eventual cuts in those same programs a few years later. What business would ever hire when it knows a few years later it's going to have to fire anyway.

Spending cuts in government workers are not particularly "keynsian" in nature. Government bureaucrats don't add to the economy, they suck it dry. (some of my best friends are government workers and they agree).

Right now, government borrowing is so outrageously high it is crowding out lending for small business. President Obama is angry about the lack of loans for small business-- well Mr. President, stop taking it all! The weekly treasury auctions are staggering and it's large US banks that are taking advantage of the easy money policy to just plow cash into treasuries.

The best thing to do is cut "baseline" spending down to 2007 levels to about 2.7 trillion, then have 2-3 years of special investments in updated infrastructure that create jobs and catch the country up with Europe and China perhaps taking spending up to $3 trillion. This kind of discipline will be tough, but it means lower long term interest rates, less borrowing and more loans available now. The temporary spending will result in a more updated and competitive US economy and give us a tax base that can pay back some of this huge spike in debt.

If we don't do this, we are looking at the potential for huge spikes in interest rates and a double dip back into panic. I'd rather take some small pain now then see the country face the Paulson Abyss Part II.