The U.S. is in a jam. For most of the post-Cold War era, elected leaders assumed a benign security environment (from a strategic perspective) would allow swapping some hard power (guns) for tax cuts and domestic spending hikes (butter). Belatedly, some in key positions believe this world of diminished risks has vanished or perhaps never existed, and therefore a course correction is required. However, because they and their predecessors went overboard with the butter in recent years, their options are now more limited and politically challenging than they would like them to be.
This predicament may rise in prominence soon because of the attention a defense funding plan released by Senator Roger Wicker, the ranking Republican on the Senate Armed Services Committee, is bringing to it. He observed a notable lack of urgency in quarters where one might assume alarms should be going off and decided to shake things up with a news-grabbing proposal. His bottom line: annual defense funding should go up in 2025 by $55 billion compared to current plans and then keep rising from there until the total defense commitment reaches 5.0 percent of GDP, which was last the norm in the final years of the Cold War (defense outlays were 3.0 percent of GDP in 2023).
Wicker is not alone in seeing a need to reset expectations about current and future defense needs. Senate Republican Leader Mitch McConnell has expressed similar views, as have others in the Senate GOP caucus.
Scholars and experts who are immersed directly in national security questions should assess and possibly critique the specifics of what Wicker is recommending. It is a separate question, however, whether such a sizeable additional expenditure, or even a more modest version of it, can be accommodated within a federal budget that is already badly out of balance.
The answer is a cautious yes, but only if political leaders also take on the larger budgetary problem of which defense spending is just one factor.
The Plan In Context
The Congressional Budget Office (CBO) currently projects the federal government will run a cumulative budget deficit over the period 2025 to 2034 of $22.1 trillion. The average annual deficit will be 6.3 percent of GDP. Over the same time span, the agency forecasts average annual defense outlays will be 2.9 percent of GDP and trending downward, with 2034 spending expected to equal 2.8 percent of GDP.
Using this baseline, it is possible to produce back-of-the-envelope estimates of the total budgetary cost of Senator Wicker’s defense plan. Assuming a linear phase-in to outlays of 5.0 percent of GDP in 2034 (after a $55 billion budget authority increase in 2025), the total budgetary cost would be about $4.7 trillion over the period 2025 to 2034. With net interest costs included, the bill rises to $5.2 trillion. Other assumptions about the pace of implementation would produce different cost estimates, but the added cost will be significant under any scenario.
While the sticker shock the plan will produce signals how hard it will be to adopt, the political hurdles are actually even higher than they first appear due to the complications of other pressing fiscal decisions.
At the end of 2025, several important tax policies enacted in 2017 will expire, and CBO’s baseline assumes the reversion to pre-2017 law will increase federal tax receipts. Most congressional Republicans, and former President Donald Trump, want these expiring provisions extended permanently, perhaps with modifications to collect even less revenue.
CBO estimates that a full extension of the expiring 2017 provisions, plus continuation of higher premium tax credits for health insurance originally approved in 2021, would reduce federal revenue and increase outlays by about $4.3 trillion over ten years. The added borrowing would push up the government’s net interest expenses by another $0.7 trillion.
Trump also recently told a business group he wanted to lower the corporate rate an additional percentage point from what passed in 2017, to 20 percent, and then suggested at a separate campaign event he would eliminate taxes on tips. Both would add to the costs of the 2017 tax cut extension.
It is thus entirely possible that the consensus position among Republicans going into 2025 will be to support a major defense spending hike combined with full extension of the 2017 tax cuts and also some additional tax relief. Together, these changes could easily push the projected ten-year federal deficit up from $22.1 trillion under current law to well over $30.0 trillion.
What Not To Do
In this election year, the official positions of both parties do not provide much hope that an even smaller defense adjustment than is being advocated by Senator Wicker could be accommodated without deepening the fiscal hole.
As the incumbent, one might think President Biden would take the lead in setting a new fiscal course in light of heightened security threats around the world, but there has been no such plan forthcoming. Instead, the administration seems content to stay the course with current plans, albeit supplemented with temporary funding to provide military support to Ukraine, Taiwan, and Israel. The administration is not promoting or planning a major upward revision of the defense base, at least not anything comparable to the Wicker plan. In the president’s 2025 budget, defense outlays are projected to fall to 2.4 percent of GDP in 2034.
The administration’s plans for domestic programs are very different. It wants to increase the size of scores of current programs and create several new ones, which it would pay for with higher taxes imposed on well-to-do households. In 2021 and 2022, the president pushed many of these plans in his Build Back Better spending plan, which, if made permanent, would have increased federal spending by $4.8 trillion over ten years. Much of this agenda failed to pass due to opposition from West Virginia Senator Joe Manchin (who is not seeking re-election). However, if the president wins in November, it is likely the parts of his agenda that were not approved by Congress in 2021 and 2022 will receive another push.
Moreover, congressional Democrats are signaling insistence on linking annual percentage increases in domestic appropriations to what is provided for national defense. The point is to force the GOP to support higher funding for Democratic priorities in exchange for a defense boost. However, there is no policy rationale for this parity, and forcing it is one of the reasons a defense reset has been so hard to come by in recent years.
Biden’s 2024 opponent, former President Trump, says he will build a great military but, unsurprisingly, has offered little by way of a specific plan even as he continues to say he will never support policies that might create the needed fiscal space to meet the commitment.
His campaign says he can offset the costs of the 2017 tax extension with much higher tariffs and also cuts to the large clean energy subsidies approved by congressional Democrats in 2022, but passing such offsets in the House and Senate would be a tall order. The tariffs would cause substantial economic upheaval and drive up inflation; they would also invite fierce opposition from the many industries that would be harmed by them. Moreover, the GOP has no real plan for addressing climate change and therefore would find it challenging to cut the Biden subsidies without replacing them with an alternative strategy, such as a carbon tax. In this way, the GOP’s position resembles what occurred when the party tried to repeal the Affordable Care Act without developing a credible plan of its own.
The bottom line is that, under Trump, the GOP will struggle to advance a multiyear federal budget that could accommodate anything close to what Senator Wicker has suggested.
Facing Up to Budgetary Reality
Annual defense outlays have never reached or surpassed 5.0 percent of GDP since 1991 (they were 5.2 percent in that year). After 9/11, funding went up for about a decade but then steadily declined. From 2015 to 2023, the average annual defense commitment was 3.1 percent of GDP.
Over this same period, federal borrowing soared due to the fallout from the financial crisis of 2007-2009 and the pandemic in 2020-2022. With an aging population also pushing up entitlement spending, the federal budget outlook has never been more adverse in the postwar era. CBO expects federal debt, which is already equal to annual economic output, to climb to 150 percent of GDP in 2049 with no signs of stopping there.
In this fiscal environment, it would be irresponsible to plus up defense on a sustained basis without making other changes that are only possible if leaders are willing to break from party orthodoxy, such as by committing to the following basic principles and policies.
- Stop Cutting Taxes. Extending the 2017 tax cuts, with no offsets, is unaffordable at this point even if one were not planning a sizeable new investment in defense. If congressional Republicans conclude (rationally) that increased funding for national security is required at this point, then they have to also find a way to pass a tax reform plan at baseline revenue levels rather than one that drains more receipts. That is not an impossible or unreasonable stipulation under the circumstances. Both the individual and corporate income tax systems still include many unnecessary tax expenditures that could be eliminated or restricted to make it possible to set tax rates as low as possible. In other words, Congress should commit to tax reform rather than another tax cut.
- And Possibly Raise Some Taxes Too. The rethink on taxes shouldn’t stop with how to handle the extensions. Congress should also consider increasing revenue above baseline levels with a new tax on carbon emissions, which could be designed to also tax imports based on the carbon required for their production. This tax, which has been recommended by many different groups and scores of prominent economists, would have two objectives. It would build into the national economy improved price signals for carbon and thus dramatically incentivize the development and deployment of the most efficient alternative energy technologies. It would also raise substantial federal revenue, with some versions generating $1.5 trillion over a decade. Some of the added revenue could also be returned to taxpayers to limit the burden on lower-income households.
If Congress approved a scaled-up carbon tax, it could simultaneously pull back on some of the direct subsidies for various energy industries approved in the Inflation Reduction Act. These payments, if sustained, will create scores of client industries that could lead to extension and expansion of their budgetary costs over time. It would be far better to rely on market signals that removed the possibility of politically motivated spending expansions occurring in the name of climate protection. - Sever Defense Hikes from Domestic Appropriations. If defense appropriations remain linked to the pace of increases for domestic accounts, the result is likely to be crumbs for both allocations. It is therefore crucial for those wishing to see a defense reset to break this pattern and make the case that, given the state of the world, a step up in funding is required for defense but not for domestic appropriations.
- But Don’t Count on Significant Domestic Savings Either. Depending on the outcome of the 2024 election, it might be tempting for the incoming Congress to try to plus-up defense spending by imposing much tighter caps on the domestic side of the appropriations process. The current House GOP leadership has pushed this approach since taking control in 2023. While there are certainly possible targets for savings, there are also many domestic accounts that the public would like to see expanded. Among the many popular line items found in domestic appropriation bills are medical research, Pell grants, local school support, and crime fighting.
Over the period 1974 to 2023, the average amount of spending on domestic appropriations was 3.7 percent of GDP and in 2023 was 3.4 percent of GDP. It will never be possible to go much below that level on a sustained basis.
- Start Modifying the Entitlement Programs. Making room for elevated defense spending over multiple years will require bringing down the costs of the major entitlement programs, including Social Security, Medicare, and Medicaid. Because neither Biden nor Trump will embrace controversial changes, it will be difficult (but not impossible) to find savings in these programs without inviting crippling opposition. Moreover, while Social Security needs reform to keep its trust funds solvent over the long run, the options for near-term savings are limited (although serious reform would go a long way toward ameliorating the long-term fiscal challenge). A few possibilities for major near-term savings exist within Medicare and Medicaid, however.
- In Medicare, many services can be provided in settings that fall outside of the management control of inpatient hospitals, and, yet, if a hospital owns an off-site center providing such services, it can add a facility fee to the bill that adds costs without any real justification. Mandating the same fees regardless of the sites in which they are delivered would save over one hundred billion dollars in Medicare over a decade and has bipartisan support.
Also, Medicare’s system for paying private insurers (known as Medicare Advantage plans) is being criticized for costing more than would be required to pay the bills directly from the traditional program. The solution is to move toward a more effective competitive bidding environment, first among the MA plans and then also between MA and traditional Medicare. With standardized benefits and a better system for presenting the options to the beneficiaries, competitive bidding would lower overall costs substantially more than only cutting MA payments. A CBO estimate from 2017 indicates that seven percent savings would be within reach, which translates into more than $1.0 trillion based on current Medicare projections (although the need to phase-in the changes would reduce the potential size of the expenditure reduction).
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- In Medicaid, many states shift costs onto the federal budget through the use of provider-focused tax and contribution arrangements (both parties have been eager participants in the various schemes). The providers pay for a state’s share of Medicaid expenses, which they then get back in the form of altered Medicaid fees and support funds. The net effect is no real tax hike within the state and more money from the federal government. The Committee for a Responsible Federal Budget estimates that an aggressive effort to curtail these cost-shifting arrangements would reduce federal Medicaid costs by about $0.6 trillion over ten years. Many states were showered with pandemic relief that they have never used, which should allow for a resetting of responsibilities within Medicaid that is more consistent with federal law as well.
What Budgeting Is For
Senator Wicker’s call to reprioritize defense spending demonstrates why budgeting should not be an optional exercise for the president or Congress. The whole point is to force elected leaders to grapple seriously with the trade-offs that are inherent to governing. If there is a consensus that U.S. security requires more investment in military readiness, then policymakers should decide what is less urgent. More defense might mean higher taxes, or reduced spending on popular programs, or possibly both. What should not be done is to increase borrowing even more to pay for spending that will not be temporary.
For most of the past two decades, the default position of both parties has been to put off hard decisions and thus avoid disappointing competing groups of voters. The result has been both widening deficits and falling investments in defense. It should be obvious to all by now that staying on this path carries substantial risks, economically and strategically.
At present, there is no evidence that either party is ready to acknowledge the seriousness of the challenges the country faces because doing so would mean acknowledging that the policy paths they have endorsed are inadequate at best and more likely misguided. That spells trouble, no matter who wins.
James C. Capretta is a senior fellow at the American Enterprise Institute
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