Even President Barack Obama appears to realize that Washington has a spending problem. His latest budget, delivered late and without enthusiasm, makes a nod toward restraining the growth of social programs, most notably “entitlements,” headed by Social Security, Medicare, and Medicaid. Alas, that baby step earned a rebuke from his left-wing allies, along with a threat by Rep. Greg Walden, who heads the House Republican campaign committee, to block the President’s “shocking attack on seniors.”
In fact, much more needs to be done to save Washington from bankruptcy.
Uncle Sam faces two fiscal crises. The first is short-term. After running more than $5 trillion in deficits over the past four years, Washington is expected to add “only” $845 billion in red ink this year.
Before Americans break out the champagne, however, they should read the latest analysis from the Congressional Budget Office. “[I]f the laws that govern taxes and spending do not change,” explained the CBO, “federal debt held by the public will reach 76 percent of GDP by the end of this fiscal year, the largest percentage since 1950.” Back then, Americans were beginning to pay down the debt accumulated during the Great Depression and World War II.
Things get a bit better through 2015. Reported the agency, “With revenues expected to rise more rapidly than spending in the next few years under current law, the deficit is projected to dip as low as 2.4 percent of GDP” ($430 billion). However, that is low only compared with recent years. In fact, $430 billion is roughly the 2008 level, before President George W. Bush started the bailout binge.
And the good times won’t last. Deficits start back up, hitting roughly one trillion dollars by 2023, the end of the CBO’s forecast. Accumulated deficits, assuming Congress doesn’t add any new programs or increase outlays for any old ones, would be seven trillion dollars. Explained the agency,
With such deficits, federal debt would remain above 73 percent of GDP—far higher than the 39 percent average seen over the past four decades. (As recently as the end of 2007, federal debt equaled just 36 percent of GDP.) Moreover, debt would be increasing relative to the size of the economy in the second half of the decade.
So much for the President and Congress solving the budget crisis.
Still, Americans may come to look back on the coming decade as halcyon fiscal times. Unfortunately, tens of trillions of dollars in unfunded liabilities are about to cascade down upon us.
The crisis has been building for many years. As Nicholas Eberstadt of the American Enterprise Institute has observed, since 1960 “entitlement transfers—government payments of cash, goods and services to citizens—have been growing twice as fast as overall personal income. Government transfers now account for nearly 18 percent of all personal income in America—up from six percent in 1960.” At that time, all social-welfare programs accounted for less than one third of federal outlays; that share now is about two thirds, and, absent reform, will continue increasing.
What Americans commonly call “welfare” alone costs the federal and state governments about a trillion dollars per year. The impact on family and community has been even more devastating.
However, Social Security and Medicare expenditures, essentially middle-class welfare, already are higher than “welfare” costs, and are rising far faster. These programs also create dependency. The problem is demography: America’s population is aging. More people live longer, and an increasing percentage of the population will be elderly. Fewer young taxpayers will be available to underwrite more retirees. It is a prescription for fiscal disaster.
During the 1950’s, 30 or more workers supported every Social Security beneficiary. We now are heading toward a two-to-one ratio. Moreover, when the program was originally created, almost half of all Americans died before they collected their first check. Politicians collected votes from grateful constituents but didn’t have to find funds to pay the promised benefits. Now most people are surviving and, not unreasonably, expecting their checks.
Medicare insolvency adds inflation of healthcare costs to the increased burden caused by demographic change. Unfortunately, ObamaCare has made the problem worse. Expanding insurance coverage to more people for more procedures will inflate demand and thus increase costs; this “third-party payment” effect will overwhelm the legislation’s desultory attempts to slow medical price increases.
Moreover, the planned cuts in Medicare spending are illusory. First, the administration spends the supposed savings twice—to subsidize health-insurance coverage and then to fix Medicare. Second, warned Richard Foster, the system’s chief actuary, “there is a strong likelihood that certain of these changes will not be viable in the long range.” That is, arbitrarily cutting reimbursements will drive providers from the program, forcing Congress to retreat. That, however, “would lead to far higher costs for Medicare in the long range than those projected under current law.”
Simply put, federal officials are lying when they offer improved forecasts for Medicare outlays. Foster explains that the official financial projections
do not represent a reasonable expectation for actual program operations in either the short range (as a result of the unsustainable reductions in physician payment rates) or the long range (because of the strong likelihood that the statutory reductions in price updates for most categories of Medicare provider services will not be viable).
Thus, if Congress does not act, Americans will be hit by a tsunami of spending. Over the last 40 years the federal government averaged around 18 percent of GDP in taxes and 20 percent of GDP in spending. The next 40 years is likely to be very different. Assuming present trends continue, by 2050 Social Security, Medicare, and Medicaid collectively will account for 18 percent of GDP, sopping up every penny in expected federal revenue. Given that, my Cato Institute colleague Michael Tanner noted, “everything else that the government does, from domestic programs to national defense, including paying interest on the federal debt, will have to be paid for through still more debt, or else government will have to raise taxes to astronomical levels.”
The looming financial crisis is no secret. Every year the CBO publishes a detailed “long-term budget outlook.” And every year the agency’s conclusion is depressing.
Unfortunately, there is no easy out. Last year, the CBO warned that,
Without significant changes in government policy, [demographic and medical] factors will boost federal outlays relative to GDP well above their average of the past several decades—a conclusion that holds under any plausible assumptions about future trends in demographics, economic conditions, and health care costs.
No “rosy scenario” is going to save the day.
The CBO’s most recent long-term analysis figured that, by 2037, Medicare and Medicaid together will account for roughly ten percent of GDP, almost double today’s figure, and Social Security will absorb more than six percent of GDP. If the reductions mandated by ObamaCare are reversed, “the increase in spending on health care programs and Social Security would be even larger. Absent substantial increases in federal revenues, such growth in outlays would result in greater debt burdens than the United States has ever experienced.”
Indeed, the list of potential, contingent, and likely liabilities is long. Heading the list is the collective unfunded liability for Social Security and Medicare, which exceeds $100 trillion. Medicaid expenditures are high and rising. Federal retirement and healthcare benefits are unfunded. Uncle Sam will have to come up with cash to bail out the Federal Housing Administration and Pension Benefit Guaranty Corporation, both of which are under water. Even the Postal Service is broke, having lost $16.7 billion last year. Economist Laurence Kotlikoff has figured total federal indebtedness, including unfunded liabilities, at $222 trillion.
Unfortunately, the problem is not just increased spending. If the outlays are financed by borrowing—Washington’s favorite tool in recent years—debt would rise, as would interest payments. Of late the euro crisis has helped drive foreign investors to dollar assets, but the Europeans might eventually sort things out. Meanwhile, ever-greater U.S. borrowing is likely to force up interest rates. By some estimates total interest payments could quadruple, breaking $800 billion annually, over the next two to three decades.
Moreover, higher borrowing or taxing would suck more and more productive resources out of the economy. This would shrink Americans’ wealth when more money becomes necessary to finance higher entitlement payments. According to the CBO, “large budget deficits and growing debt would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment—which in turn would lower the growth of incomes in the United States.”
Eventually, the entire financial house of cards could tumble down. The CBO, which is not given to fearmongering, warned nonetheless that “Growing debt also would increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget and the government would thereby lose its ability to borrow at affordable rates.” Think the equivalent of Greece—not just in the states of Illinois and California, but across the entire country—and without a bailout by the European Union.
A pessimist would say that we are doomed. An optimist would say that there is no problem that cannot be solved by enlightened and selfless political leadership. (Of course, the pessimist might point out that, in practice, this means we are doomed.)
It is impossible for Americans to tax their way out of the current mess. The rich already pay the vast majority of taxes, especially income-tax levies. In a separate study the CBO figured that the top one percent of households paid 39.5 percent of all income taxes. The top five percent paid 61 percent, and the top ten percent paid 72.7 percent. In contrast, the Tax Foundation found that roughly half of American households don’t owe any income tax. (Either they don’t file, or they file and receive refundable tax credits—welfare delivered through the tax code.) Despite President Obama’s best efforts, it simply isn’t possible to fund an ever-growing welfare state by extracting more and more cash from those who are already paying most of Uncle Sam’s bills.
The only alternative is to reduce outlays. That terrifies Washington, which has been convulsed over the prospect of $85 billion in sequestration “cuts” out of a $3.6 trillion budget. Imagine the normal family, faced with the prospect of borrowing close to a quarter of budgeted spending, responding by savagely slashing a mere 2.3 percent of its planned expenditures. Only in Washington could supposedly serious legislators—not to mention policy analysts and political journalists—maintain straight faces while behaving this way.
Obviously, more needs to be done. Much more.
It’s time to have an adult conversation with the American people. Politicians have lied. There are no Social Security accounts. Workers’ tax payments have not been invested for their use. There is no trust fund filled with money. Instead, Uncle Sam immediately spent the cash collected, while filling a file cabinet in West Virginia with nonrecourse bonds—meaningless pieces of paper. If the building burned down tomorrow, destroying the securities, nothing would be different.
Outlays must be cut. Pork and foreign aid and corporate welfare. Subsidies and grants. Military expenditures to subsidize rich allies and rebuild failed states. The defense budget should protect America, not act as a form of foreign aid.
Entitlements must be cut as well. No, Americans have not paid for their Medicare and Social Security benefits. They have paid for other people’s benefits. Unfortunately, there won’t be enough other people with enough money in the coming years to pay for their benefits.
That might not be fair, but, as Jimmy Carter said, life is not fair. We could open the graves of the culprits—Franklin Roosevelt, Richard Nixon, Claude Pepper, and many more—and desecrate their remains. Or we could suck it up and move on, and begin acting on our responsibilities to care for ourselves, our families, and others in need.
Social Security benefits should be means tested for young workers, who would have to save more money for their own retirements. The retirement age should be increased. The way benefits and cost-of-living increases are figured, which inflates payments, should be adjusted.
Similarly, Medicare benefits should be means tested. The program should be turned from a defined-benefit into a defined-contribution plan, with beneficiaries receiving a means- and risk-adjusted voucher to purchase the specific insurance policy that best meets their needs. Medicaid should be similarly reformed, with benefits restricted to the truly poor.
None of this would be easy, of course. Americans have become used to getting something for nothing from their government: Use borrowed money for a wild party today and let someone else deal with the consequences tomorrow. This strategy is no longer viable.
President Obama has taken the first step toward admitting that Uncle Sam has a spending problem. Next comes doing something serious about it. Americans must stop expecting easy answers. Washington is broke. It’s time we responded accordingly.