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Entitlement spending is driving federal government debt up to 100% of GDP

Monday saw one of the biggest news stories of the year, though you’d never know it if you watched the news. While news networks worked themselves into a frenzy over the latest goings on in the Trump administration, the Congressional Budget Office released its Budget and Economic Outlook for 2018 to 2028. The main finding is that, by 2028, federal government debt will reach 96% of GDP, “the largest since 1946 and well more than twice the average over the past five decades”

What is causing this flood of red ink? Brian Riedl explains in an excellent commentary for the Manhattan Institute.

In the Washington Post, a distinguished group of liberal economists argues that entitlements are not chiefly to blame for the coming deluge of debt. Specifically, Martin Neil Baily, Jason Furman, Alan Krueger, Laura D’Andrea Tyson and Janet Yellen – all former Democratic chairs of the White House Council of Economic Advisers – dispute a group of Hoover Institution economists who had earlier shown that long-term deficits are determined by escalating entitlement program costs.

However, the Congressional Budget Office’s “2017 Long-Term Budget Outlook” indisputably proves that Social Security and Medicare’s shortfalls overwhelmingly cause the coming long-term debt.

Social Security and Medicare costs are rapidly rising due to the retirement of 74 million baby boomers into a system that already runs substantial per-person deficits. Today’s typical retiring couple has paid $140,000 into Medicare and will receive $420,000 in benefits (both adjusted into net present values). Most Social Securityrecipients also come out ahead. Back in the 1960s, 5 workers supported the benefits of each retiree, yet within 15 years each retiree will be supported by only 2 workers.

CBO’s Long-Term Budget Outlook shows that between 2017 and 2047, Social Security and Medicare will run a cash deficit of $82 trillion. Specifically, Medicare will run a $40 trillion cash deficit, Social Security will run a $19 trillion cash deficit, and the interest costs of those deficits will add $23 trillion more. The rest of the budget had been projected to run a $4 trillion surplus over this period, although making the latest tax cuts permanent would likely change this to a roughly $5 trillion deficit.

As a percentage of GDP, CBO projects that Social Security and Medicare will continue to collect approximately 6 percent of GDP in dedicated revenues yet see spending rise from 8.1 percent today to 12.5 percent of GDP by 2047 – or 16.4 percent when including the interest cost of these deficits. The rest of the budget will remain approximately balanced at around 12 percent of GDP (or run a 1 percent deficit if the tax cuts are extended).

Generally, federal program spending outside Social Security, Medicare, and Medicaid is projected to continue declining as a share of the economy. Tax revenues – even with the tax cuts made permanent – are expected to soar past the 17.4 percent of GDP average of the past few decades and then continue rising due to inflationary increases in taxes and taxed retirement distributions.

In other words, CBO projects above-average tax revenues and falling spending for other programs. But the rise in Social Security, Medicare, and resulting interest costs from 8.1 percent to 16.4 percent of GDP between 2017 and 2047 determines nearly the entire rise in budget deficits. The subsequent tax cuts (perhaps one percent of GDP) do not negate this broad narrative.

How do the authors deny the overwhelming role of Social Security and Medicare in America’s coming debt?

First, by confusing the short-term and the long-term. The authors refer to the “long-run fiscal challenge” and the “next 75 years” as not overwhelmingly driven by entitlement costs. However, they attempt to support their points by discussing the supposedly-small role of Social Security and Medicare in past budget deficits (before most baby boomers retired), and the notable effect of the tax cuts on the budget deficit for 2018 and the next few years. Given that Social Security and Medicare deficits will grow rapidly over the next several decades – while tax revenues also recover to surpass historical averages – focusing on the very short term says little about the drivers of long-term deficits.

That said, even an examination of the short run shows that Social Security and Medicare costs have increased by 1.3 percent of GDP over the past decade, and are projected by CBO to rise by 2.2 percent of GDP over the next decade – compared to (at most) 1 percent of GDP in new tax cuts.

Second, the authors vastly underestimate Social Security and Medicare’s costs. They estimate that the short-term tax cut cost – 1.1 percent of GDP – “is roughly the same size as the preexisting shortfalls in Social Security and Medicare.” Yet, as stated above, Social Security and Medicare’s dedicated revenues are estimated by CBO to remain roughly constant at 6 percent of GDP, while their spending soars from 8.1 to 12.5 percent of GDP over the next three decades – or 16.4 percent when including the interest cost of these deficits.

Third, the authors minimize Medicare’s role in future budget deficits by counting only Medicare’s Hospital Insurance trust fund (Part A). This ignores the massive and growing taxpayer subsidies to Medicare Parts B and D, which are the main cause of Medicare’s $40 trillion cash deficit over the next 30 years. Perhaps the authors determined to look only at the portion of Medicare with a traditional “pre-funded” trust fund. But when assessing the overall cost of Medicare and its effect on the national debt, simply ignoring tens of trillions of dollars in general revenue subsidies to Medicare Parts B and D makes no sense, especially when these subsidies represent possibly the fastest growing portion of federal spending.

As for Social Security, CBO forecasts that its annual non-interest cash deficit will gradually rise from 0.4 percent to 1.8 percent of GDP over the next 15 years, and then level off for the rest of the 75-year window. The Social Security trust fund (which is also a liability for taxpayers who must repay the loans), accounts for just over $3 trillion of the system’s $19 trillion cash deficit through 2047, according to CBO.

Overall, CBO projects that Social Security and Medicare will run annual cash deficits that rise to 6.6 percent of GDP within three decades – or 10.5 percent when including the resulting interest costs. In no way is that “roughly the same size” as (at most) one percent of GDP in long-term tax cuts.

None of this data suggests that taxes cannot be part of the solution. Reasonable people can disagree on how to close the future deficits (although deficit reduction would likely require a large value-added tax to close the $80 trillion gap without significant benefit reforms). But the first step is to accurately diagnose the long-term debt as indisputably driven by the $82 trillion projected cash deficit for Social Security and Medicare. 

John Phelan is an economist at the Center of the American Experiment.

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