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Facing America’s Long-Term Budget Challenges Brian Riedl Grover M. Hermann Fellow for Federal Budgetary Affairs The Heritage Foundation Washington is Spending Nearly $30,000 Per Household in 2010 $38,500 (2020) $40,000 Inflation-Adjusted Dollars $35,000 $30,000 $25,000 $21,105 (2001) $20,766 (1990) $24,650 (2007) $29,466 (2010) $20,000 Current-Policy Budget Baseline $15,000 Actual Spending per Household $10,000 $5,000 $0 1990 1995 2000 2005 Fiscal Year 2010 2015 2020 Above-Average Spending – not Falling Revenues – is Driving Long-Term Deficits Upward 30% 28% 26.5% 2020 26% %GDP 24% 22% Spending 1960-2009 Average: 20.3% 20% 18% 16% Revenues 14% 12% 18.4% 2020 1960-2009 Average: 18.0% 10% 1960 1970 1980 1990 Fiscal Year Current-Policy Budget Baseline 2000 2010 2020 Composition of Federal Spending: 1962-2020 100% 90% 29% Other Programs 18% 80% 70% 6% 60% 3% 13% 50% Antipoverty Programs 40% 30% 18% Net Interest Social Security & Medicare 14% 36% 49% 20% Defense 14% 10% 0% 1962 1970 1978 2011-2020 reflect baseline projections 1986 1994 Fiscal Year 2002 2010 2018 The Long-Term Challenge 77 million baby boomers will retire between 2008 and 2029. Ratio of workers supporting each retiree: 1960 – 5-to-1 2010 – 3-to-1 2030 – 2-to-1 By 2030, a married couple will have to support themselves, their children – and their very own retiree. In addition to demographics, Medicare also must deal with rising health care costs. Senior health care will also push up Medicaid costs. Spending (%GDP) Social Security, Medicare, & Medicaid Costs As a Percent of GDP 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 18.6% 3.1% 14.5% 2.5% 8.4% 1.4% 2.7% 4.3% 2007 9.4% 5.9% 6.1% 6.1% 2030 2050 Medicaid Medicare Social Security Option 1: Tax Increases Per Household & Translated Into Today’s GDP $14,000 $12,072 $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 2008 2012 2016 2020 2024 2028 2032 2036 2040 2044 2048 Option 1: Implications Would have to raise taxes every year until they were 10.2% of GDP higher than today. In today’s economy, a 10.2% of GDP tax increase would average $12,072 per household. Marginal tax rates would likely more than double. Combined federal, state, and local taxes would reach European levels. Generally, these high tax rates have been shown to reduce economic growth, depress incomes, and increase unemployment. Option 2: Other Program Cuts % of Federal Budget Yearly Budget Breakdown, Assuming No Tax Hikes or Budget Deficits 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% All Other Programs Social Security, Medicare, Medicaid, and Net Interest on Earlier Debt 2006 2010 2014 2018 2022 2026 2030 2034 2038 2042 Fiscal Year Option 2: Implications Would have to immediately begin terminating programs to make room for Social Security, Medicare, Medicaid, and interest on past debt. By 2030, defense would be the only other remaining program. By 2049, defense would have to be eliminated too. By that point, 100% of the budget would go towards Social Security, Medicare, Medicaid, and interest on past debt. Clearly, this is not realistic. Option 3: Continue Current Policies And Cover Shortfalls With Budget Deficits 80% Federal Spending as a % of GDP 70% 60% 50% 40% Net Interest 30% Medicare 20% Medicaid Social Security Defense Other 10% 0% 2000 2010 2020 2030 Fiscal Year 2040 2050 Option 3: Implications Hold all taxes and other spending constant as a percent of GDP, and then cover shortfalls with budget deficits. Borrowing 10.2% more of GDP per year ($1.4 trillion more in today’s economy) would raise the federal debt to levels never seen before. Such debt could increase interest rates, which would in turn trigger an exponential increase in federal debt and net interest costs. Such large expenses could create an economic crisis. Option 4: Modernize Social Security, Medicare, and Medicaid Reform is the only way to avoid the scenarios listed above. Delays only push up the final reform costs. Hold harmless those under age 50? Four million baby boomers cross this threshold annually. All will have by 2014. Some pain now, or more pain later. Conclusion This issue is about more than economics. It is about the future we want. There is a moral question of whether one generation should hand a multi-trillion dollar retirement bill over to the next generation. In the absence of fundamental reform, those entering the workforce today will experience both higher lifetime tax rates and lower incomes than their parents as a result of these retirement costs.