Download Facing America’s Long-Term Budget Challenges

Facing America’s Long-Term
Budget Challenges
Brian Riedl
Grover M. Hermann Fellow for Federal Budgetary Affairs
The Heritage Foundation
June 19, 2006
Spending Growth is Accelerating
8.8%
7.9%
8%
7.3%
7%
6.3%
6%
5.1%
5%
4.1%
3.7% 3.7%
4%
3%
7.9%
3.0%
2.6%
3.2% 3.0%
2.0%
2%
1%
0%
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
Nominal Spending Growth
9%
Fiscal Year
Spending is Rising Across Government
Defense and Homeland Security account for just 30% of all
new spending since 2001.
Other 2001-06 Increases:
 Education: 137%
 International Affairs: 111%
 Health Research/Regulation: 78%
 Social Security & Medicare: 38%
 Antipoverty Programs: 45%
 Veterans’ Benefits: 56%
Projected 2016 Budget Deficit: $700-$800 Billion
The Problem

77 million baby boomers will soon begin retiring.

Ratio of workers supporting each retiree:





1945 – 42-to-1
1950 – 15-to-1
1960 – 5-to-1
2005 – 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.
Social Security, Medicare, and Medicaid
Costs As a Percent of GDP
20%
18.9%
% of GDP
18%
16%
15.4%
14%
2.5%
3.5%
12%
10%
9.3%
8.4%
8%
1.5%
6%
2.7%
4%
2%
4.2%
6.8%
6.1%
6.2%
2030
2050
0%
2005
Medicaid
Medicare
Social Security
Option 1: Tax Increases
Per Household & Translated Into 2005 GDP
$12,000
$10,000
$8,000
$6,000
$4,000
$2,000
$0
2005
2010
2015
2020
2025 2030
Fiscal Year
2035
2040
2045
2050
Option 1: Implications

Would have to raise taxes every year until they were
10% of GDP higher than today.
 In today’s economy, a 10% of GDP tax increase
would average $11,000 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
Yearly Budget Breakdown, Assuming No Tax Hikes or
Budget Deficits
Spending as a % of the Federal Budget
100%
90%
80%
All Other
Programs
70%
60%
Social Security,
Medicare,
Medicaid, and
Net Interest on
Pre-2006 Debt
50%
40%
30%
20%
10%
0%
2006
2011
2016
2021
2026
Fiscal Year
2031
2036
2041
Option 2: Implications

Would have to immediately begin terminating
programs to make room for Social Security, Medicare,
Medicaid, and interest on past debt.

By 2026, defense would be the only other remaining
program.

By 2045, 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% more of GDP per year ($1.2 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.

Depending on interest rates, 2005-2050 net interest spending
alone (adjusted into today’s GDP) could range from $44 trillion to
$118 trillion.

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.

Social Security reform may involve transitioning to a system
whereby individuals’ payroll taxes go into their own personal
retirement fund.

Medicare and Medicaid reforms allowing more consumer choice
and competition may hold down costs.

Limiting the Medicare drug entitlement to low-income seniors
would save $8.1 trillion over the next 75 years – an amount twice
as large as the entire Social Security shortfall.
Conclusion

This issue is about more than economics.

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.