Facing Americas LongTerm Budget Challenges

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Facing Americas Long-Term Budget Challenges

• Brian Riedl
• Grover M. Hermann Fellow for Federal Budgetary
  Affairs
• The Heritage Foundation
• June 19, 2006

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Spending Growth is Accelerating
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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

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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.

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Social Security, Medicare, and Medicaid Costs As
a Percent of GDP
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Option 1 Tax IncreasesPer Household
Translated Into 2005 GDP
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Option 1 Implications

• Would have to raise taxes every year until they
  were 10 of GDP higher than today.
• In todays 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.

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Option 2 Other Program CutsYearly Budget
Breakdown, Assuming No Tax Hikes or Budget
Deficits
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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.

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Option 3 Continue Current Policies And Cover
Shortfalls With Budget Deficits
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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 todays 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 todays
  GDP) could range from 44 trillion to 118
  trillion.
• Such large expenses could create an economic
  crisis.

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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.

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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.