The Treasury Department recently released final budget numbers for fiscal year 2019 (which ended on September 30th), and both parties are glad no one paid much attention. While the observers who downplayed the dismal results, including a nearly $1 trillion annual deficit, are right that there is no need for precipitous deficit-cutting, Congress needs to act soon to limit the borrowing projected for ten, twenty, and thirty years from now. Eventually, high levels of federal debt will constrain effective governance, hurt the economy, and invite a crisis.
The 2019 numbers leave no doubt that the federal budget is headed in an ominous direction. With the economy at or near full employment, revenue fell compared to 2018 (measured relative to the size of the economy). Total revenue was 16.3 percent of GDP, down from 16.4 percent in 2018. Over the past fifty years, the average annual amount of revenue was 17.4 percent of GDP.
While nominal revenue growth was modest (4.0 percent), outlay growth was robust. The federal government spent $4.4 trillion in 2019, or 21.0 percent of GDP, up 7.1 percent compared to 2018 (after controlling for anomalies related to the timing of certain benefit payments). Every corner of the government got much more expensive. The fastest growing line item was interest on the debt, up 14 percent compared to 2018. Spending on Social Security, Medicare, and Medicaid grew at a combined rate of 5.9 percent, while spending on the military grew 8.0 percent. Combined spending on all other agencies and programs, mostly funded in the appropriations process, grew 6.6 percent in 2019.
Rapid spending growth pushed the deficit up to $985 billion in 2019, or 4.6 percent of GDP, up from 3.8 percent of GDP in 2018. The average deficit over the period 1951 to 2018 was 2.4 percent of GDP. The added borrowing in 2019 increased total federal debt to 79.2 percent of GDP. At the end of 2008, federal debt stood at just 39.4 percent of GDP.
With a strong economy and rising wages, now is the time for fiscal consolidation, not expansion. Postponing a correction is only adding to the burden that will fall on younger generations of workers as entitlement spending surges in coming years.
The Congressional Budget Office’s most recent long-term projections show combined spending on Social Security and the major health entitlement programs growing from 10.2 percent of GDP in 2019 to 14.6 percent of GDP in 2040, an increase of more than 40 percent. Revenue is expected to grow because, under current law, a significant portion of the 2017 tax cut will expire in the coming decade. Even so, taxes will not keep pace with the accelerated growth in entitlement spending. By 2040, CBO expects federal revenue collection to reach 18.9 percent of GDP, while the deficit will be 7.1 percent of GDP. Over the decade 2031 to 2040, CBO forecasts an average deficit of 6.1 percent of GDP, and that’s probably an optimistic scenario. It assumes Congress will let the 2017 tax cuts expire and allow tax increases imposed by the Affordable Care Act, which have been repeatedly postponed, to go into effect as scheduled. If those and other similar assumptions are relaxed, CBO projects federal debt will soar to over 200 percent of GDP by 2049 (compared to 144 percent in its base projection).
Persistent and growing deficits are inconvenient for both parties. It is clear that the largest source of additional financial pressure is entitlement spending growth, but the problem is too big to solve with spending cuts along. In the age of Trump, however, the GOP is unreliable on entitlement reform even as it also opposes every kind of tax increase. At the same time, Democrats are campaigning to vastly expand entitlements before a plan is in place to pay for what is already on the books.
A correction can occur gradually over two decades and focus on sensible reforms to Social Security and Medicare, starting with increases in the expected age of normal retirement, adjustments in benefits and hikes in premiums for new retirees who earned relatively high wages during their working lives, and reforms that bring stronger market discipline to the provision of medical care. These changes need not affect any current retirees to have a significant and salutary effect on total program costs in 2040 and beyond. To secure these reforms, Republicans should be willing to entertain tax hikes, especially those that fall more on consumption.
It is reasonable to question why Congress should worry about long-term deficits, given all of the pressing problems voters are facing today. But a government that has already promised far more than it is prepared to collect in taxes has much less room for decisive action than a government with its fiscal house in order. That’s a problem when facing all manner of challenges and crises. Moreover, the expectation of fiscal stress in the future can change economic decision-making today. Investments that improve productivity sometimes do not pay off for many years. Those commitments occur less frequently when the fiscal outlook is uncertain and potentially risky.
Narrowing the deficit in 2030 and 2040 also is best accomplished with adjustments enacted now. Changes to entitlement programs need to be phased in gradually to avoid needless disruption; the savings will build over time and become substantial in time to make a difference when fiscal stress would otherwise be nearing a peak.
The current forecast for a correction is gloomy, given the views of President Trump and the leading candidates to oppose him in 2020. There are some glimmers of hope, though. The latest is a mainly modest budget process bill passed out of the Senate Budget Committee on a bipartisan basis. Among its reforms is a new requirement that Congress set a target for the debt-to-GDP ratio in the congressional budget resolution. That step alone would force Congress to identify a level of cumulative borrowing it deems appropriate. The bill also establishes a new pathway for eliminating breaches of the established debt target with budget plans that enjoy significant bipartisan support. There is little prospect that the reform will become law in this Congress, but it is encouraging that some Senators are focused on reorienting the process toward the long-term challenge.
Neither party is capable of fixing the budget on its own. The problem is too big, and the political risks are too high. Progress will require compromise, and probably occur in steps rather than all at once. While fiscal concerns are not on either party’s radar right now, outside events have a way of forcing leaders to focus on matters they were planning to ignore.
James C. Capretta is a RealClearPolicy Contributor and a resident fellow at the American Enterprise Institute.