The Debt Is Still a Major Threat
Federal budget deficits and the growing national debt are less in the news these days for a couple of reasons. For starters, annual deficits are expected to be lower for the next several years compared with the recent past. The Congressional Budget Office projects that the 2015 federal deficit will be $486 billion — a lot of borrowed money for sure, but far less than the $1.3 trillion average deficit from 2009 to 2012. CBO expects the annual deficit to remain essentially the same through 2018. Further, deficit spending and what to do about it is an unpopular topic for politicians, so if they can avoid talking about it, they do. And journalists and the public care only if there's an immediate crisis that cannot be ignored.
But just because the issue isn't in the news every day doesn't mean the problem has gone away. Indeed, CBO's recent report on the long-term budget outlook makes it clear that mounting federal debt remains the most serious non-military threat to our continued strength and prosperity.
The size and scope of the problem were made much worse by the financial crash of 2008 and its aftermath. From 2009 to 2012, the federal government ran a cumulative deficit of $5 trillion, almost doubling the national debt. This put the government in a very deep financial hole even before the retirement of the Baby Boom generation. Federal debt now stands at 74 percent of GDP, far above the post-war norm of around 35 to 40 percent. This means the country is entering a very challenging period of fiscal stress, driven by the aging of the population and rising health expenses, from a position of considerable weakness.
CBO's long-term forecast shows federal debt will never again return to the post-war norm. Instead, the national debt will rise inexorably and exceed 100 percent of GDP in 2040. The primary cause of unending federal deficits is rapidly rising entitlement spending. In 1970, spending on Social Security, Medicare, and Medicaid totaled about 3.7 percent of GDP. By 2040, CBO expects spending on these programs, plus the subsidies made available by the Affordable Care Act (ACA), will total 14.2 percent of GDP. That's an immense shift of resources toward consumption-oriented entitlement spending.
As bad as that CBO's projection looks, it is almost certainly too optimistic. It assumes spending on everything outside of the big entitlements — everything from welfare programs, to highway funds, to defense spending — will fall from 9.1 percent of GDP today to 6.8 percent in 2040. For that to happen, the U.S. military would have to become a shell of what it has been for a century, even as spending on the National Institutes of Health and much else also got cut. That's never going to happen.
Further, CBO's baseline scenario assumes revenues will rise, from 17.7 percent of GDP today to 19.4 percent by 2040. That's a more realistic possibility, but it still presumes a tolerance for federal taxes that is well outside of the historical norm.
CBO acknowledges that this baseline — built around current law and policy — will seem infeasible to many observers, and thus constructs an “extended alternative fiscal scenario” with differing assumptions. In this scenario, spending outside of the main entitlements is slightly higher in 2040 than it is today, and federal revenue is held close to its historical average throughout the projection period. If actual policy matched these assumptions, the result would be absolute fiscal calamity. Debt would soar and exceed 100 percent of GDP by 2030 and 150 percent of GDP by 2040.
And even these projections are likely to be too optimistic. That's because the projections for Medicare assume implausible restraint on payments to hospitals and physicians. The ACA imposed a “productivity adjustment factor” on future payments to hospitals, which, in practical terms, means the normal inflation adjustment added to hospital reimbursement rates every year will be reduced by an average of 1.1 percentage points. And this isn't a one-time event. The adjustment occurs every year, indefinitely. Similarly, physicians are now looking at getting no more than a 0.75 percentage-point annual increase in their fees for taking care of Medicare patients. The actuaries who do the projections of Medicare finances believe both of these restraints on payments are unsustainable and will eventually have to be overridden with new legislation. And when that occurs, Medicare's future spending path will be well above the levels in CBO's current forecast.
The United States is not Greece, but it is still instructive to observe what has occurred there and elsewhere when debt levels have soared. At some point, countries with high levels of public debt pass a threshold above which continued borrowing to cover expenses is prohibitively expensive or infeasible. When they reach that point, the only available path forward is painful and immediate austerity.
There's no reason the U.S. should stumble into such a disastrous future. But avoiding it will require making serious and fundamental changes in fiscal policy, beginning sooner rather than later.
In practical terms, that means reforming the major entitlement programs so that they do not consume such an immense proportion of projected federal revenues. The key themes of a serious reform effort should be: encouraging longer working lives, e.g. by raising retirement ages and lowering explicit and implicit taxes on wages; altering programs to require middle- and upper-middle-class households to finance more of their own retirement and health-care needs out of their personal resources; improved efficiency in the health system through strong price competition and consumer choice; and more state flexibility and responsibility in running programs within fixed budgets.
It goes without saying that implementing reforms of this kind will not be easy. But, if policymakers begin the process now, they can protect current beneficiaries from any changes and implement these policies for future program participants in ways that allow benefits to grow in generosity, just not as fast as projected in current law.
The alternative is to simply ignore the problem and hope it somehow goes away. That's effectively what policymakers are doing today. But CBO's latest report is another reminder that pretending the problem doesn't exist is really an invitation to be hit with a fiscal and economic crisis of such severity that everyone, politicians included, will regret not taking action to head it off.
James C. Capretta is a senior fellow at the Ethics and Public Policy Center and a visiting fellow at the American Enterprise Institute.