The Fiscal Challenges of the Post-Obama Era

The Fiscal Challenges of the Post-Obama Era

As President Barack Obama approaches the end of his time in office, the United States is approaching a fiscal day of reckoning.

That’s apparent in two startling reports on the budget outlook released in July that have gone largely unnoticed in a political season dominated by purposeful distractions and peripheral issues.

The first is the Obama administration’s mid-session review — an updated budget projection produced each summer by the Office of Management and Budget (OMB). The mid-session review makes detailed projections of federal spending, revenue, deficits, and debt over the coming decade.

This year’s review shows that from 2017 to 2026, the federal government will run a cumulative deficit of $8.8 trillion under current law. And that assumes large cuts in defense and other appropriated spending that neither the president nor a majority in Congress support. The federal government’s annual budget deficit is projected to rise from 3.3 percent of GDP in 2016 to 4.8 percent of GDP in 2026.

This gloomy projection probably explains why President Obama rarely mentions the federal budget or the federal debt in his public remarks. He would rather not bring attention to a part of his legacy unlikely to earn praise from historians. At the end of 2008, just before he entered office, federal debt was $5.8 trillion, or 39 percent of GDP. During his eight-year presidency (2009 to 2016), the federal government will have run a cumulative deficit of $7.3 trillion — more than doubling in eight years the debt it took the nation 219 years to accumulate before he was elected. At the end of 2016, President Obama’s last full year in office, federal debt will equal 77 percent of GDP and will rise to 85 percent of GDP in 2026 under current law. Over the period 1966 to 2008, the average level of federal debt was equal to 35 percent of GDP.

To be fair, much of the run-up in debt in recent years occurred because of the financial crash in 2008 and the slow recovery that followed. But during his two terms in office, President Obama had multiple opportunities to demonstrate leadership and work with Republicans in Congress on a bipartisan basis to lower deficits over the medium and long-term. For a variety of reasons, the president, in what was perhaps the most significant missed opportunity of his presidency, could never bring himself to make the compromises necessary to strike a reasonable deal.

The second important budget forecast released last month, from the Congressional Budget Office (CBO), provides projections of federal spending and revenue  over the coming three decades. It lays bare the consequences of continued procrastination by politicians on a major budgetary course correction. A key fact: the U.S. is in the beginning stages of a massive and unprecedented demographic transformation. Between 2010 and 2040, the number of Americans age 65 and older will double, from 41 million to 82 million. In 2000, there were 4.7 working age Americans (ages 20 to 64) for every person 65 or older. By 2040, there will be only 2.6 people of working age for every person 65 or older. 

This surge of older Americans will swell enrollment in Social Security and Medicare.  Meanwhile, health-care costs are also expected to grow faster than economic growth, further pushing up Medicare costs as well as federal spending on Medicaid and the insurance subsidies provided in the Affordable Care Act. The combined effect of population aging and rising health expenses will be massive growth in federal entitlement spending. CBO projects that the combined federal spending on Social Security, Medicare, Medicaid, and the ACA subsidies will grow from 11 percent of GDP in 2016 to 16.3 percent of GDP in 2046. This run-up in spending will increase annual federal budget deficits and push cumulative federal debt to 141 percent of GDP in 2046 — well past the point that most economists would consider dangerous for the economy. (Spain’s debt is 99 percent of GDP in 2016).

CBO’s base case scenario is also probably too optimistic. CBO’s projection assumes federal revenue will grow from 18.2 percent of GDP in 2016 to 19.4 percent in 2046 (the 50-year average of federal revenue, from 1966 to 2015, was 17.7 percent of GDP). But the projected growth in federal revenue derives from tax provisions that are sure to change in coming years. For instance, under the ACA, a new 3.8 percent tax was imposed on non-wage income for persons with incomes over $200,000 annually and on couples with incomes over $250,000 per year. These thresholds are not indexed, which means more and more taxpayers, and, eventually, the middle class, will pay this tax as their incomes grow naturally with inflation.

In addition, the ACA imposed a “Cadillac” tax on high-cost health insurance plans, with thresholds that are set to grow with consumer inflation but not health costs. This, too, will mean more and more taxpayers will pay this tax as health premiums grow much faster than the tax’s cost thresholds. (The tax will be passed on by employers to workers in the form of higher deductibles and other restrictions on their benefits). CBO’s projections assume Congress and future presidents will allow this new version of 1970’s-style “bracket creep” to occur, despite the fact that in recent years Congress has acted repeatedly to protect the middle class from other versions of bracket creep (such as the Alternative Minimum Tax).

Neither of the two candidates competing to succeed President Obama, Hillary Clinton and Donald Trump, have offered anything close to a realistic plan to deal with mounting federal debt. Clinton’s focus is on raising taxes on higher income households to pay for the new entitlement programs she has promised to voters. She has also endorsed expanding Social Security benefits, despite the fact that the program is already underfunded by $32 trillion, according to the latest report from the Social Security trustees. 

Trump, for his part, has decried the level of government debt, but he hasn’t offered any plan to deal with it. He has proposed a large tax cut, says he won’t restrain Social Security or Medicare, and boasts that the military under his command would be so strong that nobody would “mess with us.” So how would he bring about budgetary discipline? Elimination of “waste, fraud, and abuse,” he says — the go-to dodge of every politician who doesn’t really have a plan.

What’s needed is a plan no politician wants to promote — one that reforms the major entitlement programs to bring promised benefits in line with a realistic expectation of federal revenue over the long-run. That can be done with sensible reforms that are phased in over a number of years. But it won’t happen so long as the nation’s top political leaders prefer to avoid the subject altogether — or, worse, tell voters that all is fine and no corrective action is necessary. That has been the primary message to voters in recent years — and, unfortunately,  there seems to be little prospect of that changing anytime soon.

James C. Capretta is a resident fellow at the American Enterprise Institute.

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