The fiscal outlook: Tough choices ahead

Posted by on August 13, 2010 @ 8:54 am in Retirement

The long-term budget outlook for the federal government is bleak. What is surprising is that this is considered news.

The forces driving the U.S.’s long-term budget problem have been known for decades. We’ve also known for years that sometime in this decade, the outlook would begin to worsen considerably. And now it has. And no, the deteriorating fiscal situation has little to do with stimulus spending, bank or auto bailouts, or the wars in Iraq and Afghanistan.

Instead it has to do with the aging of the baby boom generation.

As boomers enter retirement, budget outlays will soar for Medicare, Social Security, and the part of Medicaid that helps pay for old-age nursing home care. The other factor is that health spending is growing faster than the economy, leading to spiraling costs in all health programs—whether for retirees, the working population, or children.

For full details, you can read the Congressional Budget Office’s long-term budget outlook. Here are two nuggets from page 10:

  1. All future growth in spending (other than interest on the debt) is due to growth in benefit programs. On the health side, that means Medicare, Medicaid, and (to a lesser extent) the new insurance exchanges. On the retirement income side, it means Social Security.
  2. Eighty percent of the increase in non-interest spending over the next 25 years is due to health programs. (Social Security is the other 20%.) Again, driving this is partly the aging of the population, and partly rapid growth in health costs.

Right now, the country is spending 10% of GDP on health programs and Social Security. By 2035, this figure will grow to 16% of GDP.

To pay for that increase solely through tax revenues, we would need to reverse the Bush-era tax cuts (which run about 2% of GDP) and then increase taxes by twice that amount. In other words, we’d need to “triple reverse” the tax cuts. Alternatively, we’d have to nearly double today’s 15% payroll tax for Social Security and Medicare (my estimates, using CBO data).

To pay for the increase solely with spending cuts, benefits under Medicare and Social Security would have to be substantially scaled back. For example, putting Social Security on a sound fiscal footing through spending cuts only would require a 20–25% benefit reduction.

This is why Congress is having such difficulty with the budget. Who wants to tell constituents that the great surge in benefits spending (particularly health spending) of the past 50 years has to slow? The choices are unappealing politically: benefit reductions, higher taxes, or a combination of the two.

Rapidly rising health costs threaten the fiscal stability of state and local governments, private employers, workers, and retirees. If we don’t “bend the cost curve,” health costs will threaten the federal government itself.

Under the CBO’s worst-case scenario, federal debt will exceed 200% of economic output by 2035. That’s definitely “Greek crisis” territory for the U.S.

Note: The link to CBO.gov will open a new browser window. Except where noted, Vanguard accepts no responsibility for content on third-party websites.

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