Where Does the Increase in Entitlement Spending Come From?

On Monday, I penned a post arguing that Sen. Orrin Hatch (R-UT) was wrong when he commented that we have a spending problem and more revenue is not part of the solution. I used Congressional Budget Office (CBO) data from its 2012 Long Term Budget Outlook to make my point, but that data is a bit out of date. Luckily, the CBO released its 2013 Long Term Budget Outlook two days ago and guess what it showed? Our deficit is magically disappearing!

That’s thanks to the Fiscal Cliff deal that raised taxes on the highest earners, which increased projected revenues. As for spending, health care costs are growing at a much slower rate than expected, not only due to the recession, but also because we seem to have bent the cost curve permanently. That’s a huge improvement. In addition, the sequester is looking more and more like permanent policy. Thus, overall spending has dropped significantly compared to last year.

Nevertheless, entitlement spending is still projected to rise from 9.6% of GDP in 2013 to 14.3% of GDP in 2038. That’s still a large gap. The only reason the budget deficit doesn’t rise a similar amount is because the CBO projects other spending – the stuff the sequester mostly cuts – to fall from 10% of GDP to 7.1%. The increase in entitlement spending (4.7 percentage points) in the 2013 report is less than in last year’s (6.2 percentage points), but it’s still substantial. So, what’s driving that increase? The CBO breaks it down:

  1. 54% Aging: This is an unavoidable aspect of our future budget. Baby boomers are retiring and will start collecting Social Security and Medicare. There’s nothing we can do about that. As America gets older, our retirement programs are going to cost more. Not surprisingly, that’s what the CBO found to be the largest driver of entitlement spending growth. Of that 4.7% increase, 2.5 percentage points is due to aging. It’s not out of control spending on entitlements. It’s just Americans getting older. We can’t pretend that’s not the case.
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  2. 28% Excess Cost Growth: Excess cost growth is the increase in health care spending beyond the rate of inflation. It’s an area we have made significant progress on in recent years, but we can still do better. However, this doesn’t require cutting benefits or changing the eligibility requirements for different programs. It requires bending the health care cost curve even more so that health care is provided more efficiently. Obamacare includes a number of different experiments to try to find ways to do just that.
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  3. 19% Medicaid Expansion and Exchange Subsidies: This is the area that conservatives are dying to cut. but of the main drivers of long-term entitlement spending, the Medicaid expansion and exchange subsidies account for less than one-fifth of it. In addition, excess cost growth is increases spending due to rising costs of programs. It doesn’t mean that seniors receive more benefits or that more people are eligible for the programs. It just means health care is getting more expensive. The Medicaid expansion and exchange subsidies do more than that though. They bring healthcare to millions of people. Eliminating them may have a positive impact on the long-term budget, but it has serious side effects as well.

Unlike my post on Monday, my main point here is not that we need more revenue. The main point is that we have solved a large part of our budget deficit and of the part we haven’t solved, most of it is due to demographic changes and millions of more people getting health care. Republicans can yell about how entitlement spending is running out of control, but the fact of the matter is that it isn’t. It’s on an unsustainable path, but one that is caused mainly by an aging population. Policymakers shouldn’t forget that.

The Magically Disappearing Deficit

The Congressional Budget Office (CBO) released its 2013 Long Term Budget Outlook today and there’s a lot of good news. Total public debt is projected to hit 100% of GDP in 2038, thanks to growth in entitlement spending and interest payments. However, this number is well below CBO’s estimate last year that public debt would hit 200% of GDP in 2037.*

This is thanks to slightly higher taxes and significantly reduced spending on entitlements and interest payments.

The fiscal cliff deal at the end of last year (officially known as the American Taxpayer Relief Act) made the Bush tax cuts permanent for most Americans and fixed the Alternative Minimum Tax (AMT) to limit its reach. However, the deal also allowed taxes to rise on the wealthiest Americans. Due to that, the CBO now projects that revenues will equal 19.7% of GDP in 2038, up from 18.5% in last year’s report.

On the spending side, two major developments drastically reduced the CBO’s projected spending totals.

First, health care cost growth has slowed considerably over the past couple of years and there is more and more evidence demonstrating that this slowdown is not a short-term result of the recession, but is a permanent bending of the cost curve. This led the CBO to lower its projected health care costs:

A particular challenge currently is estimating the extent to which the recent slowdown in growth can be attributed to temporary factors like the recession or instead reflects more enduring developments. Studies have generally concluded that a portion of the observed reduction in growth cannot be linked directly to the weak economy, and CBO’s own analysis has found no link between the recession and slower growth in spending for Medicare. Accordingly, over the past few years, CBO has substantially reduced its projections of spending on Medicare and Medicaid during the coming decade and slightly lowered its estimate of the underlying rate of growth for health care spending per person for the country as a whole. CBO’s estimate of that underlying rate takes into account spending trends since 1985 but gives greater
weight to the recent experience; because of the pressures to constrain spending growth, the underlying rate is projected to decline gradually in the long run.

The CBO’s 2012 Report projected Medicare and Medicaid spending (plus CHIP and the exchange subsidies) to hit a combined 10.4% of GDP in 2037. In this year’s report, the Budget Office expected those programs to be just 8.2% of GDP. That’s a significant drop.

Second, the extended baseline scenario assumes that sequestration is not repealed, compared to last year’s extended alternative baseline scenario that assumed otherwise. This projection made sense in 2012 when it was widely assumed that Congress would find a way to replace the sequester. But now, sequestration is already in effect and the parties aren’t any closer to finding a replacement. It’s more and more likely that sequester could be here to say. This reduces the CBO’s spending projections significantly:

The Congressional Budget Office (CBO) projects that if current laws generally continued without change, other federal noninterest spending would drop from a total of 11.3 percent of gross domestic product (GDP) in 2012 to 7.6 percent in 2023 and then to 7.1 percent in 2038.

Under the extended alternative baseline scenario in 2012, the CBO projected that spending to be 9.6% of GDP in 2037.

The icing on the cake is that all of this reduced spending will lead to significantly lower debt payments, compared with the CBO’s 2012 projections. Debt payments will still rise from today’s low level of 1.3% of GDP to nearly 5 percent of GDP in 2038 (that’s why it’s a sin we aren’t taking advantage of today’s low rates). But that is much less than the CBO’s 2012 projection of 9.5%.

Having gone through all of that, here’s the overall change in U.S. revenues and spending between last year’s Long Term Budget Outlook and this year’s report:

2013 Long Term Budget

The deficit has dropped by almost two-thirds in the last year alone!

Now, the sequester is still dumb policy and the current projections still leave us with an unsustainable budget (economists and budget wonks agree that we need to get our budget down to around 3% of GDP). But the overall picture is abundantly clear: we’ve already done a huge amount of deficit reduction.

*Note: I’m using the extended alternative baseline scenario from the 2012 Report because it more accurately represents the future policy of both taxes and spending. In this year’s report, I’m using the extended baseline scenario as the Fiscal Cliff deal cleared up the unrealistic assumptions that the CBO used under this scenario in 2012.