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:
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. .
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. .
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 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:
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.
Last week, National Journal hosted a policy summit on our federal budget and the deficit. The first keynote speaker was Senator Orrin Hatch (R-UT) and he repeatedly emphasized the need to cut entitlement spending to get our long-term deficit under control. He pointed out that both current federal outlays and revenue are above average compared to the past 40 years. He argued that we need to cut spending, not raise revenues:
Based on the most recent CBO (Congressional Budget Office) data, revenues are projected to average 18.3% of the economy through 2023, almost a full percentage point over the average of the past 40 years. So, despite the repeated claims that we don’t collect enough revenue, we are actually set to collect more than the historical average. At the same time, federal spending over the next 10 years will average 21.1% of the economy according to the CBO – actually, I think it will be much higher than that – exceeding the 20.4% average of the last 40 years. In other words, anyone claiming the lack of revenues is the root of our fiscal problems just hasn’t studied the numbers.
First, I’m going to correct Senator Hatch. Last week, the CBO updated its budget projections for the next 10 years. Government revenue averages 18.9% of GDP from 2014-2023 and federal spending averages 21.9%. These numbers are actually both higher than the ones Hatch cited so they actually help the Senator’s case that we need to reign in federal spending.
Over the next couple of decades, federal spending will be significantly higher than it has been over the past 40 years, because baby boomers are retiring. The aging of our population increases the costs of entitlements and there’s nothing we can do about that if we are to uphold our contracts to our parents and grandparents. In order to keep those promises, it’s going to require increased government revenues to fund those programs. There’s no escaping that fact.
Don’t believe me? Let’s go to the numbers:
Those numbers come from the CBO’s 2012 Long-Term Budget Outlook*. When performing these calculations, the CBO is forced to make a number of assumptions about future policy. They do so under two different scenarios. The first, known as the extended baseline scenario, assumes that the Bush tax cuts expire, that sequestration stays in effect and that Congress will no longer pass a doc-fix each year. None of those are realistic. That’s why the CBO created the extended alternative baseline scenario. It assumes the extension of the Bush tax cuts, that sequestration will be overturned and Congress will continue to pass a doc-fix each year. Of course, we now know that the Bush tax cuts were extended for all but the wealthiest Americans, and sequestration is looking more and more like permanent policy. But this report was from June 2012 so it’s a bit out of date. However, my point still holds.
Since the extended alternative baseline scenario more closely aligns with the American Taxpayer Relief Act (which extended the Bush tax cuts) and expected future policy, I will use CBO’s projections under it. As you can see from the table above, federal spending is predicted to increase significantly over the next 25 years as a percentage of GDP and that increase is driven entirely by growth in entitlements.
The increase in entitlement spending comes from two areas: rising healthcare costs and an aging population. Fortunately, the CBO recognizes this as well and breaks down which area has a greater effect on the deficit. The report finds that 68% of rising entitlement spending is due to aging while just 32% is due to cost growth. Here’s the CBO:
Through 2022, the aging of the population will cause spending on the major health care programs and Social Security to rise significantly, CBO projects. In fact, during that period, almost all of the projected growth in such spending as a share of GDP is effectively the result of aging.
Aging remains the more important factor for a few decades following the coming one.
To demonstrate this, let’s assume that there is no excess cost growth in entitlement spending over the next 25 years (meaning health care costs grow at the same rate as inflation). Thus, the only increase in costs is from an aging population. To calculate this, we can multiply the estimated increase in Social Security, Medicare and Medicaid (6.2 percentage points) by 0.68 to eliminate all excess cost growth. The answer is 4.2%. This means that aging of the population will cause entitlement spending to rise 4.2 percentage points over the next 25 years. If you factor that in to total spending, the federal government will spend approximately 24.2% of GDP in 2037. That’s not sustainable without increased revenues.
Economists and budget wonks generally agree that the U.S. should aim for a budget deficit of 3% each year. If federal spending is 24.2%, revenues will have to be 21.2% to hit that 3% mark. That’s WAY above our historic level. It’s WAY above our current level. And this is working under the assumption that there is no excess cost growth in entitlement spending. We’ve done a better job of controlling healthcare costs over the past few years, but we’re not going to get to zero excess cost growth anytime soon.
Hatch’s claim that we have a spending problem is technically true, but it’s an unavoidable spending problem. If Hatch wants to keep revenues at 18.9% – the CBO’s prediction for the next 10 years – he would have to cut spending by 2.3 percentage points (to 21.9% of GDP) in order to keep the deficit to 3%. And that’s still assuming there’s no health care excess cost growth. Since Hatch wants to do that by cutting entitlements, he’ll have to reduce them from an expected 14.6% of GDP to 12.3% in 2037. That’s a huge cut.
To put this in perspective, two of the most common suggestions to reduce the budget deficit are to raise the Medicare and Social Security eligibility age to 67 and to switch to chained-CPI to calculate yearly changes in the cost-of-living adjustment for Social Security benefits. The CBO found that raising the eligibility age would reduce the long-term budget by 0.4% of GDP by 2035 while switching to chained-CPI for Social Security would reduce the deficit by 0.2%. That’s nowhere close to enough to both keep revenues at 18.9% and keep the deficit to 3%.
All of this is to say that Hatch and his fellow Republicans need to go back and look at these numbers again. It’s simply not possible to keep our promises to seniors, keep the budget deficit to 3% and keep revenues unchanged. Demographic changes make it impossible.
But it’s not just Republicans who believe this. To pay for our entitlement programs, we’re probably going to have to raise taxes on the middle class. We have a big gap to make up and as I just demonstrated, we can’t do it with spending cuts alone. That’s going to require everyone else to pay more as well. How many Democrats have mentioned this though? Very few. They don’t have any interest in increasing revenue as well. Right now would be a poor time to raise taxes on the middle class of course, but at some point it’s going to need to happen and most Americans have no idea that it’s coming. Years of Republicans claiming we don’t need more revenue and Democrats promising not to raise middle class taxes have lulled the country into a false belief that taxes aren’t going up. They are. An aging population requires it. It’s about time politicians revisited these numbers and stopped fooling their constituents. Either we break the promises to our seniors or we increase revenue. There are no other options.
*The CBO is releasing its 2013 Long Term Budget Outlook tomorrow. I’ll have a full update on the numbers then.