Entitlement Spending and the Long-Term Budget Outlook

November 10, 2009

Last week I gave a talk at the annual fall research conference of the Association for Public Policy Analysis and Management. The session was titled Aging and Health: The Challenges of Entitlement Growth, and my slides drew on our August report The Budget and Economic Outlook: An Update and our June report The Long-Term Budget Outlook.

Entitlement spending is often viewed as a long-term budget challenge, but in fact such spending contributes significantly to the budget challenge facing the country during the next 10 years as well as the more distant future. CBO estimates that, if current laws remained in place, the federal deficit would shrink sharply during the next few years but would remain a little more than 3 percent of gross domestic product (GDP) between 2013 and 2019. Although the country has experienced persistent large deficits beforedeficits during the economic expansion of the 1980s averaged about 4 percent of GDPthe budget challenge of the next decade will be especially acute in three respects:

  • Federal debt held by the public will equal about 60 percent of GDP by the end of this fiscal year, the highest level since the early 1950s. As a result, further large deficits and increases in the debt will raise serious economic risks.
  • The difference between current law (which underlies CBOs baseline projections) and current policy as perceived by many people (in particular, the personal income tax rates now in effect) is very large. If the 2001 and 2003 tax cuts were extended (rather than expiring at the end of 2010, as under current law), the exemption amount for the alternative minimum tax (AMT) was indexed to inflation (rather than falling back sharply, as under current law), and no other policy changes were made, the deficit would exceed 6 percent of GDP by 2019 and debt would be nearly 90 percent of GDP.
  • The aging of the U.S. population and rising costs for health care are making federal spending on Social Security, Medicare, and Medicaid a much larger burden relative to GDP. During the expansion of the 1980s, federal spending on those three programs stayed close to 7 percent of GDP; by 2019, CBO projects that spending on those programs will be a little below 12 percent of GDP.

Beyond the 10-year budget window, the budget outlook is even more sobering. CBOs report on the long-term budget outlook presented two scenariosone that adheres closely to current law, and one that extrapolates current policy as many people might view it (including the tax changes I mentioned earlier and federal spending apart from Social Security, Medicare, and Medicaid that stays a roughly constant share of GDP). In the latter scenario, debt continues to rise sharply relative to GDP in the 2020s and beyond.

The imbalance between spending and revenues widens in part because of the aging of the population. As the baby boomers retire during the next two decades, the number of beneficiaries of Social Security, Medicare, and Medicaid will increase significantly. The imbalance between spending and revenues also widens because, under current law, spending per beneficiary in the Medicare and Medicaid programs will probably continue to increase more rapidly than total spending and income in the economy (and thus more rapidly than the tax base that supports that spending).

I concluded the talk by emphasizing that fiscal policy is on an unsustainable path to an extent that cannot be solved by minor tinkering. The country faces a fundamental disconnect between the services the people expect the government to provide, particularly in the form of benefits for older Americans, and the tax revenues that people are willing to send to the government to finance those services. That fundamental disconnect will have to be addressed in some way if the budget is to be placed on a sustainable course.