Riding the Spending Wave

The Congressional Budget Office’s recently released long-term forecast does not paint a pretty picture of the federal government’s financial future.  Deficits are expected in all future years as federal spending grows faster than tax revenues. The aging of the US population combined with rapidly growing per capita health care spending are the root causes of the spending growth.

The CBO’s forecasts are presented in: The 2018 Long-Term Budget Outlook. The adjacent figure depicts projected and historical federal revenues, expenses, and deficits as percentages of GDP based on the CBO’s report.  Federal spending averaged 20.3% of Gross Domestic Product (GDP) over the last fifty years and federal revenues averaged 17.4% over the same time period. The average deficits of 2.9% of GDP have been financed through issuing public debt and that debt now stands at 76% of GDP.

The CBO estimates that federal revenues this year will equal to 16.6% of GDP and expenditures will be equal to 20.6% of GDP. The recent tax bill has lowered federal revenues by 0.8 percentage points of GDP, relative to the historical average for 2018. Federal expenditures are expected to be up by 0.3 percentage points of GDP relative to the historical average this year. The expected deficit this year of 4% of GDP is up by 1.1% of GDP compared to the historical average.

In ten years, the projected deficit rises to 5.1% of GDP, but note that expected spending is 3.3% of GDP higher than the historical average. Also note that revenues are expected to be higher by 1.1% of GDP by 2028 relative to the historical average. This makes it clear that within ten years the rise in the deficit is definitely due to higher spending and not due to lower revenues. Within 20 years, federal spending will rise to 26.3% of GDP, 6% of GDP higher than the historical average. Federal spending as a share of GDP will rise 30% in just 20 years. Under current law, revenues rise to 19.1% of GDP by 2038, producing an expected deficit of 7.2% of GDP.

What is the cause of spending growth? The figure below provides a quick look at the composition of federal spending in 2017. Social Security, Medicare, and Medicaid (including CHIP) account for almost half of all federal spending. Of the other main categories, only national defense, at 15%, rivals these three programs. Together, all of the other means-tested programs are about the same size as Medicaid and CHIP. If lawmakers attempt to move to a more balanced budget in the future, they must determine whether they will raise tax revenues by 30% within 20 years, reduce spending to match projected revenues under current law, or do a combination of both. The sheer size of the Social Security, Medicare and Medicaid make them targets for reforms.

These three programs are also the main drivers of future spending growth. The figure below is derived from the CBO’s recent long-term forecast and shows the increase in spending as percentages of GDP relative to each program’s spending in 2018. In ten years, Social Security will require additional spending equal to 1.1% of GDP, Medicare’s additional spending is expected to be 1.3% of GDP and Medicaid, CHIP, and the marketplace subsidies are expected to require an additional 0.2% of GDP. Combined, the additional spending is 2.6% of GDP or over 86% of the net increase in federal spending as a percentage of GDP. These additional funding requirements will continue to grow relative to today’s funding. By 2038, the programs’ combined share of GDP rises to 14.3% up from 10.1% today, an increase of 42%.  Much of the additional spending is due to the health care programs.

What if anything can be done to address this growth in spending? Much of the anticipated growth in Social Security and Medicare is due to the influx of baby boomers into the programs along with the rapid growth in per capita health care spending. The change in the US population’s age structure has been known for years. Researchers and policy makers have been well aware of the forecasted effects of this demographic change on the programs’ spending, but the programs have not been reformed. Twenty years ago, the Social Security and Medicare Trustees noted in their message to the public:

“There is time to discuss and evaluate alternative solutions with deliberation and care, and we must use the coming months to find changes that effectively guarantee a basic level of income for the aged, disabled and survivors of deceased workers. Social Security is too important both to individuals who receive benefits and to our society as a whole to fail to find an acceptable means for protecting this program’s future.

With proper public discussion and timely legislative action, Social Security and Medicare will continue to play their critical role in the lives of virtually every American.”

Status of the Social Security and Medicare Programs, A Summary of the 1998 Annual Reports, Social Security and Medicare Board of Trustees, April 1998.

This warning was made during the first year of four years of budget surpluses. Over the past 50 years, these were four of only five years that the federal government ran budget surpluses. While the need for reforms has been known and discussed for years, the biggest change to the two programs was the addition of pharmaceutical benefits to Medicare in 2003. There have also been legislative attempts to constrain Medicare’s overall spending, but these attempts have not been effective. Similarly designed constraints are part of the Affordable Care Act. Time will tell whether they will actually work. On the funding side, there have been increases in Medicare premiums for higher income retirees.

Overall, Medicare and Social Security increasingly rely on general revenues in addition to dedicated payroll taxes, taxes on benefits, and premiums. Almost 23% of the programs’ combined spending is now financed by general revenues. Based on the CBO’s estimates, this percentage will rise to 37% in ten years.

Last month the programs’ trustees wrote:
“Lawmakers have many policy options that would reduce or eliminate the long-term financing shortfalls in Social Security and Medicare. Lawmakers should address these financial challenges as soon as possible. Taking action sooner rather than later will permit consideration of a broader range of solutions and provide more time to phase in changes so that the public has adequate time to prepare.”
Status of the Social Security and Medicare Programs, A Summary of the 2018 Annual Reports, Social Security and Medicare Board of Trustees, June 2018.

The current and coming funding shortfalls have been predicted for years, and now the window of opportunity is even narrower. Fewer reform options are available today than in the past, but as the trustees continue to point out, it is better to act now than to wait any longer.
Andrew J. Rettenmaier is the Executive Associate Director of the Private Enterprise Research Center at Texas A&M University.
For a discussion of reform options see: Federal Entitlement Spending, PERC Study, No. 1801, June 2018.


Posted: July 06, 2018 by Andrew J. Rettenmaier