Facing America’s Long-Term Budget Challenges

Brian Riedl

Grover M. Hermann Fellow for Federal Budgetary Affairs

The Heritage Foundation

Washington is Spending Nearly $30,000 Per Household in 2010

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

1990 1995 2000 2005 2010 2015 2020

Fiscal Year

Infl

atio

n-A

dju

sted

Do

llar

s

$20,766(1990)

$21,105 (2001)

$38,500(2020)

$24,650(2007)

$29,466(2010)

Current-Policy Budget Baseline

Actual Spending per Household

Above-Average Spending – not Falling Revenues –is Driving Long-Term Deficits Upward

10%

12%

14%

16%

18%

20%

22%

24%

26%

28%

30%

1960 1970 1980 1990 2000 2010 2020

Fiscal Year

%G

DP

Revenues

Spending

26.5%2020

18.4%2020

1960-2009 Average: 18.0%

1960-2009 Average: 20.3%

Current-Policy Budget Baseline

Composition of Federal Spending: 1962-2020

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1962 1970 1978 1986 1994 2002 2010 2018

Fiscal Year

Social Security & Medicare

Defense

Antipoverty Programs

Net Interest

Other Programs

13%

36%49%

18%

29%

6%

18%

14%

14%

3%

2011-2020 reflect baseline projections

The Long-Term Challenge

77 million baby boomers will retire between 2008 and 2029.

Ratio of workers supporting each retiree: 1960 – 5-to-1 2010 – 3-to-1 2030 – 2-to-1

By 2030, a married couple will have to support themselves, their children – and their very own retiree.

In addition to demographics, Medicare also must deal with rising health care costs.

Senior health care will also push up Medicaid costs.

Social Security, Medicare, & Medicaid Costs As a Percent of GDP

4.3%6.1% 6.1%

2.7%

5.9%9.4%

1.4%

2.5%

3.1%

0%2%4%6%8%

10%12%14%16%18%20%

2007 2030 2050

Sp

end

ing

(%G

DP

)

Medicaid

Medicare

Social Security

14.5%

18.6%

8.4%

Option 1: Tax IncreasesPer Household & Translated Into Today’s GDP

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

2008 2012 2016 2020 2024 2028 2032 2036 2040 2044 2048

$12,072

Option 1: Implications

Would have to raise taxes every year until they were 10.2% of GDP higher than today. In today’s economy, a 10.2% of GDP tax increase would

average $12,072 per household. Marginal tax rates would likely more than double.

Combined federal, state, and local taxes would reach European levels.

Generally, these high tax rates have been shown to reduce economic growth, depress incomes, and increase unemployment.

Option 2: Other Program CutsYearly Budget Breakdown, Assuming No Tax Hikes or Budget Deficits

Social Security, Medicare, Medicaid,

and Net Interest on Earlier Debt

0%10%20%30%40%50%60%70%80%90%

100%

2006 2010 2014 2018 2022 2026 2030 2034 2038 2042Fiscal Year

% o

f F

eder

al B

ud

get

All Other Programs

Option 2: Implications

Would have to immediately begin terminating programs to make room for Social Security, Medicare, Medicaid, and interest on past debt.

By 2030, defense would be the only other remaining program.

By 2049, defense would have to be eliminated too.

By that point, 100% of the budget would go towards Social Security, Medicare, Medicaid, and interest on past debt.

Clearly, this is not realistic.

Option 3: Continue Current Policies And Cover Shortfalls With Budget Deficits

OtherDefense

Social SecurityMedicaid

Medicare

Net Interest

0%

10%

20%

30%

40%

50%

60%

70%

80%

2000 2010 2020 2030 2040 2050

Fiscal Year

Fed

eral

Spe

ndin

g as

a %

of

GD

P

Option 3: Implications Hold all taxes and other spending constant as a percent of

GDP, and then cover shortfalls with budget deficits.

Borrowing 10.2% more of GDP per year ($1.4 trillion more in today’s economy) would raise the federal debt to levels never seen before.

Such debt could increase interest rates, which would in turn trigger an exponential increase in federal debt and net interest costs.

Such large expenses could create an economic crisis.

Option 4: Modernize Social Security, Medicare, and Medicaid Reform is the only way to avoid the scenarios listed above.

Delays only push up the final reform costs.

Hold harmless those under age 50? Four million baby boomers cross this threshold annually. All will have by 2014.

Some pain now, or more pain later.

Conclusion

This issue is about more than economics. It is about the future we want.

There is a moral question of whether one generation should hand a multi-trillion dollar retirement bill over to the next generation.

In the absence of fundamental reform, those entering the workforce today will experience both higher lifetime tax rates and lower incomes than their parents as a result of these retirement costs.