I sometimes feel like a broken record about entitlement programs. How many times, after all, can I point out that America is on a path to become a decrepit European-style welfare state because of a combination of demographic changes and poorly designed entitlement programs?
But I can't help myself. I feel like I'm watching a surreal version of Titanic where the captain and crew know in advance that the ship will hit the iceberg,
yet they're still allowing passengers to board and still planning the same route. And in this dystopian version of the movie, the tickets actually warn the passengers that tragedy will strike, but most of them don't bother to read the fine print because they are distracted by the promise of fancy buffets and free drinks.
We now have the book version of this grim movie. It's called The 2017 Long-Term Budget Outlook and it was just released today by the Congressional Budget Office.
If you're a fiscal policy wonk, it's an exciting publication. If you're a normal human being, it's a turgid collection of depressing data.
But maybe, just maybe, the data is so depressing that both the electorate and politicians will wake up and realize something needs to change.
I've selected six charts and images from the new CBO report, all of which highlight America's grim fiscal future.
The first chart simply shows where we are right now and where we will be in 30 years if policy is left on autopilot. The most important takeaway is that the burden of government spending is going to increase significantly.
And it's also worth noting that revenues are going up, even without any additional tax increases.
The bottom part of this chart shows that revenues from the income tax will climb by about 2 percent of GDP. In other words, more than 100 percent of our long-run fiscal mess is due to higher levels of government spending. So it's absurd to think the solution should involve higher taxes.
This next image digs into the details. We can see that the spending burden is rising because of Social Security and the health entitlements. By the way, the top middle column on "other noninterest spending" shows one thing that is real, which is that defense spending has fallen as a share of GDP since the mid-1960s, and one thing that may not be real, which is that politicians somehow will limit domestic discretionary spending over the next three decades.
This bottom left part of the image also gives the details on built-in growth in revenues from the income tax, further underscoring that we don't have a problem of inadequate revenue.
Last but not least, here's a graphic that shows the amount of fiscal policy changes that would be needed to either reduce or stabilize government debt.
I think that's the wrong goal, and that instead the focus should be on reducing or stabilizing the burden of government spending,
but I'm sharing this chart because it shows that spending would have to be lowered by 3.1 percent of GDP to put the nation on a good fiscal path.
Some folks think that might be impossible, but I'll simply point out that the five-year de facto spending freeze that we achieved from 2009-2014 actually reduced the burden of government spending by a greater amount. In other words, the payoff from genuine spending restraint is enormous.
The bottom line is very simple.
We need to invoke my Golden Rule so that government grows slower than the private sector. In the long run, that will require genuine entitlement reform.
Or we can let America become Greece.
The U.S. is bankrupt. Of course, Uncle Sam has the power to tax. But at some point even Washington might not be able to squeeze enough cash out of the American people to pay its bills.
President Barack Obama would have everyone believe that he has placed federal finances on sound footing. The deficit did drop from over a trillion dollars during his first years in office to “only” $439 billion last year. But the early peak was a result of emergency spending in the aftermath of the financial crisis and the new “normal” is just short of the pre-financial crisis record set by President George W. Bush. The reduction is not much of an achievement.
Worse, the fiscal “good times” are over. The Congressional Budget Office expects the deficit to jump this year, to $544 billion.
The deficit is not caused by too little money collected by Uncle Sam. Revenues are rising four percent this year, and will account for 18.3 percent of GDP, well above the last 50-year average of 17.4 percent. But outlays are projected to rise six percent, leaving expenditures at 21.2 percent of GDP, greater the 20.2 percent average of the last half century.
Alas, this year’s big deficit jump is just the start. Revenues will rise from $3.4 trillion to $5 trillion between 2016 and 2026. As a share of GDP they will remain relatively constant, ending up at 18.2 percent. However, outlays will rise much faster, from about $4 trillion this year to $6.4 trillion in 2026. As a percent of GDP spending will jump from 21.2 percent to 23.1 percent over the same period,
Thus, the amount of red ink steadily rises and is expected to be back over $1 trillion in 2026. The cumulative deficit from 2017 through 2026 will run $9.4 trillion. Total debt will rise by around 70 percent, to roughly $24 trillion in 2026.
Reality is likely to be worse. So-called discretionary spending, subject to annual appropriations, is to be held to record, and probably unrealistically, low levels. In contrast, entitlements will be exploding.
Last June, CBO published a report looking at the federal budget through 2040. Warned the agency: “the extended baseline projections show revenues that fall well short of spending over the long term, producing a substantial imbalance in the federal budget.” By 2040 the agency imagines revenues rising sharply, to 19.4 percent of GDP, but spending going up even further, to 25.3 percent of GDP.
Using its revised figures, CBO warned: “Three decades from now debt held by the public is projected to equal 155 percent of GDP, a higher percentage than any previously recorded in the United States.” Even when exiting World War II—106 percent in 1946, the previous record.
CBO noted the potentially destructive consequences of such indebtedness. Washington’s interest burden would rise sharply. Moreover, “because federal borrowing reduces total saving in the economy over time, the nation’s capital stock would ultimately be smaller than it would be if debt was smaller, and productivity and total wages would be lower.” Americans would be poorer and have less money to fund the steadily rising budgets.
Worse, investors could come to see federal debt as unpayable. Warned CBO: “There would be a greater risk that investors would become unwilling to finance the government’s borrowing needs unless they were compensated with very high interest rates; if that happened, interest rates on federal debt would rise suddenly and sharply.” This in turn “would reduce the market value of outstanding government bonds, causing losses for investors and perhaps precipitating a broader financial crisis by creating losses for mutual funds, pension funds, insurance companies, banks, and other holders of government debt—losses that might be large enough to cause some financial institutions to fail.”
As I wrote for American Spectator: “There’s no time to waste. Uncle Sam is headed toward bankruptcy. Without serious budget reform, we all will be paying the high price of fiscal failure.”
A recent report from the Social Security Advisory Board’s Technical Panel found that the 75-year shortfall could be 28 percent (roughly $2.6 trillion) larger than the estimate in this year’s Trustees Report due to changes in some of the underlying technical assumptions. This disparity is more the product of the difficulties related to projecting the trajectory of a program as large and complicated as Social Security so far into the future, with the chair of the Technical Panel taking pains to reiterate that “the methods and assumptions used by the Social Security actuaries and Trustees are reasonable.” Even so, the report reveals the uncertainty related to the long-term projections for Social Security, with relatively small changes to some of the underlying assumptions significantly changing the program’s financial solvency outlook. Social Security is the largest government program in the world, and changes in its fiscal outlook could have a large impact on the government’s overall finances.
The changes in the Technical Panel report that would have the largest impact are concentrated in a few variables:
- Higher fertility rate
- Higher life expectancy
- Higher interest rates
Other changes to inflation and real earnings growth rate assumptions have a small negative impact, while changes to immigration assumptions slightly improve the program’s financial picture. Some of the changes reflect developments that are good overall but have a negative impact on Social Security’s finances, like higher life expectancy.
Some of the panel’s recommendations focus on making the methodology of the Trustees’ Report more transparent and the degree of uncertainty more clear. While it’s possible that unforeseen changes to underlying variables like the fertility rate could improve the program’s financial outlook, it is much more likely that the trillions in unfunded obligations published in the Annual Trustees’ Report understate the shortfall, if anything.
To some extent we don’t know what Social Security’s long-run shortfall is, but we do know that there will have to be significant reforms to make the program solvent, and the longer these changes are delayed the bigger they’ll need to be. Whether it is raising payroll tax rates or cutting benefits, delaying reform only makes the needed changes more severe.
Percent Change Needed for 75-Year Solvency
Source: Social Security Administration, The 2015 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds, July 2015, p. 25.
One of the goals Social Security is to remove some degree of uncertainty related to life in old age, but this new report confirms that a high degree of uncertainty remains, both for the program’s overall solvency and for individual workers. Younger workers already get a worse deal than previous generations due to demographic change and the program’s structure. Even more troubling, they can’t know how much worse their deal will become as benefits are cut or taxes are increased in the future to try to address this shortfall.
One option that could remedy some of these inherent problems would be to allow workers, especially young workers, to divert some of their payroll taxes to individual accounts. Cato has explored this issue in the past. Chile, for example, has an elderly extreme poverty rate of 1.6 percent, and pension funds have seen a real annual return of 8.6 percent from 1981 to 2013. The United States should heed some of these lessons. Other countries, especially those in South America, have successfully introduced reforms along these lines.
Last September, I wrote about some very disturbing 10-year projections that showed a rising burden of government spending.
Those numbers were rather depressing, but a recently released long-term forecast from the Congressional Budget Office make the 10-year numbers look benign by comparison.
The new report is overly focused on the symptom of deficits and debt rather than the underlying disease of excessive government. But if you dig into the details, you can find the numbers that really matter. Here's some of what CBO reported about government spending in its forecast.
The long-term outlook for the federal budget has worsened dramatically over the past several years, in the wake of the 2007–2009 recession and slow recovery. ...If current law remained generally unchanged..., federal spending rises from 20.5 percent of GDP this year to 25.3 percent of GDP by 2040.
And why is the burden of spending going up?
Well, here's a chart from CBO's slideshow presentation. I've added some red arrows to draw attention to the most worrisome numbers.
...spending for Social Security and the government’s major health care programs—Medicare, Medicaid, the Children’s Health Insurance Program, and subsidies for health insurance purchased through the exchanges created by the Affordable Care Act—would rise sharply, to 14.2 percent of GDP by 2040, if current law remained generally unchanged. That percentage would be more than twice the 6.5 percent average seen over the past 50 years.
By the way, while it's bad news that the overall burden of federal spending is expected to rise to more than 25 percent of GDP by 2040, I worry that the real number will be worse.
After all, the forecast assumes that other spending will drop by 2.2 percent of GDP between 2015 and 2040. Yet is it really realistic to think that politicians won't increase - much less hold steady - the amount that's being spent on non-health welfare programs and discretionary programs?
Another key takeaway from the report is that it is preposterous to argue (like Obama's former economic adviser) that our long-run fiscal problems are caused by inadequate tax revenue.
Indeed, tax revenues are projected to rise significantly over the next 25 years.
Federal revenues would also increase relative to GDP under current law... Revenues would equal 19.4 percent of GDP by 2040, CBO projects, which would be higher than the 50-year average of 17.4 percent.
These CBO numbers are grim, but they could be considered the "rosy scenario."
The Committee for a Responsible Federal Budget (CRFB) produced their own analysis of the long-run fiscal outlook.
Like the CBO, CRFB is too fixated on deficits and debt, but their report does have some additional projections of government spending.
Here's the key table from the CRFB report. Not only do they show the CBO numbers for 2065 and 2090 under the baseline scenario, they also pull out CBO's "alternative fiscal scenario" projections, which are based on more pessimistic (some would say more realistic) assumptions.
As you can see from my red arrows, federal spending will consume one-third of our economy's output based on the "extended baseline scenario" as we get close to the end of the century. So if you add state and local spending to the mix, the overall burden of spending will be higher than it is in Greece today.
But if you really want to get depressed, look at the "alternative fiscal scenario." The burden of federal spending soars to more than 50 percent of output. So when you add state and local government spending, the overall burden would be higher than what currently exists in any of Europe's welfare states.
In other words, America is destined to become Greece.
Unless, of course, politicians can be convinced to follow my Golden Rule and exercise some much-needed spending restraint.
This would require genuine entitlement reform and discipline in other parts of the budget, steps that would not be popular from the perspective of Washington insiders.
Which is why we need some sort of external tool that mandates spending restraint, such as an American version of Switzerland's Debt Brake (which you can learn more about by watching a presentation from a representative of the Swiss Embassy).
Heck, even the IMF agrees that spending caps are the only feasible solution.
Self awareness is supposed to be a good thing, so I'm going to openly acknowledge that I have an unusual fixation on the size of government.
I don't lose a wink of sleep thinking about deficits, but I toss and turn all night fretting about the overall burden of government spending.
My peculiar focus on the size and scope of government can be seen in this video,
which explains that spending is the disease and deficits are just a symptom.
Moreover, my Golden Rule explicitly targets the spending side of the budget. And I also came up with a "Bob Dole Award" to mock those who mistakenly dwell on deficits.
With all this as background, you'll understand why I got excited when I started reading Robert Samuelson's column in today's Washington Post.
Well, there’s a presidential whopper. Obama is right that the role of the federal government deserves an important debate, but he is wrong when he says that we’ve had that debate. Just the opposite: The White House and Congress have spent the past five years evading the debate. They’ve argued over federal budget deficits without addressing the underlying issues of what the government should do, what programs are unneeded, whether some beneficiaries are undeserving... The avoidance is entirely bipartisan. Congressional Republicans have been just as allergic to genuine debate as the White House and its Democratic congressional allies.
By the way, I have mixed feelings about the final sentence in that excerpt. Yes, Republicans oftentimes have displayed grotesque levels of fiscal irresponsibility. Heck, just look at the new farm bill. Or the vote on the Export-Import Bank. Or the vote on housing subsidies. Or...well, you get the point.
On the other hand, GOPers have voted for three consecutive years in favor of a budget that restrains the growth of federal spending, in large part because it includes much-needed reforms to major entitlement programs such as Medicare and Medicaid.
But Republican inconsistency isn't my focus today.
I want to address other parts of Samuelson's column that left a bad taste in my mouth.
He argues that you can't balance the budget merely by cutting discretionary programs. That's technically untrue, but it's an accurate assessment of political reality.
I'm much more worried about his assertion that you can't balance the budget even if entitlement spending also is being addressed.
Let's look at what he wrote and then I'll explain why he's wrong.
Eliminating many programs that are arguably marginal — Amtrak, subsidies for public broadcasting and the like — would not produce enough savings to balance the budget. The reason: Spending on Social Security, Medicare and other health programs... But even plausible benefit trims for affluent retirees would still leave deficits. There would still be a need for tax increases.
This is wrong. Not just wrong, but demonstrably inaccurate.
The Ryan budget, for instance, balanced the budget in 2023. Without a single penny of tax hikes.
Sen. Rand Paul and the Republican Study Committee also have produced balanced budget plans. Even as scored by the statists at the Congressional Budget Office.
By the way, you don't even need to cut spending to balance the budget. Spending cuts would be very desirable, of course, but the key to eliminating red ink is simply making sure that government spending climbs at a slower rate than revenues.
And since revenues are expected to grow by about 6 percent per year, it shouldn't take advanced knowledge of mathematics to realize that the deficit will fall if spending grows by less than 6 percent annually.
Indeed, we could balance the budget as early as 2018 if spending merely was restrained so that the budget grew at the rate of inflation.
But never forget that the goal of fiscal policy should be shrinking the size and scope of the federal government, not fiscal balance.
Ask yourself the following questions.
- If $1 trillion floated down from Heaven and into the hands of the IRS, would that alter in any way the argument for getting rid of wasteful and corrupt parts of the federal leviathan, such as the Department of Housing and Urban Development?
- If the politicians had all that extra money and the budget was balanced, would that mean we could - or should - forget about entitlement reform?
- If there was no red ink, would that negate the moral and economic imperative of ending the welfare state?
In other words, the first part of Samuelson's column is right. We need a debate about "the underlying issues of what the government should do, what programs are unneeded, whether some beneficiaries are undeserving."
But we're not going to come up with a good answer if we don't understand basic fiscal facts.
There's a saying in sports that teams that come back to win in the final minutes often "snatch victory from the jaws of defeat ."
I don't like that phrase because it reminds me of the painful way my beloved Georgia Bulldogs were defeated a couple of weeks ago by Auburn.
But I also don't like the saying because it describes what President Obama and other advocates of big government must be thinking now that Republicans apparently are about to do away with the sequester.
Specifically, the GOP appears willing to give away the sequester's real and meaningful spending restraint and replace that fiscal discipline with a package of gimmicks and new revenues.
I warned last month that something like this might happen, but even a pessimist like me didn't envision such a big defeat for fiscal responsibility.
You may be thinking to yourself that even the "stupid party" couldn't be foolish enough to save Obama from his biggest defeat, but check out these excerpts from a Wall Street Journal report.
Sen. Patty Murray (D., Wash.) and Rep. Paul Ryan (R., Wis.), chief negotiators for their parties, are closing in on a deal... At issue are efforts to craft a compromise that would ease across-the-board spending cuts due to take effect in January, known as the sequester, and replace them with a mix of increased fees and cuts in mandatory spending programs.
The supposed cuts wouldn't include any genuine entitlement reform. And there would be back-door tax hikes.
Officials familiar with the talks say negotiators are stitching together a package of offsets to the planned sequester cuts that would include none of the major cuts in Medicare or other entitlement programs that Mr. Ryan has wanted... Instead, it would include more targeted and arcane measures, such as increased fees for airport-security and federal guarantees of private pensions.
The package may get even worse before the ink is dry.
Democrats on Thursday stepped up their demands in advance of the closing days of negotiations between Ms. Murray and Mr. Ryan. House Democratic Leader Nancy Pelosi (D., Calif.) brought a fresh demand to the table by saying she wouldn't support any budget deal unless in included or was accompanied by an agreement to renew expanded unemployment benefits that expire before the end of the year—which would be a major threat to any deal.
Gee, wouldn't that be wonderful. Not only would the GOPers surrender the sequester and acquiesce to some tax hikes, but they could also condemn unemployed people to further joblessness and despair.
That's even worse than the part of the plan that would increase taxes on airline travel to further subsidize the Keystone Cops of the TSA.
But look at the bright side—for D.C. insiders. If the sequester is gutted, that will be a big victory for lobbyists. That means they'll get larger bonuses, which means their kids will have even more presents under the Christmas tree.
As for the rest of the nation? Well, you can't make an omelet without breaking a few eggs.
P.S.: I suppose we should consider ourselves lucky that this looming agreement isn't as bad as some past budget deals, such as the read-my-lips fiasco of 1990.
I'm currently in the Faroe Islands, a relatively unknown and semi-autonomous part of Denmark located in the North Atlantic. Sort of like Greenland, but too small to appear on most maps.
I'm in this chilly archipelago for a speech to the annual meeting of the Faroese People's Party. According to Wikipedia, "the party is supportive of the economic liberalism." But liberal in this context is classical liberal, so they're my kind of people.
I spoke on the economics of fiscal policy and talked about issues such as my Golden Rule and the Laffer Curve, but today's post is about what I learned, not what I said.
The current government of the Faroe Islands, which includes the People's Party, has modernized its Social Security regime with a system of personal retirement accounts. Starting next January, workers will begin setting aside some of their income to finance a comfortable retirement income. When fully implemented, workers will be putting 15 percent of their income in their accounts, creating a system that's even larger than the private retirement models in Australia and Chile.
So why did Faroese politicians take this step? Well, unlike politicians in most nations, they looked at the long-run data, saw that they had an aging population, realized that a tax-and-transfer scheme no longer could work, and decided to reform now instead of waiting for the old system to collapse.
Here's a chart put together by the Nordic Council. As you can see, the Faroe Islands were (and other jurisdictions are) heading to an intolerable and unsustainable situation of too few workers and too many retirees.
By the way, the same situation exists in the United States.
Our population is aging, the Baby Boomers are going into retirement, and birth rates have dropped. Our long-run numbers aren't as grim as some other nations, but our Social Security system is basically insolvent.
Indeed, Social Security's long-run deficit is measured in trillions, not billions. According to the most recent Trustee's Report, deficits over the next 75 years are expected to equal $36 trillion. And that's after adjusting for inflation!
For what it's worth, if a private insurance or pension company kept its books in the same was as Social Security, it would be forced into bankruptcy and its managers would be indicted for fraud..
But when politicians operate a Ponzi Scheme, we're supposed to applaud them for compassion!
This is why it might be worth the cost if we sent the politicians in Washington on a junket (using their taxpayer-financed fleet of luxury jets) to Torshavn, the Faroese capital. They could eat some lamb and fish and learn what it's like to responsibly address a problem before it becomes a crisis.
Or we could save the money and simply force them to watch my video on personal retirement accounts.
P.S. In you like gallows humor, you can enjoy some Social Security cartoons here, here, and here. And we also have a Social Security joke, though it's not overly funny when you realize it's a depiction of reality.
P.P.S. You probably don't want to know how Obama would like to "fix" the Social Security shortfall.
P.P.P.S. On Monday, I continue my tour of the North Atlantic with a speech in Iceland on the Laffer Curve. I don't know if I'll say anything memorable, but I'll use the opportunity to learn more about some of that nation's policies, including their very successful privatized fishery system. Iceland has some bad policies, of course, but it's also worth noting that they wisely have rejected membership in the European Union, they've reduced the burden of government spending in recent years, and they also made the right decision when they decided (with help from an outraged electorate) to limit bailouts when their banks went bust. You won't be surprised to learn, though, that the Paris-based OECD has been using American tax dollars to advocate bad fiscal policy in Iceland.