The Nation's Pulse

Understating the Budget Crisis

How do you solve a problem like entitlement?

By From the October 2012 issue

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LAWRENCE SUMMERS published an article recently in the Financial Times asserting that U.S. federal spending will continue to grow both in real terms and as a share of the economy regardless of whether Barack Obama or Mitt Romney is elected in November. As one of the nation’s eminent economists and a former Treasury Secretary, Mr. Summers is someone whose judgments deserve careful attention. Readers may safely assume that his article reflects high-level thinking in Democratic circles in Washington. Nevertheless, his case is flawed on several counts.

Mr. Summers is certainly correct on one point: Pressure for more spending will continue to grow over the next decade. Baby Boomers are beginning to retire in large numbers, putting increased strain on Social Security and Medicare. Interest costs on public debt are certain to rise as a share of federal spending and GDP. The costs of goods and services purchased by government in health and education will grow more rapidly than those purchased in the private sector. At the same time, governments at all levels are running out of short-term gimmicks to cover or disguise their spending. Mr. Summers argues the problems are such that spending will grow and taxes will increase no matter which party controls the government.

In fact, the likely outcome is very nearly the reverse: Spending will have to be cut, and cut drastically from current trend lines. That is a near certainty. But when we will begin to address our spending problems is a vital question. The longer we wait, the deeper the fiscal hole we will dig for ourselves. On this point, it will matter a great deal which party wins this election.

Mr. Summers understates the true magnitude of the problem, in part because he misstates some facts about current levels of federal spending. For example, he writes that U.S. public debt (that is, debt owed to the public, rather than debt one part of the government owes to another) will reach 65 percent of GDP by the year 2020. It is not clear where he gets this figure. U.S. public debt now stands at about $10 trillion, out of a total debt of $16 trillion, while GDP in 2012 is expected to be about $15.5 trillion. Thus, publicly owed debt is already over 60 percent of GDP and is climbing by 10 percent or so every year. At these rates, publicly owed debt will probably exceed 100 percent of GDP long before the year 2020. Total debt, including IOUs the government has written to itself, already exceeds that figure.

He also tells us that federal entitlement programs, mainly Social Security, Medicare, and Medicaid, take up about 32 percent of the federal budget, or 7.7 percent of GDP. In fact, the U.S. government is on track to spend about $1.7 trillion in 2012 on these three items, about 40 percent of total anticipated expenditures of $3.8 trillion, or 11 percent of GDP. These expenditures will grow rapidly over the next decade or so as Baby Boomers become eligible for old-age programs.

Mr. Summers reports that the ratio of Americans over 65 to those of working age will increase from 1 in 4.6 now to 1 in 2.7 over the next generation, implying that by roughly 2030 there will be almost three workers supporting each beneficiary. But a more telling ratio to consider is that between the number of program beneficiaries and the number of people in the workforce paying taxes to support them. Here the picture is more foreboding.

There are currently about 55 million Americans receiving Social Security benefits and 50 million on Medicare, of which about 42 million are retired persons and their dependents (others receive disability or survivors benefits). These populations overlap so that most people are receiving benefits from both programs. According to the Bureau of Labor Statistics, the U.S. labor force consists of 158 million adults, giving us a current ratio between beneficiaries and workers of about 1 to 3. But given the unemployment rate, only 142 million people currently have jobs, and, of these, about 26 million hold parttime jobs. This leaves us with about 115 million people paying the full schedule of payroll and income taxes against 50 or 55 million people receiving benefits. That gives us a ratio of about 1 to 2, which will improve only on the margins if or when the unemployment rate declines.

According to the 2010 census, there are an estimated 80 million Americans in the “Baby Boom” generation, defined as those born between the years 1946 and 1964, whose leading edge reached age 65 in 2011. Over the next 15 years, the U.S. may add 3 to 4 million people per year to the Social Security and Medicare systems. Adjusting for deaths, this trend could leave us with 80 million people eligible for benefits by 2025 or 2026. Given the increasing life expectancy of our population, it could easily be more.

At the same time, the U.S. labor force is expected to grow by just 0.6 percent annually between now and 2030, an increase of about 1 million per year on a current work force of 158 million. If these projections hold true, the workforce will grow to 171 million or so by 2025. Assuming that only a portion of these new entrants find full time jobs (a reasonable assumption), we will have perhaps 130 or 140 million full time workers supporting 80 million (or more) beneficiaries. Long before we reach this point, workers will undoubtedly revolt against the payroll taxes required to sustain these programs, while at the same time beneficiaries will revolt against the cuts in benefits they will be forced to absorb.

NEITHER MR. SUMMERS nor President Obama has faced up to the difficulty of the developing problem, perhaps in the hope that something will turn up to fix it or in the belief that nothing can be done anyway. There are few realistic options available. We have already borrowed ourselves to the hilt. Many think that we can grow ourselves out of the problem, as we did with the deficits of the 1980s. But at that time we were not looking down the barrel of an entitlement crisis. Federal spending has grown by 7 or 8 percent per annum over the past several years, a rate that (according to Mr. Summers) will continue or even increase between now and 2020.

It is hard to see how this can be sustained, since economic growth has averaged a feeble 2 percent per year since 2008, and new projections from the Congressional Budget Office (CBO) suggest that economic growth in 2013 and 2014 will fall short of even this figure. Given the recession in Europe and the looming “fiscal cliff” in the United States, the CBO warns that there is a real risk that the U.S. economy will slip into recession in 2013. At 2 percent growth per year, GDP expands by about $300 billion, of which the federal share in taxes might be 20 percent, or $60 billion. Those proceeds are not going to close a $1 trillion deficit or provide the revenues to sustain the spending that Mr. Summers and others envision.

A stagnant economy, growing at rates of 2 percent or less per year, perhaps with a recession thrown in, will render the above problems far more difficult to address. Even a modestly expanding economy will not come close to providing the revenues needed to close the deficit or cover the exploding costs of entitlements. One thing is certain: Spending is going to slow down for one reason or another, either because we will not have the resources or cannot continue to borrow the funds to pay for it.

Mr. Summers (and President Obama) suggests that the budget can be brought under control by incremental measures like tax hikes on the wealthy and gradual increases in the age of eligibility for entitlement programs. These are Band-Aids at best; at worst, they indulge the fantasy that nothing painful or difficult needs to be done. Governor Romney and his vice presidential candidate Paul Ryan propose several fundamental reforms in entitlement programs and the tax system more commensurate with the magnitude of the challenges. To be sure, these may fall short of what will be needed to bring expenditures and revenues into a semblance of balance. But their approach takes the problem seriously—and, more importantly, permits us to start now to attack a problem that, if we wait to address it, will in a few years impose spending cuts of a kind that few dare to contemplate today.

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About the Author

James Piereson is president of the William E. Simon Foundation and senior fellow at the Manhattan Institute. He is the author of Camelot and the Cultural Rev­olution: How the Assassination of John F. Kennedy Shattered American Liberalism (Encounter Books).