Entitlement Spending: Our Coming Fiscal Tsunami

Entitlement Spending: Our Coming Fiscal Tsunami

by David Koitz

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Overview

David Koitz clarifies misconceptions and presents the facts on the impending fiscal crisis driven by spending on Medicare, Medicaid, and Social Security. Although these programs are idolized as pillars of the nation's safety net, he shows how they are in fact the largest drivers of our looming fiscal problem. Koitz explains that, if an effective remedy is to emerge, those three programs must contribute heavily to the changes lawmakers consider and offers some policy directions for dealing with them.

Product Details

ISBN-13: 9780817915544
Publisher: Hoover Institution Press
Publication date: 10/15/2012
Edition description: 1st Edition
Pages: 160
Product dimensions: 5.90(w) x 9.10(h) x 0.80(d)

About the Author

David Koitz is a consultant involved with a variety of public policy matters. Over a long career as an analyst on Capitol Hill, he worked for numerous members of Congress and various congressional committees.

Read an Excerpt

Entitlement Spending

Our Coming Fiscal Tsunami


By David Koitz

Hoover Institution Press

Copyright © 2012 Board of Trustees of the Leland Stanford Junior University
All rights reserved.
ISBN: 978-0-8179-1556-8



CHAPTER 1

OUR COMING TSUNAMI


THE UNITED STATES WILL SOON confront a major economic problem, perhaps one unparalleled in the nation's history. It won't strike tomorrow, next week, or next month, but it is out there, its roots sown by the demographics of the past half-century and a body politic hesitant to tamper with aging institutions of government. When it emerges, like a tsunami, the destructive consequences of amassing unprecedented federal indebtedness will be overwhelming, and though seemingly distant, when it rears its head it will rise suddenly in our consciousness as if coming without warning.

While a searing left-right ideological debate pervades the nation's economic dialogue, the enormity of our hovering dilemma gets short shrift. The lack of clarity in the policy discourse, the inclination by lawmakers to procrastinate on politically difficult decisions, and the propensity to pass blame and kick the can down the road are stunning. But like the tearing down of the Twin Towers, a hurricane devastating the Louisiana coast, or an earthquake striking San Francisco, our looming fiscal problem has no political division. It is not a Democratic or Republican problem. It has no party signature. It is simply an American problem. And as it draws ever closer, the need for political convergence becomes ever more pressing.

The problem is very transparent. Unlike the miasma of derivative markets or the opaque operations of hedge funds, it's not clouded by the vagaries of our financial institutions. It's a pretty straightforward dilemma. As our federal budget deficits have grown, the level of debt taken on by the U.S. Treasury has risen precipitously. Some people take solace by looking at other nations, whose debts represent a considerably larger share of their economic output, making our debt seem manageable. But given the sheer magnitude of our problem, this measure may obscure how significant even a moderate increase in the debt would be and the risk it would pose if we stay on our current course.

The challenges in our path are not modest. Starting today and continuing over the next 20 years, the post — World War II baby-boom generation will nearly double the nation's aged population, and the baby trough that followed (and has lingered since) will slow the growth of the working population. The baby boomers and the major advances in life expectancy for subsequent generations will cause a swelling number of recipients of Medicare, Medicaid, and Social Security, and the expenditures of those programs will soar, programs whose creation and inherent promises largely preceded the birth of those who now or will soon seek their benefits.

Our looming economic tsunami is simply the mountain of debt those promises portend.


Our Debt Is Not Benign

When someone asks to borrow money — which is what a country is doing when it puts its Treasury's securities up for sale — the foremost question of the lender is "If I buy these securities, what risk do I take? Is your government capable of paying me back in the period we have agreed to? Do you have a vibrant enough economy to enable your government to levy enough taxes or otherwise draw on its national resources to pay me off?"

In the growing discourse about the rising amounts of governmental debt worldwide, the common denominator of a country's creditworthiness is its debt as a percentage of what its economy produces each year. It's a proxy indicator, a way to gauge which nations are over-extended and which nations have their fiscal house under control. Eyebrows certainly get raised when a nation's debt-to-economy ratio hits triple digits. A ratio of 100 or 200 percent sets off alarms. Investors get skittish, interest rates in that country rise, and at some point, the prospect of an investor revolt ignites fears of calamity in that nation's financial markets and, potentially, those around the world.

Exactly how high does it have to go to become a concern? How much debt is too much? In 2011, Zimbabwe's debt-to-economy ratio (debt-to-GDP, or gross domestic product) was 231 percent; Japan's was 208 percent; Greece's, 165 percent; Italy's, 120 percent; Belgium's, 100 percent. Greece has certainly caught the world's attention with the fiscal turmoil it has experienced. With the possibility of default, investors got scared. Unprecedented changes in taxes and spending became necessary. Spain and Italy have also teetered on the brink, as have various other European nations. Britain too, recognizing its potentially precarious position, has undergone major belt tightening.

Can we in the U.S. take comfort because our debt-to-economy ratio was only 68 percent last year? With a lower ratio than that of other highly developed nations, with our Federal Reserve keeping short-term interest rates near zero, and with investors around the world flocking to U.S. Treasury securities as a safe haven, must we really worry? And while some countries for sure are having difficulty, other countries have markedly higher debt-to-economy ratios than we do, and they haven't collapsed or sent shock waves around the world.

For many economists, the answer is far more complicated than simply observing this ratio. What's the direction of the ratio and how rapidly is it moving (up or down)? How quickly has a high-ratio country's economy advanced and what are its future prospects? How significant are the future commitments its government has taken on? And is the country's political system stable?

The current level of U.S. Treasury debt and the direction it's headed are not benign. The U.S. may be a large and powerful nation and our debt-to-economy ratio may not be as bad as others, but that's no reason to be sanguine. Our debt will very likely go higher. The climb in our ratio from 63 percent in 2010 to 68 percent in 2011 — seemingly modest — raised our Treasury debt by $1.1 trillion. That single year's rise was larger than the economies of all but 12 of the 190 nations tracked by the World Bank. It's equal to the economy of the state of New York. Absent changes that raise federal revenue or constrain spending, our debt-to-economy ratio could rise above 80 percent over the next three years, exceed 100 percent by 2024, and reach an unfathomable 200 percent by the mid-2030s.

Yes, our economy is advanced and diverse and can produce a lot. Today, it generates one-fourth of the goods and services produced worldwide. And our circumstances differ greatly from those of Greece. But when we look to the future, our governmental spending commitments are enormous. As other burgeoning countries such as China, India, South Korea, and Indonesia expand their economies, their net worth relative to ours will likely grow. Their propensity to generate larger growth rates has been demonstrated. As the Far East and South America continue their rapid spurts, how much more prominent will they become on the world's economic stage? And what happens to our dollar's strength then? As our Treasury debt continues its unrelenting rise, will the dollar and our securities still be viewed as a safe haven? Is there possibly a saturation point in the future when investors will say, "We're looking elsewhere"?

Equally important is that nearly half of our total Treasury debt is held in foreign hands, with most of that concentrated among a relatively small group of players. Three-fourths of what is owed abroad is held by China, Japan, the major oil-exporting nations, and four other countries and banking centers; 44 percent of that amount is held by China and Japan alone. That makes the debt an obvious national-security concern. In early 2010, a shiver ran through the financial markets after China let go of $34 billion of our debt. The Chinese could create turmoil for us by flooding the markets with their dollar holdings, but they would also hurt themselves in the process, and that in itself serves as an impediment for exploitation. But what happens when there are other countries that become increasingly attractive for international trade and development, and our consumer demand for their goods becomes less important?


It's About Risk to Our Way of Life

Ultimately, what's at issue is our future risks: future risk to our economy, our ability to grow, our standard of living, and our national security. Today, we may be in a bubble. The dollar is king, and so are our government's securities. But where will we be in 10 years? It's not just the trajectory of our debt, but what causes it: our government's propensity to spend more than we are willing to tax ourselves. The level of debt the Treasury has issued publicly could rise to more than $11 trillion by the end of this year, but if we count the debt it owes to the Medicare and Social Security trust funds, as well as to other "entitlement" programs — another $5 trillion — our debt-to-economy ratio suddenly rises above 100 percent.

Should we count those other obligations even though they are simply internal debt, IOUs from one arm of the government to another? Yes, because they represent future spending commitments already set in law. Lawmakers have the ability to change that, and they could raise taxes too. As yet, however, their steps have been no more than tepid, with little or no change to the fiscal path those commitments put us on. Moreover, even if we somehow came up with the money to pay off those debts (probably through more borrowing from the public), we still won't have enough coming in to pay all of the future spending commitments we've made through those programs. According to the most recent projections of the Medicare and Social Security trustees, even if those internal IOUs are paid off, the programs will run down their legal authority to spend in 2024 and 2033, respectively. Taking all that into account, the Congressional Budget Office (CBO) projects that the amount of federal debt held by the public could rise to 157 percent of our annual economic production by 2032 and 200 percent by 2037. In today's dollars, it would total more than $30 trillion.

It's inconceivable that we could run up the national debt to that level. If it existed today, it would equal nearly half of what the entire world produces in a single year. Where are we going to find the investors — at home or abroad — who will allow us to generate such debt? It's one thing when Zimbabwe runs up a debt of 231 percent of its economy. Its annual economic output is only $7 billion. That doesn't create economic paralyses in world markets. It's vastly different to think of the U.S. doing so. By year-end, our $11 trillion or more in publicly held debt will account for one-fourth of the $45 trillion in outstanding debt issued by all governments worldwide.

As a nation, we have come to treat borrowing as simply another ready source of revenue, a spigot that we blithely presume will continually supplement what we tax ourselves. But it's not, and it won't. It's a loan that needs repaying, and as such it's a claim against future taxes — taxes that may someday fall short because the loan and our spending expectations have grown too large. There is no single trip-wire that signals danger. Complacency has a way of perpetuating itself — no pain, no worry. However, like the precipitous bursting of the tech bubble in 2000, like the air coming out of the housing market in 2008, and like investor panic over the mounting debts of established European nations, inattentiveness and procrastination toward the rising debt of the world's largest economy will someday catch up with us, likely quick and with little warning. As a policy path, the status quo won't suffice. There's no calamity at our front door today, but the warning signs are there.


It Stems from the Loss of Budgetary Control

In many ways, and through a multitude of provisions embedded in law, the federal government's spending and revenues are on autopilot. Indexing provisions tie federal revenues and spending to changes in the economy — to inflation, increases in average wages, the rise in the gross domestic product, and various other economic measures. The indexing of income-tax brackets to inflation — which keeps people's incomes from edging into higher brackets — constrains revenues. Automatic hikes of the standard deduction and personal exemptions do too. Automatic benefit increases in Social Security and other entitlement programs cause spending to rise. And benefits for Social Security recipients are automatically indexed for wage growth in the economy even before people become eligible. Automatic increases in Medicare payments to hospitals and doctors keep health-care expenditures growing at a rapid clip. The thresholds for eligibility under various anti-poverty and other support programs are automatically raised to keep needy people enrolled and allow higher benefits and reimbursements.

It's an understatement to say that indexing is embedded deeply throughout both sides of the federal ledger. In some cases it has favorable budget effects — by increasing revenues or avoiding spending — but its larger effects are to constrain revenue and increase spending.

In most if not all cases, the various indexing provisions have strong underpinnings and rationales, but they were not enacted with a larger view of the fiscal path of the nation. They were enacted incrementally, program by program, tax provision by tax provision, and in most instances with little or no overall budget plan under which to view them. It was too easy to justify them individually on programmatic or tax-policy grounds. Today, the nation's economic times are turbulent and will continue to be so over the coming decade. But those indexing provisions are still operative. They are like a faucet left running with little regard for the capacity of the well to keep delivering.

Equally instrumental is the degree of spending authorized under what are referred to as "permanent appropriations." Medicare and Social Security benefits are the primary examples. Unlike the many hundreds of programs that must receive funding approval each year through annual appropriations bills, entitlement programs such as Medicare, Medicaid, Social Security, federal and military retirement, veterans benefits, and the like are given indefinite permission to spend through the legislation that governs them. They are on autopilot until Congress sees some reason to re-examine them, which tends to be far less frequent than with programs subjected to annual appropriation. And with the numerous programs that have indexing provisions, the autopilot nature of those provisions is facilitated by the indefinite nature of their spending authorizations.

In the nomenclature of federal budgeting, programs falling under the annual appropriations umbrella are referred to as "discretionary," as they reflect those parts of the budget where Congress routinely exercises its prerogative to raise or lower spending, to reallocate, "re-program," earmark, and even change the nature of the programs involved. The rest of the budget is comprised of "entitlements," programs that have their eligibility criteria and payments to individuals or institutions defined by the laws that created them — not by annual appropriations. These programs are labeled as "mandatory," reflecting the largely uninterrupted nature of their expenditures. Not all mandatory programs are indexed, but they do manifest the more passive role Congress takes in reviewing their goals and purposes and the multi-year (sometimes multi-decade) paths of their spending.

Mandatory spending has grown from 38 percent of the budget in 1972 to an estimated 56 percent in 2012.


We Need to Change Course

Of late, the President and Congress have been focused on putting the economy back on track with stimulus measures and safety-net add-ons that increase federal spending and curtail revenues. But the public is expressing unease with the mounting budget deficits and an ever-increasing national debt. Policymakers are aware of the emerging tension, and the public's unease has resulted in some resistance to enacting additional costly stimulus measures without commensurate offsets.

However, while the disquiet is palpable, so is the hesitancy. There is considerable reluctance in fiscal-policy circles to reverse the general path the federal budget is on. Among economists, the prevailing view is that tightening the fiscal belt too soon could weaken the economic recovery. For politicians, there's apprehension about the public's willingness to accept large tax increases and a retrenchment of entitlement benefits — shorthand for raising taxes on middle- and higher-income taxpayers and constraining Medicare and Social Security benefits.


(Continues...)

Excerpted from Entitlement Spending by David Koitz. Copyright © 2012 Board of Trustees of the Leland Stanford Junior University. Excerpted by permission of Hoover Institution Press.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Table of Contents

List of Figures and Tables ix

Preface xiii

Acknowledgments xv

Introduction 1

I Our Coming Tsunami 3

II Facing Up to the Elephants in the Room: Medicare and Medicaid 25

III Cutting Through the Social Security Fog 37

IV There Is No Time Left to Punt Again 47

V "The Man Behind the Tree Is You and Me" 75

Appendices 79

Appendix 1 The National Debt 81

Appendix 2 The Federal Budget 85

Appendix 3 The Potential Consequences of Our Current Fiscal Path 87

Appendix 4 Perceptions, Misperceptions, and Myths About the Problem 89

Appendix 5 Why the "Problem" Is a Problem 91

Appendix 6 The Significance of Addressing the Problem Sooner Rather than Later 117

Appendix 7 What Options Are There to Address the Problem? 119

Supplementary Material

Brief Descriptions of Medicare, Medicaid, Social Security, and "All-Other" Spending 125

About the Author 135

Index 137

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