November 9, 2010

The Truth About Entitlements

Key materials

Does the United States really have to restructure the entitlement programs that affect seniors? Some would argue that Social Security is sound.1 Some would suggest that greater taxes on the highest earners would be a solution.2 Some would say that Medicare’s problems can be solved with painless reforms to control costs. Some would suggest that we have room to raise overall taxes to levels seen in European countries. Some would say that high economic growth is likely to eliminate the problem. This paper looks at the feasibility of these alternatives to scaling back spending promised for seniors.

We start with the projections made by the Congressional Budget Office in the alternative fiscal scenarioof its Long-term Budget Outlook, issued in June of 2010.3 These are shown in table 1.

Table 1. Spending and Revenues as a Percent of GDP, CBO alternative scenario

Category 2014 2020 2035
Social Security 4.8 5.2 6.2
Medicare and Medicaid 5.7 7.2 10.9
Other Non-Interest Spending 10 9.7 9.3
Total Primary Spending 20.5 22.1 26.4
Revenues 18.7 19.3 19.3
Primary Surplus -1.8 -2.8 -7.1

The table looks at spending and revenue as a share of GDP, ignoring the cost of interest payments. We start in 2014, when the effects of the current economic downturn will have largely faded, according to the projection. The budget will still have a primary deficit of 1.8 percent of GDP in that year. Over the next two decades, this deficit is projected to widen to 7.1 percent of GDP. However, there is a significant risk that a deficit of this size, combined with the soaring interest costs along this path, could cause a loss of confidence in U.S. fiscal solvency.4

Other estimates are more pessimistic. For example, the Concord Coalition projects what it calls a “plausible baseline” that in 2020 the overall budget deficit will be 9.1 percent of GDP in 2020, of which interest costs will be 5.2 percent. Thus, the primary deficit in the Concord Coalition's “plausible baseline” is 3.9 percent of GDP in 2020, compared with 2.8 percent in the CBO's “alternative fiscal scenario.”5

In the CBO alternative fiscal scenario, the increase from a primary deficit of 1.8 percent to 7.1 percent of GDP means that the primary deficit deteriorates by 5.3 percent of GDP over the next 20 years. Social Security spending accounts for more than 25 percent of this deterioration, as Social Security outlays are projected to climb from 4.8 percent of GDP to 6.2 percent of GDP, an increase of 1.4 percentage points in the share of GDP that Social Security will absorb. The remaining increase in the primary deficit is more than accounted for by Medicare and Medicaid, as other primary spending actually is projected to edge down while overall revenues edge up.

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1 For example, on August 13, 2010, Kathy Ruffing and Paul N. Van de Water of the Center on Budget and Policy Priorities wrote, “Because Social Security’s finances are fairly predictable, it is not difficult to craft revenue and benefit proposals that would place the program on a sound long-term footing.”
2 See Ruffing and Van de Water.
3 The CBO report can be found at http://www.cbo.gov/doc.cfm?index=11579. It contains an “extended baseline scenario,” which interprets current law. However, I have used figures from what the CBO calls its “alternative fiscal scenario.” As the CBO describes it, this scenario “incorporates several changes to current law that are widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period.”
4 See Arnold Kling, "Guessing the Trigger Point for a U.S. Debt Crisis," August 24, 2010. https://www.mercatus.org/publication/guessing-trigger-point-us-debt-crisis
5 “The Concord Coalition Plausible Baseline,”http://www.concordcoalition.org/concord-coalition-plausible-baseline