You have heard it before, but it bears repeating: Even under very rosy assumptions, the growth of Social Security, Medicare, Medicaid, and interest on the debt will squeeze out all other spending going forward. This week’s chart makes that point.
It looks at the projected composition of federal spending from 2010 to 2084 using data from the Congressional Budget Office’s most recent Long-Term Budget and Economic Outlook. The costs of the largest mandatory programs (Social Security, Medicare, and Medicaid) and interest on the debt are plotted in blue; all other spending is shown in red. These components of federal spending matter not only because of their magnitude, but also because they are on autopilot. Unless lawmakers in Congress reform current laws, federal spending will continue to grow.
As a result of this automatic spending, we will face two major consequences: First, smaller portions of federal spending will be under lawmakers’ functional control. As we can see here, the proportion of federal spending under lawmakers’ control is projected to collapse over time. According to the CBO, this year, $0.48 of every dollar of federal spending will be devoted to Social Security, Medicare, Medicaid, and net interest spending. By 2084, that will have risen to $0.90 of every dollar the federal government spends. This means that only $0.10 of every dollar of federal spending will be available to fund everything else.
Second, we will face gargantuan deficits into the foreseeable future; just because this chart fits in a neat rectangle, that doesn’t mean there will be money to pay for all this spending.
We should expect these two elements to have significant negative impact on economic growth. More government spending shrinks the private economy. Secondly, more spending and wider deficits will mean more borrowing and more debt. That in turn reduces the amount of savings devoted to productive capital and thus will result in lower incomes than would otherwise occur.
Higher debt also means higher interest payments. In theory, larger deficits simply require tax increases or spending cuts to make fiscal policy sustainable. However, our investors understand that these options are very unpopular and that instead lawmakers will likely revert to printing money. Hence, they are likely to ask for an inflation premium in the form of higher interest rates (probably on top of rate increases triggered by the fact that the more in debt we are, the closer we are to the point where our investors change their perceptions about our ability to pay them back). Higher rates will mean higher interest payments and slower economic growth, and higher debt and slower growth makes it harder for policymakers to respond to unexpected problems, such as financial crises, recessions, and wars.
All of which means that the reality will be much worse than this chart shows, since these projections assume that interest rates on the debt will remain low. Here are some projections of what interest rates could end up really looking like and what those rates would mean for federal spending and the deficit. For more on this issue, you should check this excellent piece by the editors of e21 called “The Next Entitlement Program: Interest on the Debt.”