The Corner

Entitlements Are Going to Consume Even More of The Federal Budget than Projected

It’s old news that the U.S. is on an unsustainable fiscal path. As I explained earlier in June, the 2013 Trustees’ Report, which looks at the financial situation of Medicare and Social Security, confirmed that, while the situation is not deteriorating as fast as it had in previous years, things are not looking up. But it’s worse than it looks at first. As you know, the cost projections for Medicare programs outlined in the report rely on unrealistic assumptions about current laws (e.g., deep cuts in Medicare physician payments and the Affordable Care Act’s performance), cost savings, and higher revenue. There is many reason to expect that some of these fixes will fail to materialize. For instance, Social Security and Medicare Public Trustee Charles Blahous explains why Medicare costs almost certainly will be higher than current-law projections used by the 2013 Trustees’ Report:

Like other federal scorekeepers, the trustees are required to project program operations under current law regardless of whether most people assume that current law will be sustained. This is particularly important with respect to Medicare projections because current law specifies that physician payments will be cut by nearly 25 percent in early 2014 under the statutory Sustainable Growth Rate (SGR) formula. Lawmakers have overridden similar payment reductions in every year since 2003 and are widely expected to do so again. 

This chart contrasts the Medicare cost projections under current-law assumption with more realistic alternative assumptions, measured as a percentage of the economy. The Medicare Trustees’ Report presents an illustrative alternative scenario that assumes that Congress will override the same scheduled Medicare cuts it has in the past years, and another alternative scenario in which, in addition to those overrides, certain controversial elements of the 2010 Affordable Care Act (ACA) are either scaled back during the period from 2020 to 2034 or eliminated altogether. Overall, it looks very grim:

The growth is health-care costs is obviously a contributing factor to this sad state of affairs, but the main culprit is demographics. Over at Roll Call Paul Krawzak has a good piece explaining this issue:

When Congress created Medicare in 1965 to handle the health care needs of the older population, less than 10 percent of Americans were old enough to collect Social Security and the new medical benefit.

Since then, the share of Americans 65 and older has soared, from 9.3 percent in 1965 to 13.7 percent in 2012.

And as the number of retirees increases and expected life spans extend far beyond 65, the share of those who work and financially support the programs has been shrinking. In 1965 there were four workers for every retiree drawing benefits. By 2012, the ratio had fallen to 2.9-to-1.

This is only the beginning. As the retirement ranks of the baby boom generation grow, an expanding elderly population and the shrinking share of workers will put even more pressure on entitlement programs. Experts project that life expectancy will rise to 83 years by 2035, compared to 78 years in 1965. As the population ages, the ratio of workers to beneficiaries will plunge — to a projected 2.1-to-1 in 2035.

This explains why, counting the Medicaid funds going to Seniors, by 2030, half of the federal budget will be spent on older Americans. Reforming these programs is imperative.

Over at Marginal Revolution, Tyler Cowen writes that “Morgan Stanley estimates that most developed economies are, when unfunded liabilities are taken into account, in some manner insolvent.  Or ask how the fiscal picture would look if the standards for private pension funds were applied to the government.” He has an interesting discussion about what can and cannot be done about it, and whether to start reforming now. For instance, he notes that slowly implemented reforms, rather implementing drastic cuts overnight (which in theory is what will happen to benefits when the Trusts dry up) would allow people to adjust. Here is Cowen quoting David Henderson on this: 

David Henderson makes numerous good points, here is one: “people can adjust better when they have more time to adjust. If the Social Security formula is altered for the future, people can have longer to save to make up for the higher benefits they would have got but will not get. That’s the argument for doing something about it now rather than later. Remember what happened in 1981 when OMB Director David Stockman tried to cut the early retirement benefit by about one third for people retiring only a few years later. That got nowhere. People looking at a one-third reduction in their retirement benefits who are planning to retire in a few years will not look on that kindly. But what if some previous Administration had announced in 1962 a gradual reduction in the early retirement benefit for people retiring in the early 1980s. Those people would have had much more time to plan.” 

Cowen’s conclusion is fairly pessimistic:

Overall I do not see entitlement spending paths as very easy to alter, mostly for political reasons.  One plausible scenario is simply that it is already too late and has been too late for some time (the rejection of managed care in the 1990s?), although denouement (which does not have to mean default) remains a ways away.  If you are fiscally and/or growth doomed anyway, hurry at the margin will indeed seem of not much extra value.  But that is on net hardly an argument for fiscal complacency. 

The whole thing is here.





Veronique de Rugy — Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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