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Budget Crisis at the Door

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Document date: October 01, 2003
Released online: October 01, 2003

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

Note: This report is available in its entirety in the Portable Document Format (PDF).

In 1995 the Bipartisan Commission on Entitlement and Tax Reform concluded that "If we do not plan for the future, entitlement spending promises will exceed financial resources in the next century. The current spending trend is unsustainable ... If we fail to act, we have made a choice that threatens the economic future of our children and our nation" (U.S. Congress 1995). Now, well into the next century, we have still failed to act. Yet the problem not only remains, but in many ways has intensified simply because we are years closer to the day of reckoning. Relative to both available revenues and societal needs, we have promised more than we can afford to an elderly and fairly well-off near-elderly population that will soon grow very rapidly as the baby boomers retire and life expectancy continues to increase.

Sitting in the eye of the storm, some tend to believe that these problems, if they exist at all, are merely for some distant future. Yet the number of years available to undertake a reasonable transition is quickly shrinking as the leading edge of the baby boom population reaches Social Security eligibility age around 2008. But even citing 2008 creates a misleading impression that the problem is not with us already and that procrastination is costless. Though baby boomers are still working in the years before 2008, public financial support for older Americans is already placing an enormous strain on the federal budget. And declining revenues in recent years have only added to the pressure.

The economic health of the major programs for the elderly—Social Security and Medicare—is often discussed by examining the financial health of the related trust funds (Old-Age, Survivors, and Disability Insurance [OASDI], Hospital Insurance [HI], and Supplementary Medical Insurance [SMI]). However, focusing on the trust funds is misleading. Long before the OASDI trust fund is emptied around 2042 and the HI trust fund around 2016, Social Security and Medicare outlays will be rising much faster than the gross domestic product (GDP).1 Combined with the rapid growth of Medicaid, which provides nursing home support for the elderly, these programs will be imposing severe pressures on the overall federal budget that will be large enough to threaten an economic crisis.

The revenues earmarked for the OASDI and HI trust funds currently exceed benefits, so those trust funds help finance the deficit in the rest of government. Before the end of the decade, this financial contribution will start to shrink relative to GDP and that shrinkage will start placing upward pressure on the overall deficit, a pressure that grows over time. The total trust fund surpluses are misleading, because total trust fund revenues also include interest on their debt holdings—payments from one part of government to another that merely shift the locus of responsibility for coming up with money and do not affect the government's overall deficit. In other words, demographics will be exerting compounding pressures on the budget and the economy long before the OASDI trust fund is in intensive care, and even before the HI trust fund runs out of money. Moreover, all the growing expenses for Medicare, Part B, and Medicaid are currently absorbing increasing shares of a reduced part of general revenues. In a sense, the trust fund for Part B never goes broke, nor does any implied trust fund for Medicaid (there is none), but such permanent trust fund "solvency" does not make them more affordable any more than does the temporary trust fund ability to pay Social Security and Medicare, Part A, benefits.

Even though the growth of the elderly population slows temporarily in the last decade of the 20th and first decade of the 21st centuries—largely because of the low birth rates in the Great Depression and World War II—elderly programs have continually been absorbing ever-increasing shares of gross domestic product and the federal budget. Figure 1 shows the resources commanded by Social Security, Medicare, and Medicaid alone as a percentage of GDP. While almost three-quarters of Medicaid goes to the nonelderly, much of its growth is in long-term care. The total spending shown in figure 1 does not include the cost of many federal and veterans retirement and health programs for the elderly. Nevertheless, the Social Security, Medicare, and Medicaid projection is considered a good proxy for long-run spending on the elderly and disabled. As figure 1 shows, these programs combined have witnessed an almost inexorable rise for decades now, and the rate of increase threatens to accelerate past 2008.

Figure 1. Social Security, Medicare, and Medicaid Outlays as a Percentage of GDP, Fiscal Years 1950-2075

When the share of GDP or of total federal expenditures absorbed by elderly programs increases, the share spent on everything else must decline (see figure 2). When elderly programs rise from 50 percent to 70 percent of federal spending, for instance, then everything else falls from 50 percent to 30 percent. It is not necessarily true that the share of GDP spent by the federal government on everything else must decline as the burden of supporting the elderly rises, since the government can start absorbing ever-greater shares of GDP through increased taxes. However, that has not happened to a significant degree for over 50 years. Later, we shall examine in more depth just how other federal spending has been declining relative to GDP.

For now, note that as a share of the budget, close to one-half of total spending outside defense and interest on the debt goes to people 65 and over. Social Security is the single biggest federal program, having surpassed defense in 1993. Medicare is growing so rapidly that it will eventually overtake both defense and Social Security, even without the addition of a new prescription drug program.

Figure 2. Composition of Federal Outlays, 1950-2008

Notes for this Section

Throughout most of its history, Social Security and Medicare laws have been enacted in a way that keeps taxes and benefits more or less equal. One modest exception has been the period since the 1983 amendments, when the tax rate was set at a constant rate sufficient to bring about a modest, although temporary, buildup in funds. Even when OASDI Trust Fund assets peak at $7,233 billion in 2026, however, they cover only a fraction of total future liabilities and will be rapidly spent down after the peak. In Medicare, this buildup is smaller and even more misleading, since a substantial infusion of general revenues already finances Part B or Supplementary Medical Insurance (SMI). Only Hospital Insurance has a dedicated payroll tax.

Note: This report is available in its entirety in the Portable Document Format (PDF).

Topics/Tags: | Retirement and Older Americans

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