“A Budget for a Declining Nation”

A Summary of Remarks by
Eugene Steuerle
Richard B. Fisher Institute Fellow, The Urban Institute
April 29, 2010

A subject gaining increasing concern among policymakers and economists alike is the growing federal deficit. In his speech to the National Economists’ Club, Eugene Steuerle describes this deficit as one that is unique in history, in the sense that it combines recovering from recession-level deficits with an unprecedented level of growth in spending in non-discretionary programs like social security and Medicare that are built into law and are promised to grow as fast or faster than the economy.  Steuerle describes the unique nature of the current deficit and provides a cautionary note of optimism with regard to current projections and some possible solutions.

The U.S. deficit as a percentage of GDP is projected to grow to 250 percent of GDP in the next 25 years if current tax and spending policies are maintained, with interest costs dominating in the long-term. He compares the current budget to that of the end of World War II, when debt held by the public reached nearly 120 percent of GDP. He explained that the debt spiked quickly due to Keynesian spending policies enacted during the war, but came down almost as quickly after it had ended (indeed, the debt-to-GDP fell below 60 percent during the Truman Administration).  Several factors were involved: spending was scheduled to decline at the end of the war while tax increases remained in place. At the same time, almost all spending measures enacted were discretionary, and thus policymakers were able to take into account the current state of the economy when making budget decisions. In that sense, the 120 percent debt levels were not as alarming as our current deficit, which is built on non-discretionary spending measures that will occur year after year regardless of economic performance.

Assume that current policies stay in place: the Bush’s tax cuts are made permanent and spending on social security, Medicare, Medicaid grows as planned, defense declines as a percent of GDP although not dramatically, interest continues to grow.  Those spending items absorbed all revenues and will do so again in the near future.  President Obama does propose to let the Bush tax cuts expire for couples making more than $250,000 and to reinstate the estate tax, yet these tax policy proposals are not enough to tighten the gap between non-discretionary spending and revenues.

Although this is a depressing scenario, Steuerle explains that the US did not arrive at this point due to bad economics, but rather because things have been going well. As wealth increases, as it has over the past 60 years, leisure (a luxury good) becomes more desirable. Thus, for the past 60 years, and for the next 70 years in the future, more and more of the federal budget has been dedicated to social security spending as US citizens spend a greater number of years in retirement. This, combined with rising costs of health care and the unwillingness to raise revenues to pay for all these promises, are the culprits behind projected large deficits into the future.  Steuerle poses that in addition to constraining health cost growth efficiently—or paying for it—the demographic issue that now must be answered is as the US drops from 3 to 2 workers per retiree, is whether to tax more, cut benefit growth rates, or work more. 

Currently, $21 to $22 thousands of dollars per household per year is being dedicated to health care costs (all spending, from government dollars to personal costs).  This amounts to 17 percent of GDP and over 25 percent of the money income of individuals, but politicians like to argue as a general rule, no more than 10 percent of income should be spent on healthcare—and then try to design health reform with that disconnect in mind.

With regard to Medicare and social security, the average-wage, two-earner couple today receives $907,000 in present value benefits from age 65 onward. In 1985, this number was only $575,000 (in 2009 dollars). And the number is rising significantly over coming decades.  That doesn’t count the value of Medicaid to finance nursing home expenses once personal pension savings are exhausted. Steuerle explains that increased life expectancy helps explain long-term trends.  Life expectancy at the earliest Social Security retirement age (62) is 18 years for a man and 22 for a woman. As a comparison, Steuerle says that if life expectancy were a condition for retirement, today people would be retiring at age 75 if number of years retired were at 1940 levels.

Because of the built-in growth of these “mandatory” spending measures, smaller and smaller portions of the budget are scheduled to be dedicated to children (education programs, etc.), investment, and mobility programs (including homeownership and pension savings incentives).  This increasing focus on consumption and decreasing focus on investment, particularly in human capital, leads to a “budget for a declining nation.”

Regardless of costs, Steuerle believes that there is also a poor allocation of social security and health care dollars. Social security dollars are increasingly going to the younger and the healthier, which threatens the wellbeing of the elderly later in retirement, as each household’s benefits are spread across a longer period of life.  Additionally, even after enacting the recent health care reform package, the government’s health budget still favors acute to preventative care, specialization over primary care, and chronic care over cures.

Steuerle takes a look at what the budget might look like in 2015, considering additional revenues that will be expected resulting from President Obama’s FY2011 Budget Proposal. Compared to 2009, the budget projects that there will be a $1137 increase in revenues due to economic growth and recovery from the recession. With these revenues, the biggest portion of spending will be on net interest, followed by spending Medicare, social security, Medicaid, and health reform. This leaves a mere $426 billion residual to finance $750 billion in deficit reduction.  Put another way, the budget is reconciled only through a cut in other programs on the order of over $300 billion.   

He poses that these projections might be wrong for two reasons. First, regarding health care, deficit projections assume constant rates of excess health cost growth, which implies declining rates of growth in non-health consumption. This might put pressure on the rest of the economy, including on some employees and firms to take negative cash increases to make up for these costs. Secondly, retirement projections generally ignore the demand for labor. He suggests that for the labor market the 55+ age cohort during the first half of the 21st century will represent what women did for the last half of the 20th century: the largest pool of underutilized human capital.   

As for solutions, Steuerle suggests additional work for retirees, moving away from a fee for health care services by bundling and voucher-izing health care, placing budgets on each government program so as to provide incentives for improvement, and reallocating budgets to needs such as greater anti-poverty protection, removal of social security discrimination against single heads of household, and relatively more attention to health prevention and primary care.

Looking at the debt projections, Steuerle asks whether this is a crisis or an opportunity for Congress. In the battle for winning over the hearts and minds of the middle class, Democrats tend to focus on progressivity and Republicans on lower tax rates, but then both compete to offer more goodies to the middle class.  Yet, as each tries to control an unknown future before the other—putting into the law unbalanced promises for low taxes and high benefits, a classic prisoners dilemma prevails. Steuerle points out that while these issues are constitutional (in that they involve processes on how to handle promises put into the law), they are not necessarily Constitutional in nature.  Regardless, we now have the opportunity to redefine priorities and move beyond some now rather stale debates on the future direction of government.     

Eugene Steuerle is the Richard B. Fisher Institute Fellow at the Urban Institute in Washington, D.C., and author of the online column The Government We Deserve. His previous positions include Deputy Assistant Secretary of the Treasury for Tax Analysis, President of the National Tax Association, and chair of the 1999 Technical Panel advising Social Security on its methods and assumptions. From 1984 to 1986, he worked as the original organizer and economic coordinator of the Treasury Department's tax reform effort. Gene is also the author, co-editor, or editor of 15 books and hundreds of articles and Congressional testimonies, as well as a prolific columnist who has written for Tax Notes and the Financial Times. Among other honors, he received the first Bruce Davie-Albert Davis Public Service Award from the National Tax Association in 2005. He has a PhD in economics with a distinction in public finance from the University Wisconsin at Madison.

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