Sunday, June 20, 2010

Budget Basics (3): The Long Term, Demographics, and Entitlements

Even while the debate continues over short-term fiscal stimulus vs. austerity, it is important to look further into the future. Projections reaching 30 to 50 years into the future show that the U.S. federal debt is clearly on an unsustainable path, even given the most optimistic assumptions about legislation, demographics, and interest rates. More realistic assumptions show the debt exploding to unsustainable levels in little more than 20 years. (See the second post in this Budget Basics theories for a discussion of the meaning of debt sustainability).

According to the Congressional Budget Office (CBO), increases in entitlements, including Medicare, Medicaid, and Social Security, will be the big drivers of increases in future debts and deficits. Entitlement spending is projected to increase so rapidly that it will swamp an expected gradual increase in revenues as a percentage of GDP.

In the first 20 years, aging of the population will be the biggest force behind the growth of  entitlement spending. After that, excess growth of medical costs are the culprit. The health care legislation passed earlier this year will supposedly make a small start toward controlling medical costs, but not enough to change the long-term budget picture. All really major cost-cutting proposals proved too controversial for inclusion in the bill. If Congress waits 20 years before revisiting health care (as happened between the Clinton and Obama initiatives), the debt will have already exploded.

The really frightening thing about the CBO budget projections are the estimates of the cost of delaying fiscal consolidation. If fiscal consolidation were to begin as the current business cycle moves into expansion, an adjustment of about 8 percent of GDP (spending cuts, revenue increases, or a mix of the two) would be required to ensure sustainability. If adjustment is instead delayed until 2030, the needed correction balloons to 12 percent of GDP.

The bottom line, according to the CBO: "The choice facing policymakers is not whether to address rising deficits and debt but when and how to do so. . . . The longer that policy action on the budget is put off, the more costly and difficult it will be."

Click here to download a free set of classroom-ready slides discussing long-term projections of the U.S. federal debt.

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