The Federal Budget Now and In the Future

• If we continue on our current course, we are going to build up debt at an unsustainable rate.
• This chart shows the history of the nation’s debt held by the public (the debt we borrow on the open market from citizens, foreign savers, and foreign governments) as a share of its economy. We are on a trajectory where in a short time, debt will rival the WWII era’s largest level in history; and if current policies remain in place, debt levels will double that of during WWII — yet not because of a full-scale mobilization of all of the country’s resources to fight global tyranny.
• Instead, these projections assume a relatively peaceful security climate and stable economic growth, but assume that the nation continues to avoid making tough, but not drastic, choices about our levels of domestic spending and taxation.
• Such a large debt buildup will have troubling consequences. Even before reaching its peak, it is likely that the debt buildup will lead to slower economic growth and less private investment, and possibly much higher interest rates. We will also saddle future generations not only with a poorer standard of living, but with less flexibility to make their own fiscal and budgetary choices because they will be forced to pay large sums to service debt and they will be constrained by budget priorities they had no part in setting.

• This is a projection of where the nation’s money came from (revenues) and where the money went (outlays)
• The deficit, the mathematical difference between outlays and revenues, has been growing, is over a trillion dollars, and is expected to keep growing for as far as the eye can see — despite current benign economic conditions of low unemployment and a growing economy. This is unprecedented in the nation’s modern economic history.
• One bar to pay attention to here is the “interest costs”. This is the money the government spends annually just to pay interest on the national debt. This money could be put to more productive uses, given that it is such a large sum, but instead, like paying interest on a mortgage or credit card, the money goes out the door just to be able to keep borrowing.

• The mix of “automatic” spending dictated by permanent law (which includes Mandatory spending and Interest) vs. spending within the annual Congressional appropriations process (Discretionary spending) — has changed over time.
• Mandatory spending is determined by legal formula and often changes due to demographic change, health care inflation, or economic conditions. Discretionary spending is voted on each year by Congress in the appropriations process in ‘must-pass’ pieces of legislation. Thus, much more of our spending is now on autopilot.
• Often when you hear politicians talk about wanting to restrain spending, they tend to only focus on discretionary appropriations — about half of which is defense spending and half non-defense, and thus about two-thirds of the budget is basically “off limits” for cuts during most Congresses.

• This chart is a snapshot of what the government expects to spend on various mandatory spending programs.
• A vast majority of total mandatory spending is on Social Security, Medicare, and Medicaid.
• Social Security spending is currently the largest of the mandatory programs, but within two decades, Medicare will be the largest.
• The other much smaller programs tend to be safety net programs, including the so-called “automatic stabilizers” that kick in during economic downturns to protect the most vulnerable (food stamps, unemployment, etc.).

• The non-defense discretionary programs are much smaller in magnitude than the mandatory programs.
• Congress controls the amount of money that is allocated for each program by voting each year.
• By capping to this type of spending, politicians get to avoid specifics on the hard choices required to cut these individual programs. Note: there is no category labeled “waste, fraud and abuse.” That is one reason why the appropriations process has broken down — it is very difficult to enact the specific cuts implied when attempting to restrain overall discretionary spending.
• This is the part of the budget where investments are made for future economic growth — in infrastructure, human capital, and science and technology.

• After a nearly decade-long period of the imposition of caps and a sequester threat on discretionary spending (a period that ended in 2019), such spending trended downward as a percentage of the economy (GDP). It is now below the historical average and is at its lowest point since the modern budget process began in the 1970s.
• Based on past history, sticking to the continued projected downward trend might be unrealistic.
• Furthermore, because this is the part of the budget where investments are made, continuing on that path while avoiding hard choices in taxes and mandatory spending is shortsighted and concerning.

• Investment spending by the government, especially discretionary spending done through the appropriations process, has been declining over time. This widespread decrease in federal investment spending threatens economic growth in the future since most of our growth will need to come from increases in worker productivity.

• Like with non-defense discretionary spending, defense spending is also declining as a share of the economy (GDP).
• This might seem a little surprising because often you hear people say that our entire budget problem is the result of the wars in Iraq and Afghanistan. As this chart clearly shows, we are spending less on defense than in our recent past and yet the budget situation has been getting worse.
• These numbers, and all of the numbers for defense in this talk include Iraq and Afghanistan war spending.

• One characteristic of the budget that is receiving a lot of attention in policy debates are the numerous deductions, exclusions, loopholes and special provisions in the tax code.
• Because these are economically equivalent to mandatory spending programs in that they involve the government encouraging and incentivizing behaviors with economic resources — and that such decisions are written into law and grow on autopilot — they have been given the name “tax expenditures” or “tax entitlements.”
• Almost half of all individual income tax revenue and corporate income tax revenue is lost due to these provisions.

• While the shorthand “loopholes” is sometimes used to describe tax expenditures, one glance at the list of the largest tax expenditures shows how they are large federal programs, deeply embedded in the fabric of the nation’s economic and social life. That is why they are as difficult to tackle as other entitlement programs.
• The problem with using the tax code for these purposes is that it is an inefficient and regressive delivery system for these benefits. They increase the complexity of the tax code — reducing efficiency. They also provide a larger benefit to those who earn the most income — making them regressive.
• Over 80% of Americans don’t earn enough income or benefit enough from the provisions to itemize their deductions. And, those in the higher tax brackets get substantially higher subsidies from the government for these behaviors because a deductions’ benefits are determined by one’s tax bracket percentage.
• The 2017 tax law reduced some tax expenditures by reducing the number of Americans itemizing deductions (notably reducing the amount ‘spent’ by the government on the home-mortgage interest deduction and the charitable contribution deduction). However, it also put in place a new, expensive deduction for certain types of business income.

• The size of our economy is measured by Gross Domestic Product (GDP), currently around $22 trillion.
• Economists like to measure the size of government not necessarily in dollar terms, but as a share of our economy.
• Major political battles are fought over which level is the “right” size of government—should it be 21% of the economy or 17%? But the problem is that we tend to have a “big government” spending program (21% of GDP) and a “small government” tax system (17% of GDP).  Whatever the right level of government spending is, we have to be willing to pay for it with our taxes.
• You can see that in the late 1990s and early 2000’s we had a unique situation where those averages were reversed — we were taxing at 20.5% of GDP and spending at 17.5% — that is why we had a brief period of budget surpluses under the Clinton Administration and the Republican Congress.
• The situation quickly reversed back to deficits after the tax cuts in 2001, then an economic downturn and the Wars in Afghanistan and Iraq. Then deficits increased dramatically due to the recession and the financial crisis.
• Currently, the lines are diverging again even though the economy has been growing. That is because of actions taken by policymakers and because we are entering into a new period of structural deficits due to demographic change.

• As borrowing grows in a normal or growing economy, so do interest costs.
• Increased interest costs mean we are dedicating a large amount of money to servicing our debt, a less productive use than other forms of spending. We already spend more on interest than Education, Transportation, and Homeland Security combined.
• The chart shows interest under the 10 year Congressional Budget Office baseline. The power of compounding interest works against us as borrowing increases, leading interest costs to be the fastest growing program in the federal budget.
• These projections are also sensitive to interest rates. If they rise faster than projected, we must spend more on interest payments.

• A large portion of the interest payments we make flow overseas due to the foreign investors who hold our debt.
• While access to foreign savings is a generally good thing that has helped keep our interest rates low and domestic investment relatively high, it does make our economy more susceptible to decisions that are out of our control and indicates we’re probably not doing enough of our own saving.
• Our low domestic saving and high indebtedness to other countries means that when these debts are repaid they represent flows of income out of the U.S. and into other countries; future generations of Americans won’t benefit the way they would if U.S. debts were paid back to mostly American investors.
• The top two major foreign holders of Treasury securities are China and Japan.

• The demographic transformation

• The prior charts deal with the short-term fiscal challenges the country faces, and yet that isn’t the bad news. The bad news is that the negative trends over the short-term continue even more dramatically over the long term.
• That is because over the long term, the federal budget faces rapidly rising mandatory spending in just three programs, Social Security, Medicare and Medicaid. All other federal spending in the non-defense discretionary budget, on national defense, and on smaller mandatory programs, is projected to shrink quite dramatically when measured against the size of the economy.
• Interest on the debt grows rapidly because of the mismatch between the growth in the “big three” and the revenue taken in from the inefficient and inadequate tax system.

• The percentage of the population age 65 and over (those who comprise the bulk of who benefits from the Social Security and Medicare programs) will grow rapidly while the working age population is projected to barely grow.
• This is largely the result of the large baby boom generation getting older and leaving the workforce while having had fewer children.
• Nearly 10,000 individuals reach the age of 65 every day.

• The demographic transformation

• When you look at how this aging affects entitlement programs, especially Social Security, it is instructive to think of the worker-to-retiree ratio since current benefits are paid for by current workers (one’s own benefits are not pre-paid as far as the Federal Budget is concerned). This chart shows how there were five workers supporting every one Social Security beneficiary in 1960 and that will shrink to two workers for every one beneficiary by 2030. This means there is a much larger burden on workers to support retirees.

• This chart shows the resulting deficits in Social Security. These deficits are caused by less workers paying into the system relative to the number of retirees collecting benefits. As such, the only options to close this gap would be to raise tax burdens on workers, shrink benefits for the retirees, a combination of the two, or piling on more debt.
• These numbers assume current levels of immigration, both illegal and legal.

• The total cost of Medicare — on paper — is projected to grow by 50 percent due to the aging of the population and health care inflation. However, this projection may prove optimistic because it assumes the Affordable Care Act (ACA) cost control and provider cuts are sustainable over the long term — something that the Medicare Trustees suggests might prove too difficult. Thus, they have an alternative scenario where these cuts do not continue throughout the entire projection period.
• With these more realistic projections, Medicare costs more than double over the long-term.
• Over the long term, the federal budget faces rapidly rising federal entitlement spending due to a combination of the aging of the population (retirement of the baby boomers) and to health care costs rising faster than economic growth.
• Without those factors, federal spending remains relatively stable as a percent of the economy. Looking at aging explains most of entitlement spending growth between now and 2035, and health care cost growth explains most of it beyond 2035. (Spending on Medicare and Medicaid is driven by both factors, while Social Security spending rises due to just the aging/demographic factor.)
• The Medicaid expansion and exchange subsidies are one-time contributors to growth in that they increase rapidly in the next few years, then settle in and grow along with the growth in health care inflation — cost growth attributable to their beneficiary population is expected to remain more stable than Medicare’s.

• If we continue on our current course, we are going to build up debt at an unsustainable rate — this is the main point from the beginning of our talk and the fundamental challenge for our nation’s fiscal future.
• Solving this problem is not out of our reach as a nation and numerous bi-partisan commissions made up of current members of Congress, former members, policy experts and business leaders have developed plans that stabilize the debt and even bend that curve of debt back down.
• Thus, action on this challenge is a matter of political will, not policy know how.

• Per-Person

• The Fiscal Wake-Up Tour and our other grassroots initiatives have demonstrated that people of different political and ideological perspectives can agree on the need to do something to get us off this unsustainable fiscal track.
• Although the potential economic consequences of continued fiscal irresponsibility are severe, they are mostly a concern about the future. That is why the issue should be of greatest concern to those who care about future generations and should be considered a moral issue as much as an economic one.

• Individual action to work on solving the nation’s fiscal challenges is a difficult thing to explain, because ultimately our political leaders have to make necessary changes in our tax and spending laws. One way to get involved and stay informed is to sign up for Concord’s Washington Budget Report, a weekly newsletter that has the latest developments on the federal budget and straightforward analysis on major tax and spending issues.