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Executive Summary #1897 on Federal Budget

November 30, 2005

November 30, 2005 | Executive Summary on Federal Budget

Executive Summary: Entitlement-Driven Long-Term Budget Substantially Worse Than Previously Projected

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Federal budget projections consistently warn that America faces a future of unaffordable entitlement spending, deep federal debt, and economic stagnation unless lawmakers modernize runaway entitlement programs. This paper shows that the long-term budget picture may even be substantially worse than previously projected.

Specifically, a realistic budget projection shows that combined nominal Medicare, Social Security, and Medicaid spending will double over the next decade. Adding in the costs of the war on terrorism, Hurricane Katrina, and other congressional spending priorities pushes total 2015 federal spending well past $4 trillion, and the budget deficit to $873 billion-a level that could lead to harmful tax increases.

Dismal Budget Picture. The 2006-2050 budget picture is even more dismal. Because of the cost of fully funding Social Security, Medicare, and Medicaid, leading long-term budget projections have calculated that federal spending will increase from the current 20 percent of gross domestic product (GDP) to a peacetime high of nearly 33 percent of GDP by 2050.

Yet even that may be a severe underestimate. These projections assume slower entitlement growth than estimated by the Social Security and Medicare trustees as well as substantial reductions in defense and other spending. Most critically, they assume that the resulting unprecedented increase in the national debt will not affect interest rates. More realistic assumptions show that Social Security, Medicare, and Medicaid costs will leap from 8.4 percent of GDP to 18.9 percent of GDP by 2050. Unless lawmakers reform these programs, they will have to fund their costs by:

  1. Raising taxes every year until federal taxes are 57 percent ($11,000 per household, adjusted into today's economy) above the current levels;
  2. Eventually eliminating every other federal program, including spending on defense, education, anti-poverty programs, and veterans benefits, by 2045; or
  3. Running massive budget deficits (the status quo option). This is the most expensive option because it would cause the federal debt to increase from the current level of 40 percent of GDP to 500 percent of GDP. Beginning in 2025, just a small interest rate response would push federal spending to 44 percent of GDP by 2040 and 73 percent by 2050-levels twice as high as previous projections.

Those who consider these scenarios overly pessimistic should examine the Western European economies that are already sinking under the weight of their enormous social insurance systems. With birth rates that are not even sufficient to replace their current population, many "old Europe" nations have been forced to impose steep tax increases on their remaining workers to fund these bloated benefit systems.

Overall, government spending in the 15 nations comprising the pre-2004 European Union (EU-15) averages 48 percent of GDP, and tax revenues average 41 percent of GDP. These high tax rates and expenditures, combined with tight economic regulations, have hammered their economies. Compared to the United States, per capita income is 30 percent lower in the EU-15, economic growth rates are 34 percent lower, unemployment is substantially higher, and living standards match only America's poorest states.

As their populations continue to age, the economies of countries such as Germany and France risk collapsing under the weight of their unrealistically generous retirement and welfare systems. These European crises provide a glimpse into America's future if government spending continues to increase steeply.

Conclusion. The data presented in this paper are not predictions of what will occur. They merely represent three painful possible outcomes if lawmakers choose to continue on their current course with Social Security, Medicare, and Medicaid. The data show that unreformed entitlements not only could cause significant economic pain, but also could eventually place the entire American economic and financial system in crisis. Modernizing entitlements and averting this calamity is the most important economic challenge of this era.

Brian M. Riedl is Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

About the Author

Brian M. Riedl Grover Hermann Fellow in Federal Budgetary Affairs
Thomas A. Roe Institute for Economic Policy Studies