July 22, 2014

Hidden in Plain View: Aging, Health Care Costs and Interest Drive the Budget

For those inclined to look beyond the sharp drop in the deficit this year, as we should, the budget update released by the Congressional Budget Office (CBO) on May 14 has some striking indications of things to come. 

Not surprisingly, these indications tell us that the most powerful factors in the current budget dynamic are aging, health care costs and interest on the debt -- things political leaders seem the least interested in doing anything about.

One way to show the looming problem is to compare the composition of federal spending in 2013 with 2023 under the CBO current-law baseline. During those 10 years, total spending is projected to rise from 21.5 percent of the economy (GDP) to 22.6 percent. However, it is far from a uniform acceleration.

Discretionary spending, which includes defense, is projected to shrink from 7.6 percent of GDP to 5.5 percent, the lowest level on record.  

Mandatory spending other than Social Security and the major health care programs is also projected to shrink, from 2.6 percent of GDP to 2.1percent. Between these declining categories, the total drop in spending totals a very substantial 2.5 percent of GDP.

The reason that total spending goes up, however, is that Social Security, health care programs and interest on the debt all grow faster than the economy, by a cumulative 3.6 percent of GDP, canceling out the savings in other programs.

The deficit shrinks over the 10 years because revenues rise from 17.5 percent of GDP to 19.1 percent. Even so, the debt is 74 percent of GDP and rising at the end of the 10-year budget window by 2023.

The lesson for policymakers is clear. Even with remarkable restraint on discretionary spending and higher taxes on “the rich” from the fiscal cliff deal, not enough has been done to put the budget on a sustainable path. Nor will it ever be enough if those are the boundaries of deficit-reduction efforts.

Policymakers like to crow about how much spending they’ve cut or plan to cut, but the real cost-driving dynamic is not waste, fraud and abuse or even a bloated defense budget. It’s about structural issues such as aging, which increases the number of beneficiaries for major entitlement programs every year, and health care costs, which tend to grow faster than the economy and compound the budgetary effects of aging. And it’s also about an inefficient revenue system that is not up to the challenge of an aging population.

Fiscal reforms that leave health care programs and Social Security largely untouched or that pursue “revenue-neutral” tax reform will leave us stuck in a fiscal ditch.

It’s not ideology; it’s arithmetic.