Facing America’s Long-Term Budget Challenges

Facing America’s Long-Term Budget Challenges Brian Riedl Grover M. Hermann Fellow for Federal Budgetary Affairs The Heritage Foundation

Washington is Spending Nearly $30,000 Per Household in 2010

Above-Average Spending – not Falling Revenues –is Driving Long-Term Deficits Upward

Composition of Federal Spending: 1962-2020

The Long-Term Challenge • 77 million baby boomers will retire between 2008 and 2029. • Ratio of workers supporting each retiree: • 1960 – 5-to-1 • 2010 – 3-to-1 • 2030 – 2-to-1 • By 2030, a married couple will have to support themselves, their children – and their very own retiree. • In addition to demographics, Medicare also must deal with rising health care costs. • Senior health care will also push up Medicaid costs.

Social Security, Medicare, & Medicaid Costs As a Percent of GDP

Option 1: Tax IncreasesPer Household & Translated Into Today’s GDP

Option 1: Implications • Would have to raise taxes every year until they were 10.2% of GDP higher than today. • In today’s economy, a 10.2% of GDP tax increase would average $12,072 per household. • Marginal tax rates would likely more than double. • Combined federal, state, and local taxes would reach European levels. • Generally, these high tax rates have been shown to reduce economic growth, depress incomes, and increase unemployment.

Option 2: Other Program CutsYearly Budget Breakdown, Assuming No Tax Hikes or Budget Deficits

Option 2: Implications • Would have to immediately begin terminating programs to make room for Social Security, Medicare, Medicaid, and interest on past debt. • By 2030, defense would be the only other remaining program. • By 2049, defense would have to be eliminated too. • By that point, 100% of the budget would go towards Social Security, Medicare, Medicaid, and interest on past debt. • Clearly, this is not realistic.

Option 3: Continue Current PoliciesAnd Cover Shortfalls With Budget Deficits

Option 3: Implications • Hold all taxes and other spending constant as a percent of GDP, and then cover shortfalls with budget deficits. • Borrowing 10.2% more of GDP per year ($1.4 trillion more in today’s economy) would raise the federal debt to levels never seen before. • Such debt could increase interest rates, which would in turn trigger an exponential increase in federal debt and net interest costs. • Such large expenses could create an economic crisis.

Option 4: Modernize Social Security, Medicare, and Medicaid • Reform is the only way to avoid the scenarios listed above. • Delays only push up the final reform costs. • Hold harmless those under age 50? Four million baby boomers cross this threshold annually. All will have by 2014. • Some pain now, or more pain later.

Conclusion • This issue is about more than economics. It is about the future we want. • There is a moral question of whether one generation should hand a multi-trillion dollar retirement bill over to the next generation. • In the absence of fundamental reform, those entering the workforce today will experience both higher lifetime tax rates and lower incomes than their parents as a result of these retirement costs.

Facing America’s Long-Term Budget Challenges