Federal budget deficit to balloon

The federal deficit is expected to more than double to $1 trillion next year, but budget experts concerned about the fiscal impact of Social Security, Medicare and Medicaid think 2009 will be remembered as the good old days.

Now that the first of the nation’s 76 million baby boomers have reached age 62 and begun to collect their Social Security checks, the demographic time bomb no longer seems such a distant threat. Indeed, baby boomers will begin filing Medicare claims in 2011, just as the next president begins his campaign for a second term.

Judged by the proposals of Sen. John McCain, Arizona Republican, and Sen. Barack Obama, Illinois Democrat, to address the potentially catastrophic fiscal explosion, neither presidential candidate seems prepared to deal with the long-term fiscal tsunami that has been gathering force for years.

“If they implemented their policies as stated, they would make the deficit and the national debt problems worse,” said David Walker, the former comptroller general who headed the Government Accountability Office (GAO). “My hope is that the winning candidate has an epiphany,” he told The Washington Times.

“Beyond the current crisis, the biggest economic question facing the candidates is the threat to the long-term fiscal health of the country caused by changing demographics and soaring health care costs,” said Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget. “What is striking in the presidential campaign is the notable absence of a discussion about how to address these long-term challenges.”

Because the candidates are focusing on the current economic crisis, “they’re not talking about the long-term entitlement problems,” said Diane Lim Rogers, chief economist of the Concord Coalition, a nonpartisan organization concerned about the challenges facing America’s unsustainable entitlement programs. “They have not got very specific. They rarely bring up Medicare and Social Security in their speeches today except to criticize the other’s proposals.”

Addison Wiggin, executive producer of the debt documentary “I.O.U.S.A.” and co-author of a prescient 2006 book, “Empire of Debt: The Rise of an Epic Financial Crisis,” said he is “greatly disappointed by the fact that the candidates won’t discuss the entitlement crisis before the election. They won’t talk about it because they can’t get votes that way. They’re getting a free pass.”

Long-term budget challenges

The Congressional Budget Office’s latest annual report examining “The Long-Term Budget Outlook” details the problem. The CBO reported that federal spending on the three largest entitlement programs (Social Security, Medicare and Medicaid) was on track to increase from 8.4 percent of gross domestic product in 2007 to 18.1 percent in 2050 and 25 percent or more in 2082.

Although Social Security today is significantly larger than Medicare, the retirement program’s long-term problems are relatively manageable compared to those of Medicare, the health care program for the aged.

Social Security outlays, which hovered around 4.4 percent of GDP in 1987 and 2007, are expected to stabilize slightly above 6 percent in 2050.

Medicare spending, however, is projected to increase from 1.6 percent of GDP in 1987 and 2.7 percent in 2007 to 8.9 percent in 2050 and 14.8 percent in 2082.

Federal spending on Medicaid, the health care program for the poor, would rise from 0.6 percent of GDP in 1987 and 1.4 percent in 2007 to nearly 4 percent in 2082.

In its baseline scenario, which assumes that President Bush’s 2001 and 2003 tax cuts are allowed to expire at the end of 2010 and that revenues from the alternative minimum tax (AMT) are allowed to soar, ravaging the middle class, CBO projects the budget deficit would exceed 18 percent of GDP in 2082. That’s about triple the share of GDP that a $1 trillion deficit would command this year.

Under more realistic scenarios, which would prevent the AMT from affecting more middle-class households (as Mr. Obama and Mr. McCain say they would do) and extend many (Mr. Obama) or nearly all (Mr. McCain) of the Bush tax cuts, then the deficit would be far higher - so high, in fact, that CBO’s model (and the economy) would implode long before 2082 arrived.

Unfunded obligations

Another way to grasp the severity of the problem is to answer a simple question: Above and beyond the payroll tax receipts and beneficiaries’ premiums the programs will receive in the future, how much money would the two largest entitlements - Social Security and Medicare - have to invest in interest-bearing accounts today in order to meet their benefit commitments during the next 75 years?

These “present-value” totals are the “unfunded obligations” of the programs. Not only are they huge, but they are also growing very rapidly. That’s especially true for Medicare because health care costs are rising so much faster than the economy’s output.

According to the 2007 Financial Report of the U.S. Government, prepared and issued by the U.S. Treasury, Medicare’s unfunded obligations totaled $34 trillion last year. That included more than $8 trillion in unfunded obligations for Medicare’s prescription-drug program, which Congress passed in 2003.

Social Security’s unfunded obligations in 2007 were nearly $7 trillion. To be fair, this sum included $2 trillion of bonds in Social Security’s trust funds. However, those assets can only be redeemed by dipping into general revenues or by borrowing because the White House and Congress have already spent the money. Remember Al Gore’s lockbox? Well, someone picked the lock.

Mr. Walker, the former comptroller general, reported earlier this year that the $41 trillion in unfunded obligations in 2007 represented an increase of more than 200 percent since 2000 alone, when they totaled $13 trillion.

“The window for timely action is shrinking,” the GAO warned Congress (again) in a June report. “Albert Einstein said the most powerful force in the universe is compound interest, and today the miracle of compounding is working against the federal government,” the GAO explained. “Meeting this long-term fiscal imbalance is the nation’s largest sustainability challenge.”

The long-term fiscal challenge has already begun - and the trends are ominous.

This year, the outlays for Medicare Part A (hospital insurance) will exceed cash income, which is generated by a payroll tax. In two years, Social Security’s cash surplus, which is being used to finance other federal spending, will begin declining, putting pressure on the rest of the budget. In 2017, Social Security’s cash flow turns negative, requiring still more borrowing or the use of general tax revenues to fund benefits. In 2041, the Social Security trust funds will be exhausted, and payroll-tax receipts will be sufficient to pay only about 75 percent of promised benefits.

There are no trustee reports on Medicaid, which is funded jointly by the federal and state governments.

Social Security proposals

Presidential candidates are reluctant to stick their necks out proposing entitlement reforms.

“Understandably, talking about the necessary reforms is not always welcomed by the voters, whether the changes are tax increases, slowing the growth of benefits or increasing the retirement age,” said Ms. MacGuineas. Social Security did not earn its reputation as the third rail of American politics for nothing.

Even relatively minor forays into the entitlement-reform arena can be treacherous for politicians. For example, in an effort to demonstrate that he would not begin a negotiation over Social Security with an ultimatum, Mr. McCain said all options would be on the table, even payroll-tax increases, which he opposes. He was immediately pilloried by conservatives, including talk radio and the Club for Growth.

In the past, Mr. McCain has supported personal investment accounts by diverting a portion of Social Security’s payroll taxes. Now he says he favors personal investment accounts as a supplement to Social Security. In September, he repeatedly told AARP, the nation’s largest group of older Americans, that he did not support privatizing Social Security. Mr. McCain talks favorably about the 1983 compromises reached between President Reagan and House Speaker Tip O’Neill based on the work of the Social Security commission headed by Alan Greenspan.

Mr. Obama has always opposed any privatization of Social Security. He also opposes reducing Social Security benefits for “current and future beneficiaries alike,” including raising the retirement age. Mr. Obama says he is considering assessing a Social Security tax in the range of 2 percent to 4 percent on income above $250,000. Currently, only the first $102,000 in wage and salary income (adjusted for inflation each year) is subject to a 12.4 percent Social Security payroll tax, which is split between employee and employer. Mr. Obama would eliminate income taxes for seniors earning less than $50,000.

Medicare fireworks

In early October, after Douglas Holtz-Eakin, Mr. McCain’s chief economic adviser, told the Wall Street Journal that the Republican candidate planned to pay for his health care plan in part by achieving savings in Medicare and Medicaid, the Obama campaign charged that Mr. McCain would cut Medicare by nearly $900 billion over 10 years, representing “a 22 percent cut in benefits.”

In a conference call with reporters, Mr. Holtz-Eakin insisted that the McCain plan would provide seniors with “exactly the same benefits.”

One McCain reform that would generate cost savings would subject the prescription-drug subsidy to a means test. Mr. McCain voted against the 2003 Medicare prescription-drug plan in large part because the legislation included subsidies for the affluent.

Mr. Obama would expand the drug program by eliminating the “doughnut hole,” which suspends prescription coverage after the first $2,500 and then begins covering 95 percent of the costs after $5,700. Mr. Obama would allow Medicare to negotiate for cheaper drug prices, and he would allow seniors to import cheaper drugs from overseas.

Mr. McCain supports a commission to address Medicare’s challenges.

Both campaigns have endorsed many similar Medicare cost-saving proposals, including computerizing health records, reducing fraudulent Medicare claims, increasing the use of generic drugs, more effectively managing chronic diseases and emphasizing preventive care. Mr. Obama would eliminate subsidies for private Medicare Advantage plans, while Mr. McCain would maintain Medicare Advantage.

On Medicaid, Mr. McCain would give states greater flexibility managing their costs. While giving states flexibility to reform their health policies, Mr. Obama would expand eligibility for Medicaid.

Neither candidate has offered nearly enough reforms and savings options to close the ever-widening fiscal gap caused by the large entitlement programs, said Brian Riedl, a budget analyst at the Heritage Foundation.

“Obama’s proposal to eliminate Medicare’s prescription-drug doughnut hole would dig Medicare’s fiscal hole deeper,” Mr. Riedl said. “Since Obama has ruled out increasing the retirement age and adjusting Social Security benefit levels, that leaves only tax hikes, and his tax proposal would not significantly close the long-term funding gap,” Mr. Riedl said.

“McCain’s proposals would likely do more to fix the long-term entitlement problems,” Mr. Riedl said, largely because of his “openness to address Social Security, Medicare and Medicaid spending by bringing it in line with revenues.”

Ms. MacGuineas of the bipartisan Committee for a Responsible Federal Budget said many experts agree that a compromise package of reforms would likely include several of the following: raising the retirement age, increasing Medicare premiums and reducing Social Security benefits for the affluent, adding a surtax on income and increasing health care efficiency - although she stressed that improvements in health care information technology will not be a magic bullet.

Addressing the larger problems posed by Medicare and Medicaid, Ms. MacGuineas said, “The bottom line is the country will have to come to terms with how much health care we want and how we intend to pay for it.”

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