YOUNG: Entitlement spending hidden behind defense

COMMENTARY:

entitlements. The spending resulting from these mandated payments to “entitled” individuals is the recognized future threat to fiscal stability.

However, attention is so focused on the coming tsunami that America has neglected the rising tide over the last 60 years. Now just below its fiscal chin, the red ink rose gradually and, as importantly, was masked by an equally dramatic decline in defense spending.

Despite the continuous clamor over the federal budget, it seems very stable. Over the last 60 years, spending has averaged 19.5 percent of gross domestic product (GDP), revenues 17.9 percent and the deficit 1.6 percent. In 2007, spending and revenues were slightly higher (20 percent and 18.8 percent, respectively) and the deficit slightly below average (1.2 percent). But beneath this surface stability there has been a dramatic shift from defense to entitlement spending.

The 60-year averages of defense (6.4 percent) and entitlements (5.1 percent) are closely balanced. However as the accompanying table shows, these six decades encompass four distinct periods. The first period, 1947-73, was the hot part of the Cold War - the Korean and Vietnam wars. The second period, 1974-89, the cool part of the Cold War; the third, the post-Cold War; and the fourth, post-Sept. 11, 2001. Starting from the astronomical levels of World War II, defense spending fell in each of the first three. Only after Sept. 11, 2001, has defense spending even slightly reversed five decades of decline.

In each period, entitlement spending has at least taken up the slack. It started slowly in the first period, prior to the mid-1960s origins of Medicare and Medicaid (two of the largest entitlement programs). These two health-care programs are uncapped entitlements, their spending limited only by generosity of the benefits offered and the individuals’ use of them. Because Washington has been exceedingly generous and the public uses free goods freely, their enormous spending potential helped trigger rapid entitlement spending growth.

At the end of this 60-year period, defense and entitlement spending had roughly traded places. This allowed the largest spending exercise in U.S. history to be absorbed without dramatic impact on the federal budget. That budget elasticity has now ended.

With declining defense spending gone and Baby Boomer retirements beginning in 2011, America confronts unmitigated and unleashed entitlement spending. According to the Congressional Budget Office, the three largest entitlement programs - Social Security, Medicare and Medicaid - alone will increase from 8.4 percent of GDP in 2007 to 25 percent in 2082.

Even this enormous increase to a quarter of U.S. economic output is built on the conservative assumption that “rates of spending growth in the Medicare and Medicaid programs would probably moderate to some degree” to below their past performance.

On the ledger’s other side, CBO assumes very high revenue levels via the 2001 tax cuts’ expiration, the Alternative Minimum Tax’s full effect, and all existing short-term tax cuts disappearing. Even so, revenues project to only 25.5 percent of GDP in 2082. Though this is 22 percent higher than the previous all-time high (reached in 1944 and 2000), this would still just cover the cost of the three most expensive entitlement programs!

Entitlements have not drained the economy because they drained the only part of federal spending that Washington was willing to reduce: defense. This was endurable because conventional threats were decreasing - primarily due to a strong defense commitment. However, as Sept. 11 demonstrated, reduction can not be an indefinite exercise.

It is also important to recognize that CBO’s tax estimates refute assertions that taxes need only be slightly raised to sustain entitlement spending. CBO’s tax projections include tax increases across the income range - including the insidious AMT, which all now lament as sweeping in ever more of the middle class. Despite a tax system more onerous than anyone now is willing to countenance, the taxes raised are insufficient to sustain entitlements and the rest of the federal budget.

For many the entitlement tidal wave is a new story. In fact, it is merely the retelling of an old one. Both stories reach the same conclusion: uncontrolled spending. There is no longer a silent spending cut to offset entitlements and even the most draconian of tax codes and tax levels can not produce enough revenue to support it and the rest of the federal government.

The entitlement flood of the last 60 years sets an ominous tone for the future - because as obvious as it is that this spending must be controlled, it is equally clear it never has been.

J.T. Young served in the Treasury Department and the Office of Management and Budget from 2001-04 and as a congressional staff member from 1987-2000.