2004 February 16 Monday
Democrats, Republicans Ignore Long Term Gov't Finance Problem

Robert Samuelson points out that 70% of the projected fiscal 2004 budget deficit is not due to Bush's tax cut of 2001.

Democrats commit the same sin. They're gleefully denouncing Bush's tax cuts for the super-rich as creating reckless deficits. This is not exactly true. For fiscal 2004, the Congressional Budget Office has estimated the causes of the swing from a once-predicted surplus to today's deficit as follows: 40 percent, a weaker economy and "technical re-estimates" of spending and taxes; 30 percent, higher spending (mostly for defense and homeland security); and 30 percent, tax cuts. Even without tax cuts -- which also benefit the middle class -- there'd be big deficits.

Samuelson argues that both parties are failing to deal with the long term financial problem that the US government faces. The biggest cause of the financial problem is the growth of the entitlements programs for old age.

In a Business Week article Christopher Farrell say the long-term gap between obligations and tax revenue is in the tens of trillions of dollars.

Taking into account the funds that need to be spent on this demographic time bomb lifts the long-term fiscal gap to $44 trillion. That's the "optimistic" calculation made by sober economists and green-eyeshade budget experts drawn from the U.S. Treasury, the Federal Reserve, the Office of Management & Budget, and the Congressional Budget Office during the tenure of former Treasury Secretary Paul O'Neill.


The leaders of the study, Jagadeesh Gokhale and Kent Smetters, estimate that restoring fiscal sanity requires either hiking federal income tax collections by 69% or raising payroll taxes by 95%. Don't want to raise taxes? Well, Social Security and Medicare benefits could be slashed by 56%. Another alternative is to cut federal discretionary spending by more than 100% (although that's impossible).

I am skeptical of Farrell's claim that the Bush Administration's restrictions on education spending are going to make matters worse. The whole education industry is incredibly inefficient. It cries out for automation and great reforms to accelerate the rate of education. In fact, one of my favorite policy suggestions to help deal with the declining ratio of net taxpaying workers to retirees and other recipients of government benefits is to acclerate education of the young to put them into the labor market at earlier ages. People who go to college and graduate school and do not enter the labor market until their mid to late 20s are a source of costs rather than sources of tax revenue and production. If children went to school all year around and went to college sooner they'd get into the labor market sooner and become net assets to the economy sooner. This would lower the cost of raising children while simultaneously increasing tax revenues and the proportion of the population that is working.

The number of Medicare beneficiaries is going to grow even as the cost in benefits paid per beneficiary grows due to the prescription drug bill and to the general increase in available treaments as a result of advances in medical science.

The CBO projected last summer that the growth in the number of Medicare beneficiaries will rise from about 1 1/2 percent a year between 2005 and 2008. Between 2009 and 2013 that growth doubles to 3 percent. In the years thereafter we see the steady retirement of the baby boom generation.

Medicare and Social Security spending will double by the year 2030.

In his written testimony, he noted that increased demand for Medicare, Medicaid and Social Security will rise significantly as a percentage of GDP. Social Security and Medicare cost $745 billion in 2003, about one-third of government spending and 6.9 percent of GDP.

By 2014, Social Security and Medicare spending is expected to rise to $1.5 trillion, or 42 percent of federal spending and 8.4 percent of GDP. The CBO estimates that this number could rise to more than 14 percent of GDP by 2030.

A Winter 2003 paper from the National Bureau of Economic Research (NBER) examines the effects of existing retirement programs in incentivizing late middle aged people into retiring early in a publication entitled Social Security and Retirement Around the World.

The United States and many other developed countries around the world face looming financial crises in their social security programs. For example, member countries in the Organization for Economic Cooperation and Development are projected to experience a roughly 50% increase in the share of GDP devoted to old age pension expenditures over the next fifty years, from 7.4% of GDP to 10.8% of GDP. (1) The aging of the population is widely recognized as one important cause of these financial crises - most countries' programs are financed on a "pay as you go" basis, and a rising fraction of the population will be retired and collecting benefits as the population ages, causing program expenditures to swell. Less attention has been paid, however, to the fact that the provisions of social security programs often penalize work beyond the first age of benefit eligibility. If workers are induced to retire earlier as a result of these incentives, this will magnify the financial burden caused by population aging.

We need changes in public policy to give people greater incentives to work more years into their early old age. The longer people work the longer they will pay taxes and the less they will receive in benefits from all the other taxpayers. At the same time, the point of entry into the labor force needs to happen sooner in life so that people become taxpayers sooner. But neither political party wants to be the first to tell the public news they are going to be unhappy to hear. Do not expect leadership on this issue to come from elected officials.

Update: In a December 2002 Tech Central Station article Arnold Kling focuses in on the expected growth in Medicare spending and the need to gradually raise the age for Medicare eligibility.

As large as Social Security looms when the Baby Boom retires, it will be smaller as a proportion of GDP than Medicare. An analysis for the Concord Coalition reports that starting from a current ratio of 2.2 percent of GDP and making some conservative assumptions "just the increase in Medicare spending over the next forty years - 4.5 percent of GDP - would be greater than everything we spend today on Social Security."

Arnold is correct. People are going to have to continue under private medical insurance and stay in the workforce longer or the United States is going to become like Europe with long term slow growth rates. The US is in danger of entering a period of economic stagnation if old age spending is allowed to grow to the point where taxes to fund it choke off economic growth.

Share |      By Randall Parker at 2004 February 16 10:00 PM  Economics Political

Mike Trier said at February 17, 2004 8:11 PM:

Did anyone read a recent article on the pharmaceutical industry pointing out that there is a lack of new drugs in the developmental pipeline to replace many of the high revenue generating drugs currently under patent protection? Once the patents run out prescription prices should go down as generic substitutes become available. The budget analyst in me thinks that these projections on the medicare prescription benefit may well be overstated. There may also be a failure to recognize an improvement in the general health profile of the new retirees. Future projections based on old cost relationships linked to demographic shifts could substantially puff up the forecast numbers. However, there may be some real political benefit in this for the Republicans if you are trying to cut spending on programs you don't like.

Fly said at February 18, 2004 3:03 PM:

Advanced biotech will lead to relatively inexpensive cures instead of costly long-term management of disease. Old people will be healthy, energetic, and productive. No longer hampered by failing health and diminished mental abilities, seniors will be fully capable of supporting themselves. As their numbers grow, they will have to do so.

Rather than projecting future economic disaster, I suggest that we instead identify the major diseases or conditions that dominate health costs. Aggressively fund research for prevention and low cost cures. (This is already happening but could be accelerated.)

View seniors as potentially productive members of society. Aggressively fund research to restore diminished mental and physical capabilities.

Sell this program to seniors. The country aggressively treats the diseases and ailments of age and in return the healthy, long-lived seniors support themselves.

Randall Parker said at February 18, 2004 3:17 PM:

Fly, I'm all for research to reverse aging. But the idea that we can reverse aging is far from the mainstream. What you propose can not be sold politically. In fact, as the demands for immediate money to pay people who are old and to treat their present ailments increases the ability to raise research spending will decline. That is already happening right now.

Yes, eventually what you describe will happen. But when? In the meantime taxes will rise. Entitlements spending will rise. It is already happening and has been happening for decades. The decline in defense spending in the 1990s was matched by rises in Social Security amd Medicare.

Heck, push out the availability of entitlements to later ages and people become more eager for treatments that enable them to remain productive. Necessity is a mother.

As for targetting diseases: Useful working life can be better extended with rejuvenation therapies than with disease treatments. Cure cancer and prevent a few other diseases and old folks will still get getting older with their minds and bodies slowing down.

More generally, it is hard to sell people on pursuing basic and applied research to solve problems. This is equally true for aging and fossil fuels energy dependency. I advocate for both and do so repeatedly. But I'm not optimistic that attitudes will shift rapidly on either topic.

Randall Parker said at February 18, 2004 3:24 PM:

Mike, Yes, the drug pipelines are looking pretty barren. But keep in mind that even as their has been a marked shift toward the use of generics the total spending on drugs has risen. Also, drugs spending is only about a tenth of total medical spending.

Programs I don't like: Look at the big picture. The government is going to eat up another 7% of GDP by 2030. That means the private economy is not going to produce as much and total production will not be as great as it otherwise would have been. The Republicans can not hope to cut the absolute size of any major enitlement program. They are all going to grow in size. So proposals for what are called "cuts" really should be labelled "reductions in the rate of growth above the rate of inflation and total population growth".

As for drug pipelines in the longer term: I expect eventually this pattern to reverse as new biotech advances enable more effective methods for searching for new drugs and other types of therapies. Gene therapies, immunotherapies, and other therapies are going to become more common. So I do not think it makes sense to count on the drug pipeline to stay so depressed.

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