If we accept that it is possible to reduce non-defense spending in the federal budget by 50%, we now understand that even this drastic change in spending policies will not solve the problem of our growing national debt. Before I present the case for addressing federal entitlement programs, let me illustrate the debt problem with the following graph.
This graph shows that in 2015 federal government borrowed 38 cents of every dollar spent for both non-defense and defense spending. Obama’s 2017 budget projects that by 2025, the federal government will have to borrow 87 cents of every dollar it plans to spend for both non-defense and defense spending. All other federal revenue from various taxes will go to entitlements and interest. We cannot decide to pay less interest without defaulting on our debt. Therefore, entitlements represent a huge wall to be scaled in order to address the national debt effectively.
The term used in the federal budget for entitlements is “Mandatory Programs”. These include Social Security, Medicare, Medicaid, and Other. The federal government collects taxes from payrolls for Social Security and Medicare. All other entitlement programs, Medicaid, veterans’ benefits, etc. are financed mostly from individual and corporate income taxes.
Do the taxes collected specifically for Social Security and Medicare cover the expenses of those programs? They do not! In Obama’s 2017 budget, expenses for both programs grow faster than income through 2025. The following graphs illustrate the tax receipts and expenses for these two programs. Red equals income, blue equals expenses.
At least Social Security expenses are close to Social Security tax receipts, but Medicare expenses are more than two times Medicare tax receipts in 2015 and grow to three times expenses by 2025. In order to accomplish the goal of reducing the national debt, we will look at different scenarios for changing the trajectory of all entitlement programs, including reducing the growth rates of Social Security and Medicare expenses so that they are less than the growth rates of Social Security and Medicare tax receipts.
I have defined four alternative approaches to changing the mandatory entitlement programs. The first three are the same as the alternatives I defined for reducing non-defense spending:
Alternative #1: Gradual decline – growth rates are reduced in 2017 to 2020 to different amounts, and then set at 2.5% per year from 2021 to 2025. Average growth rate from 2015 to 2025 reduced to about 3.2% per year.
Alternative #2: Hold spending – growth rate of all mandatory programs set to 0% from 2018 thru 2025. Average growth rate from 2015 to 2025 reduced to about 1% per year.
Alternative #3: Shock treatment – growth rates are set to 0% in 2018 to 2020, and then set at 2.5% per year from 2021 to 2025. Average growth rate from 2015 to 2025 reduced to an average of approximately 2.5% per year.
In addition, I define a fourth alternative.
Alternative #4: Program Cuts – Social Security and Medicare are treated the same way as in Alternative #3, but Medicaid is completely eliminated by 2025 and all Other mandatory programs are reduced to the 2015 spending level by 2020 and held constant.
The following graphs are grouped so that you can easily compare the impact of each alternative on the Social Security and Medicare entitlement programs. In all cases, the objective is to alter the Social Security program so that Social Security taxes exceed expenses, and then to reduce the gap in Medicare expenses to income to 2 or less.
The resulting changes to the annual deficit shown below also include the previously discussed changes in non-defense spending. Furthermore, as the annual deficit turns to surplus, the total national debt is reduced and the amount of interest paid on that debt is reduced, which also has a positive impact on the federal budget.
I see good news in these illustrations. If the federal government can start to control spending in mandatory programs, as well as non-defense appropriations, it is possible to accomplish the following objectives:
- Produce surpluses in Social Security so that this politically treasured program does not go broke. This can be accomplished as early as 2021.
- Reduce Medicare expenses so that they are no more than 2 times Medicare receipts. This can also be accomplished by 2021.
- Change annual budget deficits into budget surpluses and start paying down our national debt. This happens around 2025 in the gradual alternative. In the most aggressive alternative involving real budget cuts in mandatory programs, the turning point is in 2020, and by 2025, we are paying off $1 trillion per year.
The impact of these alternatives on human lives is the subject of my next post. I will finish this post by examining the implications for the federal budget.
This graph shows the trend of the federal budget in each of the cases I am illustrating.
In the 2017 Obama budget, federal spending grows to $6.3 trillion by 2025. In the alternatives I present, federal spending grows to somewhere between $4 or $5 trillion.
Here is a comparison of the impact on the federal budget deficit. A negative value on this graph is a budget surplus.
Next, this is a comparison of the size of the national debt in each scenario.
Finally, this graph illustrates the differences in the amount of interest the federal government would be paying in each scenario.
As you can see, if the federal government even pursued the “Gradual Decline” alternative, it would be paying $126 billion less in interest than Obama is projecting for 2025. Also, the national debt would have leveled off at $21.9 trillion.
Recall from my previous post about the story of Fred where I showed a graph of the Income to Debt ratio of the federal budget through 2025. Each year the ratio was nearly equal to 18%. Another ratio will challenge this picture of the federal budget as being stable. It is the ratio of the federal budget to the size of the US economy. In 2015, the total US gross domestic product (GDP) was $17.9 trillion. The federal budget was $3.69 trillion, or 21% of the US GDP. Since 1947, on average the US GDP grows at the rate of 3.22%. In the second quarter or 2016, however, the growth rate was reported to be a mere 1.2%. Assuming that the rate of growth goes back to the average for the years 2017 through 2025, the US GDP will grow to $24.1 trillion. This graph shows the ratio of the federal budget to the US GDP for each scenario discussed.
As you can see, the Obama 2017 projections show that the federal budget will consume 26% of the US GDP by 2025 if the economy grows at the average rate since 1947. Alternatives 1, 2 and 3 put the federal budget on a course to consume somewhere between 19% and 21%. Alternative #4, the most aggressive scenario, reduces federal spending to 17% of the US GDP.
Let’s look at the case, however, where growth of US GDP continues to grow at the slow pace of 1.2% as reported in the second quarter of 2016. In this scenario, the US GDP would only be $20.2 trillion in 2025 and the federal budget will be consuming 31% of the US GDP by then!
Even the “Gradual Decline” scenario would mean that the federal budget is consuming 25% of the US GDP. From 1947 to 2015, the historical average of federal spending as a percent of the US GDP has been 19.2%. The only time it has ever been over 30% is during World War II. In order to maintain federal spending at the level of 20% to 23% of the US GDP, the federal government clearly will have to invoke some sort of shock treatment or dramatic cuts to current entitlement programs and non-defense spending.