Our Debt and Deficit Mess — The Real Story

This week at the conventions there has been a lot of talk about the US debt and deficit.  The debt has spiralled up toward 100 percent of GDP, and the deficit to over $1 trillion.  Awful, right?  Yes — it’s a problem that must be addressed before it undermines the US dollar and the US economy.

But how did we get here and how do we get out?  The answer lies not with President Obama, nor President Bush, nor with any particular president or party.  Nor is it just a matter of handouts to the poor that need to be pulled back (as Paul Ryan suggests with talk about a ‘hammock’ of government support) nor of tax cuts for the rich that need to be ended (as President Obama insists).

The problem began much earlier, from the 1930s to the 1960s, when bipartisan majorities passed the popular social security and medicare programs to provide pensions and health care to struggling seniors — programs that over the following years were pumped up with added coverage and indexing to inflation.

When social security began paying benefits in 1940, only 55% of Americans lived to see age 65; today 85% reach age 62, when many start taking their social security payments.  In addition, people’s life span after reaching 65 has increased by about 40%.  Altogether, the number of Americans over 65 has increased fivefold since 1950, from 8.3 million to 41.1 million, while the total US population has only just doubled.

Even more importantly, in the 1950s, health care for the elderly consisted mainly of aspirins, antibiotics, and fluids, with an iron lung in emergencies.   One reason there were fewer people who lived much past 65 is that heart attacks, cancers, and even falls for the elderly were all too often fatal.  Since then, as available procedures and costs to save, extend, and improve lives have multiplied many-fold (heart, kidney and liver transplants, pacemakers and stents, joint replacements, cataract surgery, anti-cancer drugs and drug treatments for high blood pressure, diabetes, depression, and other ailments), the amount spent on health care for seniors has skyrocketed.   These changes have driven medicare costs up from 3.5% of federal expenditures in 1970 to 15.1% today.

The US made a set of decisions from the 1950s to the 1970s:
(1) We will have a privatized, market-driven health care system that provides the most expensive health care in the world,
(2) We will provide basic pensions indexed to inflation for all seniors, and
(3) We will provide free health care to all seniors

Having made those decisions, the rise in life expectancy and the run up of health care costs inevitably drove a massive increase in transfer payments over time, regardless of which party was in power.  $1.9 trillion of the 2012 federal budget goes to pay for health care (to medicare, medicaid, and veterans), social security and federal retirement.  That’s over half of all federal expenditures that’s been driven entirely by demographic change and escalating health care costs.

As to all those federal spending entitlements that Republicans denounce as corrupting, like unemployment benefits, school lunches, food stamps, etc., all those income support programs total much, much less, under $600 billion (less than a third of the health/aging driven transfer payments), and that is after
four years of exceptionally high unemployment from a cyclical

Still, the US budget was in balance under President Clinton.  That is because while the huge cohort of baby boomers were in their prime earning years, their payments into medicare and social security paid the costs of those programs and more.   That is why the Congressional Budget Office, under George Bush, said it was okay to fight two large wars and cut taxes.  But the CBO warned that in 2011, when the baby boomers started to retire, the rising costs of entitlements for social security and medicare would start to surge, while the boomer pay-ins would start to decline.  That is why the Bush tax cuts came with an automatic expiration date of 201o; even a dozen years ago, when we thought the Iraq war would pay for itself and before the Great Recession was in sight, it was clear that if the Bush tax cuts were extended past 2010 the federal deficit would start to explode.

There are some other factors that mattered too.  Social security taxes are only collected on the first $110,000 of income; everything above that is social-security exempt.  But since the 1980s, the wages of most Americans have stagnated, while the incomes of those making more than $110,000 has shot up.  So much less of the total growth in earnings has gone into paying social security taxes than would have been the case if earnings were more evenly distributed.  In addition, Medicaid eligibility has expanded faster than anticipated as the number of Americans in poverty has gone up in recent years, not down as was expected.

Still, the core of our federal debt and deficit program was created by our decision to take care of our elderly population, followed by the rapid growth of that group and their health care costs as we did the wonderful things that extended and improved their lives.

What we need to beat back the deficit problem is to restructure retirement (have people work longer, at least part time, and not go on medicare until they fully retire); restructure social security taxation and benefits (less generous indexing, more means testing so people with higher incomes don’t get extra funds they don’t really need and funds are available to those in need, and ending the exemption of high incomes from social security taxation), and most of all, find ways to restrain the growth of health care costs, which are at least half again as high in the US as a share of GDP as in any other rich nation.

Mitt Romney praised Israel’s health care system when he was there, noting that Israel spends only 8% of GDP on health care, while the US spends 18% of GDP.  Yet Israel has an Obamacare like health system on steroids, with mandatory insurance and strong national
regulation of health care to contain costs.  If the US matched Israel in its health spending efficiency, we could cut the cost of Medicare and Medicaid by $400 billion per year, and eliminate half the federal deficit at one blow!

But we have a health care sector that insists on market-driven pricing that supplies health care for a profit at whatever cost the market will bear.  That is the American way, after all.  But it is foolish to blame our deficit problems on ‘runaway spending’ and ‘entitlements’ as if it was just voluntary spending choices that are at fault, when it is demography and escalating health care costs that have driven US entitlements to their current excessive levels.

We can get the debt and deficit under control.  Letting the Bush tax cuts expire as intended, ending the exemption of higher incomes from social security taxes, adjusting social security and medicare eligibility ages to reflect rising life expectancies (as several other nations have done), phasing out a few of the worst tax loopholes that mainly benefit the best off, and bringing US health care costs in-line with all other rich industrialized countries would do it without any further increases in income taxes or cuts in federal spending.

If the Clinton years are any guide, balancing the federal budget to end deficits, even with somewhat higher taxes, leads to much stronger economic growth than lower taxes with vast deficits.  So getting the federal budget back into balance, not tax cuts for their own sake, should be our goal.

There are real challenges in getting support for the policies necessary to end the deficit, to be sure.  But we will make no progress in fixing our deficit unless we recognize its true causes and start working on real solutions.  Campaign talk that suggests we can solve the deficit problem simply by cutting federal spending on handouts, or by taxing the rich, are fantasies.  So let’s work on the real problems; they can be fixed if we set out to do so.

About jackgoldstone

Hazel Professor of Public Policy at George Mason University
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