FROM "THE ECONOMIST" - DEC. 2015
The federal budget
Reflections on projections
As Congress hammers out yet another budget deal, future fiscal problems lurk
WHEN John Boehner handed the Speakership of the House of Representatives over to Paul Ryan in October, he hoped to leave a "clean barn" for his successor. The budget deal he bequeathed to Mr Ryan was an outline, rather than a finished work. It set total spending limits for 2016 and 2017, but left the finicky work of doling out that money until now. In all likelihood, Congress will do this in time for the new year. The Republican leadership has little appetite for a shutdown, which would blot Mr Ryan's nascent Speakership. But as Congress steers away from a shutdown next week, it has lost sight of bigger fiscal problems on the horizon.
America's population is ageing. This is squeezing the federal budget by increasing the cost of Social Security (public pensions) and Medicare, government-provided health care for the over-65s. By 2025 these programmes will have roughly 70m beneficiaries, up from 44m in 2007. Today, they consume about 10% of GDP. That will rise to 12% of GDP by 2025 and 14% of GDP by 2040, according to the Congressional Budget Office (CBO). At the same time, rising interest rates will increase the cost of servicing the national debt. Only eight of 34 members of the OECD, a club of mostly rich countries, have failed to reform their public pensions in the past two years - America is one of them. To keep debt in 2040 beneath today's 74% of GDP, taxes need to rise, or spending needs to fall, by about 6%.
In 2010 the president established a commission, headed by two Washington veterans, to tackle the problem. It contained a sensible mix of higher taxes and reduced spending and was pronounced dead on arrival. In 2011 Congress and the White House tried to force an agreement by planning a decade of deep and indiscriminate cuts that would bite, painfully, if no long-term deal were reached. None was. Since then, budget negotiations have sought mainly to slow this self-flagellation.
As a result of the cuts-and an improving economy-the deficit has fallen from 8.7% of GDP in 2010 to just 2.5% of GDP today, its lowest level since 2007. But the knife has fallen mainly on so-called discretionary spending: on infrastructure, education, transport and the like. For instance, federal investment, adjusted for depreciation, turned negative in 2014 for the first time since 2001, despite the woeful state of the nation's roads and bridges.
This is the fiscal equivalent of bloodletting, because the long-term problem remains unsolved. From 2019, the CBO predicts, borrowing will begin to rise again. This will push debt up to 78% of GDP by 2025, compared to a historical 45-year average of 45% of GDP. America could tolerate much higher borrowing: Moody's, a rating agency, estimates debt could safely rise.to 124% of GDP in many countries. That does not mean it should. The pressure on the budget still matters for three reasons. The first is risk-management: higher debt leaves less leeway with which to respond to future downturns. The second is investment: in the long-term, government debt gobbles up savings, pushing up interest rates for private-sector borrowers and deterring productive investments. That is not a worry while interest rates are at zero, but such conditions will not last for ever.
The third pressure is politics. Though the budget deficit counts all the Treasury's spending and receipts, Social Security and parts of Medicare are officially paid for by trust funds, which raise ring-fenced revenue through payroll taxes. The latest forecast says the Medicare fund will run dry in 2030 and the Social Security pot four years later. There is a rationale for the funds: ring-fencing makes it clear where taxpayers' money goes, and limits the share of the budget that entitlements can swallow.
To that end, Republicans favour trimming Social Security and raising the retirement age to account for longer lives. But recent gains in life expectancy have been concentrated among the rich. Between 1980 and 2010, life expectancy at 50 for the poorest fifth of Americans actually fell.
Benefit cuts do not save much if focused on rich folk. Chris Christie, a Republican candidate, wants to phase out benefits for those earning more than $200,000, but by one estimate from 2011 these account for just 0.6% of Social Security spending. (Other Republican candidates have similar but less detailed plans.) Better, reckon Democrats, to raise revenues. Bernie Sanders wants to levy Social Security taxes, which currently stop at $118,500, on incomes over $250,000. This would impose a whacking 15 percentage-point increase on the marginal tax rate of high-earners.
Social Security is stingy by international standards. Between 2010 and 2015 America ranked joint 29th of 33 OECD members for pension spending - a rank that will barely change by 2050. It is not surprising that Americans overwhelmingly favour protecting Social Security from cuts.
By contrast, Uncle Sam's extravagant health spending stands out. Adjusted for purchasing power, America's government spends more per person on health care than Canada, Sweden and Britain-all of which have universal taxpayer-funded systems. Health-care inflation has slowed since 2012, but will soon accelerate again, according to Alec Phillips of Goldman Sachs, a bank. Controlling health costs, which account for two-fifths of the fiscal pressure until 2040, is crucial. The sequester cuts Medicare payments to doctors, but this can only go so far. Expanding pilot programmes to contain costs, which formed part of the Affordable Care Act, is a more promising route to savings.
Ultimately, though, the country must confront a deep question: what is the purpose of spending on the silver-haired? If it is to provide only a minimum standard of living, there is plenty of scope to pare back benefits. If it is to provide an expansive alternative to private saving, the solution must be higher contributions.