Debt Ceiling Resolved, But Long-Term Budget Outlook is Bleak

 /  Nov. 30, 2015, 12:02 a.m.


With unusual expediency, Congress approved legislation to raise the debt limit on October 30. Unlike  the 2011 crisis, when the debt limit was raised only after months of negotiations and Republican demands to cut spending, this time Republican leaders in the House and Senate all but ignored murmurs of protest from fiscal hawks, including incoming Speaker Paul Ryan. Besides deactivating the debt limit until 2017, the new budget deal actually increases spending by $80 billion, of which only $75.7 billion will be offset by additional revenue and spending cuts in other areas. Washington has clearly lost the sense of urgency it once had to reduce the nation’s credit obligations, and politicians have shifted their attention away from fiscal issues. This doesn’t mean our nation’s budget woes are over, however: the federal budget deficit is still hovering around $439 billion. While this is far lower than the $1.3 trillion dollar deficit of 2011, running year after year of shortfall still hurts the nation’s fiscal health.

The debt limit was only the latest episode in a long series of fiscal standoffs between Congress and President Barack Obama. On October 22, Obama vetoed a defense spending bill because the bill reversed budget cuts made under “sequestration” without reversing corresponding cuts to domestic programs. These cuts are relics of the 2011 debt crisis supercommittee’s failure to craft a budget acceptable to both parties, which triggered automatic spending cuts, commonly known as the “sequester”. As a result of sequestration, the partial repeal of the Bush tax cuts, and the growing economy, revenue collections have risen and spending growth has slowed when compared to the 2011 crisis.

The latest budget deal partially reverses sequestration cuts to both defense and non-defense programs, the third time Congress has done so. While the debt limit deal attempts to make some minor reforms to entitlement programs, the bill ultimately takes one step forward and one step back. Medicaid expenditures will decrease thanks to stricter cost controls on generic drug manufacturers, but any savings will be offset by a reprieve on rising Medicare part B premiums, which had been scheduled to rise 52% in 2016.

Worse, the measure only appears deficit neutral on its face. In reality, the 2015 deal relies on spurious accounting practices to close the gap. Billions of dollars in “budget cuts” to Medicare aren’t scheduled to take place until eight years from now, and close to $10 billion in new revenue depends on one-time sales of  oil reserves and broadcast spectrum rights. This is not a sustainable strategy for keeping the budget afloat.

Long-term budget outlooks are even less favorable. While the pattern of fiscal standoffs has slowed spending in the short term, Congress has done little to address the structural causes of the deficit. For all the debate about deficit reduction, Democrats or Republicans have ventured only to make small, politically safe adjustments to the budget.  There will be no easy solutions for balancing the nation’s checkbook. Today’s $439 billion dollar deficit is only a temporary lull: the Congressional Budget Office (CBO), an independent federal agency that estimates the budgetary impact of legislation and forecasts future economic growth, predicts the deficit will rise to $739 billion by 2020.

On the spending side, “mandatory” programs such as Social Security, Medicare, and Medicaid are in large part responsible for our growing debt. Entitlement programs are categorized as “mandatory” spending because they are essentially on autopilot: the amount they pay out is predetermined by law unless Congress explicitly opts to modify the program.

“Discretionary” spending, on the other hand, must be approved by Congress each year. The result is the “Great Paradox of Deficit Reduction.” Although mandatory spending constitutes 62% of federal expenditures, the popularity of Social Security and Medicare among voters discourages Congress from cutting benefits—and since Congress does not have to reauthorize these programs annually, it simply chooses to do nothing. Discretionary spending, which pays for defense, education, the courts, and other well-known federal services, constitutes a mere 32% of federal expenditures. Despite taking up a much smaller share of the federal budget than mandatory spending, it is discretionary spending that has become the epicenter of constant budget battles—precisely because discretionary programs must be reauthorized each year. With discretionary spending, budget hawks have the leverage to demand cuts in lieu of blocking a program’s continued operation. Supporters of programs like the National Park Service are forced to accept cuts rather than risk failure of the authorization bill and loss of all federal funding for the program, or worse, a complete government shutdown.  

Focusing on discretionary spending ignores the true source behind the deficit. Fueled by rising healthcare costs and an aging population, Medicare and Medicaid expenditures are expected to  increase by 6-7% annually, much faster than projected economic growth rates. As a result, Medicare spending is expected to account for 4.3% of GDP in 2025, as opposed to 3.5% now. Medicaid spending is projected to increase by a more modest amount, from 1.9% of GDP today to 2.1% of GDP in 2025. Still, in absolute dollar amounts, this is a $253 billion increase. Social Security, currently the single most expensive item on the federal budget, will also grow relative to the size of the economy, from 4.9% of GDP to 5.7% of GDP over the next decade. As a whole, CBO data show that mandatory spending has risen from 11.2% of GDP in 1999, to 12.5% today, and may well reach 14.2% of GDP by 2025.  

On the other hand, political pressures have kept a lid on discretionary spending. Relative to the size of the economy, spending on the sum total of all discretionary programs is projected to shrink from 6.5% of GDP in 2015 to 5.1% of GDP in 2025.  This means that discretionary spending is mostly unchanged from the Clinton era, when the budget generated a now unthinkable $107 billion dollar surplus with discretionary spending as 6.6% of GDP. Today, veterans’ benefits take up 11% of non-defense discretionary spending—a proportional increase from 1999, when they comprised 6.4% of non-defense discretionary spending. But besides that, most discretionary programs have kept their expense levels constant in proportion to the size of the economy and their share of the budget.  

If we return to our comparison with the Clinton budget, there is another reason why deficits are so high right now: tax revenues are lower. In 1999, total revenue collected by the federal government amounted to 20.7% of GDP, significantly higher than 2015’s projected collection level of 17.7% of GDP. 3% of GDP does not sound like much, but it amounts to billions of dollars of tax revenue. In a hypothetical scenario where the impact of higher tax rates on the economy were minimal, applying 1999 taxation levels to 2015’s economy would generate $540 billion in additional revenue—more than enough to flip the budget from deficit to surplus. The surpluses of the Clinton budget seem unachievable today, but the simple truth is that much heavier taxation, when combined with somewhat lower expenses for mandatory programs (about 1.3 percentage points’ difference in GDP), kept the budget $107 billion dollars in the black.

Of course, this doesn’t mean that a steep hike in taxes tomorrow is economically wise—today’s economy has not reached the strength of the 1990s dot-com boom. A large tax increase could slow down the economy and generate less revenue than expected. But as the economy continues to recover, Congress may have a good opportunity to slightly raise taxes for individuals and corporations. As long as Americans like getting benefits from government programs, but are not willing to pay for them, the national debt will only continue to grow.

But above all, the most compelling reason to fix the budget now rather than later is that deficit reduction is in the best interest of the United States—literally. The Congressional Budget Office (CBO) reports that the U.S. paid out $229 billion in interest to the public last year. If this number seems staggering, consider that the CBO projects the federal government to pay out $827 billion in interest in 2025. Congress has no power to reduce interest payments—except by reducing the national debt.

While necessary to finance the budget, interest payments alone do very little to benefit America.. Each dollar spent on interest payments is a dollar that can’t be spent on scientific research, tax cuts, or “detoxifying” the offices Paul Ryan inherited from John Boehner. Seeing as one-third of all U.S. debt is held by foreign nations, the federal government is sending billions of dollars overseas each year instead of keeping it where it could do the most good.

Furthermore, the budget is currently benefiting from extraordinarily low interest rates on Treasury securities; the low rates are probably the result of extremely weak growth in the global economy.  Don’t expect this fiscal reprieve to last forever. It would be very unwise to tie the fate of the budget on an anomaly: the CBO warns that if interest rates drift 1% above expected rates, $1.745 trillion in additional debt will accumulate over the next decade.  

Three days after Congress passed the bill, President Obama signed the legislation that raises the debt ceiling into law. Media attention to the national debt will likely decline now that this conflict has been resolved. From the ease with which the bill sailed through Congress, an outside observer might be fooled into believing the nation’s debt crisis is over. However, this could not be farther from the truth: the fiscal wave is still building, and has yet to come crashing down on Washington.

The image featured in this article is licensed under Creative Commons. The original image can be found here

James Gao