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Economic Analysis: The Democratic Budgets Are Fiscally Irresponsible, Part 2

We've cranked all the numbers underlying the three Democratic budget proposals, and they don't make a pretty picture. Take your pick: President Obama's proposed budget, the House budget resolution, or the Senate budget resolution. It doesn't matter. The federal debt is spinning out of control. In less than two decades, the federal debt as a percentage of GDP will exceed 100 percent. In less than two decades, the federal debt as a percentage of GDP will exceed even the record levels set during World War II. And after that it just keeps on growing. All this is illustrated in the figure below.

Figure 1. Projections of Federal Debt as a Percentage of GDP
Under Various Democratic Budget Proposals, 2008-2030

Source: Tax Analysts Calculations

The main forces driving this trend are entitlements and interest payments. According to our projections, under the Senate plan (the most fiscally sound), from 2009 to 2030, Social Security spending will grow from 4.8 percent to 6 percent of GDP. Medicare will grow from 3 percent to 5.7 percent of GDP. Medicaid will rise from 1.8 percent to 2.4 percent of GDP. Interest payments as a percentage of GDP will increase fivefold from 1.2 percent to 6 percent. (See figures A-3 and A-4 at the end of this article.)

Here's our prediction for the future. One or more of the following must happen: (1) taxes increase significantly; (2) entitlements are cut significantly; (3) economic growth exceeds anyone's wildest hopes and saves the day; or (4) the debt ratio continues to skyrocket, threatening inflation and financial turmoil.

Of course, our leaders always want to avoid 1 and 2 as they hope for 3. The news here is that 4 can no longer be ignored. Every year of delay brings the day of reckoning a little closer and makes the steps for avoiding it even more painful.

On a Scale of 1 to 10 . . .

How painful? Projections under the Senate plan would leave the debt-to-GDP percentage at about 60 percent at the end of 2010 (when, hopefully, the recession will have run its course) and at about 120 percent at the end of 2030. To keep the debt-to-GDP percentage at 60 percent (keeping the ratio of debt-to-GDP constant meets the economists' standard of sustainability), the government would have to cut spending or increase taxes to reduce the deficit by 2.7 percent of GDP each year. In 2009 that is $380 billion.

That means that if Congress approves the Senate budget and it wants to keep the debt-to-GDP level at 60 percent (far above historical averages), it must, starting in 2010, cut the deficit each year by an additional amount equivalent to $380 billion.

To give you a better feel for the difficulty, here are some options that could achieve this deficit reduction goal: (1) raise both the individual and corporate income taxes by 25 percent; (2) impose a broad-based 6 percent VAT; (3) cut defense spending by 55 percent; (4) cut Medicare spending by 90 percent; or (5) cut Social Security benefits by 60 percent.

On the horizon is a gathering fiscal storm of unprecedented proportions. Don't fall for the propaganda from the White House and Congress. Their budget proposals do not address the problem.

Notes and Sources

Congressional Budget Office baseline figures for 2009-2019 are from the supplementary data entitled "Budget Projections," which can be found at http://www.cbo.gov/doc.cfm?index=10014. They are attached to the March 2009 report titled "A Preliminary Analysis of the President's Budget and an Update of CBO's Budget and Economic Outlook." General figures are from the spreadsheet titled "baseline," and more detailed figures are available from the spreadsheet titled "mandatory."

House budget resolution figures for 2009-2014 are from Concurrent Resolution on the Budget for Fiscal Year 2010, H.Con.Res. 85. (Rept. 111-60), March 27, 2009, summary tables 1, 2, and 3, pp. 71-76.

Senate budget resolution figures for 2009-2014 are from Concurrent Resolution on the Budget for Fiscal Year 2010, S.Con.Res. 13 (S.Prt. 111-16), March 30, 2009, summary tables, pp. 45-52 (available online at http://budget.senate.gov/democratic/documents/2009/senate%20budget200.pdf).

Obama administration budget figures for 2009-2019 are derived by starting with CBO baseline figures and then making adjustments as enumerated in Table 1.5 of "A Preliminary Analysis of the President's Budget and an Update of CBO's Budget and Economic Outlook" (cited above).

Figures from these official projections were gathered to create a data set with the following categories: revenues, mandatory spending, discretionary spending, net interest, and debt held by the public. Mandatory spending was subdivided into Social Security, Medicare, Medicaid, and other mandatory spending. Medicaid spending is net of Part B and Part D premiums. Data not already on a fiscal year basis are converted.

From these official projections we proceeded in two steps. First we extrapolated House and Senate budget resolution estimates forward from 2014 to 2019. Then we extrapolated all four budgets forward into the long-term beginning in 2020.

For 2015-2019 in the House and Senate budget resolutions, revenues, discretionary spending, and other mandatory items were extrapolated forward to stay at a constant level relative to GDP as reported for 2014. This almost certainly overstates revenues that can be expected from the House and Senate resolutions, which assume no extension of relief from the individual alternative minimum tax found in current law and in the Obama budget. Social Security and Medicaid spending for 2015-2019 are the same as the budget baseline. Medicare spending for 2015-2019 is extrapolated forward from 2014 levels using growth rates for Medicare spending for the corresponding years in the projections for the baseline budget.

Interest costs are computed based on an average interest rate for the accumulated debt assumed to be paid midyear in the fiscal year. Average interest rates for 2015-2019 on debt are computed by dividing net interest by midyear debt found in the CBO baseline estimates.

For 2020 and beyond, revenues, discretionary spending, and other mandatory items were extrapolated forward to stay at a constant level relative to GDP. Social Security was extrapolated forward using spending projections from Table VI.F4 (found at http://www.ssa.gov/OACT/TR/TR08/lr6f4.html) of the single-year tables consistent with the 2008 OASDI trustees' report entitled The 2008 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds, March 25, 2008.

For 2020 and beyond, net Medicare expenditures are extrapolated forward using projections found for Part A, Part B, and Part D gross expenditures found in Table III.A2 of The 2008 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds (http://www.cms.hhs.gov/ReportsTrustFunds/downloads/tr2008.pdf). Part B premiums are estimated to be 25 percent of Part B benefits after 2020. Part D premiums are estimated to be 11 percent of Part D benefits after 2020.

All figures from the trustees' reports are based on intermediate assumptions.

Medicaid expenditures are from the CBO's "The Long-Term Budget Outlook," December 2007, Table 2-2, "Projected National Spending on Health Care as a Percentage of Gross Domestic Product Under CBO's Extended-Baseline Scenario."

Over the long term, the government's cost of funds is assumed to be the simple average of the projected rate of interest of three-month Treasury bills (4.8 percent) and 10-year Treasury notes (5.6 percent) for 2019 from Table C.1 of the CBO's latest projections, found in the March 2009 report on the president's budget. The calculated average rate is 4.91 percent in 2019. The assumed rate transitions linearly from 4.91 percent to 5.2 percent over the 2020-2029 decade. GDP for 2009 through 2019 is from the same table of the same CBO report and is extrapolated forward after 2019 at the 3.5 percent nominal rate of growth estimated for 2019.

Figure A-1. History and Future of the Federal Debt, 1940-2040

Figure A-2. Projected Federal Deficits as a Percentage of GDP

Figure A-3. The Growth of Entitlement Spending as a
Percentage of GDP
(Senate Plan)

Figure A-4. The Exploding Interest Cost of the Federal Debt as a
Percentage of GDP
(Senate Plan)

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