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The Obama Budget’s Long-Run Savings Delusion

e21 | 4/15/2013 |

Among the spurious contentions made by President Obama’s FY 2014 Budget submission, none is bigger that the claim that enactment of its policy proposals in full would completely erase the long-run U.S. budget imbalance and pay-off the U.S. federal debt in its entirety.  These audacious claims are contained in the “Long Run Budget Projections” section of the Analytical Perspectives.  According to the Trustees of Medicare and Social Security, the combined unfunded liabilities in these programs exceeded $60 trillion in present value, over the infinite horizon.  The Obama Administration claims that the extension of the tax policy, discretionary spending caps, and health care savings proposed in the 2014 Budget would either close the entitlement gaps directly, or generate sufficient savings elsewhere to render them meaningless.  

The claim is illustrated in Chart 4-1, which is reproduced below.  The President’s budget would reduce the deficit as a percentage of GDP to an estimated 3.5% by 2023, largely due to $600 billion of incremental tax increases.  While the Administration suggests that its budget passes the fiscal sustainability test because it results in a declining debt-to-GDP ratio, this phenomenon is temporary.  After 2023, debt again grows faster than the economy, with the deficit increasing 50% by 2030.  The deficit stabilizes at the higher level for the next ten years, at which point the public debt reaches 76% of GDP.  At this point, the cost increases associated with the surge in the elderly population have largely run its course and the budget is assumed to move into structural surplus.  The debt ratio is assumed to drop at a 2% per year annual rate before reaching zero in the 2070s.  After that, the government is assumed to be a major acquirer of financial assets, with a portfolio that grows to 57% of GDP by 2085.

Publicly Held Debt Under 2014 Budget Policy Extended 

This is obviously a ridiculous forecast; indeed, one wonders why the Obama Administration went through the exercise at all.  One reason could be that the White House felt the need to demonstrate that the President’s budget would reach balance at some point.  (The Budget argues that would be 2055).  Another explanation could be the Administration’s desire to downplay the debt and unfunded obligations as an issue.  Speaker Boehner demanded “structural changes” to entitlement programs as a condition of a “Grand Bargain.”  The Administration may have decided to use the Long-Run Budget Projections to show that structural changes are not necessary to achieve long-run fiscal balance.  Finally, the Administration may be using the long-run projections as a political prophylactic, as future fiscal crises could be blamed on the House of Representatives, which refused to pass a budget that would have achieved long-run fiscal balance.

Whatever the motivation, the three primary mechanisms through which the 2014 Budget is assumed to achieve long-run balance are straightforward:

 

  1. Since incomes grow faster than inflation, on average, the federal tax burden is assumed to gradually increase to 23.8% of GDP, or about 15% higher than the previous record federal tax share of the economy.
  2. All discretionary spending – including defense – is frozen at 2023 levels.  Instead of growing with the economy, discretionary spending is assumed to grow at the rate of inflation plus population growth.  This assumption would cause discretionary spending to fall by 74% – to just 2.3% of GDP in 2085.  
  3. Finally, the President’s Budget proposes to turbocharge the savings generated by the Independent Advisory Board (IPAB) by lowering the target rate of health care spending growth from 1 percent above the growth rate of GDP per capita to just 0.5 percent above the GDP per capita growth rate.  The IPAB would be required to propose changes in Medicare should Medicare should cost growth exceed GDP + 0.5%.  The proposed changes would take effect automatically, unless overridden by the Congress.  

 

There’s no trouble believing that President Obama supports increasing the federal tax share to nearly 24% of GDP.  In our progressive income tax system, real income growth causes tax receipts to grow faster than the economy.  This is indeed a feature of our current tax structure and one the President likely supports.  It is relatively easy to claim the long-run budget situation in the U.S. is overblown if you’re willing to assume tax burdens rise to record levels.  In the past, budgets assumed that tax revenues to GDP would remain constant so as to measure the amount of spending that could be accommodated with historic tax burdens of 18.3% of GDP.  Of course, the decision to tax future generations much more aggressively does not solve the problem as much as transfer it to future workers.

The bigger problems are presented by assumptions (2) and (3).  First, given the President’s demagogic approach to the sequester, it is audacious to propose cutting discretionary spending by 74% as a share of the economy.  If 2% cuts in these cherished programs would throw our economy into a tailspin and inhibit public administrators from delivering necessary services, how could the Administration possibly support larger annual cuts sustained without reprieve for 75 years?  The only reason such aggressive cost cutting is included is that absent this assumption, the budget would only reach balance in the 2070s, with the debt-to-GDP ratio on an upward trajectory for the next 20 years.  Still, the admission that budget balance is impossible absent aggressive discretionary spending caps is a rare moment of truth in the FY 2014 Budget.

Finally, assuming the IPAB is able to make these changes and they are not overridden is essentially equivalent to assuming away the health care spending problem, which slashes long-run spending projections at an exponential rate (i.e. savings grow nonlinearly with time as the savings compound).  For all of the conjecture about reductions in medical spending delivered by the Affordable Care Act, the only savings that can actually be quantified comes from IPAB care rationing mandates.  Under the ACA, the IPAB is supposed to reduce reimbursement rates to providers, health plans, and pharmaceutical firms, or eliminate reimbursable treatments on whatever scale is necessary to keep cost growth to GDP + 1%.  The 2014 Budget decided that it would double the already enacted level of rationing to cap spending at GDP +0.5%.  

Of course, it is not only impossible to know what cuts will be proposed, it’s not at all clear that they’ll be political palatable.  First, spending reductions based on denials of care or reductions in reimbursement rates have led to predictably bad outcomes for patients.  2011 study found that every 1% reduction in Medicare payments resulted in a 0.4% increase in mortality rates in hospital over the long-run, due to reductions in staffing and higher operating costs.  Eventually, IPAB rate cuts will lead physicians to stop accepting government insurance, which will lead to denial of care or longer waits at those facilities that continue to accept government insurance.  

Second, it is unlikely that Congress will stand idly by while IPAB denies coverage for certain treatments.  During the ObamaCare debate, Senator Mikulski offered an amendment to ensure patients are entitled to mammograms and other preventive health screenings without co-payments to providers.  Amendments to protect clearly defined populations from budget cuts tend to pass overwhelmingly, making the sustainability of the IPAB mandate highly questionable.  Of course, the IPAB is not allowed to institute consumer-oriented reforms or otherwise reorient the burden of health care spending away from fee-for-service.  So these kinds of reimbursement cuts or coverage denials are the only means to reach the defined spending target.

The President’s 2014 Budget is a case study in picking an outcome in advance and then reverse-engineering assumptions so the model achieves that outcome.  To achieve a balanced budget by 2055, the President’s budget requires: (1) the economy to expand continuously between now and then; (2) tax burdens to grow to more than 30% their historic average and 15% more than the previous record; (3) 74% cumulative reduction in discretionary spending, as a share of GDP; and (4) the implementation of a rationing program to slow the growth of health care costs.  The real value of the President’s Budget may be explaining how delusional one needs to be to believe the fiscal gap can be closed without structural reforms to entitlement programs.


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