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Obamacare and the Coming Debt Crisis

James C. Capretta | 02/10/2014 |

The Congressional Budget Office released its new economic and budget projections last week, and most of the subsequent commentary has been on the revised estimates of what Obamacare will do to work incentives. In addition, CBO projects that rapid entitlement growth will increasingly burden the federal budget and the American economy. Deficits over the next decade will be $1 trillion higher than previously forecast.

CBO notes in the report that the agency now believes Obamacare will lead to the equivalent of 2.5 million full-time workers leaving the labor force by 2024.

This finding has sent shock waves through the political system, and rightly so. The electorate is likely to take in this latest bit of bad news about what the law will do the American economy and become even more convinced that the whole Obamacare exercise was a gigantic mistake.

Of course, it is not news that Obamacare creates strong disincentives to work. Even before Obamacare was enacted, federal benefit programs were creating large disincentives to work among low-income households because the benefits get withdrawn as earnings rise. The combination of the earned income tax credit, food stamps, and payroll and income taxes push the effective marginal tax rates for many low income families to rates in the 30 to 50 percent range, depending on the family structure. When Obamacare’s subsidies are added in, the effective marginal tax rates often exceed 50 percent, as Urban Institute economist Eugene Steuerle has noted. When housing vouchers are also included, the effective marginal tax rate can reach a remarkable 80 percent or more.

After taking a careful look at the evidence, CBO’s not-too-surprising conclusion is that families will tend to work less when faced with the prospect of losing half or three-fourths of every extra $1.00 they earn to taxes and lost benefits.

The Obama White House and its allies are trying their best to spin this into a good news story. Not to worry, they say. It is not that jobs were destroyed for the poor, but that the poor no longer have to work as much as before to meet their life objectives. 

This argument is unlikely to work with voters. What is happening is not hard to understand. The government, in a well-intentioned effort to improve the life circumstances of low-income families, has made earned income less necessary to pay for some of life’s necessities. The problem is that work is the pathway out of poverty and to a better life. The last thing public policy should be doing is discouraging lower-income workers from taking better paying jobs. But Obamacare is doing just that, in a significant way.

All of this attention on Obamacare’s work disincentives has obscured what is perhaps the bigger story from CBO’s report, which is that rapid entitlement spending growth continues to create substantial risks for the federal budget and the American economy.

According to CBO’s projections, federal entitlement spending is projected to rise at an average annual rate of 5.9 percent over the coming decade, pushing spending up from $2.1 trillion in 2014 to $3.7 trillion in 2024. This is the main reason CBO is projecting federal budget deficits will rise to above 4 percent of GDP in the latter part of the coming decade, even with strong economic growth and low unemployment. Over the ten year period 2015 to 2024, CBO is now projecting a cumulative deficit of $7.9 trillion, which would push debt held by the public to nearly 80 percent of GDP in 2024. That is far above the post-war norm for the United States and perilously close to levels from which it is hard to recover. 

CBO is also notably more pessimistic in these latest estimates compared to those issued last year. For the period 2014 to 2023, CBO is projecting deficits that are about $1 trillion larger than those from its most recent previous projection.

The outlook would be worse if not for rosy estimates of discretionary spending in future years. CBO’s forecast, which builds off of the levels agreed to in the recent budget agreement, shows discretionary spending—on annually appropriated accounts such as national defense and medical research—rising from $1.2 trillion in 2014 to $1.4 trillion in 2024, for an average annual growth rate of just 1.5 percent. 

These levels for total discretionary spending assume a significant downsizing of the nation’s defense capabilities, with defense spending rising from $604 billion in 2014 to $719 billion in 2024, for an average annual growth rate of just 1.8 percent. If allowed to happen, this would bring defense spending as a percentage of GDP to levels not seen in the post-war era—at a time when global conflicts and potential threats are clearly on the rise.

CBO’s latest longer term projections, issued last fall, are equally bleak. The large budget deficits in the near-term are expected to be followed by even larger deficits in years beyond the ten-year budget window because entitlement spending will continue to rise rapidly with the aging population and health care inflation. The long-term projections would look even worse if not for the unrealistic Medicare cuts from Obamacare that are built into the current law baseline. If those cuts are overridden, and other unrealistic assumptions in the baseline are also replaced with more realistic scenarios, then CBO expects debt held by the public to reach 190 percent of GDP by 2038. 

The risk is that the nation could face a debt crisis much sooner than 2030 or 2040. With a couple of bad breaks and perhaps another economic crisis, CBO’s projection of deficits of 4 percent of GDP at the end of this decade could quickly become deficits of 6 percent, 7 percent, or 8 percent of GDP. With debt levels already high by historical standards, the risks of a debt crisis at that point would rise substantially.

At the beginning of the Obama presidency, the administration convened a fiscal responsibility summit during which there was a lot of talk about the need to finally address the ticking time bomb of runaway entitlement spending. Suffice it to say that, in year six of the Obama presidency, people are not holding their breath that a breakthrough on entitlements is imminent.

Sooner or later, however, the country will have to grapple seriously with this problem. Automatic spending on entitlement programs is crowding out every other priority in the federal budget, and creating the real risk of an economic crisis. It would be far better to taking action now and head off the crisis before it ever happens than to wait for the crisis to hit and then attempt to scale back benefit commitments. Unfortunately, this administration seems all too willing at this point to take its chances by avoiding a serious discussion on entitlements and hope that the crisis will not occur in the next three years.

 

James C. Capretta is a senior fellow at the Ethics and Public Policy Center, a visiting fellow at the American Enterprise Institute, and a contributor to e21.


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