National Debt and Entitlements
By Nayyer Ali MD
Now that Republicans have given corporations a giant and totally unnecessary tax cut, one that will increase the deficit and add to the national debt substantially, they are pivoting to demanding that “entitlement reform” take place to prevent the national debt from soaring even more. This is beyond hypocrisy, and involves a substantially fraudulent argument about the nature of government debt and of entitlements.
It’s been said that the Federal government is essentially a retirement home with a police station. This reflects the fact that Social Security, Medicare, and the Defense Department combined account for almost 75% of Federal spending not counting interest on the debt. Social Security alone is about 1 trillion dollars, and keeps America’s elderly out of poverty after they have aged out of the work force. It also takes care of people who are prematurely disabled.
When Republicans speak about entitlements they mean Social Security and Medicare, the two most popular government programs ever created. When they say “reform”, what they mean is to cut benefits and increase the costs on the elderly for their retirement and health care.
The reason given for this is that as the population ages, and as health care becomes more expensive due to more and new technologies and treatments, the Federal budget will not be able to pay for these programs. Instead, we will have to borrow more and more money, creating explosive annual deficits that pile on more and more debt, with the resulting interest payments becoming terribly burdensome.
The reality is quite different. Most of these terrible projections are based on presumptions about costs of entitlements in the far future, even going out past 2050. Needless to say, such projections are little better than hallucinations. Even among these projections, there are actually a sharp divergence between Social Security and Medicare. Social Security is expected to increase only modestly. As the economy and population and inflation are always changing the numbers, to make the comparisons of present to future we need to use a common yardstick. The best is to look at the cost of programs as percent of the economy (the GDP). Currently, Social Security costs 5% of GDP, but even the high point in the next few decades results in a cost of 6% of GDP. This is not a disaster, and just a modest increase in Social Security taxes on the wealthy would easily cover that cost.
On the Medicare front though it is a different story. Over the next 50 years, the CBO projects spending on Medicare to rise from 6% of GDP to 18% of GDP. Such a rise is not feasible, it would take a near doubling of current taxes to pay for that, and that is politically not possible. But are we really fated to spend 18% of GDP on health care 50 years from now? Long before we get there, economic logic will force the US health care system to become much more efficient than it is. Currently, Americans pay twice as much for health care as Europeans, but go to the doctor and get medications and surgeries at about the same rate. Americans don’t spend anymore time in the hospital. So why the cost difference? It is the prices. America’s unregulated health care industry is able to charge twice as much for its services as the European systems can. US doctors, drug companies, nurses, and hospitals make much more income than European counterparts. There is tremendous scope for bringing down health care costs if the political will is there.
This is why the long term debt picture is not as bad as the Republicans state, and we should not be stampeded into cutting Social Security and Medicare benefits (though we should use the power of Medicare to negotiate lower prices for drugs and other services). The national debt should not be judged simply on a per capita basis, as debt is always rising and the numbers in the future can look quite scary. But that is not correct, one must compare debt to income. If per capita debt has doubled but per capita GDP has also doubled, then the debt burden has stayed the same. Some claim that the reason the debt burden is growing is because of slower economic growth. This is not true, debt grows because we don’t tax ourselves enough to pay for the amount of government we want. If we taxed ourselves to cover our spending, then the debt burden would shrink. In the late 1990’s tax collection as percent of GDP was 21% at the Federal level, and we had budget surpluses, which meant we were actually paying down principal. We now pay about 17% of GDP in taxes, and yet our growth is slower than in the high tax 1990’s. Deficit spending is a political choice, not some iron law that we are yoked to.
Another key point to remember that is often missed by those who write about debt is that the principal should never be repaid. Repaying principal means transferring money from current taxpayers to current bondholders, and there is no good reason to ever do that. As a nation does not grow old or retire or die, it has no need to pay down its debts. It can carry them into perpetuity, and the effect of long run inflation and economic growth turns those debts into rounding errors. US debt during World War II surged to over 100% of GDP, but that was only 200 billion dollars, by 1980, 200 billion dollars was less than 10% of GDP. As long as interest payments were made on the debt so the principal did not grow, the 200 billion dollars turns into nothing. The same thing happened with the two trillion dollars in debt run up in the 1980’s, that too has become about 10% of current GDP.
As government debt in your own currency is essentially a risk-free asset, the real rate (after inflation) of return on such an asset according to financial theory should be close to zero for short term debts and slightly above zero for longer term, meaning that government debt should not pay much more than the inflation rate. In fact, that has been true. This is why US debt carries such a low interest rate. If you do the math on a hypothetical where we have debt equal to 100% of GDP, inflation at 2%, economic growth at 4% (2% real and 2% inflation), and average interest rate on the debt at 3% (inflation plus 1%), and we run a primary budget balance (taxes equal current spending, but borrow to cover the interest costs), then after 10 years, debt to GDP declines to 90% of GDP even though absolute value of the debt increases by 34%. If we ran a balanced budget for those ten years (so not even a surplus like Clinton) the debt to GDP would decline to 67% of GDP. Debt burden can be shrunk quite rapidly without actually paying down the debt, that is never required and is politically untenable as any sustained surplus would create pressure for a tax cut or increased spending.
One quirk in this whole entitlement argument is the existence of the Social Security and Medicare “Trust Funds”. In both case, a bait and switch has been played on the public. In the early 1980’s, payroll taxes were raised so they exceeded the taxes needed to pay for SS and Medicare benefits for the last 30 years. The surplus was to be invested in government bonds (a safe investment for any pension plan, and one used by most private pension plans) by a separate Social Security Trust Fund and Medicare Trust Fund, and then those bonds were to be sold to cover the benefits needed in the 2015-2035 timeframe as the baby boomers retired.
Now either those surpluses were real, in which case the trust funds were real, or they were fake, in which case the boomers were tricked into overpaying for SS and Medicare while they worked, and now are being told there is not enough to pay for their benefits. The whole concept of SS and Medicare going “bankrupt” is a fiction predicated on the idea that they have a fixed income stream that cannot be altered based on existing payroll taxes. Right now, Social Security and Medicare are funded by a separate tax on income called a “payroll tax”. The two programs are supposed to survive on the taxes generated by the existing “payroll tax”, although in the past we have moved that tax up and down for various reasons. We don’t do that for any other government program. We don’t have a separate “defense tax” that limits how much we can spend on defense, or a “VA tax” that defines how much money is available for the VA, or a “NASA tax”. We just have a Federal government that collects taxes and spends money. If we did away with the fiction that SS and Medicare have fixed income streams, and that they can be paid for by the Federal government just like any other program, then the nonsense about them going bankrupt becomes obvious.
They are only bankrupt to the extent that we don’t want to pay the taxes it takes to fund them. That is a difficult argument to sustain from a pure economic standpoint, it is not obvious that we will face economic ruin if we tax ourselves at 21% or 22% of GDP instead of 16% or 17%. The high tax blue states (Massachusetts, New York, California etc.) are still hotbeds of innovation and growth and rising living standards combined with a much more generous web of government services. Comments can reach me at Nali@socal.rr.com.
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