The Entitlement Crisis: Washington’s Highest-Stakes Debate


Although there’s consensus that the Federal Government has a massive debt problem, the issue to resolve the crisis remains contentious among politicians and lawmakers. As a result, the country has yet to arrive at any truly effective solutions. Some argue there’s too much spending on inefficient programs and projects, while others believe that revenues are too low and the government should therefore tax the wealthy at a higher rate.

But there’s an inherent problem with both sides of this argument: Even if you could cut out all the Solyndras in the Federal Government and more aggressively tax the Warren Buffetts of the world, it would only scratch the surface. These issues are a mere distraction from the chief threat facing America right now: Entitlements. Without a major shake-up, no amount of cuts in discretionary spending or increases in taxes will be able to cover the approaching avalanche of entitlement spending, raising the stakes for our economy’s welfare. Putting aside the political thinking behind these programs, they remain cost-ineffective and overly expensive. While it certainly makes sense that forms of these programs need to exist to ensure the welfare of all Americans, the government needs to also become fiscally responsible for the sake of our future.

Starting with the Great Society program of the 1960s, spending on entitlements and other required programs has continued to expand. At the start of 1965, Federal spending accounted for 16.1% of annual GDP. Now, less than 50 years later, Federal spending as a percentage of GDP has increased by nearly 50% to 23.8%. To get a better understanding of how entitlement promises have and will continue to swell, think of the Federal budget as three separate units:

  • Discretionary spending is subject to the approval of Congress and authorized through an appropriations bill. Examples of discretionary spending include defense, agriculture, homeland security, transportation, and housing and urban development.
  • >Mandatory spending consists of expenditures mandated by law that are not subject to the approval of Congress. This includes entitlement programs like welfare, Social Security, Medicare, Medicaid, veterans benefits, etc. Barring a change in established law, mandatory spending is automatic, runs on autopilot, and rises at predefined levels.
  • Interest on the debt is a function of the amount of debt and prevailing interest rates.

In a surprising trend, discretionary spending as a share of total spending has been decreasing for several decades. In 1972, it accounted for more than half (55.7%) of all Federal spending. Today, it is down to 37.4%, and by 2023 the Congressional Budget Office (CBO) forecasts discretionary spending will account for less than a quarter (24%) of all Federal spending. Stripping out defense (which is as necessary as anything), discretionary spending as a share of total spending has declined from 21.3% in 1972 to 17.9% today, and it is forecast to decline to 12% by 2023. Accounting for less than one-fifth of all Federal outlays now and only 12% 10 years from now, discretionary spending (ex defense) is not the problem most Americans believe it to be.

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While discretionary spending has declined as a share of total spending, mandatory spending has been on the rise. In 1972, it accounted for 37.6% of total spending, and it accounts for 56.3% of all spending today. Within the next 10 years, mandatory spending will account for 61.6% of all Federal spending.

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The increase in mandatory spending over the last several decades has been the result of a snowball effect of the Federal government’s policy of continuously promising more to Americans. According to a recent book by Nicholas Eberstadt (A Nation of Takers: America’s Entitlement Epidemic), spending on entitlements has increased at an annualized rate of 9.5% over the last 50 years. At that rate, spending doubles every eight years! Two of the biggest programs behind the increase in entitlement spending have been Medicare and Medicaid. Created in the mid-1960s, these two programs went from zero to an annual cost of more than $900 billion today.1

In his book, Eberstadt notes that entitlement transfers have been growing twice as fast as overall personal income, according to the Bureau of Economic Analysis. Government transfers now account for nearly 18% of all personal income in the United States. As a result, the US Census Bureau calculates that 49% of Americans live in households that are receiving at least one government benefit, up 20 percentage points in the last 30 years. Finally, while the longer lifespan and aging of the baby boomers is often cited as the culprit behind increased entitlement spending, Eberstadt contends that only one-tenth of the increase in spending is due to pensions and health care programs for seniors.2

An aging population may not yet be a major factor behind increased outlays for entitlements, but that chapter of the entitlement crisis has just begun as the baby boomers, born between 1946 and 1964, now move into their retirement years. This new era began in 2011 and will last through 2029, and it will increasingly become a burden on Social Security, which in 2010 already paid out more in benefits than it received in payroll taxes.3 The stress on Social Security is just beginning, as the pool of workers paying into the system shrinks relative to the number of retirees drawing benefits.

Health care costs are another major threat. As of 2009, the average annual per capita cost of health care was $5,511 for Americans between the ages of 45 and 64. Once you turn 65, the average cost increases by 77% to just under $10,000 per year.4 According to the AARP, approximately 8,000 Americans will turn 65 each day between now and 2029.5 That’s 8,000 Americans every single day between now and 2019 that will see their average health care costs double.

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Compounding matters further, retirees are also living longer. The chart to the right shows the historical life expectancy in the United States since 1900. When the Social Security Act of 1935 was signed into law, the average life expectancy of Americans was 61.7 years. By 2011, the average life expectancy had risen to 78.7 years.6 The original Social Security Act of 1935 set the minimum age for receiving full benefits at 65, which was an age most Americans never even reached.7 Today, the average American can expect to receive Social Security benefits for more than 13 years. While receiving these benefits, the average per capita cost of health care for these beneficiaries, based on current life expectancy, will exceed $125K, much of which will be paid out by Medicare.

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While 8,000 Americans will turn 65 every day, baby boomers will still be retiring in 2023. Projections from the Peter G. Peterson Foundation, which has been at the forefront of this issue for many years, provides a glimpse of just how much of a burden entitlements will become by 2035, or just a little more than 20 years from now.8

In 2012, total mandatory spending (mandatory spending + net interest) accounted for 64% of all Federal spending. By 2035, due to continued deficits and ballooning entitlement costs, more than three-quarters of all spending will be mandated by law, and a third of that mandatory spending will simply be interest on the debt.

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And as anyone who ever carried a high balance on credit cards can tell you, once debt hits a certain level, paying it down becomes very difficult as the monthly payments only cover the interest. By 2080, the CBO has estimated that if nothing is done to change the current trajectory, America’s public debt could rise from 44% of GDP in 2007 to 716% by 2080.9

The recent crises over the debt ceiling, fiscal cliff, and sequestration riled markets, but if Washington and the American public can’t agree on reforming entitlements, markets could face significant volatility. Hopefully, lawmakers will soon realize that the stakes are simply too high for both sides to do nothing.


Disclaimer
This market commentary is an advertisement. The commentary concept has been developed by the Conway Wealth Group LLC at Summit Financial Resources, Inc and written by third party contributors edited by the Conway Wealth Group. Investment decisions should not be solely based upon paid advertising.


Footnotes

  1. Nicholas Eberstadt, A Nation of Takers: America’s Entitlement Epidemic (Templeton Press, 2012).
  2. Nicholas Eberstadt, “Yes Mr. President, We Are a Nation of Takers,” Wall Street Journal, 1/24/13. http://online.wsj.com/article/SB10001424127887323539804578259940213918254. html
  3. Congressional Budget Office, “Social Security Trust Funds,” 3/31/2010. http://www.cbo. gov/publication/25052
  4. Health Care Costs: A Primer. Kaiser Family Foundation, May 2012. http://www.kff.org/ insurance/upload/7670-03.pdf
  5. “Boomers @65,” http://www.aarp.org/personal-growth/transitions/boomers_65/
  6. US Health & Human Services, “Deaths: Preliminary Data for 2011,” October 10, 2012 http://www.cdc.gov/nchs/data/nvsr/nvsr61/nvsr61_06.pdf
  7. Social Security Act of 1935, Title II, H.R. 7260 8/14/35. http://www.ssa.gov/history/35act. html#TITLE II
  8. “Selected Long-Term Charts on the Long-Term Fiscal Challenges of the United States,” Peter G. Peterson Foundation, April 2013.
  9. The Long Term Budget Outlook. Congressional Budget Office, June 2009. http://www.cbo. gov/sites/default/files/cbofiles/ftpdocs/102xx/doc10297/06-25-ltbo.pdf

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