Unsustainable spending will force tax increases

Posted: Feb 06, 2004 12:00 AM

President Bush's 2005 budget came out last week. Different administrations approach the budget differently. Some agonize over every line item, trying as best they can to really get it right. Others take a more blase attitude, treating the budget as a necessary chore to be gotten over with as soon as possible, or a PR exercise designed to get a few days of good press and nothing more.

Over time, all administrations have tended to treat their budgets with less and less seriousness. This is mostly due to creation of the Congressional Budget Office in 1974. Prior to this, the president's budget was really the only source of comprehensive budget data. The Office of Management and Budget had a monopoly on detailed budgetary information. As a consequence, it took its job more seriously, and Congress also took the president's budget more seriously.

Today, Congress can get all the budgetary detail it wants from CBO. Moreover, it is required by law only to use CBO estimates of the cost of budgetary proposals when considering them. Sadly, this became a loophole that the Bush administration was able to exploit to get its ill-conceived Medicare drug bill passed.

The administration knew that Congress' budget resolution provided only $400 billion over 10 years to pay for the drug benefit. Even a penny higher and theoretically the bill would have been subject to a point of order that would have delayed its passage. Any figure much larger than $400 billion would have killed it entirely.

Therefore, it was very disturbing when The New York Times reported on Jan. 30 that the Bush administration's internal estimate was that the drug bill passed by Congress would actually cost $534 billion over 10 years. There is absolutely no question that if Congress had known this figure, the bill would have gone down to defeat. If the administration hid these data deliberately, it was utterly irresponsible and deplorable.

Of course, Congress played its own games with the drug bill. It delayed the actual start of benefits for 2 years, meaning that $400 billion was really being spent in 8 years rather than 10. Moreover, the program is phased-in so that spending in the early years is low. Once it really gets going, however, spending shoots up rapidly. In the second 10 years, spending will rise to $2 trillion, according to CBO Director Douglas Holtz-Eakin.

This brings us to the most important chapter in President Bush's budget, one titled "Stewardship." Buried in an appendix volume where reporters are unlikely to notice, it paints a chilling picture of long-term budgetary trends.

It shows federal spending rising from about 20 percent of the gross domestic product this year to 53 percent in 2080. Much of this comes from interest on the debt, which rises by 20 percent of GDP. But this is because the budget assumes that taxes will not rise to finance rising entitlement spending. In all likelihood, taxes will rise sharply at some point. It is completely unrealistic to think that federal taxes will remain close to 20 percent of GDP for the next 75 years.

I believe that taxes will probably rise by an amount at least equal to the projected rise in entitlement spending. The two largest components of this are Social Security and Medicare. President Bush talks a great deal about the need to reform Social Security, but the budget makes clear that Medicare is in far worse shape and in much greater need of reform. Spending for Social Security is only projected to rise from 4 percent of GDP to 6.8 percent in 2080. But Medicare is projected to rise from 2 percent to more than 12 percent over the same period.

We can assume that a rise of 10 percent of GDP -- over $1 trillion per year in today's economy -- is the absolute minimum increase we can expect for Medicare. Projections of Social Security tend to be fairly accurate because they are driven mainly by demographics. But spending for Medicare is much harder to predict because the cost of medical services has risen sharply over time. The original estimate of Medicare spending after 25 years when the program was established in 1965 was low by a factor of 10.

The addition of an expensive new unfunded benefit to Medicare for prescription drugs means that future spending will be much, much greater than projected. When people are given something that is heavily subsidized, they use a lot more of it. Consequently, we can expect drug spending by the elderly to rise very rapidly, especially since drug prices are also likely to rise as demand outstrips supply.

The budget itself admits that these trends are "unsustainable." Since Congress will never reduce benefits to retirees, the only way to make the trends sustainable is by raising taxes significantly.