Debt and Defect: The problem with Entitlements

Debt and Deficit: The Problem with EntitlementsMark Schug Ph.D.Professor EmeritusUniversity of Wisconsin-Milwaukee

OverviewWhat is the national debt?How is federal spending changing?What are entitlements?How does Social Security work?What is debt, deficit, and surplus?What might be done?

What Is the National Debt?

The Founders Would be Surprised!Thomas Jefferson and Alexander Hamilton would be surprised at the expanded role of the federal government in todays economy. Jefferson advocated for a decentralized, largely rural republic. Hamilton sought a stronger central government and favored the interests of commerce and industry.

The Founders Would be Surprised!Neither one of them could have imagined the expansion of the federal government as it is today.However, life in 2012 is much different from what it was in 1789. Should Americans be worried about the expansion of the federal role in the economy? Entitlements?

The History of the National Debt Through most of its history, the federal government added substantially to its debt in time of war. Then, in the aftermath of the war, it worked to spend down the debt. The federal debt dropped noticeably following World War II.

But in recent years - - beginning in the 1980s - - the debt has once again started to increase. Lets explore why.

What Is the Difference between Deficit and Debt?When the federal governments total annual spending is in excess of its total collected revenues, it is called a deficit. When the federal governments total annual spending is less than its total collected revenues, it is a surplus. As the government runs a deficit as it has over the past several years, the U.S Treasury borrows money and accumulates debt. The national debt is the amount of money the federal government owes, the sum total of the deficits it has accumulated. The current level of the federal debt is about $15 trillion.

National Debt

Federal SpendingTransfer payments: Payments of income from tax payers to recipients who do not provide any goods or services in return for the payments. Examples of transfer payments include Social Security payments, unemployment compensation and payments to people with disabilities.

This is the largest part of the federal spending today.

Federal SpendingPurchases of goods and services: This includes payments for national defense, roads, parks and schools.

Federal SpendingInterest on the national debt: The federal government often spends more than it takes in. To close the gap between spending and income, the federal government borrows money. It sells bonds. A bond is certificate issued by the government which is a promise to pay the owner the amount borrowed plus interest.

How Is Federal Spending Changing?

Types of Federal SpendingYear 1960:Percent of Federal BudgetYear 2000:Percent of federal BudgetYear 2010Percent of federal BudgetTransfer Spending14 %55%58%Purchase of Goods and Services76%33%37%Interest of the National Debt10 %12% 5%Source: http://www.usgovernmentspending.com/What Are Entitlements?

Entitlement SpendingTo understand the changes in federal spending, we need to understand entitlements. An entitlement is a government promise that certain benefits are to be provided to particular individuals.Social Security was passed in 1935.Medicare was passed in 1965. The Patient Protection and Affordable Care Act was passed in 2010.

Social SecuritySocial Security created a permanent social insurance program designed to pay retired workers aged 65 or older a continuing income after retirement. Over the years, the Social Security program expanded.Cost of Living Allowances (COLAs)Workers disabilitySupplemental Security Income (SSI)

MedicareOn July 30, 1965, President Johnson signed Medicare into law as an amendment to the Social Security legislation. Like Social Security, the Medicare expanded over the years to provide additional benefits:Health insurance for the disabledPrescription drug coverage

Revenue and ExpendituresAs the federal government expanded its commitments, a problem began to emerge. The Congressional Budget Office (CBO) estimates 2011 tax revenues at $2,230 billion. The CBO estimates 2011 expenditures are $3,655 billion.The 2011 projected deficit = $1.4 trillion

CBO Estimates March 2011

Current Expenditures

Current Revenues

Congressional Budget Office

Concerns about Spending and Revenues: Social SecuritySome economists are concerned about the inability of revenues to keep pace with the sharp increase in spending. In 2008, 50,898,244 people received Social Security payments totaling over $615 billion dollars.7,520,501 people received Supplemental Security Income (SSI) payments totaling over $43 billion.

SSDI beneficiaries increased from 6.6 million in 2000 to 10.2 million in 2010

Concerns about Spending and Revenues: Medicare and Health CareOver 47 million elderly and disabled Americans receive Medicare. Spending on Medicare in 2010 was $520.4 billion. The Congressional Budget Office in 2010 estimated that the Patient Protection and Affordable Care Act will cost $940 billion over 10 years.

The Baby Boomers RetireThe system functioned well as long as the number of people in the workforce was larger than the number of people in retirement.

The Baby Boomers RetireEnter the baby boomers now at retirement age.There are fewer workers in the work force to support this large number of retirees. The number of workers supporting each Social Security recipient is projected to fall from 3.3 today to 2.2 in 2041.In 1950 there were 16 workers for every 1 recipient.

In 1950 there were 16 workers for every 1 recipient.

Baby Boomers Live Too Long!Due to many improvements in health care, baby boomers are likely to spend many more years in retirement. In 1935, the retirement age was set at 65 at a time when the average life expectancy was nearly 62. Today, the average life expectancy is over 78 years.

How Does Social Security Work?

Who is FICA?Remember the 1994 episode of Friends, when Rachel receives her first paycheck from a waitressing job?

http://www.youtube.com/watch?v=whf3S85q0bk

Who Pays for Social Security?Remember the 1994 episode of Friends, when Rachel receives her first paycheck from a waitressing job?She rushes to her friends, saying Look . . . my first paycheck!But when she opens it, she says:Whos FICA? Why is he getting all my money?

Who Pays for Social Security?The Social Security Act of 1935 imposed a new payroll tax. Social Security payroll taxes were authorized under the Federal Insurance Contributions Act or FICA.

Is Social Security a Social Insurance Program?From the beginning, Social Security has been described as a social insurance or an old age pension program. Many Americans imagine that they have an account in which they have made contributions during their working years from which they will eventually be able to draw benefits.

How a Private Plan WorksIndividuals make regular payments into the program over several years. A pool of savings is built up. Not everyone will retire at the same time. Benefits will be paid out gradually. In the meanwhile, these savings accumulate and grow as they are invested in stocks and bonds. A well-managed pension plan should be taking in more in payments and in investment earnings than it pays out. The amount of money in the private pension program will have ups and downs with changes in the stock and bond markets but should be sustainable.

How Does Social Security Work?Social Security was designed from the beginning as a pay as you go system. Social Security is funded by the payroll taxes of current workers. These funds are used to pay for the benefits of current retirees.

How Does Social Security Work?For several years, Social Security built up a trust fund - - a surplus of income over expenditures - - in anticipation of the increasing number of baby boom retirees. The surplus is held in Special Exchange Issue Bonds issued to Social Security by Treasury.This surplus is currently expected to begin to decline in 2016. By 2037, the Social Security trust funds will be exhausted. SI Bonds are redeemed by payments from Treasury.Where do you suppose Treasury will get the funds to redeem the bonds?It Gets Worse

Assets as a Percentage of Annual Expenditures

Source: Social Security : Trustees Report Summary, 2010Once Over Lightly: What is Debt, Deficit, and Surplus?

Deficit, SurplusIncreases in entitlement spending will add to the federal debt and deficit. When the federal governments total annual spending is in excess of its total collected revenues, it is called a deficit. When the federal governments total annual spending is less than it total collected revenues, it is a surplus.

Federal Surplus or Deficit

What Is the Difference between Deficit and Debt?When government revenues fall short of expenditures, the U.S. Treasury borrows money. That annual shortfall is the deficit. As the government runs a deficit year after year it accumulates debt. The national debt is the amount of money the federal government owes, the sum total of the deficits it has accumulated.

National Debt

What Might Be Done?

Implications of Persistent Deficits and DebtAn increase in inflation such as was experienced in the 1970s.A growing portion of the savings of individuals and financial institutions may go towards purchases of government debt, rather than investments in productive capital goods such as factories and computers, leading to reduced production of goods and services. In other words, it may result in fewer jobs and a slower growing economy.If higher tax rates are be used to pay rising costs of the interest paid on the national debt, savings would be reduced and some might be discouraged from working. Rising interest costs on the national debt could force reductions in important government programs such as transportation, health and defense.

Entitlement Growth as a Percent of GDP

Ben BernankeThe arithmetic is, unfortunately, quite clear. To avoid large and unsustainable budget deficits, the nation will ultimately have to choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above. These choices are difficult, and it always seems easier to put them offuntil the day they cannot be put off any more.

Source: http://www.federalreserve.gov/newsevents/speech/20100407a.htm

Think Tank AWe think that the best way to reduce the increase in entitlement spending is to raise the retirement age. When Social Security was first approved in 1935, the retirement age was set at 65 while life expectancy was 63. Today, the typical person claiming Social Security at age 62 lives into his or her early or mid-80s. Our research suggests that raising the age of retirement from todays age 66 to age 69 will provide significant savings without reducing benefits.

Think Tank BWe think that the best way to reduce the increase in entitlement spending is to reduce the benefits. Social Security was never intended to be a primary source of income for people in retirement. First, we recommend a gradual reduction in the increases in Social Security payments. For example, Social Security payments include Cost of Living Allowances (COLAs) to adjust payments for inflation. Reducing the amount of the COLAs will provide significant savings. Second, we recommend reducing the benefits for individuals with high incomes. These folks should be able to save sufficiently to provide for their own retirement needs.

Think Tank CWe think that the best way to reduce the increase in entitlement spending is to raise taxes. In 2010, individuals paid a 6.2 percent Social Security tax on earnings up to $106,800. We propose lifting this cap and gradually expanding the Social Security tax to including all earned income. After all, Medicare taxes are already increasing for those earning over $200,000 and couples earning over $250,000 under the new health care reforms. Why not continue down that path? This change would allow us to keep the retirement age where it is and not reduce benefits to retirees.

Questions?