Douglas Holtz-Eakin
Subject: Cutting Entitlements
Bio: President of the American Action Forum and former Director of the Congressional Budget Office
Transcript:
Larry Bernstein:
Welcome to What Happens Next. My name is Larry Bernstein. What Happens Next is a podcast which covers economics and politics.
Today’s topic is Cutting Entitlements.
Our speaker is Douglas Holtz-Eakin who is the President of the American Action Forum and the former Director of the Congressional Budget Office. Douglas will discuss the implications of the impending explosion in entitlement spending, and the coming crowding out of discretionary and defense spending.
Economics is about making choices. We can’t have it all. We must choose between more money for senior or other public needs like basic research, education, infrastructure, and arms.
I recently held a conference in Washington DC with a bunch of my friends where we chatted with Douglas. This podcast will be different from normal because some of the questions will be asked by my friends. This conversation was greatly assisted by my co-host Colin Teichholtz.
Douglas, please begin with your opening six-minute remarks.
Douglas Holtz-Eakin:
US Treasury closed the books on fiscal year 2024. The U.S. ran a deficit of $1.8 trillion, about 6% of GDP in an economy close to full employment and has no need for a big stimulus. This continues a phenomenon that in the 21st century, the Federal Government has not been able to control the rise in debt relative to GDP.
We have not changed the trajectory of fiscal policy. The annual appropriations that Congress deliberates so much on where we do basic research, infrastructure, education, national security, all the things our founders saw as the role of government, those are now a sideshow in the budget. My old shop, the Congressional Budget Office estimates we will spend $85 trillion over the next 10 years. It is the baseline projection, 13 of which is interest of the remainder only 21 is discretionary spending where you fund defense and non-defense needs.
Mandatory spending is called entitlements. And of the 51 trillion in mandatory spending, 36 is Social Security and Medicare. If you are going to deal with the spending side of the federal ledger, you must deal with Social Security and Medicare that the current president has vowed not to touch. Candidate Trump vowed not to touch Social Security and Medicare. Harris vowed not to touch Social Security and Medicare. She broke that pledge. She made a proposal to make Medicare much bigger to have it cover long-term care. So that is like equipping the Titanic with its own iceberg. It's insanity.
The troubling aspect is those two programs grow faster than everything else. Social Security last year grew 9% and is projected over the next 10 years to grow an average annual rate of 5.5%. Medicare grew 8% last year is projected to grow 7% every year for the next 10 years. Those numbers are important because federal revenues are going to grow at basically the pace of the nominal economy. So, if we have over the next 10 years, 2% real with 2% inflation and we hit all those targets, federal revenues are going to grow on average about 4%. The problem is that the spending is big and diverging from any plausible revenue source.
You'll hear people say, we just got to raise taxes and we probably will in solving this problem when we come to terms with it.” But if you just raise taxes, you get the level up, you close that gap for a while, but then they just diverge again. Everything about genuinely solving the mechanics of the problem is about getting Social Security and Medicare to grow closer to the pace of the nominal economy. Whatever you might think about the near-term outlook for federal debt, it is terrible for the next two years. There is no question about it.
We are already at a hundred percent of GDP; we will be well above the highest level in U.S. history by the time four years rolls around at this pace. This is a real problem.
I spend most days doing is screaming at Paul Krugman. Paul was among the people who always says, “oh, well this isn't a problem. You do not have to worry about the federal debt. Look at Japan. Japan's fine. Japan is not fine. Japan did not have a sovereign debt crisis. That's not failing.” Not failing is getting a D. And Japan got a D for two decades.
We need to aim at better than getting a D. The notion that somehow if we do not have a crisis, we are fine, misses the point. Deficits crowd out private sector economic activity. They crowd out the things that generate increases in productivity. In the 20th century, back when we did quaint things like balance the federal budget and we had fiscal policy set for long-term growth purposes, GDP per capita grew at an average annual rate of 2.4%.
Does not sound like anything great, but at that pace, the standard of living doubles every 29 years. In the 21st century, it is at 1.4% per year and the standard of living doubles every 56 years. Getting that under control will have great beneficial impacts on trend economic growth and growth in prosperity in the United States. And it should be our number one policy priority. It is not, but it really should be.
Larry Bernstein:
Why are long term Treasury yields so low and equity prices so high if the budget is out of control?
Douglas Holtz-Eakin:
Your question is where is the indicator that is going to raise awareness of the problem? Why aren't there any bond market vigilantes out there?
So truthful answer is we are the best-looking horse in the global glue factory. They are giving us a lot of capacity. So, it is not a situation where the dire emergency is showing up and you get huge rises in spreads, long yields go up, things like that. That is the entry into the sovereign debt crisis. It is the failure to take advantage of those conditions and allow the private sector to have an even bigger role instead just suck the money out for purposes in the federal budget.
Social Security and Medicare is there to have people live better in old age. Most of what the federal government does is subsidized consumption. The federal budget is just a big machine that takes money from saving and investment and transforms it into consumption. And the only way economies grow successfully is to defer consumption, save and invest for the future. So, it is stacked to make things perform worse. I want to stack it the other way.
Larry Bernstein:
Our next question comes from Colin Teichholtz.
Colin Teichholtz:
It sounds like your message is this is a ticking time bomb and at some point, is there going to be a crisis?
Douglas Holtz-Eakin:
Markets they will start pricing in the ability to mismanage an extraordinarily strong underlying economy. And I would prefer not to see that. The honest assessment is if you look at the 21st century, the budgets of George W. Bush were not about fiscal policy. They are about winning the war against terror at all costs, period. We are going to fight terrorists around the globe.
The Obama administration, they are not showing any great concern, right? They do the Affordable Care Act, expand the mandatory spending, their budgets basically if you read them say if the rich pay their fair share, we are good. Do not worry about it. Four years of the Trump administration said nothing. You cannot find debt and deficits in the State of the Union. Not a word. It is all good. Biden comes in, Build Back Better. We can do anything. All these big new programs do not worry about it.
Social Security, the trust fund exhausts inside of 10 years. When the trust fund is out of money, by law, they cannot pay any more than what is in the trust fund. That will be annual payroll tax revenues. So that means that 21% across the board cut to everyone in retirement under Social Security. Now that is not going to happen, but it does mean that there is going to be a social security reform somewhere in the next 10 years. And it does mean that if you are 55 thinking about retiring in 10 years, you have no idea what your social security benefit is. There is going to be pressure to deal with this. Social security contributes $3 trillion cashflow deficits over the next 10 years. So, you just mismatch between what is going out and what's coming in.
Larry Bernstein:
Our next question comes from Rory MacFarquhar who previously worked six years for the Obama Administration in the White House National Security Council and National Economic Council.
Rory MacFarquhar:
The basic problem is the rate of increase of Social Security and Medicare benefits. On the social security side, can you explain what options there are for bending that curve?
Douglas Holtz-Eakin:
Social Security benefits are people and benefits per person, and we are getting more people because of the demography. And so, we are seeing this permanent rise in the ratio of older Americans over 65 to workers. That is the baby boom coming through. The second thing is social security retirement benefits are indexed to real wages. And we offer current retirees a better standard of living than we offered people who retired 20 years ago. And we are going to offer an even richer retirement to people in the future. We want it to be comparable to their lifestyle when they are in the labor force.
So, you got to deal with that growth and the benefits. and most things amount to first awarding those who have high lifetime earnings less in their initial benefit than they are getting under current law, sometimes not even indexing it for anything other than just inflation and giving them in the same standard of living that people got 20 years ago in real terms. So just price index instead of waging indexing and then in retirements doing a better measurement of inflation so that they do not increase on an annual basis more rapidly than actual inflation. Those two things end up being the real drivers of how aggressive a reform you do. So, it just really amounts to how aggressive you want to be with affluent earners. In the extreme, would we ever take someone off the rolls? The left has always said no, it must be a universal program. And I think that is going to be the big discussion.
Larry Bernstein:
I always thought that we would help the elderly as much as we can. If we cannot afford it, we will not. If we can, we will. If we amended the formula for social security benefits would by design that does not go bankrupt. Maybe what we should do is link the aggregate benefit to nominal GDP?
Douglas Holtz-Eakin:
So, you could do that for Social Security is analytically not that hard. It is politically extremely hard because it's super transparent. Social Security is money in payroll taxes, money out clear formulas. When they do a social security reform, everybody knows who won who lost. And all the losers will live in the Ways and Means Chairman's Office and that will be that. It has been hard to get it done. Bush tried 20 odd years ago, he did not even get a vote in the House. The politics of it are quite difficult.
Larry Bernstein:
How do we fix Medicare?
Douglas Holtz-Eakin:
The place where a budget would be useful is Medicare. Medicare is a mess from a structural point of view. The original program was just major medical hospitalization part A, and it is a little mini-Social Security. It has got a payroll tax and a trust fund, then you pay the hospital benefits that is going to go bankrupt in the next 10 years as well.
Parts B, C and D, so outpatient care drugs and then Medicare Advantage, the all-in-one insurance package were all supposedly premium paid programs. The premiums were going to pay for them. But when they looked at the premiums, they thought those are too high for seniors to pay. We will just have them be a quarter of the program cost and take three quarters from the general revenue. Medicare's just bleeding red in as a program, it is responsible for a third of all federal debt outstanding all by itself. And one of the things you might want to do is put Medicare on a budget. Do you remember what that was? Death panels.
They had that group that was, if Medicare ticked above a designated share of GDP, the group would convene to find ways to get it back down. And that got turned into death panels by Sarah Palin.
Larry Bernstein:
Colin Teichholtz, can you ask the next question.
Colin Teichholtz:
Notwithstanding the politicization of death panels. If you put Medicare on a budget, that is going to require these tough decisions to get made by somebody, isn't it?
Douglas Holtz-Eakin:
I don't disagree. Which choices do you want to make? A quarter of the federal budget of the next 10 years is the discretionary programs. Defense, a research university, education and infrastructure and things like that steadily getting squeezed out. We are making the implicit choice that we can give seniors whatever they want, and these are the ones we are going to not serve. Rebalancing. That is simply the act of them saying no more. And that is going to start to happen.
Research universities saying we must get entitlement reform because there is going to be nothing for us. And so those are the political pressures are going to rise. The recognition, the top line problem, the composition pushing to get some entitlement reform. It is just that is how we make choices.
Colin Teichholtz:
In past episodes in this country when we have needed to spend more for defense spending or for a war with an understanding that we needed to pay for it in taxes or other spending would get cut. Maybe there would be an increase in the deficit for a period, but it would be managed. Is that historical perception that I have, correct? And would you agree like that philosophy has completely vanished.
Douglas Holtz-Eakin:
So historically we have had episodes of high deficits and high debt and certainly World War II constitutes an emergency. During the Korean War, we raised federal spending by 50% in a single year. And we got inflation comparable to what we just went through, jumped by more than six percentage points in a year, never seen anything like that. But in the aftermath of those episodes, they have always cleaned it up. They brought down the debt by having higher taxes, lower spending. They let the economy grow and debt as a fraction of GDP going down. The difference now is we are not cleaning up. We do the great recession, financial crisis debt goes from 30% to 70% of GDP, it stays there and then we go hit the pandemic, we jump up until about a 100% of GDP, it stays there. We now have for the first time the underlying structural mismatch that comes from these big entitlement spending programs. The debt now is of different character than a hundred percent of GDP that we got World War 2, which was emergency, all hands-on deck. We are not doing that now.
Larry Bernstein:
The next question comes from Boris Vladimirov from Goldman Sachs.
Boris Vladimirov:
Europe's healthcare costs about 10-11% of GDP. In the US it is 20-22%.
The federal government should be setting the rules of the game, is there a way to work on the cost side to solve that problem?
Douglas Holtz-Eakin:
All roads lead to Medicare. Medicare reimbursement sets the tone for all reimbursements in the healthcare sector. GDP is much higher here. And the reason is the prices are higher here. We pay more for medical devices and for drugs and all of that. And dealing with that pricing issue is dealing with the healthcare inflation issue. And our doctors like to be paid well, and that is a hard thing to conquer politically. When they were debating the Affordable Care Act, Christie Romer saying “We're going to do this and we're going to take $600 billion out of the American healthcare bill.” And I just laughed because you are taking $600 billion of someone's money, and they are not going to give it up easily. And then so far, they have not given it up ever.
Larry Bernstein:
Why are entitlement programs imploding now?
Douglas Holtz-Eakin:
Blame the boomers, the large, self-indulgent, unwilling to sacrifice anything generation. What we are seeing now is basically generational theft on a large order because we are just not willing to pay the cost of what we are up to pass that bill along. Not complicated. So, the cheap answer is always blaming the boomers. There is always sort of more complicated answers as well. I think a seminal moment that set the tone for the 21st century was Bush not being honest about the costs of the Afghanistan and Iraq wars and those never being budgeted in the federal government.
Larry Bernstein:
Our next question comes from Larry Goodman the Founder and President of the Center for Financial Stability.
Larry Goodman:
There are more people in the defense department working on procurement than in the Marine Corps. There is a tremendous amount of government waste.
There has been talk about creating some committee to tackle government waste. Do you think it might be productive and effective to go forward with that exercise here in the United States?
Douglas Holtz-Eakin:
So, there is a lot of waste mismanagement, erroneous payments in many of our programs. And the staffing in the federal government resembles large American corporations in 1980. And then we invented information processing capabilities, and we took out a whole swath of middle management. They do not exist anymore. The executives get their data. Those guys who just managed memos and sent the stuff up the chain are all gone. We have never cleaned that out here. The pentagon's full of them. Every agency is. So yeah, we need a big reorg to have a modern, more effective set of agencies. We need less in the way of fraud. We must restructure programs to do it. That means somebody loses their job. It is hard to do.
If you did all that, you would still have to come to terms with the fact that the bulk of what we are doing is paying benefits and the benefits are big numbers and you will not solve our fiscal problems with waste, fraud, and abuse. But I do not think it is easy to go after a grandma's social security check if you are not also being judicious in your use of taxpayer money. They are going to have to do something like this. I am also slightly skeptical because I am old and I do budgets, so I am pessimistic. But we had the Grace Commission, you remember Reagan Grace Commission big thing. It accomplished zip zero, the greatest deficiency commission in history. They can try and they should and will, but I do not think it will change the trajectory dramatically.
Larry Bernstein:
The next question comes from the investment banker Lee Stettner.
Lee Stettner:
My understanding of Medicare is that that most of the expenditures for someone happens in the last two years of life. We take a hugely different perspective on death than Europeans and how we apply medical care as policy. Is that something that how we look at death versus other countries and how we spend to keep people alive?
Douglas Holtz-Eakin:
The facts are well recognized, and you can slice health data and you will always find these big fat tails where last couple of years of life or small faction of the population spending all the money that is just characteristic of it. Politicians run from that conversation. You can understand why. I mean the ethics of behavior in those moments is extremely important, and they do not want to be making those decisions. And they run from them. And it is one of the reasons that I have always favored reforms that place more money in the control of families, because they are the only people ethically well suited to make those calls and use the money or not. We do not want insurance companies doing it. We do not trust bureaucrats to do it. You got to find a way to put the money and the decision-making locus in the same place. We do not do that.
David Brail:
Trump wants Elon Musk to take a hatchet to government spending. What can Musk do?
Douglas Holtz-Eakin:
He will not get free reign. It is a democracy in the end. And he would have to get elected officials to give him free reign and say damn the consequences. So, he will not get it. He will get at most a commission that can recommend anything, but he will not get to do it. Impossible to imagine because you will have to get that done in regular order in the House and Senate. You must get signed off by Democrats. They are not going to hand a blank check out to Elon Musk.
Colin Teichholtz:
We need to wrap it up and I know you've kind of described everything through the rose color glasses, but we like to close on a note of optimism.
Douglas Holtz-Eakin:
I am fundamentally optimistic about the U.S. All our problems are self-inflicted. They can all be fixed. This is politics, pure and simple, needs to be dealt with in a political fashion and it will be. And I would say that the thing I have always been most optimistic about is our heavy reliance on the private sector as the engine of growth. And if we do not give up on that, then we can solve any problem. If you make it the business community's interest to solve a problem, we will solve it. That is it. We can solve anything we want to.
Larry Bernstein:
Thanks to Douglas for joining us.
If you missed our previous podcast the topic was Surging New Business Formation. Our speaker was John Haltiwanger who is a Professor of Economics at Maryland. John spoke about the critical role that new firms do to increase productivity and provide job growth. We also discussed the movement towards more self-employed and 1099 independent contractors and how that phenomenon influences the job market.
I would like to make a plug for our next podcast with the Middle Eastern Diplomat Dennis Ross to discuss whether Israel at the current time should fight on or seek a cease fire.
You can find our previous episodes and transcripts on our website whathappensnextin6minutes.com. Please follow us on Apple Podcasts or Spotify. Thank you for joining us today, goodbye.
Check out our previous episode, Surging Business Formation, here.
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