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Budgetary Long Game

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Budgetary Long Game

The debt-ceiling fight won’t bring entitlement reform, but Republican plans to curtail long-term federal spending will grow increasingly attractive over time. January 23, 2023
Politics and law
Health Care

After three years of record spending, the federal government will soon face decades of steadily rising entitlement costs. Some Republicans believe that they can force reform by obstructing an increase in the federal debt ceiling, but doing so would more likely force House leaders to accept proposals crafted by Senate Democrats. Yet as interest rates rise and fiscal constraints tighten, the longer-term prospects for entitlement reform become more propitious. Balancing the budget by increasing taxes is even less popular with voters and both parties than doing so by reforming Medicare and Medicaid, because tax hikes would represent a greater disruption to the status quo.

The past few years have made a brutal impact on the federal budget. Federal spending soared from $4.1 trillion in 2018 to $6.8 trillion in 2021, owing to a combination of the Coronavirus Aid, Relief, and Economic Security Act (under President Trump) and the American Rescue Plan Act (under President Biden). These waves of emergency expenditure will soon subside, but entitlement spending is about to surge. The Congressional Budget Office projects that federal outlays will swell from 21 percent of GDP in 2019 to 30 percent in 2050. Four-fifths of this increase owes to the rising cost of health-care entitlements and the debt interest payments that will result. Under current law, federal spending on Medicare and Medicaid will increase from $1.4 trillion in 2021 to $2.7 trillion in 2032. The culprit is a combination of expanded eligibility, an aging population, and the rising capabilities of medical care. With interest rates rising, annual debt service costs will soar from $0.4 trillion in 2021 to $1.1 trillion in 2032.

Even these projections are likely too optimistic. They assume that discretionary defense spending will decline by 15 percent from 2021 levels—the year before Russia’s invasion of Ukraine—as a share of GDP. The Ukraine conflict has already led to an unscheduled leap in expenditure. Intensified geopolitical rivalry with China would have an even greater fiscal impact.

Some Republicans are clearly unwilling to battle for fiscal conservatism. But the past four years demonstrate that spending will explode absent constant pressure to the contrary. And restraining the cost of government is the main thing voters want Republicans to do: YouGov recently found that 81 percent of Trump voters rated taxes and government spending “very important” in determining their vote choice, compared with, say, the 36 percent who cited abortion.

The newly elected GOP majority in the House is understandably responsive to this concern—especially following a $1.6 trillion omnibus spending bill rushed through the lame-duck Democratic Congress in December. The agreement reached by Speaker Kevin McCarthy requires the House Budget Committee to produce a resolution balancing the budget within ten years, using 2022 spending as a baseline.

The federal government is again set to breach the debt ceiling permitted by Congress, which was raised by $2.5 trillion in December 2021. Trump gleefully planted a banana skin for his rival Republican leaders, suggesting that by obstructing a debt-ceiling increase they could “get back almost everything” that Democrats had secured in recent spending hikes. In response, Democrats have grown excited by the prospect of Republican overreach. Senate Finance Committee chairman Ron Wyden claims that “Republicans are demanding cuts to Medicare, Medicaid and Social Security, and if they don’t get what they want, they’re willing to tank the American economy, destroy a strong job market and jack up interest rates and inflation.”

But the debt ceiling does not provide much political leverage. Republicans are no more eager than Democrats to see the federal government default on its debts and collapse financial markets. Nor have Republicans internally agreed to any significant agenda of spending cuts. The House GOP’s majority is slim, and many within it care more about increasing military aid to Ukraine than reducing domestic spending; Trump, meantime, said that Republicans should under no circumstances reduce Medicare or Social Security spending to pay for Biden’s spending. One can more easily imagine Republican defections getting a Democratic debt-ceiling package through the House than a conservative bill passing through the majority-Democratic Senate. Speaker McCarthy has therefore played down the prospect of near-term entitlement cuts.

Yet since Democrats have now lost control of the House of Representatives, while retaining an extensive spending wish-list beyond health care, they will, to some extent, need to play ball with Republicans to free up funds.

The secret to Medicare reform is that both parties are quietly eager to reduce the program’s spending—it is on track to absorb so much money that they’d prefer to use for other things. Major cuts to Medicare repeatedly formed the basis of major bipartisan budget agreements in the 1980s, in 1997, and in 2011. Each party would prefer to capture savings exclusively for its own purposes, but only Democrats have successfully done so (in 2010 and 2022). Nonetheless, Medicare spending in 2021 was one-quarter less than the Congressional Budget Office had predicted 13 years earlier.

Beyond this, Republican leverage is likely to be limited so long as Democrats control the Senate. But over the longer term, the balance of pressures is likely to favor spending cuts over tax increases.

Since the Second World War, Congress has never been able to raise more than 20 percent of GDP in revenue without provoking a tax revolt, and has repeatedly been forced to cut its spending commitments to fit. With great effort and electoral pain, Democrats may be able to increase revenues beyond that level by a percentage point or two. But this will fall far short of the 30 percent of GDP that existing spending commitments are on track to consume.

Whereas Republicans are merely inhibited in cutting Medicare, Democratic candidates in 2020 entirely disavowed broad-based middle-class tax increases; Joe Biden pledged not to increase taxes on those with annual incomes less than $400,000. Combined with Republican refusal to entertain tax increases of any sort, the Democrats’ position will leave the Trump tax cuts unchallenged for 98 percent of the population. In 2011 negotiations over a “grand bargain” to reduce the long-term deficit, Democrats struggled to identify tax increases that their own members of Congress would be willing to support.

In ordinary times, politicians fear being blamed for raising taxes or cutting benefits. But as rising debt-interest payments tighten fiscal constraints and Democrats refuse to consider plans to balance the budget through tax increases, Republican proposals to do so via entitlement reforms will be the only blueprints available.

Reforming entitlements would likely impose less pain on voters than hiking taxes. The entitlement-cost problem owes less to existing spending than to statutory commitments to increase future spending beyond the economy’s growth rate. Compared with tax increases, reforming entitlements means simply holding the line.

In the past, Republicans proposed to do this by capping the growth of federal matching funds that states could claim for Medicaid. This ran into concerns from governors of both parties, who feared that they would be unable to maintain basic services in recessions as enrollment soared. A better approach would be for the federal government to take full responsibility for the program’s core benefits and leave states to finance optional expansions of the program by themselves. Such a switch would strengthen the provision of basic benefits, while greatly reducing the capacity of states to inflate extraneous expenses borne by federal taxpayers.

Medicare’s rising cost as a share of GDP does not result from changing prices or the aging of the population but owes entirely to new and inflated volumes of services. The basic structure of the program is already on the right track. The share of beneficiaries opting for Medicare Advantage plans has increased from 19 percent in 2007 to 48 percent in 2022 and is projected to rise to 60 percent or 70 percent in the 2030s. As these plans can manage utilization as well as reimbursement rates, they can reduce costs without triggering the loss of access to care, as would be the case under the original Medicare system. Medicare Advantage plans are funded through defined contributions, so their expenditures can be reined in over time simply by adjusting the scheduled growth path of funding contributions to a sustainable level.

America’s main fiscal challenge is a long-term one. It will not be solved by the actions of a minority within one congressional chamber against the immediate priorities of most voters. But so long as conservatives are patient and clear-eyed about developing viable plans to balance the budget, they can expect those plans to win out.

Photo: akinbostanci/iStock

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