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Health Alert | How Bad is Our Fiscal Crisis?

Economists on the left and right are expressing concern - in some cases alarm - over the fiscal health of the U.S. government. Currently, we are running a deficit equal to about 10% of GDP; but the government is still able to borrow at 3%. No other country in the world could do that. And we may not be able to do it much longer.

We may be living in the calm before the storm.

As in the case of Greece - and possibly all of southern Europe - international investors may decide that we have neither the will nor the ability to pay back our debtors. In that case, the government's borrowing costs will soar.

How bad are things? How much of the problem is health care? Can we tax our way out of it?


Another day older
And deeper in debt

My own view is that the crisis is going to begin at the bottom and rise to the top. Already we have seen some local governments declare bankruptcy. Expect more of that. In the next several years, I believe some very large cities are going to announce that they cannot pay their bills. State governments will be next. Whereas local governments can declare bankruptcy, state governments can only default. A default by the state of California seems almost inevitable.

But is it conceivable that the U.S. government could default? Actually, yes. Every projection shows the gap between spending and tax revenues rising through time. And the problem at the federal level is basically the same as it is at the state and local levels: We made promises, mainly promises of benefits for retirees, that we were unwilling to fund.

Two years ago the first of the baby boomers started claiming early retirement under Social Security. Next year, they will start signing up for Medicare. Before they are through, 78 million people will quit working, quit paying taxes, quit contributing to our retirement system and start drawing benefits instead. And we are not ready for them. Not in Social Security. Or Medicare. Or Medicaid. By not ready, I mean we have put no money aside to pay for the benefits the baby boomers think they have been promised.

In terms of short-term cash flow, the Obama administration is forecasting that federal spending will be at 25% of GDP by 2020, while revenues will be less than 20%. To keep the deficit at no more than 3% of GDP (not zero, but 3%), an Urban Institute/Brookings tax analysis suggests that tax rates must rise by 40% beginning in 2015. That means the bottom 10% rate would have to climb to 14% and the top 35% rate would go from 35% to 48%.

The problem is not just a federal problem. State and local governments have unfunded retiree obligations of $2 trillion or more. Private companies have made (defined benefit) promises that are underfunded. And one-third of the baby boomers have an employer promise of post-retirement health care - almost none of which has been funded!

What I am describing is a huge gap between what the baby boomers think they have been promised and the resources available to meet those promises. What I am describing is oncoming generational warfare.

So let's think about solutions. As described previously at this blog, President Obama has appointed a commission on the federal debt, the National Commission on Fiscal Responsibility and Reform. Although nothing is for certain, many believe a value-added tax (VAT) will figure prominently in the proposed solutions.

But is a VAT tax, or any other tax, really an answer to our problems? Professor Laurence Kotlikoff and his colleagues have modeled the U.S. economy in the middle of a world economy to project the consequences of various policy proposals. For example, suppose we continue on the current path and fund the growth of entitlement spending with a VAT tax or a payroll tax or a consumption tax. What will the future look like for the United States as well as Europe?

  • In the United States, the average tax on wage income will rise from 40.6% today (that's a 15.3% payroll tax plus a 15% income tax plus state and local taxes) to 55% by 2030 and 62.1% by midcentury.
  • If Europe follows the same path, the average tax on wage income will rise from 60.1% today to 72.5% in 2030 and 79.3% by 2050.

Tax rates of this magnitude would be enormously harmful to the economy and are probably uncollectable. (Note that these are average tax rates; marginal tax rates would be much higher.)

Is there a better solution? Yes. We must move immediately from a pay-as-you-go (unfunded) entitlement system to one which is funded and in which each generation pays its own way. For Social Security and Medicare we have described how to do that elsewhere.

John_GoodmanJohn C. Goodman is president and CEO of the National Center for Policy Analysis. The Wall Street Journal and the National Journal, among other publications, have called him the "Father of Health Savings Accounts," and the Media Research Center credits him, along with former Sen. Phil Gramm and columnist Bill Kristol with playing the pivotal role in the defeat of the Clinton Administration's plan to overhaul the U.S. health care system. He is also the Kellye Wright Fellow in health care. The mission of the Wright Fellowship is to promote a more patient-centered, consumer-driven health care system.

Dr. Goodman's health policy blog is the only right-of-center health care blog on the Internet. It is the only place where pro-free enterprise, private sector solutions to health care problems are routinely examined and debated by top health policy experts throughout the country-conservative, moderate and liberal. 

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