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June/July 2010 – Web Exclusive

A Bigger and Bigger Hole - Weathering the Storm - A Series of Reports on the Texas Economic Climate

“There doesn’t seem to be the political will to make the changes needed to save the system.”

— Dr. Michael H. Granof
Ernst & Young Professor of Accounting
University of Texas at Austin

Entitlements and the Economy

by Bruce Wright

Dr. Michael H. Granof

In our last issue, Fiscal Notes examined the spiraling federal deficit. This time, we’re taking a look at its major cause: entitlements.

An entitlement is a government program that guarantees benefits to a person by virtue of their belonging to a specific class defined in law. Number-crunchers also call such programs “mandatory spending,” since population and federal law, rather than Congress, determine the amounts spent on them.

Entitlement programs include a wide variety of government spending. The largest by far, however, are Social Security, Medicare and Medicaid, whose costs are soaring.

According to the Center on Budget and Policy Priorities, Social Security accounts for 20 percent of the 2010 federal budget, and Medicare, Medicaid and the Children’s Health Insurance Program take up another 21 percent. Various “safety-net” programs such as low-income housing assistance and the food-stamp program account for 14 percent more.

As up to 78 million baby boomers enter their golden years, entitlement costs have nowhere to go but up. The Congressional Budget Office (CBO) estimates that Medicare, Medicaid and Social Security alone will account for 47 percent of all federal spending by 2020.

Based on CBO figures, the Heritage Foundation estimates that costs for the three largest entitlement programs will double by 2050, and account for nearly 18 percent of the U.S. gross national product at that time.

The bill for this avalanche of spending falls largely on federal taxpayers — but not entirely. The federal and state governments jointly fund Medicaid. Texas expects to spend $9.5 billion in state funds on the program in fiscal 2011, or about 20 percent of all state-funded appropriations for the year.

the Storm

Read the entire “Weathering the Storm” series:

Dr. Michael H. Granof, Ernst & Young Professor of Accounting at the University of Texas at Austin, recently pointed out that the federal government’s own financial reports make it clear that its revenues cannot continue to support entitlements at their current levels. Fiscal Notes spoke with Dr. Granof on this thorny topic.

FN: You said in a recent article that federal accounting figures make it clear that “the sky is indeed falling.” Could you elaborate?

Granof: The best thing I can do is cite the federal government’s own 2009 annual report. The feds have issued a statement that says plainly that present trends are unsustainable. And the longer we run up deficits, the longer we wait to solve the problem, the greater the federal debt. And the greater the debt, the greater the interest costs we have to pay.

“The feds have issued a statement that says plainly that present trends are unsustainable.”

We’re digging ourselves into a bigger and bigger hole. There’s no question about that. And in large part that’s driven, in addition to interest, by entitlements, mostly Social Security, Medicare and Medicaid.

FN: Do they all represent an equal threat?

Granof: No. Social Security’s a relatively easy problem to solve. We can raise the retirement age and remove the cap on contributions. Right now, if you’re employed, you only pay a Social Security tax of 6.2 percent on the first $106,800 of your salary. You can readily remove or increase that cap to solve that problem.

The problem is that there doesn’t seem to be the political will to make the changes needed to save the system.

Big Slices of the Pie

Based on Congressional Budget Office figures, the Center on Budget and Policy Priorities reports that major entitlement programs — Social Security, Medicaid, Medicare and the Children’s Health Insurance Program (CHIP) — account for 41 percent of federal spending in fiscal 2010. “Safety-net” programs represent another 14 percent.

2010 Federal Budget:
Major Components

Breakdown of budget is Social Security 20%, defense and security 20%, interest on debt 6%, Medicare, Medicaid and CHIP is 21%, safety-net programs 14% and 19% for all other programs.

* Safety-net programs include the refundable portion of the earned-income and child tax credits; programs that provide cash payments to eligible individuals or households, including Supplemental Security Income and unemployment insurance; various in-kind assistance for low-income persons, including food stamps, school meals, low-income housing assistance, child-care assistance and assistance with home energy bills; and other programs such as those that aid abused and neglected children.

Source: Center on Budget and Policy Priorities

FN: Advocating changes to Social Security seems to be a career-limiting move for federal legislators. If that’s the “easy” problem, it doesn’t bode well for the hard ones.

Granof: It’s medical costs, Medicare and Medicaid, which are the big problem, largely because of administrative costs, costly new technologies and trends in population.

FN: You mean the aging of the baby boomers?

Granof: The baby boomers are part of it, for sure, but it’s also the overall increase in life expectancy. People are living longer, and getting benefits for a longer period of time. You can’t increase demand without increasing supply and then expect costs not to go up.

Again, though, the problem we face now, and have faced in recent years, is that of governments [being] unable to successfully address even those problems that should be fairly simple to resolve. Thus we’ve been unable to enact Social Security reform, which should be a piece of cake compared with health care.

FN: And on the health care front, you see administrative costs as a major problem.

Granof: Yes. We’ve been unable to take steps in any meaningful way to decrease the administrative costs connected with health care.

You go to any doctor and you’re going to see people sitting around filing insurance claims, maybe three or four of them. And presumably, there’s another four people at the insurance company at the other end. That’s a lot of added costs.

Eventually, we’re just going to have to bite the bullet and make some really major changes to the health care system. In some countries, doctor’s offices don’t keep medical records or financial records. You give the doctor a card, like a credit card, that has all of your medical records embedded in it. For billing purposes, the doctor just has to slide it through a reader, again like a credit card, and the doctor’s automatically paid. That’s efficiency.

Our system of employer-based insurance is hurting the economy in many ways, some obvious and others less so. It makes it much more difficult for us to compete with other countries in terms of manufacturing, because the cost of health insurance is literally built into every product we make. Certainly, that’s a major factor that has hurt the automobile industry, for example. But it hurts other industries as well. In other countries, those costs aren’t built in.

There’s an apocryphal story that the chairman of one of the Big Three automobile companies once asked his board, “Who’s our biggest supplier?” And of course, people guessed steel companies, rubber companies, whatever. But no, it was Blue Cross Blue Shield, their health insurer.

FN: I’ve heard the old GM described as a health insurance provider that also made cars.

Granof: Right! That’s what I’m saying! Our employer-based insurance system simply isn’t working very well.

FN: But what would you say to arguments pointing out, for instance, that government-administered health insurance programs in European countries are being supported by fewer and fewer workers? That they, in other words, may not be sustainable either?

Granof: Look, they have problems too. But we can’t close the door on any options. We’ve got to come up with reasonable solutions, and one way or another, they’re going to have to involve government. That’s just reality, it’s pragmatism.

I was in favor of the recent health care bill. But it doesn’t solve the problem of increasing long-term costs. We’ve got to figure out a way both to control those costs and to pay for them, and we haven’t done that yet. The problem is, the trends are so unfavorable, we’re going to have to figure out a solution. FN

For the most current statistics and projections on the federal budget, visit

FN: What’s your outlook for the nation’s finances?

Granof: I fear there may be an event beyond our control that will cause a major fiscal crisis. Something similar to the recent financial meltdown, but it could come from other events, perhaps a war or economic disaster elsewhere in the world.

With very substantial debt and deficits, you don’t have many degrees of freedom in controlling the economy. It could be, for example, that something will cause foreign countries to stop buying our federal securities. When federal debt exceeds 100 percent of gross domestic product — which will certainly be the case in just a few years — that’s the risk you run.

Sound government policy dictates that, in periods of prosperity, you should at the very least be close to a balanced budget, or even have surpluses. Because downturns are inevitable. And the reason we’re in such a mess now is that, when we had years of prosperity, we still ran substantial deficits.

When you have downturns, the traditional way to react is to decrease taxes and increase spending. And three or four years ago, many, many people were saying we’ve got to reduce the deficits, because when a recession comes, we’re going to have very little ability to use those approaches.

In a recession, we should be increasing spending, and we should be cutting taxes, but because we’ve lost so much of our financial leeway, the previous deficits are causing very serious problems.

We’re going to have to change our policies. We’re going to have to increase revenues or reduce costs. I assume it will be some combination of the two.

For the most current statistics and projections on the federal budget, visit the Congressional Budget Office.

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