Emmons takes a look at the popularity of federal spending programs like Social Security, Medicare and defense. The cost drivers of these programs, which include the aging population, continually rising health care costs and the need for the social safety net, are very difficult or impossible to affect. Meanwhile, the U.S. revenue-to-GDP ratio has remained flat since 1945.
William Emmons: So can we slow spending growth? Well, we probably can't do much about interest rates in the long term. The Federal Reserve is really focused on shorter term horizons. In the long term, the markets will determine what the rate on the debt is. And so I want to point out two reasons why it's probably not going to be easier. It's certainly not going to be easy to slow down spending growth.
The first point is that the major federal programs are extremely popular. So in a sense, this audience is a little bit unrepresentative. Those questions that we asked you before are almost verbatim the questions that are asked in repeated surveys. The most recent one was in late March. A CBS news poll asked over a thousand people across the country the questions that we asked you, and the results were 82 percent of those who expressed an opinion—we forced you to express an opinion—82 percent opposed reduced spending on Medicare. And this group said 57 percent favored, so 43 percent opposed. 43 percent of our audience opposed, 82 percent of the general public opposes cutting spending on Medicare. For Social Security, 81 percent of the general public said don't cut Social Security. Among us, it was, what, 42 percent. So we have a somewhat unrepresentative audience here. So maybe we've self-selected ourselves, people who maybe are willing to face these issues.
And actually that's kind of where I want to go, too, is how do we get the general public to move off these numbers, to be more open, more willing, at least to think about, to discuss making these hard decisions? The other point I'll make here is that 60 percent of the general public are opposed to reduce spending on defense, and in our audience we had 28 percent opposed. So this group, if you were all in charge, there would potentially be some room for making those hard cuts. What I want to take away from this public opinion poll though, however, is that these under current circumstances these are absolutely non-starters. You cannot possibly cut Medicare, not even a dime. And you cannot possibly cut Social Security. Maybe you can get away with some in defense, but even that's going to be very difficult.
So if those are the major cost drivers, particularly the healthcare costs, and you have this sort of public opposition to those cuts, how can you possibly balance the budget based on cutting those spending programs? So that's as I said, that's the irresistible force. And all of the trends suggest that those costs are going to rise faster than overall GDP.
The second reason that I think slowing spending growth is going to be very, very difficult is that the program cost drivers are very difficult or impossible to effect. For example, the demographics. We will have, and we're already in process, and we will have a substantial and permanent aging of the population, and there's nothing you can do about that. So what I mean by this, substantial in the sense that it has noticeable effects on how many people are available for work, how many people are in retirement ages, for example. It is permanent in the sense that we think a lot about the baby boom having moved in through the population. Even after all of us baby boomers are gone, the population will look different, the age structure will look different than it did before. There are other trends going on that will tend to make our population older.
I should point out, of course, this is true in many, many countries, certainly in all of the other rich countries and around the world. What we think of as emerging and developing economies also typically are in the midst of very rapid demographic transitions. We all know about China, the one child policy, and the very, very rapid aging that's going on there. But maybe we aren't as well aware, Mexico is in a very, very rapid demographic transition. Just 30 or 40 years ago, the average mother in Mexico had six children, today it's closer to two. So in fact, those changes are more rapid than are occurring in the United States. So demographics, that's one. There's very little that we can do about that.
Second, healthcare costs have risen faster than GDP for many decades and are expected to continue to do so. Now, is that a fact that we have to accept? Well, no, but then the question is, how are you going to affect those costs? And, of course, we've got lots of different experiments, lots of different approaches. To date, we can't say with any confidence that any of these approaches—whether it's more competition, more regulation—that any of those have been effective in helping the overall rapid growth of healthcare costs.
And the third point that I think is important is that we still do have a compelling case for some amount of a safety net for those less fortunate. I would say that we have not won the war on poverty. There are still many, many, especially in this time after this severe recession. So there are, I think by virtually anyone's definition, millions of Americans who face genuine need. And so there is probably going to be some—in fact, in our group I think we had fairly strong support. Yeah, so Medicaid, 53 percent—even of this tough audience—would be opposed to cutting spending on Medicaid. So the immense popularity of the programs, plus the underlying cost drivers that are very difficult to effect, lead me to conclude that this is a runaway train and there's no realistic way under current circumstances that we can get that spending slowed.
Well, what about on the revenue side? This is a picture of total federal revenues relative to the size of GDP—again, running from 1940 up to the present—and then to the right of the vertical bar of projections from the CBO. So you could say that World War II was really the cause—the excuse, if you will—for raising the tax burden a great deal from something around 7 percent up to close to 20 percent of GDP, a huge increase in the taxes collected. And after the war ended, we never lowered taxes again. So the tax yield has been something like 15 to 20 percent of GDP since 1945. It's essentially flat. There's no real trend. You can certainly see little waves, higher and lower levels. And even with what is a fairly significant fiscal tightening going on right now with tighter budgets, with the fiscal cliff sequestration, all of those things, what that really does is just bring us back up to the historical level. It doesn't go beyond that. It brings us back up closer to the 18 to 20 percent, 19 percent of GDP level. And that's, in fact, what the CBO expects is likely to occur.
So if you put those two together, the top line is spending and the bottom line is revenues. The difference is the budget deficit year by year. So you can see even in the immediate future as we expect revenues to recover somewhat from very depressed levels, and even as we think some of the spending will go down after the recession effects pass through, we don't get back to a zero deficit. And, in fact, fairly soon we know that these cost drivers are going to start putting upward pressure again on overall spending. So that by the end of this projection period, the difference there, 20 percentage points, 20 percent of GDP deficits on an annual basis if we were to go that far. Which would be in today's terms something like $3 trillion. And we've had a sequence of $1 trillion deficits which, of course, were unprecedented in peace time, but we would be looking at something more like three times as large if we were to get that far.
So the result of these exploding budget deficits is that the accumulated debt would also explode. So this shows from 1970 forward the ratio of federal debt held by the public relative to GDP. You can see the huge increase in the most recent period because of the recession, the financial crisis. And then there's some stabilization in the immediate future. And I'm showing here two potential paths. The lower one, the blue dashed line there, is what the CBO calls their baseline. This is if all current laws are, in fact, enforced as written. Relative to GDP you can see it flattens out but then starts to rise again before the end of the 10-year projection horizon. The green line, the dots, is what the CBO calls their alternative fiscal scenario. That's their judgment for what is actually more likely to happen. That is, when there are scheduled tax increases or scheduled spending cuts, they will be deferred or, in fact, eliminated altogether. And we saw that in the fiscal cliff negotiations, a tendency to push off or, in fact, permanently eliminate many of the changes that would have been painful—increased taxes or reduced spending.
I do want to mention, maybe some of you picked up on your way in, I think we have copies of a recent article in one of our publications written by Fernando Martin, one of our economists who talks a lot about the immediate, the fiscal cliff and the sequestration episodes that we've just been through. I'm here talking more about the longer term issues.
So the point I want to make here is that both of these scenarios, both the CBO baseline and the alternative—what they think of as the more realistic forecast—both of them are unsustainable. That is, as we look further out into time, the ratio of debt to GDP goes up. And so that's really the simplest and in a sense the most pertinent measure of fiscal sustainability. Can we get the debt stabilized relative to the size of GDP? So it's not the case that we have to pay off the debt and it's not the case that the debt can't grow, it's just that it can't grow faster than the economy forever. That's a situation of fiscal unsustainability. And so that's what this whole discussion is about is we've heard this term, can you bend the curve, can we sustainably bend this curve, get the debt to stabilize?
There's also kind of a secondary discussion which is, at what level? Even if we could sustain, or rather, stabilize this ratio, are we perhaps at a level, a high level that itself is dangerous? And there is, in fact, historical evidence that when countries get debt to GDP ratios up in this neighborhood, that they often have a great deal of difficulty. Perhaps we're different. Our debt is very in high demand around the world. The dollar, of course, still is the primary reserve currency. So it's possible that we have a little bit more room, a little more fiscal room than other countries, but the first requirement would be that we stabilize these ratios.