A customer pays for a prescription. By 2015, the Medicare drug entitlement will cost $174 billion.
By Tom Curry National affairs writer
updated 1/25/2005 4:55:41 PM ET 2005-01-25T21:55:41

The growth in mandatory federal spending, driven by the inexorable aging of the American population, means that well over half of all federal spending will go to entitlement programs for the elderly by 2015, Congressional Budget Office director Douglas Holtz-Eakin said Tuesday as he released a report giving his agency’s forecast for the next 10 years.

The growth in Medicare and Medicaid “will place great pressure on the federal budget,” he said. “At historic rates (of growth) there’s phenomenal budget pressure” coming in future years from Medicare and Medicaid. The eventual result, according to Holtz-Eakin, is likely to be "much higher taxes."

Medicare spending will grow by an estimated nine percent per year on average over the next 10 years, according the CBO, while Medicaid, which serves the poor but also pays for many elderly people in nursing homes, will grow by seven percent a year.

At the same time, the CBO figures that the economy itself will be growing by about five percent a year during the 2006-2015 period. Thus Medicare, for one, will be growing 80 percent faster than the ability of the economy to pay for it.

“Those two programs (Medicare and Medicaid) will collectively soon surpass Social Security as the largest program on the federal government’s books,” the CBO chief said.

Three-fifths of all federal outlays
By 2015, if the CBO forecast is correct, the three entitlement programs for the elderly will account for 55 percent of all federal outlays. That's a 30 percent hike over the 42 percent of federal spending that now goes into those three programs.

The new prescription drug benefit Congress enacted last year will add substantially to federal outlays. By 2015, the CBO forecasts, the taxpayers will be spending $174 billion on the drug entitlement and the program will account for nearly one-quarter of all Medicare expenditures.

Contradicting an argument made by President Bush that the prescription drug benefit for older Americans will save money by helping people avoid costly surgery, Holtz-Eakin said, “We have not found dramatic cost savings … certainly not over a 10-year period." But he said CBO would continue to investigate whether cost savings would materialize.

Persistently large federal deficits would “have a corrosive and detrimental impact" on the U.S. economy, said Holtz-Eakin.

The United States cannot borrow to meet its needs forever, the CBO chief said. At some point, “much higher taxes” seem unavoidable.

For fiscal year 2005, which ends on Sept. 30, the CBO estimates a federal deficit of about $400 billion or 3.3 percent of Gross Domestic Product (GDP). This includes CBO's estimate of additional costs for operations in Iraq and Afghanistan that weren't in the original fiscal year 2005 budget.

A deficit of 3.3 percent of GDP would be substantially lower than federal deficits were in the 1980s. From 1983 to 1986, federal deficits each year averaged 5.2 percent of GDP.

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“Do deficits matter? Yes, they matter, they impact the economy, the government is a large player in our economy," Holtz-Eakin observed. "How do deficits affect the economy? Well, unfortunately that depends as much on the state of the economy as it does on the deficit.”

When one looks back at the weak economy of 2001 and 2002, Holtz-Eakin said, it is hard to argue that deficits were harmful. The federal deficits “supported the economy at a time when spending was relatively weak.” But in the future, he said, the challenge would be “maintaining satisfactory economic growth so we can finance all the demands” for government services.

Although spending will grow in nominal dollar terms, the CBO report estimated that by 2015 federal outlays as a percent of the GDP would be slightly less than they were last year: 18.9 percent in 2015, compared to 19.8 percent in 2004.

If tax cuts enacted in 2001 and 2003 are extended through the 2015 projection period, it would add another $1.6 trillion to cumulative deficits.

Holtz-Eakin said his agency anticipates that military spending would be increasing at an average annual rate of 8.5 percent over the next 10 years while non-defense discretionary spending, which omits Medicare, Medicaid and Social Security, will grow by an average annual rate of 2.1 percent.

But that forecast is based on CBO’s “baseline projection,” which does not factor in extra supplemental spending packages for Iraq or elsewhere.

The CBO report did provide one scenario that assumed continued spending on counter-terrorism, the war in Iraq, operations in Afghanistan and perhaps elsewhere, adding another $590 billion in outlays and interest costs during the period 2006-2015.

Key unknown: productivity growth
Holtz-Eakin said one key unknown in the next several years will be whether productivity, which he said has “risen quite dramatically recently,” will continue to grow at a rapid clip.

“Labor productivity, or output per hour worked, rose at an average annual rate of 4.4 percent during the three-year period ending in the third quarter of 2004, well above its post-World War II average of 2.3 percent,” the CBO report said.

The report added that “total factor productivity (TFP), or output per unit of labor and capital combined, grew at an average annual rate of 3.5 percent during the same period — which is about 2.2 percentage points above its trend rate of growth.”

The increase in productivity, the CBO director said, is “probably the most important economic phenomenon to keep an eye on in terms of long-term budget outlooks.”

He said a one-tenth of one percent increase in productivity each year for 10 years would reduce cumulative federal deficits by $250 billion.

In his briefing to reporters Tuesday, Holtz-Eakin repeatedly emphasized the uncertainty that is inherent in all economic projections. “There’s an enormous amount of variability in the historical performance of the economy" which he said, "transforms into budget uncertainty.”

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