As lawmakers continue to grope their way toward a short-term compromise on raising the debt ceiling and ending the government shutdown, this week’s executive outlook focuses on the long-term fiscal challenges facing the nation. House Republicans, in particular, have put this issue back on the public policy agenda, from which it had largely disappeared after the “fiscal cliff” deal at the beginning of the year.

In the absence of policy change, by 2038 CBO projects that the deficit will be 6.5 percent of GDP (compared with 4 percent today) and the publicly held federal debt-to-GDP ratio will hit 108 percent (compared with about 70 percent currently)

The Congressional Budget Office’s latest long-term budget outlook, published Sept. 17, made clear the agency remains decidedly pessimistic. In the absence of policy change, by 2038 CBO projects that the deficit will be 6.5 percent of GDP (compared with 4 percent today) and the publicly held federal debt-to-GDP ratio will hit 108 percent (compared with about 70 percent currently). There is lively debate about whether or when deficits and debt of these magnitudes would trigger a major increase in interest rates, but no one disputes that the long-run budget trends are unsustainable.

Given the low likelihood that lawmakers will rely exclusively on tax increases to close projected deficits of 6 percent to 7 percent of GDP (or larger in future years), changes in the big entitlement programs — Social Security, Medicare and Medicaid — are inevitable, if not in any discussions that the president and congressional leaders may have in upcoming weeks, then eventually at some point down the road. Two entitlement-related aspects of CBO’s latest report are especially noteworthy.

Social Security Imbalances Have Worsened:

A little-noticed aspect of CBO’s latest long-term budget outlook is its change in the assumed growth of longevity — or actually the continued decline in mortality — that underlies its Social Security spending projections.

Up to now, CBO has relied on the Social Security Administration’s mortality projections. The SSA projected earlier this year that mortality would decline, adjusted for the age and gender composition of the population, by 0.8 percent annually. This decline was slower, the CBO reported, than “the one seen for the past several decades.”

Finding this assumption difficult to swallow, CBO adopted its own mortality projection: a decline of 1.17 percent a year, the historical rate since 1950. Under this assumption, average life expectancy in 2060 will be 84.9 years, rather than 83.6 years as projected by the SSA trustees.

This seemingly small difference in longevity makes a big difference in the projected Social Security actuarial deficit during the next 75 years — from 1.9 percent of taxable payroll to 3.4 percent. This increase may elevate the importance of addressing the long-term imbalances in the Social Security program in any future deficit reduction talks.

Rising Medicare/Medicaid Costs Still a Problem:

One of the best surprises of recent years has been a dramatic slowdown in the annual growth of health-care spending, both in the care reimbursed by Medicaid and Medicare and care paid for by private insurance.

While economists argue over the reasons for America’s slowdown, the rising cost of Medicare and Medicaid continue to pose a critical problem to the long term growth of the United States

Economists have been busy arguing over the reasons for the slowdown: the recession and slow recovery, higher co-pays and deductibles that discourage people from using health-care services, and more efficient delivery of health care, among other factors. More importantly, economists continue to spar over whether, or to what extent, the cost and spending slowdowns will be permanent.

CBO accepts the view that something significant has happened in health-care markets that will restrain the growth of costs and spending, notwithstanding the steady retirement of baby boomers and increased longevity of seniors on Medicare. Nonetheless, the CBO projects that Medicare and Medicaid health-care spending per beneficiary, adjusted for demographic changes, will grow faster than potential GDP during the next 75 years (ending at 1 percentage point faster for Medicare, but the same rate as potential GDP for Medicaid). This is why, in CBO’s 25-year time frame, combined Medicare/Medicaid spending is projected to rise from 4.7 percent of GDP in 2013 to 8 percent in 2038.

CBO’s projections of future Medicare/Medicaid spending seem roughly consistent with a draft study presented at the September meeting of the Brookings Panel on Economic Activity. Professors Amitabh Chandra and Jonathan Holmes of Harvard and Jonathan Skinner of Dartmouth provide extensive evidence suggesting that overall health-care costs will continue to grow more rapidly than GDP by 1.2 percentage points per year. Especially important in their calculations is the fact that there has been no slowdown in the growth of health-care employment, while new technologies, which in the past have been the major factor driving up costs, should continue to do so in the years ahead. In addition, medical costs and spending have slowed before, only to bounce back, so it is premature to take too much comfort from their recent slowdowns.

What’s Next?

The truthful answer is that no one really knows, although at this writing it appears likely a short-term deal to raise the debt ceiling and reopen the government may end the current stalemate. If a process is created for addressing long-term budget issues, it is anyone’s guess how much progress will be made, given the deep philosophical divide between the political parties on spending and taxes.

Historians and pundits will argue why Republicans put their chips on defunding and then delaying implementation of the health-care law rather than long-term deficit reduction, which is directly related to both the appropriations and debt ceiling votes. The CBO’s latest report provides yet another reminder that sooner or later the parties must devote serious attention to long-term deficits.

If such action occurs sooner rather than later, it will be a silver lining in this otherwise sorry episode in American politics.

(Robert Litan is the director of research for Bloomberg Government. A version of this executive outlook originally appeared Oct. 11 for BGOV subscribers.)

–Editors: Daniel Parks, Jodie Morris

To contact the analyst: Robert Litan in Washington at
+1-202-416-3441 or rlitan2@bloomberg.net

To contact the editor responsible: Daniel Parks at
+1-202-416-3435 or dparks9@bloomberg.net