Many factors contribute to the long-term outlook for the U.S. economy and budget, but in particular, there is a structural mismatch between the amount of revenues that the federal government collects and the amount of spending promised under current law. On the spending side of the budget, there are three major drivers of federal spending: rising healthcare costs, America’s demographics, and interest costs on the debt.
Currently, there is a fundamental imbalance between spending and revenues. Furthermore, that gap between federal receipts and outlays will continue to grow over the next three decades — pushing the national debt to historic levels. Spending, driven by rising healthcare costs, an aging population, and rapidly growing interest costs, is expected to grow from 21.0 percent of gross domestic product (GDP) in 2020 to 30.4 percent in 2050. Revenues, on the other hand, are only expected to climb from 16.4 percent of GDP in 2020 to 18.6 percent in 2050 according to the Congressional Budget Office (CBO).
One of the primary drivers of America’s long-term fiscal challenges is our inefficient healthcare system. America has one of the most expensive healthcare systems among advanced nations. Combined with the demographic realities of an aging population, America’s healthcare system leaves us with an unsustainable fiscal future. Not only will more Americans qualify for federal healthcare programs like Medicare and Medicaid in the coming years, but older people, on average, need more healthcare. Consequently, without reform, the federal budget will bear the cost of rapidly growing healthcare bills.
The United States spends $3.6 trillion — or 18 percent of the national economy — on healthcare. On a per capita basis, our healthcare system is the most expensive among advanced nations. Yet, America’s health outcomes are generally no better than those of our peers, and in some cases are worse, including in areas like life expectancy, infant mortality, asthma, and diabetes.
Put simply, we are paying more than other countries, but we aren’t seeing better results. Healthcare experts have estimated that 30 percent of our total healthcare spending goes to unnecessary and wasteful services. Furthermore, healthcare spending is projected to keep rising — faster than inflation, wages, and the overall economy. Not only does the system result in health outcomes that are generally no better for patients, but its inefficiency also creates enormous challenges for the U.S. economy and federal government.
The primary reason why our healthcare system underperforms is because the typical factors that fuel improvement and innovation in other industries are lacking in healthcare:
Under this system, the demands and rewards for quality, efficiency, and price sensitivity are sharply reduced.
The growth in healthcare costs per person has slowed in the last few years, but it is uncertain how long this welcomed trend will continue. Despite the slowdown, the Centers for Medicare and Medicaid Services projects that total spending for healthcare will climb to 19 percent of GDP in 2025. According to CBO’s most recent full set of long-term projections, spending on the major federal healthcare programs will rise from 5.2 percent of GDP in 2019 to 9.3 percent in 2049 — an increase of about 80 percent. That’s faster than the growth of any other major category of the budget except net interest on the debt.
Over the next 25 years, another major driver of rising long-term federal spending is the aging of America’s population, as the number of people age 65 or older will increase much faster than the working-age population. This stems from both the aging of the baby boom generation (those born in the post-World War II period of 1946 to 1964) as well as from increases in life expectancy.
Baby Boomers: The first wave of baby boomers turned 65 in 2011, and the number of people over that age will climb by nearly 28 million people over the next 30 years. Meanwhile, the working age population will increase by only 23 million people over the same period, according to the U.S. Census Bureau.
Increasing Longevity: Not only will the number of older Americans increase, but they are also expected to live longer in retirement. Overall life expectancy among Americans who live to age 65 has risen significantly over the past several decades. As those aging and longevity trends continue, the number of people age 85 and older is expected to almost triple over the next 30 years.
It is great news that Americans are living longer, and the retirement of the baby boom generation comes as no surprise. However, those trends mean that the government will spend more on programs that serve this growing population of older Americans. In fact, spending on Social Security and the major health programs (which include Medicare, Medicaid, the Children’s Health Insurance Program, and subsidies to purchase health insurance) accounts for all of the increase in federal non-interest spending relative to the size of the economy over the long term.
Such demographic trends are already putting pressure on the federal budget — threatening the sustainability of vital programs benefitting older and vulnerable Americans.
As the national debt grows, so too can the cost of servicing that debt. Not only can net interest costs crowd out opportunities to invest in other areas of the economy, but they also play a sizable role in the growth of federal spending.
Interest costs are the fastest-growing “program” in the federal budget — exceeding the growth in Social Security or Medicare — and will total almost $6 trillion over the next decade according to CBO. Furthermore, such costs crowd out the nation’s ability to invest in other programs vital for our future such as education, transportation, and research and development.
It would be one thing if our tax code were designed to fund all the promises we’re making, but it’s not. The U.S. tax system does not generate enough revenues to cover the spending levels promised.
Our tax code is also overly complex, confusing, inefficient, and unfair. For example, it remains riddled with tax expenditures, or “tax breaks,” that provide financial benefits to specific activities, entities, and groups of people. Those tax breaks, which total $1.5 trillion annually, increase annual deficits and can create market distortions that are damaging to economic growth and productivity.
A strong fiscal foundation can only be obtained by addressing the structural imbalance between revenues and spending — a result of our changing demographics, rising healthcare costs, and the interest costs on our growing debt. Understanding these key drivers of the debt is crucial to resolving our fiscal imbalance and improving our fiscal outlook.