Why We Have Federal Deficits

Today the Mercatus Center is releasing a study I completed earlier this year that comprehensively analyzes the policy decisions underlying federal deficits.  Too often partisan advocates focus on a limited time period to purposely throw blame on a targeted political figure.  Instead I dissected the entire budget

, identifying deficit-driving policies regardless of when they were enacted.  The study was a mammoth undertaking; it required the digestion of practically every Congressional Budget Office (CBO) and Office of Management and Budget (OMB) budget report published over the past forty years.

The striking finding is that more than three-quarters of our long-term fiscal problem derives from a set of policy decisions made over a period of just seven years, 1965 to 1972.  1965 saw the establishment of Medicare and Medicaid, advocated for and signed by President Lyndon B. Johnson.  Both of these programs were later expanded in 1972 during the Nixon administration, as was Social Security.  Nothing done by any recent President or Congress carries long-term fiscal consequences as daunting as those arising from these 1965-72 decisions.  

The study examined deficits from three different vantage points.  The first was to analyze the specific policy decisions that moved us from budgeting norms practiced over the last forty years to current projections of untenable long-term deficits.  The second was to analyze the policy decisions that led to the current 2013 deficit.  The third analyzed which office holders ran the largest deficits when they were responsible for federal budget policy.  These methodological details are accessible in the full study.  

The Long-Term Deficit:  Our long-term deficit problem turns out to be pretty simple.  It consists entirely of spending growth in Medicare, Medicaid, Social Security, and the new health insurance exchanges established in the 2010 Affordable Care Act (ACA).  If it were not for spending growth in these four programs, we would not have a long-term budget problem.  Under current law tax revenues will well exceed historical averages going forward, and spending in all other areas will be far less, as a  percent of GDP.   

Let us review these contributors one by one:

1) Medicare.  Medicare is the single biggest contributor to our long-term deficit problem.  The vast majority of currently projected Medicare costs derive from the program’s original enactment in 1965.  There was a significant Medicare expansion in 1972, and its Part D prescription drug benefit was added in 2003.  Most Medicare legislation in recent decades has reined in projected cost growth rather than added to it.  

2) Medicaid and the ACA Health Insurance Exchanges.  Around 30 percent of the projected excess spending growth in this combined category is due to the ACA, which dramatically expanded Medicaid and established new health insurance exchanges.   Most of the other costs here derive from Medicaid’s original enactment in 1965.  Medicaid also underwent an expansion in 1972, and a series of smaller-scale expansions from 1985 through 1990.

3) Social Security.  If its pre-1972 benefit formula were still on the books, projected Social Security spending would be well within affordable historical norms.  Legislation in 1972 increased benefits by 20 percent across the board, in addition to introducing annual COLAs and indexing the growth of benefits paid to new claimants.  

The Current-year Deficit: The causes of the current-year deficit are more diffuse.  As with the long-term deficit, growth in Medicare, Medicaid and Social Security is a big part of the problem.  In addition, growth in income security programs as well as lower-than-typical tax revenue collections have played a role.  Legislation enacted by the last outgoing Congress and signed by President Obama is primarily responsible for the tax side.  Some of the recent growth in income security spending is attributable to expansions of the earned income tax credit (EITC) and child tax credit, and extensions of unemployment insurance, during the Obama administration.  Another significant portion traces back to an expansion of the EITC enacted in 1993 under President Clinton.  Notably, even with ongoing military operations abroad, all current appropriations spending remains within levels affordable within a balanced budget assuming current interest rates and historical spending prioritization.

Allocating Responsibility: The study assumes that 50 percent of the responsibility for fiscal policy decisions resides with the president, 25 percent with the House majority party, 20 percent with the Senate majority party, and 5 percent with the Senate minority party.  Those assumptions produce an allocation of responsibility for our deficit predicament that is accessible in the full study.  For example, it finds that President Johnson bears the greatest responsibility (28.6 percent) for our long-term imbalance of any individual.  

Fiscal Stewardship Track Records:  Due to the last five years of record deficits, deficit responsibility shares have been much higher on an annual basis during the Obama administration than during any other studied, by a wide margin.  

In sum, the fiscal problems now bedeviling policy makers are largely those created during the seven-year span of 1965-72.  We will not solve our deficit problem until we scale back the spending commitments originally made to Medicare, Medicaid, and Social Security during those years, in addition to scaling back the ACA’s health insurance exchanges.  From a budgetary perspective, everything else is mere distraction.

Charles Blahous is a senior research fellow for the Mercatus Center, a research fellow for the Hoover Institution, a public trustee for Social Security and Medicare, and a contributor to e21.