U.S. Federal Budget: Mandatory Spending

Mandatory Spending, at $2 trillion in FY 2010, is 57% of the U.S. Federal Budget. The largest mandatory spending programs are Social Security and Medicare, as follows:

• Social Security - $695 billion
• Medicare - $453 billion
• Medicaid - $290 billion
• All other mandatory programs - $571 billion. These programs include Food Stamps, Unemployment Compensation, Child Nutrition, Child Tax Credits, Supplemental Security for the blind and disabled, Student Loans, and Retirement / Disability programs for Civil Servants, the Coast Guard and the Military

Social Security is funded through payroll taxes. Through 2017, Social Security collects more in tax revenues than it pays out in benefits because there are 3.3 younger workers for every beneficiary. This has created a surplus in the Social Security Trust Fund.

However, in 2008 the first of 78 million Baby Boomers turned 62 and became eligible to draw down benefits. Over the next 30 years, there will be fewer and fewer workers per retiree to support Social Security via payroll taxes. By 2040, the Social Security Fund will be depleted and income will be insufficient to pay benefits promised to, and earned by, retirees.

Unlike Social Security, Medicare payroll taxes and premiums cover only 57% of current benefits. The remaining 43% is financed from general revenues. Because of rising health care costs, general revenues would have to pay for 62% of Medicare costs by 2030. As with Social Security, the tax base is insufficient to pay for this.

Medicare has two sections:

• The Medicare Part A Hospital Insurance program, which collects enough payroll taxes to pay current benefits.
• Medicare Part B, the Supplementary Medical Insurance program, and Part D, the new drug benefit, which is covered by premium payments and general tax revenues.

Mandatory spending is 56.6% of total Federal spending. It almost three times as much as the military budget, and 1 1/2 times all discretionary spending. (Source: OMB FY 2010 Budget, Table S-2).

With over half the entire budget dedicated to mandatory programs, the Federal government is restricted in spending on programs that will build the economy, such as education, business loans and even infrastructure. In FY 2009, the government is spending $497 billion on TARP. However, this is a short-term emergency solution to avoid a deeper recession.

In the long run, the high level of mandatory spending means rigid and unresponsive fiscal policy. This is a relentless drag on economic growth.

The first Baby-Boomer turned 62 in 2008 and became eligible to retire on Social Security benefits. By 2025, those aged 65+ will comprise 20% of the population.

As Boomers leave the work-force and apply for benefits, three things happen:

1. The percentage of the labor force under 55 stops growing, providing less payroll taxes to fund Social Security.
2. GDP growth declines to less than 2%, thanks to fewer workers.
3. By 2040, the Social Security Trust Fund goes bankrupt.

As a result, the U.S. Federal Budget in 2012 and beyond will have to choose among the lesser of three evils, none of which are good for the economy:

1. Devote more of the budget to pay Social Security benefits. However, to maintain current benefits, the federal budget will have to increase to 25% of GDP by 2045.
2. To fund this increased budget, taxes would have to increase, further slowing the economy.
3. Decrease the benefit amount paid to retirees. This would force able-bodied Boomers to continue working, and those who couldn’t work would provide a further drain on the economy.