FY 2013 Federal Mandatory Budget

Mandatory spending is that part of the U.S. Federal budget that has been mandated by Federal law outside of the annual budget process. A great example is the Social Security Act of 1935, which set up the Social Security retirement program. The Federal government must, by law, pay retirees their benefits. Other Federal laws require the government to provide benefits to people with disabilities, people under a certain income level, and the unemployed. The mandatory portion of the budget simply estimates how much it will cost to fulfill these Federal laws.

It literally takes an act of Congress to change a mandated program. For example, Congress amended the Social Security Act to add Medicare. However, Congress has a difficult time reducing the benefits entitled under any mandated program. Most consider it political suicide because such cuts guarantee voter opposition by the group receiving less benefits. As a result, mandatory spending continues to grow without restraint. It is now nearly two-thirds the annual budget.

The other portions of the Federal budget is discretionary spending. This must be approved each year via 13 annual appropriations bills. (Source: Congressional Budget Office, Mandatory Spending Control Mechanisms)

In FY 2013, mandatory spending is budgeted at 60% of total Federal spending, and 2 1/2 times as much as the military budget. The mandatory budget is estimated to be $2.293 trillion, a new record. The mandatory budget was $2.252 trillion in FY 2012 and $2.073 trillion in FY 2011.

The largest mandatory spending programs were Social Security and Medicare, as follows:

• Social Security - $820 billion
• Medicare - $523 billion
• Medicaid - $283 billion
• TARP - $12 billion
• All other mandatory programs - $654 billion. These programs include Food Stamps, Unemployment Compensation, Child Nutrition and Tax Credits, Supplemental Security for the Disabled and Student Loans.

(Source: OMB, Table S-5)

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 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 2036, the surplus will be depleted. The Social Security payroll tax will only be able to pay 77% of projected benefits. The rest would have to come out of the general fund. However, the shortfall could be covered by an extra 2.22% increase in payroll taxes.

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.

With nearly two-thirds of the budget dedicated to mandatory programs, the Federal government is restricted in discretionary spending. This is one reason President Obama asked for health care reform.

Mandatory spending now includes the TARP program. In FY 2009, the government spent $150 billion to rescue troubled banks. In FY 2010, banks paid back $110 billion and another $38 billion in FY 2011. TARP spent $35 billion in FY 2012, and has budgeted $12 billion in FY 2103, for programs to help homeowners modify mortgages and avoid foreclosure.

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

Demographics means that, at some point, Congress must bravely bite the bullet and amend the laws that created these mandatory programs. The first Baby-Boomer turned 62 in 2008, becoming 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, four things happen:

1. The percentage of the labor force under age 55 does not provide enough income via payroll taxes to fund Social Security benefits.
2. Economic growth slows as government spending becomes almost exclusively focused on paying benefits for these mandated programs.
3. The debt comes closer to Japan's crushing burden of a 200% debt-to-GDP ratio.
4. The dollar weakens as investors in Treasury bonds switch to currencies in countries with brighter growth prospects.

As a result, Congress 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. This would reduce defense spending, the largest discretionary budget item. It would also constrain the government's ability to stimulate the economy in case of recession.
2. Increase the overall size of the budget. However, to fund this increased spending, either taxes would have to be raised, or the debt further increased. Either would slow economic growth.
3. Decrease the benefit amount paid to retirees. This is the most likely scenario. This would force able-bodied Boomers to continue working.

(Article updated February 16, 2012)