U.S. Federal Budget FY 2008 - Mandatory Spending

What Is Mandatory Spending?: Mandatory Spending, at $1.412 trillion in FY 2006, is over half of the U.S. Federal Budget. The largest mandatory spending programs are Social Security and Medicare, as follows:

• Social Security - $544 billion
• Medicare - $325 billion
• Medicaid - $186 billion
• All other mandatory programs - $357 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

How Is Social Security Funded?: 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 workers for every beneficiary. However, as Baby Boomers start to retire and draw down these benefits, there will be fewer workers to support them. By 2040, the Social Security Trust Fund will be depleted and 100% of benefits will be paid from that year’s payroll and general tax revenues.

How Is Medicare Funded?: 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 will have to pay for 62% of Medicare costs by 2030.

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 only covered by premium payments and general tax revenues.

What Does the FY 2008 Budget Propose for Mandatory Spending?: The FY 2008 budget proposes dozens of program adjustments. (See OMB FY 2008 Budget, Table S-5. Mandatory Proposals for details). In FY 2008, the total savings is $9.7 billion, rising to $56 billion in 2012. Of these, reforms to Medicare ($21.7 billion in savings by 2012) and the President’s Personal Savings plan ($29 billion in savings by 2012) are the largest. Although this is a lot of money, it is still only 3% of spending.

How Will the FY 2008 Budget on Mandatory Spending Affect the U.S. Economy?: Through 2012, mandatory spending is budgeted at about 10.5% of GDP, with payroll tax revenue at about 6.5% of GDP, so that these unfunded obligations add to the general budget deficit. For example, in FY 2006 Social Security brought in $608 billion in “off-budget," extra funds from payroll taxes. However, other mandatory programs had expenses that far outweighed this “extra” revenue, creating a mini-deficit of $574 billion within the mandatory spending budget alone. The amount increases to $784 billion by 2012.

Short-term Impacts

Through 2012, the impact of the Budget’s savings proposals is negligible, since it only cuts spending by 3%. Although a lot of press and debate will be devoted to these plans, and a lot of lives will be affected by the outcome, the proposals will not affect the economy one way or the other in the short-term.

Long-term Impacts

Long-term, however, the impact of doing nothing about these burgeoning unfunded mandates will be huge. The first Baby-Boomer turns 62 this year, and becomes 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 labor force stops growing, providing less payroll taxes to fund Social Security.
2. GDP declines to less than 2%, thanks to fewer workers.
3. By 2040, the Social Security Trust Fund goes bankrupt.

Choices for FY 2012 and Beyond: 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.