Spending that can’t be ignored

Medicare, other programs eat up big chunk of U.S. budget

The sequestration cuts that took effect Friday could be the opening salvo in a long battle to rein in federal spending and deal with the growing mountain of government debt.

To succeed, an effort to get spending more in line with revenue must get even more aggressive and painful: It must address the costs of popular programs that help sustain the elderly and the poor.

More than $6 of every $10 the federal government spends now goes to Social Security benefits, Medicare for the elderly, Medicaid for the poor and other entitlement and related programs to aid individuals.

Within a few years, if changes aren’t made, such payments to individuals will consume two-thirds of the U.S. budget.

Social Security remains the biggest expenditure, but the bulk of spending growth today is driven by

health-care programs, especially Medicare and Medicaid, which didn’t exist 50 years ago. With more Baby Boomers retiring over the next two decades, changing demographics could force the government to devote an even larger share of the budget to entitlements.

Defense and other programs have expanded as well, resulting in a federal budget that’s eight times larger than it was a half-century ago, adjusted for inflation. In recent years, between 30 and 40 percent of all spending has come from borrowed money. By conventional estimates, Washington now owes more than $16 trillion, having added $10 trillion to the total in little more than a decade.

Dealing with all that debt, and the annual deficits that add to it, will involve a hard look at all federal spending, and at tax revenues. The sequestration cuts focus on defense and relatively minor programs, leaving untouched Social Security and Medicaid, and having hardly any impact on Medicare. Ultimately, scrutiny will need to fall on entitlements, since they represent the biggest slice of the pie.

Solutions to address shortfalls could include higher payroll taxes, increased eligibility ages to receive benefits and means-testing that would limit them for wealthier recipients.

Fixes will require action by Congress and the president, who appear as polarized as the public. Families often argue over money, and when a family counts more than 300 million people, squabbles can get intense. Clearly, compromises won’t be easy.

“But you got to start doing it, and it’s going to be painful, for everyone,” said former U.S. Sen. Alan Simpson, co-chairman of a national debt-reduction commission, during a recent stop in Phoenix.

“The big bucks are where the big four are,” said Simpson, referring to Social Security, Medicare, Medicaid and defense.

Chronic excesses

America has grappled with debt for most of its existence, as have other Western governments. The hymn “Rock of Ages” was composed by an Englishman concerned about his country’s national debt 237 years ago.

The nascent American republic took on debt almost from day one. The federal government borrowed so much money to pay for World War II that its debt briefly exceeded total economic output. But the bloated wartime borrowing was unusual and temporary.

Now, the debt numbers are rising to similar proportions relative to the size of the economy, triggered not by a shortterm emergency but by spending that chronically exceeds what the government brings in through taxes.

One major reason for concern is the two big entitlement programs, Social Security and Medicare, face tough demographic pressures as millions of Baby Boomers reach retirement age with fewer younger workers to support them.

Debate about addressing deficit spending and paring the debt has intensified amid the tough economic climate of recent years, with earlier tax cuts and federal stimulus measures adding substantially to the red ink. Although a consensus seems to be building that spending cuts are needed, economists, politicians and others differ over what they should be.

Sequestration, the automatic spending cuts that were included in legislation passed in 2011, began Friday. The White House says Arizona will feel an impact of roughly $89 million over the rest of the fiscal year.

Much of that involves military facilities in the state. Other affected programs range from food-safety inspections and environmental regulation to workforce training and efforts serving children and seniors.

While they might prove painful, spending cuts from sequestration, running about $1trillion or so nationally over the next decade, aren’t enough to solve the debt problem or even eliminate annual deficits, which topped $1 trillion in each of the past four years. Deficits are projected to ease over the next few years but climb again later in the decade.

Nor do the sequestration cuts reach into Social Security or Medicaid or affect the bulk of Medicare. That means other federal programs will absorb an outsize impact, with defense a prime target.

A half-century ago, it would have been pointless to discuss cuts without focusing on the military, which accounted for nearly one-half of federal spending. While its relative size has shrunk in subsequent decades, the military remains a prominent target.

The reason many Democrats in Congress accept sequestration is that they finally get to “stick it to the Defense Department,” said Simpson, a Republican who headed President Barack Obama’s National Commission on Fiscal Responsibility and Reform along with Erskine Bowles, former chief of staff in the Clinton administration. Many Republicans, Simpson added, like that sequestration finally brings some overall limits on spending.

Yet downsizing the nation’s defense forces won’t by itself get the job done. At 19 percent of the budget, military spending just isn’t large enough.

Efforts to rein in debt can’t succeed without including Medicare, Medicaid, Social Security and other entitlements. Payments to individuals, including those made through state-government programs, have jumped from 27 percent of federal spending in 1962 to 62 percent last year, and are likely to top 67 percent by 2017, according to the White House Office of Management & Budget.

Demographic pressures

Social Security and Medicare are designed as pay-asyou-go systems. The government withholds taxes on worker paychecks to fund the two programs. Financial pressures have escalated as the ratio of workers supporting each retiree has decreased in recent years. Taxes and other revenues now are falling short, requiring the government to fill the gap from general revenues or borrowed money.

Social Security has faced solvency issues before, as in the early 1980s. Reforms, which included higher payroll taxes and a gradual increase in the full retirement age to 67 from 65, got the system back on track.

The wave of retiring Baby Boomers again has ratcheted up funding concerns. Proposals to fix the system again include some combination of higher taxes and reduced benefits.

“Our younger population should not be the only ones making the sacrifice,” said Carol Glomski, a retired Maricopa County adult-probation worker who lives in Phoenix. “Seniors need to bend a little, too.”

She favors reducing Social Security benefits to more affluent seniors, arguing that Social Security was designed to meet basic living needs, “not contribute to vacations and second homes.”

David Jewett, a retired aerospace worker who lives in Payson, believes Social Security payroll taxes should apply on all income, as opposed to the current cap that limits the tax to the first $113,700 of earnings. As for Medicare, he suggests raising the eligibility age gradually.

John Gough, 28, said he isn’t upset about having to pay taxes to support entitlement programs that likely won’t offer benefits for his generation for several decades and which might be cut back over time.

“The face of entitlement programs will change over my lifetime, but I expect them still to exist in some form by the time I retire. I can’t expect them to change so drastically that there won’t be a safety net,” said Gough, co-owner of Skyhook Internet Marketing in Mesa.

But Sergio Arellano, a 29year-old military veteran living in Sahuarita, said he’s con- cerned that Social Security and Medicare might not be around when it’s time for his generation to retire. Arellano puts tax reform, focused on eliminating loopholes, at the top of the list for shoring up federal finances. He is involved in a group, www.thecankicksback.org, that represents the views of younger people on fiscal issues.

Jacob Gold, 34, a financial adviser in Scottsdale, warns younger adults that they might need to rely more on themselves. “They recognize that the current entitlement programs will most likely be diluted substantially,” Gold said. “The good news is that they are young. With adequate time and a good plan, people can accomplish amazing things.”

The debt commission headed by Simpson and Bowles offered suggestions for Social Security. One was a formula change that would slow future benefit increases for high-wage earners. Another would have a similar effect for everyone by adopting a new inflation measure to decrease cost-of-living adjustments.

The Simpson-Bowles panel also argued in favor of applying payroll taxes to cover more higher-income wages. And it suggested a gradual increase in the full retirement age to 69, along with a hike in the age at which early Social Security benefits can be taken to 64, from 62 currently.

Social Security was established in the 1930s when life expectancy was about 63, said Simpson, speaking in Phoenix. Now, seniors who reach 65 can expect to live until 83 if male and 85 if female — and millions of people live well beyond those ages. “The system can’t possibly handle that,” Simpson said.

Proposals on health

Medicare is trickier, with expenses rising not just because of demographic pressures but also because of other factors such as the widening use of medical procedures and the adoption of costly new medicines and technology.

Various proposals would attempt to better align incentives within the Medicare system so that doctors aren’t encouraged to provide unneeded services and patients aren’t encouraged to request them. Having patients share in more costs is one possibility. Another would pay doctors and other health providers a fixed sum per patient, then let them determine how best to allocate the money for each individual.

Other suggestions have ranged from a voucher system, where the government would give beneficiaries a set sum to be used for purchasing private medical insurance, to caps on the amount of employer-provided health benefits that could be excluded from income taxes.

Currently, employers don’t pay taxes on the value of healthinsurance premiums paid on behalf of workers, and workers generally don’t pay taxes, either. Limiting this exemption could generate significant tax revenue, at the risk that some companies might stop offering health benefits. This exclusion reduces federal and state tax revenues by $260 billion a year and ranks as the third-largest government health “expenditure” after Medicare and Medicaid, according to the National Bureau of Economic Research.

The Simpson-Bowles panel embraced several of these ideas and others, including more government funding to reduce Medicare fraud, cutting payments to hospitals for medical education and not paying providers for uncollected bills owed by patients.

There’s also the thorny problem of how to set reimbursement rates for health-care providers.

Congress hasn’t been willing to reduce physician fees for fear of cutting off medical access for a lot of Medicare beneficiaries. Instead, it has chosen to scrape up scarce funds each year to pay for those reimbursements.

Marjorie Baldwin, a health economist at the W.P. Carey School of Business at Arizona State University, believes it’s critical to involve consumers more to help control costs. “Medicare generally has focused on squeezing providers and reducing reimbursement rates,” she said. “But the only way to affect costs is to look at the consumer side.”

That would include making consumers more aware of health expenses, getting them more involved in decisions and having them pay more. “As a society, we have to get past the thought that health care should be free or a minimal cost,” she said. “Health care is expensive.”

In particular, Baldwin feels people need to rethink the massive expenditures that often are needed to prolong life for elderly individuals in poor health. “We spend a lot on the last years of life that doesn’t have much marginal benefit,” she said.

Medicaid ranks as the thirdbiggest source of entitlement spending after Social Security and Medicare, but the dynamics are different.

This isn’t a pay-as-you-go system supported mainly by payroll taxes but a program funded directly by the federal government and individual states.

Medicaid doesn’t incur the hefty costs of elderly medical care but serves lower-income families and children. It doesn’t face the same graying-of-America pressures. Instead, demand for its services often rises during periods of economic stress, including the past several years.

Baldwin believes Medicaid cost savings can be realized in large part by having the federal government give states more flexibility to run their respective programs more efficiently.

Obama’s health-care reforms haven’t fully kicked in yet but likely will add further pressure on federal spending when they commence in 2014, she predicted.