Tuesday, March 26, 2013

Why Medicare bills are like College Tuition

Imagine you're married and have two teenagers. Somehow you ended up with $25,000 in credit card debt and payments are you don't know how it happened. Since you kids are in their teens you know that in a few years they will go off to college and tuition bills will start arriving in the mail. You don't want to get deeper in debt in the future so you've dedicated most of your financial planning to dealing with those tuition bills.

Does that make any sense?

Sort of. That is how most policy wonks think about the federal budget. The U.S. is deep in debt and Medicare costs are increasing rapidly. If costs continue to grow as the baby boomers retire the country will be forced to run massive deficits (or raise taxes) to pay those big bills off on the horizon.

But the question everyone is interest in today is how the U.S. got so deep in debt and what we can do to get out of debt. To understand why we have a large debt today you have to focus on what we spend money on in the past, not what we will spend money on in the future.

The fixation on future costs has led many to minimize discretionary spending. Their projections assume discretionary spending will decline as a percentage of GDP into irrelevance while Medicare costs will explode. So the talking point for the anti-sequester bloc is that "discretionary spending isn't a real problem so we don't need the sequester."

1) It is like saying "I don't need the medicine, the doctor said I would heal."
Projections of declining discretionary spending are based on the premise that Republican leadership will remain obsessed with cutting discretionary spending to the bone. Telling them to stop worrying about the problem because it is going to get fixed is like saying you don't need to take the medicine (the sequester) because the doctor said you would feel better next week (... if you take the medicine).

2) We have a huge debt because of discretionary spending.
This point cannot be emphasized enough. If discretionary spending was so obviously going to recede into irrelevance why hasn't it happened yet. In theory when the Cold War ended there was going to be a major "peace dividend" as military spending decreased. Why did it go? Military spending remains close to 5% of GDP when costs for the wars are factored in and are two biggest factor in explaining why the U.S. fiscal position deteriorated over the past decade.

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