With the midterm elections now concluded, people should naturally want to consider how Washington might shift its spending priorities. The answer, regardless of what the candidates have promised or whoever runs the government for that matter, is that Washington can change very little on this front. Entitlements—Social Security, Medicare, Medicaid, unemployment insurance and the upcoming outlays associated with the Affordable Care Act—so dominate the budget already that there is little room for anything else. Without serious reform in these areas, such financial constraints will only intensify in coming years and ultimately close out all other spending options, whatever presidents, senators, or Congress people say.
These constraints are crystal clear in existing budget data. Entitlements have grown relentlessly over the decades, from 30 percent of all government spending in 1950 to fully 70 percent today. They amount to 15 percent of the gross domestic product (GDP). More than one dollar in seven, then, of everything this country produces now gets paid out in one or the other of these programs. Since the full implementation of the Affordable Care Act promises only to increase those proportions, and voters clearly show no desire to fork over still more economic resources to Washington, the rest of the budget, everything else that Washington does, faces a relentless financial squeeze.
In the past, defense cuts relieved the strain entitlements otherwise would have imposed on other budget priorities. Of course, Pentagon outlays have continued to grow absolutely, but their take of Washington’s spending pie has declined over the long haul, dramatically and relentlessly. At the height of the Cold War, defense constituted half the entire budget and fully 10 percent of GDP. Today it is just over 15 percent of the budget and about 3.0 percent of GDP. It is noteworthy that the War on Terror, for all the financial hand wringing it engendered, did little to interrupt this relative decline. At the height of the Iraq war, Pentagon spending rose from 3.0 to 3.8 percent of GDP, hardly a bump in the long-term downtrend.
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These past declines have so reduced defense as a portion of the whole that future relative cuts at the Pentagon can provide only the thinnest of cushions against the growth of entitlements going forward. Many would argue President Obama plans to cut defense further, though the rise of ISIS makes the prospect dubious. Still, even if this somehow occurred, in the highly unlikely event that he cuts defense in half, he would free only 7-8 percent of the budget at most and buy the rest of the government only a few more years before the relentless growth of entitlements would begin to squeeze. That last bit of bought time may work for those who live by the election cycle, but most citizens take a longer perspective over which this budget reality will close options, including spending on things such as research and development, technical education and the ever-popular infrastructure spending.
Rising interest expenses on the government’s outstanding debt will compound the pressure and shorten the time to this inevitable squeeze. Recently, very low interest rates have relieved much of this budgetary strain. The expense of debt financing takes up just over 6.0 percent of the federal budget, well down from the 1980s, for instance, when higher interest rates took such expenses up to fully 14 percent of the budget. Interest rates, however, will not stay this low indefinitely. The Federal Reserve has made clear its intention to push them upwards. The White House, to its credit, recognizes this reality and has built into its expectations a rise in such financing expenses to 11.6 percent of the budget. That jump alone would all but offset any relief offered by otherwise unlikely defense cuts and make the point of pressure on the rest of the budget immediate.
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The arithmetic is irrefutable, whatever some people would like to believe. There simply is no room in the budget for much else but entitlements. Washington will either reverse sixty-plus years of practice and turn to serious entitlements reform, or it will have to give up on most of its other priorities. The only remaining question is this: can the White House, the Senate and the House do the math?
Milton Ezrati is senior economist & market strategist for Lord, Abbett & Co. and an affiliate of the Center for the Study of Human Capital at the State University of New York at Buffalo. He writes frequently on economics, finance, and politics. His most recent book, Thirty Tomorrows, on aging demographics, the challenge it presents, and how the world can cope, was recently released by Thomas Dunne Books of Saint Martin’s Press.
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