Key Factors Affecting Long-Term Growth in Federal Spending

June 29, 2009

Last week CBO released the Long-Term Budget Outlook. Under current law, the federal budget is on an unsustainable path: projected spending rises well above projected revenue, producing growing budget deficits and accumulating debt. Almost all of the projected growth in spending relative to GDP (other than interest payments on the debt) is attributable to Medicare, Medicaid, and Social Security. For these three programs together, the two health programs account for 80 percent of spending growth over the next 25 years and 90 percent over the next 70 years.

Two factors underlie the projected increase in federal spending on Medicare, Medicaid, and Social Security as a share of GDP: rapid growth in health care costs and an aging population. To demonstrate the relative importance of these factors, CBO calculated how much of the projected increase in federal spending for the three programs would be attributable to aging and excess cost growth (growth in age-adjusted health care costs per person that exceeds the growth of per capita GDP) under the extended-baseline scenario (see my June 26 blog entry on the fiscal gap for a description of our long-term scenarios). CBO did so by comparing the outlays projected under that scenario with the outlays that would occur under two alternative paths: one with an aging population but no excess cost growth for health programs and one with no aging but with excess cost growth.

The interaction between the aging of the population and excess cost growth accentuates their individual effects. Higher spending per person has a larger influence as the number of beneficiaries in Medicare and Medicaid rises. Conversely, having more beneficiaries in those programs imposes a larger budgetary cost when health care costs are growing. That interaction can be identified separately, or it can be allocated according to the shares attributable to aging and excess cost growth.

Aging is the more important factor over the next 25 years or so. If the interaction is allocated between the two factors, aging accounts for about 64 percent of the projected growth in spending on the major entitlements by 2035.

That result is not surprising because the aging of the baby-boom generation significantly expands the number of Medicare, Medicaid and Social Security beneficiaries. Over the longer term, however, the situation reverses: 56 percent of the growth in total federal spending for those three programs by 2080 is attributable to health care costs per person rising more rapidly than per capita GDP. (Of course, the growth of health care costs has no effect on spending for Social Security.)

Identifying the interaction separately from the direct effects of aging and excess cost growth gives a slightly different perspective. By 2035, aging alone accounts for 56 percent of the projected growth in spending for the three entitlement programs. Excess cost growth accounts for another 32 percent, and the interaction between the two factors causes the remaining 11 percent. For the period through 2080, the picture changes, as aging accounts for 32 percent of the increase in spending, excess cost growth accounts for 41 percent, and the interaction effect contributes 26 percent.

Looking only at Medicare and Medicaid, excess cost growth is the primary factor driving the growth of federal spending, even over the intermediate term. By 2035, excess cost growth by itself accounts for 46 percent of projected growth in federal spending on those two programs. Adding in that factors share of the interaction raises the contribution of excess cost growth to 56 percent. The figure for excess cost growth alone is similar in the long term and in the intermediate term (49 percent by 2080 and 46 percent by 2035). But with its share of the interaction included, excess cost growth is responsible for 70 percent of the projected growth in federal health care spending by 2080.

Factors Explaining Future Federal Spending on Medicare, Medicaid, and Social Security
(Percentage of gross domestic product)

Factors Explaining Future Federal Spending on Medicare, Medicaid, and Social Security