One glaring omission from both the Democratic and Republican platforms are substantive proposals to curb the deficit. To be fair, both platforms hint at the issue, but neither deals honestly with the challenge before us. The clear reason is that honesty is probably electoral disaster for either party. For that, we must blame ourselves.
It is too early to know if compromise will happen after the next election, or if we’ll have wait until things worsen enough to force compromise. Until then, its best to think about the magnitude of the problem, and what types of policies might for a basis for a budget solution.
First, the current debt is not at crisis level, but our debt-to-GDP ratio is now high enough that it threatens long-term increase to our borrowing costs. It is akin to paying more of our monthly credit card bill in interest than on things we might wish to buy, like national defense, public health or infrastructure.
Right now, the federal government is spending about 23.3% of our GDP, while collecting about 19.4% of GDP in tax revenue. That gap is about $6.5 trillion dollars, or roughly $19,350 per citizen. It seems like we could easily cut spending—until you understand what we are spending money on.
We spend 28% on Medicaid and Medicare, 25.3% on Social Security and a further 22.2% on national defense, including veteran benefits. Those three things sum to 74.5% of our federal budget, but our annual deficit last year was close to 74.3 %.
So, without cutting Medicaid, Medicare, Social Security or defense, we’d need to cut everything else and still would not balance the budget. But what would such a drastic step really mean?
Even if we stopped maintaining federal roads, closed all federal parks, cut all science funding, housing, education and agriculture subsidies, closed the FAA and fired air traffic controllers, ended pensions for all retired federal employees, abolished NASA, and stopped all border enforcement, we still couldn’t balance the budget.
It is clear to most adults that nothing like that is going to happen. There aren’t votes to fire air traffic controllers, cut farm subsidies or let the interstate road system disappear. There aren’t places within the federal budget to make big enough cuts to close the annual deficit without deep cuts to defense, Medicaid and Medicare, or Social Security.
It is necessary to point out that we are spending less of our GDP on national defense—including aid to allies, like Ukraine—than at any time since the end of World War II. The “fat” in the federal budget is in the form of Medicaid, Medicare and especially Social Security. Any fix involves these programs and higher taxes.
Social Security has always been an intergenerational transfer from working adults to retired adults. This works fine if there is steady population growth of younger people relative to older people. But a large baby boom and longer life expectancy means the program collects too little money in payroll taxes. Medicare is much the same.
There are several ways to deal with these problems. The first is to boost payroll taxes by a percentage or two. The second would be to make income taxes more progressive for Social Security recipients, exposing more affluent ones with higher taxes. Finally, we could collect Social Security and Medicare taxes on all income, not just the first $168,600 as we currently do.
None of these are ideal policies. All have costs and benefits, as well as winners and losers. So, this is an area ripe for political compromise.
The Medicaid program has more options. The Affordable Care Act (Obamacare) ended up being a large Medicaid expansion with protections for pre-existing conditions. So, it was neither as great as supporters claim, nor as damaging as its enemies contend. However, it could be modified in ways to significantly improve the federal budget.
Medicaid could have an expanded co-pay system, like Indiana’s HIP 2.0. Also, the federal government could tax nonprofit hospitals for windfall profits.
The biggest savings in Medicaid would come from treating all states the same and ending the practice of rich states subsidizing poor states. Currently, individual states pay between 38.9% and 14.3% of their total Medicaid costs. The federal government picks up the remainder of the bill. Part of this huge difference is because states may choose to vary some aspects of their Medicaid offering. But, most of the difference is simply that Medicaid’s formula pays more to states that are poorer.
If all states were required to pay the same share as the highest state share, the total federal cost of Medicaid would drop by more than $82 billion a year, or more than 10%. Of course, for many states, that is an eye-watering budget shock. Just hitting the national average would cost Indiana $1.03 billion per year, and matching the highest state level would cost taxpayers $2.75 billion per year.
It should be obvious why the Medicaid formula would be a ripe target for congressional compromise, but the real issue runs a bit deeper. Not only do rich states pay a larger share for Medicaid out of their own budgets, but also the progressive federal income tax collects a higher share of earnings from residents of richer states, like Massachusetts, New York and Connecticut.
So, rich states get a triple whammy on Medicaid. Their residents pay a higher federal tax and then get less back in Medicaid payments. This forces them to also raise state taxes to provide the same level of Medicaid to their residents as poor states.
For example, the average Illinois resident pays $91 more in state taxes each year to fund their state’s higher share of Medicaid than the average Hoosier. Illinois gets back a whopping $680 less per resident from the federal government for Medicaid than Indiana, while at the same time, the average Illinois resident pays $90 more in federal taxes than the average Hoosier.
Just to further complicate the issue, 24 of the 25 states with the lowest state share of Medicaid are firmly Republican, while 21 of the 25 states with the highest Medicaid share are firmly Democratic. So, I would expect every budget negotiation to include equalizing Medicaid payment share across states.
I have no idea where the discussion will end up, but it will undoubtedly be part of negotiations for the coming years.
Michael J. Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to [email protected].
