Which Way Can We go!
(c) Can Stock Photo / svanhorn

There is no doubt about it!  Unless the federal government drastically reduces mandatory entitlement expenditures in the near future, it will soon be bankrupt . What can be meant by “bankrupt” in terms of a nation? In terms of a person or a private organization, the dictionary meaning of the word is that the person or organization is declared in a court of law unable to pay outstanding debts. Whether or not a court will ever declare the United States government as being incapable of paying outstanding debts, I would settle for the definition that the U.S, government in fact can not pay its outstanding debts. And the time when that will be true may be a lot sooner than you think.

Historical U.S. Expenditures and Revenues

In my posts  The Thoughts that Haunt Me and The U.S. Federal Government Budget, I noted that the largest piece of the federal budget — approximately two-thirds of it — is the part devoted to mandatory entitlements, i.e. Social Security, Medicare, and Medicaid, plus other mandatory expenditures. I also wrote that the data strongly suggested that within one or two decades, the entitlements plus interest on the national debt will grow so large they will absorb every single penny of federal revenues.

Note that the defense budget, which is counted as discretionary spending because it has to be reauthorized every year, is only about 16 percent of the budget. I will come back to this fact later.

What I will attempt in this post is to make a somewhat more rigorous estimate of how long it will be before bankruptcy happens. First, let us take a look at total Social Security expenditures, decomposed into its two major programs: Old Age and Survivors Insurance (OASI), which is what you get when you retire after age 65; and Disability Insurance (DI).

Note that total Social Security Administration (SSA) expenditures appear to be increasing along an exponential growth curve and are approaching $1 trillion. Note also that although a non-negligible contribution is provided by Disability Insurance, nevertheless OASI provides the bulk of the growth.

The next two largest pieces of mandatory spending come from Medicare and Medicaid. In addition, with a large and growing national debt we should also be very aware of how the interest on the national debt is behaving with time. All three are plotted with time below along with total Social Security costs and the sum of these four budget components. One problem is that Medicaid is lumped together with some other mandatory health expenditures from other programs and labeled “Health” expenditures in the historical tables of the U.S. Government budget. Since those programs are also mandatory, and since Medicaid is almost certainly the largest component, I take “Health” as synonymous with Medicaid. With that caveat, the results are shown below.

The mandatory entitlements plus interest currently sum to a humongous $2.144 trillion, and as you would expect, the sum also appears to be on an exponential growth curve. One comment should be made about the one component of the sum that does not appear to be growing exponentially, namely the interest on the national debt, which is the black curve. The only reason this expense is not also growing exponentially is that the U.S. Federal Reserve has kept long-term interest rates as close to zero as they could since November 2008 with their Quantitative Easing (QE) program. The Fed ended their last QE program in October, 2014, but they have yet to sell the long-term bonds on their balance sheet. This limits the speed with which long-term interest rates can rise. Increasing the number of long-term bonds on the market would decrease their price and therefore increase their yield, increasing long-term interest rates. Because of this, the Fed has been very circumspect in unwinding their long-term bond balance sheet. However, they are also showing signs of allowing interest rates to rise to more natural market values. As this happens, we can expect the interest costs of the national debt also to begin rising exponentially.

The next issue we must examine is the revenue side of the problem. The historical data for federal government revenues is plotted below.

Of course the data in the last two graphs is for the past, and what we would like to do is to extrapolate into the future and see if the mandatory expenditures curve and the revenue curve intersect sometime in the future. This is an extraordinarily dangerous thing to do as it assumes that spending and revenue trends will remain the same as in the past. What it assumes is that politicians will behave much as they have in the past, which may or may not be a good bet. What the exercise will do is tell us what to expect if politicians do not change!

To perform this extrapolation we must do a nonlinear fit of an exponential to both curves and then see if the fitted curves intersect sometime in the future. When that task is performed, we obtain the plot shown below.

The goodness-of-fit of the exponentials to the data points is measured by a statistical parameter called R². If the fit were absolutely perfect with every single point falling right on the fitted curve, we would have an R²=1, and if there is no semblance of a fit we would have R²=0. The exponential fit to the entitlement expenditures plus interest on the national debt (the blue curve) is quite good with an R²=0.976. As you might surmise from the greater scatter of data points about the exponential fit to government revenues, that  R² is somewhat worse with  R²=0.796. The extrapolation is performed by calculating points on the fitted curves far beyond the data points in time, which I have done to the year 2045.

The bad news is that if you take these fits seriously (which you should not necessarily do. See below), then the cross-over when entitlement expenditures plus interest on the national debt absorb every single penny of federal government revenues will occur sometime in April, 2031. Actually, long before we reach that date, assuming these trends continue, we could expect financial pressure from entitlements and servicing the debt to cause a large number of activities with discretionary spending, e.g. defense, to come close to total collapse.

We Are NOT Inescapably Bound to This Destiny!

The dark, foreboding  conclusions from the previous section are not necessarily our destiny. They will come true only if our government does not change its catastrophically bad spending habits. Progressives would like to think the problem will go away if we would only tax ourselves more. Yet, because of the empirical Hauser’s Law, the amount the federal government receives in taxes hangs persistently around 19 percent of GDP. The only way the government can collect more in taxes is if the GDP increases. However, government almost always allocates capital worse than the private market would (see How is the Weather Like a Country’s Economy?). Allowing the government to choose more of the investments by letting it tax more of the available capital assets would only cause GDP to be less than it otherwise would be. That suggestion is a recipe for failure.

Almost everyone on the political Left (who suggest cutting defense to the bone) and a not insignificant number of people on the Right suggest that cutting discretionary spending could go a long way to solving the problem. Unfortunately, their just ain’t that much of the budget that is discretionary! Only about one-third of the budget is. (See pie chart above.) Also, discretionary spending is falling while the most rapidly increasing part of the budget is the mandatory entitlements part. No matter how you cut it, if we are to get out of this mess we will have to significantly cut entitlement expenditures to keep total expenditures below government revenues. As an elderly 70 year old man of modest means, you can appreciate how much it pains me to say this! If we do cut entitlements and also cut taxes, particularly business taxes, we will not only keep the government solvent, we will also grow the economy by letting private businesses allocate the resources rather than government.

I have one last point to make. There is at least one possibility for our situation to grow significantly worse. By unwinding its long-term bond balance sheet, the Federal Reserve could cause long-term interest rates to go up. If that happens, then the interest payments on the national debt part of mandatory spending could begin to increase exponentially again. Yet if the Fed does not allow long-term interest rates to rise, it will continue to discourage savings required for future investments and also allow the stock market bubble to continue to inflate. Not only do we need to get entitlement spending under control, but we need to cut it enough to make inroads in paying back the national debt!

May God continue to look after the downtrodden, the poor, and the United States of America!

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