Welcome to the world of permanent $1 trillion (or more) budget deficits. The Congressional Budget Office released new budget projections last week, and as troubling as they sound, that’s a rosy scenario that assumes peace, prosperity, and low interest rates. CBO projects that the budget deficit will surge toward $2 trillion by the end of the decade, but that could push to $3 trillion with a return to 1990s interest rates.
Economists have long warned that the federal budget would eventually sink under the weight of surging Social Security and Medicare costs. Taxpayers have heard these warnings for so long that many understandably began tuning them out. A decade ago, the Great Recession brought a $1.4 trillion deficit, most of which gradually evaporated as the economy recovered. That cyclical budget deficit gave many Americans a false sense of security that large budget deficits no longer matter, or at least will go away on their own.
That is no longer the case. The new $1 trillion deficits are occurring in a full-employment economy, and are driven by Social Security and Medicare costs that will continue to accelerate. There is no easy off-ramp, and low interest rates cannot be taken for granted. And even then, a government’s debt cannot rise as a share of its economy indefinitely. At a certain point, perhaps when the next recession grows the debt even faster, the bond market may determine that soaring U.S. debt is no longer a safe investment. The resulting sell-off could trigger a financial panic.
How did we get here? Costs are accelerating because America is now in the middle of 74 million baby boomer retirements occurring between 2008 and 2030. Someone who retires at age 66 and lives until 90 will spend one-third of his adult life in taxpayer-funded retirement. While demographics drive Social Security’s expanding budget, Medicare faces the additional challenge of rising health care costs.