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Mr. Chairman, Congressman Spratt, and Members of the Committee, I appreciate this opportunity to appear before you today to discuss the budgetary implications of an aging population.

My testimony focuses on several major themes:

• Financing the nation's current promises to the elderly will require a major reallocation of society's resources once the baby-boom generation has retired.
• A strong and growing economy will make fulfilling pledges to Social Security and Medicare recipients easier, but it is not the entire solution.
• Although government trust funds arguably have some value as an accounting mechanism, their projected solvency does not by itself ensure that economic resources are available to cover program costs.

THE CURRENT OUTLOOK

Earlier this month, the Congressional Budget Office (CBO) projected that under current policies, the federal government would accumulate total surpluses of about $4.6 trillion to $5.8 trillion over the next 10 years (see Table 1). The off-budget surpluses, which are basically the Social Security surpluses, total $2.4 trillion over the decade; the on-budget surpluses amount to $2.2 trillion to $3.4 trillion, depending on the assumptions about discretionary spending. Two important caveats apply to those projections:

• Demographic and economic forces already in place are expected to erode the surpluses, renewing the federal government's fiscal imbalance of previous years. According to CBO's long-term budget projections published in December 1999, federal deficits will return in about three decades under current policies and eventually cause the federal debt and its corresponding interest costs to escalate as a percentage of national income.
• Deficits will reappear earlier if the government spends more or taxes less than CBO projects under current policies. Significant pressures are already building to cut taxes, increase Medicare spending, and boost discretionary spending.

The projected long-range fiscal shortfall is associated with three phenomena: the aging and eventual retirement of the baby-boom generation; increased life expectancy, which will lengthen the time people spend in retirement; and escalating per capita medical costs. Under the intermediate assumptions of the Social Security trustees, from 2000 to 2030 the number of elderly people in the United States will nearly double while the number of people ages 20 to 64 will grow by about 16 percent.

With demographic trends such as those, federal programs for the elderly will consume sharply increasing shares of national income and the federal budget. According to the Social Security and Medicare trustees, spending for Social Security and Medicare as a percentage of gross domestic product (GDP) will rise from about 6.5 percent in 2000 to almost 11 percent in 2030. Using similar projections, CBO expects that in 2030, those programs will constitute more than half of total federal spending excluding interest, compared with 39 percent in 1999. In addition, the Medicaid program will experience severe budgetary pressures in meeting the needs that low-income elderly people will have for long-term care.

But those projections, as unfavorable as they may seem, may be too optimistic for at least two reasons. First, the Medicare trustees' projections assume that the growth rate of Medicare costs per enrollee will gradually slow to equal the growth of average wages. No policy currently in place would accomplish that end, and little historical evidence would suggest that the slowdown could occur on its own. When CBO updates its long-range projections, the middle-cost assumption will be that costs per enrollee will continue to climb more quickly than wages. Moreover, pressures are growing to increase Medicare spending through a new prescription drug benefit, increased payment rates for providers, or both. For example (as shown in Table 2), in the Mid-Session Review, the President has proposed specific initiatives in those areas, which CBO estimates would cost $427 billion in direct spending over the next 10 years, with Medicare alone accounting for three-quarters of that. (The President also has proposed to move Medicare's Hospital Insurance Trust Fund off-budget, which I will address later in this statement.)
 

TABLE 2. ESTIMATED EFFECT ON DIRECT SPENDING OF CHANGES IN THE PRESIDENT'S HEALTH INSURANCE PROPOSALS
			Ten-Year Cost (Billions of Dollars)
Medicare
	CBO's Estimate of February Proposalsa		67.3
	Changes in Mid-Session Review
		Expand prescription drug benefitb	167.6
		Drop policies to reduce payment rates	34.9
		Add policies to increase payment rates	40.5
	CBO's Estimate of Mid-Session Review Proposals		310.4
Medicaid and SCHIP
	CBO's Estimate of February Proposalsa		98.2
	Changes in Mid-Session Review
		Expand prescription drug benefitb	14.6
		Other changes and interactionsc	3.6
	CBO's Estimate of Mid-Session Review Proposals		116.4
Total (Medicare, Medicaid, and SCHIP)
	CBO's Estimate of February Proposalsa		165.6
	Changes in Mid-Session Review
		Expand prescription drug benefitb	182.2
		All other changes	79.0
	CBO's Estimate of Mid-Session Review Proposals		426.8
SOURCE: Congressional Budget Office.
NOTE: SCHIP = State Children's Health Insurance Program.
a. CBO's estimate of the February budget proposals reflects the estimate of the Medicare prescription drug benefit as revised in testimony presented before the Subcommittee on Health of the House Committee on Ways and Means on May 11, 2000.
b. Consistent with the estimates in the Administration's Mid-Session Review, this estimate assumes that subsidies for low-income beneficiaries will cover all of their costs each year in excess of the initial coverage limit but less than the annual out-of-pocket cap. If the President's proposal does not include coverage of those costs, CBO estimates that the change in direct-spending outlays from expanding the prescription drug benefit would be $163.3 billion over 10 years for Medicare, $1.5 billion for Medicaid, and $164.8 billion in total. CBO has made minor technical changes to its estimating methods since preparing estimates of the February budget proposals. Those changes account for a very small portion of the estimated cost of expanding the prescription drug benefit.
c. Includes the effects of dropping the school lunch initiative (because it was enacted), freezing allotments for disproportionate share hospitals, and interactions with Medicare provisions and with a proposal to change rules regarding the treatment of income for veterans in nursing homes.

Second, the intermediate assumptions about demographic and economic trends could prove to be too favorable. Under the high-cost assumptions of the Medicare trustees and the assumption that Supplementary Medical Insurance spending equals the same proportion of Hospital Insurance outlays as projected under the intermediate assumptions, Social Security and Medicare outlays would exceed 15 percent of GDP in 2030.

Some analysts have argued that focusing on the resources directed toward the elderly ignores an important offsetting factor--the drop in children's share of the population. That is, while the elderly population is projected to climb from 12.4 percent of the total population to 19.7 percent over the next 30 years, the portion represented by children will fall from 28.6 percent to 24.7 percent. The combined share for the two groups will change only from 41 percent to 44 percent. But for the outlook for the federal budget, the combined share is misleading because federal spending for an elderly person is roughly seven to eight and one-half times that for a child. Although state and local governments spend much more on children than on the elderly, that support is at a much lower level than federal spending for the elderly (see Tables 3, 4, and 5).
 

TABLE 3. ESTIMATED FEDERAL SPENDING FOR THE ELDERLY UNDER SELECTED PROGRAMS, 1971-2010 (By fiscal year, in billions of dollars)
		1971	1980	1990	2000	Projected 2010
Mandatory Programs
Social Securitya		29	85	196	307	471
Federal Civilian Retirement		2	8	21	33	50
Military Retirement		1	2	7	14	21
Annuitants' Health Benefits		*	1	2	4	9
Special Benefits for Coal Miners and Black Lung		*	1	1	1	1
Supplemental Security Income		1	2	4	6	10
Veterans' Compensation and Pensions		1	4	7	9	14
Medicare		8	29	96	189	377
Medicaid		2	5	14	33	73
Food Stampsb		*	1	1	1	1
	Total	44	137	349	597	1,026
Discretionary Programs
Housing		*	2	4	7	10
Veterans' Medical Care		1	3	6	9	13
Administration on Aging Programs		*	1	1	1	1
Low Income Home Energy Assistance Program		n.a.	*	*	*	1
	Total	1	6	11	18	24
Total
All Federal Spending on People 65 and Over		46	144	360	615	1,050
Memorandum:
Federal Spending on People 65 and Over
	As a percentage of the budget	21.7	24.3	28.7	34.8	42.8
	As a percentage of gross domestic product	4.2	5.3	6.3	6.4	7.1
	Per elderly person (In 2000 dollars)	8,896	11,839	15,192	17,688	21,122
SOURCE: Congressional Budget Office.
NOTE: * = less than $500 million; n.a. = not applicable.
a. Includes Tier 1 of Railroad Retirement.
b. Includes the federal share of states' administrative costs and nutrition assistance to Puerto Rico.

 

TABLE 4. FEDERAL SPENDING FOR CHILDREN UNDER SELECTED PROGRAMS IN 2000 AND 2010 (By fiscal year, in billions of dollars)
		Estimated 2000		Projected 2010
Mandatory Programs
Medicaid		23		52
Family Supporta		16		21
Earned Income Tax Credit (Outlay portion only)		14		17
Social Security and Railroad Retirement		13		20
Child Nutrition		9		14
Food Stamps		9		13
Foster Care and Adoption Assistance		5		10
Supplemental Security Income		5		10
State Children's Health Insurance Program		2		5
Social Services Block Grant		1		1
Child Tax Credit (Outlay portion only)		1		*
Medicare		*		*
	Total	99		163
Discretionary Programs
Elementary and Secondary Education		20		27
Housing Assistanceb		10		14
Other Health and Human Development Programsc		9		12
Nutrition Programsd		4		5
Community Services, Development, and Other Block Grants		2		3
Youth Employment and Traininge		2		3
Low Income Home Energy Assistance Program		1		1
Department of the Interior (Indian Affairs)f		1		1
Juvenile Justice		*		1
Refugee and Entrant Assistance		*		*
Other		*		*
	Total	50		66
Total
All Federal Spending on Children		148		229
Memorandum:
Federal Spending on Children
	As a percentage of the budget	8.4		9.4
	As a percentage of the gross domestic product	1.5		1.5
	Per child (In 2000 dollars)	2,106		2,541
SOURCE: Congressional Budget Office.
NOTES: * = less than $500 million.   These numbers do not include payments to adults, even when adults receive the payments because of the presence of children.
a. Family support programs include Temporary Assistance for Needy Families, Family Support, Emergency Assistance, Child Care Entitlements to States, Children's Research and Technical Assistance, and Child Support Enforcement.
b. Includes federal assisted-housing dollars based on data from the American Housing Survey. Housing assistance includes low-rent public and Indian housing, Section 8 low-income housing aid, Section 236 interest-reduction payments, Section 101 rent supplements, and Section 235 homeownership assistance.
c. Includes services provided to children by community and migrant health centers; some programs of the Centers for Disease Control and Prevention and the Substance Abuse and Mental Health Services Administration, such as immunization programs and programs for children with serious emotional disturbances; spending on the National Institute on Child Development; services for children through the Indian Health Service, and various programs and aid administered through the Department of Health and Human Services, including Healthy Start, perinatal facilities, pediatric emergency medical service, Ryan White Title IIIB and IV programs, family planning, child welfare and child abuse programs, programs for runaway and homeless youth, programs involving children with developmental disabilities, and Head Start.
d. Includes the Special Supplemental Nutrition Program for Women, Infants, and Children; the Commodity Supplemental Food Program; food aid provided by the Federal Emergency Management Agency; and the Emergency Food Assistance Program.
e. Includes Job Training Partnership Act programs such as youth training grants, youth opportunity grants, and Job Corps.
f. Includes services to Indian children, the elderly, and families; Indian housing assistance; Indian Affairs schools; and other educational services funded through the Department of the Interior for the Bureau of Indian Affairs.

 

TABLE 5. FEDERAL SPENDING ON CHILDREN AND THEIR PARENTS UNDER SELECTED PROGRAMS IN 2000 AND 2010 (By fiscal year, in billions of dollars)
		Estimated 2000		Projected 2010
Mandatory Programs
Medicaid		31		69
Family Supporta		23		29
Earned Income Tax Credit (Outlay portion only)		25		30
Social Security and Railroad Retirement		15		22
Child Nutrition		9		14
Food Stamps		9		13
Foster Care and Adoption Assistance		5		10
Supplemental Security Income		5		10
State Children's Health Insurance Program		2		5
Social Services Block Grant		1		1
Child Tax Credit (Outlay portion only)		1		*
Medicare		*		*
	Total	126		203
Discretionary Programs
Elementary and Secondary Education		20		27
Housing Assistanceb		10		14
Other Health and Human Development Programsc		9		12
Nutrition Programsd		4		5
Community Services, Development, and Other Block Grants		2		3
Youth Employment and Traininge		2		3
Low Income Home Energy Assistance Program		1		1
Department of the Interior (Indian Affairs)f		1		1
Juvenile Justice		*		1
Refugee and Entrant Assistance		*		*
Other		*		*
	Total	50		66
Total
All Federal Spending on Children and Their Parents		175		269
Memorandum:
Federal Spending on Children and Their Parents
	As a percentage of the budget	9.9		11.0
	As a percentage of the gross domestic product	1.8		1.8
	Per child (In 2000 dollars)	2,491		2,986
SOURCE: Congressional Budget Office.
NOTES: * = less than $0.5 billion. These numbers include payments to adults when adults receive the payments because of the presence of children.
a. Family support programs include Temporary Assistance for Needy Families, Family Support, Emergency Assistance, Child Care Entitlements to States, Children's Research and Technical Assistance, and Child Support Enforcement.
b. Includes federal assisted-housing dollars based on data from the American Housing Survey. Housing assistance includes low-rent public and Indian housing, Section 8 low-income housing aid, Section 236 interest-reduction payments, Section 101 rent supplements, and Section 235 homeownership assistance.
c. Includes services provided to children by community and migrant health centers; some programs of the Centers for Disease Control and Prevention and the Substance Abuse and Mental Health Services Administration, such as immunization programs and programs for children with serious emotional disturbances; spending on the National Institute on Child Development; services for children through the Indian Health Service; and various programs and aid administered through the Department of Health and Human Services, including Healthy Start, perinatal facilities, pediatric emergency medical service, Ryan White Title IIIB and IV programs, family planning, child welfare and child abuse programs, programs for runaway and homeless youth, programs involving children with developmental disabilities, and Head Start.
d. Includes the Special Supplemental Nutrition Program for Women, Infants, and Children; the Commodity Supplemental Food Program; food aid provided by the Federal Emergency Management Agency; and the Emergency Food Assistance Program.
e. Includes Job Training Partnership Act programs such as youth training grants, youth opportunity grants, and Job Corps.
f. Includes services to children, the elderly, and families; Indian Housing assistance; Indian Affairs schools; and other educational services funded through the Department of the Interior for the Bureau of Indian Affairs.

Today's children are the taxpayers of the future, so they will be the ones called upon to pay for the increasing portion of the federal budget that will be devoted to programs for the elderly. However, significant wage growth is assumed in most projections, so today's children will be more affluent and may be able and willing to share an increasing portion of their income with the generations that preceded them.
 

PREPARING FOR THE FUTURE

The resources required to finance the government's obligations are drawn from the overall economy when the obligations are liquidated. That is, in 2030, as in any year, pledges to the elderly as well as other federal priorities--such as national defense, assistance to state and local education agencies, public health services, and transportation projects--will require the government to draw on economic resources available at that time. Whether a program receives earmarked revenues and is accounted for through a government trust fund or relies upon annual appropriations does not alter that fact. Whatever the federal government is required to spend, it must acquire those resources through taxes, borrowing, sales of assets, or some combination of those.

One way to prepare for the budgetary pressures expected in the 21st century would be to save more as a nation. By implementing policies that promote capital accumulation, the nation could boost both its productive capacity and its wealth and essentially help prefund future consumption. But adding to the supply of capital requires less current consumption in exchange for more national saving and investment. One approach to increasing national saving is for the federal government to run annual budget surpluses, so long as the policies creating the surpluses do not come at the expense of private saving. Strategies to encourage private saving might also help pay for future consumption.

Economic growth would expand the capacity to fund future Social Security benefits and other federal commitments, and a larger economy could ease the transfer of additional resources to retirees. Strong growth swells revenues, which, if used for debt reduction, would reduce interest costs and improve the overall outlook for government budgets. Yet despite those benefits, growth will not eliminate the imbalances of the current Social Security program. The reason is that economic growth generally increases real (adjusted for inflation) wages, and under the current benefit formula, higher wages subsequently translate into higher Social Security benefits, although with a substantial lag. Therefore, although the nation might be wealthier, it would still face a sharp increase in the budgetary resources necessary to pay for the Social Security and health care costs of the baby-boom generation during retirement.

The sharp rise in the share of national income directed toward programs for the elderly could be mitigated directly by curtailing promised benefits. If the benefits provided to the elderly are to be reduced relative to those promised under current law, it is desirable that such changes be announced well in advance so that people who will be affected can change their plans accordingly.
 

GOVERNMENT TRUST FUND ACCOUNTING

Some analysts suggest that government trust fund programs offer a mechanism for accumulating public savings. They point to the Social Security trust funds as an example. However, government trust fund accounting often can be misleading. Simply because surpluses are recorded in a particular government account does not necessarily mean that the government is actually contributing to national savings. The overall budget deficit or surplus better indicates the federal government's potential contribution to savings.

The federal budget contains more than 150 trust funds. They vary widely in size and purpose, but the best known ones fall into two categories: major benefit programs (such as Social Security, Medicare, unemployment insurance, and retirement programs for federal employees) and infrastructure programs (notably, the Highway and the Airport and Airway Trust Funds). The federal government's trust funds, including those for Social Security, are not trust funds in the same sense as private trust funds but rather are accounting mechanisms. They record the income from earmarked taxes and transfers from the general fund; spending for benefit payments, purchases, grants, and administrative expenses; and the interest that accrues on the difference. Private trust funds such as pension plans, by contrast, preserve assets for future use. Government trust funds do not necessarily do that because surpluses in a trust fund may be offset by higher spending or lower taxes elsewhere in the budget. Moreover, even the nature of the government's trust funds is different since the federal government can unilaterally establish the terms for benefits and contributions.

Simply stated, the government has a deficit when it spends more money than it takes in and a surplus when the reverse is true. Any change that affects outlays or revenues, regardless of whether it concerns trust fund or federal fund activities, alters the measured deficit or surplus and therefore the potential contribution to national savings. Nevertheless, people often attempt to portray the true deficit or surplus as excluding trust funds. Such attempts ignore the fact that trust fund revenues and outlays are an integral part of the federal government's tax and spending policy and the fact that decisions affecting trust funds generally are not made in isolation. They also overlook the extent to which trust fund surpluses reflect the effects of transfers within the budget rather than genuine surpluses of earmarked taxes over spending.

From 1983 to 1997, the government's accounts--including trust funds--added $1.4 trillion in holdings of government securities, while the debt held by the public grew by $2.6 trillion as total federal revenues lagged well behind spending. Currently, the government's trust funds are credited with $1.9 trillion in government securities, but the publicly held debt stands at $3.6 trillion. Thus, even though surpluses generated by Social Security and other government trust funds may have helped reduce overall borrowing from the public, the government remains a net borrower.

Ultimately, the government's ability to pay future commitments, whether they are Social Security benefits or some other payments, depends on the total financial resources of the economy--not on the balances attributed to the trust funds. As the President has stated, "[T]he existence of large trust fund balances . . . does not, by itself, have any impact on the government's ability to pay any benefits." Trust fund balances indicate that the government may provide funding in the future for certain programs, but they do not have direct economic significance. The government can prefund future obligations--that is, make it easier to meet them--by taking actions that enhance economic growth. Reducing debt held by the public is one of the most effective means of increasing saving and investment. Thus, the economy is the true "trust fund" because it forms the pool from which future consumption--public and private--will come.
 

PROPOSED ACCOUNTING CHANGES AND INTRABUDGETARY TRANSACTIONS

Notwithstanding the limitations of government trust funds, proposals abound that would use trust fund accounting to achieve various policies. For example, the President's Mid-Session Review contains two proposals for the budgetary treatment of Medicare's Hospital Insurance trust fund. One would transfer additional funds from the general fund of the Treasury to the trust fund; the other would place the receipts and outlays of that fund off-budget.

Transferring Additional Funds to the Hospital Insurance Trust Fund

The Administration proposes to assign an extra $115 billion to the Hospital Insurance trust fund over the next 10 years: $31 billion in 2001, $14 billion in 2002, and $70 billion between 2008 and 2010, over and above the income the fund would ordinarily receive. Those transfers are described in the Mid-Session Review as "interest savings resulting from devoting the Medicare surplus to debt reduction"--although, under current law, the trust fund is already credited with interest earnings on the surplus it generates.

Since the transferred amounts would not be needed immediately to pay benefits, they would add to the trust fund and make it appear more "solvent." But, as illustrated earlier, the solvency of a trust fund is not a meaningful measure of the government's ability to meet its future obligations because the fund's balances are really just claims against future tax collections. Under current policies, as the population ages, payroll tax collections will become inadequate to finance Medicare, which will have to be funded through general revenues and, perhaps, through proceeds from borrowing. That will be true whether or not trust fund balances exist on paper.

By themselves, changes in trust fund balances through legislated transfers would affect neither the size of the economy nor the resources available to the government in the future. There is some risk, however, that larger trust fund balances could obscure the long-term fiscal threat posed by the aging of the population and deter needed reforms by giving lawmakers and the public a false sense of security.

Taking the Hospital Insurance Trust Fund Off-Budget

The Administration also proposes to change the budget categorization of the Hospital Insurance trust fund so that its receipts and outlays would be off-budget, like those of the Social Security trust funds. That change is intended to ensure that the Hospital Insurance trust fund's surpluses over the next 10 years "are not used for other purposes and therefore will be used to reduce the debt," according to the Mid-Session Review. That proposed accounting change would have no direct effect on the economy or the overall budget. It would reduce on-budget surpluses while correspondingly increasing off-budget surpluses, but it would not, by itself, reduce the debt or change the government's financial position.

However, if the Congress and the President agreed to avoid on-budget deficits in future years, that accounting change might make the surpluses generated by the Hospital Insurance program (and any additional transfers from the general fund) less vulnerable to proposals to increase spending or reduce taxes. But even if the accounting change made expanding on-budget programs and cutting taxes more difficult, the President's proposed transfers to the trust fund might still lessen the public debt reduction that would have taken place otherwise. The reason is that the enhanced fund balances might make it easier to liberalize Medicare benefits and deter programmatic reforms.
 

CONCLUSION

The current strong economy and growing budget surpluses encourage optimism about the nation's future, but they should not breed complacency about maintaining budgetary discipline. The aging of the population will bring about major structural shifts in the amount of resources directed toward the elderly. By increasing national savings and capital accumulation that will contribute to growth, the budget surpluses offer one course of action that may make it easier for workers of the future to bear that heightened burden.

It is critically important to consider the impact that legislative action may have on economic growth and on the burden that future taxpayers will have to bear. The challenge before the nation is to find the appropriate balance between benefit levels that are both affordable and adequate to meet the needs of the elderly and an overall fiscal policy that will help create an economy strong enough to sustain those benefits.