America's Fiscal Constitution (64 page)

Federal tax law in place as of 2013 is unlikely to yield revenues that would fully fund military spending in line with the third alternative—the current consensus—presented above. In 2000 the federal funds budget balanced with spending and revenues each at 13.3 percent of national income. At that time personal income tax revenues amounted to a higher share of national income than at any time since the end of World War II.
⁵
In 2007, before the Great Recession, federal funds revenues were 11.9 percent of national income; in fiscal year 2014 federal funds revenues are projected to be 11.4 percent of national income.
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If interest expense consumes tax revenues of 3 to 4 percent of national income, a base budget for national defense, homeland security, and veterans of 4.5 percent of national income would require large cuts in existing federal funds spending for Medicare and everything else.

A cut in national security outlays equal to 1 percent of national income might not seem large in the abstract, but it does impair the ability to retain existing military capabilities and keep a step ahead of new threats. Reducing the Pentagon’s planned budgets by one-fourth would produce less than three-fourths of the combat strength. There are large fixed costs for items such as global intelligence and retiree health benefits. Because of fixed costs for research, development, and manufacturing capacity for a new weapons system, a cut in the number of new weapons purchased will raise the average cost per unit. The same type of cost increase occurs when federal officials stretch out the procurement schedule. In addition, costs contributing less directly to combat capabilities are often the hardest to constrain. Commitments made to retirees and for the medical care provided for military personnel and their families have a strong ethical dimension that makes them difficult to pare down in any budget year.

Likewise, it is no small hurdle to raise personal income tax revenues by 1 percent of national income. In fiscal year 2014, for example, the White House estimated that personal income tax receipts will amount to 8.1 percent of national income, so an additional 1 percent—bringing the total to 9.1 percent—would require 12 percent more revenue.
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An increase in personal income tax rates to generate revenue of that magnitude has not occurred since the Korean War.

The United States is unlikely to preserve the existing level of global security by complaining that other nations should be doing more. Allies
with armed services designed primarily for territorial defense and limited roles within multinational deployments have long relied on the United States to provide needed intelligence, communications, precision targeting, control of the sea, and logistical support for substantial foreign military operations.

Only a handful of countries have the economic strength to invest in capabilities such as carrier task forces, elite special forces capable of rapid deployment anywhere, and airborne precision-guided munitions operating within a global satellite grid. Developed nations with aging workforces are unlikely to invest significantly more of their national incomes in support of international security. Japan and Germany, with the world’s third and fourth largest national economies, occasionally have interests that differ from those of the United States. For example, dependence on exports to China and oil imported from the Persian Gulf could temper the commitments of those nations to the security of Taiwan and Israel.

China, with the world’s second largest economy, has the economic capacity to expand its military and shares some interests—such as freedom of the seas—with the United States. Chinese policy does, however, diverge from that of the United States on issues such as international commercial bribery, intellectual property, violations of human rights, and preferential access to raw materials. In the months preceding the 2012 transfer of the Chinese presidency, Chinese leaders and the national press stoked the flame of old grievances with Japan, a key US ally. The People’s Republic is less interested in providing a security umbrella for South Korea, Israel, and—of course—Taiwan.

Rather than presuming to prescribe an optimal level of military spending, this chapter has sketched several budget alternatives in broad strokes. However, if the United States is to restore effective “pay as you go” budget planning and confine debt to its traditional uses, citizens who favor a stronger military should urge their fellow citizens to pay the corresponding price of taxation. With a global economy, the fate of Americans has never depended so much on events beyond our borders. The case for retaining military spending at the level of the current consensus is well summarized by Robert Kagan in
The World America Made
. Kagan asserts, however, that “even the most draconian cuts in the defense budget would produce annual savings of only $50 to $100 billion, a small fraction . . . in the annual deficits the United States is facing.”
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To some this number may appear to be small, but budgets projected for many years after 2013 do not contain revenues
to pay for that amount and other important federal obligations. Like many others, Kagan dismisses “runaway deficits” as a product of “ballooning entitlement spending.” In fact—as shown in the previous chapter—since the budget last balanced in 2000, the nation has borrowed principally for a combination of higher costs for base military budgets, wars, tax cuts, and Medicare. Payroll taxes have paid for the rise in Social Security pensions, and no one believes that the public will support the diversion of those taxes from trust funds to military procurement.

There has always been a division of public opinion on the proper balance between taxes and military spending. That trade-off has been debated since George Washington’s administration. The willingness of citizens to tax themselves to pay for military spending strengthens the bond between civilians and soldiers, conveys national resolve to potential adversaries, and preserves credit needed during war. Robust American defense budgets for over half a century have protected the nation’s values abroad as well as its citizens at home. These values include a belief in democracy. The very principle of democratic self-governance is undermined when political leaders mortgage the future in order to spend more for international security than the amount they ask the public to pay for with tax dollars.

21

P
AYING FOR
M
EDICAL
C
ARE

T
HE
R
ISE OF
P
UBLICLY
S
UBSIDIZED
M
EDICAL
I
NSURANCE

The cost of medical services has grown far faster than federal revenues, and the federal government has borrowed since 2001 to fill the gap. Despite that fact, one can search in vain for a speech by a federal candidate entitled: “Why We Should Mortgage Tomorrow’s Taxes to Pay for Today’s Medical Bills.” People sometimes justify debt-financed tax incentives or spending on education and infrastructure as means of enhancing economic growth. No one touts the economic benefits of borrowing to pay for routine medical expenses.

Federal medical programs arose from the desire to bridge the gap between the cost of medical insurance and the amount of premiums that some people—especially retired and disabled Americans—could afford to pay. Public demand for insurance rose along with the costs and effectiveness of medical services in the late twentieth century.

People dread putting a price on the health of a loved one, and patients often lack the expertise to calculate the trade-off between the price and quality of medical alternatives. Medical insurance helps solve these problems by separating decisions on cost from the process of diagnosis and treatment. Insurance also reduces the financial risk of unexpected or very high medical bills. These advantages of insurance, however, give rise to its principal disadvantage: patients and physicians who worry less about the payment of bills will also be less likely to economize on costs.

By its very nature, insurance redistributes the financial burden of medical services. Premiums paid by people with fewer or less severe medical needs subsidize the cost of caring for those with greater or more immediate needs. As a result, the average premium depends on the total costs incurred for people in an insurance pool. Private insurers, including nonprofits, do not borrow funds they use to pay medical costs because interest on debt would increase their costs.

Hospitals and doctors—not politicians—originated American medical insurance. In 1929 Dallas hospitals created a nonprofit insurance plan, Blue Cross, to secure more stable funding. That same year doctors in Los Angeles began to enroll municipal employees into a plan financed with monthly premiums.

By the 1940s employers competed for skilled workers by offering medical insurance. Federal tax law made medical benefits more attractive to employees, since they were not required to pay income tax on premiums paid on their behalf. Dramatic improvements in medicine have since increased both the cost and the value of these benefits.

Medicare gave older Americans a form of insurance comparable to group health insurance available to employees.
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Through 2000 dedicated revenues from premiums and payroll taxes covered about three-quarters of the program’s cost. After 2000 the cost of Medicare Part B and the new Part D grew much faster than dedicated revenues. Because other existing federal obligations already absorbed every penny of federal funds revenues, debt filled Medicare’s funding gap.

For decades federal officials have tried to restrain growth in medical costs. They implemented ambitious reforms including advance payment systems, fixed price schedules, extensive audits, managed care, and incentives to shorten hospital stays. For brief periods of time, those efforts succeeded. Ultimately, the results of cost-saving initiatives were overwhelmed by costs associated with the increased use of services and the greater sophistication of medical diagnosis protocols and treatment.

Everyone applauds greater efficiency, though that concept often is difficult to apply to the delivery of medical services. For example, there is no accepted means of assigning an economic value to the benefit of a diagnostic test that might save one life out of several hundred patients tested.

Decisions that may diminish the length or quality of life involve basic values that transcend politics. Ideology is often used as a tool to help politicians and voters simplify the alternatives for dealing with complex
problems, but it offers little realistic guidance to those seeking to reduce medical costs. For example, conservatives frequently blocked actions that would have limited costs by intruding on the relationship between provider and patient, while progressives resisted efforts to restrict eligibility or services.

Between the collapse of the American Fiscal Tradition in 2001 and the onset of the Great Recession in 2008, medical services accounted for almost the entire rise in domestic federal funds spending as a percentage of national income. By 2010 the total cost of all medical care consumed 17.9 percent of national income, or $8,400 per person on average. Medicare and Medicaid—including premiums and payroll taxes dedicated to trust funds—paid for more than a third of that amount.
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Employer-based health insurance premiums paid for another third. By 2010 Medicare and Medicaid within the federal funds budget rose to about 3.1 percent of total national income, a fifth of all federal funds spending.
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Then Baby Boomers began to become eligible for Medicare.

T
HE
I
MPACT OF
B
ABY
B
OOMERS

The phrase “perfect storm” refers to a combination of unrelated and unusual meteorological conditions that result in a weather disaster. That overused metaphor is not an appropriate way to describe the combined effect of aging Baby Boomers, new medical treatments, higher prices for the medical services, and federal debt. Weather events cannot be forecasted years in advance, while the budgetary impact of those medical, demographic, and financial trends has been predicted for decades.

Chart 5
depicts the challenge.

Between 2011 and 2021 the number of Americans eligible for Medicare will increase by a third. Moreover, every year the population over the age of eighty-four grows as a percentage of all retired Americans. A combination of Medicaid and Medicare pays for the residential care of millions of Americans with severe age-related and other disabilities, a number that will rise as the population continues to age.
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The American Fiscal Tradition once confined federal medical services to the availability of tax revenues. Because there were no spare revenues or tolerance for greater taxation, by the late 1970s various plans for expanded medical coverage included mandates on employers or employees. Those plans were intended to broaden participation in group health insurance. That left the challenge of how to subsidize some portion of premiums for those people who could not afford to pay them. In addition, employers in some competitive labor-intensive businesses who did not offer insurance could obtain a cost advantage by not offering group coverage.

Chart 5:
   
US Population 65 Years and Older and 85 Years and Older, 1980–2040