By Carl Close • Tuesday April 1, 2014 11:33 AM PDT •
Social Security, Medicare, and the federal component of Medicaid are easily the leading sources of the U.S. government’s worsening fiscal nightmare. By 2037, the ongoing growth in spending for these programs will have pushed up total federal spending to 35.7 percent of GDP, according to the Congressional Budget Office. This share is about 75 percent larger than the average since the end of the Korean War.
But federal tax revenues can’t keep pace; it’s practically an “iron law” of our political culture that the U.S. government takes in approximately 17 percent to 20 percent of GDP, argue economists David R. Henderson and Jeffrey Rogers Hummel. In fact, you can count on one finger the number of years since 1950 that the feds took in more than 20 percent of GDP. (The year: 2000; the take: 20.4 percent.) Only during World War II did federal revenues get close to reaching as high as 22 percent of GDP.
Nor would a policy of high inflation solve the problem, Henderson and Hummel argue. One reason is that the public holds much more of its cash balances in the form of privately created bank deposits and money-market funds than in government-issued notes and coins; consequently, the potential income gain for government via monetary expansion is relatively small. This helps explain why, in recent decades, developed countries never generated revenue exceeding 1 percent or so of GDP from their inflationary policies. Only if the Federal Reserve were willing to sustain a policy of hyperinflation could the government hope to cover the fiscal shortfall exclusively via the expansion of money and credit, but it’s extremely unlikely that the Fed would invoke the “Zimbabwe option.”
Therefore, unless federal spending on “entitlements” and transfer payments slows down in the coming decades, the government will face the prospect of defaulting on the national debt.
“The default could range from outright repudiation to partial repudiation,” Henderson and Hummel write in an article for the Spring 2014 issue of The Independent Review. The worsening financial health of Medicare Part A and Social Security are among the potential triggers of default, they explain.