The Effects of Changing Demographics on the Federal Budget Part II: A Smaller Workforce, Higher Federal Outlays

In Part I of our series on how the changing demographic profile of America will affect the federal budget, we focused on the key issues behind a smaller labor force and its impact on the economy and, in turn, federal revenues. In this, our second of three reports on demographics and the federal budget, we will focus on how federal outlays will be affected by the aging of the population and the resulting smaller labor force. 

The baby boomer generation, those born in the U.S. between 1946 and 1964, is beginning to retire at a pace of 10,000 individuals per day.1 This demographic shift of the baby boomers, which currently account for 16 percent of the population, will cause a long-term trend of a shrinking labor force and will have profound effects on federal revenues due to lower payroll tax collections. In fact, over the next 25 years, the population age 65 or older (those expected to draw entitlement program benefits) will grow by 37.6 million, while those aged 20-64 (the bulk of the typical working-age population, who typically pay payroll taxes to support entitlement programs) will grow by only 20.9 million. 

The aging of the U.S. population will also play a role in affecting federal spending over the next several years. There are three key areas of federal spending that will be affected the most by an aging population: Social Security, Medicare and Medicaid. These programs combined represent the greatest challenge to federal outlays and, in turn, federal debt growth over the next several years. By 2024, these three programs are expected to account for just over 52 percent of the federal budget according to the latest estimates from the Congressional Budget Office (CBO).2 With such a large and growing share of the federal budget tied to these programs, the Congressional Budget Office has warned that the current path of federal spending for these programs is unsustainable. To preserve these programs going forward, tax increases, benefit cuts or some combination of the two will be needed. We begin with an in-depth look at the Social Security program and the challenges presented by the aging of the population. We then turn to the two major health care programs – Medicare and Medicaid.

The Expected Rapid Growth of the Social Security Program

The Social Security Act was passed in August 1935, which included old-age benefits for workers, aid for the physically handicapped and blind, and benefits for dependent mothers and children.3 Since the enactment of the Social Security program, several reforms have been made that affected the appropriate age for retirement, cost of living adjustments (COLAs) and the appropriation of funds in the Social Security trust.4 The program is funded by a payroll tax based on worker incomes and trust fund asset reserves from the general fund of the Treasury.5 Since 2012, there has been a deficit as outlays have exceeded payroll tax revenues. The interest earnings from the  Social Security fund currently offset the cash flow deficit, but by 2019, costs are projected to rise such that the program will have to dip into the Social Security fund to finance the outlays.

For the purpose of this report, we will focus primarily on the “retired workers and families” aspect   of Social Security. Over the next 10 years, the number of retired-worker beneficiaries and the average monthly outlay per beneficiary are expected to rise substantially as the baby boomers begin to claim Social Security (Figure 2). This will prompt the total outlays of the Social Security program to rise substantially; in 2013, Social Security outlays totaled 4.9 percent of GDP but are expected to reach 5.6 percent by 2024. According to the 2014 Annual Report by the Social Security and Medicare board of trustees, the Social Security reserve fund and financing plan does not pass the short-range or long-range test of actuarial balance, indicating that the fund will continue to deplete at an unsustainable rate that will pose a problem for future funding. 

The trust fund ratio, or reserves as a percentage of annual costs, peaked in 2003 but has continued to decline since, and remained at 62 percent at the start of 2014. This ratio is expected to decline in the coming years before the fund is depleted in 2037, and following that date, income from payroll taxes are projected to be available to pay only three-quarters of benefits through 2079.