Entitlement Cuts Necessary Now To Forestall Bond Defaults? Fed’s Lawrence Lindsey Says Bill Will Come Due 30 Years From Now

The U.S. government might be forced to default on bonds in 30 years if politicians fail to act now to curtail spending on entitlement programs, Federal Reserve Gov. Lawrence Lindsey said Monday.

Budget cuts proposed by President Clinton in Medicare, Medicaid, Social Security and other programs “simply will not be enough to be sustainable over the long term,” Lindsey told a meeting of world treasury officials in Palm Beach.

“Postponement of needed reforms merely increases the magnitude of changes that will ultimately have to be made and the disruptions that they will cause,” Lindsey said in a prepared text. Citing a “blackout period” in the week leading up to Fed Chairman Alan Greenspan’s Humphrey-Hawkins testimony to Congress, Lindsey refrained from comment on the current state of the U.S. economy and the outlook for U.S. interest rates.

Greenspan is scheduled to present his outlook on the economy and monetary policy to the House Banking Committee today, and to a Senate Committee Wednesday.

Recent concerns about the ability of the U.S. government to meet its financial obligations aren’t as severe as those in other leading industrial democracies, especially Canada and Sweden, Lindsey said. Still, “These developments have reinforced the notion that default actually is just a part of the continuum of public finance options.”

Those concerns were heightened in recent months when Republicans in Congress sought to link a resolution of the ongoing battle over spending priorities and the federal budget to an extension of the $4.9 trillion U.S. debt ceiling.

Treasury Secretary Robert Rubin managed to avoid bumping up against the debt ceiling by tapping two U.S. government trust funds. Congress and the White House are expected to agree on a measure to raise the debt ceiling before the end of this month, as talks on a strategy to balance the budget in seven years continue.

The United States will never again have the same chance to reduce entitlement spending, and as much public support to do it, as it does now, Lindsey said.

Under budget proposals submitted by both the White House and Congressional Republicans, however, the U.S. Treasury will eventually come up against its “day of reckoning,” Lindsey said. Although, he added, the Republican proposal will postpone that day somewhat because of more drastic cuts in Medicare and Medicaid.

Both proposals call for a balanced budget by 2002, but neither goes far enough to prevent a financial crisis at some later date, Lindsey said.

The number of people reaching retirement age will begin to shoot up when people born in the “baby boom” begin to reach 65, about 15 years from now, Lindsey said. That will both increase spending on entitlement programs and increase the number of people likely to oppose cuts in those programs, Lindsey said.

Under the president’s budget proposal, Medicare and Medicaid spending would rise to 7.1 percent of gross domestic product in 2026, when this year’s 30-year Treasury bonds come due, from 3.6 percent of GDP this year, he said.

Funding for that spending will have to come from somewhere, and a default on bond payments might be the best option politically because few other options will be available, Lindsey said.

Even the complete elimination of the national defense budget wouldn’t be enough to cover the costs, he said, and increased taxes would be unfeasible because the money required would be a whopping 97 percent increase in Medicare payroll taxes and an additional 15 percent income tax surcharge to pay for Medicaid.

Drastic cuts in benefits will also be unlikely in 2026 because Medicaid beneficiaries will comprise about 24 percent of eligible voters, up from 17 percent today.