Congress’s solution to the debt limit crisis and rising deficits is fully operational, but many are left wondering whether the bipartisan Joint Select Committee on Deficit Reduction (the Deficit Reduction Committee) is capable of fulfilling its mandate when Congress as a whole couldn’t make the hard decisions that were necessary for a long-term solution. And the Deficit Reduction Committee is even more susceptible to deadlock than the full Congress since the Committee is populated by six Republicans and six Democrats.

The super-committee was the end result of months of negotiations between Democrats and Republicans during the debt limit debates. The resulting compromise included $917 billion in discretionary spending cuts over 10 years. The Committee must come up with another $1.2 to $1.5 trillion in cuts.

The Committee must pass a deficit reduction plan by a simple majority vote (7 out of 12). The plan will then go to Congress for a vote. If the Committee fails to reach a compromise proposal or Congress does not adopt the Committee’s proposals, a series of sharp automatic cuts will kick in, slashing budgets across the entire federal government, including the Defense Department.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the debt limit fight and resulting compromise in Advisor’s Journal, see Democrats Call Debt Limit Unconstitutional (CC 11-134), Debt Limit Standoff Boils Over (CC 11-115) and Storm Clouds over U.S. Debt (CC 11-85).

Why is this Topic Important to Wealth Managers? The subject presented today provides wealth managers with valuable information to provide to clients interested in self-funding their retirement. The current projections of the Social Security and Medicare programs actually opens the door to present annuities and other insurance products as one means to that end. Astute wealth managers will realize this opportunity.

Each year the Trustees of the Social Security and Medicare trust funds report on the current and projected financial status of the two programs. The 2011 report was recently released.

The 2011 report shows the financial conditions of the Social Security and Medicare programs are far from great. Projected long-run program costs for both Medicare and Social Security are not sustainable under currently scheduled financing, and would require program modifications if disruptive consequences for beneficiaries and taxpayers are to be avoided.

Both Social Security and Medicare, the two largest federal programs, face substantial cost growth in the upcoming decades due to factors that include population aging as well as the growth in expenditures per beneficiary. Through the mid-2030s, due to the large baby-boom generation entering retirement and lower-birth-rate generations entering employment, population aging is the largest single factor contributing to cost growth in the two programs.

In only 25 years by 2036, one year earlier than was projected in last year’s report, the Social Security Trust Fund will have completely exhausted its assets and projected incoming revenues will be insufficient to maintain payment of full benefits. In only 13 years, by 2024, Medicare’s Hospital Insurance Trust Fund is projected to exhaust its assets, five years earlier than was projected in last year’s report.

Social Security expenditures exceeded the program’s non-interest income in 2010 for the first time since 1983. The fund experienced a $49 billion deficit last year (excluding interest income) and $46 billion is the projected deficit in 2011. This deficit is expected in the long run to increase as the retirement of the baby boom generation swells the beneficiary population.  It is projected that tax and interest income will be sufficient to pay benefits through 2022, after which the Trust Fund will be drawn down until depleted in 2036.

Under current projections, the annual cost of Social Security benefits expressed as a share of workers’ taxable wages will grow rapidly from 11-1/2 percent in 2007, to roughly 17 percent in 2035. Costs display a slightly different pattern when expressed as a share of GDP. Program costs equaled roughly 4.2 percent of GDP in 2007, and are also projected to increase around 50% to 6.2 percent of GDP in 2035.

The projected 75-year actuarial deficit for the combined Old-Age and Survivors Insurance and Disability Insurance (OASDI) Trust Funds is 2.22 percent of taxable payroll, up from 1.92 percent projected in last year’s report. This deficit amounts to 17 percent of tax receipts, and 14 percent of program outlays.

Relative to Social Security’s combined Trust Funds, Medicare’s Hospital Insurance (HI) Trust Fund faces a more immediate funding shortfall. HI has run cash deficits since 2008 and under current projections will continue to do so until Trust Fund assets are exhausted in 2024, at which time dedicated revenues would be sufficient to pay 90 percent of HI costs. The share of HI expenditures that can be financed with HI dedicated revenues is nevertheless projected to decline slowly to 75 percent in 2045.

Finally, Medicare costs are projected to grow substantially from approximately 3.6 percent of GDP in 2010 to 5.5 percent of GDP by 2035.

As was mentioned earlier, the shortfall of federal funds available for retirement has presented a compelling reason to provide clients with annuity and other retirement products.

Tomorrow blogticle will continue to address issues surrounding the private wealth management practice.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

The downgrade of U.S. debt could soon be more than just a threat. Taking note of the US’s large budget deficits and continually increasing government indebtedness, Standard & Poor’s (S&P) gives mixed signals about the state of reform, having changed its outlook on the U.S. long-term credit rating from “stable” to “negative.”

While talks about debt limit increases are still speculative, S&P believes there is a one-in-three probability it will downgrade the U.S. long-term debt rating within the next two years. Such a downgrade could cause an economic catastrophe by signaling that there is a heightened chance the US will be unable to pay its debts as they come due. A downgrade would likely tank the markets, the federal government would be forced to agree to higher interest payments to sell its debt, and consumers would face an even tougher lending environment.

For previous coverage of the U.S. budget in Advisor’s Journal, see Republican Ryan’s Budget Faces Bipartisan “Gang of Six” (CC 11-80).

Your questions and comments are always welcome. Please post them at our blog, AdvisorFYI, or call the Panel of Experts.

Why is this Topic Important to Wealth Managers?   A wealth manager should be able to present Advanced Market Intelligence on the long-term economic impact of government spending and its ability to raise revenues with clients.

The United States faces daunting economic and budgetary challenges. The economy has struggled to recover from the recent recession, which was triggered by a large decline in house prices and a financial crisis—events unlike anything this country has seen since the Great Depression.

For the federal government, the sharply lower revenues and elevated spending deriving from the financial turmoil and severe drop in economic activity—combined with the costs of various policies implemented in response to those conditions and an imbalance between revenues and spending that predated the recession—have caused budget deficits to surge in the past two years. The deficits of $1.4 trillion in 2009 and $1.3 trillion in 2010 are, when measured as a share of gross domestic product (GDP), the largest since 1945—representing 10.0 percent and  8.9 percent of the nation’s output, respectively. [1]

Also, the recovery in employment has been slowed not only by the moderate growth in output in the past year and a half but also by structural changes in the labor market, such as a mismatch between the requirements of available jobs and the skills of job seekers, that have hindered the employment of workers who have lost their job. Payroll employment, which declined by 7.3 million during the recent recession, gained a mere 70,000 jobs (or 0.06 percent), on net, between June 2009 and December 2010. [2]

However, under current law, CBO projects, budget deficits will drop markedly over the next few years—to $1.1 trillion in 2012, $704 billion in 2013, and $533 billion in 2014. Relative to the size of the economy, those deficits represent 7.0 percent of GDP in 2012, 4.3 percent in 2013, and 3.1 percent in 2014. From 2015 through 2021, the deficits in the baseline projections range from 2.9 percent to 3.4 percent of GDP. [3]

Nevertheless, the deficits that will accumulate under current law will push federal debt held by the public to significantly higher levels. Just two years ago, debt held by the public was less than $6 trillion, or about 40 percent of GDP; at the end of fiscal year 2010, such debt was roughly$9 trillion, or 62 percent of GDP, and by the end of 2021, it is projected to climb to $18 trillion, or 77 percent of GDP. [4]

With such a large increase in debt, plus an expected increase in interest rates as the economic recovery strengthens, interest payments on the debt are poised to skyrocket over the next decade. CBO projects that the government’s annual spending on net interest will more than double between 2011 and 2021 as a share of GDP, increasing from 1.5 percent to 3.3 percent.

Beyond the 10-year projection period (though 2012), further increases in federal debt relative to the nation’s output almost certainly lie ahead if current policies remain in place. The aging of the population and rising costs for health care will push federal spending as a percentage of GDP well above that in recent decades. Specifically, spending on the government’s major mandatory health care programs—Medicare, Medicaid, the Children’s Health Insurance Program, and health insurance subsidies to be provided through insurance exchanges—along with Social Security will increase from roughly 10 percent of GDP in 2011 to about 16 percent over the next 25 years. [5] If revenues stay close to their average share of GDP for the past 40 years, that rise in spending will lead to rapidly growing budget deficits and surging federal debt.

Next week’s blogticles will discuss relevant topics for wealth managers in 2011.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts

 

NB: This work or parts thereof originated from previous official Federal Government publication available to the public.

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[1] See generally Congressional Budget Office. “The Budget and Economic Outlook: Fiscal Years 2011 to 2021”.  January 2010.  http://www.cbo.gov/ftpdocs/120xx/doc12039/SummaryforWeb.pdf.  Last Accessed 2/17/2010.

[2] Id.

[3] See generally Office of Management And Budget. “Budget of the U.S. Government Fiscal Year 2012”-Summary Tables.  http://www.whitehouse.gov/omb/budget/Overview.  Last Accessed 2/16/2011.

[4] Congressional Budget Office. “The Budget and Economic Outlook: Fiscal Years 2011 to 2021”.  January 2010

[5] See Congressional Budget Office, The Long-Term Budget Outlook (June 2010), revised August 2010.