The U. S. has been living beyond its means – way beyond its means. We’ve been running the government on credit and racking up a huge amount of debt. What’s more, we have some very big expenses ahead: the 78 million baby boomers who have been paying into Social Security and Medicare are beginning to start pulling money out.

Health care expenses continue to skyrocket, meaning that it's increasingly expensive to give seniors the care we've promised. These facts have led experts inside and outside of government -- both conservatives and liberals -- to warn of an approaching "fiscal train wreck" unless we take measures to address the problem.

It’s not some hazy, far-off, inside-the-beltway problem. If the red ink keeps flowing and we don’t face up to some realistic choices on the budget and Social Security and Medicare, we could jeopardize the health of our economy and our standard of living.

The choices we make now will affect the amount of your paycheck, whether you can get a college loan or home mortgage, whether interest rates are high or low and whether older Americans (maybe that’s you, or your parents or grandparents) can make ends meet and get the medical care they need.

To put the federal budget into perspective, consider your personal finances. When you make a household budget, you start with certain fixed expenses: rent or mortgage, utility bills, insurance, etc. What's left over can be spent at your discretion. The same principle applies to the $3.1 trillion national budget.

Where The Money Goes

Here's a breakdown of how the government spends that $3.1 trillion:

• More than 40 percent of the federal budget goes to fixed expenses like Social Security, Medicare and Medicaid. The government is obligated by law to pay these “mandatory” programs. They’re also known as entitlements, because when you reach a certain age or drop below a certain income level, you’re entitled to them. The benefits are set by specific formulas, so they’re essentially on autopilot.
  
  
• About 20 percent of the budget goes to defense. It’s a huge amount of money, but the defense budget took up an even larger share of the budget (over 25 percent) in the late 1980s.
  
  
• Interest on the federal debt accounts for 8.7 percent of the budget. No way around that. The country has to pay it. Think of it as the equivalent to the minimum balance payment on your credit card.
  
  
• What's left over is called "non-defense discretionary" spending, which is essentially everything else, from parks to foreign aid. It's this part of the budget that attracts the most debate, with politicians annually haggling over how much to spend and on what.
  
  

Social Security and Medicare: Why the Experts Worry

One very big problem in the budget is federal spending on Social Security and Medicare, which is on the rise and is going to keep on rising for quite a while. Here’s what you need to keep in mind:

• Social Security is a pay-as-you-go system. People working now pay taxes that are mostly used to pay benefits for people who are retired now. Now that the huge baby boom generation is getting older, the number of retired people is about to rise dramatically.
  
  
• The first baby boomers have just started applying for Social Security. An estimated 10,000 people a day will become eligible for Social Security benefits over the next two decades.
  
  
• In 2017, Social Security will start paying out more in benefits than it collects each year in payroll taxes.
  
  
• There is a Social Security trust fund, which will run out in 2041, but since politicians have already borrowed money from it to cover other government expenses, that’s not as comforting as it sounds. Meeting Social Security’s expenses will put pressure on the government long before 2041.
  
  
• Sometimes people say Social Security will go bankrupt in 2041, but that’s not exactly true. Workers will still be paying into the system, so it will still function, but it would only be able to pay three-quarters of the promised benefits.
  
  
• Medicare, the giant health care program that covers the elderly and disabled, is facing a double whammy. Not only does Medicare face a rising tide of boomers, but it also gets hit by the rapidly rising cost of health care.
  
  
• Projections say the Medicare trust fund will be exhausted in 2019, a mere 11 years away. At that point, the federal government would either have to cut benefits, raise premiums or shift money from other programs to cover the costs.
  
  

The worst-case scenario would be that the country keeps procrastinating. The entitlement programs, flying along on autopilot, could become just plain unaffordable or the government has no money left to do anything else. That would leave us in a horrendous position. Either we would have to start putting crushing taxes on working people to cover the cost or we would have to cut back on benefits for people who are frail and elderly. This is choice we can avoid if we start making reforms to Social Security and Medicare right away.

Where The Money Comes From

So we know where the money goes once it comes in, but where does it come from? To pay the bills, the government relies on tax revenue from you, your neighbors and your employers.

Here’s the big picture:

• 45.3 percent comes from income taxes. Although income taxes are always controversial, it’s worth noting that the top tax rates today are substantially lower than they were after World War II, really up through the mid-1980s. President Bush and Congress passed significant cuts in 2001 and 2003, but these are set to expire in 2010.
  
  
• 33.9 percent are payroll taxes for Social Security and Medicare. These are taxes paid by workers and matched by their employer.
  
  
• 14.4 percent comes from corporate taxes. Although the first images that come to mind may be big corporations like Exxon Mobil and Microsoft, it’s worth remembering that this category also includes small businesses and even “mom-and-pop” stores.
  
  
• The remainder comes mainly from taxes on alcohol, tobacco and gas. These excise taxes make up about 2.5 percent of the government’s revenues. States also collect taxes in these areas, so if you’re really steamed about taxes on gas or cigarettes, you probably need to blame both the feds and elected officials closer to home.
  
  

What usually happens, however, is that the revenue isn't enough to cover all the expenses – that’s considered a deficit.

Both revenues and spending climbed to record levels in 2008. But we are still spending more than we take in -- hence, the deficit. The White House projects the federal deficit will hit a record $480 billion in 2008 – and that projection may well be low, since it doesn't take into account the full cost of the wars in Iraq and Afghanistan.

The nonpartisan Congressional Budget Office projects that deficits will remain above $400 billion a year through 2010. The CBO projects the deficit will go down after that, but they estimate the government will be running deficits through 2018, even if we let the Bush tax cuts expire as planned in 2010.

Every year that there’s a deficit, the government borrows money to cover its bills, often from banks and foreign countries such as China. The total tally of all the past deficits, plus interest, is called the national debt. We've added more than $3.5 trillion to the debt since 2001.

Another Day Older and Deeper in Debt

The national debt is remarkably similar to your personal credit card. Think of the debt as the total amount you owe. You have to make regular minimum payments, which is the interest. Every time you ring up a new charge (the deficit), you add to the total debt. So even if you stop making any new charges (eliminate the deficit), you still have this outstanding debt that requires interest payments. Interest payments on the national debt are the fifth-largest spending category in the federal budget, just behind the defense and the three major entitlement programs.

One other development that worries many people is that about a quarter of the national debt is now held abroad. Our top lender is Japan, but China is right behind. The top ten list also includes “oil exporting” nations and Caribbean banking nations. In some ways this is a compliment because it means that other countries consider U.S. Treasury bonds a good place to put their money. The risk is that, at some point, some of them may decide that they would rather put their money elsewhere, which could leave the U.S. government in a credit crunch. Some foreign policy experts also worry that this reduces our influence worldwide – we are less likely to really press the Chinese, for example, on intellectual property rights or global warming because we need them to keep lending us money.

The Time Has Come

The nation’s finances are actually a bunch of interconnected problems. The national debt has grown because of the government’s inability to balance its year-to-year budget. Social Security needs help because of the demographic pressure from the baby boomers, while Medicaid expenses are rising because of skyrocketing health care costs. And Medicare is in trouble because of demographics and health care costs together.

But while the solutions to each of these may be unique, each also has to be tackled as part of the larger problem. The next president and Congress won’t be able to avoid some choices here. President Bush’s tax cuts are set to expire in 2010; whether some or all of them are extended will have a significant impact on the year-to-year budget. Republicans have argued that the tax cuts helped jump-start economic growth and contributed to an increase in revenues. Democrats say most of the tax breaks were skewed to the wealthy and instead spurred the record deficits.

Most experts also say that the sooner we start on reforming entitlement programs, the less painful the adjustments will be. Waiting until the crisis is upon us would require really drastic measures, either in terms of raising taxes or cutting benefits.

What happens in Iraq and Afghanistan will have an impact on the budget, too. Some people blame the wars for the skyrocketing national debt, but that’s only partly true, at best. The Congressional Budget Office estimates the government spent $651 billion on the “war on terror” between September 2001 and February 2008. During that same period the national debt swelled by about $3.2 trillion. The CBO estimates that, presuming we maintain a presence in both countries the war on terror could be as high as $1.7 trillion by 2017.

All this means that the future of our economy and way of life may be dramatically affected by the choices we make today for managing the nation’s finances. The debate over the budget is certain to play out in the 2008 election. The numbers are large and the problems daunting. Where do we begin?

For more on these issues, visit PublicAgenda.org guides on Social Security and Medicare.