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The New Middle Class Contract
...In fact, the downfall of GM in particular — which has been very long in coming — offers a disturbingly apt metaphor for America's post-war economic order. At the height of its success, GM understood that the company's booming growth depended on its large and able work force. And this realization — together with effective lobbying by the unions representing those workers — led to an extensive array of worker entitlements, ranging from generous health-insurance coverage to comprehensive retirement pensions to ­job-security guarantees.

Premised on the growing labor and consumer markets of the boom years, these arrangements over time began to weigh down the company. But once offered, the benefits proved almost impossible to roll back — and rather than make the difficult choices involved in revising longstanding contracts and face unhappy workers and unions, the company pretended its books could somehow fall into balance by magic. The old joke that GM was a health-insurance company that made cars on the side increasingly became the company's grim reality. As its commitments grew while its profits shrank, GM became unsustainable.

Over the same period, the United States government came to a similar arrangement with the country's growing and industrious middle class. To offer some security to the workers powering America's prosperity, a series of entitlement programs took shape, aimed especially at providing for retirement income and health-care expenses. These programs' finances were built on demographic and economic trends that could not have been expected to go on forever; yet even as their underlying logic has grown obsolete, these arrangements have proven extremely difficult to change. Today, America's political leaders are essentially in the position that GM's management was a decade or two ago: They have made a contract with the middle class that now threatens to bankrupt all involved, but seem unable to do anything about it.

The dire consequences of failing to change this arrangement are clear. According to the Congressional Budget Office, the trajectory of spending laid out in President Barack Obama's first budget would push the nation's debt to 82% of gross domestic product at the end of 2019 — up from 41% at the end of 2008. (And that's before the retirement of the Baby Boom generation hits with full force.) Politicians of both parties routinely decry this mounting debt and urge a thorough scrubbing of the budget. But while there is certainly much fat to trim around the edges, the great bulk of America's debt burden will come from three key entitlement programs: Medicare, Medicaid, and Social Security — the core of the middle-class contract.

For perspective, consider that in 1970 — just a few years after Medicare's enactment — the defense budget stood at 8.1% of the nation's economic output, as measured by GDP. Combined spending on Social Security, Medicare, and Medicaid, meanwhile, stood at 3.9% of GDP. But in 2019, almost a half-century later, defense is expected to fall to about 5% of GDP, while the big three entitlement programs will approach 12%. By 2050, they will exceed 18% of GDP — which is about the historical average of total revenue collection each year. The U.S. government, like GM today, will then be mainly in the business of providing health and pension benefits, and will struggle to perform its other basic functions — maintaining a standing army, for example — on the side.

The paradox of our entitlement system is that although it is designed to mitigate risk at the individual level, it is now creating a massive ­economy-wide risk. For years, economists across the political spectrum have been warning that unconstrained federal borrowing will ultimately leave the country unable to issue debt at favorable and affordable rates of interest. When that point is reached, there will be little choice but to embark on a long period of painful fiscal contraction and austerity, with deep and immediate cuts in benefits and steep rises in taxes....

...CBO has estimated that, between 1975 and 2005, annual Medicare per capita costs rose, on average, 2.4 percentage points more rapidly than per capita GDP growth. Medicaid's costs, meanwhile, have grown 2.2% faster than GDP, and privately funded health-care costs have grown 2.1% faster than GDP.

Combining escalating health-care cost inflation with the retirement of the Baby Boom generation makes for a budgetary nightmare. Between 2010 and 2040, CBO expects the combined costs of Medicare and Medicaid to increase from 4.9% of GDP to 10.6%....