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Day of reckoning

While Washington debates how to fix America’s safety net, the real-world stakes are getting higher

By Jay Fitzgerald
Globe Correspondent / June 12, 2011

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For the better part of 20 years, lawmakers and policy makers have talked about the oncoming wave of aging baby boomers and exploding costs of Social Security and Medicare, warning that the nation faced a day of financial reckoning unless it brought spending on these popular entitlements under control.

That day, if not quite here, is fast approaching — within months, or even weeks, according to one prominent economist — and political leaders in Washington are still talking. As the first of nearly 80 million baby boomers turn 65 this year, when and how Washington addresses rapidly rising entitlement costs and, consequently, the burgeoning national debt, will have vast implications for business and the economy.

If something isn’t done relatively soon, economists say, higher interest rates, a weaker dollar, increased payroll taxes, and deep cuts to other federal programs are among potentially dire consequences that could mean slower growth, higher unemployment, and lower standards of living.

The stakes for Massachusetts are particularly high since many of its key industries, including technology, biotechnology, and hospitals, depend heavily on federal spending for defense, scientific research, and health care.

“Business executives should be very concerned,’’ said Jonathan Gruber, an economics professor at the Massachusetts Institute of Technology. “The business community has a huge stake in keeping the federal government solvent.’’

Among the potential consequences:

Higher borrowing costs. As the government floods financial markets with debt to meet entitlement obligations, it would likely have to offer higher interest rates to attract buyers of its bonds. Those higher rates would trickle through the economy, affecting everything from auto loans to corporate bonds.

A further weakening of the dollar. As currency investors lose faith in the government’s financial state, the relative value of the dollar would fall, reducing Americans’ purchasing power. US products would become less expensive to foreign customers, increasing exports, but imported goods, from electronics to cars, would become more expensive here.

Increases in payroll taxes to support Medicare and Social Security. Businesses currently chip in half of the 2.9 percent Medicare tax and half of the 12.4 percent for Social Security taxes. Employees pay the rest. Any grand compromise on Medicare and Social Security would probably increase taxes.

Cuts in other federal programs. If more taxpayer money is funneled to Medicare and Social Security, there would be less money for defense, research, education, and other federal programs important to the Massachusetts economy.

Disruptions to the health care and biopharmaceutical industries. Medical cost saving initiatives, especially changes to the Medicare payment system for health services and drugs, could shake up these key Massachusetts industries.

As difficult as the issues appear, economists across the political spectrum said Washington can’t wait much longer to begin addressing entitlements, viewed as main drivers of the long-term national debt.

Combined Social Security and Medicare spending is projected to nearly double over the next 10 years to $2.2 trillion, from $1.3 trillion, and accelerate as more baby boomers flood the systems. Baby boomer retirements are expected to peak early next decade.

The problem comes if financial markets lose confidence in the nation’s ability to manage these costs and pay its debt; witness the global financial turmoil and drag on economic growth from the debt problems of Greece, which has an economy just a fraction of the size of the US economy.

When such a crisis might happen here is anyone’s guess, but the risks increase the longer it takes US leaders to agree on a plan, economists said. Laurence Kotlikoff, a professor of economics at Boston University and an expert on entitlements, said it could happen sooner than anyone expects.

“I think we can see a meltdown within the bond markets within five weeks if we don’t do anything,’’ he said. “I could be wrong. But too many people are nervous these days. Markets can move very quickly. We’re playing with fire.’’

Most other economists say the nation has about five years to start making a serious dent in projected Medicare and Social Security deficits.

But they are also not discounting the possibility of a rapid deterioration of markets if Washington doesn’t send a signal that it’s addressing long-term budget woes.

Currently, political leaders appear at a standoff. The Republican-controlled House recently passed a plan to overhaul Medicare by providing government vouchers to help seniors buy private health insurance. The Democratic-controlled Senate rejected that plan.

Meanwhile, there has been little discussion of possible compromises to address Social Security’s problems. Republicans and Democrats can’t even agree on whether to raise the nation’s debt ceiling to pay for today’s programs.

Economists say lawmakers can’t waste much more time.

“Markets are forward looking,’’ said William Cheney, chief economist at Boston’s John Hancock Financial Group. “If the markets see that nothing is getting done, then the markets can quickly lose their tone and confidence.’’

Cheney doesn’t see an immediate crisis as severe as those in Greece, Spain, and other European countries struggling with long-term debt.

“But my big fear,’’ he added, “is that we’ll get hit suddenly and fast by markets, causing turmoil and making it more difficult to react. It could happen at any time.’’