Relative Solvency of Entitlement Programs

A reader asked me to explain Medicare’s solvency problem (I mean U.S.’ Medicare, not Canada’s). I’m going to do that in several subsequent posts. Before I dig into Medicare’s financing problems (in two subsequent posts) and some solutions to them, it is worth mentioning the other huge federal program with a solvency issue: Social Security.

The Social Security Trustees predict that the program will be unable to pay benefits in full beginning in year 2037 (28 years from the time I’m writing this post). At that time it is predicted that benefits would need to be reduced by 24 percent unless other action is taken. By 2083 benefits would need to be reduced another 2 percentage points to 26 percent. (See also the FAQ on Social Security’s future.)

The reason for the predicted shortfall is demographics: longer lives and fewer workers relative to retirees. Social Security’s financing problem could be solved in a number of ways: increasing taxes, decreasing benefits, using other financing sources, or a combination thereof. For example, raising payroll taxes to 16.26% in 2037 and increasing them to 16.74% by 2083 could preserve full benefit levels. (The current Social Security payroll tax rate is 12.4%.)

To be sure Social Security has a problem. And solving it will be easier the sooner we start. But Medicare’s problems are upon us (expenditures for Medicare Hospital Insurance already exceed revenue) and require bigger adjustments in benefits or funding to fix (a halving of benefits or doubling of payroll tax). So, anytime you hear someone getting all worked up about how Social Security’s financing problem is the most important entitlement program issue to be addressed be skeptical. That person may have some other reason to want to fix Social Security now. For example, (s)he may not like the program and would prefer it be configured very differently, as they likely propose.

Medicare is actually the most important entitlement program to fix right now. It’d be great if we could fix it and Social Security at the same time and soon. But it is politically difficult to do either. If any single president or congress did just one, that would be a big achievement. Likely it will take different presidents working with different congresses before both are solved. Medicare should come first.

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