• 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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    • Don’t forget that SS is about 2x larger (in absolute dollar cost) than Medicare. So While Medicare may already be broke, it does impact fewer people. I don’t really care which we “fix” first, they are basically the same to me: just a big poor tax.

      But to put your proposal into perspective – the tax increase you propose to save SS is a 35% increase in taxes! It doesn’t seem like much when you say, “just increase taxes from 12.4% to 16.74%”, but a 35% tax increase would be unprecedented! Since this is a straight payroll tax, you’re basically taking 4% off the top, which would likely translate into a 1-4% increase in prices combined with a 1-4% increase in unemployment.

      But even if we implement that increase, it will go broke again. Why? Because historically, it always has. The pattern has been simple with SS for 50 years: increase the taxes, go broke, increase taxes more, still go broke… Here is the historical table. http://www.ssa.gov/OACT/ProgData/taxRates.html So, if you think that your 35% tax increase solves the problem until 2080, you’re just wrong. Medicare is following suit – although it was only introduced in 1966, it is an ever-increasing program, requiring never ending tax hikes to stay solvent.

      Another way to think about these programs is this: 50% of the federal budget goes to Medicare and Social Security alone. Although we don’t have balanced budget – imagine if your taxes could be cut in half? Would you be able to save more for retirement if you had half of your tax money back? I think so!

      The choice is not about fixing these two programs. They fundamentally only get bigger, and history proves me right. Thinking long term, we should be pursuing a fix which weens us off of these programs and gets us back to individual responsibility.

      • @Mike – I’ll make a few quick comments and then get out of the way of the debate at this level. In all things, I’m interested in options that are politically feasible. That’s a professional necessity. That is not meant to imply thinking about the bigger picture, as you are, is not worthwhile or important. It is just not something I’m going to do too much of because, in the end, if I want to make a difference I have to focus on the possible, not just the ideal. Even if the paths of possibilities all lead to a bad outcome there are still relevant degrees of badness. Same goes for good and goodness.

        Lastly, I don’t believe any predictions of the length we’re talking about, not yours, not CBO’s, not the Trustees’. In all cases, every single assumption can be questioned. In the long term everybody is wrong. In the short term, Medicare needs to be addressed. That fact relies on far fewer assumptions.