June 18, 2024

Economix: The Real Social Security and Medicare Problem (and a Doable Fix)

Today's Economist

Bruce Bartlett has served as an economic adviser in the White House, the Treasury Department and Congress.

On Friday, the trustees of the Social Security and Medicare systems issued their annual reports for 2011. Commentary on these reports always tends to dwell on the date when their trust funds become exhausted; in the case of Social Security it is 2036 and for Medicare it is 2024. But in truth, these figures are virtually devoid of meaning.

Benefits are not paid out of a trust fund filled with income-producing assets, like a private pension fund; benefits are paid out of tax revenues. The trust funds are merely accounting devices best thought of as budget authority. As the trust funds draw down their assets, general revenues — that is, tax revenues besides the payroll taxes earmarked for these programs — are injected into the trust funds to redeem bonds that had previously been placed there during years when revenue from the payroll tax exceeded costs.

Although there is often speculation that Social Security and Medicare benefits would have to be slashed to the level of payroll tax revenue on the day the trust funds are empty, this is simply nonsense. It would take Congress a matter of hours to change the law to allow explicit general revenue financing for these programs.

There is never going to be a day when Social Security checks are cut across the board because the Social Security trust fund became exhausted.

What really matters for the viability of both Social Security and Medicare is their aggregate costs relative to the economy’s ability to pay them. In this regard, it is best to look at spending as a share of the gross domestic product, especially in the long run.

Looking at Social Security, we see spending rising from 4.8 percent of gross domestic product to 6.2 percent by 2035, an increase of 1.4 percentage points.

The long-term cost of Social Security is best summarized in Table IV.B6 of the trustees’ report, which calculates it over the “infinite horizon.” This is a statistical technique that takes spending far in the future and puts it into today’s dollars, adjusted for the rate of interest. This calculation says that Social Security would need $17.9 trillion in productive assets – stocks, corporate bonds, buildings, whatever – to produce enough income today to cover the difference between what the payroll tax will generate and the benefits that have been promised.

Of course, no such trust fund exists.

The current Social Security trust fund contains only Treasury securities, which simply allows general revenues to fund benefits up to a point. The economy isn’t large enough to create a sufficiently large real trust fund even if we wanted to create one. The country’s gross domestic product is about $15 trillion dollars, so if we put 100 percent of a year’s production by every business and worker in America into the Social Security trust fund, it would not be enough to pay benefits in perpetuity.

Put another way, the Federal Reserve says that the nation’s net wealth is about $57 trillion. That figure would have to be $18 trillion larger to generate enough additional G.D.P. to pay Social Security benefits without making anyone worse off in the future through higher taxes or lower benefits.

Another way to think about it is that the long term Social Security deficit is 1.2 percent of G.D.P., or 3.6 percent of taxable payrolls.

Thus we could raise the Social Security tax rate from 12.4 percent, which it has been for the last few years,  to 16 percent immediately and forever, or we can assume general revenue financing for the unfunded liability and would have to increase federal income taxes from 6.2 percent of G.D.P. to 7.4 percent, about a 30 percent increase in the amount of income tax revenues the government needs to collect.

Turning to Medicare, its finances are more complicated because it is really three separate programs that are financed differently.

Part A pays for hospital visits and is financed by the Medicare portion of the payroll tax, which is 2.9 percent. (That leaves the total payroll tax rate, at 15.3 percent, ignoring the temporary cut enacted last year as a stimulus program.)

As a result of cost saving measures implemented by the Affordable Care Act, this portion of Medicare has virtually no long-term unfunded liability according to Table III.B10 of the trustees’ report. The 2009 report, before passage of the new health care law, had estimated a long-run unfunded liability of $36.4 trillion, which is equivalent to 2.8 percent of G.D.P. forever and would have required a payroll tax increase of 6.5 percent. (Also Table III.B10.)

But Medicare has two other important components.

First is Part B, which pays for doctors’ visits and is financed partly by premiums paid by beneficiaries and partly by general revenues. It has no trust fund. Originally, premiums paid 50 percent of Part B’s costs, but now that is down to just 25 percent. The long term general revenue contribution to Medicare Part B is estimated at $22.4 trillion or 1.5 percent of G.D.P. in perpetuity. (Table III.C15.)

Finally, there is Medicare Part D, which George W. Bush and Congressional Republicans rammed into law in 2003. Even though Medicare’s finances were rapidly deteriorating, they provided no additional funding for Part D beyond trivial premiums paid by beneficiaries. The unfunded cost of this program is estimated at $16.1 trillion, or 1.1 percent of G.D.P. in perpetuity. (Table III.C23.)

Thus we see that Social Security and Medicare are underfunded relative to promised benefits by $56.4 trillion or 3.8 percent of G.D.P. per year forever. To put these programs on a sound footing, federal income taxes would have to rise from 6.2 percent of G.D.P. to 10 percent, an increase of 61 percent.

In other words, whatever amount you paid on your federal income tax return this year would need to be 61 percent more, now and forever, to pay all the Social Security and Medicare benefits that have been promised over and above the payroll tax.

What’s worse, these numbers may be conservative.

Medicare’s actuaries do not believe their own projections are realistic because they were required to assume that a key provision of current law will take effect as scheduled. This is known as the “sustainable growth rate” (S.G.R.) and involves implementation of a law enacted in 1997, but repeatedly postponed by Republican and Democratic Congresses. It would require a 29.4 percent cut in fees for doctors who treat Medicare patients on Jan. 1, 2012.

The Medicare actuaries just don’t believe this provision will be allowed to take place because they think Congress will punt the ball once again. Therefore the official estimates of Medicare’s fiscal position are much too optimistic.

But what if President Obama and House Speaker John Boehner agreed, as part of negotiations on raising the debt limit, to let the this cut in Medicare fees take effect as current law requires?

That would cut Medicare’s costs very substantially over current policy – something Mr. Boehner has demanded as a price to prevent the Treasury from defaulting on the debt. The virtue of this approach is that no one has to do anything – the sustainable growth rate is already in law. All our leaders have to do is promise not to change the law and instead allow it to take effect on schedule.

The doctors will scream bloody murder and threaten to stop treating Medicare patients. It will be ugly.

But everyone knows that Medicare needs to be cut, and as the biggest contributor to long-run deficits, doing something meaningful to reduce spending on this program will demonstrate resolve and commitment to deal with entitlement spending. It’s exactly the sort of thing Mr. Boehner says he wants in order to raise the debt limit.

I think if he and Mr. Obama jointly committed not to implement another so-called “doc-fix” — the delay in cutting Medicare fees — it would be a solid first step on finding a bipartisan approach to dealing with the deficit.

Article source: http://feeds.nytimes.com/click.phdo?i=bb40af905e43312b865b2e403f29793d

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