Medicare and Social Security SolvencyThe trustees of Medicare and Social Security issued their annual reports on the short- and long-term prospects of these two enormous programs at the end of March, 2008.
Both reports were generally consistent with those of last year, in their projections of when the systems will have to start dipping into trust funds and when those funds will be depleted. Demographics pose the greatest threat to Social Security’s future, while Medicare faces not only a similar growth in its beneficiary population, but rapidly rising health care costs as well. The structure and policies of the Medicare program may also contribute, but it is noteworthy that Medicare spending per enrollee rose an average of 8.7% annually between 1970 and 2006, while private health insurance spending rose 9.7% per year over the same period.
The Social Security long-term shortfall is only a fraction of the comparable problem facing Medicare, and also only a fraction of the cost of extending the 2001 and 2003 tax cuts that are scheduled to expire in 2010. As a percentage of the gross domestic product (GDP), the Social Security shortfall over 75 years is projected to be 0.56% and the Medicare Part A shortfall will be 1.6%. The cost of extending all the 2001 and 2003 tax cuts (which will expire in 2010 if Congress does not extend them) will be 1.95% of GDP, based on Congressional Budget Office estimates – almost as much as the 2.16% of GDP required to make both Social Security and Medicare Part A solvent for 75 years.
Social Security projections – The trustees predicted that benefit payments will begin to exceed Social Security tax revenues in 2017 if no changes are made in benefit or revenue levels. At that point the trust fund will have $4.5 trillion in assets, and the system will have to start using some of the interest it earns on the federal bonds held by the trust fund. In other words, in nine years the system will no longer have a surplus that it can lend to the U.S. Treasury – and the Treasury will have to either borrow less or find another source from which to borrow. Even though from 2017 on the system will be using some of the interest to pay Social Security benefits, the trust fund will continue to grow until it peaks at $5.5 trillion in 2026. At that point the system will start dipping into the principal of the trust fund to supplement current Social Security tax revenues and interest. This combination will be sufficient for fourteen years, but in 2041 the trust fund will be depleted; that is, the system will have cashed in all its federal bonds. Thereafter, the system’s tax revenue (the payroll tax plus the earmarked tax on benefits) will be sufficient to pay 78% of promised benefits. That percentage will gradually decline to 75% in 2082.
The report estimates the 75-year shortfall at $4.3 trillion in net present value, or 0.6% of gross domestic product (GDP). This is the amount by which full promised benefits over 75 years will exceed the trust fund’s income and revenues during that period. Another way to measure the shortfall is that it will equal 1.70% of taxable payroll.
The shortfall for the “infinite horizon” (i.e., to eternity) is estimated at 1.1% of GDP and 3.2% of taxable payroll. (The latter figure is a reduction from last year’s projection of 3.5%, because of some changes in the methods and assumptions used in making these projections. Most of the pertinent assumptions concerned the number of immigrants who will be paying Social Security taxes and the number who will actually collect benefits.) The American Academy of Actuaries and some other Social Security analysts are dubious about the infinite horizon projections, which they consider highly speculative and misleading. The further into the future projections are made, the more sensitive the results are to small changes in assumptions and the less reliable the results are.
The projections of costs in excess of revenue in 2027 and of depletion of the trust fund in 2041 are unchanged from last year. There have been only slight changes in these dates since 2002. But despite the relatively stable outlook for Social Security, the program faces large deficits, largely but not entirely caused by the retirement of the baby boom, beginning this year.
Many possible combinations of Social Security revenue increases and benefit cuts would eliminate the projected 75-year shortfall. These changes could be phased in gradually, although the longer they are postponed, the more drastic they will have to be. The enclosed AARP report, “Reform Options for Social Security,” discusses a variety of these options, which it divides into three categories:
1) Increases in revenue through tax coverage or tax rates by:
• Raising the limit on annual earnings subject to the payroll tax (currently $102,000);
• Including newly hired stated and local government employees in the system;
• Taxing Social Security benefits as private pensions are taxed;
• Increasing the payroll tax rate, currently 6.2% each on the employer and employee.
2) Reductions in benefits by:
• Raising the full retirement age beyond the increase to 67 that is already being phased in;
• Indexing benefits to longevity;
• Increasing the benefit calculation period, which is currently 35 years;
• Reducing benefits by 5% for all new beneficiaries;
• Adjusting the COLA, which some economists believe overstates inflation;
• Modifying the benefit formula to reduce benefits progressively;
• Indexing benefits progressively.
3) Increasing the return on trust fund investment by:
• Allowing some of the trust fund to be invested in stocks or nongovernmental bonds.
AARP does not include privatizing Social Security by establishing individual accounts among its list of reform options, because this proposal would in fact hasten the system’s insolvency by diverting money from the trust fund.
The report also estimates how much each proposal would reduce the total Social Security shortfall, although of course many details in each proposal could alter these projections somewhat. It also observes that each proposal would affect different groups differently, especially based on their age and income. Relying on just one or two of the possible reform strategies could therefore concentrate the impact of the total reform package on some segments of the total population while leaving others relatively untouched. This echoes the U.S. Treasury’s concern for equity within generations and between generations, in its reports on Social Security. Certainly this aspect of any reform proposal should be carefully considered.
Medicare projections –
The Medicare Hospital Insurance (HI, or Part A) Trust Fund is projected to start running deficits in 2010 and to be fully depleted in 2019 (a few months earlier than predicted last year). Thereafter, if no changes are made, the Part A trust fund would be sufficient to cover 78% of projected expenditures. The Part A shortfall will average 1.6% of GDP over 75 years. This is 2.6 times the size of the Social Security shortfall over the same period. Thus Medicare presents a far greater financial challenge than Social Security, in both the short- and the long-term. Part A expenditures will increase at an annual average rate of 7.4% over the next ten years, faster than either GDP or the Consumer Pride Index.
The Supplementary Medical Insurance (SMI) Trust Fund (Part B) is kept in balance every year because the Part B premium (currently $96.40 per month) and general revenue financing are adjusted annually to match projected costs for the coming year. But Part B payments have increased an average of 9.6% per year for the past five years, and are likely to continue to do so. The Medicare trustees warn that Part B costs will exceed the current projections if Congress overrides existing regulations that would impose substantial reductions in Medicare payments to doctors over the next ten years. Congress has done this repeatedly for several years. These increases will put increasing pressure on Medicare beneficiaries, who pay the premiums, and on all taxpayers, who provide the general revenue.
U.S. Secretary of Health and Human Services Michael Leavitt recently described the Medicare system as “drifting toward disaster.” He noted that projections that Medicare spending alone will account for 3.3% of GDP next year. The next administration will have to act quickly to stop rising costs and control the $400 billion program, because it is unlikely that the Bush administration will be able to do so in its remaining months. He therefore offered “some general advice on the creation of a political construct for action and a general strategy to solve the problem.” In particular he said that paying separately for each medical action is wasteful and “often results in bad referral decisions, sloppy hand-offs, duplication, fraud, and poor quality of care. The result is inappropriate care and unnecessary cost. . . . It troubles me that this matter is not receiving more attention in the presidential candidates’ discussions. The next president will have to deal with this in significant part.” |
