Social Security, Medicare, Medicaid: One of these things is not like the others

Posted by Nolan Miller on Feb 17, 2011

Filed Under (Health Care, Retirement Policy, U.S. Fiscal Policy)

Interesting goings on in the world of government budgets these days.  I’ve written in the past about the problems of increasing health care costs in the U.S. and how this is a problem that, at this point, we just don’t know how to solve.  Social Security, on the other hand is another matter.  Despite the gloom and doom about the coming insolvency of the system, things aren’t really all that bad.  (Of course, that statement should be interpreted relative to health care entitlements, but still …)  I’m relatively uninformed on the subject, but it seems like, if we wanted to “fix” social security, we could (i) raise taxes, (ii) reduce benefits, (iii) increase the retirement age, or (iv) some combination of these.  None of these options is great, but any would work.

President Obama raised a similar point in his Tuesday press conference.  Asked about the “long-term crushing costs of Social Security, Medicare [and] Medicaid” which his budget proposal did not address, he responded:

Now, you talked about Social Security, Medicare and Medicaid.  The truth is Social Security is not the huge contributor to the deficit that the other two entitlements are.  …  Medicare and Medicaid are huge problems because health care costs are rising even as the population is getting older.

So, just how bad does the future look for Social Security?  Well, bad, but not that bad.  Take this excerpt from the Summary of the 2010 Annual Reports on the Status of the Social Security and Medicare Programs:

Social Security expenditures are expected to exceed tax receipts this year for the first time since 1983. The projected deficit of $41 billion this year (excluding interest income) is attributable to the recession and to an expected $25 billion downward adjustment to 2010 income that corrects for excess payroll tax revenue credited to the trust funds in earlier years. This deficit is expected to shrink substantially for 2011 and to return to small surpluses for years 2012-2014 due to the improving economy. After 2014 deficits are expected to grow rapidly as the baby boom generation’s retirement causes the number of beneficiaries to grow substantially more rapidly than the number of covered workers. The annual deficits will be made up by redeeming trust fund assets in amounts less than interest earnings through 2024, and then by redeeming trust fund assets until reserves are exhausted in 2037, at which point tax income would be sufficient to pay about 75 percent of scheduled benefits through 2084. The projected exhaustion date for the combined OASI and DI Trust Funds is unchanged from last year’s report.

So, even if NOTHING were done, Social Security would be able to pay at least 75 percent of scheduled benefits through 2084.  Like I said, that’s bad, but it could be worse.

What about health care?  For that, let’s turn to a new working paper by Kate Baicker and Jon Skinner entitled “Health Care Spending Growth and the Future of U.S. Tax Rates.”  Not exactly beach reading.  They note that health care spending currently accounts for 17.6 percent of GDP and health care expenditures currently grow, on average, about 2.5 percentage points faster per year than GDP.  If this trend continues, health care expenditures are expected to account for 26 percent of GDP by 2035.  Of course, escalating health care costs are expected to reduce GDP, so the future might actually be worse.  According to the CBO (reported by Newhouse here), if health care cost growth exceeds GDP growth by 1 percentage point (on average) until 2050, this will lead to a 3 – 16% decrease in GDP over what would have happened if there were no gap.  Things will be substantially worse if the 2 percentage point gap continues.

What about government revenues?  Here’s where it gets really scary.  Suppose that health care costs continue to grow at a rate 2.5 percentage points faster than GDP grows.  In 2007 (too lazy to look up this year’s number), spending on Medicare and Medicaid was about 4.5 percent of GDP.  If the 2.5 percentage point gap continues, CBO estimates that by 2050 spending on Medicare and Medicaid will account for approximately 20 percent of GDP.  If this increased expenditure were financed by increasing income taxes and rates for all income groups were increased proportionately, CBO says:

Before any economic feedbacks are taken into account, and again assuming that raising marginal tax rates was the only mechanism used to balance the budget, the tax rate in the lowest tax bracket would have to be increased from 10 percent to 26 percent; the tax rate on incomes in the current 25 percent bracket would have to be increased to 66 percent; and the tax rate in the highest bracket would have to be raised from 35 percent to 92 percent. The top corporate income tax rate would also increase from 35 percent to 92 percent. Such tax rates would significantly reduce economic activity and would create serious problems with tax avoidance and tax evasion. Revenues could fall significantly short of the amount needed to finance the growth of spending, and thus tax rates at this level may not be economically feasible.

Not that they need to, but in the longer term, things are even worse.  Chernew, Hirth and Cutler project the meaning of a 2 percentage point health expenditure-GDP gap until 2083 and find that, on average, 118 percent of all real income growth between now and 2083 will be devoted to health expenditures.  The Newhouse study illustrates this point with a graph showing that if a household has about $40,000 to spend on everything other than health care in 2008, under the current projections it will have about $30,000 to spend on everything else in 2084.

So, the comparison between Social Security and health care is pretty clear.  If nothing is done, Social Security will be able to pay at least 75% of benefits through 2084.  If nothing is done on the health care front, (according to the CBO report) “if health care costs per beneficiary grew an average of 2.5 percentage points faster than GDP per capita each year, as they have over the past four decades, and the spending was financed solely with a proportional increase in income tax rates, the economic costs would be significant and the circumstance probably impossible to sustain through 2050.”