Imagine if a candidate for office promised to introduce legislation called “The Social Security Do Nothing Plan.” Under this bill, promised retirement benefits would be cut by 16% for today’s 30-year-olds, by 29% for today’s 20-year-olds and by 35% for today’s newborns. Alternatively, payroll taxes would go up suddenly by 34% in 2042. With either choice, we would still need to borrow trillions of dollars to pay benefits. How many candidates would campaign for office with such a plan? Probably none, and yet these will be the results if we do not reform Social Security.
Unfortunately, we’re not hearing much straight talk about this looming disaster on the campaign trail this election season. Democrats too often minimize the enormous challenges facing the current system by arguing that Social Security trust funds are “solvent” for about 40 years. Republicans too often assume that the challenge can be met by simply creating personally owned retirement accounts, in which a portion of one’s Federal Insurance Contributions Act taxes are diverted into a separate account. It is time to set aside comforting slogans and confront the fundamental fact that Social Security has promised more in future benefits than it can deliver under current law. That is why any responsible plan, with or without personal retirement accounts of the sort that President Bush has proposed, must start with cost-saving measures that close the program’s long-term cash deficit.
Social Security is the country’s largest government program, comprising 22% of all federal spending. Social Security’s revenues, which come mostly from payroll taxes, are more than sufficient to pay benefits in the near term. But changing demographics make the current system unsustainable over the long term. Social Security is generating annual surpluses now, but large and growing deficits loom in the future. Between now and 2018, the program is projected to generate a $1.1 trillion cash surplus. But from 2018 through 2077, Social Security faces a cumulative cash deficit of $26 trillion.
This change is due to the rapid aging of America’s population. Low birthrates are reducing the number of taxpaying workers, while longer life spans are increasing the number of beneficiaries. In the years immediately following World War II, there were more than five workers per beneficiary. But by the time the baby boomers are fully eligible for benefits, there will be only two workers per beneficiary. This declining ratio is a problem because current workers pay for the benefits of current retirees. Ultimately, the need for reform is not a matter of ideology — it is a matter of simple arithmetic.
The Social Security trust fund does show a positive balance through 2042. However, the trust fund is simply an accounting device with “assets” consisting of Treasury IOUs. The cash needed to pay these IOUs will have to come from tax increases, spending cuts or borrowing from the public, all unattractive options for future policymakers. The key point is that the trust fund assets are also taxpayer liabilities. Their existence on paper does not ease the fiscal challenge of paying future benefits.
Redeeming the bonds in the trust fund from 2018 through 2042 will cost $5.4 trillion in today’s dollars. Pretending that there’s no problem until 2042 is fiscal and generational irresponsibility of epic proportions.
However, there are cost-saving options that could form the basis of a compromise. Means-testing, reduced cost-of-living adjustments, raising the age of eligibility and linking benefit levels to inflation rather than to wages ought to be on the table as reform options.
Such reforms, of course, carry serious political risk. When it comes to Social Security, good politics is at odds with good policy. It’s good politics to promise a free lunch or to say that nothing is wrong — but it’s precisely the wrong policy.
Unfortunately, the window of opportunity to gradually phase in cost-saving reforms and have the baby-boom generation pre-fund a portion of their retirement benefits is rapidly closing. Given the magnitude of the projected Social Security deficits, it is clear that the failure of our nation’s lawmakers to enact reforms will have dire consequences for future generations.
The challenge facing Social Security is daunting, but it cannot be viewed in isolation. Medicare will also feel the impact of the retirement of the baby boomers.
Health care costs in this country are growing rapidly, and the total cost of Medicare is rising along with them. Medicare consists of many separate programs that cover different services and are financed through different means. Only Part A, primarily covering hospitalization, is financed by payroll taxes. The government’s general revenue pays for 75% of Part B, which covers physician visits, outpatient services and home health care services. Beneficiary premiums cover only 25% of these costs. The new prescription drug benefit is also paid mostly through general revenues.
The drug benefit is estimated to add about 20% per year to Medicare spending by 2013. Furthermore, the benefit’s structure is such that it has the potential to shoot costs well above that. It contains a large gap between front-end coverage and the catastrophic backstop. In other words, coverage begins, then stops at a certain level, then starts again at a certain level. This is the so-called “doughnut hole” in the coverage, and it will be very tempting and expensive to fill.
This gap is completely arbitrary and has no policy rationale, making it an easy target for pressure by seniors desiring more generous coverage for the $1.8 trillion they are estimated to spend on prescription drugs over the next decade. The benefit’s main cost containment provision is toothless — an unenforceable call for congressional consideration when Medicare’s general revenue funding rises to a certain level.
While Medicare represents 13% of the federal budget today, it is expected to consume nearly 20% of the budget by 2030. In that year, the program is on track to consume 24% of all income tax revenues, jumping to 32% by 2040. When combined with Social Security, the two programs are projected to eat up nearly half of all total federal income tax dollars by the time today’s newborns turn 40. The fiscal constraints posed by recent deficits are nothing compared with the constraints we will face when half of all income taxes must go to just two programs.
These are harsh truths. But it is time for politicians to stop ignoring this impending fiscal crisis and start explaining what they will do to fix it. Both parties must reject free-lunch and do-nothing plans and face up to the real trade-offs that must be made to reform Social Security and Medicare so that they are fiscally sustainable and generationally equitable over the long term.
Harry Zeeve is national field director of The Concord Coalition.