Trustees of the Social Security funds released their newest annual report Tuesday announcing that benefits paid out of the Medicare Trust Fund will exceed taxes paid beginning this year. All the money held in this trust fund will be exhausted by 2019.
Annual revenues under the Old Age, Survivors and Disability rubrics of Social Security are projected to exceed annual disbursements until 2018 and accumulated trust funds for these programs won’t be gone until 2042.
Some lessons to take from this: The funding basis for Medicare is considerably less sustainable than that for the rest of Social Security. The general direction of projected changes is more important than specific predicted dates. Do not place much credence in specific dates more than a few years away, as they are highly influenced by the assumptions and structure of the projection model.
Start with some background: The trustees who released the report consist of four government officials, the secretaries of the Treasury, Labor, Health and Human Services, and the head of the Social Security Administration plus two university professors.
The report is prepared by Social Security Administration actuaries and analysts. Mandated by law and prepared every year, the report contains new 10-year and 75-year projections using a consistent set of analytic procedures.
All concerned know that reliability of any projection falls off rapidly as one looks further into the future. The likelihood that any economic event projected 75, 50 or even 25 years into the future will occur is extremely low. Nevertheless, if projections are made consistently, trends or changes in projections do convey useful information even if any specific forecast is doubtful.
Reports noted that the projected date for Medicare trust funds running out of money fell to 2019 from the 2026 projected in the report released just 12 months ago. How could this happen? The answer is that much depends on the rate of increase in health care costs, and such costs are rising rapidly right now. Moreover, payroll earnings — and thus Medicare revenues — are growing more slowly than previously estimated.
For the nation as a whole, health costs rose by 35 percent from 1998 to 2002, an annual rate of nearly 8 percent. Private employer-sponsored health care premiums rose 14 percent in 2003 alone.
When such high rates of health cost increases are factored into projection models, the inexorable logic of compound interest implies large changes down the road.
For example, with all health spending now taking up 15 percent of GDP, if one projects unending annual increases in health spending of 8 percent and GDP growth of 3 percent, health care will consume 100 percent of GDP in 40 years. That is a logical impossibility.
The point is that, from the point of view of society as a whole, putting details of Medicare funding aside, the important questions involve limiting the growth of health spending and fostering strong growth in total output. Those two factors will determine how great a burden health care will place on the economy. This is far more important than how we finance health care for Social Security recipients.
That is largely a political question, but with economic implications. The “trust funds” contain only U.S. Treasury bonds. As annual fund tax receipts fall below annual benefits paid, the Social Security Administration will cash in some bonds and use the proceeds to pay benefits. If projections are correct, by 2019, all of the bonds will have been cashed. That is what is implied by the phrase “exhaustion of trust fund reserves” in the new report.
Critics note that the bonds held in these funds are not a “real asset,” but only a promise by the government to levy taxes to pay principal and interest on the bonds. This is true, but one could make the same argument about any Treasury bond. Defaulting on a promise made within government would have similar political fallout as defaulting on promises made to private bond investors.
Drawing down these trust funds does mean, however, that the Treasury will have to either: 1) raise more in general taxes; 2) spend less on non-Social Security programs; or 3) borrow more from the general public than it would if the trust funds were not tapped. Starting already this year, high Medicare costs will increase Treasury borrowing from the general public, all other things being equal.
That is why non-Social Security deficits are important. For 20 years, the true magnitude of these deficits has been camouflaged by surpluses in Medicare and general Social Security funds. That camouflage begins to disappear this year.
We can cut noninterest general Treasury spending, which is already at a 45-year low relative to GDP, or we can raise general taxes. Or we can continue blithely on our current course, which is to depend on Asian central banks buying our bonds at low rates of interest. That is the most risky alternative.
© 2004 Edward Lotterman
Chanarambie Consulting, Inc.