Federal outlays for Social Security and Medicare, our nation’s two largest entitlement programs, will come to $1.24 trillion this fiscal year, almost exactly one-third of all spending.
Neither program’s financing is fully sustainable over the long run. Medicare’s problems, however, are far more difficult than those of Old Age, Survivors and Disability Insurance. Moreover, the two programs are fundamentally different in ways citizens need to understand if we are to solve our nation’s fiscal problems.
Start with some basic similarities. Both are examples of “social insurance” programs whose origins go back to 19th century Prussia. Social insurance, as introduced under “Iron Chancellor” Otto von Bismarck, was not designed as some sort of socialistic program to redistribute income from one social class to another. Rather, the government mandated participation in insurance-like programs into which workers paid during their working lives or while healthy that paid benefits when they got old or sick.
As with voluntary private insurance, the benefits received compared to premiums paid could vary greatly from one individual to another. But each generation of workers as a group would pay in an amount equal to what they as got out as a group.
That goal—equality between overall pay-in and payout—has never strictly been true for either Social Security or Medicare. But Social Security itself is close.
The fact that at current FICA tax levels, Social Security is projected to be able to pay out current benefit levels until the mid-2030s, and 70 percent or so of the same levels after that, shows we are not too far off. Some combination of modest benefits cuts and tax increases can make the program sustainable.
With Medicare, however, no age cohort has ever paid in anything close to what it drew out. People on Medicare get average benefits two to three times what they paid in.
Yes, the Social Security Administration recently released more optimistic projections for Medicare based on the assumption that the Affordable Care Act of 2010 will reduce long-term outlays. Many analysts question those assumptions.
Nevertheless, Medicare remains financially shakier than OAS&DI itself. This is because the two programs differ fundamentally in several ways.
First, Medicare is more open-ended. Social Security itself pays benefits to retirees, survivors or the disabled based on a formula involving a person’s actual earnings over many years and the degree to which average wages for the nation as a whole changed over that time. There are hard caps on the benefits one can get as a retiree, a survivor or if disabled.
Regional cost-of-living variations aren’t factored in. A widow living in a rented apartment in the Bronx who gets a $900 check is really poor. One getting the same check but living in a paid-for home in small-town Minnesota is much better off.
Moreover, while initial benefit levels go up as average wages increase, and while ongoing benefits go up with the Consumer Price Index, higher consumption spending by recipients does not increase benefit outlays. Nor do we increase benefit levels in reaction to technological change. No one is getting higher Social Security because increasing numbers of people, even among the retired, think having TiVo or a 4G cellphone is a necessity.
Medicare reimbursement rates now are limited in all sorts of ways by formulas too complex to detail here. But we still pay more for the same procedure in high-cost states like New York or Florida than we do in lower-cost states like Minnesota.
Medicare outlays go up even faster than per-procedure medical prices, which have been rising faster than either earnings or general consumer prices. From the last increase in the Medicare FICA tax rate in 1987 until 2009, the general CPI went up 3 percent a year. The wage index Social Security uses for calculating initial benefit levels went up 3.7 percent a year. The CPI component measuring medical costs went up 4.6 percent a year. Overall outlays for all Medicare programs increased 7.8 percent a year.
Part of that differential is due to more people on the program as the population ages. Part stems from beneficiaries getting more medical procedures per person. Many of the most expensive of these procedures were not yet known in 1987.
The upshot is that each cohort of Medicare recipients pays only a fraction of the cost of the benefits they receive, even considering generous implicit interest earnings on the FICA taxes they pay until they start drawing benefits.
The difference is a transfer from younger generations that on average have lower incomes than the people on Medicare. In other programs, we call such income redistribution “welfare,” but Medicare has a special hallowed status in modern American culture, and most recipients resent that term.
We face the “hard choices” many political candidates proclaim themselves ready to make but flee from once elected. We can increase Medicare taxes. We can reduce the level or range of treatments we pay for.
Or we can go on transferring large amounts of money from the young to the old. That could continue for a long time as the dominant response, but don’t call it just or fair.
© 2011 Edward Lotterman
Chanarambie Consulting, Inc.