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Opinion
April 27, 2005

Social Security and Medicare - Sensible Wealth Transfers or an Exercise in Political Power?

President Bush has raised the awareness level of the projected insolvency of Social Security in 2041.  Details of proposed changes to Social Security have not been released, but the President favors diverting a portion of the payroll tax to personal accounts in return for lower benefit levels for participants who make the election.  The President’s proposal begs the obvious question.  Will it reduce the unfunded liability of Social Security?

The Financial Report of the United States Government should be required reading for every citizen of the country.  The current report for the fiscal year ending September 30, 2004 is available on the U.S. Treasury Department’s website at http://www.fms.treas.gov/fr/. 

Page 11 of the report summarizes the financial position of the U.S. Government.  The Balance Sheet column includes the estimated present value of future pension payments for all government employees to arrive at a net liability of $7.7 trillion.  The financial statements are prepared on the basis of the Statements of Federal Financial Accounting Standards (SFFAS), which recognize only expenses that are currently due and payable for social programs such as Social Security and Medicare.  The Treasury Department provides an estimate of the present value of the future cost (net of expected revenue) of the social programs under a column called “Additional Responsibilities.”  Using a 75 year period for the closed group of current participants, the estimate of the unfunded liabilities is $24.6 trillion for Medicare (Parts A, B & D), $12.5 trillion for Social Security, and $1.0 trillion for other social programs. 

Pages 88 and 89 of the Report, however, say that the 75-year projection is incomplete because it includes revenue from some future workers but only a fraction of their future benefits.  An open-group infinite horizon projection to “provide a complete estimate of the long-run unfunded obligations of the programs” represents the present value of all expected future program outlays less the present value of all expected future program tax and premium revenues.  According to the open-group infinite horizon projections, the present value of the unfunded obligations for Social Security and Medicare are $11.9 and $61.8 trillion, respectively, for a total of $73.7 trillion.  To get some perspective on the magnitude of these obligations, the net worth of all households and nonprofit organizations at the end of 2004 was $48.5 trillion according to the Federal Reserve.  The annualized gross domestic product of the country at the end of 2004 was $12 trillion.

Based upon preliminary information about the President’s proposal, the projected revenue and expenditures of Social Security, excluding personal accounts, would be reduced by a like amount.  Thus, the projected unfunded liability would not change.  While the President’s concerns about the unfunded liability of Social Security is legitimate, his proposal for private accounts is a non-solution because it would not reduce the unfunded liability which he cites as the call to action for his prescribed changes to the system.

Based upon the actuarial projections for Social Security, benefits must be reduced and/or taxes increased in order to reduce the projected net liability.  Neither Republicans nor Democrats are inclined to reduce benefits being paid to current retirees, regardless of need or benefits received relative to taxes paid into the system.  Years ago, when asked at a town hall meeting to address the lack of fairness between generations of the Social Security system, Congressman Jim Kolbe demonstrated one of the prevailing biases of Washington when he replied that young people don’t vote but retirees do.

The historical tax rates for Social Security and Medicare show why current retirees will benefit much more than future retirees.  A complete table can be found at http://www.taxpolicycenter.org/taxfacts/payroll/rate_historical.cfm.  A condensed version, showing ten year intervals and 2005 follows.
 

Historical Social Security and Medicare Tax Rates

Year	OASDI Maximum Taxable Earnings	Medicare Maximum Taxable Earnings	OASDI Tax Rate	Medicare Tax Rate	Maximum OASDI Tax	Maximum Medicare Tax
1940	3,000	N/A	2%	N/A	60	0
1950	3,000	N/A	3%	N/A	90	0
1960	4,800	N/A	6%	N/A	288	0
1970	7,800	7,800	8.4%	1.2%	655	94
1980	25,900	25,900	10.16%	2.1%	2,631	544
1990	51,300	51,300	12.4%	2.9%	6,361	1,488
2000	76,200	Unlimited	12.4%	2.9%	9,448	Unlimited
2005	90,000	Unlimited	12.4%	2.9%	11,160	Unlimited

Current workers are paying higher tax rates on much higher maximum taxable earnings.  Given the magnitude of the unfunded liability, it is a virtual certainty that current benefit levels cannot be maintained for future retirees.

One study by Lee, McClellan and Skinner, “Distributional Effects of Medicare,” published in Tax Policy and the Economy, August 1999, estimated the ratio of benefits received to taxes paid for Medicare participants.  For males in the 0-35 age bracket, participants are projected to receive 14 cents in benefits for every dollar paid for Medicare.  For males in the 61-64 age bracket, participants are projected to receive $3.99 in benefits for every dollar paid for Medicare.

Curiously, although the projected unfunded liability for Medicare is more than five times larger than that of Social Security, it has received little attention in the recent national debate.  During fiscal year 2004, the unfunded liability for Medicare increased by $9.6 trillion over 2003 based on the closed group of current participants.  Most of the increase was due to the Medicare Prescription Drug Plan (Part D), which accounted for $6.3 trillion of the increase.  The total increase in liabilities and additional responsibilities (on a 75 year closed group basis) for fiscal year 2004 was $11.1 trillion.

The United States spends more on health care than any other country.  In 2002, the U.S. spent 14.6% of GDP on health care.  The average for member countries of the Organization for Economic Co-operation and Development (OECD) was 8.5%.  Spending 6% of GDP more than other countries puts U.S. businesses at a competitive disadvantage.  In the U.S., more than 40 million people lack health insurance while nearly all developed countries have some type of national health coverage. 

Do we get more for our money spent on health care?  Dr. Barbara Starfield of Johns Hopkins School of Medicine published an article in the Journal of the American Medical Association a few years ago.  She found that on the basis of 16 available health indicators such as infant mortality, the United States ranked an average 12^th among 13 countries included in the comparison.  Dr. Starfield recently stated that since her study was published, many more international comparisons have been done and she believes that the situation has gotten worse.

Both Social Security and Medicare transfer substantial wealth from younger generations to older generations.  The amount of the wealth transfer is large relative to household net worth.  According to the U.S. Census Bureau, the median household net worth in 2000 was $55,000.  There are substantial differences in household net worth based upon age.  The median net worth for householders under the age of 35 and between 35 and 44 was $7,240 and $44,275, respectively.  The median net worth for householders 65 and older was $108,885.  Thus, Social Security and Medicare transfer wealth from younger workers to older retirees who have substantially higher net worth.  Retirees receive a positive return on their investment while younger workers are forced to invest in a retirement plan with negative returns.  In addition, young workers must subsidize the health care of retirees when they may not be able to afford health care for themselves.

Do Social Security retirement benefits and Medicare reflect sensible wealth transfers or do they represent the exercise of political power?

Robert G. Kahl
CFA, CPA, MBA

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