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Borrowed Prosperity


The claim by James Surowiecki in his recent Financial Page column in The New Yorker that Social Security and Medicare were “designed to be self supporting” overstates the intent (and ability) of their designers. (See “In Funds We Trust?,” December 24, 2012)

True, they are different from most federal programs, which are funded out of general revenues. While Social Security and Medicare’s Hospital Insurance program (Medicare Part A) have a dedicated revenue stream via payroll taxes imposed on workers, mere earmarking of revenues does not ensure that the programs would be self-supporting. The original intent was that if population growth continued as projected before the baby-boom — which began in 1946 and lasted through 1964 — there would generally be more workers than retirees to pay into the programs’ trust funds. And with generally positive productivity growth, retirees would receive a small but positive rate of return on their past payroll taxes. 

As the article mentions, payroll taxes have increased sharply over the years. But those tax increases were implemented by politicians in the past to fund the very generous benefit increases granted during the 1960s and 1970s, mainly to pander to retiree voters. In particular, Social Security benefits were protected against inflation during the 1970s, securing their real value and growth over time. Those benefit increases meant earlier participants in the programs received handsome returns on their payroll taxes — more than they would have received on average had they invested the income lost to payroll taxes in stocks or bonds. The cost of these windfall awards to earlier generations falls on future generations of workers and retirees, who will have to pay for them with some combination of tax increases and benefit cuts.

#more#The article cites 2024 as the trust-fund exhaustion date for Medicare and 2033 as the exhaustion date for Social Security. Note that the Disability Insurance trust fund — which is a part of social Security — is projected to be exhausted even earlier, by 2016. But these entitlement programs’ trustees are underestimating their future revenue shortfalls, and official exhaustion dates are likely to prove optimistic. Indeed, the latest news from the U.S. Census Bureau is that, this year, we’ve registered the smallest birth rate in many decades. If the birth rate continues to be this low, the programs’ trust funds will be exhausted even earlier.

It follows that the article’s claim that “relatively minor tweaks” can restore the programs to financial health is unsupported. But thank heavens that these programs have dedicated funding — because it helps to clarify their huge costs. The article’s suggestion that they should revert to general-revenue funding is really a plea to restructure the funding to help disguise their true cost. My recent estimates show that the total long-term imbalance of these two programs (including Social Security and Medicare’s Parts A, B and D) is $66 trillion, and restoring them to sustainability will require almost doubling the payroll-tax rate. 

Yes, these programs’ growth should be curbed and their benefits and funding restructured. The motivation for this is not simply a whimsical ideological preference but is based on careful analyses of the economic incentives that the programs create. Both payroll taxes and Social Security and Medicare benefits, under the current setup, reduce workers’ incentives to remain in the workforce and be productive. And Americans can no longer afford the now considerably diluted ”social insurance” benefits that these programs provide at a high economic cost. It’s time to reverse the trend of ever growing entitlement benefits and ever rising payroll taxes. Carefully crafted reforms could strengthen the old-age finances of future generations without harming the retirement security of today’s retirees. But let’s not kid ourselves into believing that the borrowed prosperity these programs have provided past generations can be continued forever.

— Jagadeesh Gokhale is a senior fellow at the Cato Institute.


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