Entitlement Madness, Part I

In the near future, the Social Security/Medicare Trustees will produce their annual report. Gloomy as the report will no doubt be, it will likely be a whitewash of the underlying reality. If the past is a guide to the future, the release of the report will focus everyone's attention on the trust funds (which scholars understand have no economic importance whatsoever) and ignore the huge unfunded liabilities we keep piling up and the severe cash flow problems elderly entitlement programs are already creating.

These obligations are especially important in light of the enormous increase in unfunded liability and cash flow deficits that are about to be added. Currently, about 100 million people depend on Medicare and Medicaid for their health care. Under President Obama's new health reform plan, an additional 100 million or so could be enrolled in public and quasi-public plans with the entitlement guarantee that their premiums will not exceed 10% of family income.

httpv://www.youtube.com/watch?v=PMJlIFo3XG4

Ground Control to Major Tom

As of last year's report, Social Security and Medicare had an unfunded liability in excess of $100 trillion (see Table I), about 6 ½ times the size of the entire economy. This is the excess of promises we have made over and above expected taxes and premiums. To avoid draconian benefit cuts or tax increase in future years we would need to have that $100 trillion in the bank, earning interest today. But of course we do not. (Although it is of small comfort, Jagadeesh Gokhale has shown that our European trading partners are in even worse shape.)

The $100 trillion figure is based on looking indefinitely into the future. (For reasons we have explained before a shorter time horizon gives misleading estimates.) Yet a different way of accounting is to use the method private companies and state and local governments now have to use. If we halted these programs tomorrow, collecting no more taxes and allowing no more benefit accruals, how much do we owe people for benefits they have already earned? Answer: $52 trillion.

Of more immediate concern is the cash flow problem these programs are creating. Social Security and Medicare combined are paying out more than they are taking in. As the baby boomers retire, the deficit will grow dramatically. By 2012, we will need 1 in every 10 income tax dollars to cover the deficits in these two programs. By 2020, we will need 1 in 4. By 2030, we will need 1 in 2. (See Figure I.) Clearly, elderly entitlements are on a course to crowd out everything else the federal government is doing. And this doesn't include Medicaid.

Of course, all of these numbers are based on underlying assumptions. The most important being assumptions about the growth of health care spending.

But here is the real shocker: a new report by Andy Rettenmaier and his colleagues shows that both the trustees and the Congressional Budget Office assume future health care spending well below the actual path we are on! More about that next week.

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