America's entitlement spending problem

America's entitlement spending problem

I want to highlight two points from the Reports of the Social Security and Medicare Trustees, released Tuesday.

Point 1:  If you do not change Social Security’s promised benefit payouts you would need to set aside $23.2 trillion today to permanently fill the hole between promised Social Security benefits and dedicated Social Security taxes (almost all of which are payroll taxes).

For comparison $23.2 trillion is about one and a half years of U.S. GDP.  Take the entire economic output produced in the USA for the next 18 months.  Set it aside.  Now you have enough cash, when combined with future projected Social Security payroll and other dedicated taxes, to pay current and future benefit promises.  That’s a mighty big hole to fill.

For the technicians, the present value of the infinite horizon liability is $20.5 trillion, but that assumes one will magically find $2.7 trillion of change under the couch cushions to “pay back the Social Security Trust Fund’s obligations.”  The concept I’m trying to capture with the $23.2 trillion is the cash needed now to defease the Social Security liability:  suppose you were going to give someone all future revenues dedicated to Social Security, and they would commit to forever paying all promised Social Security benefits.  How much additional would you have to pay someone today to accept this deal?  I think that’s the appropriate way to measure the size of the Social Security funding gap.

Point 2:  For the next two decades demographics are a bigger driver of entitlement spending growth than is health cost growth.  Here are the Trustees:

Through the mid-2030s, population aging caused by the large baby-boom generation entering retirement and lower-birth-rate generations entering employment will be the largest single factor causing costs to grow more rapidly than GDP. Thereafter, the primary factors will be population aging caused by increasing longevity and health care cost growth somewhat more rapid than GDP growth.

There is an incorrect and misleading conventional wisdom that health care costs are the principal driver of our long-term entitlement spending problem.  That’s true, but only starting about 20 years from now.  For the next two decades demographics, specifically the retirement of the Baby Boomers, is the biggest driver of entitlement spending growth.  The point that everyone misses is that Medicare (and Medicaid) spending growth are driven by a combination of health cost growth and demographics.  When you combine the demographic factor driving part of Medicare spending growth with the demographic cost driver of Social Security, you account for more of the total spending growth than if you look only at the effect of per capita health spending growth.

Health cost growth dominates everything in the long run, but on our current path we won’t make it to the long run.  If policymakers do not change the spending paths of Social Security and Medicare (and Medicaid, but that’s not in these reports) soon, things will break long before we get to the time when health costs are the principal driver.

This conventional wisdom and confusion result from two factors:

  1. People ignore the demographic drivers in Medicare spending.  Medicare grows because there are more seniors collecting it and because spending per senior is growing unsustainably fast.
  2. Advocates for the Affordable Care Act, including President Obama and his former budget director Peter Orszag, worked hard to convince people that “It’s all about health cost growth.”  This served two of their purposes:  to make an argument for their health care reform proposal and to rationalize not doing anything to fix Social Security.

I am not arguing that we should ignore health cost growth; just the opposite.  It is a huge driver of short-term entitlement spending growth, it’s just not the biggest factor in the next two decades.  Instead we must change policy to address both demographics and health cost growth, and we must address demographics in all three major entitlement programs: Social Security, Medicare, and Medicaid.

(photo credit: RenoTahoe)

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