Tuesday, February 14, 2012

Social Security and Medicare: Collected Taxes, Benefits Received

One grows weary of hearing all the lies told about the status of our entitlement programs—and then one becomes angry. C. Eugene Steuerle and Stephanie Rennane of the Urban Institute have provided us with some data that brings needed perspective to any discussion: Social Security and Medicare Taxes and Benefits Over a Lifetime.

These authors provide an extremely useful set of tables.

"These tables provide estimates of the lifetime value of Social Security and Medicare benefits and taxes for typical workers in different generations at various earning levels. The tables are updated to reflect assumptions and projections in the 2011 OASDI and Medicare Trustees reports. The "lifetime value of taxes" is based upon the value of
accumulated taxes, as if those taxes were put into an account that earned a 2 percent real rate of return (that is, 2 percent plus inflation). The "lifetime value of benefits" represents the amount needed in an account (also earning a 2 percent real interest rate) to pay for those benefits."

The assumption is made that taxes collected are invested and earn interest. This is a reasonable approach to take, but what actually happens is more complicated. This will be discussed below. The important thing is that the authors have put benefits and taxes paid on the same footing so that they can be compared.

The extent to which the financing of Social security and Medicare have changed over the years is indicated by this chart.

Early retirees clearly received much more in the way of benefits than could be covered by the taxes they had paid. But over time, the situation changed dramatically for Social Security benefits, and, as the chart indicates, there will be ever more people who are paying more into the system than they receive in return. Medicare is a different issue entirely.

Since our focus here is on the immediate future of these programs, we will examine the data provided for 2011 retirees at age 65. The authors consider several income situations. The following table summarizes the relevant data.

This table tallies the ratios of benefits received to taxes paid for Social Security.

What is clear from these tables is the fact that Social Security, after its last modification, is quite close to a self-supporting program. The higher income participants are actually paying in more than they will receive in benefits. The program would be healthy today if incomes, and income distributions, had trended as expected. It is the fall in real wages for many workers that has contributed to the projected Social Security shortfall. We did not promise more than we could deliver; we chose policies that caused us to deliver less than we promised.

What, exactly, is the state of Social Security today? The Congressional Budget Office (CBO) provided projections in a 2010 report. These estimates will bobble around in time as economic conditions change, but the conclusions are inexorable. Sometime around 2017 the current income from levied payroll taxes will begin to be insufficient to cover required benefit payments to retirees. After that it will be necessary to draw down the "Reserve."

"CBO projects that beginning in 2039 the Social Security Administration will not be able to pay those scheduled benefits, however. If revenues were not increased, benefits would need to be cut by about 20 percent in 2040 to equalize outlays and revenues. Those proportionately lower payments, which would be made to all Social Security recipients once the trust funds were exhausted, are known as payable benefits."

It is not until around 2039 that the funds "owed" to retirees run out. At that point, the worst thing that can happen is that a net 20% reduction in benefits is required. If that should happen the reduction could be made progressive so that the most in need are least affected. Does that equate to bankruptcy? The CBO lists a few dozen tweaks that could be made to the system to improve its outlook. There are many options as we move forward.

Social Security is not a Ponzi scheme, and it is not going bankrupt, and it will be there for our children.

A word about the Social Security "Trust Fund" is in order. There is a nice discussion here. The funds collected in taxes do not go into a separate bank account where they sit and earn income until needed. They are required by law to be invested in government securities. What this means in practice is that they purchase nonnegotiable debt obligations that would otherwise have to be sold in the marketplace. The tax money effectively disappears into the general federal budget, but by offsetting the need to issue interest bearing securities, it can be claimed to be saving the government those interest charges, and it can be claimed that the tax revenue is "earning" that saved interest charge. That is why the authors chose to describe the funds the way they did in the very first quote. As a practical matter, around 2017 the federal budget will have to include funds to cover the program’s current revenue deficit.

Consider this table that provides a ratio of benefits to taxes for Medicare.

The situation here is quite different. By any measure of reckoning healthcare costs are too high. One could envisage reductions as high as 30-40%. That would still not be enough.

What to do? Well, place yourself in the shoes of a 65 year-old who is planning to retire and will have no employer-provided health coverage. What would it cost the 65 year-old cohort to go out on the open market and purchase insurance? The only viable option for senior citizens is based on the existence of Medicare. All employer-provided plans ride on top of Medicare. If Medicare was not there, no employer would provide healthcare to retirees. So as senior citizens, a healthy Medicare Program is a matter of life and death for most of us. Let us pay some more in taxes and be thankful for the opportunity to do so. But let us also demand that the waste, fraud, and excessive greed are expunged from the system.

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