Paulson: Social Security and Medicare

Every stakeholder in the U.S. Social Security and Medicare systems should read the Treasury Secretary’s recent comments on their status, following release of the Trustees’ annual reports to Congress. The outlook for Social Security is not pretty:

Social Security’s unfunded obligation–the difference between the present values of Social Security inflows and outflows less the existing Trust Fund–equals $4.3 trillion over the next 75 years and $13.6 trillion on a permanent basis. To make the system whole on a permanent basis, the combined payroll tax rate would have to be raised immediately by 26 percent (from 12.4 percent to about 15.6 percent), or benefits reduced immediately by 20 percent.

 And the outlook for Medicare is especially dire:

The 2008 Medicare Trustees Report shows that the Medicare program poses a far greater financial challenge than Social Security. Medicare faces the same demographic trends as Social Security, and, in addition, the system must cope with expected large increases in health care costs. Medicare’s annual costs were 3.2 percent of GDP in 2007, or nearly three-quarters of Social Security’s, but are projected to surpass Social Security expenditures in 2028 and reach nearly 11 percent of GDP in 2082, compared to 5.8 percent for Social Security.

Cash flow for the Hospital Insurance (HI) Trust Fund is projected to be negative this year and for all subsequent years. The HI Trust Fund is projected to become insolvent in 2019, the same as projected in last year’s Report.

Barring any truly creative solutions, FICA burdens (payroll taxes) will increase. And because those taxes are regressive, this will only exacerbate the anxieties (and underlying realities) of growing income disparity in the U.S. Lump in the heavier tax burden expected from a Democratic President and Congress, and the outlook becomes that much uglier, even Japan-like.

There are two silver linings to a Democratic economy that we’re currently aware of: (1) an allegation that Senator Clinton would lower corporate tax rates as President, and (2) Rep. Rahm Emmanuel’s recent calls for universal savings accounts. Unfortunately, these two items are far too little to inspire any optimism about U.S. economic policy and performance under full Democratic control.

On a side note, it’s interesting to think about how the current policy threats arose. In 2006, the electorate resoundingly handed Congress to the Democrats, 12 years after the Gingrich-led GOP takeover.  To us, it appears that the relevant factors were dissatisfaction with the state of affairs in iraq, and with corruption and rampant pork in the Republican Congress. The mandate then, at least on a national level, was to (1) address the problems in Iraq and (2) address problems of pork and corruption. However, as it usually happens in electoral politics, the mandate was taken to be whatever any particular interest group wanted it to be. Thus, we’re faced with the prospect of legislation aimed at "tax fairness", wealth and income redistribution, "fair (not free) trade", and costly environmental measures borne of a renewed Malthusian hysteria that has been dormant since the 1970s* (to be fair, some of the Malthusian hysteria may turn out to be valid, but that does not change the fact that looming costs are sure to be imposed upon the economy, whether it’s by climate disasters, risk averse legislators, or both).

*-The 1970s were a period with some important parallels to today, with the following distinctions: China is playing the role filled by Japan in the 1970s; the Bernanke Fed is playing the role of the Burns and Miller Feds, except that its focus is on housing and credit markets, whereas Burns/Miller focused on employment levels; and Congress is playing the role of, well, Congress, blissfully unaware that monetary policy is not the best suited lever to domestic economic turmoil, tossing in some rather meaningless fiscal measures, and saying little about the importance of meaningful, pro-growth tax reform. In the 1970s, it all started to turn around in 1977-1978, although the full effects did not kick in until the early 1980s, and only after a (perhaps excessive) use of draconian monetary policy to ‘break’ inflation expectations. It was a good 10+ years between the start of the crisis in 1971 and the eventual turnaround in 1983. Here’s hoping we don’t have to wait that long this time around, although it is seems possible, given where we are in the political cycle.