Entitlement Deficits Have Arrived

An interesting survey taken a few years ago found that young people in their twenties think it’s more likely that they will see UFOs in their lifetime than that they will ever collect a Social Security check.  The survey results may not be that far-fetched.

Why?  Because the federal government has overpromised future entitlement benefits without having a way to pay for them.  Social Security and Medicare are the two most problematic unfunded liabilities.  According to the 2009 Medicare Trustees Report, the present value of Medicare’s unfunded obligation is $36.4 trillion.  The present value of all future Social Security deficits totals $17.5 trillion.

The Medicare trust fund is expected to run out of money in 2017 and the program will then face annual deficits.  Social Security was also expected to have a cash shortfall beginning in 2017.  However, the Congressional Budget Office (CBO) issued a report this past week announcing that benefits now exceed incoming funds.  For the current year, the program will pay out $29 billion more than the amount collected in payroll taxes.

The program shortfalls have arrived earlier than anticipated, partly due to the current recession.  The poor economy has persuaded more people to retire early and start withdrawing funds from the entitlement program.  To compound problems, high unemployment has translated into less tax revenue available to support those on the receiving end.

By law, Social Security cannot pay out more in benefits than it receives in funding during any given year.  A current $2.5 trillion trust fund will offset this year’s $29 billion shortfall.  But once the trust fund is depleted, which will happen as larger deficits are expected to pour in over the next decade, benefits will have to be cut.  Or, more likely, the program will have to be bailed out.

Undoubtedly, the surprise report from the CBO has restarted talks on Social Security reform.  President Obama’s bipartisan debt commission will soon discuss possible fixes to the entitlement structure.  Reps. Paul Ryan (R-WI) and Steny Hoyer (D-MD), for example, both support raising the retirement age and making benefit levels progressive.

But talk is cheap and there is a reason why entitlement programs are out of control.  Once benefits are provided, they are politically impossible to scale back.  In fact, it’s even difficult to keep benefit levels flat.

Last year, President Obama caved in to pressure on the annual cost-of-living adjustment (COLA) for Social Security benefits.  Consumer prices fell in 2009 which meant that there should have been no annual increase in Social Security benefits in 2010.  But to avoid angering 57 million Social Security beneficiaries, President Obama called on Congress to authorize $250 ‘relief payments’ to seniors.

If Washington is unwilling to cut entitlement benefits, then the only remaining option is to raise taxes.  In 2008, the CBO estimated that if Social Security, Medicare, and Medicaid remain unchanged, by 2082 “the tax rate for the lowest tax bracket would increase from 10 percent to 25 percent; the tax rate on incomes in the current 25 percent bracket would have to be increased to 63 percent; and the tax rate of the highest bracket would have to be raised from 35 percent to 88 percent.  The top corporate income tax rate would also increase from 35 percent to 88 percent.  Such tax rates would significantly reduce economic activity and would create serious problems with tax avoidance and tax evasion.  Revenues will fall significantly short of the amount needed to finance the growth of spending; therefore, tax rates at such levels would probably not be economically feasible.”

It’s rather ominous that entitlement deficits have begun within a few days of Congress approving another massive entitlement expansion.  It will be a triumph of hope over experience if the new healthcare legislation will be deficit neutral or costs less than $1 trillion over the next decade, as supporters have promised.  Consider what happened to Medicare.  The original cost of Medicare in 1966 was $3 billion.  At that time, the House Ways and Means Committee projected that the program would cost, allowing for inflation, only $12 billion by 1990.  Actual costs for the program in 1990 were $107 billion.  (Medicare cost $462 billion in 2008).

The CBO’s report on the Social Security program’s deficit is the tip of the iceberg.  Larger, more serious entitlement deficits are just a few years away and failure to make spending cuts will eventually cause significant economic damage.  Unfortunately, UFO sightings are probably more likely than cuts in entitlement spending.

Neil Rosekrans