The 2004 Medicare and Social Security Trustees Reports

Studies | Health | Social Security

No. 266
Friday, June 04, 2004
by Andrew J. Rettenmaier & Thomas R. Saving, Ph.D.


Executive Summary

The 2004 Medicare and Social Security Trustees Reports show that programs for the elderly are on an unsustainable course. The expenditures exceed the revenues to be collected, and the funding gap is projected to grow through time.

One way to assess the problem is to calculate the present value of the difference between expenses and revenues. This year, for the first time, the Trustees reported such calculations for all the elderly entitlement programs and the numbers are startling:

  • Over the next 75 years, scheduled benefits exceed dedicated revenues by $33 trillion, measured in current dollars.
  • Looking indefinitely into the future, the present value of the additional revenues required by Social Security and Medicare total almost $74 trillion.

To put that number in perspective, obligations to the elderly are more than six times the size of the economy and 18 times the size of the outstanding federal debt.

For many years, the Trustees Reports adopted a 75 year time horizon. But it is now understood that looking only 75 years into the future gives a misleading picture. Consider a worker who will retire in year 76. A 75 year horizon counts all of the taxes this worker will pay over the course of a lifetime, but ignores the benefits. To avoid this problem, the Trustees Reports are now including calculations that look indefinitely into the future.

What does it mean to have a $74 trillion revenue shortfall? It means that in order to pay benefits to current and future generations without using general revenues or cutting benefits, we need $74 trillion on hand right now, invested at the government's borrowing rate. Because we don't have $74 trillion invested today, next year the liability will be even larger. The year after that it will be larger still.

What is the composition of this implied debt? It may surprise many to learn that:

  • Although policy makers have focused on the long-run sustainability of Social Security, the financial problem in Medicare is five times as great ($62 trillion versus $12 trillion).
  • And while lawmakers have not reformed Social Security (which requires $12 trillion), they have more than doubled the size of that problem by creating a prescription drug benefit (which will require additional revenues of almost $17 trillion).

Some have asserted that an immediate solution to the problem is not needed, because the Trust Funds are flush with surpluses that can pay benefits well into the future. Yet these Trust Funds are not assets that can be used to pay benefits like the assets in a conventional pension fund. They are more like IOUs the government has written to itself. Every asset of the Trust Funds is a liability of the Treasury. Summing over both parts of government, the assets and liabilities net out to zero. In order to pay benefits in future years, the government will have to tax, borrow or cut spending on other programs.

To see the impact these programs will have on the government's finances and how quickly it will arise, we have calculated the percent of federal income taxes that will be needed to pay the deficits in Social Security and Medicare:

  • This year, for the first time in many years, the federal government will have to draw on general revenues to cover the excess of spending over revenues in the combined elderly entitlement programs.
  • Specifically, the funding deficit this year is equal to about 3.6 percent of federal income taxes.
  • In less than five years, the share of income taxes needed will double, and five years beyond that it will double again.
  • By 2019 (when the Medicare Trust Fund technically will be exhausted) the federal government will need more than one-in-four federal income tax dollars to pay benefits to the elderly, in addition to dedicated revenues.

With the retirement of the baby boomers, the financial problems begin to soar. But even after the baby boomers have exited the programs, the financial burden will continue to climb:

  • By 2030 (about the mid-point of the baby boomer retirement years) we will need more than half of all federal income tax revenues to pay for the deficits of Social Security and Medicare.
  • By 2040, we will need two-thirds of federal income taxes; by 2050, three-fourths.
  • And, by 2070, the elderly will need all federal income taxes (in addition to all payroll taxes and premium payments), leaving nothing to pay for any other federal programs.

What can be done to avert this calamity? We have made reform proposals elsewhere. Clearly, we cannot sustain a pay-as-you-go system, under which promises made to today's workers must be paid by generations not yet born. Instead, we must move quickly to a funded system, under which each generation pays its own way.


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