"As America's population ages, the burden of elderly entitlements is on a collision course with reality."

"Future workers will pay a larger share of their income just to support the elderly than today's workers pay to fund all government services."

"Under intermediate assumptions, 40 percent of workers' incomes will go to the elderly by 2045."

"Under the pessimistic assumptions, more than two-thirds of workers' incomes will go to the elderly by 2045."

 

• Executive Summary 
• The Problem 
• Future Tax Burdens 
• Assumptions behind the Forecast 
• The Illusory Trust Funds 
• Is Social Security Fair? 
• Trying to Salvage the Current System 
• Fundamental Reforms 
• Principles of U.S. Reform 
• Notes 
• About the Authors 

Social Security Administration actuaries make projections about the future of Social Security that are contained in the annual report of the trustees. These projections are labeled "intermediate," "low cost" (optimistic) and "high cost" (pessimistic). Although people are encouraged to assume that the intermediate forecast is the most likely, many students of Social Security and Medicare believe that the pessimistic projection more closely reflects our recent experience.  

Spending on Social Security currently takes about 11.5 percent of the nation's taxable payroll. If both parts of Medicare (Parts A and B) are also expressed as a percent of taxable payroll, they take about 5.5 percent. In the future both programs will require more:   

• By the year 2045, when today's 20-year-old college student will be eligible for Social Security, the fraction of employee earnings needed to pay Social Security benefits will be almost 50 percent higher than at present, according to the intermediate forecast. 
• We will need almost one-third of workers' incomes to pay Social Security plus all of Medicare. 

• Under the pessimistic forecast, by the time today's college students retire the Social Security tax burden will be almost twice its current level.

  
• Almost 53 percent of the entire taxable payroll will be required just to fund Social Security and Medicare benefits already promised the elderly under current law. 

• Under the intermediate assumptions, 40 percent of the income of workers will be needed to pay retirement benefits to today's college students. 
• Under the pessimistic assumptions, the amount will be more than two-thirds of workers' incomes! 

• Britain allows employers and workers to opt out of the second tier of the state pension system by setting up private pension plans with benefits at least as generous as those promised under the government system.

  
• Australia requires workers to contribute to privately managed retirement savings plans.

  
• Chile requires workers to save for their own retirement by making regular deposits to private pension accounts, similar to American Individual Retirement Accounts (IRAs).

  
• The Chilean system has been copied to one degree or another in Argentina, Bolivia, Colombia, Costa Rica, Hong Kong, Mexico, Peru and Uruguay, and it will soon be implemented in Ecuador and El Salvador.

  
• Singapore requires employees and employers to contribute jointly to individual investment accounts, which may be used not only for retirement income but also to pay medical expenses, make the down payment on a home or send a child to college. 

The year Ida Fuller retired, there were 42 workers for every retiree. That's why the tax rate needed back then was only 2 percent on the first $3,000 of wages. By the time Miss Fuller received the first cost-of-living increase in 1951, there were 16 workers for every retiree. And by the time she died in 1975, the ratio had fallen to 3.2 workers for every beneficiary.³ For the future, things look bleak. By the middle of the next century, the ratio is expected to fall still further, with only 1.5 to 2 workers for every beneficiary. That means each worker will be supporting two-thirds of the cost of an elderly person in addition to all other taxes and all other family responsibilities.⁴  

As America's population ages, the system of income maintenance and health care for the elderly is on a collision course with reality. Longer lifespans and lower fertility rates will lead to fewer workers paying taxes to support a growing number of the elderly. Higher health care costs will add to the burden. The key to understanding how these forces affect elderly retirement programs is to recognize that the programs are all based on pay-as-you-go financing. Taxes collected today are used to pay benefits to today's retirees. Each generation of retirees depends on the government to provide its Social Security and health care benefits by taxing the next generation. If we continue this practice, the burden we create for tomorrow's workers will be impossible for them to bear.  

This study is based on official forecasts by the Social Security Administration and the Health Care Financing Administration, which administers Medicare.  

In 1965 Medicare was established to provide health care to the elderly. There were two parts: hospital insurance (Medicare Part A), funded by an additional payroll tax, and Supplementary Medical Insurance (Medicare Part B) to cover physicians' services and outpatient care, funded by a combination of premiums paid by the elderly and funds from general revenues.⁵ This study's calculations assume that premiums will continue to cover 25 percent of Part B costs.  

Social Security and Medicare actuaries make projections about the future of the programs that are contained in the annual reports of the trustees. These projections are labeled "intermediate," "low cost" (optimistic) and "high cost" (pessimistic). Although people are encouraged to assume that the intermediate forecast is the most likely, many students of Social Security and Medicare believe that the pessimistic projection more closely reflects our recent experience. Figures I and II show how bad the future looks for the United States under the intermediate and pessimistic forecasts. These figures show the percentage of the nation's taxable payroll that will be required to pay benefits each year under the current system of government-paid elderly retirement and health care benefits.⁶  

Intermediate Forecast. Currently, spending on Social Security is about 11.5 percent of the nation's total taxable payroll. Social Security and both parts of Medicare combined take about 17 percent. But consider the year 2045. A 20-year-old college student in 1998 will reach the age of eligibility for Social Security (which will then be 67) in that year. As shown in Figure I (and Appendix Table I): 

• According to the intermediate forecast, the fraction of employee earnings we will need in 2045 to pay Social Security benefits will be almost 50 percent higher than today.

  

• We will need almost one-third of workers' incomes in order to pay Social Security plus both parts of Medicare.

Pessimistic Forecast. Nor, as shown in Figure II (and Appendix Table II), is this the worst that can happen. 

• Under the pessimistic forecast, by 2045 the Social Security tax burden will be almost twice its current level.

  
• Almost 53 percent of the entire taxable payroll will be required just to fund Social Security and Medicare benefits already promised the elderly under current law. 

Taking a Closer Look at Medicare. In recent years, health care costs have been increasing at twice the rate of real wages. Were this trend to continue, health care spending would consume the entire gross domestic product by the middle of the next century. The Trustees understand that this is impossible. To get around the problem, they have arbitrarily assumed in the intermediate forecast that health care costs will grow faster than taxable payroll until 2020, but thereafter will rise at the same rate as hourly wages. The optimistic forecast assumes an annual increase 2 percent less and the pessimistic forecast assumes an annual increase 2 percent more than hourly wages. But even the optimistic and pessimistic forecasts assume that the difference diminishes gradually until all three forecasts mirror the rate of growth of wages beginning in 2046.⁷  

As with Medicare Part A, the Trustees have arbitrarily restricted the growth rate of medical costs for Part B. The intermediate forecast for Medicare Part B projects that the increase in health care costs per enrollee will gradually decline after 2010 until it reaches the same growth rate as gross domestic product per capita in 2021, where it will remain for the next 50 years. The optimistic and pessimistic forecasts assume initial growth rates 2 percentage points lower and 2 percentage points higher, respectively, diminishing gradually until all three assumptions show health care costs growing at the same rate as GDP per capita by 2021.⁸  

Other Health Care Spending. Medicare is not the only way we pay the medical bills of the elderly. We also pay through Medicaid (for the poor), the Veterans Administration (VA) system and other programs. No matter what pocket the funds come from, however, the overall burden the elderly create for working-age taxpayers remains the same. To assess the total burden, health economists at the National Center for Policy Analysis have estimated elderly health care expenses borne through all government transfer programs.⁹ The projections when all government spending on the elderly is considered [see the final column of Appendix Tables I and II] are: 

• Under the intermediate assumptions, 40 percent of the income of workers will go to Social Security and government-provided health care for the elderly by 2045. 
• Under the pessimistic assumptions, the amount will be more than two-thirds of workers' incomes.

We have had little experience with tax rates 40 percent and more for middle-income taxpayers, but we have had a lot of experience with tax rates above that figure for the highest-income earners. In general, whenever we have increased the rate for the highest-income earners, their total tax payments have gone down. In other words, beyond a certain point, higher tax rates collect no additional revenue.¹⁰  
 

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