April 27, 2005
Understanding the Long-Term Finances of Today's Entitlement Programs
By Bruce Bartlett

A key reason why we have a problem with entitlement programs like Social Security is that they were enacted with insufficient regard to their long-term finances. For example, the only concern Congress had about the recently enacted Medicare drug benefit was whether it would cost less than $400 billion in the first 10 years. The period afterward was almost completely ignored in congressional debate.

This myopia makes it too easy to enact new programs that cost little in the short run but are massively expensive in the long run. In the case of the drug benefit, the costs in the first two years were virtually nil and then it phases in for several more. It is only in the last years of the initial forecast period that the long-term spending trend becomes visible. At that point, the drug benefit will cost taxpayers more than $100 billion per year, according to the Congressional Budget Office.

Once a year, however, we get a look at the government's largest long-term financial liabilities when the trustees of the Social Security and Medicare systems issue their annual reports. The prose may be impenetrable, but it makes for interesting reading if one knows where to look.

Last year, the actuaries, who actually write the trustees reports, made an important methodological change. Historically, they had presented financial data for 75 years out. But some of the trustees felt that it would be more informative if perpetual costs could be summarized in present value terms. (A present value calculation takes account of the fact that $1 in the future is worth less than $1 today even with no inflation.) These figures have become the most revealing indicators of the true financial condition of our major entitlement programs.

Starting with Social Security, which President Bush repeatedly says is in precarious financial condition, we see that the present value of all future costs for that program less expected taxes in perpetuity is estimated at $13.7 trillion. The $1.7 trillion currently in the Social Security trust fund is treated as if it is a real asset, which lowers the unfunded liability to $12 trillion.

Since those who do not yet qualify for Social Security benefits will get back less than they will pay in present value terms, it lowers the long-term cost by another $900 billion, for a net unfunded liability of $11.1 trillion -- $12.8 trillion if you don't believe there are really any assets in the trust fund.

In short, we would need about one year's gross domestic product in a bond fund somewhere, backed by productive tangible assets earning a real return, in order to pay all of Social Security's promises without either raising taxes or cutting benefits.

As bad as this news is, however, it pales in comparison to Medicare's problems. According to its trustees, Part A, which pays for hospital care, has an unfunded liability of $9.4 trillion for current participants and $14.7 trillion for future participants, for a total of $24.1 trillion.

Medicare Part B, which pays for doctors' visits, will require $25.8 trillion in funds from taxpayers to pay for promised benefits over and above the modest premiums that retirees pay . And the newly enacted Medicare Part D, which pays for prescription drugs, will need $18.2 trillion from taxpayers on top of beneficiary premiums and state transfers.

Adding up all of Medicare's unfunded costs yields a total of $68.1 trillion -- six times Social Security's unfunded liability, which President Bush says is in crisis and requires immediate action to repair. Indeed, the drug benefit alone, which he rammed through Congress two years ago, has a liability $7.1 trillion greater than Social Security. This suggests that we could repeal the drug benefit, fund Social Security forever with no tax increases or benefit cuts and still cut $7.1 trillion off our national indebtedness.

To make these very large numbers somewhat more concrete, Social Security's unfunded liability comes to 1.2 percent of GDP in perpetuity (1.4 percent without the trust fund) -- about what is currently raised by the corporate income tax. The comparable number for Medicare is 7.1 percent -- about what is raised by the individual income tax. And remember that these figures are for the unfunded portion of these programs, so they are over and above payroll taxes.

The chilling conclusion is that virtually 100 percent of all federal taxes, on a present value basis, do nothing but pay for Social Security and Medicare. Unless there are plans to abolish the rest of the federal government, large tax increases are inevitable.

Avoiding such tax increases is the best reason to reform Social Security now. It's too bad that President Bush made the Medicare problem so much worse before trying to fix Social Security.

Copyright 2005 Creators Syndicate

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