James C. Capretta, fellow at the American Enterprise Institutes, asks, “How can the largest items in the federal budget, Social Security and Medicare, be preserved without more borrowing? (Tightening the Terms of the Social Contract, Law and Liberty, Nov. 7, 2023)”
The original concept of tying retiree benefit payouts to the payroll taxes has been stretched. Due to the growing gap between Social Security and Medicare contributions and payouts, the federal government is on the edge of a financial crisis and must borrow to cover costs.
Americans have never viewed Social Security and Medicare as welfare. Voters still believe they pre-pay Medicare and Social Security annually in the form of payroll taxes from their first job to retirement; as such, they tend to deny that reform is necessary.
The common perception is that payroll taxes have been set aside from the rest of the federal budget and reserved for the monthly checks and healthcare payments received in retirement. Americans were told when Social Security (SS) was initiated in the 1930s that receipts and spending would be tracked and that elected leaders would not be able to appropriate payroll contributions for any other purpose.
In 1964, a nationalized system of health insurance, called Medicare (HI), was added. HI would offer retirees medical coverage but for hospital expenses only. It would be financed with an add-on to the SS payroll tax and paid into a separate Medicare Hospital Insurance (HI) trust fund. At the same time, however, two additional programs were established. One program was voluntary and designed to pay for physician services, this is generally referred to as Medicare Part B. Another program, Medicaid, funded jointly by state and federal government, was also created at this time.Any premiums paid by participants flow into a separate account called the Supplementary Medical Insurance (SMI) trust fund.
From the very beginning, Social Security (SS) and Medicare Hospital Insurance (HI) were designed to be financed through payroll taxes with any excess revenue held in trust funds. This was not the case for additional Medicare programs financed from premiums and subsidies from the federal government. The creation of Supplementary Medical Insurance (SMI) has had lasting effects on the federal budget.
Because it receives substantial and uncapped subsidies from federal tax revenue, Supplementary Medical Insurance (SMI) is altogether different from Social Security and Hospital Insurance. This has resulted in annual federal budgetary deficits that increase the national debt of the U.S.Federal allocations to Supplemental Medical Insurance in 2023 equal 1.6 percent of total GDP.
Expanding Supplementary Medical Insurance (SMI) benefits has made it politically challenging for Congress to increase premiums or limit expenses.Meanwhile, given that 30.7 percent of the population is now aged 65 and older, the separate Social Security trust fund will be exhausted by 2034.For the Medicare Hospitalization Fund, insolvency is expected in 2031.
What principles should guide Social Security and Medicare reforms? Capretta first suggests getting a handle on Supplementary Medical Insurance (SMI) in order to address a significant portion of the overall federal government deficit.His modest proposal is to prevent the general fund contribution to SMI rising from its 2023 level (1.6 percent of GDP).
Capretta then tackles the rapid depletion of the payroll-financed Social Security and Medicare Hospital Insurance trust funds. Something needs to be done relatively soon with support from the two major parties.
It is now presumed that current law prohibits spending by Social Security (SS) and Medicare (HI) when their trust funds are exhausted. To sustain the principle that Social Security and Medicare Hospital Insurance payments reflect premiums paid during a person’s working career, consider two reforms: 1) Current formulas for payment requests must be amended in order to lower costs; and 2) increased revenue must flow into these trust funds.
Another option being considered would transform the programs by raising taxes on taxpayers with incomes exceeding $400,000 from all sources; this would essentially remove the programs from payroll taxes. Alternatively, policymakers could work with the public perception that payroll taxes fully cover costs and impose no financial burden on the broader federal budget. This would retain the concept of promised retiree payments based on one’s previous earnings.
Adjustments will not be popular but procrastination will surely result in a crisis, decreased trust in the program, lower labor force participation, and unsustainable increases in the national debt. Capretta proposes that whenever Social Security and Medicare Part A trust fund deficits are anticipated, half of any adjustments needed be assigned to higher payroll taxes and the rest to benefit cuts. Congress could periodically revise these formulas and protect the lowest-income retirees from any changes.
It would be wise to consider Capretta’s suggestions.The architects of U.S. Social Security wanted all American workers to own Social Security by paying for it themselves with the confidence that what was promised will be delivered.
Maryann O. Keating, Ph.D., a resident of South Bend and an adjunct scholar of the Indiana Policy Review Foundation, is co-author of “Microeconomics for Public Managers,” Wiley/Blackwell.