November 29, 2007

November 29, 2007 | Commentary on Economy

Runaway Entitlements Threaten U.S. Economy

Over the next two decades, Social Security and Medicare will add 77 million retiring baby boomers to their benefit rolls. The projected cost of these benefits far exceeds what the economy and taxpayers could possibly deliver. Getting a handle on these runaway entitlement costs while still preserving adequate retirement benefits is the greatest economic challenge of our time.

Demographics are driving this crisis, as fewer workers are being forced to support more retirees. In 1960, there were five taxpayers funding the benefits of each retiree. Today, there are 3.3; and by 2030, there will be only two workers per retiree. At that point, each married couple will have to support themselves, their children -- and their very own retiree. (The $5 trillion Social Security trust fund won't save taxpayers a dime either. Congress already raided the trust fund, leaving the entire $5 trillion to be repaid by future taxpayers.)

In addition to demographic challenges, Medicare also faces steeply rising health costs that leave its long-term shortfall six times larger than that of Social Security. Medicaid spending hikes will be driven by the baby boomers' long-term care expenses.

Overall, the Congressional Budget Office estimates that spending on Social Security, Medicare and Medicaid will leap from 8.7 percent of GDP this year, to 19.0 percent in 2050. How much is that? In today's economy, a 10.3 percent of GDP cost increase translates to $1.4 trillion (or 11,500 per household) annually.

To pay for these costs, the nation faces several painful options:

1)  Raise taxes every year until they are $11,500 per household higher than today (adjusted for both inflation and rising incomes);

2)  Eliminate every remaining non-defense program (including education, anti-poverty, veterans, and homeland security spending) over the next 20 years -- and eliminate defense over 40 years; or

3)  Borrow trillions of dollars, triggering a vicious circle of escalating federal debt and interest rates that would eventually risk an economic collapse.

There is a fourth option: Modernize Social Security and Medicare. Social Security reforms may include better aligning benefits with inflation (rather than wage growth), adjusting the retirement age, and introducing personal accounts to provide higher returns than the current system. Medicare reforms allowing more consumer choice and competition may help reduce costs.

The most obvious reform is to pare back the unaffordable Medicare drug entitlement, whose 75-year shortfall of $8.1 trillion is more than double the entire Social Security shortfall. Rather than creating a universal entitlement that includes Bill Gates, lawmakers could inexpensively target low-income seniors for a small fraction of the cost.

It's easy to duck the hard choices and assume this problem will solve itself. It will not. Western Europe is already suffering under the weight of its enormous social insurance systems with stifling tax rates, economic stagnation and persistent unemployment. Each year that America delays fundamental Social Security and Medicare reform, the more expensive and painful the inevitable reforms become

Brian Riedl is the Grover M. Hermann Fellow in Federal Budgetary Affairs at The Heritage Foundation.

About the Author

Brian M. Riedl Grover Hermann Fellow in Federal Budgetary Affairs
Thomas A. Roe Institute for Economic Policy Studies

First appeared in the Lansing State Journal