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October 11, 2005
By Tracy Foertsch, Ph.D. and Joseph R. Antos
Social Security is
in crisis. Paying Social Security's promised benefits over the next
75 years will require $5.7 trillion more than the existing payroll
tax provides, and raising taxes by that amount would reduce
employment, slow economic growth, and devastate working
however, is not the gravest fiscal crisis that America faces. The
2005 Medicare trustees' report estimates that providing promised
Medicare benefits over just the next 10 years could require over
$2.7 trillion in new tax revenues. Raising taxes by that amount
would eliminate almost 816,000 jobs per year, on average, and shave
an average of nearly $87 billion from the real (inflation-adjusted)
gross domestic product (GDP) between 2006 and 2015. Even worse, the
Medicare trustees project that providing promised Medicare benefits
over the next 75 years would require $29.9 trillion in new tax
revenues. Raising taxes to meet Medicare's 75-year shortfall would
cost an average of 2.3 million jobs and well over $190 billion in
real GDP annually through 2015.
lawmakers have confronted new federal spending with tax increases.
The economic costs of addressing Medicare in this way are, to say
the least, prohibitive.
As with Social
Security, Medicare's unfunded liabilities are its promises to
current and future retirees. For budgetary purposes, Medicare has
two components, Hospital Insurance (HI) and Supplementary Medical
HI is the part of
Medicare that helps to pay for in-patient and nursing home care for
the elderly and disabled. It is financed in large part with a 2.9
percent payroll tax. In the black for most of its 40 years, HI's
benefit payments began to outstrip its income in 2004, according to
the Medicare trustees, and those deficits will continue to grow in
size every year for the foreseeable future. HI does have a trust
fund, but it contains only IOUs that will have to be covered by
taxpayers, just like Social Security's trust fund. Over the next 75
years, the HI trust fund will face a shortfall of $8.8 trillion,
according to the trustees.
SMI consists of
Medicare Part B, which covers physician, outpatient, and other
medical services, and Medicare Part D, which is the new drug
benefit. Those enrolled in Part B and, beginning in 2006, Part D,
pay premiums covering 25 percent of Part B and Part D benefits; the
remaining 75 percent of benefits are made up with general revenue
transfers. Over the next 75 years, general revenue transfers for
Part B and Part D are projected to total $12.4 trillion and $8.7
Add it all up, and
Medicare's unfunded liabilities amount to $29.9 trillion over the
next 75 years-more than five times as much as Social Security's
The Tax Side
unfunded liabilities for Parts A, B, and D could be financed with
higher taxes. Using the Global Insight U.S. Macroeconomic Model, we
estimated the economic and budgetary effects of raising payroll and
personal income taxes to cover Medicare's shortfalls over the next
10 years and the next 75 years.
forecast is bleak. Raising payroll and personal income taxes to
cover Medicare's unfunded liabilities through just 2015 would, on
average, reduce GDP by $105.5 billion per year and private-sector
employment by over 921,000 jobs per year between 2006 and 2010. By
2015, real GDP would be more than $116 billion lower than without
the tax increases.
taxes to cover Medicare's shortfalls through 2079 would cause even
more economic damage. Between 2006 and 2010, higher taxes would
reduce GDP by over $204 billion per year and cost more than 1.7
million private-sector jobs annually, boosting the unemployment
rate by almost a percentage point. By 2015, real GDP would be
nearly $208 billion lower than without the tax increases.
The above two
scenarios assume that Congress uses new tax revenues to reduce
deficits and pay down debt. The subsequent decline government
borrowing would increase national saving and help reduce the tax
burden on future workers by expanding the wealth available to
We also consider a
third scenario. Imagine instead that Congress raises taxes to cover
Medicare's shortfalls through 2079 but then uses the new revenues
to finance additional spending.
Such a scenario is
not so unlikely. The same rationale led to the creation of the
Social Security and HI trust funds, both of which are now empty but
for special public-debt obligations that the government issued to
replace the "surplus" money that it spent. If Congress were to
pursue this course for Medicare, real GDP would be over $283
billion lower and almost 3.3 million jobs would have been lost by
Kotlikoff estimates that U.S. payroll and income taxes would need
to rise to almost 40 percent of wages to cover future retiree's
promised health and pension benefits.
This would put the United States in the economic territory now
occupied by continental Europe, whose countries have had far higher
taxes on labor income for decades. Europe also provides a
cautionary tale: its countries have experienced declines in
employment rates, average hours worked, and GDP growth since the
1970s-outcomes that many economists, such as Nobel laureate Edward
Prescott, attribute to higher taxes.
Kotlikoff estimates that the result of raising taxes to fund
promised old-age benefits would be a 25 percent drop in the U.S.
standard of living by 2030.
How Congress meets
the long-term challenge of Medicare will have profound effects on
the federal budget and the national economy. Simply raising taxes
to pay for future Medicare benefits is strategy that comes with
enormous costs, in terms of forgone economic growth and jobs.
Choosing to raise taxes would be very damaging.
Tracy L. Foertsch,
Ph.D., is a Senior Policy Analyst in the Center for Data
Analysis at The Heritage Foundation, and Joseph R. Antos, Ph.D., is
the Wilson H. Taylor Scholar in Health Care and Retirement Policy
at the American Enterprise Institute.
For complete methodology and results, see Tracy L. Foertsch, Ph.D.,
and Joseph R. Antos, Ph.D., "The Economic and Fiscal Effects of
Financing Medicare's Unfunded Liabilities," Heritage Foundation
CDA Report No. 05-06, October 11, 2005. The Global Insight
model is frequently used by private-sector and government
economists to estimate how changes in government spending and tax
policy are likely to impact the general economy. The methodologies,
assumptions, conclusions, and opinions in this memo are entirely
the work of Heritage Foundation analysts. They have not been
endorsed by, and do not necessarily reflect the views of, the
owners of the Global Insight model.
See Laurence Kotlikoff, Hans Fehr, and Sabine Jokisch, "Aging, the
World Economy, and the Coming Generational Storm," National Center
for Policy Analysis Policy Report No. 273, February 2005, at
See Edward Prescott, 'Why do Americans Work So Much More Than
Europeans?," National Bureau of Economic Research Working
Paper No. 10316, February 2004.
The economic costs of funding Medicare with higher taxes are, tosay the least, prohibitive.
Tracy Foertsch, Ph.D.
Senior Policy Analyst
Read More >>
Joseph R. Antos
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