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May 27, 2009

Trustees Reports Highlight Pressing Need to Reform Entitlement Programs

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The fact that Social Security, Medicare, and Medicaid are on an unsustainable course is one of Washington's best un-kept secrets, and it was reconfirmed by the latest annual reports from the Social Security and Medicare Trustees.

Both programs have promised benefits to future retirees without the financial means to pay for them. The level of borrowing or taxing that would be required to pay for these promises will devastate the economy over the long term, and the young and future generations will inherit the burdens of paying for these programs. Such profligacy is poor stewardship at its worst. Reforming entitlements is not simply a financial issue; it is also a moral issue, which is why Congress must take action urgently.

Need for Reform

Both the Social Security and Medicare trust funds have severely deteriorated since last year. Table 1 highlights some of the major year-to-year changes, but the most significant issue for each program is that the deficits in the Medicare trust fund have risen significantly and the year in which Social Security's expenditures will exceed income has moved up one year, to 2017.

In an era when the U.S. is running a budget deficit of $1.8 trillion with trillion-dollar deficits likely to continue in the future, additional deficits in the first- and third-largest government programs (Social Security and Medicare, respectively) pose a serious threat to the economy, particularly in the long term.

Over the next 75 years, the present value of the total shortfall in Social Security and Medicare exceeds $45 trillion. Absent reform, that shortfall would have to be filled by borrowing or tax increases. Borrowing of this magnitude would put unsustainable pressure on interest rates and consume resources otherwise available for private investment.[1]

Alternatively, federal income tax rates that would be required to close the gap would cause marginal rates to more than double.[2] And it is young Americans, not the retirees collecting the benefits, who will be forced to pay for these programs through interest on the debt or higher taxes.

Every year action is delayed, the price for resolving this problem increases by $1-2 trillion.[3] There are two main drivers behind this increase. First, both programs suffer from demographic pressures: The benefits promised to 77 million baby boomers, some of whom are already eligible for early retirement under Social Security, must be paid for by a comparatively smaller working population. Second, rising health care costs will cause Medicare costs to explode once boomers become eligible at age 65.

Hope for Reform

Encouragingly, a significant percentage of the public already recognizes that these programs must be reformed. Recent polling by Hart Research Associates revealed that 66 percent of Americans consider the growing budget deficit and national debt to be a very serious threat to the country, and 45 percent of Americans believe that addressing budget problems requires "major structural changes to entitlement programs" compared to other options.[4]

Some Members of Congress understand the problem as well. Representatives Frank Wolf (R-VA) and Jim Cooper (D-TN) and Senators George Voinovich (R-OH) and Joseph Lieberman (ID-CT) have introduced companion pieces of legislation, the Securing America's Future Economy (SAFE) Act, calling for a congressional commission to examine tax and entitlement issues.

Congressman Steny Hoyer (D-MD) also made aggressive calls for Social Security and other health reforms in remarks to the Bipartisan Policy Center,[5] and Congressman Paul Ryan (R-WI) introduced entitlement reform legislation, the Roadmap for America's Future, in the 110th Congress that would have eliminated long-term deficits while keeping taxes low.[6]

President Obama, too, appears to be aware that long-term spending has to be addressed. During a recent town hall meeting in New Mexico, he admitted "we are mortgaging our children's future with more and more debt" and that excessive debt "will have a dampening effect on our economy."[7] Unfortunately, his budget proposal, which includes massively expensive new health care and cap-and-trade programs but ignores entitlement reform, did not match his rhetoric.[8]

It is impossible to control long-term deficits without modernizing Social Security and Medicare. These two programs will consume nearly one-third of the budget this year and will double in size over the next 50 years.

To put these programs on a sustainable course and control long-term deficits, there are several key steps the President and Congress should take.

Recommendations for Reform

Recommendation #1: Create Budgets for Entitlements and Show Long-Term Obligations in Congress' Annual Budget. Entitlements are classified as mandatory spending programs, which gives them first call on federal resources and allows them to grow on auto-pilot without annual review. Moreover, unlike most other federal programs, Social Security and Medicare are not subjected to regular reauthorization or review. This special treatment absolves Congress from having to trade-off entitlement spending against other priorities as part of the traditional budget process and, consequently, fails to contain costs.

Instead, entitlements should be treated more like discretionary programs. The programs should be taken off auto-pilot and put on 30-year budgets, and those budgets should be reviewed and debated by Congress every five years to ensure targets are met.

Additionally, the full $45 trillion shortfall in entitlement programs should be reported in Congress' annual budget to hold Congress accountable for these expenses.[9] Including these figures would ensure that major policy changes are affordable over the long term.

For instance, when Medicare Part D was added in 2004, Congress only evaluated the five-year program cost of $409 billion, but the long-term, present-value cost of that program was more than $8 trillion at the time and exceeds $9 trillion today.[10] Ignoring the true costs of the program is not only negligent; it also does a severe disservice to future generations who are stuck with the bill.

Recommendation #2: Make Retirement Programs Fair but Affordable. Because all workers contribute payroll taxes to fund Social Security and Medicare, everyone over the age of 65 is eligible to collect benefits, and many retirees will spend up to one-third of their lives in retirement.[11]

This means that a large portion of promised benefits will subsidize upper- and middle-class retirees while saddling young Americans with unsustainable levels of debt. Instead, entitlement programs ought to be targeted toward the neediest retirees. The retirement age should be increased and indexed to longevity, and benefits ought to be adjusted for income levels. Premiums for Medicare Part B (outpatient care) are already income-related, and applying the same phase-out of subsidies for Part A (hospital insurance) and Part D (prescription drug coverage) would erase roughly half of the program's shortfall.[12]

Recommendation #3: Strengthen Personal Responsibility. Automatic entitlement to government-run Social Security and Medicare benefits has de-emphasized the role of personal responsibility in retirement savings. Greater effort must be made to encourage more personal savings for income and health care needs. For instance, automatic enrollment in individual retirement accounts for individuals without employer-sponsored retirement plans could increase savings participation by as much as 95 percent.[13]

The Way Forward

This is not the first year that the Trustees have issued gloomy forecasts for Social Security and Medicare, but it is one of the worst in recent years. Given that the public and Members of Congress are warming up to the need for entitlement reform, it is important to act while there is still time, because delay will only add to the trillions of dollars in debt young Americans already shoulder for these programs.

Reforming the budget process, modernizing the programs' structures, and rethinking an individual's role in his own retirement savings are all important steps Congress should take to improve the financial status of Social Security, Medicare, and the America future generations will inherit.

Nicola Moore is Assistant Director of the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

Show references in this report

[1]J. D. Foster, "The Global Government Debt Bubble Threatens the Economy," Heritage Foundation WebMemo No. 2257, January 30, 2009, at http://www.heritage.org/research/Economy/wm2257.cfm.

[2]Stuart M. Butler, "CBO's Warning on Raising Taxes to Pay for Medicare, Medicaid, and Social Security," Heritage Foundation WebMemo No. 2153, June 27, 2008, at http://www.heritage.org/research/budget/bg2153.cfm.

[3]This year, the economic crisis exacerbated the weak financial position of these programs, because payroll tax revenues that fund these programs have dropped significantly due to unemployment and declining wages. But even if the economic crisis had never occurred, these programs would still be in poor financial shape.

[4]Hart Research Associates, "Voters' Attitudes about America's Growing Budget Deficit and National Debt," at http://www.pgpf.org/resources
/Peterson_030409_Survey_Summary.pdf
(May 13, 2009).

[5]Representative Steny Hoyer, "Unprecedented Federal Debt: Putting Our Fiscal House in Order," address to Bipartisan Policy Center, April 17, 2009, at http://www.bipartisanpolicy.org/ht/display/ReleaseDetails/i/10243/pid/1175 (May 27, 2009).

[6]J. D. Foster, "Courageous Reforms in Ryan's Entitlements Road Map: Where Is the Democratic Response?" Heritage Foundation WebMemo No. 1958, June 19, 2008, at http://www.heritage.org/Research/SocialSecurity
/wm1958.cfm
.

[7]Roger Runningen and Hans Nichols, "Obama Says U.S. Long-Term Debt Load 'Unsustainable,'" Bloomberg News, May 14, 2009, at http://bloomberg.com/apps/news?pid=20603037&sid=abXWfVxx_e8w&refer
=home
(May 22, 2009)

[8]Brian M. Riedl, "The Obama Budget: Spending, Taxes, and Doubling the National Debt," Heritage Foundation Backgrounder No. 2249, March 16, 2009, at http://www.heritage.org/research/budget/bg2249.cfm.

[9]Stuart M. Butler et al., "Taking Back Our Fiscal Future," Heritage Foundation and Brookings Institution White Paper, at
http://www.heritage.org/Research/Budget/wp0408.cfm.

[10]Douglas Holtz-Eakin, "Estimating the Cost of the Medicare Modernization> Act," testimony before the Committee on Ways and Means, U.S. House of Representatives, March 24, 2004, at http://www.cbo.gov/ftpdocs/
52xx/doc5252/03-24-Medicare.pdf
(May 22, 2009).

[11]Social Security beneficiaries are eligible to collect benefits early at age 62, but their monthly benefits are lowered. The retirement age is gradually moving up to 67, and the new early retirement age will be 65.

[12]J. D. Foster, "A First Big Step Toward Medicare Sustainability," Heritage Foundation Backgrounder No. 2253, March 24, 2009, at http://www.heritage.org/research/healthcare/bg2253.cfm.

[13]Retirement Security Project, "Automatic IRAs: Extending Retirement Saving Opportunities to 75 Million More American Workers," February 2007, at /static/reportimages/77197D4A72D351BAA57A89C3F886BEF7.pdf (May 22, 2009)

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