95-543 EPW
Updated May 7, 1998
CRS Report for Congress
Received through the CRS Web
The Financial Outlook for Social Security
and Medicare
David Koitz and Geoffrey Kollmann
Specialists in Social Legislation
Education and Public Welfare Division
Summary
The 1998 annual reports of the board of trustees of the Social Security and
Medicare trust funds were released on April 28, 1998. Both programs are shown to have
long-range financing problems. Insolvency for the Disability Insurance (DI) part of
Social Security is projected to occur in 2019, and for the retirement and survivors part,
in 2034. On a combined basis, the two parts of Social Security would become insolvent
in 2032, three year later than projected in last year’s trustees’ report. Insolvency of the
Hospital Insurance (HI) part of Medicare is projected to occur in 2008, 7 years later than
projected last year. Both the Social Security and Medicare programs have benefitted
from an improved economic outlook in the near term. However, more pronounced for
Medicare is a reduction in the long-range HI deficit attributed to constraints in
reimbursement of Medicare providers as well as other changes enacted last summer as
part of the Balanced Budget Act of 1997 (P.L. 105-33). The trustees project that these
recent changes will cut the average (75-year) HI deficit in half.
The combined expenditures of Social Security and Medicare are now higher than
the taxes and premiums collected to support them, and even with this recent
improvement in the two programs’ condition, their expenditures are projected to remain
higher than their receipts indefinitely. While their income is projected to hover around
7% of the gross domestic product (GDP) well into the future, their cost would rise from
7% today to 12% in 2025.
Overview of the Outlook for Both Programs
Social Security’s financial condition is assessed annually by its 6-member board of
trustees, comprised of the Commissioner of Social Security, three members of the
President’s Cabinet, and two representatives of the public. For a number of years, the
board’s reports have projected long-range financing problems for the cash benefit system.
Although the trustee’s 1998 report continues to show a near-term buildup of trust fund
reserves, their “best estimate” for the next 75 years shows that on average Social
Security’s expenditures will be 16% more than its income. The buildup would peak at
Congressional Research Service ˜ The Library of Congress
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$3.8 trillion in 2020, and then be drawn
Projected Points of Insolvency
down as the post-World War II baby
boomers retire. The trustees estimate that
Social Security—
the disability fund would be exhausted in
Disability . . . . . . . . . . . . . . . . . .
2019
2019 and the retirement fund in 2034. On
Retirement & survivors . . . . . . .
2034
a combined basis the two trust funds would
Disability & retirement combined
2032
be exhausted in 2032.
Medicare—
Hospital insurance . . . . . . . . . . .
2008
Although these estimates imply that
Social Security can be kept solvent for 34
years, the trustees project that the program’s taxes would begin lagging its expenditures
in 2013. At that point, the program would begin relying in part on general revenues in the
form of interest payments to the trust funds. By 2021, interest payments would no longer
be sufficient to supplement the revenues, and the balances of the trust funds would begin
to be drawn down. These reserves consists exclusively of treasury bonds. By 2025, $1
out of every $5 of the program’s outgo would be dependent upon these claims against the
general fund. Expressed as an equivalent portion of today’s annual expenditures, these
claims would amount to $85 billion. The government has never defaulted on the bonds
it records to its trust funds, but the magnitude of these future claims has prompted many
observers to ask where the government will get the money to cover them.
The trustees present a more troublesome picture for Medicare. The HI part of the
program is projected to become insolvent in 2008, and on average over the next 75-years,
its costs would be about 65% higher than its income. While Supplementary Medical
Insurance (SMI), the part of Medicare that pays for physician care, is smaller and does not
have HI’s financing problems (it relies heavily on annual general revenue payments, not
a fixed tax rate), inflation and the rising demand for medical care as society ages are
causing its costs to rise rapidly. By 2015 SMI’s costs as a percent of GDP will more than
double and at that point SMI will be larger than HI.
Background
Social Security is the Nation’s largest retirement and disability program. It provides
cash benefits to 44 million retired and disabled workers and to their dependents and
survivors. Medicare provides 38 million of them with health insurance. Social Security
accounted for an estimated 42% of the income of the elderly (in 1994), and Medicare
provided more than 95% of the elderly with basic health insurance coverage. Today, one
out of six Americans receives Social Security and one out of seven receives Medicare.
The 151.9 million workers whose taxes will support the two programs in 1998 represent
one out of two persons in the population (148.5 million will pay both Social Security and
Medicare taxes; 3.4 million will pay the Medicare, or HI, part only).
Workers gain eligibility for Social Security and HI by working in jobs where Social
Security and HI taxes are levied. They pay a flat-rate tax of 7.65% on their earnings
(6.2% for Social Security and 1.45% for HI), which is matched by their employers. The
self-employed pay a tax of 15.3% (with adjustments that effectively reduce the rate). The
Social Security portion is levied on earnings up to $68,400 in 1998; the HI portion is
levied on all earnings. About 78% of these taxes go toward Social Security; the rest goes
toward HI. In 1997, payroll taxes comprise 89% of Social Security’s income and 88% of
HI’s. The rest comes mostly from government credits, the largest of which is for interest
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on federal securities held by their trust funds. There is no SMI tax; 76% of its estimated
1997 income came from general revenues of the government and 24% from premiums
paid by enrollees ($43.80 per month in 1998).
The taxes and premiums people pay flow into the federal treasury, with each
program’s share credited to separate trust funds (one for retirement and survivors benefits,
another for disability, and two others for Medicare).. When the government receives the
money, it records new interest-bearing federal securities to the appropriate fund (these
securities earn interest at the same as the average rate prevailing on outstanding federal
bonds with a maturity of 4 years or longer); when it makes payments, it writes some off.
These securities represent obligations that the government has issued to itself. In effect,
they are not assets for the government, but claims against it. Their primary role is to be
reserve “spending authority.” What this means is that as long as a trust fund has a
positive balance, the Treasury Department is authorized to make payments for it from the
treasury; the fund itself does not contain the resources to do so.
The Social Security Picture
For more than three decades after Social Security taxes were first levied (in 1937),
the system’s income routinely exceeded its outgo, and its trust funds grew. However, the
situation changed in the early 1970s. Enactment of major benefit increases in the 1968-
1972 period was followed by higher inflation and leaner economic growth than had been
expected. Prices rose faster than wages, the post-World War II baby boom ended
precipitously (leading to a large cut in projected birth rates), and Congress adopted faulty
benefit rules in 1972 that overcompensated new Social Security retirees for inflation.
These factors combined to sour the outlook for Social Security and it remained poor
through the mid-1980s. Before 1971, the balances of the trust funds had never fallen
below 1 year’s worth of outgo. Beginning in 1973, the program’s income lagged its outgo
and its trust funds declined rapidly. Congress had to step in five times to keep them from
being exhausted. Although major changes enacted in 1977 greatly reduced the program’s
long-run deficit, they did not eliminate it, and the short-run changes made by the
legislation were not large enough to enable the program to withstand back-to-back
recessions in 1980 and 1982. A disability bill in 1980 and temporary fixes in 1980 and
1981 were followed by another major reform package in 1983.
These 1983 changes, along with better economic conditions, helped to alter the
picture. Income began to exceed outgo in 1983 and the trust funds grew substantially.
Cumulatively, the changes were projected to yield $96 billion in surplus income by 1990,
and to raise the trust funds’ balances to $123 billion. The funds actually were credited
with $200 billion in surplus income by 1990, and their balances reached $225 billion by
the end of that year. Under the trustees’ 1998 “intermediate” forecast (the one cited as
their “best estimate”), surplus income of $753 billion is projected for the 1991-2000
period, and the trust funds’ balances would rise to $978 billion by the beginning of 2001.
This would be equivalent to 226% of annual expenditures (or 2 1/4 years’ worth).
Generally, the long-range picture for Social Security (viewing the retirement and
disability parts of the program as if they were one) has been worsening gradually since
1983. (This year’s report shows some minor improvement over the 1997 report largely
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because of improvement in near-term economic conditions.) By raising Social Security’s
age for full benefits from 65 to 67, subjecting benefits to income taxes, and making
federal and nonprofit workers join the system, Congress had attempted in 1983 to
eliminate the long-run problem. In fact, projections made then showed that it had, at least
on average, for the following 75 years. However, the average condition of the two trust
funds did not represent their condition over the entire period. The funds were not shown
to be insolvent at any point, but their expenditures were expected to exceed their income
in 2025 and to remain higher thereafter. Simply stated, 40 years of surpluses were to be
followed by an indefinite period of deficits. With each passing year since 1983, the
trustees’ 75-year averaging period has picked up 1 deficit year at the back end and
dropped a surplus year from the front end. This, by itself, would cause the average
condition to worsen. However, in subsequent reports assumptions about birth rates,
economic growth, and wages have been lowered, causing further deterioration in the
outlook. A small long-range deficit appeared in the 1984 report and the gap has grown
larger (with the point of insolvency generally coming closer) in subsequent reports. The
1998 report showed an average 75-year deficit equal to 16% of the program’s income and
projects that the trust funds on a combined basis would become insolvent in 2032 (it was
2029 in the 1997 report). As a percent of the Nation’s payrolls, their income would
average 13.45%, their outgo, 15.64%, and the deficit would be 2.19% (2.23% in the 1997
report.)
These long-range projections assume that GDP (adjusted for inflation) will rise
annually at rates ranging from 2.5% in 1998 to 1.3% in 2050, wages would rise at an
ultimate rate of 4.4% per year, the cost of living would go up at a 3.5% rate,
unemployment would average 6%, and that Social Security benefits would fall in relative
terms as the age at which full benefits are payable rises from 65 to 67 over the 2000-2022
period. The higher age for full benefits will mean that people retiring at age 67 or
younger will get less than under the previous rules. These assumptions by themselves
would seem to bode well for the system; however, looming demographic shifts are
projected to overwhelm them. During the next two decades, the baby boomers will be in
their prime productive years, and the baby-trough generation of the 1930s will be in
retirement. Together these factors will lead to a stable ratio of workers to recipients.
However, as the baby boomers begin retiring around 2010, this ratio will erode quickly.
By 2025, most of the surviving baby boomers will be 65 and older. The number of people
65 and older will have risen by 75%, growing from 35 million today to 61 million then.
The number of workers will have grown from 148 million to 166 million, or by only 12%.
Consequently, the ratio of workers to recipients will have fallen from 3.4 to 1 today to 2.2
to 1 in 2025 and 2 to 1 in 2030.
Under this forecast, the trust funds (on a combined basis) would be credited with
surplus income until 2020, bringing their balances to a level of $3.8 trillion. They would
decline thereafter and would be depleted by 2032. However, tax receipts begin lagging
outgo much sooner, in 2013. At that point, the program would have to rely on the interest
credited to its trust funds for part of its income, which would have to be funded from
general revenue. In 2021, the reserve balance of the trust funds would begin to be drawn
down. By 2025, $1 out of every $5 of the program’s outgo would be dependent upon
general fund expenditures for interest payments and the redemption of the government
bonds in the trust funds. The government has never defaulted on the securities it posts
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to its trust funds, but the magnitude of these potential claims has prompted many
observers to ask where the government will find the money to cover them. Basically, the
government will have three options: raise other taxes, curtail other spending, or borrow
money from the financial markets. There is nothing in the law that will dictate or
determine what it actually will (or can) do then.
Economists argue that if the surplus taxes projected for the next 15 years were to
cause the government to borrow less from financial markets, more money would be
available for investment, which could lead to greater economic growth. If this happened,
extracting resources from the economy in the future to honor Social Security claims
would not necessarily be so burdensome. Said another way, if one accepts the premise
that reductions in federal borrowing today will increase the amount of resources available
for investment, then surplus Social Security taxes today could help build a higher
economic base in the future from which to draw the needed resources.
However, rolling surplus Social Security taxes into treasury bonds will not by itself
reduce government borrowing from the markets. Reductions in borrowing occur when
the government reduces its overall deficit, not when one of its programs generates surplus
taxes. But even if economic growth were enhanced in the coming decades by less
government borrowing, Social Security’s problems would not necessarily be resolved.
Its costs would grow as the economy grows (since economic growth would likely result
in higher wages, which in turn would lead to larger benefit claims). Further, as their
numbers swell, the baby boomers and subsequent retirees will raise financial demands on
all retirement systems, not only Social Security. The goods and services to be consumed
by society cannot be stockpiled in advance, and the economy will have to adjust. Whether
this adjustment would be mild or severe is mostly conjecture.
The Medicare Picture
The trustees presented a more troublesome picture for Medicare. Although major
constraints in Medicare payment rates were enacted last summer as part of the Balanced
Budget Act of 1997 (P.L. 105-33), HI’s rapid growth is projected to continue indefinitely.
The changes extended the HI trust funds’ projected insolvency point by 7 years, from
2001 to 2008, and cut the average 75-year deficit in half; however, the remaining deficit
is large. On average, HI’s costs would be about 65% higher than its income. By 2072,
its costs would be 2 1/4 times as large as its income. This pessimistic outlook reflects a
generally aging population, the impact of the post-World War II baby boomers’ retirement
early in the next century, the persistent high rate of inflation in the health sector of the
economy, and growth in the quantity of services provided. Most significant are the
looming demographic shifts. Where there were 3.9 workers per HI beneficiary in 1997,
there will be an estimated 2.3 workers per beneficiary in 2030.
Shown as a percent of the Nation’s payrolls, HI’s costs would rise from 3.4% today
to 5.93% in 2030 and 7.79% in 2070. On average for the 75-year period, HI income
would be 3.26% of payroll, HI outgo would be 5.37%, and the deficit would be 2.10%.
To put this figure in context, the long-range HI deficit is now about the same size as that
of Social Security, but in terms of the size of each program, the HI problem is larger. The
average gap between HI’s income and outgo is equal 39% of the program’s cost in
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contrast to a gap of 14% for Social Security. Looked at in a historical context, the deficit
for each of these programs is about the same as the Social Security deficit that Congress
tackled in 1983.
Since SMI is financed with general revenues and premiums that are determined and
reset annually, it does not have an explicit financing problem like HI. However, inflation
and the rising demand for medical care as society ages are causing its expenditures to rise
even faster than HI’s. The trustees projected that its expenditures would grow from .97%
of GDP in 1998 to 2.14% in 2015. At that point SMI would be larger than HI. Over the
1998 to 2070 period, the combined costs of HI and SMI are projected to rise from 2.65%
of GDP to 6.71%.
The Combined Scenario
The trustees’ 1998 projections provide some basis to think that Social Security
overall will generate sufficient taxes to cover its commitments for the next 15 years. The
long-range outlook, however, leaves little to be sanguine about; the program faces a
sizeable 75-year funding gap. HI’s problems are more imminent, as insolvency is
projected for 2008. Resources could be reallocated to HI from Social Security; however,
this would only move Social Security’s problems closer. If Social Security and HI are
considered together, their outgo as a percent of the Nation’s payrolls would rise from
14.6% today to 22% in 2025, a level that contrasts sharply with a combined tax rate that
is set now in the law at 15.3%. As a percent of GDP Social Security’s and HI’s outgo
would rise from about 6.25% today to 9% in 2025; including SMI would raise it from 7%
to 12%. In contrast, the taxes and premiums collected to support them are projected to
hover in the 7% range throughout the period.
These projections are not based on pessimistic economic assumptions. A modest but
sustained rise in GDP and moderate inflation and unemployment are assumed. Moreover,
they hinge in large part on demographic factors that are in place today — the post-World
War II baby boom, the subsequent birth dearth, and the general aging of society. They
suggest that to restore long-run solvency, income needs to be raised, expenditures cut, or
some combination thereof. Beyond possible changes to the programs themselves,
important unknowns that can alter the outlook include: whether an effective means can
be found to rein in the spiraling cost of medical care generally and whether future
technological advances will propel productivity. Also unknown and little understood is
the effect of potential shifts in society’s wants and needs: from raising families, buying
houses, and educating children to meeting the health and service demands of an older
population. Will the higher future costs of Social Security and Medicare place a large
strain on the economy or merely reflect a shift of the Nation’s consumption priorities?