Order Code 95-543 EPW
Updated March 27, 2002
CRS Report for Congress
Received through the CRS Web
The Financial Outlook for
Social Security and Medicare
Geoffrey Kollmann and Dawn Nuschler
Domestic Social Policy Division
Summary
The 2002 annual reports of the board of trustees of the Social Security and
Medicare trust funds were released on March 26, 2002. The financial status of both
programs has improved in the near term, but both continue to have projected long-range
problems. Insolvency for the Disability Insurance (DI) part of Social Security is
projected to occur in 2028, and for the retirement and survivors part, in 2043. On a
combined basis, the two parts would become insolvent in 2041, 3 years later than
projected last year and 12 years later than projected in 1997. Insolvency of the Hospital
Insurance (HI) part of Medicare is projected to occur in 2030, 1 year later than projected
last year (29 years later than in 1997). However, in the long run the financing gap for
both programs is slightly larger than in last year’s forecast. Over the next 75 years, the
Social Security program’s average deficit is 1.87% of taxable payroll, equal to about
14% of the program’s projected income. The average deficit of the HI program is 2.02%
of payroll, equal to about 60% of the program’s projected income. By the end of the
projection period in 2080, Social Security and HI combined expenditures are projected
to exceed combined income by 96%.
Currently, taxes and collected for Social Security and HI are higher than their
expenditures. However, the situation will reverse in 2016 for HI and 2017 for Social
Security, and expenditures are expected to exceed tax revenues thereafter.
Overview of the Outlook for Both Programs
Social Security’s financial condition is
Projected Points of Insolvency
assessed annually by its 6-member board of
trustees, consisting of the Commissioner of
Social Security—
Social Security, three members of the
Disability . . . . . . . . . . . . . . . . . . . . . 2028
P r e s i d e n t ’ s C a b i n e t , a n d t w o
Retirement & survivors . . . . . . . . . . 2043
Disability & retirement combined . . 2041
representatives of the public. The board’s
Medicare—
reports have projected long-range
Hospital insurance . . . . . . . . . . . . . . 2030
financing deficits for the system since
1984. Although the trustees’ 2002 report
continues to show a near-term buildup of
Congressional Research Service ˜ The Library of Congress

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trust fund reserves, their “best estimate” for the next 75 years shows that on average
Social Security’s expenditures will be 14% more than its income. By 2080 the income
shortfall would be 50%. The near-term buildup of reserves would peak at $7.2 trillion in
2026, and then be drawn down as the post-World War II baby boomers retire. The
trustees estimate that the disability fund would be exhausted in 2028 and the retirement
fund in 2043. On a combined basis, the two funds would be exhausted in 2041. At that
point, revenues would be sufficient to pay only 73% of program costs; by 2080 only 67%
would be payable.
Although the estimates imply that Social Security can be kept solvent for 39 years,
they also show that the program’s taxes would begin lagging expenditures in 2017. At
that point, the program would begin relying in part on general revenues in the form of
interest payments to the trust funds. By 2027, interest payments and tax revenues would
no longer be sufficient to cover the program’s expenditures, and the balances of the trust
funds would begin to be drawn down. These reserves consist exclusively of Treasury
bonds. By 2027, $1 out of every $5 of the program’s outgo would be dependent upon
these claims against the general fund. The government has never defaulted on the bonds
it records to its trust funds, but the magnitude of future claims has prompted many
observers to ask where the government will get the money to cover them.
The picture is more troublesome for Medicare. Its projected expenditures are rising
at a faster rate than are Social Security’s. The HI part of the program is projected to
become insolvent in 2030. On average over the next 75 years, its costs would be 60%
higher than its income. By 2075, they would be 211% higher. While Supplementary
Medical Insurance (SMI), the part of Medicare that pays for physician care, does not have
the same type of financing problem as HI (SMI relies heavily on annual general revenue
payments, not a fixed tax rate), its costs also are rising rapidly. As a share of GDP, SMI’s
costs are projected to rise from 1.04% today to 3.67% by 2075. By 2060, the combined
costs of HI and SMI are projected to exceed that of Social Security.
Background
Social Security is the Nation’s largest retirement and disability program providing
cash benefits to 46 million retired and disabled workers and to their dependents and
survivors. Medicare provides 40 million of them with health insurance. In 1999, Social
Security accounted for an estimated 38% of the income of the elderly (people age 65 and
older). Medicare provided more than 95% of them with basic health coverage. Today,
one out of six Americans receives Social Security; One out of seven receives Medicare.
In 2000, an estimated 156 million workers paid taxes to support the two programs.
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 $84,900 in 2002; the HI portion is
levied on all earnings. In 2002, payroll taxes comprise 85% of Social Security’s estimated
income and 86% of HI’s. The rest comes mostly from government credits, the largest of
which is for interest on federal securities held by their trust funds. There is no SMI tax;
77% of its estimated 2002 income comes from general revenues of the government and
23% from premiums paid by enrollees ($54.00 per month in 2002).

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The taxes and premiums people pay flow into the 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). The government credits the money to the
Social Security and Medicare trust funds by recording new interest-bearing federal
securities to the appropriate fund (these securities earn interest at the average rate
prevailing on outstanding federal bonds with a maturity of four years or longer). When
the government makes payments, it writes some off. While these securities are represented
as assets for the trust funds, they also represent liabilities for the government. 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; however, the funds themselves do 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 to
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 (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 one 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. By the end of 2001, the trust funds’ balances had risen to more than $1.2
trillion. This is equivalent to 261% of estimated expenditures in 2002 (or more than 2½
years’ worth).
The long-range picture for Social Security has worsened considerably since 1983.
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

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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 one 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. In subsequent reports, however, birth rate and
wage growth assumptions were lowered, and actuarial methods were revised, causing
further deterioration in the outlook. A small long-range deficit appeared in the 1984
report and the gap grew larger (with the point of insolvency generally coming closer) in
subsequent reports. Projections reported over the last five years, however, have shown
small improvements in part due to favorable near-term economic conditions. The 2002
report shows an average 75-year deficit equal to 14% of the program’s income, and
projects that the trust funds would become insolvent in 2041 (three years later than
projected last year). As a percent of the Nation’s payrolls, their income would average
13.72%, their outgo, 15.59%, and the deficit would be 1.87% (compared to 1.86%
reported last year). This average deficit is just a little less than the deficit tackled by
Congress in 1983. However, an examination of the back end of the projection period
shows chronic revenue shortfalls. By 2080, the yearly deficit would be equal to 50% of
the system’s projected income.
These long-range projections assume that GDP (adjusted for inflation) will rise
annually at rates ranging from 3.8% in 2003 to 1.6% in 2075, wages would rise at an
ultimate rate of 4.1% per year, the cost of living would go up at a rate of 3.0%,
unemployment would average 5.5%, and that Social Security retirement benefits would
fall in relative terms as the age at which full benefits are payable rises from 65 to 67 over
the 2000 to 2022 period. 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. By then, the number of people 65 and older is projected to
grow from 36 million in 2000 to 62 million, an increase of 74%. The number of workers
is projected to grow from 154 million to 175 million, or by only 14%. Consequently, the
number of covered workers per beneficiary will decline from 3.4 today to 2.3 by 2025.
By 2075, there will be 1.8 workers per beneficiary.
Under this forecast, the trust funds (on a combined basis) would be credited with
surplus income through 2026 bringing their balances to a level of $7.2 trillion. They would
decline in 2027 and thereafter, and would be depleted by 2041. However, tax receipts
begin lagging outgo much sooner, in 2017. 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
drawn from general revenues. In 2027, the reserve balance of the trust funds would begin
to be drawn down, and $1 out of every $5 of the program’s outgo would be dependent
upon general revenues. The government has never defaulted on the securities it posts 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. In the absence of
surpluses for the rest of the government’s operations, policymakers would have three

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options: raise other taxes, curtail other spending, or borrow money from the financial
markets.
Economists argue that if the surplus taxes projected for the next 15 years were to
cause the government to reduce the federal debt held by the public, more money would be
available in the financial markets for investment, which could lead to greater economic
growth. If this occurred, 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 the federal debt held by the public today will
increase the resources available for investment, then surplus Social Security taxes today
could help build a higher economic base 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 the debt occur when the
government runs an overall or unified budget surplus, not when one of its programs
generates surplus taxes. Also, if economic growth were enhanced in the coming decades
by reductions in government debt, 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. The question is whether the adjustment would be mild or severe.
The Medicare Picture
The trustees present an improved near-term picture for Medicare but a more
troublesome long-range one. Although major constraints in Medicare payment rates were
enacted as part of the Balanced Budget Act of 1997 (P.L. 105-33), HI’s rapid growth is
projected to continue indefinitely. Those changes and an improved economic outlook
extended the HI trust funds’ projected insolvency point by 29 years (from 2001 to 2030),
and cut the average 75-year deficit by more than half (from 4.32% of taxable payroll to
2.02%). However, the remaining deficit is large. On average, HI’s projected costs would
be about 60% higher than its income. By 2075, its costs would be three times larger than
its income. This pessimistic outlook reflects not only the persistent high rate of inflation
in the health sector of the economy and growth in the quantity of services provided, but
also the general graying of the population. Whereas there are about four workers per HI
beneficiary now, there will be an estimated 2.4 workers per beneficiary in 2030.
Shown as a percent of the Nation’s payrolls, HI’s costs would rise from 2.75% today
to 4.8% in 2030 and 10.61% in 2075. On average for the 75-year period, HI income
would be 3.34% of payroll, HI outgo would be 5.36%, and the deficit would be 2.02%.
Although this average deficit is only a little larger than that for Social Security, it is much
larger given the size of each program. The average gap between HI’s income and outgo
equals 60% of the program’s income in contrast to a gap of 14% for Social Security.
Because SMI is financed with general revenues and premiums that are reset annually,
it does not have the same type of financing problem as HI. However, its expenditures are

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expected to rise even faster than HI’s. Projections show that SMI’s expenditures as a
share of GDP would double by 2030 (rising from 1.04% today to 2.10% in 2030). From
2002 to 2076, the combined costs of HI and SMI are projected to rise from 2.5% to 8.6%
of GDP.
The Combined Scenario
Although the trustees’ 2002 projections show that Social Security overall will
generate sufficient taxes to cover its commitments for the next 15 years, and that the trust
funds will have a positive balance until 2041, the long-range outlook is not sanguine. HI’s
problems are more imminent, as insolvency is projected for 2030. 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 13.59% today to 22.13% in 2030 and
30.37% in 2075, levels that contrast sharply with a combined tax rate that is set now in the
law at 15.3%. As a percent of GDP, outgo for Social Security and HI combined would
rise from 5.88% today to 9.02% in 2030 and 11.75% in 2075. Including SMI would raise
it from 6.92% today to 11.12% in 2030 and 15.42% in 2075. However, the taxes and
premiums dedicated to support the programs (i.e., payroll taxes, proceeds from the
taxation of benefits, and SMI premiums) are projected to hover only in the 7% of GDP
range throughout the period.
Although these projections are based in part on economic assumptions, they are
driven by demographic factors — the post-World War II baby boom, the subsequent birth
dearth, and the general aging of society. They imply that to restore long-run solvency,
increases in income, cuts in expenditures, or some combination thereof, need to be made.
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 large strains on the economy or merely reflect
a shift of the Nation’s consumption priorities?

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