Want To Learn About Entitlements? Part 2: The Problems

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We recently covered in Part 1 some basic facts about entitlements, or “earned benefits,” that gave a pretty good outline of what they are, how they are funded and our expenditures. This segment will go more into detail about the issues we face in the coming decades surrounding entitlements.

“the future is bleak, short-term projections show a fund that will start spending more than it receives. The trust funds will sustain this deficit for the near future… [but] programs in the mid-term are in a much more dire situation, that slightly improves in the long-term.” – Excerpt from Part 1

I would like to start where we left off in the first section. We are looking at fund exhaustion of Medicare in the year 2024, Social Security in 2035, and Disability in 2016.

Why?

The primary reasons for the exhaustion of these funds are as follows:

  • We have an aging population (the ‘baby-boomers’) who are beginning to cash out on Social Security and will begin receiving Medicare benefits.
  • Lack of revenue sources, we need to raise taxes to cover the rise in costs over the short-term and provide adequate funding.
  • Slow economic growth – since Social Security and Medicare are based on tax deductions, when payrolls are lower less money gets put in the system.
  • Increasing healthcare service costs

Current projections place the annual cost of Social Security benefits at 17.4% of taxable earnings in the year 2035, well over our current 12.4% rate. This represents an increase from 4.2% of GDP to 6.4%.

Medicare at the same time will also see rises from 3.7% of GDP to 5.7%.

What we have is a classic problem of increasing costs and without increased funding. The problem may partially alleviate itself well after the time we see the baby-boomers pass, but we end up with the real problem of funding for the next few decades that would involve heavy tax hikes or deficit spending if nothing is done.

Fund assets as a percentage of annual costs

Here we see the problem graphically. As you will notice, each of the benefit funds are currently over funded and until recently were on tremendously positive trajectories. The real shift comes this year where Social Security starts what I can best describe as a free-fall. This again has to do with the large number of elderly people becoming beneficiaries. The large balance of assets held by the Social Security trust means that revenues will actually be greater than expenditures (due to interest revenues) through the year 2022… then a massive deficit that increases year after year until the fund is exhausted in 2035.

According to the Trustee’s Report, the estimated yearly deficit that needs to be either added to the revenues of these funds, or cut from its cost starting today equals roughly 6.69% of taxable income. The largest by far are from Social Security and Social Security Survivor payments that total roughly 5% of this amount.

With average effective federal tax rates equaling 18.1% of income, an increase of 6.7% constitutes a 37% increase in effective tax expenditures. Because of this large figure, many have argued that a tax only option is not feasible, and to effectively solve our entitlement problems real reforms in benefits need to be taken.

2 thoughts on “Want To Learn About Entitlements? Part 2: The Problems

  1. Reply Lakersfan Oct 16,2012 8:21 pm

    The solution:

    In a nation that prides itself on fair play and equal opportunity, it seems incongruous that people with wealth-based income — interest, dividends, capital gains, rent — are excused from paying Social Security (traditionally 12.4 percent) and Medicare taxes (2.9 percent) on that income. Equally odd, they do not pay Social Security tax on wages above $110,100. Shouldn’t these taxes be paid on all income? Taxing the “earned” and not the “unearned” seems rather un-American, doesn’t it?

    The two preferences hark back to Social Security’s 1930s groundbreaking origins. Without these exclusions, would there have been a political consensus to create Social Security? Maybe, maybe not, but no decision is fixed forever.

    If these preferences were eliminated and the economy recovered to mirror a positive year like 2007, the Social Security Trust Fund would nearly double its annual revenue. We could expect to see an additional $500 billion for Social Security and $100 billion for Medicare. The additional Social Security inflow would almost cover the annual outflow, leaving most of the current revenue as a surplus to accommodate the baby boomers.

    Virtually all income of the bottom “47 percent” is earned and fully taxed for Social Security and Medicare. Many people are unaware that wealthy taxpayers are “entitled” to exempt much, if not most, of their wages, as well as investment income. Ending those exemptions would allow a major reduction in Social Security and Medicare tax rates.

  2. Reply Robin Feb 4,2013 8:39 pm

    I am the last of the baby-boomers though with many working years ahead of me before retirement. The foreshadowed assumption that the money I’ve paid into the system since my first job at 15-16 years won’t be there when I need it is of concern. Even without the badly needed reforms to help keep “earned benefits” viable, couldn’t the money paid in earn a greater share of interest if government didn’t ‘borrow’ from the trusts? Wouldn’t it offset some of the lost ground in keeping the programs more adequately funded?

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