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.
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.
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.