The 81% Tax Increase

[luckydevil]

http://www.forbes.com/2009/05/14/taxes-social-security-opinions-columnists-medicare.html

This week, the federal government published two important reports on long-term budgetary trends. They both show that we are on an unsustainable path that will almost certainly result in massively higher taxes.

The first report is from the trustees of the Social Security system. News reports emphasized that the date when its trust fund will be exhausted is now four years earlier than estimated last year. But in truth, this is an utterly meaningless fact because the trust fund itself is economically meaningless.

The 2010 budget, which was finally released this week, confirms this fact. As it explains in Chapter 21, government trust funds bear no meaningful comparison to those in the private sector. Whereas the beneficiary of a private trust fund legally owns the income from it, the same is not true of a government trust fund, which is really nothing but an accounting device.

Most Americans believe that the Social Security trust fund contains a pot of money that is sitting somewhere earning interest to pay their benefits when they retire. On paper this is true; somewhere in a Treasury Department ledger there are $2.4 trillion worth of assets labeled "Social Security trust fund."

The problem is that by law 100% of these "assets" are invested in Treasury securities. Therefore, the trust fund does not have any actual resources with which to pay Social Security benefits. It's as if you wrote an IOU to yourself; no matter how large the IOU is it doesn't increase your net worth.

This fact is documented in the budget, which says on page 345: "The existence of large trust fund balances … does not, by itself, increase the government's ability to pay benefits. Put differently, these trust fund balances are assets of the program agencies and corresponding liabilities of the Treasury, netting to zero for the government as a whole."

Consequently, whether there is $2.4 trillion in the Social Security trust fund or $240 trillion has no bearing on the federal government's ability to pay benefits that have been promised. In a very technical sense, it would lose the ability to pay benefits in excess of current tax revenues once the trust fund is exhausted. But long before that date Congress would simply change the law to explicitly allow general revenues to be used to pay Social Security benefits, something it could easily do in a day.

The trust fund is better thought of as budget authority giving the federal government legal permission to use general revenues to pay Social Security benefits when current Social Security taxes are insufficient to pay current benefits--something that will happen in 2016. Effectively, general revenues will finance Social Security when the trust fund redeems its Treasury bonds for cash to pay benefits.What really matters is not how much money is in the Social Security trust fund or when it is exhausted, but how much Social Security benefits have been promised and how much total revenue the government will need to pay them.

The answer to this question can be found on page 63 of the trustees report. It says that the payroll tax rate would have to rise 1.9% immediately and permanently to pay all the benefits that have been promised over the next 75 years for Social Security and disability insurance.

But this really understates the problem because there are many people alive today who will be drawing Social Security benefits more than 75 years from now. Economists generally believe that the appropriate way of calculating the program's long-term cost is to do so in perpetuity, adjusted for the rate of interest, something called discounting or present value.

Social Security's actuaries make such a calculation on page 64. It says that Social Security's unfunded liability in perpetuity is $17.5 trillion (treating the trust fund as meaningless). The program would need that much money today in a real trust fund outside the government earning a true return to pay for all the benefits that have been promised over and above future Social Security taxes. In effect, the capital stock of the nation would have to be $17.5 trillion larger than it is right now. Alternatively, the payroll tax rate would have to rise by 4%.

To put it another way, Social Security's unfunded liability equals 1.3% of the gross domestic product. So if we were to fund its deficit with general revenues, income taxes would have to rise by 1.3% of GDP immediately and forever. With the personal income tax raising about 10% of GDP in coming years, according to the Congressional Budget Office, this means that every taxpayer would have to pay 13% more just to make sure that all Social Security benefits currently promised will be paid.

As bad as that is, however, Social Security's problems are trivial compared to Medicare's. Its trustees also issued a report this week. On page 69 we see that just part A of that program, which pays for hospital care, has an unfunded liability of $36.4 trillion in perpetuity. The payroll tax rate would have to rise by 6.5% immediately to cover that shortfall or 2.8% of GDP forever. Thus every taxpayer would face a 28% increase in their income taxes if general revenues were used to pay future Medicare part A benefits that have been promised over and above revenues from the Medicare tax.

But this is just the beginning of Medicare's problems, because it also has two other programs: part B, which covers doctor's visits, and part D, which pays for prescription drugs.

The unfunded portion of Medicare part B is already covered by general revenues under current law. The present value of that is $37 trillion or 2.8% of GDP in perpetuity according to the trustees report (p. 111). The unfunded portion of Medicare part D, which was rammed into law by George W. Bush and a Republican Congress in 2003, is also covered by general revenues under current law and has a present value of $15.5 trillion or 1.2% of GDP forever (p. 127).

To summarize, we see that taxpayers are on the hook for Social Security and Medicare by these amounts: Social Security, 1.3% of GDP; Medicare part A, 2.8% of GDP; Medicare part B, 2.8% of GDP; and Medicare part D, 1.2% of GDP. This adds up to 8.1% of GDP. Thus federal income taxes for every taxpayer would have to rise by roughly 81% to pay all of the benefits promised by these programs under current law over and above the payroll tax.

Since many taxpayers have just paid their income taxes for 2008 they may have their federal returns close at hand. They all should look up the total amount they paid and multiply that figure by 1.81 to find out what they should be paying right now to finance Social Security and Medicare.

To put it another way, the total unfunded indebtedness of Social Security and Medicare comes to $106.4 trillion. That is how much larger the nation's capital stock would have to be today, all of it owned by the Social Security and Medicare trust funds, to generate enough income to pay all the benefits that have been promised over and above future payroll taxes. But the nation's total private net worth is only $51.5 trillion, according to the Federal Reserve. In effect, we have promised the elderly benefits equal to more than twice the nation's total wealth on top of the payroll tax.

Of course, theoretically, benefits could be cut to prevent the necessity of a massive tax increase. But how likely is that? The percentage of the population that benefits from Social Security and Medicare is growing daily as the baby boom generation ages and longevity increases. And the elderly vote in the highest percentage of any age group, so their political influence is even greater than their numbers.

The reality, which absolutely no one in either party wishes to face, is that benefits are never going to be cut enough to prevent the necessity of a massive tax increase in the not-too-distant future. Those who think otherwise are either grossly ignorant of the fiscal facts, in denial, or living in a fantasy world.

Bruce Bartlett is a former Treasury Department economist and the author of Reaganomics: Supply-Side Economics in Action and Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy. He writes a weekly column for Forbes.

[SnyderShrugged]

Crimeny!!!

"It says that the payroll tax rate would have to rise 1.9% immediately and permanently to pay all the benefits that have been promised over the next 75 years for Social Security and disability insurance."

75 yrs? ! ? !

[luckydevil]

SHF,

This is how republicans will get back in office ( though once in power they will prove to suck once again and not actually do anything about spending)

[#98QBKiller]

I see the guy that wrote this column also authored a few books adoring the Reagan Administration and Reagan's economic policies.

I am by no means a financial expert so my question is, how can Reagan's Savings and Loans Bailout not be knocked by the same people that have such a problem with the Bailouts under the Obama Administration?

[Larry]

Wow. Yet another article that claims that the Social Security Trust Fund doesn't exist, because T-bills aren't assets.

And who claims that the sky is falling because look how much money there would have to be in the funds to pay benefits forever.

(Good thing nobody ever figures out how much it would cost us if we had to come up with enough money, right now, to run the military forever, huh? Bet that number would be really scary.)

[SnyderShrugged]

SHF,

This is how republicans will get back in office ( though once in power they will prove to suck once again and not actually do anything about spending)

Did you mean SS?

True, though I wish the latter part were not so true.

[SnyderShrugged]

I see the guy that wrote this column also authored a few books adoring the Reagan Administration and Reagan's economic policies.

I am by no means a financial expert so my question is, how can Reagan's Savings and Loans Bailout not be knocked by the same people that have such a problem with the Bailouts under the Obama Administration?

Very justified point. There shouldnt be a double standard in issues like this.

[luckydevil]

Did you mean SS?

True, though I wish the latter part were not so true.

No, SHF think his party will be out of power for decades. If Obama and company are serious about universal health care, this could speed up the process ( republicans getting back in power).

[SkinsHokieFan]

SHF,

This is how republicans will get back in office ( though once in power they will prove to suck once again and not actually do anything about spending)

The problem is there are no Republicans a) with the economic knowledge and know how and credibility to offer any alternatives at the moment or in the near future

They'll keep yelling "tax cuts!" over and over again with no sense of how to apply them and where and how to cut the government and where

Until the leaders of the party prove they are not the party of big corporation, social security could collapse and they still wouldn't have a clue, nor the credibility to show they can solve the problem

[twa]

Larry, have you seen the official projection of when it will default w/o a increase in rates or reductions?

Them youguns better get a side job soon.

[Larry]

Larry, have you seen the official projection of when it will default w/o a increase in rates or reductions?

Them youguns better get a side job soon.

Uh, I think the announcement today revised the projected bankruptcy day from 2043 to 2039

I don't know if it's still true, but a few years ago they said that if they'd simply remove the cap on SS taxes (a move I oppose, since what they were proposing was removing the cap on taxes but keeping the cap on benefits), then SS was good for 75 years. The article, itself says that the same thing could be accomplished by increasing the SS payroll tax by 1.9%

[Passepartout]

Before you know it, the USA will have to file for bankruptcy unfortunately.

[HighOnHendrix]

The flaw in Social Security is that it forces those in the workplace today to pay for those who are already retired. Any increase in birthrate followed by a decrease in birthrate (baby boom, anyone?) spells trouble. Then there's inflation. The money my grandfather, for example, contributed during his 60+ years of working is now worth far less than it was at one time. Then there's the fact that Congress just cannot contain themselves when it comes to spending (on anything) and so benefits continue to increase. Combine all these problems (and probably a few I forgot) and you have a real mess. Thanks a lot, social engineering wizards!

[Larry]

The flaw in Social Security is that it forces those in the workplace today to pay for those who are already retired.

That's the biggie.

I think that, right now, 98% of the money SS takes in, goes out the door the same year.

There isn't a retirement system in the world that can "put enough away for retirement", when only 2% of the worker's contribution actually earns interest.

The problem isn't that that 2% is only invested in t-bills, which aren't paying much interest. The problem is that only 2% of the money is earning interest at all.

Ideally there would be a plan which would transition SS into a system where the worker's contributions all were invested, somewhere, for use when retirement arrives. But what would it take to accomplish that?

Would they have to double the SS tax? (Half to pay for existing retirees, the other half to pay for current workers? And that would be assuming you double the tax, but left the benefits the same.)

Pay current retirees out of general revenues, so that current contributions went exclusively into the trust fund?

[Prosperity]

why can't we scrap the thing altogether?

[SnyderShrugged]

why can't we scrap the thing altogether?

or at least allow those that won't ever benefit (at least on par with what they put in) to opt out.

[Prosperity]

or at least allow those that won't ever benefit (at least on par with what they put in) to opt out.

yeah but the conclusion will be the same... what a god damn waste these two programs are... people die, it's a fact of mortality. The dollars we spend should be making sure everyone can be as healthy as possible so that they can continue to be productive members of society in old age, and not allow them to wither and then decide to spend money on them (at that point the money we spend will be much less efficient way to increase quality of life).

[Elessar78]

or at least allow those that won't ever benefit (at least on par with what they put in) to opt out.

Agreed. As someone in their 30s, I'm not even factoring social security checks into what I will need when I can no longer work. (As an aside, I don't like the idea of "retirement" in the way people thing about it as their golden years. But I do admit that at some point I may no longer be able to hold a job that will keep the money coming in.) So I don't see a point in paying into a system that won't reciprocate.

Some politician with a lot of guts needs to step up and take one for the team and fix this thing. Whether it be scrapping it and setting a hard cutoff. I think social security pays out the people that are already in the pipeline (workers who have paid in/vested that are 45 years of age or older) and notify people under the cutoff age that they need to fend for themselves.

[Prosperity]

Some politician with a lot of guts needs to step up and take one for the team and fix this thing. Whether it be scrapping it and setting a hard cutoff. I think social security pays out the people that are already in the pipeline (workers who have paid in/vested that are 45 years of age or older) and notify people under the cutoff age that they need to fend for themselves.

it would be a great if we had courageous statesmen willing to risk their careers to fix SS and medicare, but not even Obama has the willingness to do it as far as I know. Of course there are those that would be willing out of ideology, but it would be nice if we had leaders who would do it out of rational pragmatism.

[Larry]

Agreed. As someone in their 30s, I'm not even factoring social security checks into what I will need when I can no longer work. (As an aside, I don't like the idea of "retirement" in the way people thing about it as their golden years. But I do admit that at some point I may no longer be able to hold a job that will keep the money coming in.) So I don't see a point in paying into a system that won't reciprocate.

Some politician with a lot of guts needs to step up and take one for the team and fix this thing. Whether it be scrapping it and setting a hard cutoff. I think social security pays out the people that are already in the pipeline (workers who have paid in/vested that are 45 years of age or older) and notify people under the cutoff age that they need to fend for themselves.

Yeah, I'll admit that in the early days of the last election, I had this fantasy that McCain would win, and then he'd announce that he's decided that he's too old to seek a second term, therefore he doesn't care about getting re-elected, and therefore he can go ahead and grab The Third Rail and do the things that need to be done, but that aren't popular.

In my fantasy, the first thing he did was announce that he was going to gradually, over the next 12 years, raise the retirement age by 5 years.

(You do it gradually, because it's not fair to somebody who's been planning on retiring at 65, and who's two weeks away, to tell him that we're moving the goalposts, and you've got to wait five more years. By raising it gradually, you allow the folks who are 64 to keep their existing plans, but you allow the folks who are 50 to start revising their plans.)

[Popeman38]

why can't we scrap the thing altogether?

We don't need to scrap it. We need to limit it to what it was originally intended for: OASDI. Insurance for disabled and the old without family.NOT every last citizen who uses it as a retirement. Of course, that would require a politician to take money away from voters. Which won't work. Because voters only care about what a politician can give them. Look at the last election. Obama made more campaign promises than any politician in history.

[luckydevil]

why can't we scrap the thing altogether?

You can't win on that platform.

[Predicto]

Social Security should not be scrapped. It serves a tremendously important purpose.

All we need to do is acknowledge that people live a hell of lot longer now than they did in 1933, and can work a lot longer. Move the eligibility date up a few years, and the demographic problem is solved.

[Elessar78]

Yeah, I'll admit that in the early days of the last election, I had this fantasy that McCain would win, and then he'd announce that he's decided that he's too old to seek a second term, therefore he doesn't care about getting re-elected, and therefore he can go ahead and grab The Third Rail and do the things that need to be done, but that aren't popular.

In my fantasy, the first thing he did was announce that he was going to gradually, over the next 12 years, raise the retirement age by 5 years.

(You do it gradually, because it's not fair to somebody who's been planning on retiring at 65, and who's two weeks away, to tell him that we're moving the goalposts, and you've got to wait five more years. By raising it gradually, you allow the folks who are 64 to keep their existing plans, but you allow the folks who are 50 to start revising their plans.)

These are good ideas as well.

Can you imagine what kind of shot in the arm to the economy it would be if tax payers around my age (30) and younger did not have SS contributions deducted from each paycheck?

[Predicto]

or at least allow those that won't ever benefit (at least on par with what they put in) to opt out.

How do you know you won't ever benefit? How do you know you won't have a string of bad luck and end up destitute, or disabled?

You don't. None of us do. That's the point.