Social Security and Medicare: The Economic Implications of Current Policy

Publication Date: January 2005

Publisher: Library of Congress. Congressional Research Service

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Research Area: Banking and finance

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Abstract:

The retirement of the baby boomers, rising life expectancy, and the rising cost of medical care are projected to place current federal policy on an unsustainable fiscal basis over the next several decades. Social Security outlays are projected to rise from 4% of gross domestic product (GDP) today to 6% of GDP in 2030 and Medicare and Medicaid outlays rise from 4% today to as much as 12% of GDP in 2030 and 21% of GDP in 2050. These increases in spending are not expected to subside after the baby boomers have passed away. Without any corresponding rise in revenues, this spending path would lead to unsustainably large budget deficits that would push up interest rates and the trade deficit, crowd out private investment spending, and ultimately cause fiscal crisis.

To avoid this outcome, taxes would need to be raised or benefits would need to be reduced. Altering taxes and benefits ahead of time would reduce the size of cuts required in the future if the proceeds were used to increase national saving. (Making changes ahead of time would also allow individuals time to adjust their private saving behavior.) National saving can be increased by using the proceeds to pay down the national debt, purchase financial securities, or finance individual accounts. Individual accounts that were financed by increasing the budget deficit, however, would not increase national saving or reduce the government's fiscal imbalance and could exacerbate the government's fiscal imbalance over the 75-year projection.

Relatively small tax increases or benefit reductions could return Social Security to long-run solvency. Restraining the growth in Medicare and Medicaid spending is more uncertain and difficult, however. The projected increase in spending is driven more by medical spending outpacing general spending increases than by demographic change. But it is uncertain how to restrain cost growth since much of it is the result of technological innovation that makes new and expensive treatments available. To finance projected increases in Medicare and Medicaid spending would require tax increases of an unprecedented magnitude. From a government-wide perspective, Social Security or Medicare trust fund assets cannot help finance future benefits because they are redeemed with general revenues.

The reason revenues are not projected to rise when outlays rise is that these programs are financed on a pay-as-you-go basis: current workers finance the benefits of current retirees. Current budget deficits remove the limited prefunding that already exists in the system, exacerbating the future fiscal shortfall. In the future, there will be fewer workers per retiree. Once a pay-as-you-go system is up and running and faced with an adverse demographic shift, there is no reform that can avoid making some present or future generation receive less than past generations. Under current policy, future generations will be made worse off by higher taxes or lower benefits. Under a reform that increases national saving, some of that burden would be shifted to current generations. This report will be updated as events warrant.