RateWatch #430 Social Security, Medicare

October 23, 2004 by Dick Lepre

Social Security, Medicare

In a perfect world (O.K. a moderately better world) the Presidential campaign and the debates would have shined more light on some of the important social and fiscal issues of the time.

One thing that we have recently heard about is Social Security.  I am not going to repeat what
either of the candidates said because no politician in their right mind wants to bring this up during a campaign.

There are two programs that the Federal government needs to be concerned about: Social Security and Medicare.

Social Security is the easier problem to solve. If the social security fund starts bleeding there are three possible solutions:

1) increase the tax
2) increase the age at which benefits start or
3) both of these.

If the fund does not produce enough for folks to retire at 65 then perhaps the retirement age should be moved up to something that actually works. With the jobs of today it makes sense for folks to retire later.  It is more feasible for someone who works in an office to work after 65 than it does for someone who had a physically demanding blue collar job to work after 65. Despite this, the trend has been toward earlier retirement. That might be ideal but our present social
security system is cursed by the "elderly dependency ratio" - the ratio of older folks to young ones.  This ratio has been increasing for 150 years. The combination of a lower fertility rate and better health leading to longer life had led to an increasing percentage of the population being elderly. Presently, about 12% of the population is over 65. This may be as high as 20% by 2035.

It is easy to compartmentalize this problem by looking at one of the institutions of corporate America, General Motors.  GM, like many post-WWII manufacturers, established a defined benefit pension plan. With such plans the employer is able to tax deduct its contributions. GM and other employers with large benefits programs suffered two-fold losses:
1) equity values fell and
2) interest rates fell.
Once fat benefits programs became underfunded. By federal standards, approximately one-third
of all pension funds are underfunded.

In the case of GM, consider these numbers: GM has 2.5 people on retirement for every employee; about $1,800 of the price of the average GM car goes to cover the shortfall of the pension fund.  According to the Pension Benefit Guarantee Corp (a Federal Corporation that
insures pension funds) the number of underfunded plans with a shortfall of at least $50 million
went from 166 in 1999 to 1,050 in 2003.

GM is not alone.  Other sectors that have been hard-hit are steel and airlines with the failings of United Airlines being most in the news of late.  With the airlines in a more competitive marketplace the burden of funding the pension funds becomes a real curse.  It leads to higher fares which lead
less business which spells disaster.  The older, pension-heavy airlines cannot compete with the younger ones.

Also, this is hardly a unique American problem. The first wave of the elderly dependency ratio
problem hit Japan and Europe before it hit the U.S.

Social Security suffers from the change in demographics.  Pension funds suffer because they made bad investments while promising defined cash flows to retirees.  In addition, some pension funds (like GM) share the same demographic problem as Social Security - it may have been easier to "take up the slack" if the number of workers were increasing.

Medicare is really two different programs: one providing hospitalization (Medicare Part A) and one providing health care (Medicare Part B). 

The problems that Medicare has are much larger than the problem that Social Security faces.
Medicare's problem is three-fold: 
1) it suffers the same demographic problem as Social Security
2) the fact that our health care system (Medicare and otherwise) is, essentially, a third-party subsidy system, acts to greatly increase the demand for medical services
3) the increase in demand coupled with expensive high-tech medical solutions has led to a seemingly out of control run-up in price. 

So what we have is more people seeking more of an increasingly expensive commodity. This is a sure formula for fiscal disaster.

The sad fact is that the only solution to the dual problems of Social Security and Medicare may be to moving up the ages for receiving benefits or full benefits.  People should not be promised that which cannot be delivered.

This is something that politicians want to avoid but must face.  It is something that the American public wants to avoid but must face.

There are some possible avenues of hope:

- immigration may make up for the decline in the fertility rate (maybe 30 years from now we will think that folks who illegally immigrated to the U.S. across the Mexican border saved the day).

- increasing worker productivity may continue to produce more GDP and, consequently, more tax base with the same number of workers.

- we could encourage a higher fertility rate. This is a doorway to a larger issue.  Is it the case that the concern that started in the '60's about "The Population Bomb" was ill-founded?  I do not think that concern was false.  A population growing out of hand would have created a different set
of problems.  We have engineered a lower fertility rate by encouraging birth control, allowing abortion, encouraging women to work and accepting homosexuality.  A consequence of this is a higher elderly dependency ratio.

- more can be done about the sources of ill health.  Smoking, drinking and obesity would be a start.  The Washington Post reported this week that health care for folks who are obese is 37% greater than for those of normal weight.  There is a sinister irony here.  Good health helps Medicare.  Bad health may help social security because smokers and drinkers have shorter life

The reality regarding these two programs is that people should not be promised something that cannot be delivered. That did not work for Enron and it will not work for the Federal government.
The Federal government is better able to delay addressing the problems but the consequences
of the failure to address and solve the problems with these two programs is much more serious than any corporate collapse.

The problems are addressed here are very large.  The discussion here barely scratches
the surface.  People need to understand that there are problems and that some sacrifices
must be made to keep these programs solvent.

Also, they need to be moved out of the political space because it would appear that politicians are incapable of addressing them.

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