09/ 26/ 2007
by Shannon McRae
The unsustainable future of government spending progams in the United States
Defining the issue: Federal deficits have reached historic levels as expenses for entitlement spending programs such as Social Security, Medicare and Medicaid far outpace revenues. In order to continue to provide benefits to our nation's retirees, significant reforms must be made.
Retiring isn't in Rich Gimmel's genes.
His 91-year-old father worked at his Louisville, Ky.-based family business until just three months before his death. And at age 58, Gimmel isn't planning to quit any time soon, even though his son recently became the fourth generation to join Atlas Machine Supply. For Gimmel, working late in life is a choice--but he fears that for many in his son's generation, it will be a financial necessity.
"My son is 25 years old," Gimmel says, "and I see him spending an increasing portion of his year at work to pay for retirees. And that's not the way it should be."
As federal deficits continue to rise to never-before-seen levels, the United States faces serious budget problems, especially when it comes to the top three entitlement spending programs: Medicare, Medicaid and Social Security. The money will run out--exactly when is often debated. But one thing is certain: If we don't fix the problem now, our children and grandchildren will be forced to deal with the fallout.
How the Federal Budget Works
Small-business owners have a hard time understanding the decisions of our nation's lawmakers. When you can't afford something in your business, you don't buy it. Unfortunately, though, the U.S. government doesn't always operate under the same sound financial principles. The federal budget is comprised of two types of spending: discretionary, which is appropriated annually, and mandatory, which is made up mostly of entitlement programs determined by law and, therefore, are not subject to annual changes.
The "big three" entitlement programs--Medicare, Medicaid and Social Security--get all the attention, mainly because their solvency is in question.
How these programs will serve future generations is a major concern to Americans--and it should be, considering their costs are growing at unsustainable rates. The Congressional Budget Office projects the combined cost of these three programs will double from the current 8 percent of GDP to 15 percent when today's newborns graduate from college and to nearly 20 percent of GDP when today's college graduates reach retirement in 2050. Continuing to fund these entitlement programs at today's levels will be an increasing burden on the federal budget and, if left unchanged, would cause interest rates to rise, crowd out private investment spending and lead to a financial crisis. Using conservative assumptions, the CBO predicts that under current law, the cost of these programs will drive the federal deficit from today's 3.3 percent of GDP to about 20 percent in 2050.
"Every legislative session that fails to address the issue of entitlement spending only exacerbates the problem," says Todd Stottlemyer, president and CEO of NFIB. "Small-business owners, like all Americans, are concerned about the future of Social Security and Medicare. Yet their perspective on the issue is unique--as it is both that of the future retiree and of the employer paying the payroll taxes."
The Challenges Ahead
Each year, the Trustees of Social Security and Medicare trust funds (known as OASDI trust funds) report on the programs' current and projected financial status. For years, the trustees have warned of dire financial outlooks for both programs, though the 2007 report found that Medicare faces insolvency sooner than Social Security. This year's report issued its first "Medicare funding warning," triggered because the program's general revenues will soon account for more than 45 percent of its outlays. According to trustees, the growing annual deficits for both programs are expected to exhaust reserves for Medicare in 2019 and Social Security in 2041.
Why are the trust funds' fiscal outlooks so bleak? It's because of what the U.S. Government Accountability Office calls a "large and persistent gap" between expected revenues and expected spending. It boils down to shifting demographics: America's population is aging dramatically, and, at the same time, health-care costs are soaring. Americans are having smaller families today than in the past, and people are living longer. As baby boomers become eligible for retirement benefits, the United States will have fewer workers to pay for the ever-increasing costs for retirees.
Social Security's challenges result from the program's structure, which is known as a "pay-as-you-go" model. The payroll taxes from each generation are not saved or invested to fund those workers' retirements. Instead, they're used for the current generation of retirees. Therefore, each retirement-aged generation must depend on the current working population to fund their benefits.
In 1950, there were 16 workers paying taxes into the system for every retiree who was collecting benefits. Today there are little more than three workers, and by the time baby boomers retire, there will be only two workers to pay for the benefits of every one retiree, according to OASDI trustees.
If the problem is not addressed, projections indicate younger Americans will not receive retirement benefits, despite paying into the system their entire lives. According to a report by conservative think tank The Heritage Foundation, today's 25-year-old male with an average income is predicted to receive a -0.82 percent rate of return on his Social Security taxes. In other words, he will pay more into the system than he will receive back in benefits.
While the Social Security crisis is real, a more immediate--and some say more serious--threat faces Medicare and Medicaid. During the past several decades, health-care spending has far outpaced the nation's economic growth. Small-business owners understand well the major impact that rising health-care costs has on their businesses. "For years NFIB has been working to bring about real change in our nation's health-care system," Stottlemyer says. "The Medicare/Medicaid crisis only underscores how big the problem is and how badly it needs to be fixed."
According to the GAO, "rising health-care costs pose a fiscal challenge not just to the federal budget but to American business and our society as a whole."
The Big Three
Medicare is a government-administered health-care program for Americans age 65 and older. Created in 1965, it's funded partly through a 2.9 percent payroll tax on every worker. Employers pay 1.45 percent and withhold 1.45 percent from employees' earnings.
Self-employed Americans pay the entire amount themselves. Those payroll taxes cover costs of inpatient care at hospitals and other providers, such as skilled-nursing facilities.
The remainder of the benefits (physician visits, prescription drugs, etc.) are financed through general revenues and premiums.
Medicaid is a joint, federal-state health program for low-income Americans of any age, with the federal government setting a base level of benefits. It is financed through federal payments from entitlement funds, as well as state and local contributions.
Social Security was signed into law by President Franklin D. Roosevelt in 1935. Though known mostly for providing benefits to retired Americans, the program also pays benefits to widows, disabled individuals and their children. It is funded entirely through a 12.4 percent payroll tax known as FICA (Federal Insurance Contributions Act). Employees pay a 6.2 percent tax on wages up to $97,500 (for 2007). Employers pay the remaining 6.2 percent tax. Self-employed Americans pay the entire amount themselves.
How to Fix the Problem
With a crisis as complex as entitlement spending, solutions won't be simple. Politicians have debated the issue for more than a decade, and NFIB has closely monitored the proposals to protect the interests of our small-business members. In addition, President George W. Bush spent the first year of his second term trying to address these problems, but he was unable to achieve consensus in Congress. The following ideas offer ways to fully or partly reform our current systems:
Raise taxes and eliminate tax cuts.
The U.S. government needs more money to operate Social Security and Medicare programs. One way to get more money, some lawmakers think, is to lean on American taxpayers.
With the growing gap between Social Security's revenues and expenses, some have advocated for increasing the current cap on the amount of wages subject to the Social Security payroll tax. The payroll tax cap (which is $97,000 for 2007) changes every year and is indexed to the growth of real wages in the economy. NFIB members have been polled on this question multiple times, and their position is very clear: A tax increase is not the solution.
Supporters of raising the cap argue that only a small percentage of Americans--mostly the upper middle class--would be affected. Yet, according to The Heritage Foundation, eliminating the wage cap would directly raise taxes on 3 million small-business owners by as much as $242 billion by 2010. In addition to affecting individual business owners, raising the cap also affects their families, employees and customers. Increasing taxes on this group could have severe implications for our nation's economy, as these business owners would have less money available to hire workers, purchase equipment or expand their businesses.
Furthermore, raising the cap to $150,000 would be a minor fix, only delaying insolvency by approximately four years, according to the Cato Institute. "Even after the largest tax increase in U.S. history, the program would still require a tax hike equal to a one-third increase in the payroll tax in order to pay the promised benefits," writes Michael Tanner, director of the Cato Institute Projects on Social Security Choice.
Economist Laurence Kotlikoff of the National Center for Policy Analysis estimates that payroll and income taxes would need to rise by 40 percent to cover future retirees' health and pension benefits.
Some believe that rolling back lower tax rates adopted in 2001 and 2003 would help the government fund Social Security and Medicare, but opponents point out that federal tax revenues are already above historical levels. Increasing the tax burden on Americans could pose more risks than rewards.
Cut benefits.
One way to slow the financial strain on the entitlement programs is to reduce benefits paid.
To help slow the Social Security crisis, some favor indexing benefits to price inflation instead of wage growth, which would greatly reduce outlays in the long run.
Instead of reducing benefits, some believe both federal programs would benefit from raising the retirement age to 70. As Americans live longer, healthier lives, they should continue working longer as well, proponents say. Today Americans have longer life spans, and fewer work in jobs that are physically demanding. Since the 1980s, more than half of Americans retire at 62, with fewer than 20 percent citing ill health as a reason for retiring. American males who reach age 65 can expect to live 17 more years, while females can expect to live another 20 years. In the near future, the typical American will spend one-third of his life in retirement. Our current retirement-benefit federal programs will not be able to sustain this shift.
Today, Americans age 66 and older can receive full Social Security benefits. In 2020, the age limit will increase to 67. While it's a start, many believe the increased retirement age should be accelerated. It currently doesn't apply to Medicare, but some argue that it should. Advocates of Medicare reform believe the best way to stop the pending financial challenges is to restrict the number of people eligible for benefits. Short of major reform of our nation's entire health-care system, limiting those covered is one way to lower Medicare's costs. In addition to raising the benefit age, supporters also want benefits to be tied to income so that only those who truly need Medicare receive it. Restricting the number of services Medicare covers is another way to lower costs.
Other ideas being debated include changing the entire structure of Medicare--creating a program that functions more like a free-market system.
Fundamentally restructure the programs.
Since their inceptions generations ago, Social Security and Medicare have remained virtually unchanged. Supporters of restructuring the programs argue that it's time to modernize the archaic systems.
Allowing Americans to invest in private retirement accounts is one often-discussed idea. Supporters believe if Americans were allowed to invest in retirement accounts that functioned like IRAs or 401(k)s, they would take more ownership in their financial future than they do in today's system, which functions more like social welfare.
With Social Security in such financial straits, supporters believe market-based accounts invested in stocks and bonds will yield better results than today's Social Security funds. In a 2005 NFIB Member Ballot, 71 percent of respondents said Social Security should be reformed to allow individuals to invest in personal accounts.
Yet some are concerned that creating personal accounts isn't an easy solution. The money to fund the accounts must come from somewhere. During any transition to personal accounts, workers would have to pay more or retirees would receive fewer benefits--or both.
The main argument against creating personal accounts is the fear of getting rid of a guaranteed retirement system--one that Americans have participated in for more than 70 years. Eighty-five percent of NFIB members believe that even with private accounts, the program should remain mandatory and retirees should receive minimum benefits. Opponents of personal accounts are also concerned about relying on fluctuating financial markets to fund our nation's retirement system. They argue that the crisis is overblown and that, as people live longer, they'll work longer.
Many have called for an overhaul in the way Medicare operates, forcing needed competition by injecting free-market initiatives. President Bush's latest Medicare-reform proposal lays out aggressive ways to reduce the projected red ink, including changing the complex way Medicare fees are negotiated. Though his proposals won't solve the problems completely, they would save a projected $76 billion over the next five years.
