Economists say Medicare a bigger crisis than Social Security

John Shoven

John Shoven

Despite the Bush administration's active lobbying efforts to reform Social Security, two economists at the Stanford Institute for Economic Policy Research (SIEPR) warned that health-care reform remains a much more serious—and fundamentally unaddressed—challenge.

"Social Security is a big, big problem, but Medicare is much bigger," said economics Professor John Shoven, the institute's director, during a May 4 talk with SIEPR associates on reforming the nation's largest federal program. Although the cost of Social Security is expected to increase from 4 percent to about 6.4 percent of the gross domestic product when the first Baby Boomers start retiring in three years, the increase is dwarfed by rising health-care costs, which are estimated to soar from about 2.7 to 14 percent of GDP in the next 75 years. "Medicare is in a crisis—by 2010 it [will be] spending more than it's taking in," Shoven said.

Peter Orszag, a senior fellow at the Brookings Institution and a research professor at Georgetown University, blamed the nation's political system for failing to tackle challenging issues such as Social Security, Medicare and climate change that worsen gradually over time. "For politicians on a different cycle, [these] are not compelling case[s]," he said. "The political system does not deal well [with such problems] until there is a gun to the head of policymakers."

As a result, both economists said they are pessimistic that real changes will be introduced soon to save Social Security, even though deferring the problem will only lead to more painful cuts in the future. "The outlook is bleak for what the president really wanted to do," said Shoven, referring to Bush's efforts to push for privatized retirement accounts. "I don't think we're going to get individual accounts of any variety, not this year. I think the most likely outcome is nothing. If we don't do something this year, we won't do something for the rest of the decade. I think that is a bad, bad solution."

One reason Bush has had difficulty convincing the public that change is needed is because Social Security currently operates in the black. "So where's the problem?" Shoven asked rhetorically. The program collects a whopping $600 billion in payroll tax revenue annually—more than a quarter of all federal revenue received—and it pays out more than $500 billion in benefits—a fifth of all federal outlays. The benefits for the population are huge, Shoven said. "For two-thirds of the population over 65, Social Security is more than half of their income," he said. Monthly benefits average at about $955 for single people and $1,574 for couples.

Shoven said the program is still solvent because people who have retired during the last decade were born during the Great Depression and World War II, when birth rates were comparatively low. However, he continued, the numbers will begin to jump dramatically when post-war Baby Boomers start leaving the work force in 2008.

To prepare for this, Orszag said the nation must start changing the structure of Social Security to spread program-saving cuts over several generations. For example, he said, if all non-disability benefits were reduced immediately to prevent the program from running out of money in the next 75 years, a 15 percent cut would be needed. But if reductions are delayed until 2041, benefits will have to be slashed by 30 percent. "That gives you one way of looking at the cost of delay," Orszag said. "But even that is too optimistic, because it assumes that everyone's benefits are reduced, even those who have been receiving them for 10, 15, 20 years. No one wants that to happen."

Orszag suggested that improving retirement plans today also could reap important long-term benefits. For example, he said, studies have shown that if employers automatically enroll new hires in 401(k) retirement plans, participation rates skyrocket—even for low-wage groups—compared to employees required to sign up for such benefits. In one study of workers earning less than $20,000 a year, Orszag said, only 13 percent of employees voluntarily signed up for tax-deferred retirement plans, compared with 80 percent participation for workers enrolled by default. He added that benefits continue to accrue for employees whose personal contributions are placed in diversified funds that automatically increase over time, and when accounts roll over when workers change jobs. "You should not need a Ph.D. in financial economics to navigate the pension system," Orszag said. "The defaults should make more sense than they currently do."

Shoven said that he is frustrated when critics argue against replacing or supplementing existing "guaranteed" benefits with "risky" individual accounts. "Traditional Social Security is not safe; it is quite risky," he said. "If it were guaranteed, we wouldn't be talking about cutting it. Risks depend on the evolution of mortality rates, fertility rates, immigration rates and productivity growth rates—things we can't forecast very accurately." In the past, Shoven said, the United States has raised the retirement age and taxed Social Security benefits. "We've made cuts in the past, and we'll make cuts in the future," he said.

Both economists agreed that saving Social Security requires either cutting promised benefits or raising taxes—nothing else works. "There is no other magic bullet out there," Orszag said.