When I heard the announcement on Tuesday about Social Security and Medicare, I emoted something between a grin and a grimace, and said, “A pity that I have been right on this.”  I’ve always felt that Social Security and Medicare  have had optimistic economic assumptions.  It does not surprise me that the year that Social Security revenues are exceeded by expenses has moved in by one year, from 2017 to 2016.  Medicare, we are already exceeding revenues in 2008 and now.

Many focus on when the trust funds will run out — now 2017 for Medicare, and 2037 for Social Security.  Consider this, the trust funds are invested in nonmarketable US Treasury Notes.  That’s safe, right?  Safe, yes, as safe as the US government.  They will pay with the dollars that they print via their stepchild, the Fed.

This is my advice to all who read me.  Given that these social insurance programs invest only in US government debt, on an accounting basis, it makes sense to unify their balance sheets with that of the US government.  Once we unify the balance sheets, it is easy to realize that the negative consequences will come when expenses exceed revenues, not when the funds go to zero. When expenses exceed revenues, the US government will either need to tax or borrow more in order to make ends meet.  The US Government bonds held are a convenient accounting fiction to show that the taxes paid have been spent for other purposes.  There are no “Trust Funds,” only nonmarketable bit of US debt, that will get repaid through higher taxes, or further borrowings.  China and OPEC, ready to fund US retirements in style?

As for the economic assumptions that Social Security uses, I think they are still optimistic.  One thing I have learned about cash flow modeling is that though the averages matter, the early years matter the most.  There is more time for their results to compound with interest.

We could have two more bad years (flat/down GDP on average), and then face the total system revenue breakeven in 2013.  Even if their assumptions prove correct, total system breakeven will come in 2014-2015.

And the markets will react ahead of that, because it will be so well known.  The need for tax revenues will be significant, and more so as we proceed into the 2020s.  This will lead to the need for solutions — with Medicare, much sooner than Social Security.

Medicare

Possible solutions (and their liabilities):

• Nationalize the healthcare system and Medicare goes away.  (Medicare is solved, at the expense of creating a bigger problem.  Other cultures may fit nationalized healthcare, but American will chafe at it.)
• Create a second parallel healthcare reimursement system that only serves Medicare clients with limited services to those that are terminally ill.  Ease the pain, but nothing radical and expensive.  (I like this one, so it can’t be a good idea.)
• Raise taxes.  (lower the reasons to employ labor)
• Raise eligibility ages, and quickly. (Listen to the screams.)
• Lower reimbursement rates. (Also won’t work because fewer doctors will do Medicare medicine… and quality drops as well.)
• Mandate that doctors must take Medicare clients at Medicare rates.  (Nasty.  But once rights of contract get violated in one place, they get violated in others.)
• Eliminate plan D, the drug prescription benefit.  It’s young and too complicated, so just kill it.
• Means-test eligibility for reimbursement.  (It would lose political legitimacy.)
• Terminate the system, such that children born after 1/1/2010 don’t pay in, and would not receive benefits. (Doesn’t really solve the funding problem, unless mixed with some of the above.)

Social Security

Possible solutions (and their liabilities):

• Means-test eligibility for reimbursement.  (It would lose political legitimacy.)
• Raise taxes.  (lower the reasons to employ labor)
• Raise eligibility ages, and quickly. (Listen to the screams.)
• Lower benefit payments. (More screams.)
• Remove the cost of living adjustments, and inflate the currency.  (At least this rates the problem back to the Baby Boomers, who would get hurt the worst over this… a generation that failed to save and produce enough kids.)
• Terminate the system, such that children born after 1/1/2010 don’t pay in, and would not receive benefits. (Doesn’t really solve the funding problem, unless mixed with someof the above.)

“I’ll Gladly Pay You Tuesday for a Hamburger Today.”

The nature of the US government, the lower Federal governments, many of its corporations, and some of its people has been to promise/borrow today, and pay it off later, because tomorrow will be, much, much, better than today.  With the the debt overhang and the looming pension crises, we are beginning to see that much American prosperity was a debt-fueled illusion.  We are presently in stage 1 of dealing with the grief of this shattered illusion — denial.

If the Federal Social Insurance schemes (Social Security, Medicare, Veterans Pensions, Old Federal Employee Pensions) and most State Pensions and Elderly Medical Care are going to pay off, taxes will have to be raised significantly.  That will be one nasty political fight, which might result in the death of certain sacrosanct laws governing the inviolability of pension promises to state employees, and perhaps Federal employees.  Also note, you can raise tax rates, but if it harms the economy, you will get less taxes.

The Federal Government will try to borrow its way out of the problem, until foreign creditors finally rebel, realizing they are throwing good money after bad.  After that, taxes will have to be raised, or promises abandoned/reduced.

For underfunded private defined benefit and retiree healthcare plans, they will likely be terminated, and lesser benefits paid.  All three of the legs of the modern retirement tripod (social insurance, savings, and pensions) are under threat as the era of debt deflation progresses.

Now, realize that though I talk about the US, most of the rest of the developed world is in worse shape as the demographic crisis affects pensions and elderly healthcare globally — they had even fewer kids than in the US, which is close to replacement rate, and so the ratio of workers to those supported will fall even more than in the US, setting up many nasty political fights — all the more nasty, because the governments are much more heavily involved already.  Don’t even think about China, which will come to regret the one child policy that led to so many abortions, and so many beautiful Chinese girls coming to the US to be adopted.

So What’s a Year Worth?

A year can teach us a lot.  2008 showed us the limitations of our economy.  Future years will show us the limitations of the power of our governments.  Conditions for prosperity can be created, but prosperity can never created by governments.  That is up to the culture of those governed.

This has gotten a bit long, so I will do a follow-up piece within a few days.  Here are a few good articles to consider:

• The Big Problems with Social Security
• Alarm Sounded On Social Security
• Recession Hits Social Security Projections

This entry was posted on Thursday, May 14th, 2009 at 10:11 am and is filed under Macroeconomics, Pensions, Personal Finance, public policy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.