March 31, 2004

Recently the  trustees of the Social Security and Medicare systems made two important findings.  They announced that under current law and prevailing growth assumptions, social security will remain solvent until 2042.  Medicare will run out of cash under these conditions by 2019. 

The social security date was unchanged from the previous assessment.  However, medicare was expected to exhaust its cash six years earlier than previously.  The passage of the prescription drug measure and its subsequent cost revisions led to the latter conclusion. 

In fact, neither fund has cash accumulated for future needs.  Instead, the Treasury accounts for the receipts from payroll taxes and the benefits provided to the two programs and notes whether the difference is positive or negative.  This is added to the accumulated surpluses in the programs, but only the good faith and credit of the government even now supports these benefits. 

That either fund runs out of resources to support promised benefits means that actuarial problems exist with the programs.  For social security, the current value of expected liabilities exceed expected revenues by almost $3 trillion.  The liability is less for medicare, as the program is smaller, but the deficit exceeds $1 trillion. 

When such problems develop for private pensions, the entities supporting those pensions must divert income to increase the pension pool, even if it creates a loss for those entities.  For instance, IBM put well over a billion into its pension programs in the past few years to assure that pensions will be there when employees retire. 

Not only are these government programs not required to remove actuarial deficits at all deliberate speed, but they also are not receiving adequate investment returns for the surpluses currently being created in the programs.  The fund surpluses only receive credit as if they were invested in short duration government bonds.  Any private program that had such an investment objective would be subject to legal suit for violating fiduciary responsibility. 

Frankly, the Presidentís request and the Congressís acquiescence in adding to the actuarial liability of the medicare program, when it already had problems, would not be permitted in the private sector.  The inadequate funding of new benefits should have received much more attention than it did. 

At a minimum, future benefits from these programs are put at risk.  Federal Reserve Chairman Alan Greenspan already has mentioned a combined reduction in benefits (or at least a further delay in receiving them) and increase in taxes to improve the soundness of social security.  And that programís position has not deteriorated as much as medicare. 

Alternatively, tax increases may be needed in the future to assure the soundness of these government retirement programs. 

A minor palliative can be achieved by establishing a true fund and investing the proceeds to achieve higher returns over time.  Of course, that would require putting more than $1 trillion of government debt into the market place (that is about the size of the accumulated surpluses between benefits and payroll taxes that are on the books currently). 

As the fund managers would have that trillion to invest, the impact upon financial markets might not be dramatic.  However, any shift from government to private demand for financial assets of that magnitude would have some impact upon the economy.  (Despite the positive demand for equities, I would assume that the higher interest rates that probably would prevail would have a greater restraint on the economy than the higher equity values could offset.)

The Presidentís solution of creating private investment accounts managed by individuals would lower the actuarial deficit but accelerate the cash flow shortfall.  In other words, the social security actuarial deficit would shrink but the absence of some contributions would exhaust social security funds even sooner than currently projected. 

Although experts will debate the merits of the current prescription drug program, having a medical program that includes drug therapy makes much more sense than medicare prior to the Presidentís initiative.  Hospitals should not be used to get prescriptions, which is almost the only way the old indigent can get funded drug therapy today. 

Therefore, we must develop a comprehensive program that is adequately funded or admit to the children of our seniors that they will not receive the same benefits that currently are available to their parents. 


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