Wednesday, January 20, 2010

Social Security and Medicare: "Trust Funds"

A few months ago John Lewis published a “dire warning” about the future of the economy. [] This article concerns the near future proportional increase in retirees, the Baby Boomers, and their impact on the costs of Medicare and Social Security. To say the least, it will make all of today’s arguments regarding the budget superfluous. All of the facts and figures are in the material that Dr. Lewis references. I will not include them here. This post is meant to talk through the things that are going to happen, especially the impact of the “Trust Funds” of Social Security and Medicare.

You will hear some politicians argue quite loudly that, even if there may be a problem down the road, it is not now because both programs have trust funds that will provide money for several years. The date that the government has to begin adding funding to both programs is, thus, some time in the future and they don’t worry about it now.

Well, yes, both programs have “Trust Funds”. That is, both programs have had more money paid into them over the years by taxpayers than the programs have paid out. This “surplus” has been put into a trust fund. Each trust fund has securities in it that may be exchanged for cash as needed, and the cash is then paid out in benefits. So, these politicians are correct, right?

The recent annual report of the Medicare Trust Fund revealed that this program is already spending more than the Medicare Tax is bringing in. The short fall began in 2008. Medicare has begun redeeming “Trust Fund Assets”. Because of the recent short fall, they now expect the “Trust Fund” to be exhausted in 2017.

The Social Security Trust Fund is still taking in more money than it is spending, but the recent troubles in the economy have, no doubt, changed the “projected” dates as well.

When the Medicare Administration projects that they will fall short of Medicare claims they will not cover 19% of the annual cost of the program. As these claims are “entitlements”, the shortfall would have to be made up by general Federal Government revenue, or taxes and the proceeds of bond sales. So, according to our politicians, we have 8 years to solve this problem, right? We have even more years to solve the Social Security problem.

Ahhh. Let’s take a look at those “Trust Funds”. That money is invested in securities, right? Well, depends upon your definition. What the administrators were allowed by law to buy with their “surplus” is a special class of Treasury Bonds. These bonds pay interest, which are probably close to market, so they are accumulating assets, right? Okay, we are at the crux of the issue now. The Treasury of the United States sells these special bonds to the “Trust Funds”, and guess what the Treasury did with the money? They put the money into the General Fund, and spent it as they did with all the other tax money and the proceeds from bond sales. And the accounting, you ask? The money from the “Trust Funds” reduced the annual deficit of the Federal Government. The Treasury had to sell fewer bonds.

Administration after administration has been spending the Social Security and Medicare surpluses and pretending that it was general revenue, not some future debt. In many cases the administration crowed about the way it was decreasing the Federal Deficit.

In this case, however, it isn’t like the standard Treasury Bond that no politician expects to ever pay back. These special “Trust Fund” bonds have to be paid back as the two entitlement programs fall short of meeting their required payments from the FICA taxes. In practice, it means that the Treasury will have to sell more standard bonds. Did anyone say Ponzi?

I ask you, what is the difference between taking money from taxes and the proceeds of bond sales and redeeming special bonds for covering Medicare expenditures, and giving the money directly to Medicare after the “Trust Fund” Bonds are depleted? The Trust Funds are a standard government fiction, which allows some (many, most?) politicians to duck the issue.

Social Security is “projected” to need to dip into its “Trust Fund” in the middle of the next decade. Like any government projections, the government planners have foretold of wonderful years of tax collection because the economy will be booming and employment will be below 5%. Even if you count all of the non-employed as tax payers, there are far more than 5% unemployed, and current prognoses, even from the most optimistic government hack is that the employment part of the recovery will be slow. The number of retirees is growing, maybe even faster than expected (for Social Security), thus the outflow is growing at least as fast as expected, but the income is less, probably a lot less. That means that Social Security will begin drawing on its “Trust Fund” sooner, and more Treasury Bonds will need to be sold, more money will be taken from the economy, which means either less capital for investment and slower growth (if any) or more made-up money, i.e., inflation.

All of this will be on top of whatever programs our beloved leader can manage to get passed.

Some of you are eager for the end of the year when the Democratic strangle hold on our government will hopefully be reduced. I tend to think that a mix of Dems and Republicans is a nice safe government. But it won’t help this situation, because it will require a direct look at reality and the willingness and ability to tell the American citizen, especially the older American citizen, that the cupboard is pretty skimpy. The Republicans, who are after all, working to “conserve” the New Deal, have shown just as much willingness to ignore reality as the Dems.

In the meantime we can watch the drama being played out in Japan. Their problems with the same issue are more immediate and proportionally larger than ours. More than half of their population is dependent upon the government pension. Their elderly tends to depend upon their children, but that percentage is declining. The aging of the Japanese population is more rapid than other industrial countries. At the same time the population is shrinking.

The government has been steadily pushing up the retirement age and the age that government pensions begin. Japanese use to retire at age 50, now it is 60. The government pension begins at age 65, up from age 55. So a Japanese has a 5-year period that has to be filled in somehow.

But, get this, the taxes to support the retirees is a combined 30%, down from 40%. Part is paid by the employee and part by the employer. In the U.S. the combined tax is 15.3%.

Where are they going to get the income to support their elderly? The same place we will? We may be seeing real tragedies both at home and abroad. The European countries are heading for the same problem at various speeds, most of them will begin to see major problems before we do.

When we get done with the health insurance thing, whichever way it goes, we need to begin beating upon these people about this coming storm.


  1. Finally an honest appraisal of the nature of the problem.

  2. Thank you for that compliment. I would appreciate it if you told others. I would like the traffic!