Gaping entitlement imbalance

The U.S. Social Security and Medicare Trustees’ Reports recently released show new “present value” measures of financial imbalances in the nation’s entitlement programs.

The measures show very large financial imbalances. Social Security faces an imbalance of $10.4 trillion, while Medicare’s imbalance is 6 times larger at $61.6 trillion — for a combined shortfall of $72 trillion.

These numbers confirm our own calculations for the president’s 2004 budget — widely reported in the news last year — were, if anything, quite conservative. Indeed, the president later signed a prescription drug bill the trustees estimate will cost nearly another $17 trillion in present value.

This eye-popping $72 trillion shortfall will not be immediately obvious to some readers of the Trustees’ Reports. The Reports officially claim Social Security and Medicare face a combined imbalance of $32 trillion because they assume Medicare will receive $40 trillion from general revenue.

To be sure, the law commits Congress to fund a large portion of Medicare using general revenue. But Congress has not actually allocated this money, and so the true financial strain of these two programs is $72 trillion.

The present value approach now adopted by the Social Security Trustees discounts (that is, reduces) future cash-flow shortfalls to recognize that preparing to pay $1 owed in the future requires putting aside less than $1 today because the sequestered amount can earn interest in the meantime.

Thus, the new approach places present and future dollar flows on an equal footing (that of the present) before adding them. The trustees’ calculations project shortfalls in America’s entitlement programs so massive that, even after reducing them at the government’s interest rate, they total a whopping $72 trillion today.

The new estimates show the amount of funds the government would have to “set aside” today to finance future shortfalls. Of course, the government cannot set aside $72 trillion immediately. Indeed, this imbalance is almost double the value of America’s total wealth, including the value of all companies, homes, autos, durable goods and everything else.

Instead, this shortfall must be met from increasing revenues or cutting costs over many years. No doubt, these policy reforms will require sacrifice. But they will be less burdensome if we act immediately rather than postpone action.

Although many economists from different political persuasions agree on the need for present value analyses of programs with significant long-term implications, the new shortfall estimates have opponents.

Critics argue making projections even over a few years is fraught with uncertainty: So how could we be confident about estimates incorporating shortfalls well into the distant future?

This criticism, however, is misplaced. First, ignoring the future is not the correct response to uncertainty. Second, the problems facing Social Security and Medicare are driven by relatively stable and predictable long-term demographic trends. Indeed, predicting next year’s budget deficit is relatively harder because it is subject to more volatile short-term economic shocks that average out over a longer horizon.

Finally, our own study has shown the range of policy changes needed to place the nation’s entitlement programs on a sustainable course are not very sensitive to changes in most underlying assumptions — with one very important exception.

That exception is the assumed growth rate in future health-care outlays. In their calculations, the trustees assumed federal health-care outlay growth will exceed growth in gross domestic product (GDP) by just 1 percentage point during the next several decades. However, historical experience shows overall medical expenditures outpaced GDP by about 2.3 percentage points during the last 20 years.

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