Wednesday, October 13, 2004

Sen. John Kerry is scheduled to speak at the AARP today, an organization that has focused most of its recent energy on Social Security and Medicare reform.

President Bush’s and Mr. Kerry’s positions on those issues are well differentiated by now. While Mr. Kerry opposes creating personal accounts for Social Security, Mr. Bush favors giving workers more control over their retirement savings. Recent media reports, including in the Wall Street Journal (Sept. 2, 2004, “Ambitions to fix Social Security present big hurdles for Bush.”), claim the Bush transition to personal accounts could cost up to $2 trillion over the next 75 years.

These so-called $2 trillion in “transition costs” are misleading because they simply represent payments already promised under Social Security — costs not properly tracked in the government’s current budget. While adoption of personal accounts would still require tough choices, personal accounts make explicit the costs of benefit promises implicit under current Social Security laws.

The language of “transition costs” diverts voters’ attention from the real cost they should examine: the cost of inaction.

According to Social Security’s independent chief actuary, this program currently faces a present value imbalance of $10.4 trillion. Without reform, this imbalance will grow by about $322 billion next year. Including Medicare’s $62 trillion present value financial imbalance, the two programs’ unfunded obligations will grow by a staggering $2.2 trillion next year alone.

That is why Mr. Kerry’s recent statements on Social Security and Medicare are so troubling. Besides opposing personal accounts, he promises to not reduce scheduled benefits — not even to control real benefit increases over time.

Under current law, Social Security benefits grow with wages and, therefore, faster than inflation. That can only mean that if Mr. Kerry takes any initiative to reduce Social Security’s financial shortfall, it will favor tax increases.

And for Medicare, Mr. Kerry wants to expand the new prescription drug benefit by eliminating the “donut hole” in insurance coverage. Again, that can only point to a tax increase to solve Medicare’s financing problems. In contrast, Mr. Bush has offered at least a couple of suggestions for containing Medicare’s cost growth via Health Savings Accounts.

Just how much would taxes have to increase if the growth in benefits in Social Security and Medicare were not contained? Using data produced by the independent actuaries at the Social Security and Medicare programs, we calculate payroll taxes would need to rise 17.4 percentage points — permanently. In other words, the current employer-plus-employee payroll tax rate of 15.3 percent would need to more than double.

Our 17.4 percentage point estimate is, if anything, very conservative:

(1) The calculation assumes the permanent tax raise is done immediately. If the tax increase were delayed just four years until 2008, more than $9.4 trillion in additional fiscal imbalances would have accumulated, requiring a tax increase of 19.7 percentage points.

(2) The 17.4 tax rate reflects the government’s projection of growth rates in future health-care costs. Those projections are substantially lower than the actual cost growth since 1965 when Medicare was adopted.

(3) This calculation assumes Mr. Kerry as president would not be able to expand the prescription drug subsidy — we simply assume he will not reduce Medicare benefits. Finally, we assume people keep working just as hard despite higher tax rates, thereby not shrinking the tax base.

In several recent interviews, Mr. Kerry has also suggested the Social Security and Medicare problems could be avoided with a stronger economy. However, under current law, the wage-indexed Social Security benefits grow with the economy and Medicare outlays tend to grow even faster. Faster economic growth, therefore, is not the cure for these ills.

More importantly, Mr. Kerry’s prescription puts the cart before the horse. He makes economic growth the policy instrument and the Social Security and Medicare programs the policy objectives. These roles should be reversed.

Social Security and Medicare reforms would expand domestic saving by reducing hidden liabilities and help fuel future economic growth. Conversely, failure to address these problems could lead to an anemic economy and lower living standards for future generations.

Jagadeesh Gokhale is a senior fellow at the Cato Institute. Kent Smetters is a professor at the University of Pennsylvania’s Wharton School.

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