Many commentators have claimed that Republicans in Congress were wrong to boo President Biden when, in his February 2023 State of the Union speech, he accused congressional Republicans of wanting to sunset Social Security and Medicare. These commentators had one or both of two objections: it was unseemly to boo, and they shouldn’t lock themselves into a position of not being willing to reform Social Security and Medicare because both trust funds will run out of money next decade.
I’ll focus on the second point. Whatever you think about whether Social Security and Medicare should be sunsetted, you don’t have to believe that they should be to understand that some major reforms must be done to keep those programs viable—and sooner rather than later. So, Republicans and others could oppose sunsetting those programs while still wanting long-term reforms.
Many kinds of reforms could be done. I’ll discuss a few. To set the stage, we need to consider three things: the budget crunch, the difference between Medicare and Social Security spending, and the difference between reforms that take effect within a year or two and reforms that are further out in time. The former have virtually no chance of succeeding; the latter could succeed.
The Budget Crunch Is Coming
Imagine you’re out in the jungle and that in front of you is a steep, miles-long cliff on either side of your location. You see a stampeding herd of elephants coming your way. Unless something very unlikely happens, they will soon be trampling you. Should you act on that information now or wait until the elephants are on top of you? Easy answer, right? You should act now.
The coming shortfall in revenues to pay for Medicare and for Social Security is like that herd of elephants. We can see it coming and if we do nothing, it will be here. Our one big advantage over the elephant scenario is that we have approximately one decade to make reforms so that we don’t get “trampled.”
Last week, the US Treasury, following a long tradition of reporting bad information on a Friday, released the Social Security and Medicare trustees’ reports on Medicare and Social Security. Although each report runs more than two hundred pages, the bottom line is the trustees’ estimate that:
(1) In 2031, the Hospital Insurance (HI) Trust Fund’s reserves will be depleted. After that, the revenues that the feds collect will pay only 89 percent of total scheduled benefits.
(2) In 2033, the Old-Age and Survivors Insurance (OASI) Trust Fund will be gone, and the revenues the feds collect will pay only 77 percent of total scheduled benefits.
I can see those elephants now.
The Big Difference between Medicare and Social Security Spending
If you had to choose between cutting the growth of Medicare spending and cutting the growth of Social Security spending, which would be the better choice? You might think there’s no way to tell. But if we accept the idea that people are, on average, better judges of their own welfare than the federal government is, then there’s a clear answer: cut Medicare spending and, at the same time, make it a program of per capita subsidies.
Here’s why. When Medicare beneficiaries use the program, they are spending other people’s money. The co-pays and deductibles they pay are typically a small fraction of their medical bills. And we spend other people’s money much less carefully than we spend our own.
That fact has a large implication. Someone on whom Medicare spends, say, $20,000 in a year is unlikely to value that spending at $20,000 or more. How would we tell? Give the person the $20,000 and see how she allocates it (because women outlive men on average, more than half of the Medicare beneficiaries are women. In 2017, 54.1 percent of Medicare beneficiaries were female and 45.9 percent were male). Because she then has the option of spending some or all of it on goods and services other than medical care, she may well choose that option. If she does, she is saying, with her “dollar votes,” that she values those other items more.
Social Security payments, on the other hand, are cash payments to the beneficiaries. So, we beneficiaries (I started collecting in 2017) can spend that cash however we want.
We don’t have good estimates of how much Medicare beneficiaries value one dollar in spending on them. It’s less than one dollar, but we don’t know how much less. However, in recent years health economists have come up with a measure of how much beneficiaries of a similar program, Medicaid, value one dollar of spending. In a June 2015 study published by the National Bureau of Economic Research, MIT health economist Amy Finkelstein, along with Nathaniel Hendren of Harvard University and Erzo F. P. Luttmer of Dartmouth College, used the Oregon Health Insurance Experiment to estimate that number. They found that beneficiaries of Medicaid spending value one dollar of Medicaid spending at between 20 and 40 cents.
How to Cut Spending
Let’s say that in 2024 and with no reforms, Medicare expenditures would be $950 billion and Social Security expenditures would be $1,450 billion. (Based on 2023 estimates, these numbers are roughly right and good enough for my illustration.) Let’s say also that the feds are choosing how to allocate a $50 billion cut. It would be better for us beneficiaries if it cut Medicare by the whole $50 billion and left Social Security untouched, making for $900 billion in Medicare spending and $1,450 billion in Social Security spending.
How could the federal government do this? It could turn Medicare into a per capita benefit. Medicare now spends $950 billion on approximately 65 million beneficiaries. So, spending $900 billion on 65 million people would give each person $13,800. The vast majority of people would value this $13,800 much more than they would value the amount that Medicare spent on their health care. A minority of people who would lose are those who are particularly sick. So, the reform could be altered to handle them.
Here’s how. Assume, as I think is reasonable, that most of the elderly on whom Medicare spends much more than $13,800 are people who are likely to be sick next year too. Let’s say that that’s 15 percent of Medicare beneficiaries. So, take the 15 percent on whom Medicare spent a lot last year and give them double what everyone else gets, while keeping expenditures at $900 billion. So, they would get $24,000 each while the remaining 85 percent would get $12,000 each.
This could be done quickly because probably tens of millions of Medicare beneficiaries would rather get $12,000 to $13,800 in cash rather than getting it in medical benefits.
How to Cut the Growth of Social Security Spending
What if, for whatever reason, we also need to cut the growth of Social Security spending? There are two ways, one of which would almost certainly fail to be put into legislation and one of which would have a good chance.
The way that would fail would be to cut promised Social Security spending only a few years in the future. Social Security beneficiaries would have little time to adjust and would strongly oppose such cuts. That’s what happened in May 1981 when newly elected President Ronald Reagan advocated cutting the early retirement benefit for people who retired at age 62 rather than at the then-standard age of 65. He wanted to cut the benefit by a whopping 31 percent and have the change take place in January 1982, giving those planning an early retirement only eight months to adjust. The outrage was so swift and overwhelming that the US Senate passed a resolution against it by a vote of 96 to zero.
The good news is that cutting benefits a number of years into the future is much easier. Here the story is often misreported. In December 1981, President Reagan formed a commission on Social Security to recommend reforms. It was headed by Alan Greenspan. In January 1983, the Greenspan Commission made its recommendations, and those recommendations did not include ever raising the age at which someone would receive full benefits. Instead, it was one heroic congressman who took the stance that “no way, no how” would a bill get out of his committee if it didn’t contain a gradual increase in the full-benefit age to 67. Who was this heroic congressman? A Republican from a safe seat? No, it was a Democrat from a safe Texas seat, Jake Pickle, who was chairman of the Social Security subcommittee of the House Ways and Means Committee. Ironically, his mentor had been LBJ, whose actions, along with President Nixon’s, had dug the Social Security hole deeper.
As Hoover fellow John Cogan notes in his 2017 book, The High Cost of Good Intentions, as we got closer to this age increase, there was little opposition. People had had over two decades to adjust. While that’s a long time, it’s plausible that giving people say, five years to adjust would be politically viable. If so, then some of the long-term Social Security problem could be addressed.
Higher Taxes a Bad Idea
Another way that some people advocate to deal with Social Security is to avoid cuts in the growth of spending but, instead, to raise the amount of income subject to Social Security taxes. In 2022, that amount was $147,000. This year it’s $160,200. It typically rises by the inflation rate plus a little. Some people propose that the cap be removed altogether. Others propose that it be raised substantially.
There are two problems with this proposal. First, it is profoundly unfair. Higher-income people already get a very low return on their FICA taxes, which are 6.2 percent on the employer and 6.2 percent on the employee, and a whopping 12.4 percent on the self-employed. Second, it would substantially reduce the work effort of the most productive people in the economy: remember that pay tends to reflect productivity. A single self-employed worker making $200,000 currently pays an overall marginal tax rate of a little over 40 percent (32 percent federal plus 2.9 percent for Medicare and about a 5 or 6 percent state tax rate in a typical US state). A 12.4 percentage point increase in the FICA tax would raise that person’s marginal tax rate by about 30 percent. It’s dangerous to impose such a huge tax increase on the country’s most productive workers.
If we are to avoid an ugly situation with Medicare and Social Security early next decade, we need to address it now. The proposals I lay out here are a road map for doing so.
