Social Security and Medicare

Abstract

Social Security and Medicare are important government programs that provide income and assistance to a great number of Americans. Social Security is a critical safety net that helps people avoid poverty due to retirement, disability, or the loss of a loved one. Medicare allows people access to healthcare that could otherwise be financially ruinous or nonexistent. These programs, while popular, present a significant financial challenge to the entire nation. This article reviews the basics of each program and then moves on to discuss the financial challenges posed by each program.

Keywords Healthcare; Medicare; Retirement; Social Security

Insurance & Risk Management > Social Security & Medicare

Overview

Social Security

During the Great Depression, from 1929 to 1933, the U.S. economy declined by 4 percent annually, and personal income dropped by 50 percent. In 1934, President Franklin D. Roosevelt appointed the Committee on Economic Security to investigate solutions to the economic turmoil and promised "a New Deal for the American people." The committee concluded that people of the country needed some protection from the misfortune that could not be wholly eliminated from the world. On August 14, 1935, Congress responded and Roosevelt signed the Social Security Act (SSA), declaring that it was "a law that will take care of human needs and at the same time provide for the United States an economic structure of vastly greater soundness."

Initially, the SSA covered only workers in commerce and industry and only provided retirement benefits, scheduled to begin in 1942, for workers aged sixty-five and older. In 1939, Congress moved the start date to 1940 and extended benefits to dependants of retired workers and to survivors of deceased workers. In 1950, Congress expanded Social Security mandatory coverage to include self-employed persons and gave state and local governments and nonprofit organizations the option to cover their employees. In 1983, Congress extended mandatory coverage to federal civilian employees and nonprofit employees and prohibited withdrawal of any state or local government that had previously elected to cover their employees. Initially, Social Security covered 56 percent of the workforce; in the early twenty-first century, it covers 96 percent (Pratt, 2011).

Social Security is a form of social insurance that requires gainfully employed people to pay taxes that fund benefits for the retired, disabled, and their dependants. Social Security is generally described as "pay as you go," because the benefits paid to current beneficiaries are financed by taxes paid by current workers; taxes are not saved to repay benefits when a contributing employee retires. While Social Security is often thought of as a retirement program, only about two-thirds of the beneficiaries were retirees in 2014. The program includes retirement benefits, disability benefits, dependant benefits, and survivor benefits. These benefits are designed to work together to provide employees and their families with income when their regular source is interrupted by retirement, death, or disability. All benefits are determined according to the salary or wages covered by Social Security. Workers pay premiums or "federal insurance contributions." Those contributions are matched by employers, and the system pays benefits that a worker has earned by paying premiums. Each employee and employer pays 6.2 percent each for a total of 12.4 percent of their gross wages up to a maximum taxable base of $117,000 in 2014. Self-employed persons pay the entire amount themselves.

The payroll taxes are paid to the IRS and divided between two trust funds: the Federal Old-Age and Survivor Insurance Trust Fund (OASI Trust Fund) and Federal Disability Trust Fund (DI trust fund) (together the OASDI). The OASI Trust Fund is used to pay retirement, survivor's and dependant's benefits and receives approximately 85 cents of every dollar of Social Security tax received. The DI fund is used to pay disability benefits and receives approximately 15 cents of every Social Security tax dollar. Less than 1 percent of the taxes collected go to administrative costs. The trust funds are part of the Treasury and are governed by a board of directors, composed of the Secretaries of Treasury, Labor, Health and Human Services, the Commissioner of Social Security, and two public trustees who serve for four-year terms (Pratt, 2011).

The OASDI Trust Fund is a series of accounting entries made by the United States Treasury Department. Benefits paid to Social Security beneficiaries are paid by the Treasury and coded as expenditure in the government's budget, and later debited from the trust fund. When Social Security payroll taxes are paid, the Treasury records those taxes as income to the federal government and as a credit to the trust fund. If trust fund revenues exceed expenditures, those excess proceeds are used to buy non-marketable government securities. The Treasury credits the trust fund with an increase in assets and also pays interest on those securities. The interest credited to the trust fund further increases its assets. The interest paid on the trust fund has no effect on the overall budget and is simply an intra-governmental transfer; the trust fund assets are like IOUs signed by the federal government. While the trust fund balance is positive, the Treasury has the legal authority to pay Social Security benefits. If the trust fund balance is zero, the trust fund becomes "insolvent"; the Treasury may still pay benefits, but those benefits cannot exceed revenues flowing into the Treasury and credited to the trust fund accounts.

Medicare

Medicare, established in 1965 by the Health Insurance for the Aged Act (officially Title XVIII, an amendment to the Social Security Act), is a popular part of the United States healthcare system that provides premium-free health insurance for the elderly and disabled, and covers nearly everyone over the age of sixty-five. Medicare includes four programs, Parts A, B, C, and D. Medicare Part A, hospital insurance (HI), provides basic protection against the costs of in-patient hospital, related post-hospital, plant health services, and hospice care. Medicare pays part of those medical expenses, the beneficiary is responsible for deductibles and copayments, and nursing home care is generally not covered. Medicare Part A is funded primarily by a payroll tax that functions similarly to the Social Security tax. Employers and employees each pay tax equal to 1.45 percent of wages for a combined tax rate of 2.9 percent on the first $200,000 of income for an individual or $250,000 for couples filing jointly. The tax on income above those amounts was raised to 3.8% in 2013. Generally, any person over age sixty-five eligible to receive Social Security old age benefits is also eligible for Medicare Part A; even if that person is not yet receiving Social Security, typically because they may still be working. The Centers for Medicare and Medicaid Services reports that in 2015, Medicare covered about 55 million people.

Medicare Part B is a voluntary Supplementary Medical Insurance (SMI) program that covers medical expenses outside of Part A; for example, physicians' services, outpatient hospital services, home health care, physical therapy, and medical equipment. Part B coverage is typically available to anyone who is eligible for Part A, but unlike Part A, Part B requires the payment of a monthly premium. The premiums paid by beneficiaries under Medicare Part B are designed to meet 25 percent of the program costs. The remaining 75 percent is paid by the federal government from general revenues (Pratt, 2011). Part B premiums in 2015 were approximately $105 per month. In 2006, a surtax for higher-income seniors was added.

Medicare Part C, formerly known as Medicare+Choice and renamed Medicare Advantage in 2000, is an optional program for Medicare beneficiaries enrolled in Medicare Part A and B. Medicare Advantage offers increased coverage for expenses not covered under A or B. Medicare Part D is a voluntary prescription drug program created by 2003 legislation that became effective in 2006. Enrollees pay a monthly premium and annual deductible for this prescription drug plan. The amounts of the premiums and deductibles vary based on the type of plan an enrollee chooses, as well as the enrollee’s income—a surtax similar to the one for Part B was added in 2010. In 2014, about 16 million people, roughly 30 percent of all Medicare enrollees, were enrolled in Medicare Advantage, and an additional 23 million, or approximately 42 percent, were enrolled in Part D.

Medicare is administered by the Centers for Medicare and Medicaid Services (CMS), previously called the Health Care Financing Administration, which is part of the Department of Health and Human Services. CMS issues manuals and other directives containing its interpretation of the Medicare statutes and regulations. These publications form the bases of decisions as to whether items and services are covered by Medicare, and if so, to what extent. The CMS also sets standards that must be met by hospitals, skilled nursing facilities, home health agencies, and hospices in order to be certified and qualified providers of Medicare services.

Applications

Social Security is enormously popular, and contemporary debate centers on how to fund the programs in the face of an increasing number of elderly Americans. The OASDI annual cost is projected to increase from approximately 14 percent of taxable payroll in 2010 to about 17 percent in 2037, while its projected non-interest income remains at 13 percent. The unfunded obligation of the Social Security system through 2087, according to its trustees, is $9.6 trillion. The Report of the 1994-1996 Advisory Council on Social Security (Advisory Council Report) identified four major areas of concern: the program deficit, long-term deterioration of the program's financial status due to the aging U.S. population, and the relationship between Social Security taxes and benefits and public confidence, particularly among young people (Pratt, 2011).

On March 21, 1998, sixty-three years after President Roosevelt signed the SSA into law, President Bill Clinton, in a radio address, discussed the problem posed by Social Security:

The problem with Social Security, while not imminent, appears inevitable. The heart of the problem is that the promised benefits will exceed the program revenues as the baby boom generation begins to retire and as medical advances continue to extend life expectancy. The Social Security Trust Fund has two sources of revenue: payroll taxes and interest on money in the fund that is held in bonds. Since 2010, Social Security expenditures have exceeded non-interest income (i.e., income from taxes), and expenditures are expected to exceed all income (from taxes and interest) starting in 2021. After that time, the government will have to start dipping into Trust Fund reserves to cover benefits. In 2015, the Social Security trustees estimated that the fund would then be depleted by 2034 (an update of Clinton’s estimate of 2029). Thereafter, tax revenues will be sufficient to pay about 75 percent of benefits, as Clinton stated (Blahous & Reischauer, 2013).

In addition to the significant problem posed by Social Security, Medicare poses an even greater financial challenge for the country. Aging baby boomers and sharply increasing health care costs are straining the Medicare system. Increasing health care costs are a problem because they are rising much faster than economic growth. Medicare is financed by taxes levied according to the payroll generated by economic activity. Therefore, the taxes received will be insufficient to meet costs that increase at a higher rate. Specifically, health care costs are expected to continue to rise as a proportion of GDP (gross domestic product), while Medicare revenues remain stable, assuming the Medicare tax rate stays at 2.9% of taxable payrolls. Medicare spending is thus on an unsustainable course (Hakkio & Wiseman, 2006).

Medicare HI, Part A, expenditures are projected to grow rapidly according to the same demographic factors affecting Social Security. Unlike Social Security, which is based on past earnings, Medicare is based on the increasing future cost of health care. The depletion of the Medicare and HI Trust Fund will generally occur in same manner as the Social Security Trust Fund. However, Medicare is further along in the process. Medicare expenditures have exceeded program revenues (taxes and interest) since 2008, and the HI Trust Fund is projected to be depleted by 2026. Similar to Social Security, at that time, Medicare expenditures will have to be cut to equal dedicated revenues. In 2026, the dedicated HI taxes will pay only an estimated 87 percent of promised benefits. And by 2087, the dedicated revenue from taxes will cover only 73 percent of benefits (Blahous & Reischauer, 2013).

Medicare SMI, Part B, expenditures are projected to increase for the same reasons as the HI costs — demographic changes due to the baby boom generation and rising healthcare costs. Part B expenditures are projected to rise from 2 percent of GDP in 2012 to about 4 percent in 2087, assuming the current system where premiums paid by beneficiaries cover 25 percent of the expenditure and the federal government covers the remaining 75 percent. Unlike Social Security and Medicare HI trust funds, the SMI Trust Fund has unlimited authority to draw funds directly from general government revenue as needed, which prevents a gap between funds needed and benefits promised (Blahous & Reischauer, 2013).

Both Social Security and Medicare are primarily funded by payroll taxes that increase with GDP. Therefore, those revenues become insufficient to cover expenditures that are increasing faster than the GDP. As a result, total federal spending on the two programs will have to increase consistently. In 2012, the federal government spent 8.7 percent of GDP to finance the programs; in 2087 that number is projected to be 12.7 percent (Blahous & Reischauer, 2013).

Insights

The programs' overseers argue that the financial challenge posed by Social Security and Medicare should be addressed as soon as possible. An earlier solution would give people the opportunity to adjust their plans for working, saving, and retirement spending to meet their retirement goals. Additionally, the problem becomes larger the longer reforms are delayed, requiring more drastic solutions. For example, the Medicare shortfall in 2005 was 5.7 percent of GDP. At that time, Hakkio and Wiseman (2006) argued that if nothing were done until 2021, and the Medicare HI Trust Fund becomes depleted, the shortfall from 2021 to 2080 would grow to 7.5 percent of GDP. An immediate remedy to eliminate the unfunded liability for the Medicare HI Trust Fund would require a payroll tax rate increase from 2.9 percent to 5.99 percent. To fix Medicare in 2021, the payroll tax would have to be increased to 3.79 percent and continue increasing to 12.33 percent in 2079. To eliminate the Social Security Trust Fund's seventy-five-year unfunded liability, Hakkio and Wiseman estimated the Social Security payroll tax rate would need to be increased from 12.4 percent to 14.32 percent. If the government waited until 2041 to fix Social Security, the tax rate would have to increase to 16.66 percent and continue increasing to 18.10 percent in 2079 (Hakkio & Wiseman, 2006). Kashin, King, and Soneji (2015) later found that the Social Security Administration's own annual forecasts for population change, in particular mortality rates, and for the solvency of the trust were skewed beginning in 2000, with projected trends being overly optimistic based on the real-world data that subsequently emerged.

Opponents of Social Security reform argue that if depletion occurs, it will not do so until 2033 and that date is too far in the future to warrant immediate, drastic measures, when the system is not anywhere near insolvency. Those in favor of reform claim that action is needed more urgently. As mentioned, the Social Security Trust Fund is a series of accounting entries. The balance of the Trust Fund is a recorded number that represents the difference between the total taxes collected and the total benefits paid out. Once the Treasury credits the Trust Fund account, the money is spent on other government operations. As the baby boom generation begins to retire, the excess of income over costs will soon start to decrease and reach zero. After that, the Social Security Administration will have to start liquidating accumulated government bonds. To raise the money to honor those bonds, the government will have to increase taxes or cut other government programs. Therefore, supporters of reform argue, the impact on the government's overall financial condition would be profound, and should be headed off as early as possible.

Conclusion

The looming potential crisis for these two massive federal programs has spurred political reaction and attention. The report of the 1994–1996 Advisory Council on Social Security identified four major areas of concern: the estimated deficit for the traditional seventy-five-year projection period; the long-term deterioration in the program's financial status; the relationship between Social Security taxes and benefits; and the public's confidence in the system, particularly with regard to young people. In 1999, President Clinton proposed using the projected federal budget surpluses to improve Social Security's financial condition and to invest part of the funds in the stock market. Clinton also proposed universal savings accounts to supplement Social Security and private pensions. These never came to pass, however. President George W. Bush promoted partial privatization of the Social Security system as a major piece of his domestic agenda, but his proposals never gained traction in Congress. Bush did, however, sign the 2003 Medicare Prescription Drug, Improvement, and Modernization Act, a significant overhaul of the program that created the prescription drug benefits contained in Medicare Part D. In 2010, the Patient Protection and Affordable Care Act signed by President Barack Obama included a number of measures intended to reduce the cost of Medicare. However, the most basic problems with the long-term viability of Social Security and Medicare remain politically charged issues that have yet to be successfully addressed.

Terms & Concepts

• Beneficiaries: People who claim benefits under Social Security or Medicare. Generally, a party designated to benefit from an arrangement.
• Dependant Benefits: Benefits paid to the spouse or child of a worker who paid Social Security tax.
• Disability Benefits: Benefits paid to contributors to the Social Security tax on their earnings who are disabled and have limited incomes, including children under 18 years old.
• Dedicated Revenue: Government income committed to a particular purpose, e.g., Social Security and Medicare tax are revenue dedicated to pay benefits under those programs.
• Federal Disability Trust Fund (DI trust fund): The Social Security trust fund dedicated to the payment of disability claims under program.
• Federal Old-Age and Survivor Insurance Trust Fund (OASI trust fund): The Social Security Trust Fund dedicated to the payment of retirement benefits under program.
• Insolvent: A condition where promised benefits exceed dedicated revenue; generally, the condition of being unable to pay debts as they become due.
• OASDI: The acronym that refers to both the Federal Disability Trust Fund (DI trust fund) and the Federal Old- Age and Survivor Insurance Trust Fund (OASI trust fund).
• Retirement Benefits: Benefits paid to employees that are "fully insured" — because they have paid Federal Insurance Contribution Act (FICA) taxes for the required period of time — are over the age of 62 and have filed for eligibility within one month of reaching retirement age.
• Social Insurance: Insurance provided by the government to persons facing particular perils (e.g. disability) or who have achieved a certain status (e.g. retirement age).
• Survivor Benefits: Social Security payments made to dependants of an eligible worker after that worker has died.
• Unfunded Liability: The extent to which promised benefits exceed dedicated revenue.

Bibliography

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Blahous, C. P., & Reischauer, R. D. (2013). A summary of the 2013 annual reports: Social Security and Medicare boards of trustees. Social Security Administration. Retrieved November 21, 2013 from http://www.ssa.gov/oact/trsum/

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Suggested Reading

Federal financial management: Critical accountability and fiscal stewardship challenges facing our nation: GAO-07-542T. (2007). GAO Reports. Retrieved April 8, 2007 from EBSCO online database Business Source Complete http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=24272563&site=ehost-live

Ferguson, R. W. (2013). The road ahead: The graying of America and its implications for finance and the economy. Business Economics, 48, 108–112. Retrieved November 21, 2013 from EBSCO online database Business Source Complete http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=87656194

Novack, J. (2014, October). New survey: Americans OK with tax hikes to protect Social Security. Forbes, 13. Retrieved November 25, 2014, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=99042323&site=bsi-live

Pattison, D. (2015). Social Security trust fund cash flows and reserves. Social Security Bulletin, 75(1), 1–34. Retrieved December 9, 2015, from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=100959219&site=bsi-live

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Yang, P., & Barrett, N. (2006). Understanding public attitudes towards Social Security. International Journal of Social Welfare, 15, 95–109. Retrieved April 8, 2007 from EBSCO online database Academic Search Premier http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=20060168&site=ehost-live