Wednesday, June 29, 2005

How much will Social Security and Medicare cost us in income tax increases in coming years?

The answer to this question is easy enough to find -- although rarely publicized. The Social Security Trustees provide the numbers for the projected future increase in the cost of Social Security and Medicare in percentage-of-GDP terms.

What these numbers mean in terms of required future income tax increases is given below.

Expressing them in terms of income tax increases serves two purposes:

(1) Current law requires these funding shortfalls to be made up with general revenue, which means income taxes (or the equivalent, such as additional borrowing that must be serviced with income taxes). So describing the future shortfall in terms of the additional income taxes that will be needed to cover it is entirely proper and realistic.

(2) Most discussions of the Social Security and Medicare funding shortfalls describe them in terms such as "percentage of covered wages" or the like -- which mean just about nothing to the average person. But we all know the amount of income taxes we pay, and we all know what an income tax hike of X% would mean to us. So describing the rising cost of these programs in terms of income tax increases gets a true picture of their cost across more clearly.


First we deal just with the trust funds that have absorbed your payroll taxes. If you have a paycheck it shows payroll taxes of 15.3% withheld -- 12.4% for Social Security plus 2.9% for Medicare Hospitalization program costs. To the extent these withheld taxes have exceeded actual program costs to date, they have been "invested" in the famous Social Security Trust Fund and the equally important if neglected-in-discussion Medicare Hospitalization (HI) Trust fund.

When the future program costs of Social Security and Medicare HI come to exceed their payroll tax revenue, the assets in these trust funds will be liquidated to make up the difference. However, as these assets consist only of US government bonds, liquidating them will require the government to raise revenue from new income taxes (or the equivalent) to do so.

Thus, the operation of the trust funds will have to be funded with income tax increases, as shown in the chart below. It shows the year, projected increased cost of trust fund operations compared to today in percentage-of-GDP terms, and the corresponding percentage increase in all federal income taxes* -- personal and corporate -- needed to provide that revenue.
Social Security and Medicare HI trust fund operations

Year ... % GDP increase .. income tax increase

2020 ... 1.36% ... 16.0%
2030 ... 2.91% ... 34.2%
2040 ... 3.76% ... 44.2%
2079 ... 6.45% ... 75.9%

* All federal income taxes equaled 8.5% of GDP in 2004 [BEA and CBO]. "Income tax increase" is computed as "GDP increase" / 8.5%.
So in the year 2030, midway through the projected life of the Social Security trust fund, an across-the-board 34% increase in all income taxes is projected to be needed just to carry on trust fund operations -- i.e., to reimburse the trust funds for the payroll taxes previously paid into them that were advanced to the rest of the government and spent on general governmental operations.

Of course, at the same time the government will have to be financing general Medicare operations out of general revenue. The corresponding numbers for projected percentage-of-GDP expense increase and the required corresponding income tax increase are ...
Medicare general revenue funding

Year ... % GDP increase ... income tax increase

2020 ... 1.34% ... 15.8%
2030 ... 2.22% ... 26.1%
2040 ... 2.80% ... 32.9%
2079 ... 5.22% ... 61.4%
And of, course, the total cost increase of these programs, and total required income tax increase to finance them, combines the above numbers...
Total Social Security and Medicare cost increase

Year ... % GDP increase ... income tax increase

2020 ... 2.70% ... 31.8%
2030 ... 5.13% ... 60.4%
2040 ... 6.56% ... 77.2%
2079 .. 11.67% .. 137.3%

Thus we see that in the year 2030, midway through the life of the Social Security trust fund, we face a 60% general income tax increase to finance the trust fund's operations and the cost of Medicare ... with that cost rising from there.

And by the year 2020 -- a mere 15 years from now -- we all face an across-the-board income tax increase of over 30%.

For some reason these specific, clear-cut numbers are never mentioned in the current debate about Social Security and entitlements. For all the numbers and claims that do get thrown around, I've never seen these numbers mentioned even once.

(Defenders of the status quo and its purported "intergenerational covenant" certainly never mention them as the cost of the covenant.)

Yet surely they should be, by both sides.

Critics of the status quo should be asking: "Do you want to pay these coming tax increases?" -- a pretty straightforward challenge to the status quo.

More importantly, I'd think supporters of the status quo should be getting out in front telling people about the pending arrival of these tax increases, and explaining to people why they do want to pay them.

After all, if the need for a 60+% income tax increase arrives upon the general public as a surprise, and voters who are unprepared for it don't want to pay it, it is the arrangements of the status quo that will take the pounding -- along with the political champions of the status quo, whom the surprised and upset voting public of the future might feel were less than candid in hiding the necessity of these tax increases from them.

More political thoughts along these lines later.

For now, whichever side of the debate you are on, do your bit to help the voting public become better informed -- tell your friends about these numbers.