[This piece has been published in Restoring America to highlight how unrestrained entitlement spending is contributing to the growing economic crisis.]
In the last few months, many have developed a renewed appreciation for the costs and risks that large federal government budget deficits cause. In the recent past, when inflation and interest rates were quite low, a view arose that budget deficits did not matter much, unleashing the administration and Congress to spend substantially above the revenues collected. Now, with inflation seemingly out of control and interest rates rising, the realization is reawakening that large budget deficits can cause excess aggregate demand, and that the rapidly growing interest payment burden on the federal budget arising from massive outstanding debt combined with new deficits is not sustainable. In this context, it is worth examining more closely the historical and projected role that Medicare and Social Security are playing in this growing budget problem.
There may be an impression that, with their trust funds, Medicare and Social Security are walled off from the general federal budget, with dedicated revenue sources and large reserves. However, this has never been true for Medicare. While the Hospital Insurance (HI) segment is funded by payroll taxes and taxes on Social Security benefits, the other, larger, segment — Supplemental Medical Insurance (SMI), which covers physicians’ and other provider fees and prescription drugs — is less than quarter-funded by premiums. Nearly all the rest of SMI is funded by a general revenue transfer from the federal budget. But even HI is now a drain on the federal budget, as both interest on the HI Trust Fund and the drawdown on the HI Trust Fund assets as it approaches exhaustion (projected in 2028) are funded by general revenues. Similarly for Social Security (OASDI), after 2010, cash flow into the OASDI Security Trust Fund turned negative. That is, interest on the OASDI Trust Fund has been a draw on the federal budget, and, since 2021, OASDI Trust Fund assets are being redeemed and funded from the federal budget, until the projected exhaustion date of 2035.
The draw grew rapidly in the leading up to the Great Recession, as the prescription drug benefit was introduced and health care costs increased rapidly, to around $400 billion. It then stayed at that level until increasing to around a $500 billion draw more recently. This chart shows these same statistics as a percent of GDP and places them next to the overall federal budget deficit also shown as a share of GDP. The Medicare-Social Security draw on the budget is now above 2% of GDP, which was the level of the entire federal budget deficit as recently as 2015. Recessions increase the deficit as a matter of counter-cyclical fiscal policy, but the most recent pandemic years were truly spending blowouts.
As bad as recent experience has been, the draw from Medicare and Social Security is projected to get much larger in the next decade as the baby boom generation continues to retire and grow old and health care costs rise. This chart shows the trustees’ projections, including the assumption that the HI and OASDI Trust Fund deficits will be filled by general revenue transfers past their projected exhaustion dates. The draw on the federal budget nearly doubles from 2.16% of GDP in 2022 to 4.04% of GDP in 2035, and to 4.37% in 2040. Stated another way, the federal budget responsibility for Medicare and Social Security alone from general revenues will be as large as a relatively bad government deficit year, with no consideration for other government programs, new or old.
There has been no budget planning for this eventuality. Clearly both Medicare and Social Security will require reforms, along with other areas of the federal budget. And the sooner this happens the better, to reduce risks and costs.
This article originally appeared in the AEIdeas blog and is reprinted with kind permission from the American Enterprise Institute.
