Social Security, Medicare: 'problematic'

Trustees of the two programs in annual report worry about long-term sustainability; 'Medicare funding warning' issued.

By Jeanne Sahadi, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) -- The projected dates for when the Social Security and Medicare trust funds will be exhausted have been pushed back one year, according to the programs' trustees in their 2007 annual report released Monday. But the trustees also issued a "funding warning" for Medicare.

The Social Security program currently takes in more in payroll taxes from existing workers than is needed to fund benefits for seniors. But by 2017 the trustees estimate it will start to take in less than needed and will need to start tapping its surplus.

That means the federal government - which has been spending the surplus as part of general revenue - must start to pay back the money with interest.

The surplus, the trustees project, will be exhausted by 2041 (vs. 2040 a year ago). In that year, barring any changes, Social Security would take in only enough to pay for 75 percent of promised benefits.

The trustees noted in their report that while "the program passes our short-range test of financial adequacy, it continues to fail our long-range test of close actuarial balance by a wide margin."

Workers currently pay 6.2 percent of their wages - up to $97,500 - into Social Security, and their employers match that amount, for a total payroll tax of 12.4 percent.

One way the trustees measure the long-term deficit of the system is to do so as a percent of taxable payroll. To keep the system solvent over the next 75 years, the trustees estimate that Social Security payroll taxes would need to increase to 14.35 percent.

There has been no consensus on the type of changes that should be made to make the system solvent long-term. Generally, though, the choices include an increase in the payroll tax, a reduction in benefits, and an increase in the age of benefits eligibility. And it's likely that any plan would include a combination of measures.

Those crunching the numbers advocate for action soon. "We believe changes should be made sooner rather than later," said Ken Steiner, a member of the nonpartisan American Academy of Actuaries' Committee on Social Insurance. That way you can give people sufficient notice that they should save more if benefits are reduced in any way, Steiner explained.

Few expect there to be the political will to do much about Social Security before the next presidential election. President Bush's concerted campaign in 2005 to reform the program didn't wash well with Democrats, who opposed his idea to let workers divert a portion of Social Security payroll taxes into individual investment accounts, an idea that the president insisted be part of any reform plan.

Since then, Social Security reform has taken a backseat to other issues, although Treasury Secretary Henry Paulson, who is also a Social Security trustee, has talked with lawmakers on both sides of the aisle in recent months about possible compromises.

Trustees issue funding warning for Medicare

Meanwhile, Medicare continues to be in much worse shape than Social Security, thanks to the high rate of inflation in health care costs.

The program has already begun paying out more than it receives in payroll taxes. And the trustees now forecast that its trust fund will be depleted by 2019 (vs. 2018 a year ago), at which point Medicare would only be able to pay out 79 percent of expected expenditures.

Over the next 75 years, to shore up the system, the trustees estimate that payroll taxes would need to increase by 3.55 percentage points, on top of the 2.9 percent of all wages that is paid by workers (who pay half) and their employers (who pay the other half). That would bring the Medicare taxes to 6.45 percent of all wages.

Medicare was designed to be funded by three sources: payroll taxes; Medicare premiums (paid by Medicare beneficiaries); and general revenue (typically money from income taxes).

The general revenue portion, however, is intended only to fund Medicare payments for physicians and outpatient services, as well as prescription drugs - which, together are known as Parts B and D. The payroll tax is intended to pay for hospital expenses, or Part A.

By law, the trustees had to issue a "Medicare funding warning" on Monday because for the second year in a row, they anticipate that general revenues will have to fund more than 45 percent of Medicare's total expenditures within the next six years.

Consequently, President Bush in his fiscal year 2009 budget must propose ways to prevent that from happening and Congress is obligated to consider those proposals.

Critics of the funding limit say it was arbitrarily set in 2003 and diverts attention from the real concern with Medicare: how to curb its long term funding deficit and slow cost growth.

"What they're doing isn't addressing the level of spending," said James Horney, senior fellow at the liberal Center for Budget and Policy Priorities, in a press call. If that was the intention of setting limits, he added, lawmakers could have capped spending by, for example, capping Medicare costs at a certain percentage of GDP.

Instead, by capping the percentage of costs funded by general revenue, CBPP agues, it takes off the table - in the near term anyway - raising income taxes as a way to address program deficits. "The only way to make progress is to have everything on the table," Horney said.

Other options to reduce the system's long-term shortfall include increasing the payroll tax, increasing premiums, cutting benefits, cutting payments to Medicare providers or reducing spending elsewhere in the budget.

But not everyone is worried that a funding warning itself will derail a serious conversation. "It's an opportunity for a renewed focus on Medicare's financial problems. But we can't just look at the revenue share of Medicare spending," said Cori Uccello, senior health fellow at the American Academy of Actuaries.

Instead, she said, the program should be looked at comprehensively in terms of the strain Medicare places on the federal budget, how the program's solvency has improved or grown worse, whether a potential fix would be a one-time fix or a lasting one, and whether a reduction in spending is a true reduction or just a redistribution of expense. Top of page

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.