25 Fiscal Lessons
Learned over the course of 25 years, paving the way toward a better economic future.Read the Lessons
Every year the trustees of Social Security and Medicare issue detailed reports on the financial status of these programs. While the trustees’ reports consistently warn that both programs face serious shortfalls, the urgency of this warning is often undercut by undue attention to the years in which the Social Security trust funds and the Medicare Hospital Insurance (HI) trust fund are projected to become insolvent. In the 2017 report these years are 2034 for Social Security and 2029 for Medicare HI.
There is a natural tendency for people to look at these projections and conclude that no action is needed for several years. However, the trust funds are a misleading indicator of the programs’ fiscal health and the extent to which they impact the federal budget. Trust fund solvency says nothing about fiscal sustainability because government trust funds are primarily an accounting device.
If dedicated revenue for a program is greater than its spending, the extra “savings” is not deposited in a traditional trust fund that gathers interest from external borrowers. Instead, the excess revenue is used to finance the rest of government spending, and the program in surplus gets an “IOU” from the government. These IOUs are treated like trust funds but they really just represent the federal government borrowing from itself.
Crucially, these Treasury IOUs can only be redeemed if Congress raises taxes, cuts other spending, or borrows from the public. Thus, their existence alone doesn't ease the burden of paying future benefits; they just signify that the government owes itself a lot of money.
Trust fund accounting obscures the timing and magnitude of the programs’ fiscal shortfalls because it implies that there are resources being held in reserve -- real assets that can be drawn down in the future to pay benefits. However, real assets are not created by giving the trust fund an IOU and promising to sell the IOU to the public when the money is needed to pay benefits.
Even if the trust fund IOUs will no doubt be honored, the real issue is how the government and society will afford them. The annual difference between a program’s outlays and dedicated tax revenues matters far more than the balance of its trust fund.
Social Security has been paying out more than it takes in since 2010, cashing in some of its Treasury IOUs to pay benefits and adding to overall federal budget deficits. Because there are no actual savings in this trust fund, Social Security’s annual deficits have been and will continue to be added to the government’s already large deficits. Between 2017 and 2034, Social Security deficits are projected to total over $3 trillion.
Discussions of trust funds are even more misleading with the Medicare program. The HI trust fund only covers Part A of Medicare and receives its income from the dedicated Medicare payroll tax. However, the other parts of Medicare fall under its Supplementary Medical Insurance (SMI), which receives about 25 percent of its income from beneficiary premium payments while the remainder is covered by an automatic infusion of general revenues. No one pays attention to the solvency of SMI, which is larger and growing faster than HI, because its automatic payments from the Treasury make it permanently solvent.
This infusion into SMI amounts to hundreds of billions of dollars in spending each year not accounted for when the focus is solely on HI. Leaving SMI out of the equation gives a very distorted picture of both the immediate budgetary impact of Medicare and its long-term prognosis.
Focusing on trust fund solvency may seem reassuring, but it conceals the fact that Social Security and Medicare are already drawing on growing infusions of general government revenue to pay for benefits. Waiting for trust fund insolvency to address the strains of an aging population that are already materializing would turn this problem into a crisis.