#6: Touching the Third Rail

My last post discussed the necessity, and the unavoidability of having to cut mandatory programs in order to balance the federal budget and pay down the national debt.  Any discussion of cutting Social Security and Medicare, however, has been labeled the “third rail” of politics my entire adult life.  Why?  Because these benefits go to seniors, who paid taxes to secure these benefits in their retirement, and seniors vote!

Even though Social Security benefits are credited to your personal account based on the amount of taxes you pay into the system, you never accumulate equity in the Social Security system.  Your account has no value, only a presumed benefit, which changes based on your age when you start claiming benefits.  Both Social Security and Medicare are financed on a “pay as you go” basis.  This means that until recently, Baby Boomers like myself were paying the taxes to provide these benefits to the Greatest Generation.  We are now in a transition process where the Gen-X’ers and Millennials are going to be paying the taxes for the benefits of the Baby Boomers.  The Social Security Office of Policy gives the following summary of the changes it expects in this transition.

“Due to demographic changes, the U.S. Social Security system will face financial challenges in the near future. Declining fertility rates and increasing life expectancies are causing the U.S. population to age. Today 12 percent of the total population is aged 65 or older, but by 2080, it will be 23 percent. At the same time, the working-age population is shrinking from 60 percent today to a projected 54 percent in 2080. Consequently, the Social Security system is experiencing a declining worker-to-beneficiary ratio, which will fall from 3.3 in 2005 to 2.1 in 2040 (the year in which the Social Security trust fund is projected to be exhausted). This presents a significant challenge to policymakers.

One policy option that could help keep the Social Security system solvent is to reduce retirement benefits, either by raising the normal retirement age or through life expectancy indexing, to reflect the fact that people are living longer. However, these reductions in benefits have the potential to harm economically vulnerable retirees. Other options, such as progressive price indexing proposals, explicitly protect the retirement benefits of low lifetime earners. Still other options would seek to raise additional revenue for the system.”

Social Security and Medicare are Ponzi schemes, the biggest Ponzi schemes in history.  Yes, I said it!  Anyone who would try to execute such a Ponzi scheme privately (Bernie Madoff comes to mind) would be thrown in jail.  Just because the U.S. Government passed a law making Social Security and Medicare legal, does not mean that even the U.S. Government can violate the laws of economics.  The statements above by the Office of Policy represent a confession to the American people that these programs are vulnerable to catastrophic collapse.  Before that happens, however, you can expect that our elected representatives will try to save the system, or at least make it last long enough for them to get re-elected.

We can look at the implications of the policy option mentioned above to reduce benefits.  The following graph shows the increase in federal spending for all entitlements in Obama’s 2017 budget, as well as the four alternatives we have created to cut the federal budget.

All Entitlements

With no action by the federal government to cut entitlement spending, all entitlements will cost approximately $4 trillion by 2025 compared to $2.3 trillion in 2015.  This represents an average annual growth rate of 5.69%.  Recall that the average growth rate for the US GDP is 3.2% per year.  The four alternative scenarios in the table above have the following growth rates.

  • Alt.#1:  Gradual Decline ……….. 3.27%
  • Alt. #2:  Hold Spending………….1.13%
  • Alt. #3:  Shock Treatment ………2.39%
  • Alt. #4:  Program Cuts …………. 0.06%

I suggest that a rational entitlement system would limit the growth rate of benefits paid out to at least the growth rate of the US GDP.  How would this logic impact the average entitlement benefits paid out to US citizens?

To answer this question, I make some rough calculations assuming, for example, that all Social Security benefits are paid to people who are 65 years or older.  By extrapolating the estimates available from the US Department of HHS, the population of US citizens who meet this criterion is projected to grow from approximately 47.0 million in 2015 to 62.9 million in 2025.  In order to calculate the average benefit received by a US citizen on Social Security, also known as OASDI, I then divided these population numbers into the projected expenditures for the Social Security program from 2015 to 2025 in Obama’s 2017 budget and each alternative scenario to produce the following graph.

Average Annual OASDI Benefits

In 2015, the average benefit paid out is estimated to be $18,786 per year, or about $1,565 per month.  In Obama’s 2017, the average benefit grows to approximately $2,040 per month by 2025.  In my “Gradual Decline” alternative, the average benefit grows to approximately $1,600 per month.  In my “Shock Treatment” scenario, it declines to $1,451 per month.  It turns out that the “Hold Spending” alternative produces the most drastic cut in benefits because your dividing the same budget dollars among a larger population each year.

There is no doubt that a cut in average benefits equal to $114 per month over 10 years would impact US retirees significantly.  Remember, however, that if the federal government makes this change with the acceptance of the US citizenry, then sometime between 2021 and 2022, Social Security receipts will start to exceed expenses.  The program will once again be on a sustainable path.  I submit that this sacrifice will be worth saving the program from collapse.

I create a similar graph for the average annual Medicare benefits paid out using the same population numbers for people over 65.

Average Annual Medicare Benefits

In 2015, the average Medicare benefit paid out was just under $1,000 per month.  Obama’s 2017 budget projects this to grow to $1,387 per month by 2025.  In my “Gradual Decline” scenario, the 2025 average benefit is essentially the same as in 2015.  In my “Shock Treatment” scenario it declines to $903 per month.

Note that this average benefit includes the dollars consumed by waste, fraud and abuse, which in 2012 was estimated to be approximately 10% of the total budget.  Political promises to cut waste, fraud and abuse may win elections, but never seem to be realized.  Is there a way to change the system in order to make the system fair, effective, efficient and less vulnerable?

Currently, the Medicare system works like any insurance program.  The insured pays a premium (for Part B benefits) and covers the deductible costs.  Once the deductibles are met, then the insurance covers all additional expenses for a given calendar year.  Some consumers will buy “gap” insurance to cover the deductible or non-covered expenses in the Medicare plan.

I propose the following solution to the Medicare budget problem.  It’s a concept which ensures that everyone gets a minimum level  of basic care, and fixes the problem of runaway growth in medical costs subsidized by American taxpayers for the long term.  Instead of following a traditional insurance model, my proposal follows a health savings account paradigm.

In my proposal, every senior citizen gets $10,000 of medical expenses covered every year by the federal government.  Let’s assume for example, that your Medicare card is now a debit card which is tied to a medical savings account at a bank.  The government credits the account each month or year.  The senior citizen can now use these funds to pay for prescriptions, doctor visits, supplies, even health insurance premiums, to meet their medical needs.  Instead of increasing this benefit year after year, simply allow the senior citizen to carry over any dollars remaining in the account at the end of the year.  Using these funds for non-medical expenses would result in a penalty taking the form of reduced account funding the following year.  If the senior citizen wants to cover catastrophic medical expenses, he or she can also use the funds they would have spent on a “gap” plan to purchase this additional insurance.  Each plan could have a high deductible, $10,000 for example, which means the premiums would be relatively affordable, particularly if the government allows three things to happen.  First, the government should make it legal to sell this type of insurance across state lines.  This would produce more competition which would keep prices low.  Second, the government should avoid coverage mandates in these catastrophic policies.  This means insurance companies could exclude benefits for pregnancies, for example, in these senior plans.  This would allow insurance companies to tailor insurance plans to the wants and needs of their customers.  Finally, the government must allow insurance companies to offer policies with premiums which take true health risks into account, e.g. non-smokers would pay less in premiums than smokers.

It is possible to make Medicare even more efficient by not collecting any premiums from senior citizens.  Currently, most seniors pay nothing for Part A coverage (hospital), and an income-tested premium for Part B (doctors, surgeries, equipment).  The part B premium is $1461.60 per year for people making less than $85,000 per individual per year.  You can eliminate the Part B premium collection completely simply by lowering the annual health savings account benefit accordingly.

I suggest that this individual health savings account approach to providing Medicare benefits would also be the most cost-effective way to eliminate waste, fraud and abuse.  Every senior citizen effectively becomes an unpaid guardian of their personal medical savings account making health care consumption decisions which meet individual needs.

We can save the Medicaid program in a similar way and provide a minimum level of medical care for every US citizen currently struggling to find health care with Medicaid coverage.  As of May, 2016, the total enrollment in Medicaid/CHIP programs across the US was 72.5 million people.  The federal budget for Medicaid in 2016 is $367 billion, or a little more than $5000 per person.  As with Medicare, a new Medicaid system would establish a health savings account for each person on the program.  The $5,000 benefit would not change year after year, in order to balance the federal budget.  The person could use the health savings account for any legitimate health expense.  Unused dollars would carry over year after year.  The insurance industry could then design catastrophic health insurance plans tailored to this market.  We could even consider allowing individuals to use the funds in the health savings account to pay for health insurance premiums.

Will Congress make these changes?  I suggest that the federal government is so polarized and dysfunctional that Congress cannot and will not ever do what is necessary.  The implication of this suggestion is that polarization will ultimately lead to collapse.

What hope is there that the federal government would dare to cut Social Security benefits, or make fundamental changes to the Medicare and Medicaid systems in order to eliminate the federal deficit and start paying down the national debt?  I believe our only hope for this would come from a leader who goes before the American people and appeals to their patriotism by saying the following:

“My fellow Americans, if the federal government continues on the path of spending as projected by the Obama 2017 budget, then our currency, our government, and our country will surely collapse into chaos.  As the first step, I am taking steps to reduce the size of the federal government by 50%. Simply cutting the size of the federal government, however, will not do the job by itself.  We must also reduce the amount we spend on entitlements.  This means Social Security, Medicare and Medicaid.  Congress will never fix the problem.  Congress will never reduce spending to stop the deficits which add to our national debt year after year, which will put a great burden on future generations of Americans – your children and grandchildren.  Congress will never do it, but you can.  I am speaking to you tonight to appeal to your patriotism.  I am enlisting every American in this fight for the future of our nation.  Please listen to me as I say to you, if you receive a Social Security check from the federal government, and you need every dollar to survive, keep it and God bless you.  However, if you do not need every dollar every month to survive, I ask you to send that part back to the US Treasury.  I promise that every dollar you send back will be used to reduce the amount of money the federal government borrows each year.  Every dollar will be accounted for.  If you send this money back, it will show Congress that they have your permission to fix the problem in order to save this nation from economic ruin.

I will take the first step.  As your president, I am donating my entire salary to the US Treasury.  Furthermore, I challenge every representative and senator to forego their salaries until they pass a balanced budget for the next fiscal year, along with a balanced budget amendment.

Our situation is serious.  I am serious.  We must pull together as a country, or we will surely see the end of this country that we love.”

How would you respond if you heard the President say this?


One thought on “#6: Touching the Third Rail

    1. As long as you have defined benefit payout you will have unfunded liabilities for the system. Employers contribute 6.75% to the employee’s FICA account as well as the employee’s contribution of 6.75% for an annual for a total of 13.5% of annual wages. What if the total amount contributed, plus an indexed compounded interest yield based on the U.S. Treasury annual yield were accumulated in a U.S. account for the retiring beneficiary to select from the following options:
    1) Take lump sum of the accumulated cash value and do whatever the retiree wants- put it in the bank, mutual fund, buy stock, go the racetrack or my recommendation gamble at an Indian Casino!!
    2) Let Life Insurance Companies offer annuities so that the retiree that is concerned with lifetime income would have that option.
    The Government (the taxpayer) would be off the hook.

    3) Segregate the Disability Income Benefit from the retirement benefit by having the Employer contribute a portion of the 13.5% to the FUTA payroll tax.

    4) Legalize the illegals with a guest worker permit- without amnesty or citizenship and mandate payment into the system. To legalize would entail a fine for each year they were here illegally, legalization processing fee and an annual work permit should be paid to let them become guest workers until they go to the back of the line and apply for citizenship. By collecting 13.5% from these shadow workers and employers that pay them on a cash basis would add to the trust fund.

    Some years back when I lived and wo I was engaged by a farm worker organization to structure a health care plan for migrants, who work the fields and follow the crops with health care benefits. We implemented the FARM WORKER BENEFIT TRUST that would be funded by the following:
    1) Per hour Payroll Deduction from earnings @ $0.50
    2) Matching Payment from Grower @ $0.50
    3) HEW (old Health & Human Services) monthly $25.00
    4) State Health Services Agency $12.50
    5) RX Companies discounts and max charges would be given a tax credit of 25% of discount
    6) Hospitals and Clinic Discounts with tax credit of 25% of discount given
    7) Multiple Insurance Carriers sharing the risk & providing discounts by underwriting the coverage sans agents’ (commissions) and fixed cost administrative fees.
    These parties would share the cost and expense of benefit payment with an affordable plan for each payer.
    Medicare is funded during the working life of the employee & when he reaches 65 the health care providers will be paid the limits set by the Agency.

    I was able to get the Farm Worker Organization a grant to structure and implement the Trust. The funding was to be multi-year (During the Carter Administration). After the first year of funding ($750,000), Carter lost the election & Reagan did not fund the program. My point in recounting this transaction is that I have always been of the opinion that a similar approach would be feasible to funding Medicare.

    There is no actuarial basis for these comments and opinions, but based on what is going on in the world of unsustainable “entitlements”, these alternatives in my opinion would induce some solvency to the programs. Saludos, Santa Cruz


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