Wednesday, May 21, 2008

How much will income taxes have to go up to pay for Social Security and Medicare? 

The Congressional Budget Office updates its estimate. Here's how it projects spending on Social Security, Medicare and Medicaid to increase as a percentage of GDP from 2007 to 2030 and 2050. (I've deleted the 75-year projection to 2082 because the numbers get too big to be plausible.)

Combined spending increases by 6.1 points of GDP by 2030, and by 10.2 points of GDP by 2050.

In 2007 total income tax collections (individual and corporate) were 11.2 points of GDP.

Thus, to cover such spending increases, total income taxes as a portion of GDP would have to increase 54% from today's levels by 2030, and 91% by 2050.

Well, 2030 is only about two-thirds of the length of a typical home mortgage away. That's not so far. How easy will it be for Congress to increase taxes this much by then? We can look at the record of past tax increases for perspective...

[] The 1983 tax increases that "saved" Social Security the first time it went broke -- and which traumatized the Washington political establishment sufficiently to paralyze it into inaction until the very last moment -- amounted to 0.24% of GDP, or about 1/25th of the tax increase needed by 2030, 1/42nd of the increase needed by 2050.

[] The 1993 Clinton tax increase -- which was able to pass the Democratic-controlled Senate only with vice-president Al Gore's tie breaking vote, after passing a Democratic-controlled House by only 218-216 (a single voter's difference) -- amounted to 0.83% of GDP, less than 1/7th of the tax increase needed by 2030, and less than 1/12th of that needed by 2050.

[] The post-Pearl Harbor 1942 tax increases enacted to fight World War II were 5.0 points of GDP -- 18% less than the tax increase needed by 2030, and less than half of that needed by 2050. The total post-Pearl Harbor tax increases enacted to fight World War II amounted to 6.6% of GDP -- only 10% more than needed for 2030, and a full third less than needed for 2050. And of course those war-time tax increases were largely temporary, taxes were reduced by 4.8 points of GDP from 1944 to 1948.

So ... it doesn't look like it will be all that easy.

And presumably it will be just as difficult politically to cut benefits that have been promised to retirees their entire lives, that they have relied upon.

What happens if Congress keeps on its current course, not increasing taxes while preserving promised benefits? Standard and Poor's projects U.S. Treasury Bonds will become "junk" by 2027, due to a national debt that is rocketing upward with compound interest.

What if Congress does what it instinctively does in such situations, produce a political deal to cut the baby in half "split the difference" -- to close the funding gap 50% with tax increases and 50% with benefit cuts? For instance, this is exactly what Congress did in 1983 to save Social Security the last time, increasing taxes (on the young) while reducing benefits (for the young) by nearly precisely offsetting amounts (thus converting Social Security into a such a bad deal for the young ... but that's for another post).

Well, Medicare cost is projected to grow by 3.2 points of GDP by 2030, to 5.9 from 2.7 in 2007. "Split the difference" thus would require reducing its cost then by 1.6 points of GDP to 4.3 points. But since 5.9 points is projected as needed to continue providing the current level of benefits, "split the difference" requires reducing Medicare benefits provided to individuals by more than 25% from today's levels (how are seniors going to like that?) while also increasing income taxes by 27% across the board (including on seniors, of course -- their pensions, IRA distributions, investments, and so on). And 2030 is just the start of the process.

This not pretty. And it does not consider other very significant unfunded costs coming due at the same time (federal employee/military pensions and benefits, state and local government pensions and retiree health benefits, etc.), which make the situation even worse.

OK we have got to get a grip on this -- whatever your proposed solution, on that we should all agree.

So what are our Democratic and Republican politicians making their big political-economic issues of the election season? Gas tax holidays ... more tax cuts ... expanding medical entitlements to be "for all" with no tax increase to pay for it on any income under $200,000...

It's enough to make one vote Independent (and bury a stockpile of gold bullion in the basement to fund one's own retirement...)