"Social Security and Medicare:
Where's The Pony?

Jonathan Ater
Portland, OR
February 17, 2005

As I follow the early innings of the Social Security debate, I find myself wondering what my Yale classmates think of the Bush Administration's initiatives. As we celebrate our collective entry into a golden age of entitlements, I'll put the first marker in the sand and hope that others will choose to contribute to a web site dialogue about both Social Security and health care issues.

My perspective is that of a practicing business lawyer in a small-population state, with some years looking at the economics of health care and social welfare, particularly in Oregon. I serve on Oregon's Health Policy Commission and last year co-chaired the Governor's mental health task force. From that perspective, it is clear to me that the principal social welfare problem we face as a national society is not the cost of retirement insurance, but the cost, maldistribution and poor outcomes of our present health care 'non-system.' The problem with health care is not simply an insurance or coverage problem. We need to systemically rethink what we mean by health care and how we deliver it.

The health care problem is not limited to Medicare. Indeed, the costs of Medicare simply reflect the costs of a health care system that is poorly organized, too expensive, and random in its performance, and which fails to achieve acceptable outcomes for our population as a whole. The health care system is broken, not only for retirees. Fixing it is critical to the overall economic health of our society, as well as to the physical and mental health of all of us.

That's a big statement, and perhaps a topic for another chapter in this conversation. But, I put the health care topic first because it dwarfs and makes largely irrelevant much of the current national debate about Social Security - whatever you may think about privatization.

In all the talk about reforming Social Security, there is no change that will make any sense over the long term unless we also rethink the entire health care delivery system and economics. When Medicare Part D prescription drug plans go into effect in 2006, most folks on Social Security will see a withholding of something in the order of 25% of the Social Security benefit to pay for Part B and D premiums. Thus, Medicare costs create a substantial reduction in the economic value of social security as a retirement or safety net benefit. This trend will increase rapidly unless we reinvent our health care system.

With that, let's turn briefly to several of the current issues in the Social Security debate:

First, in the US, and in most other industrialized countries, populations are aging and people are living longer. This changing demographic requires many societies, including ours, to rethink a number of social policy and economic considerations, including how we provide some combination of pension and safety net benefits, as well as health care and long term care, to large numbers of older folks. This is true whether the system has a substantial trust fund in what we used to call a "lockbox" or - instead - is funded by general government funds. The old actuarial assumptions are no longer valid.

Second, the so-called Social Security Trust Fund is not a "lockbox" - and never has been. It is only a collection of IOUs. It is true that the government has used excess revenues to pay current costs and promised to repay those funds at a later date.

But, before we get so concerned about this fact, it is important to remember that any investment account is really only a collection of IOUs. That nest egg of yours is some combination of debt and equity securities. Debt instruments are simply IOUs of the payor. Equities are IOUs of each issuer that it will manage its business so as to maintain and create shareholder value over time. The assets in an investment account are only as good as the creditworthiness of the issuers.

The situation we have now with the Social Security Trust Fund is based on federal budgetary policy that allows commingling of the social security and general funds. But, in economic reality, the result is really no different than had a Trust Fund been separately invested into government obligations. If the social security funds were not commingled with the general fund, there would now be an invested surplus. It is reasonable to assume that much of that investment would be in US government bonds. Thus, we are in essentially the same place, i.e., that future benefits depend on future government revenues and the political will of the time. Those obligations are only as good as the government issuing them. Had you invested your accounts into Argentine bonds during 2000, they would have lost a lot of value. If the US government becomes unable to raise sufficient revenues to cover its obligations, Social Security will likewise be threatened — and so too, I suggest, will all other US-based investment accounts - regardless of the form of investment ownership or budgetary accounting.

Third, it is true no one has any kind of property right in the Social Security system, but I respectfully suggest that this is a "so what" issue. Social security is analogous to insurance, just as is a defined benefit pension program. That is, any individual may receive more or less value for money based on individual life expectancy. As in all defined benefit pension systems, all a Social Security beneficiary has is a right to call on the fund to make promised payments for a period of eligibility. That call, when made, is only as good as the ability of the fund to perform at that time. In the case of social security and some other public systems, the timing and amount of those payments is not guaranteed, but is subject to revision from time to time.

What distinguishes Social Security in this discussion is that it is a response to an important social purpose, that is, how do we collectively and purposely as a society plan for a world in which some number of older folks will need a safety net. And because of this social imperative — some might call it a moral imperative — we inevitably have to devise a system, which is sustainable over time and which meets some widely accepted sense of equity.

Fourth, we don't need to "reform" Social Security for the purpose of creating ownership opportunities for retirement investing. We already have a number of incentives for individuals to create "owned" retirement benefits, including ROTH and regular IRAs, and a variety of defined contribution plans in both the private and public sector. The tax and investment advantages of these plans are widely publicized. But, a relatively small part of the population takes advantage of these privatized investment and retirement opportunities. People don't make contributions at all, or they make the minimum required, or they take lump-sum distributions when they leave employment. This real-world experience tells me that — as a whole — individuals do not understand or appreciate the importance of retirement investments (or any other kind of savings for that matter.) If we want to encourage more ownership, we ought to be teaching folks how to use the tools currently available. And, regardless of how successful we may become in such an effort, we will still have folks who have saved nothing and therefore become our collective responsibility — or burden, if you prefer.

Fifth, we don't solve the future funding problem by moving to individually owned accounts supported by reduced payroll taxes. In fact, we accelerate the funding deficit to the extent that we reduce current payroll taxes while maintaining benefits for those now retired or close to retirement. The better way to solve the future funding problem is to adjust retirement ages and/or benefits gradually and prospectively so that the system is actuarially sound. There is clearly some debate among economists as to the size and timing of the future hole, and the policy choices made as to the amount, form and timing of benefit changes must be based on some sensible and hopefully consensus set of actuarial assumptions. But, it is inevitable that the benefit structure must be changed, if only to reflect the much longer life spans of the population as a whole. We need to address this issue straight on, and I am afraid that it only confuses matters to mix this discussion with the ownership discussion. They are really quite different issues, and in my view at least, we have already adequately provided the tools for ownership.

Sixth, and back to the beginning, we don't solve anything unless we first address and resolve fundamental problems of health care access, cost, and quality for our entire population.

With luck, this short essay will provoke some of you to respond. I look forward to it. Events are moving on the national stage, and perhaps collectively, we can bring some insight to the discussion, at least for ourselves.

Jonathan's email address is jaa@aterwynne.com.

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