By Mark J. Warshawsky

In the last few months, many have developed a renewed appreciation for the costs and risks that large federal government budget deficits cause. In the recent past, when inflation and interest rates were quite low, a view arose that budget deficits did not matter much, unleashing the administration and Congress to spend substantially above the revenues collected. Now, with inflation seemingly out of control and interest rates rising, the realization is reawakening that large budget deficits can cause excess aggregate demand, and that the rapidly growing interest payment burden on the federal budget arising from massive outstanding debt combined with new deficits is not sustainable. In this context, it is worth examining more closely the historical and projected role that Medicare and Social Security are playing in this growing budget problem.

There may be an impression that, with their trust funds,
Medicare and Social Security are walled off from the general federal budget,
with dedicated revenue sources and large reserves. However, this has never been
true for Medicare. While the Hospital Insurance (HI) segment is funded by
payroll taxes and taxes on Social Security benefits, the other, larger, segment—Supplemental
Medical Insurance (SMI), which covers physicians’ and other provider fees and
prescription drugs—is less than quarter-funded by premiums. Nearly all the rest
of SMI is funded by a general revenue transfer from the federal budget. But
even HI is now a drain on the federal budget, as both interest on the HI Trust
Fund and the drawdown on the HI Trust Fund assets as it approaches exhaustion (projected
in 2028) are funded by general revenues. Similarly for Social Security (OASDI),
after 2010, cash flow into the OASDI Security Trust Fund turned negative. That
is, interest on the OASDI Trust Fund has been a draw on the federal budget, and,
since 2021, OASDI Trust Fund assets are being redeemed and funded from the
federal budget, until the projected exhaustion date of 2035. See Chart 1, where
the dollar contribution from the federal government to Medicare and Social
Security is shown from 2003 through 2021.

Chart 1: Annual Budget
Impact of Medicare and Social Security by Program (Billions USD), 2003–2021

The draw grew rapidly in the leading up to the Great
Recession, as the prescription drug benefit was introduced and health care
costs increased rapidly, to around $400 billion. It then stayed at that level
until increasing to around a $500 billion draw more recently. Chart 2 shows
these same statistics as a percent of GDP and places them next to the overall
federal budget deficit also shown as a share of GDP. The Medicare-Social
Security draw on the budget is now above 2 percent of GDP, which was the level
of the entire federal budget deficit as recently as 2015. Recessions increase
the deficit as a matter of counter-cyclical fiscal policy, but the most recent
pandemic years were truly spending blowouts.

Chart 2: Annual Net Costs of Medicare and Social Security as a % of GDP, 2003–2021

As bad as recent experience has been, the draw from Medicare
and Social Security is projected to get much larger in the next decade as the
baby boom generation continues to retire and grow old and health care costs
rise. Chart 3 shows the trustees’ projections, including the assumption that
the HI and OASDI Trust Fund deficits will be filled by general revenue
transfers past their projected exhaustion dates. The draw on the federal budget
nearly doubles from 2.16 percent of GDP in 2022 to 4.04 percent of GDP in 2035,
and to 4.37 percent in 2040. Stated another way, the federal budget
responsibility for Medicare and Social Security alone from general revenues
will be as large as a relatively bad government deficit year, with no
consideration for other government programs, new or old.

Chart 3: Projected
Annual Medicare and Social Security Draws on Federal Budget as a % of GDP

There has been no budget planning for this eventuality. Clearly
both Medicare and Social Security will require reforms, along with other areas
of the federal budget. And the sooner this happens the better, to reduce risks
and costs.

The post Medicare and Social Security Are Big and Growing Parts of the Federal Budget Problem appeared first on American Enterprise Institute – AEI.