Social Security and Medicare Taxes Won't be Disastrous for the Young

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Written by Dean Baker   
Thursday, 30 May 2013 16:27

The 2013 Social Security and Medicare Trustees reports will be released tomorrow. There is much discussion in policy circles of how the cost of these programs is projected to rise over the next three decades due to both the retirement of the baby boom cohorts and the increased cost of health care, which is the main factor behind the projected increase in Medicare costs. These projected cost increases have frequently been presented as implying a disastrous scenario for today’s young. In today’s edition, economist Dean Baker of the Center for Economic and Policy Research examines how the cost of these programs is likely to affect the financial well-being of our children and grandchildren:
 
Disaster stories about rising Social Security and Medicare costs ignore the fact that the tax increases projected over the next three decades are not very different than the tax increases that we have actually seen since 1980. Furthermore, the far more important factor in determining the well-being of our children and grandchildren is the extent to which their before tax wages increase in the decades ahead.
 
Starting with the issue of tax increases, if we assume that the projected shortfall in Social Security is met entirely by increasing the size of the payroll tax, according to the 2012 Trustees Reports it would be necessary to have an increase in the tax of 3.91 percentage points by 2045.

  • This assumes that there are no cuts in scheduled benefits, no other taxes are used to finance Social Security and the cap on wage income subject to the Social Security tax (currently around $113,000) is not raised.
  • In the 2012 Medicare Trustees report, the projected increase in the tax needed to keep the program fully solvent in 2045 was 1.91 percentage points.
  • It is worth noting that the size of the projected shortfall in Medicare has fallen by more than 60 percent since 2008, from 3.54 percent of payroll to 1.35 percent of payroll in 2012.
  • This is in spite of the fact that the change in the 75-year projection period would have increased the projected shortfall by close to 0.20 percentage points.

The combined tax increase needed to keep both programs fully funded in 2045 under the 2012 projections was 5.81 percentage points.

  • By comparison, since 1980, the Social Security tax rate has increased by 2.24 percentage points.
  • In addition, the self-employed were required to pay for the employer’s side of the payroll tax as well. This was an additional increase of 5 percentage points on the roughly 9 percent of the workforce who is self-employed, which is equivalent to a 0.45 percentage point increase.
  • That makes the total increase in the Social Security tax to 2.69 percentage points over this period.

The Medicare tax rate increased by 1.9 percentage points from 1980 to the present.

  • That brings the total increase in the payroll tax since 1980 to 4.59 percentage points.
  • While this increase is less than the 5.81 percentage point increase that would be implied by the projections in the 2012 reports for 2045, assuming no other changes to the programs, it is not hugely different.

The more important part of the equation for living standards is the wage growth that workers will see over the next three decades.

  • The wage growth assumptions in the 2012 report implied that the average annual wage would be $68,300 in 2045 (in 2012 dollars).
  • This implies an increase of more than 55 percent over the average wage of $43,800 in 2012.
  • Even if we assume that the Social Security and Medicare taxes are together raised by 5.81 percentage points by 2045, the average wage in 2045 after deducting payroll taxes would still be more than 46.0 percent higher than it is for workers today.
  • It is difficult to see this as a story in which our children and grandchildren are being impoverished by these programs.

Most workers have actually seen little real wage growth over the last three decades in spite of a substantial increase in average wages over this period.

  • This is due to the fact that top end earners -- doctors, lawyers, CEOs and those in the financial industry – have captured the bulk of the gains from economic growth over this period.
  • If this pattern continues, then the before tax wages of most workers will not be much higher in 2045 than they are today.
  • However, that would clearly be an issue of the distribution of income within a generation, not a question of distribution across generations.
  • This should illustrate the importance of wage inequality in determining the well-being of our children and grandchildren.

The amount of money at stake in terms of the distribution of future wage gains is an order of magnitude greater than the potential tax increases needed to maintain full funding of Social Security and Medicare. For this reason, it is ironic that discussions of future the well-being of our children and grandchildren tend to focus on these programs and the budget more generally. The distribution of income in three decades will be of far greater importance.

This blog post originally appeared in the Roosevelt Institute's Econobytes.