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Is Fixing Social Security and Medicare as Dire as It Seems?

Fifty years after the Employment Retirement Income Security Act, high levels of retirement risk point to the need for solutions.

Illustrative visualization showing the accumulation of dollar bills and a piggy bank.

There must be 50 ways to fix Social Security.

OK, that’s not a direct quote of the Paul Simon lyric, but I find myself humming the tune every year when the Social Security trustees issue their annual report on the program’s health.

Like clockwork, you can expect to see misleading headlines warning that Social Security is going broke or running out of money. And you’ll see similar headlines about the report of the Medicare trustees.

This year, let’s consider the inaccurate news coverage in the context of an important milestone: the 50th anniversary of the Employment Retirement Income Security Act, or Erisa. This landmark federal legislation was signed into law in 1974. Erisa established badly needed fiduciary standards and regulations for private pension plans in the wake of a series of defined-benefit plan failures and abuses. But the law’s tougher standards did ultimately play a key role in the shift by employers to defined-contribution plans.

This shift from the guaranteed lifetime income provided by pensions to tax-deferred 401(k) plans has been described as the “great risk shift,” and it has played a big role in leaving so many retirees at risk of a falling standard of living in retirement.

The 401(k) system has performed well for higher-income workers, especially those employed by large companies with strong, low-cost plans. But it leaves roughly half of workers with no retirement savings plan option. Many who work at small companies are in mediocre to bad plans with high costs that take an enormous bite out of savings.

This year’s Erisa anniversary will spark plenty of conversations about ways to improve and expand access to defined-contribution benefits—and those conversations are worthwhile.

But I hope the anniversary, and the fall elections, will also infuse new energy into efforts to improve and expand Social Security and Medicare.

A Snapshot of Social Security and Medicare Finances

Social Security and Medicare both face long-term solvency challenges.

This year’s Social Security trustee report forecasts that the combined retirement and disability programs will be insolvent in 2035, which is one year later than last year’s forecast. To be clear, that doesn’t mean the program will have no money left to pay benefits. Rather, the forecast references the year when the enormous Social Security trust fund reserves (currently $2.78 trillion) would be depleted.

Still, without action by Congress, the program in 2035 would be bringing in enough cash to pay only 83% of the benefits promised to current and future beneficiaries. In other words, beneficiaries would be facing a disastrous 17% cut in benefits.

Because Medicare is funded through a variety of sources, its situation is less dire. This year, the trustees project that the Hospital Insurance Trust Fund, which finances Medicare Part A, will be exhausted in 2036 (five years later than in last year’s report). The other parts of Medicare cannot run out of funds, because general government revenue and premiums are adjusted annually to meet projected costs.

If the Hospital Insurance Trust Fund did become insolvent, it would have sufficient funding from current revenue to meet 89% of benefits.

How to Fix Social Security’s Finances

Polling consistently shows that most Americans prefer raising new revenue to support both Social Security and Medicare, and I’d agree.

Democrats typically advocate for raising taxes on the wealthy to extend Social Security’s solvency, while Republican lawmakers want to fix the problem by cutting benefits.

President Joe Biden’s latest budget plan calls for higher-income people to pay more.

Congressional Democrats have called for an increase to the cap on the amount of wages subject to the payroll tax, and some plans also call for new taxes on investment income. These various proposals would restore solvency anywhere from 32 to 75 years.

These plans also modestly expand benefits, particularly for the most vulnerable retirees:

  • The Social Security Expansion Act would raise benefits across the board by roughly $200 per month and implement a more generous annual cost-of-living adjustment. It also would add targeted increases for very low-income workers.
  • The Social Security 2100 Act would raise benefits modestly across the board and boost the COLA. It also would reduce the share of retirees whose benefits are subject to income taxes and boost benefits for widows.

Meanwhile, Donald Trump, the likely Republican presidential nominee, usually says he would not touch Social Security. But leaving the program untouched is not a policy solution, since it results in a 17% cut in benefits.

Republican solutions center on cutting benefits. They have proposed phasing in higher retirement ages—that is, the age at which you can receive 100% of your earned benefit. They also have called for means-testing benefits, which would cut back on payments to higher-income households.

The argument for a higher retirement age often contends that “we’re all living longer,” so it makes sense to push back the eligibility age. But longevity gains have been concentrated mainly in better-educated, higher-income people. And this argument masks the underlying problems that come with pushing the full retirement age higher:

  • It would function as a benefit cut because it raises the bar on how long people must wait to receive their full earned benefit. The higher retirement age legislated in 1983 was effectively a benefit cut of 13% because it increased the full retirement age to 67 for workers born in 1960 or later. Raising the full retirement age to 70 would be an additional cut of roughly 20%.
  • It assumes that people would simply work longer to meet their living costs. But the people who rely most on Social Security are less-educated workers who often work in physical labor. And the pandemic seems to have ushered in a change in expectations about working longer. A new survey by the Federal Reserve Bank of New York finds that the share of American workers who say they expect to continue working full-time at older ages is falling sharply, especially among women and lower-income workers.

The political parties are far apart on how to right the ship.

“Many Republicans are focusing only on benefit reductions, and Democrats are focusing solely on tax increases,” says Paul N. Van de Water, senior fellow at the Center on Budget and Policy Priorities. “Most analysts think it’s going to take some combination of both to solve the problem, but so long as both sides take these positions, it’s much more difficult to reach a compromise solution.”

If that persists, I suspect Congress will turn to a different solution to avert insolvency and benefit cuts: an emergency injection of general government revenue.

The logic backing the general revenue solution is straightforward. Even if a consensus emerged for some amount of benefit reduction close to the insolvency date, the math simply does not work owing to the magnitude and timing of the cuts required.

How to Fix Medicare’s Finances

The Biden administration’s most recent budget proposal calls for a revenue fix for the Hospital Insurance Trust Fund focused on high-income households and business income. It also would credit to the fund savings from Medicare’s new power to negotiate drug prices with pharmaceutical companies and broaden that negotiating power.

The Republican Study Committee, which represents a majority of the party’s lawmakers, is looking to privatization to solve Medicare’s financial problems. Its budget plan this year calls for the introduction of “premium support,” or vouchers, an idea that has been proposed at various times for more than a decade.

All the parts of Medicare would be combined into a single program that would be offered by private insurance companies, with a mix of government support and out-of-pocket payments. Seniors would use the vouchers to shop for healthcare plans. (Last year, the RSC plan called for higher eligibility ages by mirroring Social Security’s full retirement age.)

The argument that privatization saves money flies in the face of recent evidence on what’s already going on in Medicare.

Medicare Advantage, which offers Medicare coverage through private health insurance companies, already costs taxpayers and premium-paying enrollees much more than traditional fee-for-service Medicare.

The Medicare Payment Advisory Commission, which advises Congress on policy, recently reported that Medicare this year will pay Medicare Advantage plans an estimated 122% of the cost of similar beneficiaries in traditional Medicare. That translates into $83 billion in additional Medicare spending in 2024 and $13 billion in higher Medicare Part B premiums paid by Medicare beneficiaries in 2024.

When Will Congress Act on Social Security and Medicare Funding?

Since this is an election year, don’t expect to see Congress addressing Social Security and Medicare’s shortfalls in 2024.

Optimists think action on Social Security could come in 2025. Among them is Martin O’Malley, the recently confirmed commissioner on Social Security.

“A 17% cut in benefits would be a huge hit to people who are living from one benefit check to the next,” he told me in a recent interview. “This program has done so much to lift so many seniors out of poverty, I can’t imagine that the Congress won’t act to make sure that it’s strengthened into the foreseeable future.”

The more pessimistic view? Social Security will get close to the solvency cliff, followed by a general revenue bailout.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

Mark Miller is a freelance writer. The opinions expressed here are the author’s. Morningstar values diversity of thought and publishes a broad range of viewpoints.

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