Unfunded Liabilities

Posted on March 7, 2011

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American state and federal governments are struggling to cut spending. They are unable to fulfill the budgets that they had planned on with the revenue they are now taking in. Most of the debate has been about cutting short term spending on public services with the idea that the revenue shortfall is a short-term effect of the recession. But huge parts of both the state and federal governments are the liabilities created by big programs we take for granted now.

In 2010, 43% of the federal budget went to Social Security, Medicare, and Medicaid payments. These programs are decades old, and the amount paid out each year is set by the formulae in the original laws and what changes have been made over the years. They are funded each year by payroll taxes, some paid by employees and others by employers. The problem is that the formulae are out of date. When the laws were originally written, the idea was that each worker would, on average, pay as much in payroll taxes over his or her lifetime as he or she would take out in payments. If the US population were stable, then that would mean that the payroll taxes in any given year, paid by the current generation of workers, should be enough to pay for the programs for that year, serving the current generation of retirees.

This assumption has caused difficulties in two ways. The US population isn’t demographically stable. The Baby Boomer generation for a while meant that the number of people of working age was disproportionately high, so that more taxes were coming in than were needed by that generation of retirees. A sensible, farsighted government would have saved the extra cash, knowing that later on those extra workers would become extra retirees and the programs would need more money. But over the years, few of our governments have been sensible or farsighted, and so the money was spent immediately.

Secondly, people are living much longer than they used to. When Social Security was first put in place, the retirement age was 65 and the average life expectancy was 62. Now the retirement age is inching up to 67, and life expectancy is 78. People are living much longer after retirement, and new health procedures make health care much more costly than it used to be. The only forecasted change is that people will continue to live longer and spend more money on health care. So unless we change the math, America will be stuck with budget crises for a long time to come.

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