Here’s the good news: future costs of Social Security and Medicare won’t require higher taxes. Now here’s the bad news: the reason these programs won’t require higher taxes is that they’ll be so expensive that there’s no possible way to pay for them through taxes. Everything in the US (not counting people) is worth about $50 trillion and those two programs will cost $80 trillion, unless they are reformed.
Wharton insurance and risk management professor Kent Smetters, a former deputy assistant Treasury secretary and economist for the Congressional Budget Office, explains that the only way for these problems to survive is by cutting them back drastically. From Wharton’s [email protected]:
We currently have a present value shortfall that’s twice the value of the entire country, except for the human beings. So, obviously, we can’t tax our way out. So the real issue is, what type of hit are we going to give do to benefits? You’re going to see benefits reduced, especially for higher income earners. We got a hint of that in Medicare Part D, the newest part of Medicare that gave us our prescription drug bill. They explicitly have some means testing in there, which basically says higher income people get a smaller benefit. Social Security benefits are now taxed. And in fact, they’ve been taxed since 1983. But it’s taxed on a progressive basis. Higher income workers get more of their benefits taxed. I think you’ll start to see a lot of more of that.
And so what will happen is Medicare and Social Security will become more of a flat system, [with] fewer benefits to higher income people even though they paid in more. But on the [revenue] side, I don’t see a lot of room for continuously increasing taxes. We’ll see, I think, more taxes on higher income individuals. And that will have long run implications because they’re also the ones who create jobs and invest and innovate. We already have the second highest corporate income tax rate in the world, even after you net in things like expensing and so forth. So for us to remain competitive, I just don’t see how… we can really do a lot on the tax side. But I do think we will see taxes go up. The thing I fear the most — and I think it is the most likely outcome — is that the government will print a lot of debt to pay off a lot of these shortfalls. And then the international markets, in particular the fixed income markets, will figure it out.
They will realise the government is basically monetizing that debt through higher inflation. And if you have an inflation rate that’s 25, 3% more per year than the historic average, you can really eat away a lot of debt just through the law of compounding. And so the market should figure that out and adjust the interest rates accordingly. That’s one reason why I believe that 30 year yields right now on Treasury [bonds], especially to non inflation protected Treasuries, is really too low. I believe Treasuries are in a bubble right now because everybody’s flocked to the safety. And there’s just no way that those low yields of 3.5% are going to cover the inflation rate over the next 30 years.