Sunday, May 4, 2014

Gray Skies On The Horizon

I came across some interesting data over the past week that underscores that there are gray skies on the horizon. Specifically, the gray wave of baby boomers and the impacts and implications this group will have on our economy and public policy over the next decade.

The latest labor force participation rate data shows that we are at a 38-year low in the percentage of those 16 years and older working.  Just 62.8% are in the labor force.

The percentage of those working in every age group has been consistently dropping over the last few years except for those 55 years of age and older.  This trend is expected to continue for the next decade.

Only 29% of those age 55 and over were working in 1993.  Today it is 40.3%.

Those working have increased in every age group over age 55.  For example, over 30% of those aged 65 to 69 are working today. 30 years ago only 18% were working. 20% of those 70-74 are working compared to half that number 20 years ago.

This is good news on a number of fronts. Better health and a greater percentage of workers in white collar jobs has enabled more people to continue working.

However, a number of these workers have no choice but continue to work due to scant retirement savings and concerns about the economy, inflation, health care coverage and the future direction of the country.

The reality is that at some point these people will no longer be able to continue to work.  This will put additional pressures on Social Security and Medicare especially given the meager returns that can be expected from fixed income investments considering current interest rates and bond prices.

This points to further gray skies ahead.

At the same time, Social Security and Medicare are facing critical challenges just as millions more will become more reliant on the two programs.

Look at the projected cash flow deficits in the Social Security program over the next 10 years as detailed in the most recent Social Security Trustees Report.

In 10 years Social Security will be running close to a $250 billion cash flow deficit per year.  Where is that money going to come from?  Increased payroll contributions?  Reduced benefits?  More borrowing?

As you can see from the chart we have about five years until the cash flow situation becomes precipitously problematic.

The same is true with the Medicare's Hospital Trust Fund (Part A) which is also funded by FICA payroll taxes which will be running annual $100 billion cash flow shortfalls within a decade.

A far bigger problem for Medicare are the demands on funding of the Supplement Medical Insurance program (SMI) which is more popularly known as Medicare Part B.  This program is funded by premiums on Medicare beneficiaries who pay approximately 25% of the total projected program cost with the General Fund of the Treasury (general tax revenues on you and me) paying the additional 75% of program costs.

Part A covers hospital costs.  Part B covers physician services and most everything else (except drugs which are covered in Part D).

I find that very few people understand the distinction between Medicare Part A (paid by payroll taxes during your working years) and Medicare Part B which is primarily being paid out of general funds.  When someone argues that they paid for their Medicare with their payroll taxes over their working  years they are only right if it involves a hospital bill.  For anything else, they are getting a large portion of the tab paid by their fellow citizens through current income taxation.

You get a better idea of how big this amount is by looking at this chart in the Social Security Trustees Report for 2013 that shows projected SMI (Medicare Part A), HI (Medicare Part B), and OASDI (Social Security) tax shortfalls between now and 2014 expressed as a percentage of GDP.

Source: A Summary Of The 2013 Annual Reports
Social Security and Medicare Board of Trustees

To put this all in context, you can see from the chart above that these programs currently require general funding (outside of the trust funds) of 2% of the country's $17 trillion of GDP.  That is $340 billion.

In 10 years we will needs another 1% of GDP to fund the shortfall in these programs ($170 billion in today's dollars).  In 20 years we will need an additional 2.5% of GDP to fund the shortfall.  That is $425 billion in today's dollars.

Let's put that in context.

$425 billion is about one-third of the current combined expenditures for Social Security (OASI) and Medicare.  To cover this shortfall without raising taxes would mean reducing all of these benefits to 2/3 of what they are today.

If the entire shortfall is covered by income taxes, it would require individual income taxes to be increased by one-third across the board.  Individual income tax receipts currently produce $1.3 trillion per year.

No one wants their benefits reduced and no one wants their taxes increased.  However, something has got to give.

There are gray skies on the horizon and somebody is going to get drenched...perhaps all of us.  The labor force participation rate of those 55 and older indicate that many in this age group understand the risks on the horizon.

I don't think the Millennials see it yet.  Their votes for Obama were directly contrary to their long-term economic self interest.  When the history of the Obama era is written, I think one of the ironies that historians will focus on will be the level of support that younger voters provided for Obama that will clearly be seen as having been against their self-interest when viewed in the fullness of time.

They thought that were voting for the rainbow that surrounded Barack Obama after the bleak days of George W. Bush.  They did not realize that the Obama rainbow only appears every four years during the election cycle.

They may never realize how dark the sky has gotten until they see their tax returns and paychecks when the full force of the storm is upon us.  Time is running short.  Barack Obama is not serving their interests.  They need to find someone who will.  Every day this problem is not addressed it will cost them more.

Credit: Wikipedia Commons

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