Growth, Taxes, and Retirement Programs

There are a number of different ways to characterize the findings of the latest “trustees report” for Social Security and Medicare, but the bottom line is that at some point in the future taxes are going to have to be higher.

Right now we’re set to be buried under a torrent of health care cost inflation, which highlights the need for health care reform. Tweaking Medicare in isolation is unlikely to be the most effective approach since Medicare costs track private sector health care cost shifts:

That said, controlling health care cost growth through systematic reform is necessary but not sufficient. We’re not realistically going to get health care cost inflation down to zero. And even if we did, demographic shifts imply higher expenditures for Social Security, Medicare, and Medicaid. In other words, unless we radically scale back our commitment to providing a secure and dignified retirement for senior citizens, some of this will have to be done on the tax side.

Meanwhile, note that the trustee’s report suddenly looks a lot worse because of the recession. That’s because even though these trends are driven by health care economics and demographic changes, they’re also quite sensitive to questions about economic growth. A relatively small boost in the growth rate, if sustained over time, makes our existing commitments much more affordable. One lesson of this is that even revenue-neutral tax reforms—efforts to curb deductions and loopholes in exchange for lower rates—can help a lot with this program. Another lesson is that when the time does come to talk about tax increases, it’s important to focus on tax increases that are economically efficient. Evidence suggests that the administration’s proposals to limit deductions for high-income taxpayers fit this bill as do some of the ideas about taxing public health hazards that have been vaguely leaking out around the Hill. But a broader, deeper, more fundamental reform would be highly desirable during these next few years before we shift into a higher tax equilibrium.