t

hree decades ago, angst over the looming insolvency of Social Security reached fever pitch. President Ronald Reagan responded by grasping the third rail of American politics long enough to add decades to the entitlement’s solvency by increasing the taxes employers and employees paid and by incrementally extending the age of retirement from 65 to 67.

In the years since, the sprawling Medicare/Medicaid system has replaced Social Security as the emblem of impoverished entitlements. Despite duly repeated warnings that the program is unsustainable—or perhaps as a result of those constant cries of “wolf!”—we have become numb to the peril. The entitlement train that has been a mere smudge on the horizon for years is now approaching the cliff of insolvency at high speed.

Face the figures. In 1980, the federal budget was $590 billion. This fiscal year, federal expenditures are estimated at $3.5 trillion. According to the Bureau of Labor Statistics inflation calculator, $100 in 1980 is the equivalent of $260 today. So if federal outlays had risen at the rate of inflation, the federal budget would be about $1.5 trillion today, not $3.5 trillion. How did we pile on $2 trillion above inflation?

Start by looking at Medicare/Medicaid. The former entitles those 65 and older (45 million) to government-funded healthcare; the latter guarantees care to disabled and low-income Americans (49 million).

Medicare was a wee lad of only $52 billion back in the early 1980s; Medicare/Medicaid will together consume $821 billion in fiscal 2010—and that’s not counting the 50 states’ share of the Medicaid tab. (Here is a “no wonder we are all numb” tidbit: the official 2010 budget for both programs is “only” $743 billion, but $78 billion of the $787 billion stimulus was a giveaway to the states to help offset their portion of Medicaid costs. The program is busily bankrupting states, too.)

Official projections claim that elder brother Social Security will remain solvent until the politically benign date of 2037. Unfortunately for the program’s bean counters, the Great Recession has trimmed revenues even as it has driven hordes of people to retire early at 62 rather than wait for full benefits. As a result, outlays are soaring: monthly benefits were $56.6 billion in September 2009, up from $51.5 in 2008, a staggering 10 percent increase in a single year.

Meanwhile, revenues have slipped into the negative column. Yes, the Social Security cash cow is dying. In 2007, the system generated a surplus of $191 billion; based on current trends, that surplus will be gone by 2011 or 2012, six years earlier than the program’s June 2009 trustees’ forecast.

The short answer to why our entitlement system is collapsing so quickly is the metaphorical “pig in the python”—that demographic bulge of 78 million citizens called the Baby Boom. With the first Boomers—those born between 1946 and 1964 by most accounts—eligible for Medicare next year, that program’s beneficiary count will rise 50 percent in the next decade, from 45 million today to over 67 million by 2020.

Even if the costs per beneficiary remain static, that influx of wards will boost costs by 50 percent. And unfortunately, decades of data suggest that costs per beneficiary will continue rising by about 7 percent per year. Repeated “reforms” have done little but slow the rate of acceleration.

One favorite way of dealing with politically inconvenient projections is to fudge the numbers to let the current crop of politicos off the hook. This tactic has added to the nation’s self-hypnosis, offering bright projections of future growth (“we’re going to grow our way out of this”) and unrealistically low estimates of future entitlement expenses.

Even the Reagan-era reform of Social Security relied on the bureaucratic legerdemain of the Boskin Commission, which rejiggered the methodology for calculating the Consumer Price Index. Consider the wizardry of “hedonic adjustments”: though the price of a new car rose from $6,847 in 1979 to $27,940 in 2004, after the hedonic adjustment is applied—cars are a lot better quality now, etc.—$6,847 in 1979 is only $11,708 in 2004 dollars. This artificially dropped the cost of living adjustments built into Social Security, thus lowering the overall program costs by 1 percent a year—over time, a hefty sum.

While the CPI will remain ground for mind-numbing debate until Doomsday, government agencies have a long and well-documented history of underestimating expenses and overestimating growth in tax receipts. Congressional Budget Office projections of 2009 Medicare costs were about 9 percent short of actual costs, for example, and various agency projections of GDP growth remaining between 3 and 4.6 percent in the decades ahead now look unrealistically optimistic.

In other words, federal green-eyeshaders are assuring us that if GDP grows by 782 percent in the next few years, it’s “no worries, mate.”

That may be a slight exaggeration, but the hope of outracing the entitlement train by growing an overleveraged and heavily indebted $13 trillion economy at 4.6 percent a year for decades to come is fantasy. The more likely scenario is that the U.S. will remain in a Japan-like stagnation for the next decade, with flat GDP and tax revenues as trillions of dollars in speculative bad debts are slowly written off.

The fantasy also runs counter to demographics: Baby Boomers, long the mainstay of income tax revenues, will switch from being ATM’s for the IRS to beneficiaries of government largesse. And there is little evidence that tens of millions of new jobs will be created to fund 78 million Boomers’ 30-year passage through the entitlement python.

Despite various magical thinking mantras (“biofuels, biofuels, biofuels”), there are few drivers of job growth to replace the busted bubble-era industries—construction and finance—and an environment of higher taxes and healthcare costs isn’t exactly propitious for small business. Little wonder, then, that the federal deficit is expected to remain above $1 trillion a year for the foreseeable future (unless you plug in that magical 782 percent rise in GDP, of course).

Back in the real world, tax revenues dropped 7 percent in December, even though the economy was supposedly growing at a 2.2 percent clip, and the Medicare/Medicaid budget has exploded from $595 billion in 2008 to $743 billion a mere two years later, dwarfing both Social Security ($695 billion) and the Defense Department ($663 billion). Did anyone notice that many of the long-term unemployed who exhausted their unemployment benefits now qualify for Medicaid?

The current leadership’s plan is to fill the $1.5 trillion gap between tax revenues and expenditures with borrowed money, but many observers doubt that incantations of fiscal responsibility will induce the bond market to fund endless trillion-dollar deficits at near-zero yields. Which brings us back to a key driver of those deficits: healthcare costs.

The U.S. spends over 16 percent of its GDP on healthcare, 60 percent more than Germany and double what aging Japan devotes. (Thirty years ago, healthcare absorbed 8 percent of America’s GDP.) Per capita the U.S. spends more than double what Australia and Sweden spend on healthcare—almost $7,300 per citizen, far outpacing oil-rich Norway, a distant second globally at $4,760 per citizen. Despite spending twice as much on healthcare as England, studies show that Americans are considerably less healthy than their English counterparts.

In other words, it isn’t just the federal healthcare programs that are bankrupting the nation, it’s the entire healthcare system. Where did we go wrong?

If we clear away the canards and excuses, what we have is a system of utterly perverse incentives. The system gives patients no motive to pay attention to costs and providers every incentive to pad the bill. As for quality care, there are no incentives for that either. Studies have shown that poor medical practices actually net providers more money. According to a recent report, only 3 percent of the millions of fee-for-service charges submitted to Medicare are reviewed, and over 10 percent of Medicare’s $453 billion annual expenditures are outright fraud.

As the system now works (or doesn’t), the total cost of a procedure isn’t provided beforehand to enable cost comparisons. It’s akin to taking your car to an auto mechanic and agreeing to pay for whatever services the garage deems necessary, with no penalties if the service is poor. Medicare just paid $2,000 for my 80-year-old mom to sit in a waiting room for a few moments prior to my picking her up. It was called a “recovery room” for billing purposes, but my physician sources say a recovery room is only for patients coming out of general anesthesia, and my mom had only local anesthetic on one of her toes.

Lack of transparency, no incentives for patients to skip unnecessary procedures or choose the lowest-cost service, every reason for providers to tack on questionable charges—the system is broken at the most fundamental level. The “healthcare reform” bill grinding through Congress does little to address these ills, and in a perfection of perversity will add at least $1 trillion over the next decade to U.S. healthcare costs that already outstrip every other nation’s medical expenditures.

Spending our way out of insolvency is not possible. The trends in demographics, healthcare, tax revenues, and entitlement outlays lead to an impossible end: 50 percent of the federal budget will be devoted to Medicare/Medicaid alone by 2020.

The ironic hope is that by accelerating the entitlement train toward the cliff of insolvency, the current facsimile of “healthcare reform” may hasten real change.. 
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Charles Hugh Smith writes the Of Two Minds blog (www.oftwominds.com) and is the author of numerous books, most recently Survival+: Structuring Prosperity for Yourself and the Nation

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