Big Numbers and the Federal Budget

Jeff Bennett, March 2004

Last year, Congress passed a new prescription drug benefit for Medicare that was supposed to cost $400 billion over the next 10 years. This year, the cost estimate has been raised to $530 billion. The rapid change in the estimate has upset a lot of people, and some are questioning whether the more recent figure was deliberately hidden at the time Congress was voting. It will be interesting to follow the controversy... but monetarily it is the tip of the iceberg. Hidden deeper in the news, you'll find new estimates about the long-term shortfalls in both Medicare and Social Security, and it's not pretty. For example, a 2002 study by the Treasury Department estimated that the shortfall in Medicare and Social Security would be $44 trillion over the next 75 years. In other words, the projected amount that will be owed in benefits for these programs over the next 75 years is $44 trillion greater than the taxes that will be collected for them. And this study was done BEFORE the new prescription drug benefit was passed. Here are some suggested exercises and discussion questions for class:

* Suppose Congress decided to address the projected shortfall by increasing Social Security and Medicare taxes. If the $44 trillion were to be collected in taxes evenly over the 75 years, how much would need to be collected each year? Compare this amount to current government tax revenues, which are a little less than $2 trillion per year. (Answer: $44 trillion/75 years = about $600 billion per year. This is about 30% of current total tax revenue. In other words, we'd need to increase overall taxation by about 30% in order to make up for the projected shortfall.)

* Social Security and Medicare are currently paid for by "FICA" taxes, not by general income taxes. Of the government's roughly $2 trillion in current annual tax revenue, FICA taxes contribute about
35%, or $700 billion. Suppose the tax increase in the prior question is an increase only in FICA taxes. How would it change the FICA tax rate? Note that FICA taxes are currently set at 15.3% of wages, with half paid by the employer and half paid by the employee (self-employed people pay the full 15.3% themselves). (Answer: Above, we found that taxes would need to be increased by $600 billion per year; if this is all FICA, then it means FICA taxes would nearly double (rise by 86%). So the new FICA rate would be around 30%.)

* Is it politically realistic to imagine raising the FICA rate as much as you found above? Can you think of any other alternative ways to address the projected shortfall? (Discussion points: most will say it's not very politically realistic, but the only real alternatives are to raise other types of taxes or cut future benefits or have the government debt skyrocket.)

* All of this is based on projections for the next 75 years. Historically, budgetary projections even for one or a few years have proven to be notoriously inaccurate. Should we worry about a shortfall from a 75-year projection? Why or why not? (Discussion points: This is highly debatable, since a small change in the projected economic growth rate could lead to large swings in the shortfall projections. Nevertheless, the current projection tells us that something significant will have to happen to avoid the "fiscal train wreck" that many economists fear.)

* A note on references: In Using and Understanding Mathematics, Third edition, Unit 4D has a discussion of FICA taxes and Unit 4E has a general discussion of the federal budget including Social Security. You can also use the Addison Wesley Research Navigator (http://www.researchnavigator.com) to search for recent articles about these budgetary issues in the New York Times and other news sources.