Monday, April 30, 2012

One way to look at Social Security and Medicare

Social Security and Medicare are two of biggest items in the Federal Budget. Together they accounted for 35% of all Federal spending in 2011 and their costs are predicted to only go up. As Americans we have to have a serious discussion about how much we want to spend on these two programs.

To help start this conversation I want lay out a framework for how to think about Social Security and Medicare spending. This framework revolves around thinking about these two programs as wealth redistribution from the relatively wealthy to the relatively poor.

Over the last 250 years or so in the U.S. and in most of Western Europe, each generation has been wealthier than the last. That is each generation has had on average higher levels of consumption, lower levels of physical labor, more leisure time, and increased income mobility. With this in mind it is easy to see that what Social Security and Medicare are doing is transferring wealth from the relatively wealthy generations of X, Y, and the Millenials, to the relatively poorer Baby Boomer generation. So in many ways the inter-generational wealth transfers that take place through Social Security and Medicare are no different than the intra-generational transfers that take place through the income tax system, welfare, food stamps, etc.

When thinking about either intra or inter-generational transfers, the question that has to be asked by society is, does the marginal benefit of a dollar going to the relatively poorer party exceed the marginal cost of a dollar being taken from the relatively wealthy party? If it does not, then the transfer should not take place.

I think that most people are willing to engage in some inter-generational wealth transfers. The problem that I see with the current levels of spending on Social Security and Medicare is that we have passed the point where the marginal benefit is greater than the marginal cost. To be more clear, I think that the marginal benefit to society of another federal dollar spent on senior citizens is less than the marginal cost to society, especially younger generations, of another dollar being added to the deficit. Even if you don't agree with me, and I am sure many older people don't, it is certainly not clear that the reverse is true.

Regardless of what you believe, and hopefully some empirical work will be done that can shed some light on the proper position, it is important that people think about the two programs within some sort of cost benefit framework. The one presented here, in which society chooses a proper level of spending based on the marginal benefit vs. marginal cost rule, is just one such framework, though I think it is a good one.

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