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Abstract
Will soaring health costs and high future tax rates lead people to delay retirement? This study assesses potential impacts by comparing retirement incomes under two different scenarios. The high-burden scenario assumes that health costs grow rapidly and tax rates rise nearly enough to balance the federal budget. The alternative assumes that burdens remain at their 2000 levels. Moderate-income couples retiring in 2030 would have to work an additional 2.5 years under the high-burden scenario to receive the same income in the first year of retirement, net of taxes and out-of-pocket health spending, as they would receive under the low-burden scenario.
Executive Summary
Soaring health costs are imposing enormous pressures on public budgets. Those pressures will grow rapidly in the future absent radical reforms in health policy. At the federal level, common projections imply that Medicare and Medicaid outlays alone will absorb an additional 4 to 7 percentage points of the GDP in 2030 than they do today (Congressional Budget Office 2005). At the state level, Medicaid is already putting a squeeze on other functions of government.
Government may be spending more and more, but not because it is reducing the burden on private individuals. Quite the contrary, private individuals also face large and growing health care costs. These can be particularly burdensome for older Americans. They face three types of out-of-pocket expenses. First, most pay Medicare premiums for optional Part B coverage that pays for physician services and non-physician outpatient costs. The new Part D Medicare that provides coverage for prescription drugs also require premium payments. Under current law, these premiums rise in step with Medicare outlays and are expected to absorb a growing share of Social Security benefits. Second, many older Americans also purchase private Medigap policies that cover Medicare deductibles and copayments while also covering catastrophic expenses. In addition, some make payments to past employers for retiree health insurance. Third, even those older Americans with extensive public and private insurance coverage must often make direct payments to health care providers for deductibles and copayments.
While private costs are rising rapidly, the comparable increase in public costs is likely to boost future tax burdens. Otherwise, budget deficits and the public debt will explode. It is likely that some of the increase in tax burdens will fall on older Americans, thus subjecting them to a double whammy. They will face rapidly growing private health costs at the same time as tax increases are slowing after-tax income growth.
In an earlier article, Johnson and Penner (2004) spelled out the implications of the growing double burden. The projection of health costs was based on the intermediate assumptions of the Medicare trustees. The trustees assume that Part A and Part B costs per beneficiary grow at a real annual rate of 3.2 percent between 2000 and 2030. Per capita payments to providers and private insurance companies are assumed to grow at this rate, as are Part B premiums. The projections account for the new prescription drug program that will reduce out-of-pocket costs somewhat and reduce some Medigap premiums. The Part D premium is assumed to increase 4.5 percent per year in line with the trustees' assumptions. It is assumed that the growth in Medicaid enrollment is slowed by rising real incomes, but accelerated by an increase in the participation rate as rising out-of-pocket costs strengthen enrollment incentives. The participation rate is assumed to rise from 75 percent to virtually 100 percent by 2030.
Tax policy is assumed to correspond to that in the "high revenue" path used in CBO's long-run budget projections. That path assumes that the Congress does nothing, President Bush’s various tax cuts are allowed to expire and real growth constantly pushes taxpayers into higher tax brackets. More and more taxpayers are also subjected to the alternative minimum tax. A growing portion of Social Security benefits becomes taxable, because the thresholds over which benefits are taxed are not indexed for either inflation or wages. Under this scenario, the total federal tax burden rises to 22.6 percent of GDP by 2030, about 23 percent higher than its 30-year average. But the entire increase is the result of a personal income tax increase of 60 percent over its 30-year average. It is alarming to note that this substantial tax increase is not sufficient to make fiscal policy sustainable when combined with CBO’s high outlay path. The debt-GDP ratio would reach about 100 percent in 2030. It was 37.4 percent at the end of fiscal 2005.
Income projections are made for older couples and unmarried individuals using an Urban Institute model that forecasts future social, demographic, and economic characteristics of the population. The model projects that, on average, unmarried individuals will do somewhat better than couples through 2030 with the former enjoying a before-tax income increase of 50 percent while the latter receives a 38 percent increase.
These assumptions imply that tax burdens and out-of-pocket health expenditures soar for the median couple in which both partners are 65 or older. As a result, their real after-tax income net of health spending in 2030 is almost identical to their real income in 2000. The single individual does better and receives a real after-tax income increase net of health spending of 27 percent compared to the before-tax income increase of 38 percent.
Medicaid provides considerable protection for unmarried adults in the lowest quintile and they enjoy a larger percentage increase by 2030 in after-tax income net of health spending than those in the top quintile. But poorer couples are not as lucky as singles. The median couple in the lowest quintile in 2030 has too much income to qualify for Medicaid and suffers an absolute drop in after-tax income net of health spending, as does the median couple in the second quintile. These estimates do not consider possible increases in state taxes because of budget pressures stemming from Medicaid.
The projections contained in our earlier article were not meant to be a forecast. Indeed, their main purpose was to show that current health policy cannot be sustained as long as 2030. It would take oppressive tax increases to sustain macro fiscal policy through that year, and when the necessary tax increases are combined with very large increases in out-of-pocket health spending, political pressures behind reform are likely to become irresistible. The alternative of running very large budget deficits is unlikely to be tolerated by international and domestic financial markets.
However, there is no sign of significant reform as yet. It is probably safe to assume that public budget pressures and out-of-pocket health costs will continue to accumulate for a number of years into the future. Public budget pressures will not, in fact, become very serious until a few years after the first baby boomer qualifies for Medicare in 2011.
There are not many signs of public willingness to accept tax increases either. The first response to gathering budget pressures may be to let the deficit drift upward and to cut the growth of non-health public expenditures. But, as pressures mount, tax increases are sure to be discussed more and more and may well be implemented before serious reforms in health policy. The possibility that tax increases will come on top of rapidly rising out-of-pocket health costs raises many interesting questions, but one of the most interesting is, "What would that do to the timing of retirement?" This paper will explore the conceptual issues raised by that question and provide a simulation that computes an upper bound to the effects on the retirement decision.
Note: This report is available in its entirety in PDF Format.
The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.
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