Candidates Need to Examine Future of Entitlments, Taxes (Commentary by James Bell)

Now that tax season is over, I find myself thinking not about next year’s taxes but what taxes might look like decades from now. The Social Security Trustees’ 2008 Report was released in March and it projects the present value of the unfunded obligation for the program over the next 75 years is $4.3 trillion.

The Medicare trustees expect a present value shortfall of more than $9 trillion over that same period. Stated differently, given the current assumptions we would have to add around $13 trillion to those programs’ funds today to keep them at a break-even level 75 years from now.

Of course, tweaking any of these assumptions can change the result, but there is clearly a huge deficit between our government’s obligations and the ability to pay them.

Under current assumptions, Social Security and Medicare spending are projected to go from 7.5 percent of GDP today to 16.6 percent of GDP in 2082. The Trustees’ report points out, “As a point of comparison, in 2007 all Federal receipts amounted to 18.8 percent of GDP.” Clearly we will not be able to run our economy and defend our country while spending 88 percent of our tax receipts on these entitlement programs.

There are really only two solutions to close these gaps: cutting spending and benefits or increasing governmental revenue. Cutting federal spending on Medicare and Social Security benefits does not seem to be in the nature of either political party. Increased revenue from economic expansion alone is possible, but a certain rate of such growth is already included in these actuarial assumptions. The hard answer is the government has obligated itself to certain levels of spending and benefits that are not fully funded, and it will be up to taxpayers to cover the difference through higher taxes.

I don’t want to get political, but I think it is fair to say no candidate in either party in the current election season has shown a willingness to truly address this issue. In previous elections it has been lip service at best. Certainly the solution to this problem, whether in the form of cutting benefits, raising taxes, or both, is a bitter pill, and no candidate is going to win many votes offering such a prescription. But good leaders sometimes have to make difficult decisions and we should demand that whoever wants to win the White House in November present a detailed, realistic plan to address this issue.

So what is the investment conclusion from all of this?

Taxes may well be higher in your retirement years than you had originally planned on, and Social Security and Medicare benefits may be reduced. This is a good opportunity to revisit all of your retirement planning assumptions and make sure they are still reasonable. Different inflation, return, and tax scenarios may produce startlingly different results from your current assumptions. Be sure to plan accordingly.

(James Bell, CFA, is vice president and assistant portfolio manager at Garrison Asset Management in Fayetteville. Contact him at [email protected].)