Are Entitlements A Problem?

A Google search finds the following when searching for a definition of: ”Entitlements”:

“Entitlement is a guarantee of access to benefits because of rights or by agreement through law. It also refers, in a more casual sense, to someone’s belief that one is deserving of some particular reward or benefit. It is often used pejoratively in common parlance (e.g. a “sense of entitlement”).
en.wikipedia.org/wiki/Entitlements”

“payments made to a person or government which meets the requirements enumerated in the law. Social Security benefits, military pensions, and Aid to Families with Dependent Children (AFDC) are all entitlements.
www.historycentral.com/civics/E.html”

“entitlement – Government funds issued to certain individuals because of a prescribed need. Social Security, Medicare, veterans’ benefits and food stamps are examples of entitlement programs.
www.cnn.com/2009/LIVING/studentnews/03/15/financial.glossary/index.html”

The Government describes Medicare and Medicaid as follows:

“Medicare is financed by a portion of the payroll taxes paid by workers and their employers. It also is financed in part by monthly premiums deducted from Social Security checks. http://www.ssa.gov/pgm/medicare.htm “

What is Medicaid?

“Medicaid is a jointly funded, Federal-State health insurance program for low-income and needy people. It covers children, the aged, blind, and/or disabled and other people who are eligible to receive federally assisted income maintenance payments.

Thirty-two states and the District of Columbia provide Medicaid eligibility to people eligible for Supplemental Security Income (SSI ) benefits. In these States, the SSI application is also the Medicaid application. Medicaid eligibility starts the same months as SSI eligibility.

The following jurisdictions use the same rules to decide eligibility for Medicaid as SSA uses for SSI, but require the filing of a separate application: Alaska, Idaho, Kansas, Nebraska, Nevada, Oregon, Utah, Northern Mariana Islands

The following States use their own eligibility rules for Medicaid, which are different from SSA`s SSI rules. In these States a separate application for Medicaid must be filed: Connecticut, Hawaii, Illinois, Indiana, Minnesota, Missouri, New Hampshire, North Dakota, Ohio, Oklahoma, Virginia. http://www.ssa.gov/disabilityresearch/wi/medicaid.htm”

The current disputes in Wisconsin, Ohio and other states where Republican Governors are attempting to “break” the unions who represent government employees at both a state and local level also appear to be a battle over “entitlements”.

From Fox news:

“self-employment tax

People who have salaried jobs pay 7.65% in Social Security and Medicare taxes, and their employers pay a like amount. But self-employed workers pay both halves — a total of 15.3% — in what is called the self-employment tax. In all other years, they have been able to deduct their health insurance from their net income, but not until after the self-employment tax is calculated. So, a consultant earning $100,000 and paying $15,000 for health insurance would owe the self-employment tax on the full $100,000, and then be able to deduct $15,000 before the income tax is calculated. (Half of the self-employment tax is then deductible.) That would leave her with a $15,300 self employment tax, and a taxable income of $77,400.

Read more: http://www.foxbusiness.com/personal-finance/2011/02/25/new-tax-breaks-self-employed/#ixzz1FOU3wh7p”

One of the major issues frequently raised when dealing with the causes of the US Government’s current deficit and debt problems is that the ‘Entitlement” programs are not sufficiently funded and are, or shortly will be, creating a permanent “structural” deficit federal Government finances.

Another issue frequently raised when talking about the state of public finances (governments at all levels) is the unfunded liabilities for pensions and all other employee related costs not due to be paid until some time in the future, as well as future Medicare and Medicaid costs.

The main reason for these budget problems appears to stem from the fact that they are partly financed by current taxation but the costs that have to be paid in the future, are generally, if not always, higher than the up front revenue stream can fully fund.

There are two reasons why the current revenue isn’t sufficient to meet future costs:

Demographics are working against the structure of the system. The number of older people who are seeking to collect the benefits is increasing at a faster rate than the smaller number of currently contributing taxpayers ability to fund; and the cost of the programs is significantly higher than expected when the laws creating the “entitlements“ were passed.

The funding model is seriously flawed. Besides the shortfall resulting from the taxation levels being too low to fund the future costs that were committed to in the past; there is the problem arising from the fact that the revenues are not dedicated to the programs. The tax revenues are invested in Treasury Bills issued by the Government as opposed to “real” money investments. It is somewhat like trying to pay for actual costs with Monopoly money by having the Monopoly bank print more bills.

The problems with benefits included in union contracts were highlighted when General Motors’ (NYSE:GM) and Chrysler’s union contracts were altered substantially during the restructuring process in 2009. The significant changes made during the restructuring of the automotive industry would appear to be, at least in part, the reason behind the desire of some states to force the unions who represent their employees to accept legislated changes to the bargaining process.

Rather than admit they are, for all intents and purposes, bankrupt the states are trying to use their ability to make or change laws to force a restructuring on their employees. In many ways this process is very similar to the “negotiated bankruptcy” that was forced on GM and Chrysler and their employees.

Governments have acted irresponsibly to date because they have not paid much attention and often only lip service to their fiscal obligations as legislators on behalf of the public. The stories referenced below illustrate the point.

Washington Post Headline Feb 22, 2011

“Illinois seeks to borrow $3.7 billion to shore up pension shortfall”

Stltoday.com  Headline Feb 23, 2011

“Illinois finds plenty of buyers for $3.7 billion in bonds”

The message appears to be that Governments can’t be trusted to fulfill their financial obligations to taxpayers and /or employees.

The solution might be relatively simple if two principles were adopted.

First, treat the taxes collected as trust funds. If governments were forced to treat the funds collected by taxation to fund entitlement programs as “trust” funds they would maintain separate accounts that could only be used to fund the costs associated with the revenue they collect up front.

Second, convert all of the entitlement programs to (using the definitions of the pension/insurance industry) money purchase programs from the current defined benefit structure.

At present the benefits from Social Security and Medicare are defined in the legislation. Thus, the term “entitlement”. In a money purchase situation, the funds collected for the purpose would be invested by trustees (private money managers, investment counsel, etc.), who would be completely independent and, where possible, chosen by the beneficiary as with a 401k, until the beneficiary became eligible to receive the benefit. The beneficiary would then be obligated to purchase an annuity or other form of income stream to fund retirement. In the case of medical related benefits the beneficiary (or the agency holding the funds) would purchase an insurance policy to provide the benefits.

This type of system transfers the future risk to two parties, the investment agency that is charged with investment of the funds (a manager like Bill Gross of PIMCO, chosen by the beneficiary), and the beneficiary who has to purchase a health insurance policy and a pension income investment when the funds are paid out.

Individuals would have the ability and, in fact, an obligation to ensure that the funds being set aside were sufficient to provide the benefits they require/expect when the qualifying period ended (at retirement age, etc.). In cases where employers provide contributions those contributions should be mandated by legislation and periodically subject to a mandatory review to make sure levels of contribution were reasonable in light of changing circumstances. In order to help minimize the amounts being set aside for the purposes of these programs the benefits (other than pensions) would not be subject to income or other taxation.

While the system isn’t perfect it is a basis for discussion that would help to take the uncertainties caused by politicians playing political games out of the system as much as possible.

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