Why US should not pay Warren Buffett's Social Security and Medicare

Both sides of the political spectrum recognize the severity of our yearly federal budget deficits and the growing outstanding federal debt. However, the recent proposals for addressing the debt issue do not effectively tackle the long-term problem with the funding of Social Security and Medicare.

In his July 15 news conference on the debt issue, President Obama indicated that in an effort to address the long-term problems with Medicare (and presumably Social Security), he would be willing to consider “means testing” these programs, that is, reducing the benefits for retirees with high incomes.

In my May article “The Missing Ingredient in the Budget Debate: Phasing Out Social Security and Medicare for High Income Retirees” (Social Science Research Network, Economic Growth eJournal), I set out a means testing proposal for both Social Security and Medicare.

In the article, I argue that as a tool for limiting the costs of these programs and thereby helping to put them on a sustainable basis without reducing the effectiveness of their “safety net” function, Congress should phase-out the benefits under these programs for high-income retirees.

Two phase-out proposals

Specifically, I set out the following phase-out proposals:

1. The Social Security benefit should be phased out incrementally as individuals move from $75,000 of annual retirement income to $175,000.
2. To participate in Medicare, retired persons should be required to pay an increasing portion of the premium covering the costs of Medicare benefits as they move from $75,000 of annual retirement income to $175,000.

As with the proposal Congressman Paul Ryan (D) of Wisconsin has made to reform Medicare, these phase-out provisions in general would only apply to people who are presently younger than 55. Also, the thresholds for the phase-outs would be annually adjusted for inflation and would reflect at the time the provisions become law the inflated value of $75,000 and $175,000 in 2011 dollars.

The Social Security phase-out proposal is similar to the phase-out for such payments under Canadian law. The Canadian phase-out (what Canadians call a claw-back), which was enacted many years ago, is not considered controversial and is generally accepted as fair.

Medicare premium payment requirement protects rich, too

And the Medicare proposal is structured so that even a high-income person who elected to self-insure would not see all of his or her assets completely depleted as a result of the cost of health care. This point can be illustrated as follows. Once a retired person’s investable assets (including assets held in a pension plan, but not a principal residence) produced less than $175,000 in retirement income, the person would be entitled to some support from Medicare, and if such person’s investable assets failed to produce $75,000 in retirement income, the person would be entitled to full Medicare benefits.

With a 5 percent annual return of earnings and capital gains, the $175,000 threshold would translate into approximately $3.5 million in investable assets, and the $75,000 threshold would translate into approximately $1.5 million in investable assets. So, as a practical matter, a retired person with less than approximately $1.5 million in investable assets would likely be entitled to full Medicare benefits. Consequently, someone who self-insured would not see his or her investable assets reduced below approximately $1.5 million as a result of medical bills.

Thus, the Medicare structure proposed here addresses President Kennedy’s argument back in the 1960s that Medicare is needed to prevent people from “suddenly [finding] all their savings gone because of a costly health problem.”

Stop government funding inheritances for wealthy

As a practical matter, adoption of the proposal here will, in most cases, simply mean that the heirs of the affected high-income retirees will get smaller inheritances. Under the current system, in many instances, the Social Security and Medicare benefits received by high-income retirees merely increase the assets passed on to their heirs. For example, assume that a retired person with $200,000 in annual retirement income, before taking account of Social Security or Medicare benefits, saves $25,000 of his or her after-tax income. In such case, any Social Security payments or Medicare benefits the person receives will likely have the effect of increasing the person’s savings. The increased savings will likely translate into higher inheritances for her heirs.

Of course, by cutting back on the access of retirees with high incomes to these programs, we will hear cries that these programs are moving in the direction of “welfare.” However, in view of the long-term deficits that Social Security and Medicare are projected to generate as our population ages, it is certainly reasonable to means test these programs.

I believe the overwhelming majority of Americans agree with me that it is economic folly for the federal government to be providing Social Security and full Medicare benefits to higher income retirees, at the expense of government funding for other key programs. Most Americans would agree that the government shouldn’t be disbursing these benefits, in an extreme example, to Warren Buffett, one of the richest people in the world, simply because he is older than 65. If am right on this, then for most Americans, the adoption of a means-testing standard similar to the one proposed here is just a matter of line-drawing.

Although Mr. Buffett presents a polar case, the $75,000 beginning threshold proposed here is not likely to apply to any retiree with less than $1.5 million in investable assets – a significant sum. Some will say that the $75,000 line is too low; others will argue it is too high.

In any event, politicians of all political persuasions should have an honest discussion of where to draw the line. They should have the courage to bring this government funding of inheritances for the heirs of the wealthy to an end, thereby reducing the adverse impact these programs have on our long-term debt.

Sam Thompson is a professor of law and director of the Center for the Study of Mergers and Acquisitions at Penn State University Dickinson School of Law. He is the former head of the tax department of a large Chicago law firm and dean of the University of Miami School of Law. He is the author of numerous books and articles on tax law and mergers and acquisitions.