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At the same time, however, these numbers don’t lie. With our demographics and our
debts, we’re on a collision course with the future. The good news: Although time is
growing short, we still have the capacity to create positive outcomes.

Even though USA Inc. can print money and raise taxes, USA Inc. cannot sustain its financial
imbalance indefinitely – especially as the Baby Boomer generation nears retirement age. Net
debt levels are approaching warning levels, and some polls suggest that Americans consider
reducing debt a national priority. Change is legally possible. Unlike underfunded pension
liabilities that can bankrupt companies, USA Inc.’s underfunded liabilities are not legal contracts.
Congress has the authority to change the level and conditions for Social Security and Medicare
benefits; the federal government, together with the states, can also alter eligibility and benefit
levels for Medicaid.

Options for entitlement reform, operating efficiency, and stronger long-term GDP growth.

As analysts, not public policy experts, we can offer mathematical illustrations as a framework for
discussion (not necessarily as actual solutions). We also present policy options from third-party
organizations such as the CBO.

Reforming entitlement programs – Social Security.

The underfunding could be addressed through some or all of the following mechanical changes:
increasing the full retirement age to as high as 73 (from the current level of 67); and/or reducing
average annual social security benefits by up to 12% (from $13,010 to $11,489); and/or
increasing the social security tax rate from 12.4% to 14.2%. Options proposed by the CBO
include similar measures, as well as adjustments to initial benefits and index levels. Of course,
the low personal savings rates of average Americans – 3% of disposable income, compared with
a 10% average from 1965 to 1985 – limit flexibility, at least in the early years of any reform.

Reforming entitlement programs – Medicare and Medicaid.

Mathematical illustrations for these programs, the most underfunded, seem draconian: Reducing
average Medicare benefits by 53%, to $5,588 per year, or increasing the Medicare tax rate by
3.9 percentage points, to 6.8%, or some combination of these changes would address the
underfunding of Medicare. As for Medicaid, the lack of a dedicated funding stream (i.e., a tax
similar to the Medicare payroll tax) makes the math even more difficult. But by one measure
from the Kaiser Family Foundation, 60% of the Medicaid budget in 2001 was spent on so-called
optional recipients (such as mid- to low-income population above poverty level) or on optional
services (such as dental services and prescription drug benefits). Reducing or controlling these
benefits could help control Medicaid spending – but increase the burden on some poor and
disabled groups.

Ultimately, the primary issue facing the US healthcare system is ever-rising costs, historically
driven by increases in price and utilization. Beneath sustained medical cost inflation is an
entitlement mentality bolted onto a volume-based reimbursement scheme. All else being equal,
the outcome is an incentive to spend: Underlying societal, financial, and liability factors combine
to fuel an inefficient, expensive healthcare system.

KP
CB www.kpcb.com
USA Inc. xv
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