Why Are Social Security and Medicare a Federal Budget Problem?

Social Security provides retirement, disability, and survivor benefits, while Medicare is the federal health insurance program for individuals aged 65 or older and for certain younger people with disabilities. Their significant and growing share of federal spending presents a budgetary challenge. The fiscal strain on these programs stems from their funding structure, the populations they serve, and the external pressures that increase their costs.

The Core Funding Structure

Both Social Security and Medicare operate on a pay-as-you-go system, using contributions from today’s workers and employers to pay for the benefits of current recipients. This is not a pre-funded system where an individual’s contributions are set aside in a personal account for their own future use. This structure creates a direct transfer of funds from the working population to the beneficiary population, making the system dependent on the balance between these two groups.

Revenue comes from payroll taxes under the Federal Insurance Contributions Act (FICA) and the Self-Employment Contributions Act (SECA). For Social Security, the tax rate is 6.2% for both the employee and employer, for a combined total of 12.4%. This tax applies only to earnings up to an annual limit, which for 2025 is $176,100.

The Medicare payroll tax is 1.45% for both the employee and employer, for a combined 2.9% tax. Unlike Social Security, there is no wage base limit for the Medicare tax, so all covered wages are subject to it. An Additional Medicare Tax of 0.9% also applies to employee earnings over certain thresholds—$200,000 for single filers and $250,000 for married couples filing jointly.

The system’s viability is measured by the worker-to-beneficiary ratio, which compares the number of workers paying taxes to the number of individuals drawing benefits. A high ratio indicates a healthier financial footing because more workers are contributing for each person receiving payments. A declining ratio signals financial stress, as fewer workers are available to support a growing number of beneficiaries.

The Pressure of Demographic Shifts

The funding structure of Social Security and Medicare is under pressure from shifts in the U.S. population. The main problem is the decline of the worker-to-beneficiary ratio, which is driven by three primary factors.

The first factor is the aging of the Baby Boomer generation, born between 1946 and 1964. For decades, this group was in its prime earning years, contributing to the systems. Now, as this large group transitions into retirement, they move from being contributors to beneficiaries. This shift has caused the worker-to-beneficiary ratio to fall from 5.1 in 1960 to just 2.7 in 2023.

Another element is the increase in life expectancy. People are living longer and collecting benefits for a much longer period than the systems were originally designed to support. This longevity increases the total lifetime benefits paid to each retiree and places additional demand on the system.

A third factor is the long-term decline in birth rates since the end of the Baby Boom. Lower fertility rates mean that subsequent generations are smaller, resulting in fewer workers entering the labor force. This trend ensures the worker-to-beneficiary ratio will likely continue its downward trajectory.

The Challenge of Rising Healthcare Costs

The budget problem for Medicare is intensified by the rapid growth of healthcare costs. Unlike Social Security’s predictable benefit payments, which are based on a worker’s earnings history, Medicare’s costs are far more open-ended. The program is committed to paying for covered medical services for its beneficiaries, regardless of cost, making its expenditures susceptible to inflation within the healthcare sector.

A primary driver of cost growth is medical innovation. New diagnostic tools, surgical procedures, and advanced treatments often come with a high price tag. These technologies contribute to higher spending per beneficiary as they become standard components of care, and Medicare absorbs a significant portion of these expenses.

The rising cost of prescription drugs is another factor. The introduction of new specialty drugs, which can be very expensive, places a burden on Medicare’s prescription drug program (Part D). This trend is worsened by limited price negotiation power and the dynamics of the pharmaceutical market.

Increased utilization of healthcare services also contributes to the fiscal challenge. As the population ages, it consumes more medical care. The prevalence of chronic conditions like diabetes and heart disease leads to more frequent and intensive use of healthcare resources, creating upward pressure on Medicare spending.

Trust Funds and the Federal Debt

The financial operations of Social Security and Medicare are managed through trust funds, which are accounting mechanisms to track revenues and expenditures. For Social Security, these are the Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI) funds. For Medicare, the primary funds are the Hospital Insurance (HI) trust fund for Part A and the Supplementary Medical Insurance (SMI) trust fund for Parts B and D. It is a common misconception that these are personal savings accounts; they are not.

When these programs collect more revenue than they pay out, the surplus funds are not held as cash. By law, surpluses are loaned to the U.S. Treasury in exchange for special-issue government bonds that earn interest. This arrangement means past surpluses were used to fund other government operations, and the trust funds now hold a large portfolio of these Treasury securities.

The terms “depletion” or “insolvency” are often misunderstood and do not mean the programs will be broke or that payments will cease. Insolvency means the trust funds’ reserves of government bonds will be exhausted. At that point, the programs will rely solely on incoming tax revenues, which are projected to be sufficient to pay only a portion of promised benefits, such as about 79% for Social Security.

This structure links the trust funds to the federal debt. The bonds held by the trust funds are an asset to the programs but a liability for the U.S. Treasury. To redeem these bonds and pay full benefits when costs exceed revenues, the Treasury must raise cash by increasing taxes, cutting other spending, or borrowing from the public. Drawing down the trust funds to pay benefits contributes to the publicly held national debt.