This is the fifth in a six-month series on reforming Social Security and Medicare.

The Social Security and Medicare trustees issued their annual reports belatedly this year. They waited until mid-year to include updated actuarial information that included the new Medicare surtax on high-income Americans and the even-higher tax on investment income, along with other actuarial assumptions contained in the 2010 health-care reform legislation.

The new revenue feature was double-counted by the Congressional Budget Office when health-care reform, or the Affordable Care Act (ACA), was passed. Beginning in 2013, the new law imposes a hefty 3.8 percent income surtax on wealthier investors to help fund Medicare -- in the first break from payroll-tax financing in the 75-year history of Social Security and Medicare. Washington's duplicitous double-counting is now obvious: The same tax obviously can't pay for health-care reform to expand access for the uninsured, and also pay for Medicare benefits for the already-insured. But sadly, this is Washington D.C., where such feats of fiscal prestidigitation have become routine.

Putting that issue aside, the big media news from the trustees was that on the surface, Medicare's funding problems have been magically "solved" by the ACA. The long-run actuarial deficiency plunged from 3.88 percent of national payrolls to a mere 0.66 percent almost overnight. The new Medicare surtax was maybe a quarter or a third of that, but the rest of the "solution" is an assumption that health-care costs will magically decline because we all want them to. The productivity assumptions that underlie these estimates require a reversal of cost trends without any realistic economic foundation. The ACA created a new independent medical advisory board to recommend that the Secretary of Health and Human Services cut doctors' fees if the assumptions don't pan out. I'll believe that when I see it, in light of Congressional unwillingness to accomplish that task in recent decades -- and the real-world, supply-demand economics of ever-more patients versus a limited supply of health-care professionals.

In any other line of finance, this would be called magical thinking. The trustees' report itself includes a major disclaimer that these assumptions are highly suspect. In fact, the chief actuary issued what journalists have called an "adverse opinion" with alternative projections. Unless the disputed assumptions actually play out, the Medicare program will go the way of public pension funds that made similar heroic assumptions: the funding ratio will decline, and future contribution rates will escalate. We've seen this movie before.

In this context, my previous policy suggestion takes on even greater importance. The president's fiscal commission would be foolhardy to accept the rose-colored projections in the latest trustees report without offering a Plan B that would kick into effect if reality turns less rosy. My suggestion is that in years when the actuarial assumptions are not met, there should be automatic adjustments on the benefits side so that we don't keep digging a deeper hole. Here are the key features:

The actuarial autopilot would require automatic benefits adjustments in the future if ongoing revenues are insufficient for either Social Security or Medicare. When fiscal reality falls short of the assumptions, the actuarial autopilot would trigger the following actions, as future revenues earmarked for these programs are projected actuarially to fall short of their costs:

  • Social Security cost-of-living adjustments (COLAs) would be suspended or capped that year.
  • Retirement ages would increase permanently by one more month for each year the programs are actuarially deficient.
  • Medicare subsidy levels would be frozen that year.
  • Future payment levels would then be trimmed actuarially for those who have not yet retired.
  • Payroll tax rates, if not raised by 2013, must be bumped upwards permanently by one-tenth of a percent, and the earnings limit on Social Security taxes must be raised by an additional 5 percent, in such years of actuarial deficiency. Republicans may insist on reasonable ceilings for these automatic tax increases, which Democrats will probably have to accept.

As explained in my original column, Fixing Social Security and Medicare, it would be preferable to first explicitly raise the normal retirement ages to reflect increasing longevity, and then cap the COLAs at $400 a year by statute. That would cut the structural deficits in both programs. But we still need this additional autopilot provision to ensure that benefits thereafter don't outstrip available revenues.

By making these incremental budget-balancing actions automatic, the fiscal problems of these two vital programs cannot snowball by neglect and political avoidance, as they have in the past. If benefits are frozen and retirement ages are raised, Congress will ultimately be compelled to take constructive actions. That will make our elected officials accountable for curing financial shortfalls, instead of passing them along to the next session.

Getting lawmakers to put such provision into law will be difficult. If the president's bipartisan fiscal responsibility commission proposes this concept, it would help provide the "air cover" that Congress needs. Otherwise we'll just keep kicking the can to the next generation. At some point, younger Americans will need to assert their interests and demand that lawmakers take actions to prevent an intergenerational train wreck.

Public pension officials, employers and state legislators should think about variations on this theme when they design new benefits tiers for new state and local government employees. If states adopt similar formal plan provisions to cap or freeze COLAs and increase incumbent workers' retirement ages incrementally when plans are chronically underfunded (by more than a normal recessionary financial market cycle of 15 percent), future public employees and retirees could no longer claim to have irreversible property rights to pensions at future taxpayer expense. That's far easier to accomplish than amendments to the state constitutions and abridging contract law. A "collective defined contribution" plan as described in my previous column on hybrid pensions is another, similar approach. For once, all stakeholders will have a common interest to assure that pension plans are properly and soundly funded.