For years Republicans promised revolutionary change in Washington. But after Ronald Reagan was elected president in 1980, they complained that the GOP needed to run Congress. After Republicans gained control of Congress in 1994, they said they needed the presidency as well. Now, with both the White House and Capitol Hill under firm GOP control, Republicans have no more excuses.
Unfortunately, the budget results have been ugly, and the future looks even worse. Notes Peter Ferrara of the Free Enterprise Fund, “under current law Federal spending as a percent of GDP will rise from 20 percent today to 34 percent by 2030.” That is higher than at any other point since World War II. Toss in state and local spending, and half the economy will be in government hands. And these estimates ignore the natural tendency of government outlays to climb far faster than projected.
President George W. Bush submitted a $2.57 trillion budget for 2006. Under Republican stewardship, a $236 billion surplus in 2000 turned into a deficit exceeding $400 billion last year. Only higher than projected revenues will push the deficit down to an expected $333 billion this year.
The administration’s future fiscal projections are about as accurate as its WMD claims for Iraq. For instance, writes Stephen Slivinski of the Cato Institute, “the new budget estimates assume that non-entitlement spending will be cut by $36 billion between 2006 and 2009. Yet there has never been a period over the past 40 years in which such spending has dropped more than $12.2 billion.”
Moreover, noted Robert L. Bixby, executive director of the Concord Coalition, “to leave out Social Security, the AMT [alternative minimum tax], and the war costs and say you have a plan to cut the deficit in half over five years is beyond chutzpah.” Including these and other Bush objectives, such as making the tax cuts permanent, “could add almost $3 trillion more to the national debt than Bush’s budget will claim,” according to Howard Gleckman of Business Week.
Earlier this year Vice President Richard Cheney declared that the 2006 proposal was “the tightest budget that has been submitted since we got here.” If true, that merely reflects the laxity of earlier submissions. The president’s first term featured record-setting increases in domestic outlays, highlighted by such special-interest gifts as the $170 billion farm bill. Overall, notes Veronique de Rugy of the American Enterprise Institute, in “the last four years, total spending has risen 33 percent—a figure larger than Clinton’s two terms combined.” It’s the fastest domestic growth since Lyndon Johnson.
In recent months the GOP passed bloated energy and highway bills. The unexpectedly difficult Afghanistan and Iraq occupations are costing more than a billion dollars a week, and estimates for next year have jumped $50 billion since just February.
The Medicare drug benefit—the biggest expansion of the welfare state in 40 years—is set to take effect next year. The expense, writes Derek Hunter of the Heritage Foundation, “will soon grow dramatically once roughly 70 million baby-boomers begin retiring in 2008.” Over the next 75 years, the pharmaceutical program is predicted to run $8.7 trillion—nearly a third of Medicare’s current unfunded liabilities and more than Social Security’s deficit. And that assumes no changes—unlikely once recipients discover that Congress created the so-called “donuthole,” through which coverage disappears at mid-expenditure levels.
Indeed, the drug benefit illustrates the real federal financial crisis—programs devoted to America’s elderly. The Cato Institute’s Chris Edwards warns, “The federal government is headed toward a financial crisis as a result of chronic overspending, large deficits, and huge future cost increases in Social Security and Medicare.”
Over the long term, Social Security and Medicare are the true budget busters—accounting for $518 billion and $290 billion in outlays, respectively, in 2005. Together they account for almost one-third of federal spending.
Medicaid is another budget boulder, running $192 billion this year. Medicaid is directed at the poor and has become politicians’ favorite mechanism for attempting to expand government health-care coverage. Nevertheless, one-quarter of its payments go to the elderly. Medicaid’s costs also are affected by the aging of America, though not as dramatically as are Social Security’s and Medicare’s.
Although Social Security currently outspends Medicare, the latter is the bigger long-term problem. Its financial outlook is “much worse than Social Security’s,” declared the Social Security and Medicare trustees earlier this year. Medicare is tied to fast-rising medical costs rather than wage hikes. By 2024, Medicare outlays are expected to exceed those for Social Security; left unchanged, Medicare will spend twice as much as Social Security by 2078. Douglas Holtz-Eakin, director of the Congressional Budget Office, warns that the growth in Medicare is “simply unsustainable.”
Even these estimates understate likely outlays. Notes Cato’s Michael Cannon, “there is constant pressure to expand Medicare benefits—from seniors, healthcare interest groups, and advocates of socialized medicine. Recent examples include the new prescription drug benefit, as well as coverage for preventive screening, obesity, and quit-smoking programs that President Bush added by fiat.”
Social Security and Medicare are disastrously unbalanced for three reasons.
First, “contributions” to Social Security and Medicare are insufficient to provide promised benefits. Both of these programs are primarily funded by taxes on the rest of the population.
Second is demographics. Explains James C. Capretta, Managing Director at Wexler and Walker Public Policy Associates, “First, life expectancy for persons at age 65 has increased dramatically. … Second, the fertility rate fell precipitously in a very short period of time,” more than 50 percent between 1960 and 1975. Pay-as-you-go Ponzi schemes can survive only so long as sufficient numbers of new suckers enter the system. By 2030 the number of people 65 and older will almost double while the number of workers paying for the programs will rise by just 18 percent. Whereas dozens of workers once supported every Social Security beneficiary, that ratio is now 3.3-to-1 and will fall to 2.2-to-1 by 2030, from which it will continue slowly to decline.
Health-care costs rise dramatically with age. Notes Holtz-Eakin, “the steady increase in the number of the oldest seniors (those age 85 and older)—from 1.5 percent of the population in 2000 to 5.0 percent in 2040—is projected to lead to a rise in the demand for long-term care services, including those paid for by Medicaid and Medicare.” At the same time, declining fertility means there will be fewer family members to provide informal, non-government assistance.
The third factor is the “relentless growth in federal, and private, health spending per capita above income growth,” explains Capretta. Over the last 35 years, Medicare outlays have risen 3 percent annually above the increase in per capita GDP.
John Goodman, president of the National Center for Policy Analysis, calls even the short-term estimates “sobering.” Just five years from now, he writes, “the federal government will need $127 billion in additional funds to pay promised benefits.” Add another decade and the necessary supplement rises to $761 billion.
Worst is tomorrow’s bill. Writes Chris Edwards, “In addition to today’s federal public debt of $3.9 trillion, taxpayers may be on the hook for $2.9 trillion in federal employee retirement benefits, $1 trillion in veterans’ benefits, $3.6 trillion in Social Security benefits, $15.6 trillion in Medicare benefits, and $7 trillion in the new Medicare drug benefits.” But Edwards’s figures merely run for 75 years. (Forget claims about accumulated assets in the Social Security and Health Insurance “trust funds,” which are accounting fictions filled with special, non-marketable Treasury bonds.)
The 2005 annual report of the Board of Trustees of Social Security and Medicare notes, “Even a 75-year period is not long enough to provide a complete picture of Social Security’s financial condition.” Similarly, Jagadeesh Gokhale, formerly of the American Enterprise Institute, and Kent Smetters, a professor at the University of Pennsylvania, warn that traditional fiscal measures are inadequate: “As a consequence, the degree to which current policy is unsustainable remains hidden from policymakers.” They propose a measure of Fiscal Imbalance (FI) with an infinite time horizon. Their 2003 FI estimate was $44.2 trillion. Social Security ran $7 trillion and Medicare accounted for $36.6 trillion. The rest of the federal government ran just $0.5 trillion.
The FI worsens over time. It “grows by about $1.6 trillion per year to about $54 trillion by just 2008 unless corrective policies are implemented before then,” explain Gohkale and Smetters. Long-term estimates obviously are sensitive to economic assumptions: the FI could run “only” $29 trillion if we are lucky or $64 trillion if things go less well.
The government’s estimates, based on more pessimistic economic assumptions, are even more forbidding. The Social Security and Medicare trustees estimate the full unfunded liability for Social Security to be $11.1 trillion. Medicare’s unfunded hospital and medical-insurance liability runs a shocking $49.9 trillion. And the new drug benefit, which had not been passed when Gokhale and Smetter completed their analysis, adds another $18.2 trillion. The total: $79.2 trillion.
By way of comparison, the federal government spends about $2.6 trillion a year, the entire public debt is $4.6 trillion, America’s annual GDP is about $12 trillion, and Americans’ total personal financial net worth is around $35 trillion.
No surprise, the longer we wait to act, the more difficult it becomes to close the gap. Since reforms are hardest to apply to those who have already retired, “Delaying action until the baby boom is in full retirement insures that the next generation will bear the burden of current inaction,” argue Andrew J. Rettenmaier and Thomas R. Saving, for the Private Enterprise Research Center at Texas A&M University.
The Congressional Budget Office figures that under intermediate program assumptions, federal outlays on Social Security, Medicare, and Medicaid will climb from 9 percent of GDP in 2010 to 17.7 percent in 2050. The more realistic “pessimistic” assumptions generate respective forecasts of 9.5 percent and 27.6 percent—more than one of every four dollars generated by the entire economy. And that doesn’t include spending on the military, all other federal activities, and states and localities.
In May, Comptroller General David M. Walker warned, “The only thing the United States is able to do a little after 2040 is pay interest on massive and growing federal debt. The model blows up in the mid-2040s. What does that mean? Argentina.”
The problem is not just that the elderly will be collecting so much in “entitlements.” The programs, as well as their means of financing, have adverse consequences. For instance, argues Martin Feldstein of the National Bureau of Economic Research, “Retirement pensions induce earlier retirement and depress saving.” Payroll taxes act as a direct levy on employment, discouraging job creation. These programs also make Americans ever more dependent on government.
Obviously, many elderly believe that they are entitled to their benefits. New York Times columnist Nicholas D. Kristof makes an important if exaggerated point: “We boomers won’t be remembered as the ‘Greatest Generation.’ Rather, we’ll be scorned as the ‘Greediest Generation’.”
Although titled “social insurance,” none of these programs operate as such. Given low tax rates in the past, many beneficiaries received back their lifetime Social Security “contribution” in months rather than years. Medicare makes no pretense of forcing retirees to fund their own benefits. Taxes pay the entire Part A (hospital insurance) and roughly three-quarters of Medicare Part B (supplemental medical insurance) and Part D (the upcoming pharmaceutical benefit).
What to do? Policy analyst James Capretta offers a half-dozen principles to guide reform efforts.
First, entitlements should be provided with the least taxpayer burden. As he notes, “the payroll tax rates would need to be raised from 15.3 percent today to 20.3 percent immediately—a 33 percent tax increase—to close the 75-year actuarial deficits in the trust funds, and even then large deficits would emerge in both programs by the end of the solvency measurement time frame.”
Laurence Kotlikoff, Hans Fehr, and Sabine Jokisch of the National Center for Policy Analysis figure that funding all promised benefits would require sharp payroll and income tax hikes: “the total tax on wages will rise from 24 percent to 38 percent by 2030 and 40 percent by mid-century.” A more pessimistic analysis comes from former Commerce Secretary Peter G. Peterson, who figures that payroll taxes would ultimately have to run 56.7 percent to fund currently promised Social Security and Medicare benefits. Relying instead on income tax payments would require devoting 76 percent of that levy to close the Social Security/Medicare deficit in 2050. Such hikes would, in turn, have significant economic and social impacts.
Second, benefits to current recipients shouldn’t be reduced since “these retirees have limited ability to adjust their consumption and work behavior based on changing government policy.”
Indeed, many citizens have not provided for their own medical and retirement needs. Seniors overwhelmingly rely on Medicare for health-care coverage and up to a quarter of baby boomers are thought to have saved little for their retirement. The fact that people have adapted their behavior to the government’s irresponsible promises is an important consideration, but those benefits were no more guaranteed than welfare payments. The fact that beneficiaries may not have time to make up any reduction should not trump the interest of workers, who are being unfairly taxed to provide disproportionately generous benefits.
Gokhale and Smetters note that “past and living generations are projected to receive $8.8 trillion more in benefits than they will contribute in payroll taxes,” but “future generations are projected to pay $1.7 trillion more in taxes than they will receive in benefits.” Taxing future generations even more to pay for current benefits would exacerbate the unfairness. But Gokhale and Smetters figure that meeting the shortfall solely through benefit cuts would require reductions approaching 60 percent. Political considerations dictate some degree of protection for current beneficiaries, lest the perfect, unattainable reform become the enemy of the good, achievable one.
Third, reforms should prolong work and delay retirement. More work reduces the need for government income support, while later retirement reduces program expenditures. Government could increase the retirement age and the financial penalty for early retirement. Longer life expectancies make this principle a matter of justice as well as practicality, since when Social Security was created many people died before collecting their first check—the life expectancy of men has risen by 3.9 years; women’s has risen 5.5 years.
Fourth, incentives should be increased for private retirement savings. Over the last two decades assets in retirement accounts have jumped from $1.5 trillion to $6.5 trillion. Creating private Social Security accounts is the most obvious step to take. Full privatization would be even better. Allowing people voluntarily to opt out of Social Security would ultimately reduce program outlays. Roughly 30 nations have some such program. Martin Feldstein figures that even partial substitution of private retirement accounts “would eliminate the need for a future increase in the Social Security payroll tax.” Expanded IRAs are another option, should Social Security reform prove impossible.
Fifth, entitlement programs should be reshaped, shifting benefits from higher- to lower-income retirees. The moral imperative is to care for those least able to care for themselves, not the wealthy or even the middle-class, whose members are able to save. Full means-testing is intellectually appropriate if politically suspect, though Canada and Great Britain incorporate means-testing in their policies. Another possibility would be to end benefits for those at the highest income levels. A simpler step is that proposed by President George W. Bush, to slow cost-of-living increases for higher-income Social Security recipients.
One could adopt similar restrictions for Medicare beneficiaries. In particular, the pharmaceutical benefit should be replaced with modest income support for low-income people unable to buy needed pharmaceuticals. Over the longer term, prescription benefits should be integrated into a market-oriented reform plan for Medicare that offers competing insurance options. Alas, here, as in so many areas, President Bush is proving to be a barrier to responsible policy. In February, he threatened Congress: “any attempt to limit the choices of our seniors and to take away their prescription drug coverage under Medicare will meet my veto.”
Sixth, reform health-care benefits “to rely as much as possible on market-based efficiency, with similar reforms instituted simultaneously in the private sector health system.” The use of Health Savings Accounts, with large deductibles, offers a blueprint for returning health insurance to its function as true insurance, rather than prepayment of medical expenses.
This would not be easy. The Free Enterprise Fund’s Peter Ferrara warns, “Medicare is the most difficult to reform because benefits have been so wildly overpromised it is impossible to reform the system in a purely populist way where everyone is clearly better off.” Ferrara proposes diverting both the employee’s and employer’s 2.9 percent Medicare tax to personal accounts for purchasing health insurance in retirement. Subsidies, financed through general revenues, could be provided to low-income people.
Capretta suggests turning Medicare benefits into insurance premium subsidies, as well as taking steps to encourage cost-containment in Medicaid and private health-care provision. Feldstein proposes a related plan: “A mixed financing system for Medicare could combine a tax-financed Medicare annuity for retirees geared to the then-current cost of health care plus an opportunity for individuals during their working years to accumulate funds in Retirement Health Savings Accounts.” This money would be used to purchase a private health-insurance policy.
Medical costs need to be fixed more generally. Treasury Secretary John W. Snow argued in March, “Controlling health care costs is the real key to the long run fiscal sustainability of both Medicare and in turn the federal budget.” Tort reform, disease management, preventive care, and a host of other steps would help trim health-care outlays. The most important problem, driven by a third-party payment system resulting from high federal medical expenditures and preferential tax treatment of health insurance, is the creation of a system of cost-plus medicine. Fixing that requires significant changes in the form of government health-care benefits and tax treatment of insurance.
Other nations face similar challenges. Reporting on Europe, Gary Burtless observes, “With respect to pension policy, national governments have increased contribution rates to the public programs, overhauled pension schedules to reduce promised future benefits, and introduced new features in public pension and old-age unemployment programs to encourage employment after the early or standard retirement age.”
Capretta’s ideas offer a good starting point for entitlement reform. He admits that “given the political difficulty of making far-reaching entitlement changes, closing the entire fiscal gap in one or two legislative steps is not a realistic possibility.”
Work needs to proceed as soon as possible at all levels, to adopt reforms where possible and to help change attitudes where not. But even today reform won’t be easy. It is difficult enough to discuss Social Security. Opines Rep. Kevin Brady (R-Texas), “A good Medicare solution is more difficult than the war on terrorism, education, Social Security and homeland security combined.”
In theory, the Bush administration and Congress recognize the seriousness of the elder budget tsunami facing the U.S. However, those unwilling to spend responsibly today are unlikely to legislate responsibly for tomorrow. Rep. Jeff Flake (R-Ariz.) tartly observes, “Republicans don’t even pretend any more.”
As a result, the parties are largely indistinguishable on fiscal grounds: both refuse to confront the looming budgetary crisis resulting from the intersection of senior benefits promised by wildly irresponsible politicians and growing numbers of seniors created by dramatic demographic changes. Alas, the longer lawmakers dither, the greater the financial problems will become.
Doug Bandow is a Senior Fellow at the Cato Institute and a former Special Assistant to President Ronald Reagan.