Attention: Deficit

Isabel Sawhill and Greg Anrig of the Century Foundation debate whether progressives should embrace entitlement reform or look elsewhere to narrow the fiscal gap. The full six-part discussion, the first two parts of which are below, was first published in the journal Democracy.

ISABEL SAWHILL: The growth of entitlements is on an unsustainable path. If allowed to continue, spending on Social Security, Medicare, and Medicaid will require untenable tax increases, crowd out almost all other spending, or lead to a dangerous accumulation of debt. If any of these scenarios unfolds, the nation’s ability to remain economically competitive will be substantially weakened, and enormous burdens will be imposed on the poor and middle classes.

As all sides in the debate know well, the politics of entitlement reform are toxic. Only 7 percent of the public is in favor of cutting spending on either Social Security or Medicare. Shielding these programs from change—almost any change—has been a winning hand for progressives in the past, including in 2005, when George W. Bush’s Social Security privatization efforts crashed. But it’s a political strategy that may jeopardize the entire liberal agenda going forward.

First, preserving the status quo will erode trust in government. A government that has lost control of its fiscal future, with most of its budget on automatic pilot and a fifth of its expenses unpaid for, cannot garner much respect from its citizens. The Urban Institute’s Eugene Steuerle calls this a decline in “fiscal democracy,” because mandated spending—the product of past decisions—absorbs all revenues, leaving no scope for policy innovation if these programs are considered untouchable. Already the “big three” entitlements are absorbing 71 percent of all revenues. The erosion of trust that fiscal indiscipline engenders will, over time, leave the party that wants to use government for progressive ends unable to win elections. We are already seeing public frustration with fiscal profligacy producing political victories for those who seek to minimize the activist state.

Second, preserving these programs is a transactional strategy that, despite its political benefits, is at odds with transformational ideals such as providing greater prosperity and opportunity for all Americans. If progressives care about protecting the less advantaged along with other social programs, finding savings in the big three entitlement programs will be essential. Unless we free up resources to invest in education and job opportunities for younger Americans, and provide a healthy start for children from less advantaged families, prosperity and opportunity will elude us. The rapid growth of spending on entitlements has already forced the Obama Administration to propose a freeze in non-security domestic spending. In California, Governor Arnold Schwarzenegger has proposed eliminating the state’s welfare-to-work program as well as most child-care assistance for low-income families, a harbinger of what may happen at the national level as the budget squeeze plays out over the next decade or two.

Third, the higher tax rates that unreformed entitlements will demand in the future will be even more unpopular than making the needed reforms now. Without reform, taxes would have to double or triple by 2050, according to the Congressional Budget Office (CBO). There is no lock box out of which the government can fund the costs of those who are retired. Yes, there are trust funds for Social Security and a portion of Medicare, but these funds contain nothing more than paper IOUs, not real resources that can be used to pay the costs of these programs. There are only today’s and tomorrow’s workers, whose capacity to pay the retirement costs of their parents’ generation will depend on earlier investments in their own education and other productivity-enhancing programs. Higher taxes are inevitable, but a doubling or tripling of taxes for working-age families is neither economically sensible nor politically feasible. Even before the current recession, the high costs of housing, child care, and college tuition left their wages stagnant, their job security threatened, and their pocketbooks flattened.

Reforms enacted now can be phased in gradually—no one need be seriously hurt in the process. Pushing through such changes now would send the right signals to financial markets, while slowing their implementation would provide time for the economy to recover from recession and for those approaching retirement to adjust to any reform.

What kinds of changes should progressives support? First, because health care is the biggest problem we face, we should craft reforms recognizing that not all spending on health care improves health. Second, reforms should trim benefits for the more affluent while protecting those at the bottom. Third, reforms should leave our core commitments to Social Security and Medicare intact and ensure that no one is left bereft of access to basic health care and a decent income in old age. It is only by returning these programs to solvency that we can ensure that they will be there for those who need them most.

Everyone knows that health care is the big enchilada. The recently enacted Affordable Care Act expands access to health care, but its effects on projected deficits and health-care spending trajectories are very small and highly uncertain. (For more on the health-reform legislation, see Jacob S. Hacker’s piece, “Health-Care Reform, 2015,” starting on page 8.) While a portion of the projected increase in Medicare and Medicaid spending can be attributed to the aging of the population, a bigger portion is due to rising health-care costs per capita in the public and private sectors. Health spending has grown about 2.5 percentage points faster than the economy over the past four decades. If this trend continues, Medicare and Medicaid alone will absorb every dime of federal revenues at current tax rates by some time in the 2040s. These cost increases are driven by the availability of new and better treatments and drugs, the open-ended, fee-for-service nature of the system, and a lack of incentives for either providers or beneficiaries to control costs given that most of the bills are sent to third parties (either employer-based insurance plans or the government).

Given these problems, what can be done? Over the long term, there will need to be structural reforms to the health-care system, with the goal of providing better care for less money. In the shorter term, reducing costs may well require setting limits on per-capita public spending. Such limits could lead to cost shifting to individuals or to the private sector, or to a denial of needed care to consumers. However, without such limits, it’s doubtful that the needed reforms would happen quickly, and some of them may not happen at all. Limits provide the discipline within which greater efficiency becomes not just possible, but also necessary.

How do we achieve greater efficiency? One option is to link provider reimbursements and public subsidies for patients to evidence of effectiveness. Right now, there is little relationship between medical expenses and patient outcomes. Indeed, some estimates suggest that roughly 30 percent of all health-care expenditures do nothing to improve people’s health. Instead of paying for more and more treatment, we need to start paying for better outcomes wherever possible.

Social Security is a far smaller problem than Medicare. Like Medicare, the costs of the program are rising because of the aging of the population. Because of increased longevity, today’s seniors are expected to spend one-third of their adult lives in retirement. If enacted soon, Social Security reform could make the system solvent again without reducing benefits at all for those who are most vulnerable or dependent on the system, such as the disabled, low-income individuals, and the frail elderly. Indeed, any reform of the system would probably shore up benefits for at least some of these groups and address any gaps or inequities in the process.

To reduce costs, one alternative is to slow the growth of benefits for the more affluent while protecting, or even improving, promised benefits for those whose lifetime earnings have been more limited. No one would get less than they do now, in inflation-adjusted terms, but the amount of income replaced by Social Security benefits alone would decline modestly for those whose incomes were in, say, the top fifth of the distribution. Currently, household incomes of seniors in this quintile exceed $75,000 a year, a figure that will be closer to $100,000 a year by the time any change in the benefit formula were to take effect. This linking of benefits to income is something that liberals should applaud. It would not only make benefits more progressive but also increase public confidence in the system and its ability to provide for all those who really need it.

Another option is to raise the retirement age. Under a law enacted in 1983, the normal age of eligibility was gradually increased to 67—but this provision will not take full effect until 2027. By accelerating the implementation of that provision and then indexing the normal retirement age to increased longevity for younger cohorts until it reaches age 70, a significant portion of the current financing gap (about one-third) could be closed.

Although there are other reforms that might make sense, these two illustrate what needs to be done, and by themselves would eliminate the 75-year fiscal imbalance in the Social Security system.

None of these reforms, if done right, would deprive seniors of effective health care or a basic income in retirement. Indeed, by making current systems more sustainable, these reforms would actually increase the likelihood that they will still be there for future generations. And by making Medicare, Medicaid, and Social Security less costly, the reforms would free up resources to invest in the younger generation and keep tax burdens for working-age Americans at reasonable levels.

Providing a basic entitlement to health and retirement in old age has reduced economic insecurity and made government a positive force in people’s lives. But promised benefits are no longer affordable. Americans are living longer than ever, and health care advances are swallowing a larger and larger fraction of the budget. An increase in the size of government is inevitable. The trick will be finding the right balance between higher taxes on the working-age population and slower growth in promised benefits for those who have retired. By addressing this challenge head-on, progressives can protect the vulnerable, make the system still more progressive, reallocate resources to investments in the young, and restore confidence in government’s ability to act responsibly.

GREG ANRIG RESPONDS: Isabel Sawhill believes that the best way for progressives to restore public trust in government is to make painful cuts to highly popular and effective social-insurance programs. This is, to put it one way, a counterintuitive position. My view is more straightforward: For progressives to restore public faith not only in government but in themselves, they have to forcefully defend and build on their greatest successes, such as Social Security, Medicare, and, to a lesser extent, Medicaid and its companion Children’s Health Insurance Program. These programs improved security and opportunity for all generations of Americans. They don’t need to be cut; they need to be enlarged and strengthened.

Fiscal responsibility is important, and Democrats have demonstrated for many years that they take that responsibility far more seriously than Republicans: Witness President Bill Clinton’s remarkable success in transforming deficits into surpluses as far as the eye could see. But accounting prudence is not a cause that in its own right can directly improve the lives of Americans in lasting, concrete ways that generate political excitement and attachments. Clinton’s feat yielded neither political benefits to Democrats, nor economic gains to Americans, nor a continuation of sound budgetary practices in the decade that followed.

Even worse, the mania for deficit reduction threatens to sabotage the economic recovery. The preoccupation with deficits is preventing a more robust federal response to unemployment levels near 10 percent, even with large Democratic majorities in Congress, a demonstration of just how self-destructive budget hawkery has become. Undue concern over deficits is impeding additional public investment that would lead to job growth, higher consumption, and increased tax revenues from rising incomes. Virtually all economists agree that last year’s stimulus bill helped to stanch job losses, so why not build on that proven success with a major bolus of additional stimulus to drive unemployment down further? Because, we’re told somberly, our grandchildren will suffer for it in 2050.

Once solid job growth finally resumes, whenever that might be, then indeed major steps will need to be taken to prevent deficits from climbing to unsustainable levels beginning in the 2020s. As Sawhill indicated, those daunting projections derive almost entirely from expectations that health-care costs will continue to rise much faster than inflation. Skyrocketing costs will cause spending on Medicare and Medicaid to soar, just as private insurance expenses are also expected to continue escalating rapidly. The new health-care legislation—a huge progressive accomplishment, not incidentally—extends Medicare’s solvency by a full decade while including many provisions aimed at making the program more cost-effective, primarily by reducing the use of unnecessary tests and procedures. We don’t yet know which, if any, of those changes will work. But the bill creates the beginnings of an institutional framework that has the potential to eventually reduce the rampant wastefulness in our health-care system and curb the unsustainable rate of spending growth. Going forward, progressives should be prepared to aggressively build on that structure by expanding on the successful experiments and recalibrating less effective initiatives. The next round of reforms also ought to include a public option for the new insurance exchanges that would have the potential to exert leverage in ways that further control costs.

Beyond that, though, the kinds of changes for Medicare that Sawhill recommends would do nothing to affect the central cost-effectiveness challenge. Setting arbitrary limits on per-capita public spending, as she concedes, would almost certainly lead to cost shifting to individuals or to the private sector (which in turn is already shifting them further and further to individuals as well). Given the extent to which Medicare beneficiaries already bear a substantial and rising share of their health-care costs—the program’s deductibles are generally higher than is standard in private insurance, for example—imposing a global cap on spending would simply weaken already modest protections for individuals without constraining costs. What’s progressive about that?

Deficit hawks habitually invoke bank robber Willie Sutton when they talk about having no choice but to cut social-insurance programs, arguing “that’s where the money is.” But actually, there are all kinds of multi-trillion dollar targets for long-term deficit reduction that could be tapped without imposing unnecessary pain on the vast majority of Americans, and which in many cases would make the government more cost-efficient. Taking aim at those pots wouldn’t bend the notorious health-care cost curve, but going after them beginning later in this decade would keep deficits at a manageable level until reforms eventually do significantly rein in medical costs.

The most obvious source of savings is the defense budget. A bipartisan task force organized by the Project on Defense Alternatives issued a report in June spelling out specific defense cuts that would save $960 billion between 2011 and 2020 alone. The report emphasizes how those changes would not weaken America’s military capabilities. While the powerful defense industry lobby will fiercely resist reductions to their federal largesse, the pushback arising from their parochial interests would be meek compared to the public backlash against deep cuts in universal programs.

Another massive target is the welter of so-called “tax expenditures”—basically, government subsidy programs that take the form of tax breaks. The CBO tabulates that there are some 165 tax expenditures that will cost the federal government more than $5 trillion over the next five years; those include the home-mortgage-interest deduction and 401(k) tax-deferred savings plans, as well as industry-focused write-offs like the percentage depletion allowance for oil companies. Unlike conventional discretionary spending programs, tax expenditures are not subject to ongoing congressional oversight or annual appropriations, so there’s little accountability in assessing how effective they are at advancing their intended purpose. Many of them disproportionately benefit high-income individuals or narrow industry classes.

One particular inequity is the tax-favored treatment of capital gains and dividends. Taxing income from investments at the same rate as income from work would raise upwards of $1 trillion over a decade while almost exclusively affecting very high earners—the 0.3 percent of tax returns reporting income in excess of $1 million accounted for 61 percent of all capital gains in 2006. The tax code would become much simpler, more equitable, and economically efficient in the process, without significantly affecting the economy. Such a change also happens to be a reform that Ronald Reagan signed into law back in 1986 as part of a major overhaul that reduced overall income tax rates while eliminating many write-offs, a model that just might be politically plausible again in the coming decade.

One thing we definitely don’t need to do is cut Social Security by further raising the retirement age or otherwise reducing what future retirees will receive. The program is essential to many millions of Americans, including 4.4 million dependent children—about 3.5 million under age 18 and 900,000 adults disabled before age 22. Another 3.4 million children, though not receiving benefits, live in households with one or more relatives who do. But it is by no means overly generous; the annual benefit of about $13,860 a year for an average retired worker is only slightly above the poverty level of $10,830. Compared to 30 Organization for Economic Cooperation and Development (OECD) nations, the United States ranks 25th in the share of an average worker’s earnings that is replaced upon retirement by a country’s public pension program. And those Social Security replacement rates are already scheduled to be declining in the years to come, and will continue to be substantially lower for relatively well-off retirees compared to other beneficiaries. Contrary to the implication that the elderly population has an abundance of “greedy geezers,” just 13 percent of households headed by an individual 65 or over had after-tax non-governmental income of more than $50,000. Going after their benefits with a vengeance wouldn’t raise enough money to justify the effort.

According to Social Security’s trustees, the program will be able to continue paying full benefits until 2037. Over a 75-year period, the gap between promised benefits and revenues amounts to 0.7 percent of GDP. That’s barely a drop in the bucket compared to the overall budgetary shortfall attributable to health-care inflation, which is unrelated to Social Security. Gradually raising the Social Security payroll-tax cap back up to its past levels of 90 percent of total payroll income—which would increase the lid from today’s $106,800 to about $186,000—and removing the cap entirely for just the employer contributions would sustain current benefits in full throughout the 75-year time horizon. Only the top 6 percent of earners would be affected at all.

The economic crisis that we have not yet fully emerged from would have been far worse without the protections that progressives built over the course of many political battles since the 1930s. They are the essence of what we have accomplished at the national level to make our society more humane. The abundant work still to be done will proceed more successfully if we embrace those popular programs and explain to the public why we need to make them even stronger. Delivering on that promise without abandoning the Democratic Party’s well-established commitment to fiscal responsibility is the clearest path to restoring the public’s trust in government and progressivism. For all its imperfections, the health-care legislation, which will greatly expand medical coverage while reducing future deficits, embodies what our side is about. We believe not only in efficient government, but one that effectively protects all Americans from widespread risks like inadequate retirement savings, major medical costs, and disability.