Don’t Let Good News Stop Benefit Reforms

Henry J. Aaron
Henry J. Aaron The Bruce and Virginia MacLaury Chair, Senior Fellow Emeritus - Economic Studies

April 24, 2000

Everybody was feeling great after the recently released annual reports on the financial prospects of Medicare and Social Security. The programs are financially stronger than they appeared to be just last year and much stronger than three years ago—so much stronger, in fact, that Vice President Al Gore immediately brought out proposals to fatten benefits. Then the shock of the recent financial market blood bath reminded us that good times may not endure. The prospects for Medicare and Social Security could sour if the economy softens.

The correct lesson from the combination of benign program projects and frightening financial market oscillations is that the case for radical reforms based on fears that Medicare and Social Security shortly will become insolvent—especially for proposals that would force individuals to bear financial market risks—has collapsed. Rather than stampeding into radical changes based on bogus fears of crisis or being seduced into questionable short-term liberalizations, we should address the genuinely significant issues concerning whether and how to reform these programs.

The improvements in Medicare’s bottom line are particularly dramatic. Medicare’s Hospital Insurance Trust Fund, projected three years ago to be exhausted in 2001, is now expected to stay in the black until 2023—the longest period of projected solvency since the program was created. The projected 75-year deficit has shrunk by two-thirds. Large deficits still loom over the more distant future, however. If benefits are to be sustained, more income is essential.

Yet sustaining benefits isn’t good enough. Medicare provides next to no coverage for out-patient prescription drugs. It does not adequately cover catastrophic acute illness and long-term care. To fill in these and other deficiencies, some beneficiaries buy Medigap insurance, the premiums for which are skyrocketing. Some retirees depend on supplemental coverage offered by former employers, but fewer businesses are offering such coverage. Still others joined a Medicare health maintenance organization for extra benefits, but cutbacks in federal payments have led HMOs to curtail such supplements. Medicaid supplements benefits for some of the poor, but this varies from state to state.

Medicare reform should address these shortcomings as well as projected long-term deficits. But doing so will actually raise spending and require more new revenue. The plain truth is that health insurance coverage for the aged and disabled, comparable to what most of the rest of us have, will cost more—much more—than current payroll tax rates can support. Some of that money can come from general revenues, as President Clinton has proposed. Some could come from higher payroll tax rates. But to keep payroll taxes in bounds, the elderly who can afford it should pay a bit more for their health care than current law requires.

To make such bitter medicine palatable, it will be important to link increased patient cost-sharing and higher taxes to added benefits that have widespread appeal, such as prescription drugs. This need for “linkage” means that piecemeal enactment of benefit liberalization, even enactment of an outpatient drug benefit, may inhibit rather than advance Medicare modernization.

Less dramatic, but still significant, is the continued improvement in the prospects for Social Security. Income will exceed outlays by more than $150 billion this year, more than 50% higher than anticipated three years ago. The trust fund is expected to stay in the black until 2037, eight years longer than projections indicated just three years ago. And the projected long-term deficit is about 15% smaller than it was just three years ago.

Simply closing the remaining projected long-term deficit in Social Security is technically easy, if politically difficult. A variety of modest steps would suffice, including investing part of the reserves in higher-yielding assets than Treasury bonds, transferring a small part of non-Social Security budget surpluses to Social Security, modestly increasing the payroll tax wage base and extending coverage to state and local employees who remain outside the system.

Critics of Social Security have raised larger issues. They claim that its fundamental purpose—to assure a basic income to the aged, disabled and widows and widowers—can be achieved better by forced saving through arrangements similar to individual retirement accounts and 401(k) plans. Financial turmoil has undercut the appeal of these proposals. Accounts subject to wild financial market oscillations cannot assure basic income. In addition, the cost of administering Social Security—less than 1% of benefits paid—is far lower than the 20% to 40% cost of administering other countries’ individual account systems.

This year’s good financial news brings the risk that politicians will be tempted to make their own job harder by raising benefits now. Gore’s recent proposals to provide extra benefits for stay-at-home parents and to increase benefits for widows and widowers illustrate the problem. Both proposals have political appeal in an election year but should be reserved as sweeteners in a plan to restore long-term financial balance.

Clinton stopped tax cut zealots cold with the call to “save Social Security first.” The same call should inhibit those who want to use Social Security’s current, but temporary, surpluses to fatten benefits.