Health Care, Entitlements and the Federal Budget

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

June 15, 2009

The following are Henry Aaron’s comments on the budget, health care and entitlements at the Youth Action Conference hosted by the Concord Coalition in conjunction with the Youth Entitlements Summit to highlight the grassroots efforts and policy perspectives of youth organizations in addressing America’s long-term fiscal challenge.

I want to start by commending this organization for paying attention to the very serious budget problems facing this nation. Most of us understand that the near-term deficits are necessary and, on balance, beneficial. They do, to be sure, add to the long-term debt burden. But they help avoid short-term economic calamity and grievous hardship.

Of course, the U.S. economy will recover one day. When it does, budget deficits must be reduced. They must be reduced because every dollar borrowed creates a debt burden that all of us, but especially today’s youth, must shoulder. Every dollar borrowed means a dollar less investment or a dollar more borrowed from abroad. In either case, that means less income for Americans. And every dollar borrowed abroad increases the nation’s dependence on foreign asset holders who could at any time decide that we have become bad credit risks and expose us to dramatically higher interest rates. So, bravissimo for focusing on the budget challenges confronting the United States.

But framing the budget challenge as an entitlement problem is analytically wrong. It is also the road to a partisan and failed policy debate. This nation faces no entitlement crisis. It doesn’t even face an entitlement problem. It faces two other related but distinct problems.

The first is a problem of the organization and financing of health care. Virtually all of the projected increases in budget deficits are traceable to growth of Medicare and Medicaid spending. Their outlays will grow principally because of advancing medical technology and secondarily because of population aging. But that is true of all health care spending. Every sensible analyst understands that it is possible simultaneously to slow spending growth and sustain the purposes of these programs only within the framework of total health system reform.

Even with health system reforms, however, the cost of Medicare and Medicaid will keep rising. The principal driving force behind increased spending has been the proliferation of beneficial health interventions—the ones that over the last three or four
decades have helped cut infant mortality in half and death from coronary disease and stroke by two thirds. In fact, we should all hope that continued scientific advance keeps pushing up health care spending.

And that brings me to the second problem—taxes. Spending in even the most efficient Medicare and Medicaid systems will rise faster than incomes—and taxes. That means that tax rates must go up. That was the unanimous conclusion of a panel of analysts, conservative and liberal, organized by the National Academy of Social Insurance.

Growth of total health care spending is not an entitlement problem. Reform of a chaotically inefficient health care system is not an entitlement problem. It is a health care financing and organization problem. It is the problem that President Obama is calling on the nation to address this year. And responding to that call is the most important single step the nation can take to meet the long-term fiscal challenge.

Well, what about Social Security and other entitlements? Yes, the cost of Social Security is going to go up, but less, I’ll bet, than most of you think. Social Security spending is projected to increase a bit more than 1 percent of GDP by 2035. Then the share is projected to fall. Other entitlement spending, which this year is nearly as large as Social Security outlays, is projected to fall slightly as a share of GDP. In total, non-health entitlements are projected to go up less than 1 percent of GDP by 2050. In plain English, the overall fiscal challenge from Social Security and other entitlements is trivial. Describing Social Security’s shortfall as a crisis is nonsense. Talk of an “entitlement crisis” is bogus. We have a health care financing problem, private and public—pure and not at all simple.

The recent financial crisis has certainly deepened the fiscal challenge. But it has done something else too. It has driven home that Social Security is, and must remain, the bed-rock of retirement income security. There is simply no alternative. Private income sources cannot do what social insurance does—only social insurance provides absolute inflation protection, spreads risks over generations and across the whole population, provides wage insurance, and is immune to fluctuations in asset values. Yes, changes in economic and demographic conditions can force changes in social insurance. But those changes are gradual, not abrupt.

There is, of course, the question of how high benefits should be. U.S. benefits are not high and replacement rates—that is, benefits relative to earnings—are falling. U.S. benefits average just 37 percent of covered earnings, lower than three quarters of those in other developed nations. And Social Security ‘take-home pay’—what is left after Medicare premiums are subtracted—have not kept pace with earnings. One reason is that Congress lowered replacement rates in 1983 and not all of the changes have yet been implemented. A second reason is that very rapid growth of Medicare premiums have taken an ever bigger bite out of Social Security take-home pay. Further cuts are unwarranted.

The best way of saving money and maintaining replacement rates, in my view, would be measures to encourage workers able work to remain economically active until later ages than is now customary. These measures could include positive benefit bonuses for those who retire at later ages, increases in the age at which benefits are first paid (now age 62), liberalized disability benefits for those who need to retire but are not disabled under current standards, intensified enforcement of anti-age-discrimination laws, modification of the payroll tax on older workers, or other steps.

In closing, I want to congratulate you once again for focusing on the fiscal gap. The United States must close it. It does not derive in any significant measure from Social Security or other non-health entitlements. It derives largely from increases in health care spending. Slowing the growth of Medicare and Medicaid spending should occur principally within the framework of general health system restructuring. But there is no way to slow Medicare and Medicaid spending enough while sustaining its fundamental purposes without sizeable tax increases. We have promised the elderly, disabled, and poor health care roughly like what the rest of us enjoy. That is a commitment that neither a liberal democracy nor a conservative republic should abandon. And we must pay for our commitments.