On Social Security and Medicare, Parties Must Compromise to Avoid Fiscal Train Wreck

The release this week of the trustee’s report on the solvency of Social Security and Medicare brought both good and bad news. Health care reform, according to the trustees, helps to shore up the finances of both systems, but the longer-term picture is dire. Unless the two systems are reformed, we are headed for a fiscal train wreck. Already these two programs, along with Medicaid, absorb over 70 percent of all revenues. In a few short decades, they will absorb 100 percent of all revenues if nothing is done.

President Obama’s fiscal commission has an opportunity to fix the problem, but it will necessitate a compromise. Republicans are going to have to agree to some revenue increases; otherwise Democrats on the commission are not going to agree to reforms in programs that they believe are at the heart of the progressive agenda. Revenue increases need not come from raising tax rates. All that is needed is to pare back some of the subsidies in current law that economists call “tax expenditures” because they are the equivalent of spending programs run through the tax code. As Martin Feldstein has argued (Wall Street Journal, subscription required to view full article), “when it comes to spending cuts, Congress is looking in the wrong place. Most federal nondefense spending, other than Social Security and Medicare, is now done through special tax rules” that currently cost around $1 trillion a year. Like entitlements, these tax expenditures are on automatic pilot, never subject to serious scrutiny as part of the annual budget review.

Next, as part of a bipartisan deal, Democrats must accept the need to slow the growth of Social Security and Medicare benefits. The fairest way to do this is by relating benefits more to income over the coming decades. Already 20 percent of seniors have incomes of over $75,000 a year and this number will rise sharply as the baby boom generation retires, according to projections of the McKinsey Global Institute. Many people assume they have “paid for” these benefits but this is largely a myth. Each working-age generation pays for the previous generation’s retirement benefits. There are no real reserves in the system; only the prospect of much higher taxes and reduced take-home pay for workers if we continue on our current path.

Combine these two steps with some judicious cuts in defense spending and a freeze on nondefense spending outside of the entitlement arena and one has the makings of a strong package of recommendations that Congress has pledged to take up next year.

The problem, of course, is not a shortage of ideas about how to restore fiscal sanity but rather a lack of political will to take the necessary steps. Each party is the prisoner of its own rhetoric but each also needs to consider the damage—not just to the country but to its own more parochial priorities—created by a failure to act.

For Republicans, continued stalemate almost certainly guarantees an increase in tax rates. Why? Because the closer we get to not being able to pay promised Medicare or Social Security benefits (and Social Security is for the first time this year paying out more in benefits than it collects in revenue), the greater the political pressure will be to simply raise taxes to pay the bills since the only alternative is to throw granny off a cliff. Moreover, virtually all economists agree that current tax expenditures reduce the efficiency of the economy, slowing innovation and growth.

For Democrats, stalemate produces another set of problems. First, today’s boomers and their children no longer believe that existing benefits will be there when they retire. Returning these systems to long-run solvency will shore up faith in the system. Second, if nothing is done to rein in spending on the big entitlements, everything else the government does—from improving infrastructure, investing in education, and providing a safety net for the disadvantaged—will be sacrificed to the need to devote virtually all future revenue growth to these two big programs. Third, in the interest of fairness, progressives should accept the principle that benefits be linked to incomes. They should also care about the damage that continuing deficits do to the idea of a responsive government capable of playing a positive role in people’s lives.

So a bipartisan compromise could be a win-win solution. But Democrats need to pledge not to use any additional revenues to increase spending and Republicans need to pledge not to use any reduction in future benefits to reduce taxes. Put differently, these reforms should be enacted in a way that creates a new budget baseline or trajectory which is then kept in place through a tough “paygo” rule: no new spending and no new tax cuts unless they are fully paid for. Can members of the commission pull this off? Most observers are betting against a positive outcome. But many kudos from a grateful nation await the commission if it does the right thing.

Isabel Sawhill has a new longer piece in Democracy: A Journal of Ideas called “Attention:Deficit,” which is on why progressives should care about the growth of entitlements.