THE UNITED STATES is a country that has been blessed in a great variety of ways. Its citizens are healthier than at any time in the past, and, as a consequence, they are living longer than ever before. The U.S. economy is strong, creative, and productive. Too often this success is ignored and a gloomy picture is painted, largely because of forecasts of coming catastrophe. Projections of the costs of U.S. programs to provide income for the elderly through Social Security and insurance for access to the health care system uniformly carry numbers that reach into the stratosphere and are incompatible with a well-functioning economy. Such costs cannot be sustained.
These projections are useful because they reveal a scenario that cannot be allowed to materialize. They also show that the only workable response to prevent a crisis is to adjust the programs rather than simply appropriate more money. Alternative methods to accomplish the objectives of the Social Security and health care programs must be examined, debated, and implemented as soon as possible. The costs of transition from the present structure of the programs to an alternative that makes fiscal sense are inevitable, but the sooner programs are changed and put on a solvent, sustainable basis, the more controllable the transition costs will be and the more confidently citizens can plan for their future.
What guidelines should be followed when we consider the future of U.S. entitlement programs? Here are ten commandments for successful reforms:
Bake a Big Pie: The Gross Domestic Product
The first step is to recognize that the gross domestic product—the pie—will have to be divided among the generations and among people with differing needs for access to the health care system. From that realization, it follows that the pie must be made as big as possible and the productivity of workers must continue to rise so that it can keep expanding.
The strength of the U.S. economy was described in chapter 1. For the past quarter century, the economy has grown strongly, inflation has been kept under control, and recessions have been mild and rare.
Certain features of the U.S. economy stand out:
Beyond nourishing the positive characteristics of the U.S. economy and addressing its problems, there is a clear need to enhance participation in the labor force. Participation rates among Americans aged fifty and up have been falling over the past forty years, highlighting the importance of examining incentives and disincentives to work. A number of important possible changes, identified in chapter 3, could help build up participation in the labor force.
Income for the Elderly
People instinctively think about and try to make provisions for their elderly years. Public policy should be designed to provide reasonable incentives for individuals to take care of themselves and to make it as easy as possible to do so. However, some people are more successful than others, so it is also important to create a safety net for everyone.
Chapter 4 traces the trends in employer-provided pension plans, and the conclusion is clear: Plans that provide defined benefits to retired workers are rapidly giving way to plans that allow for defined contributions. These contributions are invested and can be converted into annuities at retirement. This shift from defined benefits to defined contributions changes the structure of risks. With defined contributions, employers can reduce their risks because they can calculate costs with certainty. This change is not necessarily adverse for their employees. Recent spectacular bankruptcies show that the risk of default on defined benefit pension obligations is real and more widespread than was assumed earlier. Under the defined contribution system, employees own their plans, so movement from one employer to another does not jeopardize their pension rights. There is, of course, the risk of uncertain rates of return on investments, but if history is any guide, sensible investment programs produce reasonably stable results over extended periods of time.
Recent legislation allowing automatic enrollment in 401(k) plans makes it easier to increase the amount of money that employers or employees put into the plans.2 This legislation also takes steps to provide individuals with improved counseling geared to guide them into reasonably high-performing investments.
Social Security has helped generations of elderly people live comfortably. In fact, the poverty rate among the elderly is lower than among nonelderly Americans, a dramatic shift from the period before Social Security was enacted. Medicare and Medicaid, despite evidence of waste and inefficiency, have greatly enhanced the availability of quality health care to particularly vulnerable segments of the population. As we said at the outset, the challenge is to retain these remarkable accomplishments while bringing the growing costs of these programs under control.
Social Security
Social Security is the easiest of the programs to fix. After all, it operates by laws that transfer money from workers to retirees. If the costs must be reined in, the laws have to be changed. We have offered two primary mechanisms for bringing these costs under control.
First, change the way initial benefits are indexed. Currently, starting benefits rise with the average wage in the economy. The cost-saving alternative is to have these benefits go up with prices instead of wages. That switch alone would completely restore solvency to Social Security and then some. Note that such price indexing preserves the real value of the payroll tax amounts attributed to each beneficiary. We also think that progressive price indexing, a hybrid of wage and price indexing, is an attractive method for achieving Social Security reform. It offers wage indexing for those with low lifetime earnings, price indexing for those with high lifetime earnings, and a mix of the two for those in between.
Second, the system needs to recognize the steady but dramatic improvements in life expectancy and age-specific health that have been made over the past decades. It is not financially feasible in the twenty-first century for Americans to spend all their extra healthy years of life in retirement. The age at which people can collect full Social Security benefits and the earliest age at which they can receive benefits should be periodically or automatically adjusted upward.
We see many advantages to individual accounts. They would likely increase the national saving rate, they could replace the failed trust fund system, they would have all Americans participating in financial markets, and they would improve the adequacy of benefits. They can be part of the solution, but the real work on costs needs to be borne by two forms of indexing, one for prices and the other for increased life expectancy.
Providing adequate income for the elderly is a goal that can be accomplished. The provision of tax-advantaged status to individual or employer-sponsored contributions to retirement accounts will make the job easier. The Social Security system, the safety net for all Americans, can be transformed to ensure its solvency. The current rate of increase in benefit levels for people in the bottom third of the income distribution can be maintained, and the advantages of personal accounts can be merged readily into the system. The result: a system that is solvent, fair, and dependable. Delay is the enemy of ease and affordability of transition to this improved system. Congress must get to work.
A Healthy America
One of the principal reasons for increasing longevity is that the American people, on the whole, are healthier than ever. Better health is attributable, in large part, to the vast increase in knowledge about how the human body works, the impact of lifestyles on health, the massive research and development efforts on medications that treat diseases, and the vast improvements in medical practice. The system that produces these results, interactively on a world scale but with leadership from the United States, is a complex network of public and private efforts. Basic research is the key, and funding comes largely from private foundations and the federal government, especially the National Institutes of Health. Pharmaceutical and biotechnology companies have built upon basic research conducted in universities with dramatic results. This system needs to be preserved and enhanced.
There is a growing conviction in this country that everyone should have the opportunity for access to the health care system. That opportunity has been growing, just as the structure of the health care system has been undergoing important changes. But the costs are out of control.
Bringing health care costs under control is a tough challenge. But the first step is to recognize that they are out of control and understand what has caused the problem. A key part of the answer is simple economics. When people buy goods and services that are paid for either entirely or in large part by someone else, they generally are not wise shoppers in terms of seeking value for money. As Milton Friedman taught us, people never spend other people’s money as carefully as their own. Moreover, health care is treated differently from any other part of the economy; in many ways, it has not been subject to budget constraints.
By this time, the vast majority of Americans are covered by some form of health insurance or are enrolled in one of the many health care organizations. Historically, the system has been structured in such a way that individuals become entitled to benefits without being sensitive to the costs of those benefits. One result has been massive inefficiency and poor allocation of resources. Another result has been a system dominated by providers and financiers of health care—in effect, a stool with only two legs. Reactions to these results have arisen at federal and state levels and among private employers and individuals. What these efforts reveal is the construction of a consumer leg on the unstable two-legged stool. As the consumer leg develops, the stool becomes sturdier, and the prospect for greater effectiveness in the use of resources increases. This is the key to controlling costs while maintaining access to health care for everyone.
Our proposals would give everyone the opportunity to have access to the health care system in an organized way. But price or available money would be factors in making health care decisions, as in the case of food, housing, transportation, clothing, or any of the other necessities of life. At some point in the future, preferably sooner rather than later, health care spending will have to be subject to the same value-for-money calculation that applies to everything else in the economy. The challenge is to limit spending, or at least the growth in spending, without curtailing medical advances and losing the benefits of modern medicine. Socially we need to sustain the high return of medical treatments and rein in waste and low-return activities.
An essential step toward containing health spending, particularly in Medicare and Medicaid, is to transform benefits from services to money. That is, the obligation that is now defined in terms of an open-ended entitlement to medical services would be converted to an obligation defined in terms of money. Money could take the form of medical vouchers that would ensure the ability of all participants in these programs to afford quality health care. They also would have choice regarding how that money is spent. For example, some might choose to buy comprehensive insurance while others might opt for major medical insurance plus Health Savings Accounts.
Another important step would control the growth in the aggregate value of Medicare and Medicaid vouchers, most naturally as a percentage of aggregate labor income. The essence of the cost problem is that the increase in health spending has been growing, and is projected to continue to grow, faster than labor earnings. This imbalance cannot continue forever. Vouchers would allow the government to gain more control over the growth in spending because an established amount of health care buying power would replace an open-ended entitlement to services. The era in which the government can promise Americans access to every medical treatment that might work cannot last. This is not radical thinking; everything else in the economy is rationed today by the market system, the best rationing system ever developed. People acquire what they want limited by what they can afford. That same logic will apply to health care. Americans will have the health care system they want and will choose the services most valuable to them, but they must be limited by what they can afford.
Developments consistent with this approach are traced in chapter 9, and important areas for further action are identified. Health Savings Accounts, created by federal legislation in 2003, are an essential building block. They can be useful to individuals, to state and local governments, and to employers. States are using the opportunity afforded by federal legislation to change their Medicaid programs, with broad movement toward bringing the consumer more directly into the process of choosing among alternative routes to health care. In chapter 10, we propose and show how to manage a shift toward vouchers in the structure of Medicare.
A strong third leg for the health care stool requires more than consumers who are empowered with the resources to buy their own health care; it also needs consumers who are well informed about prices and outcomes. This kind of information is now becoming available, largely in response to consumer demand, and those with the information have recognized that they must find a way to make it accessible. More work in this area is essential.
Competition among providers of the various forms of health insurance is also essential. Evidence is overwhelming that the present system, which prevents health insurance from being written on a national basis and bars consumers in one state from purchasing insurance in another, has led to startling differences in costs. Necessary legislative change has been clearly identified, and the battle among interests vested in the present system is in full swing. This battle must be won if the health insurance problem is to be resolved.
Continued movement in the directions now under way accompanied by actions on the recommendations put forward in chapter 10 can create a system of access to health care that is far superior to the existing system. The goal of universal opportunity for access to health care is achievable with costs that, though certainly substantial, will not be of the runaway nature that is commonly projected for the current system.
The recommendations presented here constitute a plan of action to modernize our entitlement programs in keeping with today’s opportunities and results. The challenge, though difficult, can—and must—be met. Let us get on with the job.