THE UNITED STATES faces the daunting imperative of identifying solutions to manage the staggering projected costs of its Social Security, Medicaid, and Medicare systems, our so-called entitlement programs. The magnitude of these costs cannot be met by any reasonable projection of future federal government revenues. The U.S. body politic must somehow find a way to ensure that systems are in place to provide reasonable income for the elderly and universal access to health care that are consistent with fiscal sanity. The purpose of this book is to help find a way to make progress on this most important problem.
When Ben Bernanke, the chairman of the Federal Reserve Board, was asked by the Senate Budget Committee when the problems of Social Security, Medicare, and Medicaid would need to be addressed, he replied, “I think the right time to start is about ten years ago.”1
Our approach differs from the theme of impending catastrophe in much of the current writing about the U.S. economy. Two recent publications tell the story in their titles: Running on Empty by Peter G. Peterson, and “Is the United States Bankrupt?” by Laurence J. Kotlikoff.2 Both are informed, responsible wake-up calls, and they have plenty of company. Careful projections of future costs made by the Congressional Budget Office (CBO), for example, show that entitlement costs alone could reach 28.5 percent of gross domestic product by 2050, clearly an unmanageable level, especially considering that federal revenues have never exceeded 21 percent of GDP in the history of the Republic.3 And these projections reveal only part of the problems before us. Commitments by state and city governments and by private employers contribute substantially to the looming threat described in chapter 2, “The Iceberg Ahead.”
Clearly, something needs to be done, but this difficult subject merits a positive approach. America’s solid record of economic achievement holds the promise of continued success in a future filled with opportunity. American success exists on many fronts. The U.S. economy sets the world standard, and its growth is an essential ingredient in the expanding global economy. The creativity and dynamism of the American economy now yield strong gains in productivity (output per man-hour) that surpass the rate of improvement in many prior decades. The U.S. economy produces one of the highest per capita incomes in the world, and no other major developed country has been able to keep pace, let alone catch up. So it’s clear: We have success on our hands.
And the economy is by no means the only area of success. Not only do Americans live longer than ever before, but many are healthier and capable of being productive far longer than at any time in the past. These trends are likely to continue as a result of many breathtaking advances in science and technology. Such momentous developments are opportunities to nourish.
The contradiction between this clear evidence of success and the current atmosphere of unease in the United States calls for a change in mind-set. The projected gargantuan shortfalls in the U.S. budget stem largely from the interaction of constantly expanding costs of health care and longer life spans with relatively inflexible entitlement programs. Increasing longevity and better health are developments to celebrate. The challenge is to adapt income support and health care programs to these changing demographics and health care options.
The difficult problems of financing Social Security and health care commitments must be approached from a realistic perspective based on demography, medical developments, and fundamental economics. In demographic terms, we are retiring earlier and living longer. The result is a growing proportion of people outside the labor force compared with those who are working. Medical treatment options too have expanded. As a consequence, the federal government has increasingly become a mechanism for transferring ever-mounting sums of money from younger workers to older retired Americans.
Solutions to the entitlement problems will be made easier or more difficult according to the size and rate of growth of GDP, so the first step toward seizing opportunities is the promotion of a large, growing economy. That means examining those characteristics that strengthen the U.S. economy and addressing those that need to be stronger. Any reforms of entitlement programs should be consistent with these objectives. In addition, this book will look at ways in which the structure of retirement and health systems can be changed to improve participation in the labor force and to increase the rate of private saving. Labor and capital, after all, are the primary inputs that create GDP.
The history of Social Security and health care programs in the United States shows that their structural roots come from an altogether different era, that of the Great Depression and World War II and its aftermath. These programs must be adjusted to better accommodate increased longevity as well as improved and promising medical treatments, which are often costly.
The Social Security system was part of President Franklin D. Roosevelt’s New Deal. First enacted in 1935 and changed many times since then, this program provides a base of income support for the elderly and is financed by a tax on labor earnings. Since revenues from taxes on current workers pay for the retirement income of those eligible to draw benefits, the program’s financing structure is known as pay-as-you-go.
Federal government support for access to the health care system started during World War II, when wages were controlled and heavily taxed. The provision of health insurance, which was neither controlled nor taxed, was an important way for employers to compete for scarce labor, so the use of these plans exploded. The dominance of employment-provided health insurance continues to this day. The initial structure of these plans put the employee in the position of having tax-free access to health care services without any out-of-pocket cost. Not surprisingly under these circumstances, use increased sharply.
In 1965 government involvement in the health care area expanded dramatically. Medicare provided access to benefits for those over sixty-five years of age, and Medicaid provided access, in the form of federal-state programs, for the poor. These programs have become more complex as they have evolved over the years. Nevertheless, their essential structure, like the employer insurance model, initially provided mostly free services to those eligible, or “entitled,” to receive them.
Reform of these programs will not come easily. To touch them, many politicians worry, is to touch a third rail. But well-documented projections of the costs of current programs show that inaction is simply not an option. Progress will be promoted by widespread realization of the depth of the problem and of the fact that workable options exist. In fact, the rigidity and stability of the programs are major parts of the problem. Everything about the U.S. economy is dynamic except its major entitlement programs. To serve their fundamental purposes, these programs must be modernized so that they are suitable for the twenty-first century. We shall present several proposals for reforming these important aspects of the economy along with our own recommendations, developed to meet the tests of fairness and fiscal responsibility.