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  • Triumph and Tribulation, by Henry Aaron
    Jan 24, 2014

    How progressives might approach changes to Medicare, Medicaid, and Social Security

    For U.S. progressives, the 20th century was a triumph. They fought for social insurance, and they won. They supported many income-tested benefits to ameliorate poverty, which became law.

    In retrospect, one can identify at least four reasons for these successes. First, the Great Depression taught usually individualistic Americans that the harsh discipline of capitalism is acceptable only if softened with economic protections. Second, the monumental collective victory in World War II made clear to a traditionally government-phobic nation that collective action could deliver the goods. Third, starting in 1940, the United States enjoyed nearly four decades of almost continuous economic growth. Over that period, most people enjoyed improved private living standards even as they collectively helped others. Fourth, the defense budget shrank from more than 10 percent of GDP after the Korean War to less than 4 percent after the collapse of the Soviet Union. That contraction allowed domestic spending to increase without the need to raise taxes.

    These conditions endured long enough to seem normal, but they were not. The deceptions and failures of the Vietnam War began to undermine trust that government is honest and effective. Watergate accelerated disillusionment. The first oil shock in 1973 caused stagflation. Stock prices remained depressed for years. For a time it seemed that the economic triumphs of the Clinton presidency might initiate a new progressive era, but Clinton’s personal indiscretions, the Nader candidacy, and a politicized Supreme Court intervened.

    The first decade of the 21st century was calamitous. George W. Bush pushed for and Congress enacted imprudent tax cuts just as the baby-boom generation began to retire. These cuts recklessly squandered fiscal surpluses laboriously created during the fiscally prudent 1990s. Two wars, one rashly and dishonestly begun and both mismanaged, sharply boosted federal government spending. Most of the fruits of economic growth accrued to the rich. The middle class languished. Unemployment and under-employment soared. Budget prospects deteriorated. Debt ballooned. Suddenly, the liberal successes—Medicare, Social Security, and income-tested programs such as Medicaid and Food Stamps—seemed to many to be unaffordable.

    Meanwhile principled opposition to the very concept of social insurance reemerged. When initially debated, Social Security and Medicare elicited political Jeremiads, warning that these programs would destroy personal freedom. President Obama’s health reform legislation has elicited the same absurd warnings. But even more, it seems to have aroused near-hysteria among libertarian conservatives that they are engaged in political Armageddon, a final struggle against freedom-destroying statism.
    With opposition to social insurance more intense than in decades, progressives need to consider carefully what extensions of social insurance they want to seek, what redesigns of the current system they should entertain, and what cutbacks in the current system they might tolerate in exchange for high-priority gains.

    A key baseline fact should be kept firmly in mind: U.S. social insurance is parsimonious, compared to that of other nations or to the domestic past. Social Security pensions are 30-40 percent lower than the average of other developed nations. Furthermore, Social Security benefits have been and will be cut about 15 percent under legislation enacted in 1983. There is no good reason to cut them more. In fact, the arguments for raising benefits, especially for the very old, are compelling. A recent poll indicates that large majorities of Republicans, Democrats, and Independents are willing to pay enough in added taxes not only to sustain the current program, but also to raise benefits somewhat.

    Medicare is also far from generous. It covers barely 60 percent of its beneficiaries’ medical costs. Most people are driven to obtain supplemental coverage through other sources. The program could be improved and the lives of beneficiaries simplified if a super-Medicare program were offered at a premium that fully covers the cost of incremental benefits and thereby avoids any net impact on the federal budget.

    To be sure, Medicare spending has been rising excessively. But the reason is not that benefits are generous—they are deficient in many ways—but rather because U.S. healthcare system is rife with cost-increasing incentives. No reform of Medicare operating in isolation can transform the whole delivery system. The best hope for controlling growth of Medicare spending is systemic reform of the entire U.S. payment and delivery system. That is just what the 2010 health reform legislation has begun. In the meantime, money could be saved and the program improved if more were spent to police abusive practices and to ensure that physicians and hospitals use new technologies only in ways that generate proven benefits, not in unapproved ways that pad providers’ incomes.

    While the two major social insurance programs are lean, the arithmetic of ‘pay-as-you-go’ social insurance is sobering. The tax cost of these programs is directly proportional to growth of the wage base that is taxed to pay for them. Growth of both the labor force and earnings-per-worker has slowed recently. The result is that growth of the current wage bill has slowed. Slow growth means higher tax rates are needed to pay for benefits of given generosity. This arithmetic law is inescapable. When economic growth slows, annual taxes as a share of income required to pay for benefits goes up.
    That holds directly for pensions. It is magnified in the case of health care because per person health care spending has outpaced income growth. The larger the gap, the worse the problem.

    These arithmetic relations are the essence of what is loosely and inaccurately called the ‘entitlement problem.’ The most fundamental law of economics—the law of demand—predicts that people want to buy less of almost anything at high prices than they do at low prices, other things held constant. Few doubt that a similar principle governs political tastes. That is why supporters of social insurance—Social Security, Medicare, and Medicaid—should put at the top of their near-term political agenda measures to return the economy to high employment. It is why they should put at the top of their long-term agenda measures to promote economic growth and to control growth of per capita health care spending. Not only does rapid overall growth, if broadly distributed, enable people simultaneously to enjoy rising living standards and support social expenditures, it also directly lowers the price of social insurance.

    Trends in life expectancy pose a particular challenge to the design of social insurance. Longevity of those with higher-than-average education and incomes is rising a lot. Longevity of those with lower-than-average education and incomes is rising little or not at all. Not incidentally, those with comparatively high education and earnings are remaining economically active until later ages than in the past. Because the lifetime value of Social Security benefits is linked to how long one lives, a growing share of program outlays is going to those with comparatively high education and earnings.

    These trends contain both a challenge and an opportunity. The challenge is to maintain the progressivity of Social Security. The opportunity is to modify support for the elderly in ways that encourage those who can do so without undue hardship to remain economically active until later ages than in the past. These changes could include reductions in Social Security benefits paid when people with above-average incomes claim benefits at an early age. Such changes should be combined with increased access to and support levels in Supplemental Security Income and with incentives to encourage employers to retain older workers and with income-related incentives for older workers to remain in the labor force. The higher earnings from increased labor supply would flow disproportionately to older workers who otherwise would leave work. Added income from earnings would flow primarily to those with low education and earnings who now retire comparatively early. The increased tax revenues from the added output that these workers would produce would contribute noticeably to closing projected budget deficits.

    Nor should progressives resist Medicare changes that promote competition between properly compensated managed care organizations (MCOs) and traditional Medicare, provided that the rules of competition are designed to prevent premiums for traditional Medicare from being driven up by MCO cream-skimming.

    Hovering over any such reforms are the projections that the Social Security and Medicare Hospital trust funds face projected long-term deficits. Earmarked revenues will not indefinitely cover all currently promised Social Security or Medicare Hospitalization benefits. Opponents of social insurance use these projected shortfalls to cry that the fiscal sky is falling and that neither program is sustainable. These fears are groundless. Small tax increases—combined, if politically necessary, with small and selective benefit cuts—would close projected gaps. The sooner that is done, the sooner this bogus argument can be laid to rest.

    Abraham Lincoln famously said that “The legitimate object of government is to do for a community of people whatever they need to have done, but cannot do at all, or cannot so well do, for themselves in their separate, and individual capacities.” That was and remains the essence of the case for social insurance. The two financial crises of the past 15 years have underscored the continuing strength of that case—for progressives, but even more for, all Americans.

    This piece is the first installment in a forum on the future of the social-safety net.

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