New paper: The Forgotten Entitlements

My AEI colleagues Henry Olsen and Jon Flugstad have a new article out in Policy Review on what they call "The Forgotten Entitlements," Social Security disability insurance and Medicaid long-term care. Both programs are rising in cost and both, Olsen and Flugstad argue, are in need of structural reform.

When politicians and policy wonks use the phrase "the looming entitlement crisis," most listeners know exactly what that means: Social Security and Medicare. Spending on these programs is rampant, nearly $1 trillion in fiscal 2006, and is projected to grow exponentially over the coming decades. By 2082, due to the aging of baby boomers, rises in health-care expenses, and expected lower fertility rates, Social Security and Medicare are projected to cost nearly 18 percent of gdp--roughly what the entire federal government costs today. It is now common, if as yet unacted upon, wisdom in the Beltway that if the price of these programs is not reined in, Americans will have to suffer either substantial tax increases, unsustainable budget cuts, or both.

But the bad news does not end there. It turns out that Social Security and Medicare are not the only out-of-control federal entitlements. Two little known entitlement programs, Social Security Disability Insurance (SSDI) and Medicaid Long Term Care (LTC), are also increasing at unsustainable rates. Call these the forgotten entitlements…

To read the whole paper, click here.

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Michael Kinsley on Entitlement Myths

Michael Kinsley argues in Time Magazine that we should reconsider our views of the "entitlement crisis." While always interesting, I'm not sure Kinsley's arguments really hold up to scrutiny – but see my comments below and judge for yourself.

The Peter G. Peterson foundation, a new and welcome arrival on the national scold scene, announced in a December press release that the U.S. is bankrupt. Not the government but the whole country and everyone in it. As of Sept. 30, the PGP folks reported (using figures from the Federal Reserve), the value of everybody's assets was $56.5 trillion. The value of our liabilities (public and private) was $56.4 trillion. Given what has happened to real estate and the stock market since Sept. 30, it seems certain that we now owe more than we are worth.

It seems certain, that is, if the PGP folks are correct. Now, I'm all for doom 'n' gloom--they've done very well for me in the journalism business over the years--but this struck me as too bad to be true. And on closer examination, it is. About $40 trillion of PGP's $56 trillion in liabilities is its calculation of future Medicare and Social Security benefits ($34 trillion of it is Medicare alone), which Congress has promised to future senior citizens but has made no provision to pay for. This is the entitlements nightmare we hear so much about. Trouble is, the PGP folks seem to have forgotten about this $40 trillion of dubious promises when totting up the assets of people who will (or possibly won't) get the benefits. If these entitlement promises are real government debts, they are also real assets for the people who will enjoy them. If (as we gloomsters suspect) they aren't real for the future recipients, then they aren't real for the government either.

American families may have borrowed irresponsibly, and may have elected politicians who borrow even more irresponsibly on their behalf, but the typical American family is not bankrupt. The average couple age 65-74 has accumulated a net worth (not counting entitlement promises as either assets or liabilities) of $691,000, according to the Federal Reserve in 2004. Shortly thereafter, of course, they start to die in large numbers. And what happens to the $691,000? Generally it goes to the children and grandchildren.

It's often said, on the subject of underfunded entitlements, that we are "robbing future generations." This is not completely true. You can't literally steal, say, a vacation home from the year 2050 and plant it next to a beautiful lake in 2009. Nor can you beg, borrow or steal money in 2050 and spend it in 2009. But you can reduce your savings rate in 2009, spend the money instead and leave a less prosperous country in 2050. And if you borrow money from foreigners in 2009, as we have been doing more and more, they can indeed come knocking in 2050 and demand their money back. With interest.

Meanwhile, though, families--middle-class families, not just rich ones--are passing hundreds of thousands of dollars on to the next generation in their wills. Fair enough, if they worked for the money and saved it. In fact, wonderful. But much of this generosity, it turns out, is made possible by Social Security and Medicare. How much? Hard to say. What is easier to say with certainty is that most people today and in the future will get more back from these entitlement programs in retirement than they put in during their working lives.

Medicare and Social Security are supposed to be insurance against the perils of old age: poverty and illness. They are not supposed to be gifts or subsidies to the children of retirees. Yet that is what, in large part, they have become. The reason for insurance is that you can't predict the future. If an elderly woman has diabetes and her husband needs heart surgery, then dies anyway, leaving her impoverished, Medicare and Social Security should be there for her. And if it all costs far more than she ever put into the system, that's O.K. too.

But if our elderly woman dies with $691,000 in the bank, it's evident that she didn't need the government money to pay for her health care or to avoid plunging into poverty. She wasn't lying or cheating--she might have been legitimately worried--but her worries turned out to be unnecessary. And society, having kept its promise to her, should get at least part of that money back. Oh, yes, designing a system to achieve this would be a nightmare--maybe impossible. The incentive for old folks to squander their savings would be enormous. Maybe it can't work. But the point is worth keeping in mind as we enter President Obama's "new age" of "hard choices."

And the children? Let them rob their own children, just as their parents did.

Some thoughts: First, while Kinsley's point regarding the Peterson Foundation's account seems correct – a debt to someone has to be an asset to someone else – transferring massive amounts of resources through Social Security and Medicare entails significant efficiency losses. Social Security contributions are regarded as taxes by workers in ways that contributions to personal saving are not, and therefore reduce incentives to work. So while the accounting may net out, there are economic costs in getting from here to there.

Second, Kinsley may exaggerate the size of inheritances that will be passed on to Baby Boomers and younger cohorts. This paper by Kotlikoff and Gokhale concludes that the bequest boom is likely overstated.

Third, even if households continue to pass on significant bequests to their heirs, this won't be – as Kinsley claims – due to the generosity of Social Security. For early generations of beneficiaries, Social Security provided benefits well in excess of contributions, which – assuming seniors didn't just consume this extra income – allowed for larger inheritances. But as this memo from the SSA actuaries shows, Social Security can afford to pay a typical couple retiring in 2008 benefits and interest equal to only around 75 percent of the taxes the couple paid in over their lifetime. Social Security imposes a net tax on current and future retirees and, if anything, reduces the amount of wealth they'll have to leave to their kids.

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The kind of question Social Security probably doesn’t want to answer…

A financial Q&A column in the Associated Press answers an uncomfortable question regarding Social Security spousal benefits:

Q: A friend has been a stay-at-home mom while I have worked most of my adult life and raised my children. My friend and I and our husbands have recently signed up for Social Security benefits and I've discovered that my friend will get as much as I will. How, since she hasn't contributed to Social Security, can she get as much as I will?

A: As the spouse of an eligible worker, your friend is entitled to half of her husband's benefit amount when she reaches full retirement age, which could be as early as 65. Her husband, at full retirement age, will receive his full benefit amount and she will get a check for half of that amount, even though she's never worked.

So, your friend could feasibly be entitled to as much as you are. Your benefit amount is based on the number of years you've worked, how much you earned and the age at which you begin drawing benefits. Hers is based on half of whatever her husband's benefit is.

The Social Security Administration uses a mathematical formula to figure benefits based on your average monthly earnings during the 35 years in which you earned the most.

This is the amount you would receive at full retirement age, which for most people is age 65. Beginning with people born in 1938 or later, that age will gradually increase until it reaches 67 for people born in 1962 or later.

The average monthly Social Security benefit for a retired worker is about $1,153 this year.

In addition, your friend can get Medicare when she reaches 65. Medicare provides hospital insurance, medical insurance and prescription drug coverage.

Here's how I see it: Social Security was built on the principles of equity and adequacy. Equity means that benefits are based on what you pay in, while adequacy provides a tilt to the benefit formula so low earners receive higher benefits relative to their contributions than do high earners. Neither principle justifies the payment of a benefit to the spouse of a high earner, who neither needs the money nor has paid anything into the program.

Social Security benefits need to be reduced in the future in order to balance the program's books. Here's a nice place to start.

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Samuelsson: Obama in a box

Newsweek's Robert Samuelson writes on the challenges of programs for the aged, both at the federal and state level, and the difficulties politicians face in addressing them:

What looms is a huge transfer of income from younger workers to older retirees. Ideally, we would consciously decide how large the transfer should be. But in practice, the choice occurs semiautomatically. Social Security, Medicare and pension benefits are set by law. Unless the laws are changed, the payments go out, and the pressures on taxes and other government programs are inescapable.

Beyond reassuring speeches, Obama hasn't confronted the conflicts. He's been all things to all people. Rhetorically, he's for the children. But he's also for the elderly. In the campaign, he opposed proposals for reducing the future costs of Social Security and Medicare through higher eligibility ages and lower benefits. Obama is in a box of his own making; he cannot fulfill his promises to children without repudiating some promises to the elderly.

As a society, America is in the same box. The conflicts between generations may or may not incite open political warfare, but either by design or default, we will be making decisions about America's future. The old are well organized and highly protective of promised benefits, while the young are politically passionate and unfocused. For the young, the odds look lousy.

Click here for the whole article.

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New article “Obama vs. FDR”

I have a new article up at The American, AEI's online publication, discussing how President Obama's plans for Social Security fit within the character of the program as established by FDR.

When the Social Security Act was passed in 1935, the program embodied new ideas on the role of government and engendered significant opposition. Yet one point remained clear: Social Security was not "relief," what is today termed "welfare." This new program, explained President Franklin D. Roosevelt, was to be an earned right by American workers, not a handout. This aspect of the program, the Social Security Administration (SSA) says, is "one of the basic principles of the Social Security program and is largely responsible for its widespread public acceptance and support." But some in Congress and the new Obama administration wish to make fundamental changes to how Social Security works, shifting it closer to a welfare program.

The piece builds on some of my earlier article, but includes more historical material on the founding of the Social Security program. Click here to read the whole story.

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George Will : Recklessness with Social Security

Here George Will focuses on Rep. Jim Cooper, a Tennessee Democrat who has focused on long-term budget pressures:

WASHINGTON -- "Recidivism" is Rep. Jim Cooper's laconic explanation of why he, although only 54, has spent portions of five decades on Congress' payroll. Responding with aphorisms (e.g., "Bad government starts at the grass roots") to the tedium of Congress' culture of avoidance, he grows more laconic as the welfare state's implosion approaches.

The son of a Tennessee governor, Cooper, a Democrat who represents Nashville, was a congressional page starting in 1969 and then a Rhodes Scholar before being elected to Congress in 1982. Having run unsuccessfully for the Senate in 1994, he returned to the House in 2002. A mordant Cassandra ("If members of Congress were paid on commission to cut spending we'd see fabulous results"), he is no longer astonished by Congress' bipartisan avoidance of the predictable crisis coming to the big three entitlement programs -- Social Security, Medicare and Medicaid.

"Astonishing," says Cooper of the new president's avowed determination to confront the crisis. Leadership, says Cooper, who has seen precious little of it concerning entitlements, enlarges the number of "things that can be talked about." Such as the Social Security payroll tax, which Cooper would cut for several stimulative years from 12.4 percent to 8 percent. It suppresses job-creation, is raising more revenue than Social Security is dispensing and will continue to do so until 2017. The surplus is invested in Treasury bonds. That amounts to lending it to the government "which in turn," Cooper says, "spends it on everything except Social Security."

President Lyndon Johnson, to make the deficit numbers during the Vietnam War less scary, adopted the "unified budget," under which Social Security's surplus was mingled with general revenues, thereby reducing -- disguising, really -- the deficit's size. That, Cooper says, was the "original sin" in the budgeting sleight-of-hand that prevents the public from knowing, and Congress from being compelled to act on, facts about the entitlement programs' unfunded liabilities -- promises to future beneficiaries that future taxpayers may not be willing to pay.

Cooper, who has an unshakable appetite for unappetizing numbers, wishes more Americans were similarly eccentric and would read the 188-page 2008 Financial Report of the United States Government -- the only government document that calculates what deficit and debt numbers would be if the government practiced, as businesses must, accrual accounting.

Under such accounting, future outlays to which beneficiaries are entitled by existing law are acknowledged as expenditures before they are paid. Were the Social Security surplus sequestered for accounting purposes, reflecting the truth that it is already obligated, and were there similar treatment of the other entitlement programs' liabilities, the deficit for the fiscal year that ended Sept. 30 would have been $3 trillion rather than $454.8 billion. The report's numbers show that the true national debt is $56 trillion, not the widely reported $10 trillion.

The report says that in 25 years the portion of the population 65 and older will increase from 12 percent to 20 percent, while the share of the population that is working and paying taxes will decrease from 60 percent to 55 percent. If Medicare spending continues to grow, as it has for four decades, more than one and a half times as fast as the economy, the big three entitlements, which currently are 44 percent of all federal expenditures (excluding interest costs of the national debt), will be 65 percent by 2030. Under current law, 30 years from now government revenues will cover only half of anticipated expenditures.

For years, many conservatives advocated a "starve the beast" approach to limiting government. They supported any tax cut, of any size, at any time, for any purpose, assuming that, deprived of revenue, government spending would stop growing. But spending continued, and government borrowing encouraged government's growth by making big government cheap: People were given $1 worth of government but were charged less than that, the balance being shifted, through debt, to future generations. In 2003, Republicans fattened the beast with the Medicare prescription drug benefit (Cooper opposed it), which added almost $8 trillion in the present value of benefits scheduled, but unfunded, over the next 75 years.

Liberalism's signature achievement -- the welfare state's entitlement buffet -- will, unless radically reduced, starve government of resources needed for everything on liberalism's agenda for people not elderly.

Conservatives want government limited, but not this way.

Although President Obama promises entitlement reforms, what can be expected from a Congress with a long bipartisan record of reckless enrichments of the entitlement buffet? Recidivism.

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David Langer must have compromising pictures of the N.Y. Times letters editor

The New York Times today published the latest of many letters from David Langer, an actuary based in New York who's made a business of sorts as a gadfly critiquing the Social Security Trustees projections of future insolvency. I really don't know how he gets so many letters published there.

To the Editor:

Your editorial portrays the "grim reality" facing retirees: an uncertain financial market, inadequate savings and employer contributions, shift of all risks to workers (investment, longevity) and so on. And the solutions are unsatisfactorily focused on patching up existing arrangements.

Fortunately, a superb answer is available: Simply expand Social Security to provide a benefit to replace 70 percent of average pay rather than the current 41 percent.

Consider: It's already set up as a national plan, does not depend on anyone's investment acumen, avoids financial chicanery, has expenses that are ridiculously low, provides longevity and cost-of-living guarantees, and has built-in job portability.

And the increase in cost may be surprisingly small; it will be offset by many factors, including raising the taxable wage base, use of a large part of the current $2.4 trillion surplus, and folding in the assets of existing plans by a reasonable trade-off. Definitely worth thinking about.

David Langer
New York, Jan. 27, 2009

The writer is a consulting actuary.

Ok, let's do a little back of the envelope math. The best projections of the Social Security actuaries are that to make Social Security permanently solvent would require an immediate and permanent tax increase of 3.2 percentage points – that is, an 26 percent increase in the 12.4 percent payroll tax – or an equivalent cut in benefits of around 21 percent. So, while Social Security current promises a replacement rate of 41 percent of pre-retirement earnings to an individual retiring at the full retirement age, with the taxes and resources we currently have it can actually afford to pay a replacement rate of around 32.3 percent. Langer proposes that Social Security instead pay a replacement rate of 70 percent – 2.17 times the current affordable rate. This would require that we roughly double the current payroll tax rate. Now eliminating the current $106,800 payroll tax ceiling could reduce this cost increase by around 15 percent, folding in private pension assets of around $900 billion might cut it by a percent or two, etc. But the main point is that Langer is proposing an effective doubling in size of the federal government's largest program, which is already significantly underfunded, in an environment of large present and projected deficits in the rest of the budget. People need to get a grip that we face a budget constraint and start thinking of ways to tackle it.

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