Brookings: Topics - Social Security

A Bipartisan Case for Chained CPI

Martin Neil Baily and Glenn Hubbard — Thu, 09 May 2013 00:00:00 -0400

Over the last few days, politically driven critics have called on the president to abandon his support for changing the way the government indexes provisions in the budget to inflation by switching to “chained CPI.” Looking beyond politics, we’re here to say that these critics’ arguments are wrong on their merits.

As economists from opposite ends of the political spectrum, we would strongly urge the president and leaders in Congress to continue to support moving to chained CPI, which represents the most accurate available measure of inflation and cost-of-living increases. Switching to this more accurate measure of inflation represents the right technical, fiscal and retirement policy—and policymakers should not delay any further in making this improvement.

From a technical sense, the current CPI—or consumer price index—that is used to index many parts of the budget and tax code is widely understood to overstate inflation. This is because it fails to account for so-called “substitution bias,” in which consumers reallocate their purchases depending on the relative prices of similar goods. For example, if the price of apples goes up, consumers will buy more oranges. However, this behavior is not accounted for in standard CPI measurements.

The Bureau of Labor Statistics, which calculates the CPI, is very aware of this shortcoming, which is why it has developed and refined the chained CPI for more than a decade. The nonpartisan Congressional Budget Office states that the chained CPI “provides an unbiased estimate of changes in the cost of living from one month to the next.”

Some argue that using the chained CPI to index Social Security benefits is inappropriate because it does not reflect inflation for retirees, which critics suggest is higher than it is for working-age adults because of the elderly’s higher rate of spending on healthcare. However, the CBO has said that based on the available research, it is unclear whether the cost of living actually grows at a faster rate for the elderly than for younger people, and that the CPI-E —“E” for “experimental”—which was intended to provide a more accurate measure of inflation for seniors, has several methodological flaws that overstate inflation, including underestimating the rate of improvement in healthcare.

Beyond the technical case for the chained CPI, there is a strong fiscal case. Because current measures currently overstate inflation by about 0.25 percent per year, moving to a more accurate measure would result in real deficit reduction. Measuring inflation more accurately would generate savings from throughout government: about $390 billion in the first decade alone. Roughly one-third of those savings would come from slower growth in Social Security benefits, another third from revenue increases (as certain tax provisions such as the cutoff points of income tax brackets are indexed to inflation) and the remaining savings from a combination of other spending programs and lower interest payments on the debt. Given the very real need to begin to put our debt on a sustainable path, this would be a small but important contribution. The savings would be gradual, with only a small amount in the near term, thus protecting our fragile recovery from immediate austerity.

Finally, switching to chained CPI is the right retirement policy—or rather, a small piece of it. The Social Security program is on a path to exhaust its trust fund. Current projections indicate that this will occur in 2033, threatening cuts for all beneficiaries, including the very rich and the very poor, the very young and the very old, veterans, disabled workers and others. Improving the way we measure inflation won’t prevent the program’s looming insolvency, but it will eliminate a full fifth of the long-term funding gap.

To the extent that the overpayments under the current formula offset the shortcomings of our current retirement system for the lowest-income and most-elderly beneficiaries, a switch to chained CPI can and should be accompanied by targeted policy changes providing benefit enhancements designed to help the affected populations, rather than providing higher-than-justified inflation adjustments for all beneficiaries.

The federal government should not knowingly continue to measure inflation inaccurately, especially given the costs to the budget and to the Social Security program. Changes that cut Social Security benefits are a tough sell for Democrats, and changes that increase revenue are a tough sell for Republicans. But if they cannot even agree to a technical correction to those areas of the budget, how will they be able to make the hard choices to control our debt and reform our government over the long term?

Authors

Martin Neil Baily
Glenn Hubbard

Publication: The Hill

Image Source: © Fred Prouser / Reuters

Money Illusion, the Chained CPI, and the Benefits of Inflation

Isabel V. Sawhill — Wed, 17 Apr 2013 00:00:00 -0400

Economists have long recognized the fact that money illusion plays a role in how people behave. Money illusion is the tendency to evaluate the merits of a transaction based on nominal rather than real values.

In an interesting chapter by Eldar Shafir, Peter Diamond, and Amos Tversky in the path-breaking book, Choices, Values, and Frames, these authors reports on a number of experiments where, when presented with various choices, respondents behave in a way that suggests they are influenced by nominal and not just real values.

Keynes recognized that this was one reason why wages are “sticky” – that is, hard to reduce even when prices are actually falling. If prices are falling and nominal wages are reduced, workers are no worse off than before, but they will still resist any cut in their nominal wage because a loss in dollar terms is still hard to bear.

This tendency of behavior to be influenced by money illusion goes well beyond the reaction of employees to wage gains and losses. In the investment arena, a higher rate of inflation leads people to be less fearful about losing money since they tend to evaluate the losses in nominal terms. As a result, when inflation is higher, they tend to undertake more risky investments and end up earning more money by allocating a higher fraction of their portfolio to riskier assets.

Money illusion has played a role in the huge fuss being made about the proposal to change the inflation index for Social Security to the chained CPI. No one seems to realize that under the existing formula, seniors have been getting what could be characterized as an unwarranted adjustment in their benefits measured in real rather than nominal terms. The upward bias in the current inflation adjustment is well known to economists but not to the general public. The public believes that moving to a chained CPI is the equivalent of a benefit cut. A more accurate way of looking at it is as a corrective to what has been a small but automatic increase in real benefits for many years.

An economist reading the literature on money illusion and observing people’s behavior is likely to wring her hands over what seems like irrational behavior on the part of most people. The CPI brouhaha is a nice example. But clouds of irrationality do have a few silver linings.

First, in an inflationary environment, it is easier to reallocate resources from one area to another without lowering the morale of workers or the holders of capital. These reallocations are needed to spur the growth and efficiency of the market.

Second, government budgets often contain tax or benefit program formulas that are not indexed for inflation. Up until the 1980s, for example, income tax thresholds were not indexed with the result that as inflation increased people’s nominal incomes they were automatically moved into higher tax brackets and revenues flowed into the Treasury without anyone complaining very much. A more up-to-date example is setting a nominal threshold for paying an income-tested Medicare premium. If this is not adjusted for inflation, more and more people over time will be drawn into the system. The current thresholds are $85,000 of modified adjusted gross income for single tax filers and $170,000 for joint filers. While this encompasses a very small fraction of all Medicare enrollees now, it will cover far more beneficiaries a decade or two from now, thereby enhancing the solvency of the Medicare system. For better or worse, money illusion is a politician’s best friend.

Finally, there seem to be constant worries that the buildup of assets on the Fed’s balance sheet will lead to inflation. Granted unwinding their holdings could be tricky, but it’s time we stopped worrying so much about small amounts of inflation. Serious inflation is nowhere in sight and will not occur as long as the economy is operating so far below its potential. In addition, for some of the reasons cited above, a little more inflation would not be such a terrible thing.

Authors

Isabel V. Sawhill

Publication: Yahoo! Finance

Image Source: © Brendan McDermid / Reuters

Payments to Elders Are Harming Our Future

Harry J. Holzer and Isabel V. Sawhill — Fri, 08 Mar 2013 00:00:00 -0500

Foolish, indiscriminate and badly timed cuts in the federal budget have begun. The primary reason is that Republicans have refused to budge any further on taxes. Still, Democrats must share some of the blame. By failing to propose more specific cuts to entitlement spending, they have forfeited the high ground and allowed a small but critical set of programs to absorb all of the pain.

The “sequester” is just the latest chapter in the muddled thinking that has characterized the story of the federal budget for the past several years. Alarmists who call for immediate spending cuts and immediate reductions in our debt-to-GDP ratio (now at 73 percent) overstate the dangers of current levels of spending and debt, and they understate the damage to employment and economic growth that results from recently enacted belt-tightening. That tightening, including the effects of provisions enacted in both 2011 and 2013, is expected to halve the growth rate in the gross domestic product this year, according to the Congressional Budget Office.

This self-inflicted wound to the economy and to jobs makes no sense. If anything, we should be using this period, when workers are underemployed and firms’ physical plant and financial resources are underutilized, to improve productivity by investing more in infrastructure and job training.

At the same time, those who argue that we can put off any serious discussion of debt reduction for a number of years — because of the temporarily stable debt-to-GDP ratio projected for 2015 to 2022 — understate the dangers that loom just beyond this period. The aging population and the growth of health-care costs make enacting reforms to entitlements imperative. Enacting them now would help the economy by reducing uncertainty. This would also instill more confidence in government, give people time to adjust and release the pressure on the small portion of the budget that so far has absorbed virtually all of the cuts.

The reluctance of our fellow progressives to consider sensible reforms to entitlement programs is puzzling. None of us wants to impose new burdens on vulnerable seniors or those who are about to retire. But any new provisions can be phased in gradually and structured in a way that protects the oldest and most fragile members of the population in addition to those with limited incomes.

With these caveats, progressives must begin to acknowledge a hard fact: Our very expensive retirement programs already crowd out public spending on virtually all other priorities — including programs for the poor and those that strengthen the nation’s future — and will do so at even higher rates in the next decade and beyond unless we reform these large programs.

Social Security and Medicare alone cost the federal government about $1.3 trillion last year, accounting for more than 37 percent of federal spending; they are slated, along with interest on the debt, to absorb virtually all currently projected federal revenue within the next several decades. In contrast, all nondefense discretionary spending — which includes outlays on education, job training, transportation, public safety, research and many other growth-enhancing programs — amounted to only 17 percent of the budget, and they will continue shrinking each year.

Given that Americans have always resisted paying high taxes — and we see little sign of that viewpoint changing — what will happen to other priorities as our spending on retirement programs soars? Even if revenue rises, how can we possibly begin to fund the investments — in early-childhood health and education programs, K-12 reforms, effective workforce policies, improvements to crumbling infrastructure and the advancement of science — that are so badly needed to generate broadly shared economic growth? For how long will we continue to sacrifice investments in our nation’s children and youth, as well as its future productivity, to spend more and more on the aged?

Our preference is to restructure the delivery of health care so that it delivers the same benefits in less costly ways. Growth in health-care costs has slowed over the past few years, and the Affordable Care Act may bring further progress. But such changes are likely to be insufficient, requiring some restrictions on eligibility or expenditures. Asking affluent seniors to pay more for their benefits would be a good place to start.

If the issues are fairness and growth, not the size of government per se, then the right thing to do is to ask the affluent to pay more. Cutting programs aimed at providing a way up the ladder for the young and the poor, and doing so at a time when the economy is weak, is just plain dumb.

Authors

Harry J. Holzer
Isabel V. Sawhill

Publication: The Washington Post

Image Source: © Lucy Nicholson / Reuters

A Pop Quiz About Federal Spending That May Surprise You

Henry J. Aaron — Tue, 05 Mar 2013 11:12:00 -0500

Some years ago, former Senator and one-time Harvard professor, Daniel Patrick Moynihan, remarked “It isn’t what you don’t know that hurts you. It’s what you know that isn’t so.” In that spirit, readers: here is a short quiz. Please don’t worry. The quiz is short. You won’t be graded. And you may be surprised.

Question 1: The federal government is spending a larger share of national income than at any time since World War II—True or False

Question 2: The federal government is collecting a larger share of national income in taxes than at any time since World War II—True or False

Question 3: Social Security is currently running a deficit—True or False

Question 4: Health care spending is outpacing the growth of income—True or False

I suspect that large majorities of Americans would answer ‘true’ to at least one, and perhaps to all four, of these questions. Yet, the correct answer to all four is ‘False.’ That you would answer ‘yes’ to any of them shows the unfortunate success of the campaign of misinformation to which Americans have been, and are being, subjected. And this misinformation is doing the nation profound harm.

Let’s start with government spending. According to the Congressional Budget Office, the Federal Government will spend 21.7 percent of GDP next year under current policy. Were the U.S. economy operating at capacity, that share would be less than 20.6 percent, because output would be higher and spending for such items as unemployment insurance would be lower. For the preceding three decades government spending averaged 21.1 percent of national output. In brief, the numbers flatly contradict the assertion that spending is ‘out of control.’

In fact, the reverse is true. The sharp rise in health care costs over the last three decades and the increased outlays to fight two wars and maintain homeland security after the calamitous events of 9/11 mean that federal spending on the rest of government is slated to take a steadily declining share of national output.

Well, what about taxes? The story is almost the same. Federal government revenues are projected to be 16 percent of national output, compared with an average over the last three decades of 17.7 percent. Spending and revenues are both lower than the average of the last three decades, not higher.

Which brings me to spending on Social Security and health care—the two largest elements of the alleged, but nonexistent, ‘entitlement crisis.’ Social Security is projected to have reserves at the end of 2013 $41 billion higher than it had at the start of the year. At the end of 2014, its reserves are projected to rise by another $42 billion. In 2020, reserves are projected to be $285 billion higher than at the end of 2013. What this means is that Social Security is currently running not deficits but surpluses. It means that talk of a pension crisis is poppycock. To be sure, the rising flood of retiring baby-boomers means that deficits will eventually emerge. Raising revenues or lowering benefits to prevent them from happening is vitally important. These changes are better addressed sooner than later, but cries of ‘crisis’ are baseless.

The facts with respect to health care spending are also inconsistent with widely held perceptions. Health care spending has outpaced income growth for decades. That is why the share of gross domestic product devoted to health care has tripled in the last half century. But that spending juggernaut abruptly stopped in 2009. Health care spending is projected to claim a slightly smaller share of national output in 2013 than it did four years earlier.

Over the rest of this decade, the Medicare roles will swell, and total outlays will rise. But spending per enrollee is projected to rise a bit less rapidly than U.S. per capita income. The reason is the Affordable Care Act, health reform. Contrary to the assertions of those who sought its defeat and oppose its implementation, health reform—the Affordable Care Act—will directly slow the growth of health care spending, and it contains numerous pilots, experiments, and incentives that promise to slow the growth of spending still more. Caution is in order. Not all of these measures will work. Some may not be indefinitely sustainable. Spending slow-downs have occurred and proven temporary—and it could happen again. But right now, if you said that health care spending, in general, or Medicare spending per person is rising faster than national income, you would be in error.

The misinformation that stands behind the incorrect answers to these questions is doing the nation vast harm. Because of a false belief that spending is out of control Congress stands willing to let the sequester take effect, putting needless drag and the still-weak economic recovery. Because of a false belief that Americans are shouldering unusually high taxes, Congress is unwilling to close loopholes that would raise revenue without raising marginal tax rates. Because of a failure to recognize that Social Security is actually running cash flow surpluses and will do so for years, elected officials insist on enacting benefit cuts now as a precondition for dealing with nation’s immediate crisis, a weak economy and long-term unemployment. Because people assume that health care spending continues to grow unacceptably fast, they insist on the inevitability of a long-term fiscal crisis that may never occur and will in no case occur soon.

Meanwhile, the national economic blood-letting continues with an annual loss of nearly $1 trillion a year in output that would generate added revenues and put the long-term unemployed back to work. The mistaken beliefs about overall spending, taxes, Social Security, and health care spending that are simply not so are harming and will continue to harm the country most grievously.

Authors

Henry J. Aaron

Publication: Real Clear Markets

Where Is the Urgency on the Debt Ceiling?

Henry J. Aaron — Wed, 09 Jan 2013 13:05:00 -0500

The degree to which words can distort our view of reality is remarkable and ominous. For some time, debate on public policy has been debased and misdirected by terms that bear little relation to reality. Exhibit 1 in this indictment is the term "entitlement crisis"; exhibit 2 is "fiscal cliff."

"Entitlement crisis" conjures up an "oh God, we have to do something" mentality that is appropriate to emergencies. In fact, the challenges of paying for Social Security and Medicare unfold slowly. In the case of health care, we are well on our way to solving them. The term, fiscal cliff, focused public attention on a non-event, the various legislative provisions expiring on January 1, 2013. But it obscured what threatens to become an economic and constitutional crisis of historical proportions, the potentially catastrophic deadlock over the debt ceiling.

Misplaced Urgency?

The simple fact is that there is no "entitlement crisis." "How can you say that?" you ask. Everyone talks about it. Are they deluded?” The answer is “yes, if one is focusing on Social Security and Medicare, they are deluded.”

Here are the facts. Social Security is expected to run a surplus, not a deficit, in 2013 of $41 billion. As the baby-boomers retire, spending will grow faster than revenues, but 2021 will be the first year in which total outlays are projected to exceed total income. In 2012, Social Security will have reserves estimated to be over $3 trillion. To be sure, deficits will increase thereafter, and eventually those reserves will be exhausted. So, revenues must be increased, benefits cut, or both. A problem? Yes, definitely. But hardly a crisis.

The situation with Medicare is more complicated, but not critical. The Medicare Hospital Insurance trust fund is going to run a deficit of about $18 billion in 2013— less than 2 percent of the overall federal deficit. No crisis there. But, you may say, spending on the retiring baby-boomers will cause Medicare’s spending to explode...right? Well, not at first. This Medicare deficit is expected to shrink for several years and to return to today’s level only in 2021. The reason costs are well contained may surprise you. The reason is that the Affordable Care Act (aka Obama Care) significantly slowed the increase in Medicare spending. In fact, growth of per person spending under Medicare has been a bit slower, and is projected to be considerably slower, than growth of per person spending in the rest of the health care system.

Indisputably, the United States spends more on health care than does any other nation. Our system is replete with inefficiency and waste—and that is a problem. But it is a systemic problem, not one confined to Medicare. Health reform is intended, among other things, to begin to deal with that problem by changing the way we organize and pay for health care. A health system problem? Yes. A health "entitlement crisis"? No.

What the Fiscal Cliff Was Hiding

As the New Year approached, no sentient being could escape febrile maundering from talking heads, newspaper pundits, and internet bloggers warning of the "fiscal cliff"—the collection of legislative events timed to occur on January 1st. There was a sizeable kernel of truth in these concerns. If all were allowed to take effect and continue for a few months, there is little doubt that they could have seriously damaged the economic recovery.

But with one major exception—the abrupt end on December 31, 2012 of extended unemployment benefits for about 2 million long-term unemployed—none of these events would have done great immediate damage. Rather their effects would have cumulated with time. In short, there was a need for action but there was nothing particularly special about January 1st.

Despite this fact, many acted as if the fate of the republic would be jeopardized if New Years day passed without a decision on what to do about the various expiring tax rules and the impending cut in payments to physicians under Medicare.

In the madcap rush to get legislation enacted and signed, two very bad things happened. But virtually no one noticed. The first bad thing that happened was that the president and Congressional Democrats and Republicans settled on a bill that exacerbated the very long-term deficit problem that both agreed poses a serious long-term economic threat to the nation.

When Congress passed The American Taxpayer Relief Act and the president signed it, they increased the budget deficit over the next decade by $4 trillion. If they had done nothing, if they had continued to be just as deadlocked and ineffective as they had been for most of 2012, the deficit would eventually have begun to grow less rapidly than national income. The long-term budget deficit problem would have been largely solved.

Such a course was not acceptable, of course, because the tax increases and spending cuts set to take effect in on January 1, 2013 would have turned economic recovery into renewed recession. But if the recovery needed support, then the proper course would have been to continue, or even increase, economic stimulus in 2013 while boosting tax rates and cutting spending growth once economic recovery was underway.

Instead, Congress took no action to spur economic recovery in the near term. And it increased the long-term budget deficits that virtually everyone properly fears will generate an unsustainable increase in the national debt.

About That Debt Ceiling

Not only did the American Taxpayer Relief Act create the very problem its authors said they wanted to solve, but it diverted attention from a looming crisis of vastly greater proportions. The U.S. government has reached the legislated limit on borrowing, the national debt ceiling. The mere existence of such a ceiling is a mathematical absurdity. Having voted for expenditures and tax laws, the Congress cannot logically also put a limit on the difference between those two sums.

Most past debates on the debt ceiling have been little more than an opportunity for bloviation—pious statements about the virtues of frugality but little more. In 2011, however, Congressional Republicans announced a new principle, christened the Boehner rule. According to the Boehner rule, the debt ceiling should be increased only if projected spending over the next decade is cut by the same amount. Advocates of the Boehner rule are now also saying that taxes are off the table because not all of the Bush tax cuts made permanent.

To see what the Boehner rule means, consider the following facts. Based on projections done last August by the Congressional Budget Office, the national debt will increase over the next decade by about $12 trillion under current law. To cut spending over the next decade by $12 trillion, it would be necessary to cut annual spending by an average of $1.2 trillion a year. Since total non-interest spending over that period will average $4 trillion a year under current law, about 30 percent of projected spending would have to be eliminated. Because big cuts are impossible next year or the year after, the required cuts toward the end of the decade would have to approach 50 percent to satisfy the Boehner rule. As it happens, no one in either party—and, most tellingly, none of those insisting on the dollar-of-cuts-for-a-dollar-of-increase-in-the-debt-ceiling trade-off—has indicated where spending cuts of even one half this amount should come from. Even so, they have declared that they will oppose any increase in the debt ceiling unless these terms are met. And they have the votes to make their commitment hold.

People within the Administration have referred to these demands as economic terrorism, which in my view is entirely fair and accurate. They have said flatly: "We don’t negotiate with terrorists.”

It's About to Get Ugly

The official debt ceiling has been reached. Now, the Treasury Department is using so-called "extraordinary financial means" to pay bills. The moment of reckoning will come when the limit of such extraordinary means is reached, probably late in February. What happens then is anyone’s guess. The only benign outcome would be for those who have propounded the Boehner rule to abandon it as unreasonable and face up to the fact that if they want spending cuts, they will have to name them and win enough votes to make them the law of the land.

Otherwise, the results will not be pretty. The president may cave and agree to cuts that would eviscerate public services. A deadlock may continue causing the nation to default on its debt or fail to pay at least some of its bills, including Social Security benefits, salaries of federal employees, bills from doctors and hospitals under Medicare, and veterans benefits. The president might invoke a controversial provision of the 14th amendment that some Constitutional scholars think authorizes him to borrow as needed in order to maintain "the validity of the public debt." Alternatively, he might rely on a financial gimmick to ignore the borrowing limit. Whether he invokes the 14th amendment or uses a financial gimmick, the possibility of impeachment or other political crisis would ensue.

In brief, "fiscal cliff" was a metaphor so vivid that it made people believe an event was momentous when it really wasn’t. Now the nation faces a genuinely critical event. It is not arousing appropriate concern and outrage, however, because no one has found a metaphor to make a real crisis seem real.

Authors

Henry J. Aaron

Publication: Yahoo! Finance

Image Source: © Kevin Lamarque / Reuters

Make Changes to Social Security Now to Prevent Future Debt

Alice M. Rivlin — Thu, 03 Jan 2013 10:33:00 -0500

We should act now to ensure that Social Security is solidly financed for future beneficiaries. The sooner we act, the smaller the changes in benefits and revenue need to be. Reducing future debt is just an extra benefit of preserving Social Security.

Social Security is a hugely successful program that has kept millions of older or disabled Americans from penury and dependency. But its solvency is threatened. As longevity increases and all those boomers retire, there won’t be enough workers paying into the system to support projected benefits.

We have to increase revenue and reduce scheduled benefit growth to keep the system solvent. If we act quickly, the changes can be phased in gradually and need not affect those already retired or close to retirement.

A balanced package should include increasing revenue by raising the maximum earnings subject to payroll tax, as well as progressive reductions in the growth of future benefits. High earners should get less and low earners a bit more.

Any increase in future retirement ages should account for the greater difficulty of continuing to work in physically demanding occupations. More accurate calculation of the cost of living (the chained C.P.I.) would slow the increase in benefits slightly. Adverse effects on low-income or very aged retirees could be offset by increasing the minimum benefit and adding an increase at, say, age 85. The improved index would make a more general contribution to debt if it applied to tax brackets and other spending programs.

Social Security currently adds to debt, because it pays out more benefits than it receives in taxes. While it accumulated credits when the higher ratio of workers to retirees was bringing in excess funds, Treasury has to borrow to redeem these credits.

As more boomers retire, Social Security will add increasingly to debt. By about 2033, the credits will be exhausted and benefits will have to be cut sharply. Because workers retiring in 2033 are already working and should plan for their retirement, we owe it to them to phase the necessary changes in gradually and avoid the sharp drop.

Preserving Social Security and restraining future debt are both important to American well-being and reinforce each other. There are powerful arguments for doing both — either separately or together.

Authors

Alice M. Rivlin

Publication: The New York Times

Image Source: © Fred Prouser / Reuters

Progressives and the Safety Net

Henry J. Aaron — Mon, 10 Dec 2012 15:59:00 -0500

Something wonderful happened in the United States during the middle third of the twentieth century. After decades of policies that smacked of Social Darwinism, our country created a strong, if incomplete, social-insurance safety net. The actions our government took expressed a solemn promise to vulnerable Americans. Social Security and Medicare assured the elderly and disabled basic cash income and health care roughly similar to that enjoyed by the rest of the population. They lifted the elderly and disabled from a status of privation to near equality with the nonelderly in both money income and access to health care. Various other federal programs provided food, housing, and educational support, or encouraged their provision by state and local governments. By official measures, poverty among the elderly fell below that of other age groups thanks to Social Security, and health coverage improved markedly for the nonelderly poor because of Medicaid.

Now, in the second decade of the twenty-first century, these advances are under attack and that solemn promise is in jeopardy. To be sure, these programs enjoy enormous popularity. At the same time, however, a solid minority has never accepted the idea that taxes should be used to pay for pensions and health insurance. As long as economic growth generated enough revenue to pay for these programs and the rest of government’s commitments, opponents of social insurance and other elements of the safety net gained little political traction. Three deficit reduction plans enacted during the presidencies of George H.W. Bush and Bill Clinton, along with sustained economic growth, produced budget surpluses in the late 1990s and early 2000s.

But then everything changed, and the national debt ballooned. The recessions of 2001 and 2007-2009 led to higher unemployment and lower revenues. Imprudent tax cuts slashed revenues still more. Wars in Iraq and Afghanistan following the tragedy of 9/11 led to huge increases in military spending. As a result, large and seemingly limitless deficits emerged, and budgetary angst has become epidemic.

In addition, official projections have warned that retiring baby boomers and rapidly rising health-care costs will cause Social Security and Medicare benefits to greatly outpace program revenues. Although these long-term forces have little to do with current budget deficits, they have combined to generate a sense of fiscal crisis. On top of this comes the “fiscal cliff,” the concatenation of dubious fiscal decisions timed to take effect almost simultaneously. The tax cuts enacted during President George W. Bush’s first term and the payroll-tax holiday enacted in early 2011 are set to expire on December 31, 2012. The government debt will soon breach the ceiling set in August 2011. Mindless spending cuts passed in 2011, based on formulas that pay no heed to the relative importance of programs and that have nothing to recommend them other than simplicity, are also to begin on New Year’s Day 2013.

Analysts agree that if all of the tax increases and expenditure cuts take effect, economic activity will slow, and a weak recovery will morph into recession. Failure to raise the debt ceiling would wreak tsunami-like devastation on financial markets that would inundate the rest of the U.S. and world economy.

Against this backdrop, the American public is being told that the cause of looming financial catastrophe is an “entitlement crisis.” Fiscal Jeremiahs warn that the only way to deal effectively with current deficits is to cut back Social Security, Medicare, and Medicaid years in the future. The full House of Representatives has twice passed budget plans, crafted by Budget Committee Chairman Paul Ryan, that would replace Medicare with a voucher that beneficiaries could use to buy either private insurance or a plan like traditional Medicare. The Ryan plan would also convert Medicaid into a block grant at spending levels well below what is projected under current law. The grants would not increase during recessions when Medicaid enrollments tend to spike. States, pinched by falling revenues and rising service demands, would have to cut benefits just when they are most needed.

But while reports of a crisis are overblown, and conservative proposals to solve it are draconian, progressives do need to think about how best to reform the entitlement programs. The simple fact is that Social Security, Medicare, and Medicaid form a very large and growing part of the federal budget—currently 50 percent of noninterest spending. Furthermore, the phrase “entitlement crisis” has been repeated so often and so earnestly that denying its reality is more likely to damage one’s own credibility than to dislodge what is actually profound confusion. Cuts in Social Security, Medicare, and Medicaid benefits are neither necessary nor desirable and should be resisted, even as reform of the whole health-care delivery system proceeds. But political and economic realities—the need to secure majority support for measures to lower deficits once economic recovery is well advanced—make some cuts highly likely. It behooves supporters of social insurance to have in reserve program cuts that would do the least harm and might advance other meritorious objectives. To begin this search, one should start with the underlying economic and demographic forces that are driving spending.

Read the full article at democracyjournal.org »

Authors

Henry J. Aaron

Publication: Democracy: A Journal of Ideas

Image Source: © JASON REDMOND / Reuters

A Bipartisan Proposal: Go Medium to Avoid Fiscal Cliff

Ron Haskins and Michael E. O'Hanlon — Wed, 05 Dec 2012 17:37:00 -0500

After a year of drama and high expectations, it appears increasingly likely that the current session of Congress will not solve the nation’s fiscal woes. Perhaps it was always too much to expect a lame duck to ride to the rescue. Especially after a close election and with a still-divided government, there is no clear consensus on who won a mandate to do what.

But we should be able to agree that the American people did vote for something to be done about the nation’s crippling deficit, without impeding economic recovery in the process. They also surely expressed a collective view that a balanced approach is essential. This assessment should lead President Obama and members of Congress to one central conclusion: if it proves impossible to “go big” and truly solve the nation’s long-term fiscal dilemma in the short time remaining before the New Year, they could go medium for now.

Our proposal would ask Republicans to accept slightly higher taxes than they prefer, but through reductions in deductions and exemptions as they advocate, rather than a raising of rates. It would ask Democrats to accept significant cuts to entitlements – but cuts that nonetheless phase in gradually and protect the basic integrity of all existing programs. It would also generally protect discretionary accounts including defense and domestic investments, which have already been hit by last year's deficit reduction legislation.

Some of the problems with the existing positions of key leaders are becoming apparent. President Obama wants to restore tax rates of the Clinton years on the rich and fully half of his deficit reduction dollars come from new revenues (it is not persuasive to count as savings costs from future military expenses that were never going to happen anyway). The Republicans consider this a non-starter. Republican congressional leaders talk of raising revenues through closing of tax loopholes, but to date they are unwilling to be specific. No one puts social security on the table except through bromides such as an expressed desire to “strengthen it” for the long term. And the much-heralded Simpson-Bowles plan, while a brilliant piece of work in many ways, makes too many cuts in areas like national defense.

Perhaps we can still hope for a Christmas-season miracle, but failing that, it is time to start readying a backup plan to avert the huge disruption to our economy that would result from a plunge off the fiscal cliff. Further deficit reduction of some $2 trillion to $2.5 trillion would result from the following ten-year deficit reduction plan, to complement the $1.2 trillion in savings (mostly in defense as well as domestic discretionary accounts) already achieved under the first tranche of the 2011 Budget Control Act:

Seek roughly $1 trillion in revenue increases, less than President Obama’s preferred $1.6 trillion but still a substantial amount. This is measured against a baseline that assumes continuation of the Bush tax cuts. To ensure maximum support from Republicans, these additional revenues should be achieved Simpson-Bowles style by capping deductions and exemptions rather than raising rates.
Put social security on the table but in a careful and gradual way. In principle, Social Security is not the main cause of our deficit woes. But that is only because social security taxes are, relatively speaking, so high. The hefty taxes used to support social security in effect deprive the rest of the government of funds for other purposes. Therefore, changes to the system that make it less expensive to the Treasury are warranted. At a minimum, changes like adjusting the formula for cost-of-living increases in social security payments by roughly 0.5 percent a year can save more than $50 billion annually by 2020 without affecting anyone precipitously or dramatically. Most experts agreed that the current COLA overstates inflation.
Avoid further substantial net cuts in domestic discretionary accounts for now. While reallocation is appropriate, these crucial parts of the budget fund our investments in infrastructure, science and education while also providing safety in our airports, our food supply, and our borders among other things. Under existing stipulations of the Budget Control Act – that is, the cuts made last summer – their cost is already headed towards a smaller share of GDP than at anytime under Ronald Reagan or Bill Clinton. A modest $150 billion in additional ten-year savings is ample.
Limit further defense cuts to $150 billion over ten years as well. Given last year’s budget agreement, this is ambitious enough. Today, U.S. troops remain in Afghanistan; Iran continues moving towards nuclear bomb capability; other parts of the Middle East remain in turmoil, and North Korea prepares missile launches while China squares off with other Asian powers over disputed islands and waterways. This is no time to cut the military deeply again based on hand-sweeping arguments about how the Department of Defense’s real budget is still bigger than during the Cold War. While that may be true, it is also true that as a fraction of GDP, it is headed towards 3 percent, historically a modest figure.Z
Medicare reforms should be adopted that would produce $300 billion in savings over ten years. Three possible reforms, to be suggested in any deal but left to Congressional committees to detail in 2013, would be to gradually raise Medicare eligibility to age 67, to increase co-payments for high income recipients, and to reduce payment rates in areas of the nation that have high Medicare costs. For the long-term, congress should provide funds to the Centers on Medicare and Medicaid Services to conduct demonstrations on premium support in up to five states. The version of premium support envisioned by the Ryan-Wyden and Domenici-Rivlin proposals hold great promise for using market forces to control the growth of health care costs, but we won’t know if premium support will actually work unless we try it.
Entitlement programs other than Medicare, Social Security, and Medicaid will cost $630 billion this year. We think it reasonable to achieve $300 billion in savings over ten years in these programs by adopting different COLA adjustments in civilian and military retirement programs, among other reforms.

This modest approach may not turn the Fiscal Grinch into a completely nice guy, but it will at least stop him from throwing the economy off the edge of Mount Krumpet this holiday season. And that may be good enough for now.

Authors

Publication: CNN

Image Source: © Larry Downing / Reuters

After the 2012 Election, Is a Return to Sanity Possible?

Henry J. Aaron — Tue, 02 Oct 2012 00:00:00 -0400

Well, political junkies, only five weeks of the 2012 presidential campaign remain. But, don't despair. You have four years and five weeks until the end of the 2016 presidential campaign, which will almost surely start the day after the 2012 campaign ends. If, as now seems likely, President Obama wins four more years and Republicans retain control of the House, you will be exposed to four more years of Republican efforts to make a Democratic president fail, just like the last two. And, misguided fans of divided government, you will have your way—the election will not have changed a thing.

But, wait! Maybe, just maybe, enough representatives and senators will conclude that elections do, as the pundits say, have consequences. Republican leaders just might recognize that the Affordable Care Act is, and will remain, the law of the land, that closing the deficit while retaining government services Americans demand must include tax increases, and that trying to privatize Social Security and Medicare is a losing strategy. Democrats might recognize that deficits in Social Security and Medicare sap public confidence in those programs and keep them fair game for political attacks, and that if even one of those attacks succeeds, the proudest achievements of the Democratic party would be damaged or lost. Democrats might accept program cuts they don't really like but that will lower the political heat surrounding both programs. It is just conceivable that the ‘compromise virus' might infect leaders of both parties and permit needed legislation to reach the president's desk for signature.

Impossible, you may say. But let's dream. And let's dream about legislation that in a saner political world than ours seems to be should appeal to both parties. Here are some changes to Medicare, Social Security, and the Affordable Care Act that members of both parties could vote for if they were willing to focus on principles they claim to care about.

First, beef up Medicare administration. Supporters brag how little Medicare spends on administration. But spending so little is, in this case, false economy. Hiring fewer government employees can actually cost money. For each additional dollar we spend on Medicare auditors and investigators, studies show that we will save several dollars from reduced fraud. Spending a bit more on administration will also save money. When Medicare approves a new procedure for particular types of cases, a larger number of administrators could make sure that Medicare does not pay for use of those procedures in cases for which use was not approved because safety and efficacy were unproven. Medicare enrollees could still have those services—if they are willing to pay for the services themselves.

Second, add to Medicare a key protection of the Affordable Care Act—insurance against catastrophic illnesses. Pay for this added benefit with somewhat higher premiums on upper income beneficiaries. If protection against catastrophic drug costs is a good idea, then why not for the rest of Medicare? President George W. Bush supported protections against catastrophic expenses as part of his Medicare drug benefit. Members of both parties should endorse this change because it would spare many people the added cost and complexity of buying supplemental coverage.

Third, beef up the Affordable Care Act's penalty on Cadillac health insurance plans. Ronald Reagan was the first president to call for limits on tax breaks for very expensive employer-sponsored health insurance. Although this reform has Republican paternity, no Republican supported those Democrats who won inclusion of these penalties in the Affordable Care Act. Both parties should agree to strengthen them.

Fourth, the projected long-term deficit dogging Social Security lends credence to the bogus claim that the program is unsustainable. Small tax increases or benefit cuts would assure solvency indefinitely. That said, the case for benefit cuts is weak. Social Security benefits are actually lower in relation to earnings than they have been for decades. They are downright parsimonious compared with those of most other developed countries—40 percent lower for average earners than the mean of the sixteen other richest members of the Organization for Economic Cooperation and Development. Furthermore, benefits are tied to earnings and U.S. earnings have either fallen or barely increased for decades, other than for very high earners. High earners have also been the principal beneficiaries of increased longevity. Life-expectancy among those with little education and, accordingly, with low earnings has actually fallen for the last two decades.

These trends suggest that the bulk of the work in closing Social Security's projected deficit should be carried by taxing more earnings and at a slightly higher rate, rather than by cutting benefits. But any benefit cuts should spare those with low or moderate earnings and focus on those with comparatively high earnings. Given their longer life-expectancies and the general downward age-adjusted trend in the incidence of impairments, benefits should be restructured to encourage those with comparatively high earnings to retire later than they now do.

Finally, if President Obama wins reelection, the Affordable Care Act will not be repealed. It will be implemented. It is inevitable that problems will emerge in the implementation of a law as complicated and far reaching as this one. In a politically sane world members of Congress would work out compromises on these and other issues. Members of both parties would give a little, to get a little, thereby advancing principles each party espouses.

Is it fantasy to hope that in the post-election United States of 2013 enough members of both parties will put solving problems for the American people ahead of positioning themselves for the elections of 2016?

Authors

Henry J. Aaron

Publication: Real Clear Markets

Image Source: © Brian Snyder / Reuters

Are Voters Ready to Make the Tough Fiscal Choices?

Isabel V. Sawhill — Tue, 18 Sep 2012 00:00:00 -0400

Conventional wisdom holds that the public is in denial about the need to raise taxes and reduce government benefits in order to restore fiscal sanity. Polls support the conventional wisdom. They show that the public is overwhelmingly in favor of protecting Social Security and Medicare benefits while also avoiding higher taxes. The problem is that no one is educating the public about our fiscal future and the steps that are needed to put us on a more sustainable path. If candidates for public office had the courage to educate the public, they might find voters more willing to accept the tough choices.

On September 15, I spent the day in Ohio at a town hall meeting with a reasonably representative group of registered voters sponsored by former Comptroller General David Walker’s Comeback America Initiative. The experience was eye-opening. These voters were appalled by the lack of action in Washington, eager to understand the fiscal facts and the choices, and willing to support the painful measures that will eventually be needed. After a short presentation by David Walker and myself on the facts and the kinds of policy options being widely discussed, they voted electronically on deficit-reducing measures such as putting Medicare and Medicaid on a predictable budget, raising the retirement age for Social Security, more income-relating of premiums for these health and retirements programs, raising revenues by broadening the tax base and bumping up the wage cap on the Social Security payroll tax, and cutting defense spending.

To be sure, it’s easier to support such measures in a paper (or electronic) exercise than when you actually go to the polls. Moreover, the details of each option and how it is presented matter. Although we were reasonably specific about the kinds of reforms we asked them to vote on, there wasn’t time to cover every issue. Still, there’s no question in my mind that educating these voters on the problem and the rationale for various solutions makes a huge difference.

Here are some of the results. Eighty-seven percent thought that the right way to address the debt was through a combination of spending cuts and tax increases. (This compared to 13 percent who wanted to only cut spending and 1 percent who wanted only to raise taxes.) Seventy-nine percent favored eliminating an open-ended entitlement to health care and instead putting Medicare and Medicaid on a fixed and predictable budget that would grow more slowly than in the past. Seventy-six percent favored gradually raising the retirement age for Social Security along with raising the taxable wage base and reducing the growth of benefits for the more affluent. Reforms to the way the Pentagon does business were also widely supported.

There’s a lot of talk about the need for leadership these days but little understanding about what leadership entails. Above all, it means educating the public. If candidates for national office were to tell the voters what we told them in Ohio, conventional wisdom says they would lose. But maybe, just maybe, the public is ready to hear the truth.

Authors

Isabel V. Sawhill

Publication: Real Clear Markets

Image Source: © Rebecca Cook / Reuters

The Long Term Is Now: Medicare, Medicaid, and the Financing of Long-Term Care

William A. Galston — Tue, 11 Sep 2012 12:00:00 -0400

About a decade ago, my mother’s slow mental decline became too obvious for our family to deny. She continued to live at home with my father under increasingly difficult circumstances until she fell and broke her hip. In the hospital, it became clear that her mental impairment precluded physical rehabilitation and that institutional care was unavoidable.

This is a standard baby boomer’s saga, and what came next was not unusual either. I soon learned that long-term care for institutional residents was a big-ticket item. My parents lived in Connecticut, a high-cost state. The place we chose—a “continuum of care” facility with independent living at the top and a nursing home at the bottom—cost more than $100,000 per year for a semi-private room. (The national average at the time was about $70,000, and it has since risen to $78,000, according to a Metropolitan Life survey.)

Although I had spent much of my life studying public policy, I had no idea how long-term care was financed. I soon learned that Medicare paid for at most 100 days of rehabilitation (useless in my mother’s case) and that Medicaid required beneficiaries to “spend down” nearly all their assets. Private long-term care insurance policies were available, I learned, but my parents—along with most Americans who can afford them—had not purchased one. Fortunately they had lived below their means for decades and had accumulated substantial assets, which proved sufficient to see my mother through nearly five years of full-time care.

I didn’t need to study wealth distribution tables to see that only a tiny fraction of American families could afford to do what my parents had done. The median family could self-finance only a few months of institutional care, after which they would be completely dependent on public resources. But Medicaid is devouring ever-increasing shares of hard-pressed state budgets, and huge federal budget deficits are putting pressure on the decades-old fiscal partnership between the states and the national government, and the pressure will only intensify in the decades ahead.

In this presidential election year, the impact of demographic change—especially the growing weight of immigrants and minorities—commands our attention. But another demographic change—the relentless aging of the U.S. population—will be far more consequential for national policy. Long-term care expenditures accounted for nearly one-third of Medicaid’s total outlays of $389 billion in 2010. As the population ages, the tension within Medicaid between caring for the elderly and the health needs of poor and near-poor families will escalate.

The problem is already acute. According to a recent report from the National Governors Association, Medicaid already constitutes the single largest share of state budgets—24 percent, a figure that rises relentlessly year by year. State spending on the program rose by 20 percent in the most recent reporting year and by even more—23 percent—in the previous year. The report estimated that by the end of fiscal year 2013, total Medicaid enrollment for low-income Americans and the dependent elderly will have risen by 12.5 percent in just three years. Because state revenues are growing much more slowly than Medicaid outlays, other priorities are getting squeezed. In many states, for example, public higher education—key not only to future prosperity and competitiveness but also to opportunity and mobility—is reaching a breaking point.

In short, there’s a looming crisis in long-term care because our current model for funding it is crumbling under the weight of multiple demands and inexorable demographic shifts. But we’re doing almost nothing to respond. It’s time to shift to a new long-term care model that combines personal responsibility and social insurance, the government and the market, in ways that would benefit not only current and future beneficiaries but the rest of society as a whole.

Read the full piece at Democracy Journal »

Authors

William A. Galston

Publication: Democracy Journal

Image Source: © Enrique de la Osa / Reuters

Growth in Health Consumption and Its Implications for the Financing of the OASDI Program: An International Perspective

Barry P. Bosworth and Gary Burtless — Fri, 03 Aug 2012 00:00:00 -0400

Editor's Note: The following is a paper presented at the Annual Joint Conference of the Retirement Research Consortium.

Summary

1. Introduction
For more than a quarter century, the Social Security program has faced worsening long-run financial prospects. The estimated actuarial balance has declined from a small surplus in the immediate aftermath of the 1983 reforms to a deficit that is now estimated to be 2.7 percent of taxable payroll (about one percent of GDP). Much of this deterioration can be traced to the increased benefit cost of an aging population and the inclusion of additional years in the projection period in which expected outlays will far outstrip predicted revenue. The program has also been adversely affected on the revenue side by a steady deterioration in taxable wages as a share of both GDP and labor compensation. Since the last major reforms in 1983, the share of taxable wages in GDP has fallen by 6 percentage points, from 42 to 36 percent. This paper focuses on the role of increasing health care costs as a deduction from labor compensation in computing taxable wages. The United States spends a far larger share of its resources on health care– 18 percent of GDP in 2010–compared with other rich countries, yet health outcomes are equivalent to or worse than those of others. The goal of the study is to see whether there are lessons from other rich countries’ experiences that would guide the Social Security trustees in projecting trends in health care spending and predicting a future year in which the excess of spending above that of the nation’s income will end.

1. Estimating Excess U.S. Health Spending

Figure 1 shows trends in aggregate health spending measured as a share of national output. In 1970 the United States allocated 7.1 percent of its GDP to health care, 2.1 percentage points more than the weighted average health spending of the other 19 countries. Since 1970 the share of U.S. GDP devoted to health spending has increased about 0.26 percentage points a year. In the other OECD countries, health spending as a share of GDP has increased about 0.12 percentage points per year. By 2010 we estimate that the spending gap had risen to 7.2 percentage points of GDP. If the United States had allocated the same proportion of GDP to health spending as the other 19 countries, American health expenditures would have been lower by about $1.05 trillion, or 41 percent.

One partial explanation for higher spending in the United States is higher income. Depending on the measure of purchasing power parity used, in 2009 the United States had an average income level that was between one-quarter and 40 percent higher than that of the median country in the comparison group. If the share of income devoted to health consumption increases with average income, we would expect the United States to spend a higher proportion of its income on health compared with other OECD member countries. Indeed, 2009 there was a positive correlation between countries’ average incomes and the share of their GDP devoted to health care. Most of the correlation, however, is due to the United States. The correlation between average income and the percentage of GDP devoted to health care is small in the other 20 countries in the sample.

Figure 2 shows estimates of the relationship between health care spending per capita and GDP per capita in a small sample of countries. The chart presents OLS estimates of the health spending – income relationship in 1990. It shows health spending and GDP per capita for 10 of the 21 countries in our sample – Australia, Austria, Canada, Finland, France, Japan, Norway, Spain, the United Kingdom, and the United States. Incomes and health spending for each country are converted into constant U.S. dollars using purchasing power parity estimates for 2000 published by the World Bank. The sample of countries is determined by the availability of PPP estimates of GDP per capita, published by the World Bank, and estimates of the share of GDP devoted to health, which is published by the OECD. For each year, we estimated a simple cross-national equation: Ln(H) = α + β Ln(Y).

The equation was first estimated with all 10 countries in the sample, including the United States. It was then re-estimated without the United States. The exclusion of the United States from the estimation sample in the 1960s has little effect on the regression line. Before 1965 U.S. spending on health care is close to the level that would be predicted based on the cross-national relationship between spending and GDP per capita observed in the other nine countries. By 1975, however, U.S. health spending was considerably higher than predicted given its income and the relationship between health spending and income in the other nine countries. The gap was even wider by 1990 (see chart), when U.S. health spending measured in 2000 dollars was $3,500 per person. This amount is about $1,200 (54 percent) more than would be predicted by a regression that includes the United States, and it is almost $1,500 (74 percent) greater than predicted by a regression that excludes the United States. The absolute size of the prediction error is even larger in 2009, but the proportional gap between U.S. spending and the amount of spending predicted on the basis of the other countries’ experiences is not much greater than it was in 1990.

Another way to use the results is to derive an estimate of the U.S. health spending gap compared with spending levels in the other nine countries of the panel. In the full paper we develop estimates of the gap using this method as well as alternative methods that expand the number of OECD countries in the comparison group. A notable conclusion of the analysis is that the period of excess growth in U.S. health spending was mainly concentrated in a 15-year period starting in 1980. The same basic method can be used to identify countries that have seen slower growth in health outlays relative to the growth that would be predicted based on the experience of other rich countries and their own record of income growth. Among the countries we identify as having slower growth than expected are Canada, Finland, Denmark, Sweden, and Ireland.

2. Why Is U.S. Health Care Spending So High?
The issue of why the level of health care spending in the United States is so different has been the subject of considerable research, but without a clear resolution. In the early 2000s, the OECD health care data were used as a framework to argue that that the differences between the United States and other OECD countries were largely a reflection of higher prices in the United States (Anderson and others, 2003) since researchers could find little evidence that Americans consumed a larger volume of health services. However, Cutler (2003) and others have argued that such studies fail to reflect the intensity of patients’ interactions with the health care system and that the United States differs from other countries in the use of more intensive technologies for some diseases. The most significant barrier to cross-national comparisons is the lack of meaningful measures of the prices of health services. Reliable price measures would help us to answer the basic question of whether the greater amount of spending in the United States is largely a reflection of higher prices or the provision of more health services.

Some progress has been made and we report the results from three studies that focused on the comparison of prices for inpatient hospital services, pharmaceuticals and physician incomes. By following the cost of treatment within a narrowly-defined Diagnostic-Related Group (DRG) category, it is possible to develop price indexes for medical services that are comparable to the matched-model price indexes used in other sectors of the economy. International comparisons have followed a comparable approach with efforts to obtain cost estimates for medical treatments are that sufficiently similar across countries.

In a 2010 report (Koechlin, Lorenzon, and Shreyer 2010), OECD analysts described a comparison for inpatient hospital services in 2007 for 12 OECD countries that included the United States. They incorporated nine specific cases of medical services and 23 surgical procedures that they believed represented comparable medical treatments. The price comparisons were expressed as indexes with the average of the 12 countries set equal to 100. Thus, total inpatient services in the United States were 164 percent of the group average and were 45 (164/113) percent above the level of Canada. While the United States was not the highest cost reporter in all of the individual procedures, it was never lower that 4th, and it was first in two-thirds of the specific comparisons. Within this small sample, however, some of the price differences may be attributed to variations in the level of income per capita.

Kanavos and Vandoros (2011) used data on the top-selling 50 prescription drugs in 15 OECD countries in 2007. The price measures were inclusive of all discounts or rebates. The authors used statistical regression analysis to control for differences in VAT rates, the age of the drug, and the existence of a generic, and they concluded that U.S. prices were about 30 percent higher on average.

Laugesen and Glied (2011) indentified some of the sources of the cost differences for primary care physicians and orthopedic surgeons in six OECD countries (Australia, Canada, France, Germany, United Kingdom, and the United States). They obtained data for the average fee for an office visit and a hip replacement within the six countries, and developed volume measures based on the number of primary care office visits and the number of hip replacements. On a per capita basis, the United States had by far the lowest number of office visits, but the average fee per visit was the highest of the six countries, although fees in the United Kingdom and Canada were near the same level. For hip replacements, the United States performed fewer surgeries on a per capita basis than France, Germany and the U.K, but the fees were nearly twice as high.

While not all categories of medical care have been included in the comparisons, the recent international comparisons strongly suggest that differences in prices account for most of the international variation in health care expenditures.

References Gerald F. Anderson, Uwe E. Reinhardt, Peter S. Hussey, and Verduhi Petrosyan. 2003. “It’s the Prices, Stupid: Why the United States Is So Different from Other Countries,” Health Affairs, May/June 2003, vol. 22(3):89–105.
Cutler, David M., and Ernest R.Berndt, (eds.). 2001. Medical Care Output and Productivity, National Bureau of Economic Research Studies in Income and Wealth, Vol. 62, The University of Chicago Press, Chicago.
Kanavos, Panos, and Sotiris Vandoros. 2011. “Drugs U.S.: Are Prices Too High? Measuring International Pharmaceutical Price Differences,” Significance, the Royal Statistical Society, vol. 8: 15–18.
Koechlin, Franchette, Luca Lorenzoni and Paul Schreyer (2010), “Comparing Price Levels of Hospital Services Across Countries: Results of Pilot Study”, OECD Health Working Papers, No. 53.
Laugesen, Miriam J, and Sherry A. Glied. 2011.”Higher Fees Paid To U.S. Physicians Drive Higher Spending For Physician Services Compared To Other Countries.”Health Affairs (September) 30:91647-1656.

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Authors

Publication: 14th Annual Joint Conference of the Retirement Research Consortium

Paul Ryan: The Most Daring Budget Hawk of His Generation

Ron Haskins — Tue, 27 Mar 2012 15:49:00 -0400

Paul Ryan, Chairman of the House Budget Committee, has once again lived up to his billing as the most daring budget hawk of his generation. Last year Ryan proposed, and nearly every House Republican supported, a budget that was the twin of this year's Ryan budget. The three main features of both budgets are a remarkable decline in the long-term deficit and stabilization of federal deft, a radical and politically dangerous reform to control Medicare spending, and no tax increases. If the Ryan budget were passed and implemented as proposed, the odds of which are below zero, the deficit crisis would be over.

Both Ryan budgets share another feature. Both were greeted by heavy criticism, especially the Medicare reform proposal. Last year Vice President Biden said the Ryan proposal "eliminates Medicare," a claim that Politifact labeled as the "Lie of the Year." This year, Democrat Max Baucus, head of the Senate Finance Committee, who must understand that Medicare costs are the major cause of the looming deficit crisis, said that "We can't allow the House to balance the budget on the backs of seniors and we won't—not on my watch." Although the criticisms by Democrats were predictable, Ryan and his troops did not do a terrific job of defending their budget last year. In May 2011, when a Republican candidate lost a New York congressional seat in a normally Republican district, even Republicans began to doubt that they could survive the political fallout of serious proposals to change the Medicare program and balance the budget.

Given the assault Ryan and other Republicans suffered last year, this year Ryan prepared for his budget release by conducting polls to discover the arguments the public would understand and accept, by tutoring both his House and Senate colleagues in formal training sessions to learn the arguments (and even the specific words to use) to defend his Medicare proposal, and by briefing the Republican Presidential candidates. All the candidates except Ron Paul endorsed the Ryan budget. Even Newt Gingrich, who last year called Ryan's Medicare plan "right wing social engineering," endorsed this year's version of the plan.

If members of Congress were capable of reasoned debate over our shameful and dangerous budget deficit, the debate over Ryan's plan might proceed as follows. Most Democrats would still disagree with his Medicare proposal because there are real risks involved for the elderly, because Republicans forcing tough changes in Medicare is just too tempting a political target for Democrats in an election year, and because Democrats have a natural desire to defend the program that is an historic achievement of their Party. Even so, it is not impossible to believe that Democrats and Republicans could eventually—after mountains of rhetoric and invective—reach compromise agreements on both the most difficult health reform issues in the Democrat's Affordable Care Act and the Ryan Medicare proposal as well as on other reforms needed to move the nation's budget deficit to a sustainable level.

The first is by far the least popular part of the ACA—the mandate that everyone must have health insurance. As Princeton Professor Paul Starr has argued in the New Republic, it would be possible to have nearly all the sweeping reforms in the ACA without the individual mandate. If Democrats agree to a compromise on the individual mandate (which the Supreme Court may soon force them to do anyway), Republicans should agree to the exchanges (the regional market for the purchase of health insurance policies) that are an essential feature of the ACA for everyone not just the elderly, as well as to the mechanisms designed by Democrats to control Medicare costs. Chief among these mechanisms is the Independent Payment Advisory Board that could propose health care reforms to Congress that would keep Medicare on a budget.

If Republicans compromised on these issues, Democrats should compromise on premium support, the central feature of the Ryan Medicare proposal; namely, giving seniors a fixed sum of money (perhaps adjusted for health risks and income) to purchase their preferred health care plan each year. The bargaining might result in the agreement to try Ryan's plan in several states rather than the entire nation. My own view is that the version of Ryan's Medicare plan introduced last December with Senator Ron Wyden, which is endorsed by Democratic budget guru Alice Rivlin, is the best idea developed so far for using the market to control Medicare costs. Despite its great promise, as is always the case with major policy reforms, there will be implementation problems. Better to work those out on a state-level rather than national-level scale before going universal. In short, rational people could find a compromise between Obamacare and Ryancare. I propose that we call the resulting hybrid "O'Ryancare."

A second major criticism of the Ryan budget is that it cuts the big entitlement programs for poor and low-income families, especially food stamps and Medicaid. In 2012, CBO projects that the former will spend $80 billion and the latter $262 billion. Ryan would convert these programs to block grants and give the states fixed funding that increases modestly each year. CBO says that the Ryan Medicaid block grant would reduce federal Medicaid spending by about 45 percent or around $279 billion in 2022. Could states come up with that much money to make up for the cuts? Would many poor and low-income families lose benefits? Would costs rise more slowly because states were running the program and working diligently to cut costs? No one knows for sure, but it seems unlikely that states could cover the difference.

Even if the new arrangements save some money, I doubt they will save enough. Again, the Ryan policy is pretty risky. A possible compromise would be for Democrats to accept the block grant but to allow the amount of money in the block grant to increase faster each year than allowed for under the Ryan budget. The rise in federal spending for the Medicaid block grant, for example, could be tied in some way to the rise of health care costs and state population changes in the previous year. Similar compromises could be reached on the other Ryan block grants.

An important point in thinking about spending on means-tested programs that Democrats should consider is that most people believe these programs provide benefits primarily for the poor. However, due to program rules and the way these programs are implemented, a surprising fraction of spending goes to people above the poverty level. Studies show that about half the recipients of both food stamps and Medicaid have incomes above the federal poverty line and around 20 percent have incomes above 200 percent of poverty. One way states could economize in both programs if they were converted to block grants would be to focus the benefits on people below or near the poverty line.

The major reason Ryan must have radical changes in spending on means-tested programs is that he does not increase tax revenues at all. Many Democrats and media critics claim that he reduces taxes for the rich because he lowers the top rate to just 25 percent from the current 35 percent. However, Ryan claims that he would broaden the tax base by eliminating many tax breaks so that the lower rate would apply to a higher percentage of a person's income. The various tax breaks in the federal code lose well over a trillion dollars each year, so it would be possible to lower the rates but not lose any revenue if enough of the tax breaks are ended.

Unfortunately, Ryan does not specify which tax expenditures he would end so it is impossible to know whether the actual tax payments of the rich would decline or rise. In any case, if the tax reforms were planned so that enough tax breaks were ended to produce additional revenues, Ryan could produce the same impact on the deficit with lower cuts in spending programs.

Republicans appear to be stuck in their "no new taxes" catechism, a stance that is not reasonable when one House of Congress and the presidency is controlled by Democrats who are insisting on more revenues in exchange for program cuts. But there are cracks in the no-new-taxes dike. Last year, in negotiations directly with the president, Speaker Boehner was willing to raise taxes by $800 billion as part of an overall deal that involved cuts in Medicare and other entitlements. Further, conservative Senators Tom Coburn and Mike Crapo, and former conservative Senator Judd Gregg, were willing to sign on to the Bowles-Simpson plan which increased taxes.

As always, a compromise means that both sides must give. Of all the compromises outlined above, the big compromises are for Democrats to agree to cuts in Medicare and Social Security in exchange for a Republican agreement to increase tax revenues.

Most observers are pessimistic about a deficit deal along the lines outlined above, especially in an election year. In a well-functioning democracy, legislative achievements are found through the art of compromise in which both sides give up something and get something. However, the ugly partisan debate over the deficit for the last several years makes many political observers doubt that Congress and the president are capable of the requisite deal making.

But I believe Republicans and Democrats will reach a series of compromises over the next few years that will greatly shrink the deficit through both reductions in spending, especially on Medicare and Medicaid, and increases in revenue. Why do I believe this? Because they have children and grandchildren.

Authors

Ron Haskins

Publication: Real Clear Markets

Addressing the Budget Deficit: The Next President Must Solve the U.S. Deficit Crisis

Ron Haskins — Thu, 19 Jan 2012 23:37:00 -0500

Editor's Note: The following is a Campaign 2012 policy brief by Ron Haskins proposing ideas for the next president on reducing the federal budget deficit. Isabel Sawhill prepared a response arguing that while deficit reduction is crucial, near-term economic stimulus is a better prescription for curing the nation’s economic ills. William Gale also prepared a response arguing that tax reform should make the nation’s tax system more equitable and progressive.

Introduction

The two biggest issues in the 2012 election are the economy and the deficit. Opinions vary on which issue should take priority, but the polls show that Americans put both issues at the top of those they want their new president to address. Not surprisingly, all the Republican candidates and President Obama have promised that they will reduce the nation’s deficit in the near future. Although none of the Republican candidates have laid out a detailed plan for deficit reduction, all of them would cut spending deeply and none would increase taxes. President Obama, by contrast, has consistently called for both spending cuts and tax increases, especially tax increases on the rich. All of the Republicans have also called for reducing the growth rate of entitlement programs, including Medicare and Social Security, although, again, they do not offer specific plans for doing so. However, they all call for a basic reform of Medicare financing—usually called “premium support”—in which the elderly would be given a fixed amount of money each year to purchase a health insurance plan of their choice. By contrast, President Obama, as recently as last December, has specifically ruled out this type of Medicare reform. Thus, Americans will be offered a clear choice between President Obama and any of the Republican candidates on deficit reduction: President Obama would cut spending other than Medicare and Social Security, the two biggest entitlements, and increase taxes on the rich; Republicans would cut spending, including spending on the big entitlements, while not increasing taxes.

This paper will show that the deficit is placing the nation at great risk of a financial disaster, argue that both political parties have failed to offer politically feasible plans to reduce the deficit and explain why, and outline a plan by which the new president can get the deficit under control. The next president should act decisively to solve the deficit crisis by taking the following steps:

Opening negotiations with the congressional bipartisan leadership in which everything—entitlements and taxes alike—is on the table;
Pushing reforms on Medicare based both on some of the top-down funding control mechanisms in the Democrats’ Affordable Care Act and the type of Medicare spending control measures specified in the Ryan-Wyden and Rivlin-Domenici proposals; and
Achieving reforms of the budget process, including—most important—resurrection of the paygo rule.

Background

The nation’s most serious domestic problem is the exploding federal deficit. The deficit has been over $1 trillion for the last three years and is expected by some estimates to be over $1 trillion on a permanent basis. In fact, the Congressional Budget Office (CBO) estimates that under current policy the deficit will be $3 trillion by 2030 and $9 trillion by 2050. With around 10,000 Baby Boomers retiring every day for the next three decades, and nearly all of them qualifying for Social Security and Medicare, unless the federal government undergoes a profound shift in its spending and tax policy, we will soon be Greece.

With the financial future of the nation at risk, you would think federal policymakers would take strong action to prevent the apocalypse. In a rational world, events that are certain to occur but at an uncertain time nonetheless receive timely attention and action. Even so, officials in Washington, and apparently the American people, are willing to let time pass by despite the guillotine featuring a frayed rope poised over our collective necks.

An especially distressing aspect of the paralysis in Washington is that everyone knows the broad outlines of the solution. Reducing the deficit can be achieved by cutting spending as Republicans want to do, increasing taxes as Democrats want to do, or both. It is in the very nature of democratic government that major reforms involve compromise between the contending forces. Yet Republicans and Democrats have been unable to reach a compromise involving less spending and higher taxes. If President Reagan and Ways and Means Democratic Chairman Dan Rostenkowski were still alive, they could go into a room and within an hour work out the general features of a compromise that would restore the nation’s fiscal health over a decade—and give us a more equitable and efficient tax code in the bargain.

The major reason the contending parties have been unable to make reasonable progress is that the policies that must be enacted to reduce the deficit lie at the heart of each party’s agenda. The Republican Party considers itself the philosopher of small government and its companion low taxes. Since the dramatic rise of federal social programs during the Great Depression, and even more since the flood of programs that accompanied the twin hurricanes known as the Great Society and the War on Poverty authored by Lyndon Johnson, Republicans have been on the defensive in their goal of achieving limited government. With the federal government’s annual volume summarizing domestic assistance programs now running to 2,839 pages and with spending on means-tested programs having risen from around $50 billion in the mid-1960s to around $700 billion today (in constant dollars), Republicans have long believed they are losing the battle for limited government. The record of federal spending shows why the Republican perception that they are losing the war for small government is accurate. From the 1950s through the 2000s, here are the decade-by-decade annual averages for federal spending as a percent of GDP: 17.6, 18.6, 20.0, 22.2, 20.7 and 20.0. CBO projects that spending in the 2010s will average nearly 24 percent of GDP. In 2011, one percent of GDP was about $150 billion.

In their frustration over the relentless growth of spending, around the time of the Reagan Presidency Republicans dreamed up the strategy of “starving the beast.” If they couldn’t stop either the Democrats (or, to be honest, themselves) from creating new programs and spending more money, they decided a radical strategy was called for; namely, depriving the government of money so it couldn’t continue to grow. Hence the importance of “no new taxes” to the Republican agenda. Based on the spending history of the federal government outlined above, starve the beast has backfired and both federal spending and the deficit have continued to grow to a previously unthinkable level. The United States now has a total debt of over $15 trillion, more than a quarter of it borrowed over the last four years. So much for starving the beast. Indeed, it seems possible that starve the beast taught both politicians and the public that they could have copious benefits—not to mention fight two wars—without paying for them. One consequence of our huge debt is that despite historically low interest rates, in 2010 the federal bill for interest on the debt was $196 billion. By the mid-2020s, we will be paying $1 trillion every year in interest and interest payments will continue to grow forever as we add new debt.

Republicans have had many chances to reduce federal spending, but rather than reduce spending, as often as not, they have increased it. The prime example is the prescription drug benefit Republicans added to Medicare early in the Bush administration. Not only does that program now cost the federal government over $50 billion a year, a figure that keeps rising, but it also makes the goal of controlling Medicare spending even harder to achieve. Similarly, the nation initiated two wars under Republican leadership, and neither of them was paid for. To date, expenditures on the two wars have been in excess of $3 trillion, although some estimates are even higher.

If Republicans have done their share to turn the United States into a financial banana republic, Democrats are no better. The heart of the Democratic agenda is protecting Social Security and Medicare, the two entitlement programs that Democrats rightly consider to be their greatest contribution to the American people, although both were originally enacted with and continue to enjoy strong bipartisan support. Even so, over the years Republicans have been more willing than Democrats to reform entitlements, especially Medicare. Taking a huge political gamble, the House Republican budget for 2012, developed primarily by Budget Committee Chairman Paul Ryan, contained a provision that would substantially reduce spending on Medicare and change its basic funding mechanism in a way that would control Medicare spending in the future. But many Democrats have excoriated Republicans for their Medicare proposal and are planning to claim that Republicans would throw Grandma in a pit to avoid higher taxes. Nancy Pelosi, the leader of House Democrats, said publicly that there could be no reductions in spending on either Social Security or Medicare and that Republicans are trying to let Medicare “wither on the vine.”

The upshot of the Republicans’ insistence on low taxes and the Democrats’ protection of Social Security and Medicare can be seen in Figure 1. If we continue on our present course, federal spending, which has averaged a little over 21 percent of GDP for the past several decades, will reach 30 percent of GDP by the late 2020s, 40 percent by the late 2040s, and 70 percent by the late 2080s. By contrast, federal revenues have averaged around 18 percent of GDP for the past several decades, although under reasonable assumptions future revenues could easily be under 18 percent and will almost certainly be under 19 percent of GDP. You can’t sustain a government on revenues equal to 18 or 19 percent of GDP while spending rises to 30 percent, 40 percent, and eventually 70 percent of GDP. To paraphrase the late economist Herb Stein, any trend that can’t continue, won’t.

So the big question for all the presidential candidates, and indeed all elected federal officials, is when they plan to rescue the nation from the debt tsunami and whether the rescue will occur before or after we have a catastrophic financial crisis that will bankrupt the nation.

The Obama and Republican Records

Not to be underdone by either his own party or the Republican Party, President Obama has done little to reduce the nation’s deficit and a lot to increase spending. A good argument can be made that the $790 billion passed in 2009 to stimulate the economy was justified. But most of the stimulus spending ended after 2010. Nonetheless, the deficit in 2011 was nearly as great as the deficit in 2010 and the deficit in 2012 will still exceed a trillion dollars. Granted, the deficit was already a major problem when Obama assumed the Presidency. But he has neither stemmed the tide nor spelled out and fought for a plan to substantially reduce the deficit. Before Obama took office, the nation had never had a deficit that exceeded a trillion dollars except during and immediately following wars. Now, as his term ends, we have had several years of $1 trillion deficits and these huge deficits are certain to continue increasing in the future.

In the mid-2000s, when the deficit was around a fourth of its current size, analysts at Brookings played the role of Chicken Little with regard to the mounting federal debt by publishing a series of volumes (in 2004, 2005, and 2007) arguing that the deficit was an impending national disaster and proposing policies that would avert the disaster, including changes in health policy, which even back then was widely recognized as the single biggest cause of deficit growth. For the chapter that Isabel Sawhill and I wrote for the 2005 volume, I called 20 former members of Congress or senior staffers who had participated in major compromise deals reached in the past by Congress and the president. These included the 1983 Social Security reforms, the massive 1986 tax reform, and the 1990 and 1997 budget deals. I asked them about the factors they thought were crucial to achieving the compromise deals in which they had participated. Of the twenty people we interviewed, the factor cited by the most participants (16) was presidential leadership. No wonder. Any fair assessment of all four of these major compromise packages would conclude that Presidents Reagan, Bush the elder, and Clinton, who were in office during one or more of the big compromises, showed competent and even daring leadership in working on a bipartisan basis to reach agreement. It is widely believed that George H.W. Bush lost the presidency in the 1992 election because he violated his “no new taxes” pledge in order to take dramatic steps to reduce the deficit in the 1990 compromise. Presidential leadership was also remarkable in the 1983 deal, because reducing Social Security benefits and increasing taxes was deeply controversial and politically risky, and in the 1986 deal, because huge and well-financed opposition from powerful lobbyists protecting their clients’ turf had to be overcome.

President Obama’s failure to provide the kind of leadership shown by previous presidents from both parties cannot be excused because he lacked opportunities to fight for a compromise agreement. Each of the annual budgets proposed by President Obama was an occasion for laying out his vision of how to attack the deficit over the long term. In addition, there were at least two occasions in which the president had a clear opportunity to create a political dynamic that could have led to a deficit compromise. These were the publication of the Bowles-Simpson deficit commission report in December of 2010 and the debt ceiling fight in the summer of 2011.

Of these, perhaps the greatest lost opportunity related to the report of the Bowles-Simpson Commission. First, the president himself appointed the chairs of the Commission, which would ordinarily mean that the president would have some ownership of the final report. Second, under the silly Commission rules, which seem to have been designed to ensure failure, the final report and recommendations were not considered approved unless 14 of the Commission’s 18 members voted in favor of the report. The Commission may not have reached the magic number of 14 votes, but a majority of Commission members did support the final recommendations, which included a judicious mix of tax increases and spending cuts. Significantly, those signing the report included two conservative Republicans, Senators Tom Coburn and Mike Crapo. Thus, two prominent Republicans defied their party leaders and voted to support the substantial tax increases in the final report. Moreover, the report was greeted in the press with widespread acclaim as a huge step forward. Despite all these hopeful signs of a compromise, Obama treated the report like it was a barrel of snakes. If Obama had seized on the report, asked Senator Reid to introduce it (or a modified version) in the Senate, and thrown the full power of his office behind it, there is no doubt that a significant battle would have ensued and that Obama would have been occupying the high ground. What’s more, with two Republican Senators already in the fold and numerous cracks in the no-new-taxes armor, Obama could have split the Republican Party. Even if he hadn’t won the battle, perhaps in part due to divisions within his own party, he could well have emerged a hero in the media and among the public and all but assured his second term.

A second blown opportunity was the negotiation between the president and House Speaker John Boehner during the run-up to the debt ceiling vote in the summer of 2011. The negotiations turned into a “he-said, she-said” argument between the president and speaker when they blew up. According to both sides, the size of the package under discussion could have amounted to around $4 trillion in deficit reduction over 10 years and included both tax increases and entitlement cuts. According to both sides, Boehner withdrew because the president wanted higher taxes than Republicans were willing to accept. Boehner, however, claimed that he had agreed to $800 billion in tax increases over 10 years, but the president moved the goal posts by asking for an additional $400 billion in taxes. The president denied Boehner’s version. Blame whom you will; the negotiations ended up as another blown opportunity.

The lack of presidential leadership was once again on full display in December 2011 when Republican Paul Ryan and a leading Democrat, Senator Ron Wyden of Oregon, introduced a version of the premium support approach to fundamentally reforming the Medicare program. Ryan, as part of his far-reaching plan for solving the deficit crisis, had included a less generous version of premium support that was viewed by many Democrats as putting seniors at too much risk for increased out-of-pocket payments for their medical care. Nonetheless, if viewed as an opening bid in a negotiation over Medicare funding, the original Ryan Medicare proposal could be seen as having potential for bipartisan negotiations. Alice Rivlin of Brookings, a leading Democratic budget expert, agrees with the basic approach of the Ryan proposal, although she opposed his original version. However, the version Ryan and Wyden released in December seems nearly identical to the proposal supported by the influential Bipartisan Policy Center and written by Rivlin and former Republican head of the Senate Budget Committee Pete Domenici. Both the Washington Post and the New York Times have written editorials arguing that the premium support approach to controlling Medicare costs deserves consideration and careful scrutiny. In short, a series of developments in Washington opened an opportunity to consider a reform that CBO has scored as reducing the growth rate of Medicare spending.

But presented with this opportunity to reform the single greatest force underlying the federal deficit, how did the administration respond? The White House immediately issued a statement claiming that the Ryan/Wyden proposal would “undermine rather than strengthen Medicare” and rejecting the bipartisan proposal out of hand. The White House appeared to be in the lead of a bevy of senior Democrats who, according to an Associated Press headline, “blasted” the proposal. The Washington Post, hardly a bastion of conservative thought, criticized the administration for missing a chance to explore a promising proposal that at least deserved careful scrutiny.

What Should We Expect from the Next President

The nation cannot afford another four years of a Congress and a president that fail to attack the deficit and, at a minimum, beat the debt back to a stable percentage of GDP—preferably, around 60 percent as recommended by the National Academies. The course to fiscal sanity is straightforward: Congress and the next president must work together to reduce spending, especially on Medicare, and increase taxes. None of the presidential candidates and neither political party have supported a detailed plan that involves cuts in spending, especially in Medicare, and tax increases that would avoid the pending financial crisis.

Thus, on his first day in office, the new president should meet with the bipartisan congressional leadership and agree to open a negotiation that would put everything— including entitlements and taxes—on the table, involve a determined search for a bipartisan deal and include a revamping of budget process rules so that the terms of the eventual deal would be enforced.

It would be especially wise for the new president to lay down three additional principles to guide the negotiations. First, rather than mindless across-the-board cutting of programs, the spending cuts should emphasize using evidence to eliminate or reform programs that don’t work and, if sufficient savings can be achieved, invest in programs that have strong evidence of success. One of the reasons the nation has such high unemployment is that too many of our workers lack adequate skills to flourish in a global economy. The key to rectifying this situation, of course, is education. If we are to overcome our decades-long failure to create educational institutions that can help children from the bottom complete high school and enter a postsecondary institution that provides a skill certification, a two-year degree, or a four-year degree, we should begin by providing high-quality preschool for at least two years to children from families below 150 percent of the poverty level. There is ample evidence that high-quality preschool produces long-term payoffs. The Head Start reforms now being implemented by the Obama administration are a step in the right direction, but more funding is necessary to maintain quality and to ensure a program of two years for more disadvantaged children. The United States now lags many other nations in educational achievement, a development that threatens our economic superiority. To regain our leadership position, we must make smart investments in high-quality educational programs and continuously evaluate the programs to ensure they are producing the desired results.

Second, if the new president is a Republican, he should open negotiations on Medicare by agreeing to some of the top-down funding control mechanisms in the Democrats’ Affordable Care Act, especially the advisory board that has authority to submit reforms to Congress shown by research to save money. But in exchange, Democrats should agree to some version of premium support, such as the Ryan-Wyden and Rivlin-Domenici plans, as an additional way to control Medicare spending.

Third, to ensure that the final agreement sticks and that the nation avoids deficits of the kind that now threaten our future, the president’s proposal should include reform of the budget process. The most important budget reform would be to resurrect the paygo rule under which any increase in spending or reduction in taxes that exceeds the targets in the agreement must be paid for. The agreement should also include a trigger that would impose automatic spending cuts and tax increases if the agreed upon targets are not met.

America is on the edge of a cliff. That the Congress, the president, and the American people themselves have allowed the budget disaster to fester and grow is a testament to the basic human desire to have something for nothing and the failure of our federal policymaking apparatus to put a stop to the fiscal insanity. My favorite cartoon about the nation’s deficit shows a table of adults at a sumptuous dinner with a baby seated in a high chair at the end of the table. When the bill arrives, all the adults point toward the baby as the person who will pay for their dinner. The entire nation is now at the table pointing toward the baby. One way or another, the adults must pay for their own meal and they should elect the president that they think gives them the best chance of doing so.

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Ron Haskins

Gingrich's Frightening Fiscal Fantasies

Robert C. Pozen — Sun, 01 Jan 2012 00:00:00 -0500

The idea of Newt Gingrich becoming president is no longer so far-feteched. So now that he has obtained front-runner status in some Republican presidential primaries, his positions on important public policies such as Social Security and income taxes deserve greater scrutiny. In both cases, Gingrich adopts familiar Republican concepts—but then undermines their key objectives.

Gingrich's "fix" for Social Security builds on a Bush-era proposal. He would allow younger workers to contribute a portion of their payroll taxes to a private account instead of to the Social Security fund. These accounts could be invested in one or more diversified mutual funds in a plan regulated by the federal government.

But Gingrich takes a radical step further by effectively telling those workers not to worry if their investments of payroll taxes do poorly. According to Gingrich, "The Treasury will send them a check to make up the difference" between their fund returns and their scheduled benefits under Social Security.

By guaranteeing the government's scheduled benefits as the floor, Gingrich gives workers a tremendous incentive to roll the dice. After all, if their investments do well, the workers will receive higher retirement payments. If their investments crater, the workers still get the guaranteed benefits from the Treasury. Heads you win, tails (we) taxpayers lose.

Gingrich argues that holders of private retirement accounts could not assume much risk because they would be allowed to invest in only a few diversified funds, such as those offered by the 401(k)-type plan for federal employees. Gingrich is right that this plan would prevent workers from buying stocks in individual companies such as Google or from investing in the latest social-networking initial public offering. Under that civil service plan, however, individuals can invest in international stock funds or small company stock funds—diversified funds with considerable downside risk.

Moreover, Gingrich's plan explicitly allows workers to quickly switch between funds. Such switching would increase the risks of these investments if workers attempted to time the market. Although market timing is usually not a successful strategy for unsophisticated investors, these workers would not worry about guessing wrong. Remember they would, under Gingrich's proposal, still receive the guaranteed schedule of Social Security benefits from the Treasury.

Similarly on income tax reform, Gingrich picks up the Republican idea of a flat tax for individual income—and perverts its basic principles. Under the core concept of a flat tax, individuals would pay only one tax rate, which could be quite low because there would be few, if any, tax deductions or tax credits.

Gingrich has proposed a flat tax for individuals with a 15 percent rate after an exemption for the initial $12,500 of income. But Gingrich's plan does not follow through on the elimination of tax deductions and credits. Of the current major deductions, he eliminates only the deduction for state and local taxes. Gingrich also retains many expensive credits, such as the child tax credit and the earned-income tax credit.

Simply put, Gingrich's proposal is not a flat tax. It dramatically reduces the tax rate for the top half of the income brackets without eliminating the significant economic distortions caused by tax deductions and credits. For example, he leaves intact the mortgage interest deduction, which is costly and overly broad in that it currently applies to home equity loans, mortgages on second homes and mortgages of up to $1 million per couple.

As a result, the Gingrich not-so-flat tax plan would reduce federal tax revenue by at least $850 billion per year, according to an estimate from the Tax Policy Center published last week.

In response, Gingrich argues that this shortfall would be offset by increasing overall economic growth, since he is a strong advocate of a "dynamic" model for estimating tax receipts. Even under a "dynamic" model, however, it would be extremely difficult to generate enough new growth to produce an additional $850 billion per year of tax revenue with a tax rate of only 15 percent. Indeed, to generate that much additional tax revenue at a 15 percent rate would require an increase in taxable income of $5.6 trillion—more than one-third of the total U.S. gross domestic product.

Moreover, Gingrich would allow taxpayers to choose between the taxes due under his plan and the taxes due under current tax rules. This approach would negate another objective of those advocating a flat tax—simplifying the Internal Revenue Code. Indeed, Gingrich's plan would increase tax complexity by requiring most taxpayers to compute their taxes twice.

In putting forward these extreme proposals, Gingrich has avoided the tough choices that are necessary to restore fiscal discipline in Washington. Whatever your view of private investments of payroll taxes, it would be a terrible moral hazard to guarantee such investments against bad results. Whatever your view of the merits of a flat tax, it would be a travesty of that concept to adopt a low tax rate while retaining most tax deductions and credits. These extreme proposals should raise serious questions for all voters about Gingrich's financial stewardship if elected president.

Authors

Robert C. Pozen

Publication: The Day

@ Brookings Podcast: Automatic Spending Cuts and Programs for the Poor

Ron Haskins — Fri, 30 Dec 2011 11:02:00 -0500

The failure of the congressional super committee to reach a budget accord means that the budget ax will fall across many domestic spending programs and defense spending in the next fiscal year, including a number of programs that help the poor. Senior Fellow Ron Haskins says that while the automatic budget cuts will do some harm to some anti-poverty programs, the largest and most important programs – including Medicaid and Social Security – have been largely shielded.

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Gingrich’s Flawed Social Security and Income Tax Proposals

Robert C. Pozen — Tue, 27 Dec 2011 10:28:00 -0500

With Newt Gingrich vying for front-runner status in the Republican presidential primaries, his positions on important public policies such as Social Security and income taxes deserve scrutiny. In both cases, Gingrich adopts familiar Republican concepts — but then undermines their key objectives.

Gingrich’s “fix” for Social Security builds on a Bush-era proposal. He would allow younger workers to contribute a portion of their payroll taxes to a private account instead of to the Social Security fund. These accounts could be invested in one or more diversified mutual funds in a plan regulated by the federal government.

But Gingrich takes a radical step further by effectively telling those workers not to worry if their investments of payroll taxes do poorly. According to Gingrich, “The Treasury will send them a check to make up the difference” between their fund returns and their scheduled benefits under Social Security.

By guaranteeing the government’s scheduled benefits as the floor, Gingrich gives workers a tremendous incentive to roll the dice. After all, if their investments do well, the workers will receive higher retirement payments. If their investments crater, the workers still get the guaranteed benefits from the Treasury. Heads you win, tails (we) taxpayers lose.

Gingrich argues that holders of private retirement accounts could not assume much risk because they would be allowed to invest in only a few diversified funds, such as those offered by the 401(k)-type plan for federal employees. Gingrich is right that this plan would prevent workers from buying stocks in individual companies such as Google or from investing in the latest social-networking initial public offering. Under that civil service plan, however, individuals can invest in international stock funds or small company stock funds &mdhash; diversified funds with considerable downside risk.

Moreover, Gingrich’s plan explicitly allows workers to quickly switch between funds. Such switching would increase the risks of these investments if workers attempted to time the market. Although market timing is usually not a successful strategy for unsophisticated investors, these workers would not worry about guessing wrong. They would, under Gingrich’s proposal, still receive the guaranteed schedule of Social Security benefits from the Treasury.

Similarly on income tax reform, Gingrich picks up the Republican idea of a flat tax for individual income — and perverts its basic principles. Under the core concept of a flat tax, individuals would pay only one tax rate, which could be quite low because there would be few, if any, tax deductions or tax credits.

Gingrich has proposed a flat tax for individuals with a 15 percent rate after an exemption for the initial $12,500 of income. But Gingrich’s plan does not follow through on the elimination of tax deductions and credits. Of the current major deductions, he eliminates only the deduction for state and local taxes. Gingrich also retains many expensive credits, such as the child tax credit and the earned-income tax credit.

Simply put, Gingrich’s proposal is not a flat tax. It dramatically reduces the tax rate for the top half of the income brackets without eliminating the significant economic distortions caused by tax deductions and credits. For example, he leaves intact the mortgage interest deduction, which is costly and overly broad in that it currently applies to home equity loans, mortgages on second homes and mortgages of up to $1 million per couple.

As a result, the Gingrich not-so-flat tax plan would reduce federal tax revenue by at least $850 billion per year, according to an estimate from the Tax Policy Center published last week. In response, Gingrich would argue that this shortfall would be offset by increasing overall economic growth, since he is a strong advocate of a “dynamic” model for estimating tax receipts. Even under a “dynamic” model, however, it would be extremely difficult to generate enough new growth to produce an additional $850 billion per year of tax revenue with a tax rate of only 15 percent. Indeed, to generate that much additional tax revenue at a 15 percent rate would require an increase in taxable income of $5.6 trillion — more than one-third of the total U.S. gross domestic product.

Moreover, Gingrich would allow taxpayers to choose between the taxes due under his plan and the taxes due under current tax rules. This approach would negate another objective of those advocating a flat tax — simplifying the Internal Revenue Code. Indeed, Gingrich’s plan would increase tax complexity by requiring most taxpayers to compute their taxes twice.

In putting forward these extreme proposals, Gingrich has avoided the tough choices that are necessary to restore fiscal discipline in Washington. Whatever your view of private investments of payroll taxes, it would be a terrible moral hazard to guarantee such investments against bad results. Whatever your view of the merits of a flat tax, it would be a travesty of that concept to adopt a low tax rate while retaining most tax deductions and credits. These extreme proposals should raise serious questions for all voters about Gingrich’s financial stewardship if elected president.

Authors

Robert C. Pozen

Publication: Washington Post

Comments on the 50th Anniversary Celebration of the Special Committee on Aging

Henry J. Aaron — Thu, 08 Dec 2011 00:00:00 -0500

Mr. Chairman, Ranking Member, Senator Corker, Members of the Committee:

It is a pleasure and an honor to be able to share in this celebration with you today. This committee has observed, influenced, and helped to shape a transformation in the whole meaning of growing old in the United States—a change for the better. A scrim of forgetfulness shields us from the rather ugly reality of growing old in the America of just a few generations past. Let us draw back that curtain to examine what growing old meant for the generations born in 1860, 1890, 1930, and 1960. And let us also consider what aging will hold for younger Americans.

The 1860 cohort was born in a nation that still treated slavery as a constitutional right. A quarter of those born in 1860 died before turning age 20, half before reaching age 65. Living conditions and public sanitation were appalling by today’s standards: few houses had indoor plumbing, and few cities had municipal water and sewer systems. Surgery was uncommon and dangerous because surgical technique was primitive and anesthesia was dangerous. Inoculations were uncommon. Childhood diseases winnowed the young. Pneumonia was known as the "widow’s friend."

By current standards, the 1860 cohort was a nation of educational dropouts, although the United States led the world in mass education. Out of every hundred students who started primary school, 70 finished, 12 completed high school, and 3 graduated from college. Economic growth was rapid but uneven. The U.S. economy underwent thirteen economic contractions between 1885 and 1925. Many were catastrophic by modern standards.

Women gave birth to an average of more than five children. The backbreaking job of caring for children, husbands, brothers, sisters, and parents in a world without washing machines, vacuum cleaners, refrigerators, or dishwashers was borne, typically by women, until death and lightened only as family members died or moved away. Once married, few white women worked outside the home. Those who worked for pay almost invariably performed menial tasks. Many women, especially African American women, were domestics. Old age was not a passage to a "new mode of living," but a continuation of what life had been when one was young.

Three-quarters of men born in 1860 and still alive at age 65 continued to work for pay until death, disability, or economic catastrophe intervened. Such a catastrophe–the Great Depression–did intervene when the 1860 cohort was sixty-nine years old. By 1932, a quarter of the work force was unemployed. The elderly were more likely than the young to lose their jobs and less likely to find new ones. Protracted unemployment, bank failures, plunging stock prices, and collapsing real-estate values destroyed the savings of those in the middle and working classes who had scrimped and saved for retirement. Private charities were overwhelmed. Public charity dried up as state and municipal tax collections plummeted. Only a few Civil War veterans and their widows received small pensions; otherwise, private pensions were rare.

The first Social Security check was not paid until the 1860 cohort reached age 80, and few were eligible for benefits. For the one-third of the 1860 cohort who survived to their sixty-ninth birthdays, the final years were generally grim.

America’s 1890 cohort also lived through boom and bust. World War I ended a recession. With peace came another recession. Unemployment reached 12 percent. The 1920s brought boom, except on the farm. The year 1929 ushered in twelve years that blighted what should have been this cohort’s prime earning years. Too old to fight in World War II, the men of the 1890 cohort worked to support their sons at the front. Women left home for the paid labor force. Freed from traditional jobs as secretaries, teachers, social workers, and nurses, they become machinists and assembly-line operatives.

Like its forebears, the 1890 cohort suffered high rates of infant mortality. Although this cohort benefitted from steady, if undramatic, improvements in health and education, more than one-third of 20-year-old women and two-fifths of 20-year-old men did not live to see their sixty-fifth birthdays. Eighty percent of unmarried elderly women and half of unmarried elderly men had been widowed. Four-fifths of this cohort finished primary school. One-fourth graduated from high school, but only one in 20 earned a college degree.

When this cohort reached age sixty-five in the mid-1950s, fewer than half had health insurance. Coverage was often uncertain because insurers could raise premiums sharply or refuse to renew coverage of those whose health had begun to deteriorate. Because health expenses of the elderly were less than one-tenth of what they are today (even when adjusted for inflation), medical outlays were a threat only for the minority who became seriously ill. But in one of the most striking social changes of the late twentieth century, a spell in a nursing home became common. By the late 1970s, roughly a quarter of the 1890 cohort survivors were residing in nursing homes.

Congress passed the Social Security Act of 1935, subsequently increasing benefits and extending coverage in 1939 and again in 1950. Because of these liberalizations, members of the 1890 cohort received benefits far greater than the earmarked payroll taxes they and their employers had paid. Still, benefits were modest–only about 32 percent of taxable earnings of full-time covered workers. And since roughly half of U.S. jobs were not covered until the 1950 legislation broadened coverage, many members of the 1890 cohort did not receive benefits at all. Furthermore, private pensions covered only about a quarter of members of the 1890 cohort. Even workers who were covered typically received meager benefits because most had not worked long enough under these plans to have earned meaningful benefits. With insufficient income to retire, two-thirds of surviving men from the 1890 cohort were still working at age 65, nearly half at age 70, and 30 percent at age 75. More than one-third had incomes below official poverty thresholds.

The 2.6 million American children born in 1930 enjoyed advantages unavailable to previous generations. Nearly all finished primary school. Seven in ten graduated from high school. Partly because of the G.I. Bill for Korean War veterans, one man in five and one woman in nine graduated from college. Women no longer automatically withdrew from the labor force after marriage. Those who did often reentered when still young. Just over one-third worked outside the home when they were age 30, but three-fifths did at age 50, and two-fifths still worked for pay at age 60.

If the educational achievements of the 1930 cohort were striking, the economic advances were breathtaking. Between the end ofWorld War II and the mid-1970s, output per person more than doubled. At the start of their working lives, members of the 1930 cohort earned hourly wages three times higher than members of the 1890 cohort had earned in their first jobs. By the time the 1930 cohort turned age 65, their average earnings had risen by another one-third.

Post–World War II recessions, though numerous, were shallow during the 20th century compared with the economic paroxysms of earlier eras. Furthermore, unemployment compensation, also created by the Social Security Act of 1935, cushioned the shock for those who did lose jobs–for up to six months in normal times and even longer during recessions. Higher incomes, medical advances, and improved working conditions combined to boost life expectancy for the 1930 cohort. Two-thirds of men and over three-quarters of women born in 1930 lived to celebrate their sixty-fifth birthdays. Four-fifths of 65-year-old men and three-fifths of 65-year-old women still lived with a spouse.

As they approached retirement age in the mid-1990s, members of the 1930 cohort had options and resources few of their parents had enjoyed. Most had assets that provided substantial financial security. Social Security benefits, averaging $8,500 a year for individuals and $12,000 for couples, were fully protected against erosion by inflation. One-third of the 1930 cohort received private pensions, although the amounts were modest–a median of less than $7,000 a year. Further, more than four in five members of the 1930 cohort owned their own homes at retirement. Most had benefitted from the postwar real-estate boom that tripled the real value of owner-occupied housing between 1950 and 1995. The 1930 cohort also had better protection against medical costs than ever before. Medicare, enacted in 1965, provided basic health insurance coverage for the elderly and the disabled while eight in ten also had supplementary coverage. Increasingly workers retired years before they died. One-third of men in the 1930 cohort stopped working before age 62, two-thirds before age 65. Average living standards approximated those of younger adults. Averages, however, concealed large disparities: only 4.3 percent of elderly couples were poor in 1996, compared to 18 percent of elderly single men, 20 percent of elderly single women, and 36 percent of elderly single African-American women. Whatever the future holds for the final years of the 1930 cohort, its circumstances represent a revolutionary improvement over the experiences of their predecessors.

America’s 1960 cohort was better educated than any of its forebears. Only one in eight dropped out of high school. Half attended college and nearly one-fourth earned a bachelor’s degree. The fraction of the 1960 cohort with post-baccalaureate education matched the share of the 1860 cohort who had completed high school. But not all advanced at the same pace. African Americans were only two-thirds as likely as whites to earn a college degree, and barely half of Hispanics completed high school. Even if the earnings of men with little education grew more slowly than their parents’ pay had, the 1960 cohort earned more on their first jobs than their parents had three decades earlier. The jobs filled by members of the 1960 cohort also required less brawn and more brain than had jobs in the past. Three-fifths of men and 90 percent of women in the 1960 cohort worked in white-collar or service-sector jobs. Still, roughly one quarter of men and a small but growing fraction of women worked as craftsmen, mechanics, miners, machine operators, laborers, truck drivers, or in other physically strenuous jobs that become increasing difficult to perform as one ages. Women were better educated, worked more hours, stayed in the labor force with fewer interruptions, and earned much more than women had previously. As a result, more will be entitled to their own private pensions and to Social Security based on their earnings rather than their husbands’.

Members of the 1960 cohort told pollsters that they hoped to retire earlier than have past generations. Despite these stated intentions, however, men began to retire later, starting in the mid- 1990s and this trend has continued. One reason may have been that they had not done enough to prepare economically for retirement. By 2000, only 31 percent of those born between 1954 and 1964 had nonhousing assets worth more than $100,000, and 49 percent had accumulated less than $50,000, a sum that would support an annuity of less than $4,000 a year. In their failure to save, the 1960 cohort differ little from their forebears, who began to save, if at all, only in their 40sand 50s. For a long time, it looked like members of the 1960 cohort would have more sizeable pensions than previous generations. But that hope was undercut by the drop in stock-market values and the loss of equity in owner-occupied houses in the last decade. Furthermore, there is no way for anyone of any age to convert liquid assets into annuities fully protected against inflation and market risks, in the same way that Social Security benefits are protected. And Social Security benefits are in process of being lowered relative to earnings, a delayed effect of amendments enacted in 1983. For that reason, more than previous cohorts, members of the 1960 cohort will also confront the possibility that they will outlive their assets. One-fifth of men who reach age 65 are projected to be alive at age 90, and half of women alive at age 65 are expected to live past their eighty-seventh birthdays.

The prospects for younger age cohorts are more troubling. The past record of more-or-less continuous growth of income and improvement in educational achievement is in jeopardy. Earnings of men have fallen for about four decades. High-school completion rates are falling. Male college attendance and completion rates are falling. An encouraging bright spot is the continued increase in female college attendance and completion rates. More women than men now hold college degrees and the gap is widening—in part because female attendance rates continue to rise, but also because male attendance rates are stagnant or falling.

An additional source of concern is the projected increase in the budgetary cost of Medicare. These rising costs have led to proposals to replace the defined benefits provided by those programs with cash vouchers tied to indexes that have grown less rapidly than health care costs. The combination of stagnant wages, reduced replacement rates under Social Security, increased financial market volatility, and the threat that health care costs will be shifted to the elderly raise serious concerns about the financial security of the elderly. For a variety of reasons—private calculations and shifts in public policy—workers are likely to elect to work until older ages in the future than in the past. This trend will simultaneously lighten the burden of supporting a growing elderly population and boost national output.

Furthermore, there is no sign that scientific advance is ending. Progress in medical science, in particular, holds out the promise that people will live to longer, function well until older ages, and die with less pain than in the past. Out side medicine, advances in technology hold the promise of higher incomes. In brief, we hold in our own hands the capacity to do for our children and grandchildren what our forbears did for us—promote improved education, prevent illness from becoming financial calamity, encourage hard work, and recognize that the improving living standards and security that each of us seeks requires not only individual effort but also collective cooperation and mutual support.

Authors

Henry J. Aaron

Publication: Senate Special Committee on Aging