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Entitlement Reform: The Way to Eliminate the Deficit

1.

It is understandable that many Americans are coming to the conclusion that the problems of the federal government’s deficit have at last been laid to rest. After all, the President’s budget package enacted last fall made a much publicized “down payment” on eliminating the deficit; and Clinton’s insistence in his fiscal year 1995 budget proposal on maintaining the cuts he earlier promised suggests a clear departure from the complacency of the last twelve years. The near-term projections are encouraging: it is possible that for the first time in half a century the annual federal deficit may shrink (in dollars) for four consecutive years. With the economy improving, and with health-care reform now attracting far more attention than fiscal policy, we are losing our sense of urgency about the need to stop the ongoing growth in our national debt.1

That is a serious mistake. In fact, the debt is a far more intractable problem than most politicians and policy professionals are willing to admit—at least in public. True, last year’s budget deal was designed to save $500 billion over the next five years (with the “savings” calculated as reductions from a sharply rising projection of deficits), and it is projected to reduce the annual deficit from 4.0 percent of the Gross Domestic Product (GDP) in 1993 to 2.2 percent in 1998. Seen from a different angle, however, the prospect for the deficit during the 1990s doesn’t look so bright. Even with the recent improvement, the money borrowed by the US Treasury to finance our deficits will still siphon off nearly half of all net savings made by US businesses and households—a far greater share of savings than deficits typically consume in any other industrial nation. Thanks to Clinton, America has been spared an explosion in the publicly held national debt in the near term—but the debt is still due to rise in dollars more over the next ten years than over the previous ten.

What is more remarkable is how little Clinton’s first budget has altered the long-term outlook. After 1998, the year the deficit is expected to sink to its low point, its share of GDP is expected to grow again each year. Deficits will rise to 3.3 percent of GDP by 2004, to 5.0 percent by 2010, and to 10.0 percent by 2020.2 As the economist Benjamin Friedman of Harvard recently wrote in these pages, no nation can expect to prosper if its public debts continuously increase faster than its income. Yet on our current budget trajectory, the national debt will keep climbing as a share of the economy into the next century: from a postwar low of 25 percent of GDP in 1974 to 55 percent in 2004, to 67 percent in 2010, and to 112 percent in 2020. The last figure approximately equals the previous record reached in 1946, after a ten-year depression and a five-year world war.3

Some may ask how anyone can make such long-term projections for the federal deficit. The answer is simple: the part of the budget that is called “discretionary” (32 percent of the total in 1993), but that pays for such services as national defense and public health, is already scheduled for deep cuts, and it is extremely doubtful that it can be reduced much further. Interest on the national debt (14 percent of the budget in 1993) must be paid to avoid a devastating financial panic. The rest of the budget—over half of all federal spending—consists of “entitlements,” the word for all federal benefits that are not controlled by Congress’s yearly appropriations. These include Social Security, Medicare, Medicaid, Federal pensions, food stamps, and AFDC. Since entitlement payments are made automatically according to a preset schedule, their costs can be projected by taking account of the economic, demographic, and social trends that seem most likely during the next several decades.4

As it turns out, nearly all of those trends are projected to raise the cost of our current entitlements system—from 10.3 percent of GDP as recently as 1990, to 17.5 percent in 2020, and to 21.3 percent in 2040. The cost of Social Security and Medicare (both hospital and non-hospital care) alone is projected to reach an unthinkable 38 to 53 percent of the average worker’s taxable wages by the time children born this year reach their mid-forties. Assuming that spending commitments and tax policy remain unchanged, a future of widening federal deficits is virtually assured.

All of these projections are based on calculations by the Congressional Budget Office and the Social Security and Health Care Financing Administrations. One might hope that the projections are an overstatement of the likely consequences of current policies. But, if anything, they are an understatement.

To begin with, the projections assume that all the savings promised in Clinton’s first budget will actually be made, even though (a) the administration’s estimates of future revenues from taxes have been seriously questioned, (b) its spending cuts include $116 billion in “unspecified reductions,” and (c) three quarters of its five-year spending cuts are conveniently scheduled to be carried out after the 1996 election. Second, the projections assume that no major new spending commitments will be made during the next fifty years, a questionable assumption (even within the next few years) now that Clinton has gone on record in favor of an “economic security system” for every citizen, which includes broad new entitlements in health, employment, retirement, and education. Clinton’s health plan alone promises that many new benefits—from prescription drugs to long-term home care to large subsidies for early retirees—will be made universally available with little or no regard to financial need.

Finally, the projections assume that the economy will grow steadily, with no new downturn in the business cycle and no meaningful rise in long-term interest rates. They also assume long-term rates of productivity growth and demographic change that are significantly more favorable (from a fiscal point of view) than the historical record over the past twenty years.5 Even in the near term, a sudden dip in the economy—together with faulty “savings” forecasts—can change a favorable economic outlook into a nightmare. This happened repeatedly during the 1970s and 1980s. Most recently, after the Budget Enforcement Act of 1990 was passed, the Congressional Budget Office projected in January of 1991 that the deficit would fall to $57 billion by 1995. Two years later, when Clinton took office, the CBO projection of the deficit for 1995 had climbed all the way to $284 billion. Over the long term, it seems questionable, to say the least, to assume that the country’s economic performance would not be negatively affected by increased spending on benefits, the interest costs that will result from large federal borrowing, and widening deficits. The coming explosion in entitlement spending will not only siphon a rising share of the economy’s resources away from workers’ paychecks (or company profits) and toward federal beneficiaries, it will also siphon those resources away from investment.

In my view, the only way to change the long-term trend of the deficit is by reforming the entire system of entitlements—the fastest-growing part of the federal budget. Reform will mean rethinking how public policies toward everything from health care and housing to retirement and farm aid help or hurt the public interest.6 Most of all, it will mean putting an end to the vast and largely unearned windfall we now give to the more affluent half of all American households.

2.

The hopes of most Americans for an improving standard of living are fading. For objective evidence, we can point to the fact that average real wages, household wealth, and rates of home ownership have all remained virtually stagnant over the last twenty years, while during the same period the overall poverty rate has risen. What is even more discouraging, the wellbeing of younger Americans, as measured by each of these indicators, has become considerably worse. It is not surprising that according to opinion surveys a rising share of adults doubt that the next generation will be “better off” than they are. Once again, this attitude shift is especially marked among the young. A new Roper poll shows that, among eighteen-to-twenty-nine-year-olds of both sexes, the number of those who think they have a “very good” chance of achieving “the good life” has declined from 41 to 21 percent over the last fifteen years.

An extremely revealing appendix to the Fiscal Year 1995 Budget of the US Government entitled “Generational Accounting” supports these forebodings. In it, projections made by the economist Laurence Kotlikoff of Boston University show how fiscal policy will affect future generations if tax and benefit schedules affecting all of today’s living Americans remain unchanged. The projections reveal that Americans now in their mid-thirties to mid-sixties would end up paying between 31 and 36 percent of their employment income in net taxes (“net” means all taxes paid in excess of all benefits received) throughout their lifetimes. For all Americans born after 1992, however, their lifetime net taxes would consume 82 percent of their employment income. Accounting showing the impact of current policy on future generations has been included in the last three US budgets. Yet hardly any political leader has called attention to the startling implications of this analysis.

What accounts for such blindness? The answer seems to lie in a recent and unprecedented erosion in the sense of responsibility toward future generations that used to characterize US policy-making. Throughout our history Americans have engaged in fierce social conflict over the two central questions of political life: Who benefits? Who pays? Farmers against bankers, consumers against the trusts, unions against corporations, New Dealers against Liberty Leaguers—in all these struggles, no one questioned that the issue of costs would eventually have to be settled, one way or the other, among living generations. It was understood that, as a matter of equity, huge public debts would not be passed on to our children and grandchildren. Today that understanding no longer exists. One can, for example, observe in Washington an unspoken truce between “supply-siders,” determined to oppose any tax increase, and “liberals,” determined to oppose any cut in domestic spending. More often than not, both get what they want, at the price of a larger national debt.

To be sure, politicians often express their concern for future generations: conservatives talk of “family values,” liberals of “environmental stewardship.” But when the moment comes for them to specify, in dollars and cents, what they are willing to sacrifice so as to avoid imposing heavy debts on future generations, politicians on all sides have little to say. (Conservatives especially are guilty of unseemly hypocrisy when they shun all tax hikes in favor of vast spending cuts—but then offer nothing more specific than unenforceable “caps.” Liberals do something similar when they make exaggerated claims about the increases in revenue that will result from “taxing the rich.”) Huge fiscal burdens are now being shifted to the citizens who will grow up in the next century. Nowhere is this unacknowledged transformation—this replacement of intragenerational burden-sharing by intergenerational burden-shifting—more marked than in our acquiescence in the huge growth in entitlement expenditures.

  1. 1

    This lack of urgency is reflected in the recent testimony of Alice Rivlin, deputy director of the Office of Management and Budget, that “we don’t have an administration policy on longrun fiscal policy at the moment.” It is also reflected in Clinton’s fiscal year 1995 budget, which seeks to lock in last year’s deficit reduction targets, but offers no further savings apart from his controversial health reform proposal. Yet his proposal may well mean a larger deficit. According to the Congressional Budget Office (CBO), the President’s Health Security Act would add $136 billion to the current baseline deficit. And the CBO would have projected much larger increases in the deficit if its calculations had not assumed that the health plan’s limits on insurance premiums will be politically enforceable. The CBO admitted that this assumption is a difficult one to accept—especially because most projections of health-care costs have so seriously underestimated actual costs in the past, and because the public has not been informed of the sacrifices that may be necessary to comply with overall limits on premiums. I share the CBO’s concerns about whether the premium limits (and benefit “caps”) in the President’s plan are workable, and have argued elsewhere that it is doubtful the administration’s overall approach to cost containment can succeed. See “For Health Insurance, with No Frills,” The New York Times Magazine, January 16, 1994.

  2. 2

    All budget projections in this article follow the official January 1994 CBO projections through 2004. Thereafter—for Social Security, Medicare, and Medicaid—they adhere to the “intermediate” long-term 1993 scenarios calculated and published by the Social Security and Health Care Financing Administrations. Net interest outlays assume that the average interest rate on publicly held federal debt holds steady at 6.0 percent (with inflation at 2.5 percent), which is a direct extrapolation of the CBO forecast. Revenues and all other outlays are assumed to remain constant as a share of GDP.

  3. 3

    It is a figure, moreover, that is scheduled to be exceeded each and every year after 2020. As for our previous record, as soon as the emergencies of depression and world war were over, the federal government pursued a deliberate policy of budget balance, and from the late 1940s through the early 1970s, the national debt shrank steadily as a share of the economy.

  4. 4

    By saying “most likely,” I don’t mean to imply that these projections depend entirely on forecasts about the future. We know, for example, that 95 percent of all Social Security benefits payable during the next seventy-five years will go to people already alive (and therefore countable) today.

  5. 5

    From 1973 to 1993, for example, the average annual growth rate in the real wages of workers covered by Social Security has been virtually stagnant at only 0.45 percent. The surge in productivity of the past two years, it’s true, has led some economists to speculate that we may now be experiencing a turn-about that goes beyond the cyclical improvement in productivity that typically occurs during this phase of an economic expansion. Yet even if we imagined that this sudden jump in US worker productivity points toward a permanent doubling in the future growth rate of real wages (to 0.90 percent per year), this still remains below the official long-term assumption employed in the intermediate Social Security Administration forecast (1.10 percent per year). Similarly, the SSA assumes that longevity at age sixty-five will, during the next century, grow at only half the rate (in years of life expectancy per year) at which it has actually grown over the past twenty years. Though longer life spans are to be welcomed, we cannot remain indifferent to the extra fiscal burden ever-lengthening retirements pose for working-age taxpayers.

  6. 6

    It is sometimes asserted that our entitlements problem is almost entirely a problem of health-care costs, and that cash-benefit programs, particularly Social Security, are paying their way, and hence should be exempt from reform. But this is nonsense. Although rising health-care costs are now the main reason that entitlement expenditures are growing faster than the economy, any benefit program contributes to the deficit when spending more on it would enlarge the deficit and spending less on it would reduce the deficit. The fact that Social Security has a current cash surplus is, moreover, quite misleading. To date, the retirement and disability components of Social Security have promised over $7 trillion (discounted) in benefits to today’s workers in excess of their scheduled payroll taxes plus the value of the system’s “paper” trust funds. To cover projected expenditures, the Social Security cash-benefit system would require a payroll tax rate of 16.6 to 21.5 percent of taxable wages by 2040, up from a cost rate of 11.6 percent of payroll today.

    A related contention is that reform of our health system can be expected to erase the projected long-term growth in federal health benefits, thus obviating the need for entitlements reform. But this too is nonsense. Even if we could miraculously limit the growth in per capita health-care costs for people at every age to the growth in per capita GDP, the rising share of the elderly in the total population, as well as the rising average age of the elderly population itself, would mean a continued increase in the cost of Medicare and Medicaid as a share of the economy. A calculation by the Health Care Financing Administration suggests the magnitude of the extra costs. If the United States today had the much older age profile that is projected for 2040, total health-care spending would be over 25 percent higher. Meanwhile, the cost of Medicare as a share of covered workers’ wages would be 73 to 110 percent higher. Thus, owing to demographics alone, we could expect the total cost of Social Security and Medicare (Parts A and B) to rise from 17 percent of each worker’s taxable payroll in 1993 to somewhere between 26 and 33 percent by 2040.

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