Entitlement Reform Remains an Absolute Necessity

Published June 14, 2016


Despite what presidential candidates Donald Trump and Hillary Clinton have been saying on the campaign trail, the need to reform the nation’s major entitlement programs cannot be wished away.

The primary cause of the nation’s fiscal problems, now and in the future, is the rapid rise in entitlement spending. In 1970, spending on Social Security and the major health care entitlement programs was 3.6 percent of GDP. In 2015, spending on these programs was 10.3 percent of GDP. By 2040, CBO expects spending on these programs to reach 14.2 percent of GDP.

Federal debt now stands at 74 percent of GDP — well above the historical norm for peacetime. As recently as 2008, federal debt was equal to just 39 percent of GDP. Federal debt is expected to rise rapidly in the years ahead as the population ages and the escalation in health care spending exceeds economic growth. The Congressional Budget Office (CBO) projects the debt will exceed 100 percent of GDP in 2040, and that assumes cuts in defense and Medicare payments that are unlikely to occur. An alternative and more realistic scenario shows federal debt surpassing 100 percent of GDP in 2030.

While entitlement reform is needed to put the federal government’s finances on a more stable foundation, it cannot be sold to the public on that basis. Voters are concerned about the nation’s budgetary problems, but they are even more worried about their own economic security. Therefore, reforms must be seen by the public as ensuring the major entitlement programs can meet their goals into the future because they can be sustained financially.

Over the past several months, I worked with four colleagues — Andrew Biggs and Robert Doar of the American Enterprise Institute, Ron Haskins of the Brookings Institution, and Yuval Levin of the Ethics and Public Policy Center — to draft an entitlement reform plan that would ease federal budgetary pressures over the medium- and long-term with reforms that would increase the effectiveness and efficiency of the major entitlement programs.

We based our reform recommendations on three themes:

  1. Personal Responsibility for Retirement Savings. Most working-age households with middle-class incomes (or higher) can save and provide for their own retirement without overreliance on a government program. Hence entitlement reform should proceed on the assumption that limited public resources should provide a solid safety net against poverty in old age, while those who can afford to save for their own retirements should be expected to do so.
  2. Market Discipline in Health Care. Slowing cost escalation in health care without undermining the quality of care requires higher productivity and more efficiency in how care is provided to patients. That can be achieved only by injecting market discipline throughout the health system, including in the major health entitlement programs.
  3. Promotion of Work. Much of the federal safety net is designed to help households with inadequate earned income. But the safety net becomes counterproductive when programs discourage work and thus create unnecessary dependence on public support. Our recommendations promote work in all programs and circumstances.

These three themes helped guide the reforms we developed for Social Security, health care programs, and the safety net for lower-income households.

Social Security 

The current Social Security program provides benefits to nearly all retired Americans, including those with higher incomes, based on their preretirement earnings. But Social Security does a poor job of preventing poverty in old age. Hence we should move toward providing a universal flat benefit, set initially at the federal poverty line, to all U.S. residents age 65 and older. In effect, Social Security would become a guarantee against poverty in old age, rather than a program for partially replacing preretirement earnings for middle- and high-earning households. There would be a long transition from the current formula to the new benefit to ensure that no one loses accrued benefits.

Middle- and upper-income workers could replace expected reductions in their Social Security benefits with additional private savings, facilitated with reforms promoting automatic 401(k) enrollments and simplified plans for small employers. The 12.4 percent Social Security payroll tax would also end at age 62, thus removing a major disincentive to continued work at older ages.

Health Care 

With the passage of the Affordable Care Act (ACA) in 2010, the federal government assumed significant responsibility for the nation’s system of health insurance and health care. Over time, this will result in lower-quality medical care.

The ACA should be replaced with a program with much less regulation. In our plan, employer coverage would remain the dominant form of coverage for working age Americans and their families, with no mandates or requirements. The “Cadillac” tax of the ACA would be replaced with a more rational upper limit on the federal tax preference for employer plans. Any household without access to employer coverage would get a tax credit (refundable for those with low incomes). The credit could be used to enroll in any state-approved plan. People who stay continuously insured would be protected against high premiums or restricted coverage based on previous episodes of expensive care.

The Medicare program would be converted into a premium support program, with a fixed level of support that beneficiaries would use to offset the cost of plans of their choosing. Medicaid would be separated into two components — one for the able-bodied and children and the other for the disabled and elderly — and converted into fixed, per capita federal payments to the states for the two enrolled populations. States would have substantial flexibility to manage the program according to their preferences.

Finally, the rules for enrolling and contributing to health savings accounts (HSAs) would be liberalized to encourage widespread participation, thus bolstering the consumer’s role in the marketplace

Safety-Net Programs 

The federal government spends about $400 billion annually to fight poverty (not counting health care programs), with unsatisfactory results. A major impediment is the lack of coordination among the many federal and state initiatives that have been created over the years. Accordingly, reforms to safety-net programs should emphasize work as the key to improved economic prospects, greater state control over resources to allow for innovation and coordination, and the elimination of wasteful spending.

Two major reform concepts — block grants and wage subsidies — should be tested at the state level. States could opt to receive a large portion of existing federal funding in flexible and consolidated federal grants, based on historical spending patterns. They could then design better-coordinated programs that move as many beneficiaries as possible into employment. Some states would also be allowed to use the funding to provide direct wage subsidies to lower-income households, effectively giving them a raise that the beneficiaries would see directly in their paychecks. The federal government would help facilitate the testing of this reform.

Planning for the Future

These reforms are not intended to create budgetary balance in the short-run. Large-scale change cannot be implemented in the major programs without significant transition periods, which means the reforms need to be enacted soon to reduce costs in fifteen, twenty, and twenty-five years.

Skeptics may say it’s pointless to worry about fiscal problems that are more than twenty years off. They’re wrong. Projected deficits undermine confidence in the future health of the economy: private actors are encouraged to plan for the worst and focus on the short-term rather than investing for the long haul. The result is a misallocation of resources that undermines long-term economic growth.

Entitlement reform is not optional, and it needn’t be feared by voters. Done right, reform can strengthen the safety net and provide even better protection for the most vulnerable in society. Delay, however, could be catastrophic. If we wait until a crisis is upon us, it will no longer be possible to design reforms with gradual adjustments; the cuts would be blunt and disruptive.

Neither presidential candidate seems poised to provide the leadership necessary to move entitlement reform forward next year. That makes it all the more important for Congress to keep pressing for reform, despite the many obstacles. Entitlement reform is an absolute necessity, as will soon become evident to everyone, one way or another.

James C. Capretta is a senior fellow at the Ethics and Public Policy Center and a visiting fellow at the American Enterprise Institute.

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