America's post-war prosperity has been a wonder of the modern world. Flexible and adaptable labor and capital markets, a culture that values entrepreneurial initiative and risk-taking, and an openness to the increasingly global economy have all helped create the wealthiest society in history. Above all, though, America owes its bounty to its vast and robust middle class: a skilled, efficient, and ever-expanding work force upon which American companies have built immense success.
The severe economic contraction of the past year has left many Americans wondering if we are witnessing the end of this age of affluence. Far more than other recent recessions, the present crisis appears to have exposed underlying weaknesses in our economic foundations, and has involved failures of institutions long taken for granted. These failures were not simply the result of the burst housing bubble and credit meltdown; the financial crisis was the straw that broke the backs of long-teetering giants. Americans have now been left to ask if our entire economic system might be similarly vulnerable. If General Motors can collapse into a heap, what other pillars of our post-war order may yet fall?
That question is hardly trivial. In fact, the downfall of GM in particular — which has been very long in coming — offers a disturbingly apt metaphor for America's post-war economic order. At the height of its success, GM understood that the company's booming growth depended on its large and able work force. And this realization — together with effective lobbying by the unions representing those workers — led to an extensive array of worker entitlements, ranging from generous health-insurance coverage to comprehensive retirement pensions to job-security guarantees.
Premised on the growing labor and consumer markets of the boom years, these arrangements over time began to weigh down the company. But once offered, the benefits proved almost impossible to roll back — and rather than make the difficult choices involved in revising longstanding contracts and face unhappy workers and unions, the company pretended its books could somehow fall into balance by magic. The old joke that GM was a health-insurance company that made cars on the side increasingly became the company's grim reality. As its commitments grew while its profits shrank, GM became unsustainable.
Over the same period, the United States government came to a similar arrangement with the country's growing and industrious middle class. To offer some security to the workers powering America's prosperity, a series of entitlement programs took shape, aimed especially at providing for retirement income and health-care expenses. These programs' finances were built on demographic and economic trends that could not have been expected to go on forever; yet even as their underlying logic has grown obsolete, these arrangements have proven extremely difficult to change. Today, America's political leaders are essentially in the position that GM's management was a decade or two ago: They have made a contract with the middle class that now threatens to bankrupt all involved, but seem unable to do anything about it.
The dire consequences of failing to change this arrangement are clear. According to the Congressional Budget Office, the trajectory of spending laid out in President Barack Obama's first budget would push the nation's debt to 82% of gross domestic product at the end of 2019 — up from 41% at the end of 2008. (And that's before the retirement of the Baby Boom generation hits with full force.) Politicians of both parties routinely decry this mounting debt and urge a thorough scrubbing of the budget. But while there is certainly much fat to trim around the edges, the great bulk of America's debt burden will come from three key entitlement programs: Medicare, Medicaid, and Social Security — the core of the middle-class contract.
For perspective, consider that in 1970 — just a few years after Medicare's enactment — the defense budget stood at 8.1% of the nation's economic output, as measured by GDP. Combined spending on Social Security, Medicare, and Medicaid, meanwhile, stood at 3.9% of GDP. But in 2019, almost a half-century later, defense is expected to fall to about 5% of GDP, while the big three entitlement programs will approach 12%. By 2050, they will exceed 18% of GDP — which is about the historical average of total revenue collection each year. The U.S. government, like GM today, will then be mainly in the business of providing health and pension benefits, and will struggle to perform its other basic functions — maintaining a standing army, for example — on the side.
The paradox of our entitlement system is that although it is designed to mitigate risk at the individual level, it is now creating a massive economy-wide risk. For years, economists across the political spectrum have been warning that unconstrained federal borrowing will ultimately leave the country unable to issue debt at favorable and affordable rates of interest. When that point is reached, there will be little choice but to embark on a long period of painful fiscal contraction and austerity, with deep and immediate cuts in benefits and steep rises in taxes.
Like any large political undertaking in our democracy, our entitlement system depends on the loyalty and support of the broad middle class. It is, after all, fundamentally an arrangement with middle-class voters. Its benefits accrue largely to them (with the exception of Medicaid, which nonetheless exists only because of their backing). And the consequences of the system's fiscal decline — especially the tax burden required to contend with it — will affect the middle class above all, and through them the larger economic engine they make possible.
To sustain American prosperity and pass along a healthy economy to the next generation, the middle-class contract of the post-war years must be revised. Our entitlement programs need not be abolished — but they do need to be reformed so that they are economically viable, and bolster a thriving free-market economy instead of undermining it. For such an overhaul to happen, middle-class voters will need to be persuaded that change is necessary, and that it can be undertaken rationally, responsibly, and fairly. This may be the foremost political challenge of our time.
DEMOGRAPHY IS DESTINY
Social Security, the oldest of our major entitlement programs, aims to provide retirees with a modest income — partly as insurance against poverty in old age, but also to see to it that retired workers receive a base pension bearing some relation to what they earned in their working years. The program is funded by a dedicated payroll tax of just over 12% (half of which is paid by the employer, and half by the employee). This tax has risen significantly over the years — today's rate is roughly twice what it was in 1960 — as have Social Security benefits. Although the program is designed to resemble a pension savings plan — in which workers put aside money through taxes and then receive it when they retire — Social Security is in fact a “pay-as-you-go” system: Tax payments from current workers finance benefits for current retirees.
There is a mathematical limit to what any pay-as-you-go pension system can churn out in benefits, as the implied real rate of return for the average worker over the long run cannot exceed the sum of population growth and real productivity improvement in the economy. Put simply, what comes in must keep pace with what goes out. In practice, this means that what will be affordable in the future will depend entirely on the size of the future work force relative to the size of the retiree population, and on the capacity of that work force to produce marketable goods and services.
The world's richest economies still have the ability to grow through improved productivity, but the sizes of the working and retired populations are another matter en
tirely. Since the 1960s, the developed world — and now even newly emerging economies — have seen unprecedented declines in fertility just as life expectancies have risen. We are living much longer than ever before, and having far fewer children.
In 1940, men who reached age 65 — the first year of eligibility for Social Security retirement benefits — could expect to live to about age 77. Today, a man turning 65 will live, on average, to age 82. At the same time, birth rates have plummeted. In 1955, at the height of the Baby Boom, the average American woman had 3.5 children (the so-called total fertility rate, or TFR). Today, the U.S. TFR has fallen to 2.1 — just barely enough to prevent population decline.
To be sure, the problem is far worse in other countries. Germany, Italy, and Spain all have TFRs below 1.5. Japan's has fallen to an astonishing 1.27. Between 2010 and 2050, Japan's working-age population is expected to decline by nearly 33 million people, or almost 40%.
But even in comparatively fertile America, rapid increases in our retiree population combined with dwindling growth in the number of workers will put tremendous pressure on government finances and overall economic performance. Between 2010 and 2050, the number of Americans aged 65 and older is expected to more than double, growing from 40.5 million to 81.6 million. Meanwhile, the working-age population — those persons between the ages of 20 and 64 — will increase by only 37 million. The result is a large decrease in the all-important measure of pay-as-you-go pension viability: the ratio of workers to retirees. Between 2010 and 2050, it will decrease from about five workers for every retiree to about three.
This demographic shift makes the mathematics of Social Security simply unsustainable. And the first serious problems are very near at hand. The program's trustees now project that the Social Security trust fund will run cash deficits (that is, will take less in through taxes than must be put out in benefits) every year after 2016. The outlook only gets worse over time: Social Security's projected unfunded liability is a whopping $5.3 trillion over the next 75 years.
Faced with massive imbalances in their state-run pay-as-you-go pension schemes, some other countries are trying to close the gap with payroll-tax increases on the current generation of workers, in the hope that more revenue will lessen the pressure for unpopular benefit reductions for current retirees. The Japanese government, for example, has begun a nearly five-percentage-point increase in that country's payroll-tax rate, phased in between 2004 and 2017.
But these kinds of tax-heavy solutions are counterproductive because they will exacerbate the trends causing the pension imbalances in the first place. The primary problem in these pension systems is that birth rates have fallen, so that the work force is simply too small to carry the full weight of an unreformed pension entitlement. And overly large pay-as-you-go pension programs are themselves one of the reasons for suppressed fertility. A large body of economic research confirms that the countries with the most expensive state-run pensions have seen the sharpest drops in birth rates. A 2005 study by economists Michele Boldrin, Mariacristina De Nardi, and Larry Jones found that a government-run pension system equal to 10% of a country's economy correlates with a reduction in the TFR of between 0.7 and 1.6 children, after controlling for other variables. Why? A plausible explanation is that, in earlier times, couples “invested” in children to help care for them in old age. The advent of expensive social-insurance arrangements reduced the after-tax resources a family had to raise children, while also lessening the economic need for them.
Raising payroll-tax rates to close a Social Security financing gap is therefore the last thing our country should do. The only long-term solution to an aging population is higher birth rates — and to the extent that government can play a role in encouraging these, it is by helping younger families with the costs of raising children, not raising taxes on their earnings. The Social Security crisis is a function of a larger demographic challenge now faced by every developed nation. A reformed old-age entitlement will need to take account of this reality and, where possible, try to address it.
THE HEALTH-CARE COST PUZZLE
Medicare — the health-care entitlement program whose enrollees largely overlap with those receiving Social Security benefits — is naturally burdened by the same demographic shifts that are pushing the old-age pension program toward insolvency. But Medicare also suffers from another vexing problem: rapid growth in health-care costs. While Social Security provides a cash benefit, Medicare pays for a service — and the price of that service has been skyrocketing for decades.
CBO has estimated that, between 1975 and 2005, annual Medicare per capita costs rose, on average, 2.4 percentage points more rapidly than per capita GDP growth. Medicaid's costs, meanwhile, have grown 2.2% faster than GDP, and privately funded health-care costs have grown 2.1% faster than GDP.
Combining escalating health-care cost inflation with the retirement of the Baby Boom generation makes for a budgetary nightmare. Between 2010 and 2040, CBO expects the combined costs of Medicare and Medicaid to increase from 4.9% of GDP to 10.6%.
President Obama and his aides have increasingly argued that the only way to “bend the cost curve” of Medicare is to enact comprehensive health-care reform with cost-cutting measures that can be applied across the system. That argument has some appeal; after all, Medicare buys services for its enrollees from more or less the same hospitals and physicians who take care of everyone else. And with roughly 15% of the population lacking stable health coverage, cost-cutting in the absence of a universal insurance arrangement would risk being unfairly imposed on those with the most tenuous access to care.
But upon closer scrutiny, this approach actually seems to have things backward. Yes, there is an aspect of cost escalation that is traceable to variables outside the government's control. Rising wealth and medical discovery are fueling the demand for more and better treatments (and that should not be resisted in any event). But there is widespread agreement that costs are also high and rising in significant part because of gross inefficiencies in how we pay for health care.
Here, the chief culprit is the federal government itself. The vast majority of Americans get their insurance through one of three sources: Medicare for retirees, Medicaid for the poor, and job-based insurance for workers and their families. In each instance, federal policy is driving up costs unnecessarily.
In the case of Medicare, most beneficiaries are enrolled in the program's traditional “fee-for-service” insurance arrangement. Medicare FFS allows enrollees to see any licensed service provider, with no questions asked. Medicare does require substantial cost-sharing — including a 20% co-pay to see a physician, and a deductible of more than $1,000 per hospital admission. But this is ineffective, because about 90% of the enrollees also have some form of supplemental coverage, which pays for what Medicare does not. Thus, in most instances, more care does not cost Medicare beneficiaries any more money.
It's not surprising, then, that the Achilles' heel of Medicare is volume. According to CBO, the real price Medicare paid for physician fees dropped between 1997 and 2005 by nearly 5%, but total spending rose 35% because of rising use and more intensive treatment.
Employers have been trying for years to move away from Medicare-style FFS in favor of steering patients to higher-quality, lower-cost networks of service suppliers. The private sector is also well ahead of the federal government when it comes to disease management and wellness efforts. But employers can only d
o so much when Medicare, the dominant payer in most health-care markets, pushes in exactly the opposite direction. Because Medicare will finance unlimited use, many individual practitioners and institutions see no reason to give up their autonomy and join an organized delivery model. All manner of ancillary service providers — labs, home health agencies, hospices, and others — also survive as stand-alone operations because of Medicare's open network and provider-centric payment systems.
The cost of this escalating use of services in Medicare is felt mainly by current taxpayers, not the program's enrollees. Current retirees qualified for the hospital coverage the program provides long ago. They do not have to pay any additional premium for that coverage in retirement, even though actual costs are well above what was projected when they were working. Current beneficiaries do pay a premium for physician and outpatient coverage, but it covers only 25% of the total cost. The other 75% is automatically drawn from the U.S. Treasury.
The Medicaid program, meanwhile, fuels growth in health-care costs because it is financed with a flawed system of federal-state matching payments, with no limit on the amount that can be drawn from the Treasury each year. For every dollar of Medicaid cost, the federal government pays, on average, 57 cents; the states pick up the rest. But it's the states, not the federal government, that call the shots in the program's management: They determine who is eligible for what, and how much to pay hospitals and doctors for services. Under this arrangement, if governors or state agencies want to reduce Medicaid's cost to their budgets, they have to cut the program by $2.30 to save $1.00 — because the other $1.30 belongs to the federal government. Paying the full political price for benefit cuts while getting less than half the economic benefit obviously does not appeal to most state politicians. So instead, they spend most of their energy devising ways to maximize what they can get from the federal government while minimizing the state contribution.
The private insurance market, in which most Americans get their health coverage through an employer, is also far from immune to price distortions caused by government policy. The federal tax treatment of private employer-sponsored coverage fuels serious cost escalation system-wide. Today, employer-paid health-insurance premiums do not count as taxable income for workers. No matter how expensive the health-insurance premium, if the employer is paying, it is tax-free to the worker. Employees thus have a strong incentive to take more and more of their compensation in the form of health coverage instead of cash wages. For every dollar spent by his employer on health insurance, a worker gets a full dollar of health coverage; but when the same worker gets paid in cash, a large portion is sent to the government in taxes.
The favorable tax treatment of job-based insurance was instrumental in spreading private coverage to working-age Americans in the post-war period. It has been a crucial part of the middle-class contract. But because the tax subsidy has no limit, it has also encouraged overly expansive insurance, with lower deductibles and looser networks than would otherwise have developed. Economizing in health care is hard enough under the best of circumstances; if a company and its workers are only going to keep 50 to 60% of what they save, they are going to be much less vigorous in their search for savings.
When you put it all together — Medicare's fee-for-service program and insulation of beneficiaries from rising costs, unlimited federal funding for state-run Medicaid plans, and an open-ended tax subsidy for employer-paid insurance premiums — it is not surprising that health-care costs are rising rapidly in the United States. The vast majority of Americans are in health-insurance arrangements that are heavily subsidized by the federal government. When premiums rise, much of the added cost is shifted to the Treasury. And when someone else is paying even part of the tab, demand for services always rises.
The combination of the demographic variables buffeting Social Security and the distortion of health-care costs caused largely by Medicare, Medicaid, and the tax treatment of employer-based health insurance makes for a very grim prognosis. The case for mitigating the risks middle-class families face has not grown weaker, but the system we have built for doing so must be transformed.
One obvious component of an entitlement-reform strategy is an emphasis on later retirement and longer working careers. Americans are living much longer than they did when Social Security and Medicare were enacted, and longevity is expected to increase for the foreseeable future. Current projections therefore assume that Americans will spend an ever greater portion of their lives out of the work force and in retirement, placing ever-growing pressure on public finances.
Ironically, some of the largest impediments to continued work by those in their sixties and seventies are embedded directly in the rules governing our entitlement programs. They are implicit in the middle-class contract.
For example, Social Security benefits are based largely on the first 35 years of work, and any earnings beyond the 35-year mark get counted only if they are higher than an amount credited in a previous year. But most people hit 35 years of earnings in their fifties, and if they are winding down their careers, their wages during their last years of work may fall well below what they earned in younger days.
What's more, older workers pay the full Social Security and Medicare payroll taxes — a combined 15.3% on wages, split evenly by employer and employee — even after they have signed up for benefits. In most instances, they get nothing in return for paying these added taxes. This is especially true in the case of Medicare, as the entitlement is unrelated to payroll-tax contributions and is conferred after just ten years of work.
Medicare also discourages continued work by older Americans with its “secondary payer” rules. A 1982 law requires employer-sponsored insurance to cover medical bills first, before Medicare pays for any costs incurred by someone enrolled in both the employer's plan and Medicare. This provision greatly increases health-care costs for employers with seniors on their payroll, and they have responded quite predictably by cutting the wages they are willing to pay such workers. This requirement of primary coverage by job-based insurance imposes an implicit tax on wages ranging from 15% (for men at age 65) to 60% (for women at age 80).
Given these strong disincentives to work, it is hardly surprising that most seniors choose not to. Today, just under 30% of men aged 65 to 69 remain employed, down from 46% in 1960, when men died at much younger ages.
The point of changing these features of our entitlement programs is not to create a situation in which seniors have to work, but to end the powerful disincentive to do so. Making it easier for older Americans to work longer if they wish would significantly improve the financial prospects of our entitlement system.
WORK, FAMILY, AND CONSUMER CHOICE
Creating a genuinely sustainable middle-class contract, however, will require more significant reforms that get to the core logic of our entitlement system, and reward greater self-reliance through work, family formation, and cost-conscious consumption of health care.
In this regard, a good place to start is President George W. Bush's 2005 effort to introduce voluntary personal accounts into Social Security. Fully funded personal accounts would avert fiscal disaster because they would explicitly limit what gets paid out to the amount that gets paid in. Instead of an opaque benefits formula determined by government, personal accounts pay pension annuities based on the actual accrued balances in workers' accounts at retirement. Such accounts would a
lso improve work incentives, as every dollar contributed would add to an annuity in retirement.
Clearly, moving from a mature pay-as-you-go system to funded accounts raises difficult transition problems. Directing payroll-tax contributions to non-governmental, individually owned accounts would mean reduced receipts for the Social Security trust funds, and, very likely, more federal borrowing. It is entirely plausible that such a reform would actually raise overall national savings, as the amounts in the personal accounts would offset federal borrowing. But the great uncertainty of requiring trillions of dollars in new federal borrowing at a time of existing fiscal stress proved to be an insurmountable obstacle to the Bush effort. In any case, the prospects for personal accounts during a period of Democratic dominance in Washington are dim. And justifiably or not, recent market turmoil has also reduced the public's appetite for such a move.
There is, however, another way to introduce greater personalization, budgetary control, and incentives for continued work into Social Security without transition costs. Several other countries — most of which have faced more severe imbalances than those currently projected for our Social Security system — have adopted a form of personal accounts within a pay-as-you-go structure. The idea, called “notional defined contribution” accounts, is to track worker “contributions,” assign “investment earnings,” and report “account balances” — but without actual money attached to the accounts. Pensions for current retirees are still financed on a pay-as-you-go basis, with payroll taxes collected today used to cover benefits today. But payments are calculated based on the worker's own individually assigned account, which is converted into a monthly benefit much as the balance in a 401(k) can be used to purchase an annuity. The retirement benefit is set at the amount that would, when drawn monthly, deplete the worker's “account” over his expected remaining lifespan.
Even without full funding, personalization of this kind would still vastly improve work incentives. The only way workers could boost their future pension entitlements is with higher wages and more “contributions” to their notional accounts. For older workers, automatic reductions in monthly benefits for an early work-force exit would encourage more people to stay active and delay retirement.
Notional personal accounts also lend themselves to permanent solvency and budgetary control. The key variable is the notional rate of return, which is used to inflate the “investments” in the personal accounts. Because it remains a pay-as-you-go system, that return must be limited to what population growth and productivity allow. In fact, the Swedish version of this approach explicitly ties the rate of return credited to notional accounts to observed trends in demographics and real economic growth. If, for instance, the size of the work force were to fall below expectations, the annuity calculation would be adjusted automatically to cut monthly payouts — thus ensuring that notional account balances are not overdrawn.
Yet even if a notional account system were imported into our Social Security program, the problem of relatively low fertility and a rising ratio of retirees to workers would not go away. There is not much that entitlement reform alone can do to address this larger social trend, of course. But some modest steps could at least send the right message, and perhaps also influence behavior. Under our current entitlement system, for instance, two families with identical earnings records — one with children and the other without — would get the same Social Security benefit; it doesn't matter that one carried the burden of raising members of the next generation of workers, while the other did not. Pay-as-you-go pension systems cannot long survive without a steady stream of new entrants, so it only makes sense for such schemes to explicitly and transparently reward parents for doing what is essential for the viability of the system (and, for that matter, of society in general). In the context of a reform that introduces notional personal accounts as the basis for calculating benefit payments, this could be done by providing rebates against contributions, or additions to account balances, commensurate with the costs of raising children.
The primary argument against this kind of vision for Social Security reform is that it would necessarily limit the redistributive aspect of the current program. Low-wage workers today get a higher rate of return on their contributions than their higher-wage counterparts. This advantage would be lost if benefits were tied completely to personal accounts funded entirely by worker contributions. But a switch to notional personal accounts could be supplemented with any number of additional explicit subsidies for low-wage workers to replicate the outcomes associated with today's defined-benefit formula. For instance, workers with lifetime earnings below a certain average could get supplemental contributions to their accounts financed out of general revenue. This would have the advantage of transparency and budgetary control, and, structured properly, less of a distorting effect on retirement decisions than today's opaque benefit formula.
Medicare, too, would benefit from adjustments that take account of demographic realities, like a modest increase in the age of eligibility from 65 to 67. But even more important is a concerted effort to slow the pace of rising costs per enrollee, and of health-care costs more generally. In that regard, there really are only two choices: artificial cost constraints imposed by the government (like those employed in many other industrialized nations today), or cost-conscious consumer choice in a decentralized marketplace.
President Obama and the congressional leadership have clearly signaled their preference. They have pledged repeatedly to constrain the growth of government health-care spending. But, to date, they have not admitted that what they ultimately have in mind are limits on spending enforced with price-setting or fixed budgets, which would result in painful and arbitrary rationing of care. Instead, they argue that the government can slow the pace of rising costs system-wide with smarter interventions: more federally financed health information technology, additional research funded by the government into what treatments work best, and some changes in the way Medicare pays for services.
There are two glaring problems with the idea that the government has the capacity to engineer a more efficient health system this way. First, independent analysts, including those at CBO, have already said that these kinds of reforms are unlikely to produce deep and lasting savings absent more fundamental changes in the financial incentives that drive patient and provider behavior. Second, the government has been running Medicare and Medicaid for nearly half a century, and that experience demonstrates that government micro-management of health insurance is highly inefficient. Instead of building a network of high-quality preferred providers, political control of Medicare has resulted in an open network that pays all licensed providers exactly the same fee, regardless of the quality of the care provided. And the only cost-cutting remedy Congress can ever seem to pass is a fee reduction. If applied more systematically across all of health care, such price-setting would, in time, lead to a reduction in willing suppliers of services, to waiting lists, and to government-driven rationing of care.
The alternative is a functioning marketplace in which consumers choose their insurance and the services they use, and so become far more conscious of the costs of their choices. An essential feature of such a marketplace would be fixed, rather than open-ended, subsidization of insurance by the government. That would mean the conversion of today's Medicare entitlement — as well as of the tax break for employer-sponsored insuranc
e, and even of Medicaid — into limited defined contributions toward the purchase of insurance. With fixed contributions, a consumer who wanted to buy more expensive coverage would have to pay more. Conversely, anyone willing to economize and choose a plan with more controls and a tighter network would keep the money he saved. (Such a switch in Medicare could be phased in with new retirees to prevent disruption for those already in the program.)
Opponents argue that this kind of reform would be dangerous for the middle class, and especially for Medicare recipients, because health-care costs would rise faster than the premium subsidies. But with a functioning marketplace, there would be much greater pressure on doctors and hospitals to reorganize themselves into more convenient, cost-effective, and patient-focused systems of care. It is far more likely that the inefficiency in health care the president so often mentions would be reduced through the power of consumer choice than through bureaucratic regulation.
Reforms of this sort could help bring our entitlement system into line with economic and demographic realities, so that these programs — and the larger economy so heavily influenced by them — could continue to function. America does not face a choice between our march toward fiscal disaster and leaving the elderly and the poor to fend for themselves. Rather, we face the challenge of revitalizing our entitlement system to make it what Americans once hoped it might be: an affordable safety net for those times when the people who have engaged in the work of American prosperity can no longer meet their current needs with their current income.
A NEW MIDDLE-CLASS CONTRACT
The politics of middle-class entitlements has made it extremely difficult to change America's fiscal course, even as it has become increasingly clear that this course leads to ruin. No politician wants to be the first to suggest serious reforms, and be left vulnerable to caricature as an enemy of the middle class. Those who have gotten over their fears and given it a try have failed to solve the problem, and almost without exception have been badly burned in the attempt. Their failures have only reinforced the notion that pushing serious reforms requiring genuine change or sacrifice is political suicide. Washington is littered with the lengthy reports and analyses of previous reform efforts, all of which were launched with great fanfare but came to nothing: the -Kerrey-Danforth Commission of 1994, the Breaux-Thomas Commission in 1999, President Bush's Social Security Commission (and the ensuing reform push in 2005), just to name a few.
All have run into the same wall of resistance, consisting of the lobbies built up around our entitlement system and the disinclination of the political class to make changes in popular programs. Above all, reform has been stymied by the lack of interest among middle-class voters in altering a system they have come to rely upon — and only a change on this front could make a meaningful difference. The groups that represent the beneficiaries of the current system are not about to step aside, and our politicians are not about to turn courageous. They will act only if their voters want them to.
This might make the case seem hopeless. After all, why would voters willingly sacrifice benefits they have come to expect, and believe they have earned? Nothing in our recent political history suggests that any such willingness is likely to emerge. But we are living in strange times, and proponents of entitlement reform should not miss the opportunity created by the unprecedented economic challenges and political responses of the past few months. In the crisis that began in late 2008, the American public got a taste of economic calamity like nothing we have witnessed since the Great Depression — when the first inklings of today's middle-class contract appeared. Policies that would have seemed unthinkable just a few months earlier — from massive government expenditures to save our banking system, to federal ownership of large corporations — were implemented in swift succession.
Some liberal politicians, including the president, have sought to use this moment of instability — when all past certainties seem suddenly in question — to advance their longstanding agenda and expand the role of the state in health care, energy, education, and other sectors, taking on new spending commitments and in effect exacerbating the dangers of the old middle-class contract. As Obama's chief of staff, Rahm Emanuel, said in November 2008: “You never want a serious crisis to go to waste.”
But the shock of the economic crisis may also make Americans more open to serious entitlement reforms that Emanuel, President Obama, and many other Democrats have long resisted. The logic of the case for reform is much like that of the case for the recent emergency interventions: the need for a bold response to an enormous problem, aimed at regaining some equilibrium and allowing again for sustainable economic growth and prosperity. This is the time to explain to the public just how grave the prospects for our entitlement system — and therefore for our larger economy — really are, and to argue for a serious and sensible change of course.
The impulse to insulate the middle class from the cost consequences of their choices — an impulse that has defined our longstanding middle-class contract — has done great harm and stands to do far more. The remedy must be to redesign our entitlements so that the choices the middle class makes in terms of work, family, and health care will promote more productivity, efficiency, and wealth, rather than the shrinking of the labor force and the growth of government.
Done right, a new arrangement would both strengthen our fiscal outlook and improve the economic standing of American families. The path to such a new arrangement will not be without its costs, but it will surely yield great benefits. The new middle-class contract would still work to mitigate risks and would still care for the old and the needy, but it would do so in ways that encourage personal responsibility, respect individual choice, and foster the work ethic that has made America's middle class the backbone of an unrivaled age of prosperity and strength.