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The table illustrates the long-term price tag of the last decade’s unrestrained government spending spree. In 2001, for instance, Medicaid spending came to $157 billion (in constant 2010 dollars). By 2010 it had increased to $275 billion. If nothing is done, it will cost $546 billion in 2020. If spending stayed the same as a percentage of GDP as it was in 2000, Medicaid would instead cost $234 billion.
Total spending in 2020 is projected to be more than $5 trillion under the CBO’s alternative scenario, or 26 percent of GDP. There is simply no realistic way the federal government will be able to raise that kind of revenue. Since 1950 the government has collected revenue above 20 percent of GDP exactly once. That was in 2000 and the percentage was 20.6. Good luck getting to 26.
Debt and Entitlements
The twin specters of exponentially rising debt payments and exploding entitlement programs, especially Medicare, are intricately connected. Given the government’s inability to generate revenue sufficient to cover current levels of discretionary spending, pay interest on the debt, and pay for the growing sums devoted to Medicare, Medicaid, and Social Security, it will have to borrow more and more, creating a seemingly hopeless debt spiral.
This is true even if interest rates stay at projected long-term levels. The CBO alternative scenario assumes that interest rates will stay at an average of 4.6 percent from now until 2084. The CBO estimates the rates for government debt will climb from about 2.3 percent now to just under 5 percent in 2030, then stay there for another 54 years. That’s a low figure historically, and even though the CBO alternative scenario is understood to be a more realistic projection, this particular estimate is almost certainly optimistic. As our debt level increases, investors could start seeing the United States as a riskier investment and ask for an increase in interest rates to make up for the uncertainty involved in lending us even more money. Any increase in interest rates above the projected levels could make debt uncontrollable and push the country into bankruptcy.
When it comes to entitlements, we need some basic reality checks. Social Security is not a retirement plan as any of us know the term. Taxpayers do not control any aspect of their contributions, from the amounts they pay to the instruments in which their money is invested. The Supreme Court has ruled that Social Security and other entitlements do not impose contractual obligations on the government, meaning that benefits can be cut or abolished altogether. Social Security and Medicare are instead transfer programs that move money from one group of taxpayers to another, irrespective of demonstrated need. (Medicaid is at least means-tested.) Reform discussions should begin with the understanding that such programs function as a form of guaranteed income, not some sort of sacrosanct compact between generations.
Our unsustainable entitlements are a product of a very different America. Created in 1935, Social Security was a response to the Great Depression and widespread poverty among older Americans. Created three decades later, Medicare, which provides medical coverage for those 65 years and older, was likewise motivated by a rate of poverty among seniors that was nearly double that of the overall adult population. Today, by contrast, seniors comprise one of the wealthier segments of the U.S. population. They are much less likely than average to live in poverty, and they are far more likely to own a house and other assets. This makes sense: Seniors, even those who have never earned big salaries, have spent a lifetime working and amassing wealth. According to its administrators, Social Security payments represent about 40 percent of “the income of the elderly” and in 2010, the average payment was $1,170 a month. That sort of payout can be generated at a lower cost through workers investing their wages over their careers.
More important, as the population ages, entitlements will need to be sharply curtailed if the government expects to spend money on anyone with greater needs. It would make more sense to have a system in which individuals who are too poor or sick to take care of themselves would receive financial assistance, but everyone else would be expected to provide for their retirement and health care. Instead, we have a system largely unaffected by changes in income, wealth, and life span.
Despite big increases in life spans and later entry into the work force, full Social Security benefits still start at 65 and partial benefits can be tapped at 62. The only significant adjustment currently on the books is that beneficiaries born after 1960 will have to wait until they turn 67 to get full payouts. It’s no wonder that the program will start running a permanent deficit in 2014.
Congress should cut benefits today for people who are 55 and younger. Those individuals still have plenty of time to adjust their expectations about future benefits and plan for retirement. We should gradually raise the initial age of eligibility to at least 70 and progressively increase it to track life expectancy (currently almost 79). We should also means-test these programs so that only those who really need the help get it. Such changes are relatively easy to implement and would allow lawmakers to pass reforms that won’t kick in until years down the road.
According to the CBO, the changes to the eligibility age suggested above would gradually decrease Social Security spending by 6 percent through 2040. Means testing would reduce Social Security spending by an additional 6 percent. By 2040 the program would be spending $200 billion less annually than if the status quo remains unchanged.
Similar reforms are needed for Medicaid and Medicare. Funds for Medicaid, which provides health care for low-income Americans, could be transferred to state and local governments in the form of annual fixed block grants. Because they are closer to the actual beneficiaries, more knowledgeable about regional differences in the target population, and more responsive to local needs, state and local governments are better suited to take care of poor people.
When it comes to Medicare, Rep. Paul Ryan’s roadmap is a useful place to start. Ryan suggests making Medicare a consumer-directed system by replacing the current program with tax credits and vouchers. In this scenario, instead of reimbursing doctors and hospitals, the government would provide payments directly to individuals, who would then purchase health insurance in private markets. The idea is to encourage competition among providers, increase consumer choice, and encourage cost-saving innovations.
More broadly, we need to rethink “mandatory” outlays altogether. Budgeting would be better served by creating multi-year spending commitments that sunset every five or 10 years. That would allow for planning—indeed, it would force it—on the part of the government and beneficiaries, but it would also allow for meaningful reform and even zeroing out on a regular basis.