June 27, 2010
The Entitlements Quandary
The Entitlements Quandary—Posner
As Becker explains, advances in medical technology (which are very costly) and (related to those advances) increases in longevity, create the prospect of very great increases in social security and Medicare outlays in future years. The prospect is increasingly worrisome because of the large annual federal deficits that the nation has been running and the resulting increase in the national debt. Although rapid economic growth would (as Becker has emphasized in previous posts) make the debt manageable, we may very well be facing a longish period of below-average economic growth as a result of persistent high unemployment, economic uncertainty, and anti-growth public policies such as encouraging unionism.
Becker sets forth a program for reining in the growth of entitlement expenditures. The question I wish to address is the political realism of that or alternative programs for limiting such growth.
It is extremely difficult to marshal political support to deal at present with future problems. Future problems by definition are not felt in the present, and so it is difficult to mobilize public opinion in support of solutions unless they are costless. And politicians have a short time horizon, which means that they will not benefit politically from measures that impose present costs but yield benefits to the voting public after the politician has left office.
If, however, the costs can be deferred to the future as well, the current public may not object to a measure that confers benefits only in the future. That was the approach of the 1983 social security reform, which raised the age of full entitlement to social security benefits from 65 to 67 gradually for persons born in or after 1938—and they were only 45 when the reform was enacted. And only persons born in 1960 or later would have to wait until they were 67 to be entitled to full benefits; they were only 23 in 1983. Both the costs (in reduced entitlements) and the benefits (in reduced entitlements expense) were pushed into the relatively distant future. The discounted present effects were thus slight, and so the reform was relatively uncontroversial.
The problem with repeating such a measure now is that we probably can't afford to defer entitlements reform for 30 or 40 years. Suppose Congress increased the age of full entitlement to social security benefits to 70 for persons who are 23 years old today. The reform would not take take full effect until they reached 67, which would be 44 years from now, although there would be some savings earlier if, as with the 1983 reform, a gradual rise in the retirement age began for persons who are 45 years old today; they would first begin to feel the reform in 22 years, when they reached 67.
The same problem of delay would afflict a reform of Medicare designed to raise the eligibility age for Medicare in tandem with increasing the social security retirement age. Moreover, while young people can view with relative equanimity the prospect of having to work a couple of years more for full social security benefits—which are anyway rather meager—I don't think they'd feel the same way about losing Medicare in their late sixties. A big difference is that there is no ceiling on Medicare benefits, and the expected benefit of receiving them is therefore much greater than the expected benefits of social security—and young people know it.
It seems to me that, in the short run, the only realistic measures for reining in social security and Medicare are a combination of higher payroll taxes and means testing. In the long run, social security and Medicare benefits will be cut to affordable levels when the United States finds itself in the same desperate fiscal situation as Greece, but probably not before. The only hopeful note is that the current widespread public concern with deficits may embolden some legislators and the even the Administration to propose strong measures to head off a fiscal crisis exacerbated by entitlements spending.
How to Greatly Reduce the Fiscal Burden of Entitlements-Becker
During the past couple of years, the financial crisis induced the US, Europe, Japan, and many other countries to greatly increase their fiscal deficits and government debt. Unlike the UK and Germany, and a few other countries, The Obama administration has done little to attack the fiscal deficit that has grown much larger since his election as president. The absence of action on the deficit front has been reported to be an important reason why Peter Orszag recently announced his resignation of Director of the Office of Management and Budget.
Yet despite the seriousness of the rapid increase in government spending and fiscal deficits during the crisis, the main budgetary issue facing all developed countries during the next couple of decades is the expected growth in spending on entitlements: mainly, spending on retirement incomes, and medical care given to the elderly. The growth in these expenditures is partly due to growing life expectancy and relatively low birth rates that will raise the number of retirees collecting social security benefits while reducing the relative number of men and women who are working to pay for these benefits. The growth in medical entitlements is mainly the result of technological advances and other changes that has led to a sharp expansion in both private and public spending on medical care during the past several decades, an expansion that is expected to continue into the future.
Orszag, when head of the Congressional Budget Office (CBO) in August 2008, predicted that unless radical actions are taken, the cost of Medicare, Medicaid, and social security will rise from 18 percent of GDP in 2008 to 28 percent by the middle of this century, and perhaps to 35 percent soon thereafter. Of course, such estimates depend on many guesses, such as the future rates of growth of GDP, how life expectancy will change, and how many expensive advances will occur in medical care. Still, these estimates are consistent with those made by others, and clearly indicate that health and retirement entitlements will become a growing American fiscal problem unless important steps are taken to scale them back. Similar concerns apply to the UK, Germany, Japan, and other rich countries.
I have supported changing retirement systems from pay-as-you-go to individual account defined contribution systems, as in American IRA and Sep private retirement accounts. I also support sharply increasing the fraction of all medical care spending on the elderly that comes from out of pocket spending by patients (see my post on March 28). Another reform could also greatly reduce future public spending on retirement incomes and health benefits, and make an important contribution to closing the long run fiscal deficit.
This reform involves a big increase in the average age of retirement before individuals become eligible to qualify for either social security or old age public healthcare benefits. When the American social security system was established in 1935, the expected retirement age was 65. At that time, the average life expectancy for 65 year olds was a mere 12 years. Therefore, years in retirement amounted on average to about one quarter of the 47 years that men typically worked in the 1920s (before the Great Depression) prior to reaching age 65. Expected life expectancy of men aged 65 now averages about 18 years, and it is a few years longer for women. Men who retire at age 65 have typically worked on the average about 45 years, so retirement years for these men is about 40% of working years. Actual retirement of many men and women actually occurs at age 62, despite the decline in physically demanding work, and the improvements in health.
I propose that the US and other countries greatly raise over time the retirement age before the average person became eligible for either social security retirement income or publicly-funded health benefits. One simple and attractive rule would be to raise retirement age by an amount that makes the** ratio** of years spent in retirement to years spent working equal to the ratio that existed at the beginning of the social security system. Suppose the average person starts working at age 20, and lives a further 18 years if they make it to age 65. Then the average number of years spent in retirement for these persons would equal about one quarter of their average working years, the ratio prior to the introduction of American social security, if average retirement ages were raised to age 69 or 70.
If the average retirement age were raised to near 70 to qualify for retirement and elderly health benefits, retirees would still have more absolute years of retirement than they did 90 years ago. Moreover, their retirement years would be better because they would be healthier, both physically and mentally. As at present, men and women in poor health would be able to retire earlier through the disability system.
The US has been slowly increasing the normal retirement age in stages first from age 65 to 66, and then to age 67 for everyone born after 1960. These have been steps in the right direction, but they do not go far enough and have been too slow. It is time to raise more rapidly the normal retirement age for persons in reasonably good health to age 70 before they become eligible for either social security or Medicare benefits. This would add three years to taxable earnings, and eventually reduce the number of elderly collecting social security benefits by almost 20 % compared to what it would be under present retirement ages. It would also significantly reduce spending on Medicare, although by less than 20% since persons over age 75 take the bulk of this spending because they are in worse health than younger retirees.
Maintaining the ratio of working to retirement years is a reasonable first approximation to a guideline for determining the eligible age for retirement and health benefits. As the health and life expectancy of the elderly continues to improve in the future-as they surely will- retirement ages should be raised beyond age 70.