By Peter Ferrara
Senior Policy Advisor, Social Security and Medicare Institute for Policy Innovation (www.ipi.org)
Aug 24, 2005
The Congressional Budget Office projects that under current law Federal spending as a percent of GDP will rise from 20% today to 34% by 2050. For conservatives and free market advocates, one cannot over emphasize the significance of this fact. It is quite simply earth shattering.
Federal spending has been around 20% of GDP since the end of World War II. The CBO projection indicates we are now on a path where the Federal government will grow by 70% relative to the economy in coming decades. You can add in at least another 15% of GDP for state and local spending.
If anything even close to this happens, conservatives and free market advocates will have been completely routed on the economic issues. After all the intellectual and political victories for conservatives over the last 25 years, Ted Kennedy will still have won. We will have Swedish socialism in America, and the American worker will be a tax slave. Our economy will fall into long term decline, as will our standard of living, and with the economy down, Federal spending will probably be even higher relative to GDP.
Republicans and even activist conservatives who tell me today that nothing can be done to slow the runaway spending freight train need to understand this. Over the next 30 years politics at the Federal level is going to be about either adopting dramatic reforms to slow the growth of government, or enacting enormous tax increases to pay for it. There is no other choice. Pick your side now.
Fortunately, the current doomsday scenario is not inevitable. It can be stopped. Those who have been working on these issues have developed practical, sweeping reforms that would not only stop the dramatic rise in government, but would actually in the end reduce Federal spending significantly from current levels relative to GDP. This is not about vague, theoretical, pie-in-the-sky, ideological wish lists. It is about enacting practical, concrete legislation that can win the support of the American people. Indeed, well-structured reforms would actually serve all the social welfare goals of the current system far better than the current system does.
The projected dramatic rise in big government is due to cost explosions in three programs -Social Security, Medicaid and Medicare. These cost explosions are due to well-established demographic trends, and rapidly rising health costs.
Everyone knows the retirement of the enormous baby boom generation is approaching. That alone would sharply increase the costs of Social Security, Medicare, and Medicaid (about half the costs of this program today are for nursing home care). But retirees in this century will also be living longer as modern medicine advances and life expectancies increase. In addition, as people have fewer children today, the number of workers in the economy to support these retirees will be relatively small, adding greatly to costs per worker. When rapidly rising health costs are added to these factors, the result is runaway big government.
Sketched out below are real world, proven, practical reforms of these three programs that can succeed politically. Not that it is going to be easy. Success will require highly intelligent and courageous political leadership. But when these reforms are framed properly, the American people will embrace them by large margins. For the Republican Party in particular, there is no alternative anyway. There is not room on the political spectrum for two parties that want to close to double Federal taxes relative to the economy. A Republican Party that tries to embrace this approach would have no grassroots base.
The reform plan for Social Security is now well known. A personal account option allowing workers to shift about half the total payroll tax, or roughly the employee share, to the accounts would be big enough to shift all retirement benefits to the accounts over time. Through such accounts, workers would actually get much higher benefits than Social Security even promises today, assuming just standard market investment returns. They would also enjoy personal ownership and control, freedom of choice, and all the other benefits of personal accounts.
An example of how this can be done is provided by the legislation introduced by Rep. Paul Ryan (R-WI) and Sen. John Sununu (R-NH). Their bill is a fully developed, comprehensive, practical proposal that addresses all of the concerns that can be raised by opponents of such reform. Polls have consistently showed dramatic support for a personal account option for Social Security, and many elections, indeed, have already been won on personal accounts.
The Ryan Sununu bill proposes to finance part of the transition to personal accounts by limiting the rate of growth of Federal spending by one percentage point a year for each of 8 years, with the resulting savings maintained until the transition is complete. Some attacked this provision arguing that it is completely impractical to expect Congress to limit spending growth. But the pro-vision would just reduce future Federal spending by 1.6 percentage points of GDP. We need to reduce that spending growth by 14 percentage points just to stop Federal spending from growing to 34% of GDP from 20% today. Obviously, we are going to need much more heroic spending restraint if we are going to avoid the coming crisis of big government.
Nevertheless, the transition under Ryan Sununu can now be reduced by the welfare reforms noted below. They would save far, far more than would be needed to complete the transition under Ryan Sununu. At the same time, those reforms are essential if we are going to avoid the coming crisis of big government.
Shifting the retirement benefits of Social Security to personal accounts would reduce Federal spending by about 5 percentage points of GDP. Once this reform is achieved, the personal accounts can be expanded to provide workers a better deal for Social Security survivors and disability benefits as well. This would reduce future Federal spending by roughly an additional 1.5 percentage points of GDP.
Most people think welfare reform was already achieved in the 1990s. But that legislation just reformed one program, the old Aid to Families with Dependent Children, or AFDC program. There are three more major Federal welfare programs, Medicaid, Food Stamps, and Public Housing, and a slew of additional, smaller ones.
The reform of AFDC was highly successful. The program was block granted to the states, which means that each state is given a Federal grant each year of a specific dollar amount to run the program. The amount is determined by a specific Federal formula based on population, poverty, income and other factors in each state. Each state then designs its own program to serve the purposes of the old AFDC program. If the state program costs more than the Federal grant amount, the state must pay the entire difference. In addition, the Federal reform legislation man-dated that each state program must include a strong work requirement for the program beneficiaries to receive funds, along with a 5 year limit on the receipt of welfare assistance under the program.
Under this program, welfare rolls for the old AFDC program have declined by an amazing 50% or more across the country, with some states achieving declines of 80%. That resulted because the block grant reversed incentives for the states to spend money under the program, and because the work requirement and time limit reversed incentives for beneficiaries not to work.
These same reforms should now be extended to the other Federal welfare programs, including most importantly Medicaid. The block grants must be limited to grow no faster than the rate of growth of GDP over time. This limitation would stop Medicaid completely from adding to Federal spending as a percent of GDP in the future, eliminating completely its contribution to the coming crisis of big government. The same would be true for the other welfare programs.
As indicated above, this welfare reform would provide more than enough Federal spending restraint to finance the transition under Social Security reform discussed above. At the same time, large personal accounts for Social Security would make the Medicaid reform more practical. The Medicaid problem over the long run is really due to its expenses for nursing home care. But if people are retiring with large personal accounts under Social Security accumulating to several hundred thousand dollars, part of those funds can be used to buy nursing home care insurance, effectively covering the current nursing home financing function of Medicaid through the private sector. This is a key reason why the personal accounts do, indeed, need to be large.
Such welfare reform is highly popular with the general public. So this is again a politically practical reform plan, though the unthinking partisans of the Left will still fight it harshly and victory will not be easy.
Medicare is the most difficult to reform because benefits have been so wildly over promised it is impossible to reform the system in a purely populist way where everyone is clearly better off. The one big political positive is that Medicare's problems are widely recognized across the political spectrum.
The best reform approach would be to devote the 2.9% employer and employee payroll tax to personal accounts. The benefits in retirement could then be used to purchase private health insurance. With market investment returns over a lifetime, the saved 2.9% of wages each year would go much farther in providing retirement resources for health care. The extra retirement benefits from personal accounts from Social Security would also help to finance retirement health care, which is yet another reason the personal accounts need to be large.
Close to half of Medicare, however, is financed today by general revenues. This general revenue contribution needs to be limited to grow no faster than the rate of growth of GDP each year. The general revenues should then be used to provide vouchers for lower income retirees to help them buy insurance.
This combination of reforms would mean Medicare as well would no longer contribute to Federal spending growing faster than GDP. Indeed, with spending from the Medicare payroll tax shifted entirely to the private sector, Federal spending would be reduced by at least another 2.5% of GDP.
Discretionary Spending and Tax: Reform
The strategy for averting the coming crisis of big government would involve two more components. One would limit Federal discretionary spending to grow no faster than the rate of growth of GDP, or perhaps a stricter spending cap. (When national defense needed to grow faster than this, other components of discretionary spending would have to grow more slowly). Second would be pro growth tax reform.
The first of these components would ensure that discretionary spending does not add to Federal spending as a percent of GDP. The second would help GDP grow faster, which would also help to reduce Federal spending as a percent of GDP.
The above described reform components would eliminate the coming crisis of big government. Social Security, Medicaid, welfare, Medicare and discretionary spending would no longer contribute to Federal spending rising as a percent of GDP. Moreover, with Social Security and part of Medicare shifted to personal accounts, Federal spending would be reduced by roughly an-other 9% of GDP. Faster economic growth due to pro-growth tax reform would reduce Federal spending even further. As a result, these reforms could actually reduce Federal spending as a per-cent of GDP to 10% or less.
Averting the coming crisis of big government needs to become the central concern and theme for conservatives on economic policy.
For more information about Social Security and Medicare
Institute for Policy Innovation visit ipi.org
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