Reforming Entitlements to Provide a Strong Safety Net

If we continue on our current path, entitlement programs will absorb a steadily increasing share of the budget, hobbling our ability to meet other pressing needs and placing huge burdens on our children and grandchildren. There is no solution to this problem except to make significant reductions in the growth of promised benefits of both Social Security and Medicare. And here we have two choices. We can reduce the growth of expected benefits for everybody, or we can trim them more for people who rely on the programs less. We believe that it is preferable to reduce benefits through means testing for those who do not need them in order to ensure the economic security of those who do.

There is certain to be resistance to means testing on the part of those who believe that universality is essential for maintaining popular support for social insurance programs. However, it is important to recognize that while universal benefits may engender social solidarity, they are also obstacles to the progressive and conservative goal of assuring that available funds go primarily to those in need. Rather than being seen as breaking the web of mutual obligations that bind us together as a community, means testing should be seen as enabling us to strengthen the safety net so that no one falls through.

It would not only allow us to focus our limited resources on those who need help the most, but also allow us to begin to transform Medicare and Social Security into true retirement insurance programs to protect Americans against health care and retirement costs that exceed their means. In short, by calibrating the resources provided to the elderly to their actual needs, we would have greater resources with which to meet our societal obligations to our children, to modernize our infrastructure, and to maintain our national security.

There are many ways to structure a means test for government retirement benefits so long as we adhere to the basic principle that benefits should be tied to need rather than to a preset formula with scant regard to need. Either postretirement income or lifetime income could be used to determine an individual's eligibility. And the benefit itself could be designed in any number of ways. For instance, income replacement rates in Social Security might be reduced for high-income earners (who would still receive higher benefits than lower earners); or all participants might receive a uniform flat-rate benefit; or high-income earners might receive little or no benefit at all. Medicare premiums and co-payments could be adjusted to reflect the ability to pay. We would recommend determining eligibility based on lifetime earnings in order to avoid the perverse incentives on saving that accompany simple means testing (though this would be less of a problem under a mandatory saving system) and providing the highest income retirees with no benefits at all in order to preserve and redirect scarce resources.

Changing the Budgetary Nature of Entitlements

If we are to change the nature of the social contract so as to promote fairness and efficiency while balancing competing social and economic goals, we will have to change the legislative rules governing the way federal funds are allocated. Currently, social insurance entitlement programs guarantee promises made to one set of Americans by automatically preempting budgetary resources from programs serving other Americans. Moreover, the solvency of our nation is jeopardized because of the natural tendency of politicians to create or expand popular entitlements whose long-term costs are not fully reflected in the budget. We need a budget process that presents the full range of budget choices in a transparent manner, with everything on the table, so that Congress can allocate funds according to our values and within the constraints of our resources.

This will necessitate two broad reforms. First, budget rules should be changed to require the long-term costs of programs to be identified and weighed in a meaningful way against other budget choices in the annual budget process. Under the current system, lawmakers can ignore those long-term costs and create obligations that will place huge burdens on our children and grandchildren. Second, we should modify or end the distinction between "entitlement" programs like Medicare and Social Security and "discretionary" programs like defense and housing assistance.

We should create a complete and accurate budget that clearly shows the government's financial obligations with respect to entitlements. To bring the true costs of Social Security, Medicare, and other entitlements into focus and prompt serious priority setting, the budget process should include a measure of the future obligations associated with these programs. Thus, in order to increase transparency, the budget, instead of merely showing spending projections over the next five or ten years, should also show the estimated "present value" cost of unfunded obligations over both a multi-decade period and an infinite horizon, much as private corporations are required to provide retiree costs to stockholders and as state and city governments are increasingly required to disclose the total cost of their pension obligations. In this way, during each annual budget cycle, lawmakers would be required to disclose and budget for any projected changes in the future cost of an entitlement. And to force lawmakers to take changes to these obligations seriously, any significant change in the present value of total unfunded obligations should require a separate up-or-down vote.

In addition to disclosing the obligations associated with entitlements, we need a real long-term budget for today's entitlements if we are to get these obligations under control. At the same time, it is important to recognize that such programs by their very nature involve extended time horizons and require planning for the long term. Capital budgets in the private sector and in parts of the public sector recognize this. Likewise, an individual planning for retirement requires a degree of certainty about Social Security or Medicare. Such concerns can be addressed within the framework of an adjustable long-term budget, one that would be reassessed periodically by Congress to ensure that our spending on entitlements is sustainable.

One way to do this would be to convert all spending on entitlements into 30-year "discretionary" budgeted programs that would have to be reviewed and reauthorized every five years. This is essentially what many other countries do to manage their long-term obligations. To keep the programs within the approved budget, Congress could create budget rules to limit the unfettered growth of long-term promises. For instance, it might create "triggers" that would automatically make adjustments to the programs if spending were projected to move above budgeted levels. The eligibility age for receiving Medicare benefits, or payments to providers, might be subject to such a trigger. Congress could always make other changes in the programs (by raising taxes or cutting other spending programs) with the built-in triggers serving as a backstop for inaction. To avoid the political fallout from legislating benefit cuts, it might also consider creating a standing commission to recommend to Congress for expedited review a package of changes in the programs to bring costs into alignment with funding.

Questions and Answers

Recognizing that our suggestions for reforming social insurance will naturally raise some serious concerns, we have attempted to anticipate and provide answers to some of the questions that are likely to arise.

• If we end the entitlement status of certain programs, won't we be breaking a solemn promise to the American people?

The current social insurance entitlement system commits us--and future generations--to deliver benefits without regard for their impact on society, on the economy, or on our ability to maintain our other obligations, such as to provide for the national defense or to help the needy. Consequently, the promises made in these other obligations are diluted. Altering the entitlement status of social insurance programs would not so much break a promise as replace an unsustainable promise with one that is affordable and fair, and one that recognizes other priorities and promises made.

However, we also recognize that today's aging workers are concerned about the viability of Social Security and Medicare and need to have some certainty in their planning. That is why we argue that Congress should develop multi-decade budgets for programs that are now essentially on automatic pilot. That step would allow us to address the needs of baby boomers approaching retirement while moderating our future commitments. With a firm budget in place of a mere forecast of costs, we would be able to limit our commitment to provide social insurance relative to our other needs. And the required regular revisions of that budget would ensure that the promised benefits were adjusted from time to time in response to changed economic conditions, changing priorities, and competing promises.

But we cannot continue to make promises that entail an unlimited financial obligation to certain sectors of the population without considering their impact on society as a whole. Other countries seem to understand this better than we do. In Britain, for instance, the National Health Service provides health care to all Britons. But the NHS does not automatically preempt financial resources as our entitlement programs do. Parliament allocates funds for the health service in the budget in line with a long-term funding plan and periodically makes significant changes in the NHS's spending authority, weighing health care needs against other priorities and occasionally fine-tuning the funding plan. It is left to the NHS to determine the best way to achieve the program's promise with the funds it is given.

Britain made a promise about health care that is clearer and more comprehensive than we have made in the United States, but a promise that recognizes competing interests and available resources. We, on the other hand, have made an open-ended commitment to provide medical care to retirees while increasing numbers of other Americans lack basic health care coverage. Our promise with respect to health care is fragmented and uneven, in part because Congress does not deal with the cost of open-ended entitlement commitments.

• Will liberals object to our proposal in the belief that it would cause the social insurance coalition to collapse?

For decades the assumption among many politicians and analysts has been that universality is the key to preserving the interests of the less well-off because it builds solidarity between rich and poor. Because all income groups benefit from our social insurance programs, the argument goes, middle-class and even upper-income Americans fight for them politically. The concern is that although changing those programs to focus more on lower-income Americans would help those in need in the short term, it would erode that solidarity, support for the programs would dwindle, and funds would be cut.

There are four reasons why this concern is outdated and misplaced. First, the obligation to help those in need is an ingrained American value. It is not the result of a coalition of convenience. In particular, Americans support programs to assure basic health care for the needy. That is why there is broad and enduring support for programs like the Earned Income Tax Credit and Medicaid. There is no need for us to give generous benefits to people who don't need them in order to "buy" their political support for programs for those who do.

Second, even well-off working Americans worry that they might not have enough resources when they retire or if they were to hit hard times, so there is deep and strong support for a reasonable and affordable social safety net.

Third, purchasing middle-class support for universal programs has come at a very heavy price for weaker groups in our society. Increasingly, the politically powerful, aging middle class has come to dominate the politics of entitlements. Rather than the social insurance coalition protecting the interests of the poor and the young, benefits for the middle-class elderly have risen while those for younger and more vulnerable groups have been squeezed.

Fourth, even if one does take the view that a broad coalition is needed to preserve assistance to the less well-off, our approach meets that test. What we envision is a modified coalition of supporters. Our proposed reforms would strengthen progressive support by making a greater commitment to needier individuals. And although our entitlement reforms would reduce or eliminate the benefits paid to middle-class and especially upper-income Americans, the spending control and fiscal improvements resulting from the reforms would likely win their strong and lasting support by improving the long-term economic climate and by reducing the huge unfunded obligations facing their children and grandchildren. Thus, a broad-based coalition of support would be maintained.

• Will conservatives oppose mandated savings and insurance as the equivalent of taxes?

While conservatives typically oppose government mandates as well as most taxes, substituting a mandate for an existing tax or benefit program is a different issue. For example, when conservatives strongly supported proposals to permit working Americans to dedicate part of the Social Security payroll tax to individual retirement accounts in recent reform proposals, they were also accepting a mandate to make private provision for retirement. Many conservatives also support a mandate on families to buy basic health insurance coverage to shield the community from having the obligation to pay for expensive emergency room care for the uninsured under the terms of current law. In each case, the substitution of a mandate in place of the traditional social insurance program is seen as a step toward a fairer and more affordable system of financial protection and more choice and control for families. Mandated saving is also more efficient than imposing taxes because individuals see a direct link between what they save and their own assets and future benefits. Furthermore, while conservatives may still think of mandates as a form of taxation, they typically see them as more tolerable because mandates permit choice and are more consistent with personal responsibility.

Still, conservatives would be wary of "creeping mandates" that go beyond a substitute for existing taxes. They are likely to worry that the government might start ratcheting up the size and scope of mandates on individuals to save or to insure themselves against certain risks. This is not a meaningless worry because, to politicians, a mandate is a "free" program in contrast to programs that must be paid for by raising taxes. A related concern is that the steadily increasing regulation associated with mandates can wring out any semblance of personal choice, making the requirement merely the means of privately financing government-determined services.

In order to solidify conservative support for a structural reform of entitlements that combined a retirement insurance safety net with a mandate, it would be wise to limit the mandate explicitly to financing alternatives to current programs. An important question would be whether the level should be what the existing program can finance (the level most Republicans would opt for) or what the program has promised (the level Democrats would likely want to see). That needs to be debated and discussed with the American people.

• Will there be unacceptable risk to individuals?

Some critics of a restructured social insurance system argue that limiting entitlements would unfairly increase the financial risks Americans face, but this overlooks the distribution of financial risk today, as well as the reasonable protections included in our proposed reforms.

Under today's system there is actually enormous financial risk, but it is hidden and unfairly distributed. Middle- and upper-income beneficiaries of retirement programs enjoy considerable protection (especially under Medicare) from the potential costs of services they can actually afford, but many poorer retirees still face insurmountable costs because they are not adequately protected. And while current retirees enjoy less financial risk due to social insurance, the growing unfunded obligations related to these programs mean that younger Americans and future generations face huge financial risks related to having to finance huge payments to preceding generations while their own expected benefits are not assured yet their ability to save is reduced. Further, the ability of legislators to make sensible budget decisions is undermined because the very design of our social insurance programs makes it politically attractive to continually expand and yet underfund benefits.

Our proposed reforms seek to contain financial risk and distribute it more fairly. Under our proposal, middle-income and affluent Americans would shoulder more of the predictable costs of aging or sickness because they are better placed to do so. Poorer Americans would receive government assistance to save for these life occurrences. All Americans would be insured and protected against major illness, disability, and the death of the family breadwinner. And there would be a final layer of universal protection with an affordable safety net in place. The balance of risk between generations would also be made more equitable. Finally, by limiting the scale of social insurance and transforming it into real insurance with a stronger safety net, the costly expansion of programs would be curbed, thereby reducing the financial risk for all taxpayers.

• How should retirement health insurance be structured? Would private insurance lead to risk segmentation?

Proposals to substitute individual insurance for part of an existing social insurance program invariably raise concerns about adverse selection in the case of health care. The concern is that if the collective feature of Medicare is reduced and replaced with private insurance, healthier people will be able to buy relatively inexpensive insurance, while sicker individuals will face much higher costs or be unable to purchase coverage.

This is a legitimate concern that has to be addressed. To be fair and viable, the reform we propose must maintain a degree of social solidarity with private coverage that is affordable and available to all (which will require risk pooling and reinsurance arrangements to spread the insurance risk). This is also an issue with respect to all efforts to expand private health insurance coverage. Fortunately, the states and the federal government are exploring ways to structure pools and reinsurance systems to address adverse selection. We envision private insurance reforms of this nature accompanying the social insurance and budget process reforms we propose.

• How do we get from here to there?

The transition from the current social insurance system to the future we envision will require the phasing in of the new system and the phasing out of the old one. The first step will be to determine precisely what purposes the saving mandate will cover, how much individuals will have to save for each of these purposes, and what basic required insurance packages will be included. We envision requirements to save for retirement and basic health care spending and to purchase unemployment, disability, catastrophic health, and long-term care insurance.

At the same time, the government should change its budgetary rules so that the costs of our long-term commitments are apparent and can be controlled. Thirty-year budgets and trigger mechanisms for our current entitlement programs should be put in place immediately. These budget steps will spur Congress to balance the long and short terms more openly and sensibly. In so doing, it will have more incentive and opportunity to plan for the transition costs required to achieve long-term savings. In addition, new infrastructure--including automatic-enrollment savings systems in the workplace, mechanisms to ensure that all have access to financial institutions, and systems that will allow the federal government, the states, and the private sector to work together to devise methods to spread large insurance risks more effectively--will also have to be put in place.

As quickly as possible, we should phase in a means test for premiums and benefits for Medicare and Social Security. The sooner the scaling back of unnecessary benefits is phased in, the less other programs will have to be cut. We support including current and near-retirees in this change since these demographic groups have fared disproportionately well under our social insurance programs and because the more widely the benefit reductions are spread, the smaller they will have to be--though the political process may not allow for such a bold change.

We also support speeding up the increase in, and further increasing, the retirement age. Under current law, the normal retirement age is scheduled to rise from 66 to 67 between 2017 and 2022. This increase in the retirement age should be accelerated, increased further, and indexed to longevity to reflect the growing life expectancy of the population. This change would generate savings both by allowing individuals more years to accumulate personal savings and by allowing for fewer years of collecting benefits from social insurance programs.

During the transition period, individuals should be required to begin saving and purchasing the required insurance coverage immediately to replace part of today's benefits. The level of required saving would increase gradually as we are able to reduce the payroll tax due to other reforms in entitlement programs. Then benefits could be curbed more steeply for younger generations once their private savings had built up. The "transition generations" would receive some benefits from the old system to help augment their private savings at retirement.

Conclusion

Our proposed restructuring of social insurance requires a complete rethinking of existing programs. As the cost of providing social insurance for all Americans--whether they need it or not--becomes prohibitive, our commitment to provide real insurance for unanticipated or unaffordable events and to help lower-income individuals must be maintained and strengthened.

Our society can and should be committed to protecting people from unanticipated events that could prove devastating to their economic well-being. However, it is too costly, economically inefficient, and utterly unnecessary to provide benefits that serve more of a political purpose than an economic or moral one. The purpose of a just social contract should be to balance security and personal responsibility. We believe this is best accomplished by protecting people from unforeseen disruptions in their lives while encouraging them to prepare themselves for probable eventualities, including retirement and medical costs late in life.

Under our proposal, Americans would have to take more personal responsibility for their future, but they could rest easy in the knowledge that a secure income-related safety net was in place to protect them against catastrophic occurrences. Americans of every age group also would have the assurance that their needs and priorities would be given fair consideration in the budget process. And while some middle- and upper-income working Americans would have to accept lower Medicare and Social Security benefits than they once anticipated, they would have access to affordable private insurance and personal savings to offset the decreases.

We believe that this approach lends itself to bipartisan support because it better reflects both progressive and conservative principles than our current social insurance system does. Our proposal would result in a more progressive approach to assistance for the needy, a better balance between expectations and responsibility on the part of citizens, and a budget process that truly reflects the nation's priorities and values.

Stuart M. Butler, Ph.D., is the Vice President of Domestic and Economic Policy Studies at The Heritage Foundation and Maya MacGuineas is the Director of the Fiscal Policy Program at the New America Foundation.

The authors would like to thank Alison Fraser, James Capretta, Joe Antos, Ron Haskins, Alice Rivlin, William Galston, Bob Reischauer, Gene Steuerle, Belle Sawhill, Julia Isaacs, Pietro Nivola, Bob Bixby, Rudy Penner, and Will Marshall for their extremely helpful comments.

Nothing written here is to be construed as necessarily reflecting the views of The Heritage Foundation, The New America Foundation, any institution with which the authors are affiliated, or as an attempt to aid or hinder the passage of any bill before Congress.