January 31, 2007 | Testimony on Federal Budget
Testimony before the Committee on the Budget, United States Senate
My name is Stuart Butler. I am Vice President for Domestic and Economic Policy Studies at The Heritage Foundation. The views I express in this testimony are my own, and should not be construed as representing any official position of The Heritage Foundation.
The new Congressional Budget Office (CBO) baseline once again underscores the scale of the entitlement spending problem:
But these 10-year figures actually only hint at the far more serious budget problem - the tsunami wave of entitlement spending that will hit the budget when the Baby Boom generation begins to retire in large numbers. As the CBO's long-term forecast indicates:
As Comptroller General David Walker has pointed out, this entitlement-driven unfunded growth in spending will impose staggering financial burdens on our children and grandchildren:
Why Raising Taxes Is Not the Answer
Given the scale of future entitlement spending, and the enormous unfunded obligations, it may be tempting to say that the prudent step would be to raise taxes to keep pace with the mounting obligations. But there are at least three reasons why this would be folly:
America does not face a long-term decline in the level of federal revenues as a percent of GDP. In fact, we face a worrying increase in the burden of taxation.
How Should We Address This Long-Term Problem?
When a family has bought a house that is too big, and it cannot pay the mortgage, the answer is not to send its youngest members out to get jobs and for the parents to take second jobs. It is for the family to admit that it is overextended and to move to a more modest house with a lower mortgage. That is what we must do with entitlements - admit that we have overextended ourselves and overcommitted our children and seek fair and reasonable ways of reducing future spending. That means looking hard at the promises we made to ourselves and making reasonable and prudent changes - changes that still provide necessary resources to those who need them but reduce the burden on future generations.
To do that fairly and efficiently, Congress should take the following steps:
Replace the drug benefit provision of the Medicare Modernization Act with a targeted benefit
The 2003 Medicare drug bill was a huge and unaffordable new entitlement. Instead of providing help only to those seniors who needed help to afford their prescriptions, it provided a heavily subsidized drug benefit to all retirees on Medicare, including millions of retirees quite able to pay for their prescriptions. The new Part D program has increased unfunded obligations on future generations by a present value of $7.9 trillion - larger than the entire publicly held debt in 2000.
It is hard to imagine how the burden of future generations can be addressed without revisiting this unaffordable credit-card legislation. Congress should repeal the general subsidized benefit it enacted and replace it with a limited benefit targeted to only needy seniors.
Introduce full income testing of Medicare parts B and D
Parts B and D are not social insurance programs. Unlike Social Security and Medicare Part A these are not benefits that retirees "paid for" in payroll taxes during their working life. They are heavily subsidized voluntary insurance programs.
Today the Part B premium charged to seniors, even to millionaires, is just 25 percent of the true cost. For the Part D drug benefit, the premium charged for basic coverage is also approximately 25 percent of the total cost. Given the excessive spending level and future borrowing required to subsidize these voluntary programs, it is time to say that the subsidy should be based on need. Richer seniors should have a smaller, or no, subsidy for their Part B and D premiums.
The best step, as already noted, would be to repeal the new Part D drug program and replace it with a far smaller subsidy restricted to those who need. If that cannot be achieved, then the Part D and Part B premiums should be fully income adjusted, with Congress raising these premiums to 100 percent of their real cost for affluent seniors. At the very least, as an interim measure, Congress should make the subsidy in Parts B and D taxable for those with moderate and higher incomes, thereby recouping some of the subsidy for upper-income retirees.
Make all Social Security benefits fully taxable for higher-income seniors
Recognizing the unfunded obligations of retiree benefits, Congress has already accepted the principle of taxing Social Security benefits in order to recoup some of the benefit costs. The tax applies to single seniors with annual incomes greater than $25,000 ($32,000 for couples). Above these incomes, seniors must pay tax on a rising proportion of their benefits (starting with 50% of benefits included in taxable income, rising to 85 percent).
With the principle of recouping unaffordable benefits in this way, it is time for Congress to phase in 100% taxation of benefits for all single seniors with incomes above $25,000 and married couples above $32,000. The full 100% taxation should apply on single incomes of $35,000 and married couples with $45,000.
Eliminate Disincentives that Discourage Workers from Working Longer
As Urban Institute economist Eugene Steuerle pointed out almost a decade ago, today's workers are likely to have a longer lifespan, are healthier, and are less likely to work at physically demanding jobs than was the case for workers fifty years ago. A male American today who reaches 65 can expect to live about another 17 years, while a female can expect to live almost 20 more years. Yet, since the 1980s, over half of workers retire at 62, with less than 20 percent saying that they retired because of ill health. We are approaching the point where typical Americans can plan on spending one-third of their adult life in retirement, with financial support guaranteed from other working Americans. This is not sustainable. Retirement programs should not begin at age 62. Workers can and should be encouraged to work longer.
Part of increasing working life will require cultural changes. Workers need to expect to work until later in life, and employers to value older workers for the experience they bring. But in addition, existing disincentives in the tax system need to be eliminated to make it more attractive to spend a more reasonable and sustainable proportion of adulthood at the workplace. A major disincentive today is that Social Security benefits are calculated on a worker's highest 35 years of earnings. So for an individual who works beyond today's normal retirement, the only way that working longer can increase benefits is if the worker's pay, indexed for wage growth, is higher at, say, age 68 than it was in his or her 30s. As an incentive to work longer, therefore, Social Security taxes should not be imposed on those who are employed after their normal retirement age. Since half of payroll taxes are paid by employers, they would also have an economic reason to retain older workers longer.
Gradually Increase the Social Security Retirement Age to 70
In the last major reform of Social Security, Congress recognized that increasing longevity required a gradual increase in the normal retirement age (NRA) - the age at which a worker can receive his or her full Social Security benefits - from 65 until 67. In the nearly quarter century since then, the average lifespan has continued to go up, and so it is time for Congress to again raise the normal retirement age to adjust for that increase in longevity. Today the NRA is 66, with a scheduled increase to 67 set to begin in 2020. This is too long to wait for an overdue adjustment. Congress should at least begin phasing towards 67 in 2010 at the rate of 2 months per year until NRA reaches 70 in about 2034. At the same time, Congress should gradually raise the early retirement age - the age at which a worker can receive a reduced Social Security benefit - from today's 62 to at least 65.
Future increases in longevity should lead to additional increases in these thresholds. Moreover, periodic changes to these thresholds for Social Security, and the eligibility age for Medicare, should be a regular part of the five-year re-examination of entitlement programs mentioned later in my testimony.
Focus Social Security Benefits on those who need them the most
The way to give additional meaning to Social Security's promise to insure workers against retirement poverty is to focus the system's resources on those who face the greatest hardship.The best way to accomplish this would be change the Social Security benefit formula so that the benefits of lower income workers grow at a faster rate than those for upper income workers. Under this "progressive indexation" proposal the benefits of upper-income workers (those who earn over $100,000 today) would increase only at the rate of inflation, instead of at the rate of wage growth as they do today. Benefits for lower-income workers (those who earn less than $25,000 today) who retire in the future would continue to grow as they would under today's benefit formula. This is only fair, because lower-income workers are less likely than other workers to have any other retirement savings and more likely depend on Social Security benefits for almost all of their retirement income. Meanwhile, middle- and upper-income workers, who are typically able to put aside money for retirement, would receive smaller increases in traditional benefits.
Progressive indexation preserves the principle of social insurance for workers of every income level, but it also recognizes that in an era of limited resources, benefits should be concentrated on those who need them the most. Depending on how this change is implemented, it could reduce Social Security's unfunded liability by about 60 percent. However, for it to be successful without reducing retirement income, Congress must also act to ensure that every worker has a retirement saving program that they are strongly encouraged to participate in from when they first go to work until the day they retire.
Change the budget status of retirement entitlements
The current budget treatment of entitlements has two major shortcomings, which frustrate attempts to put reasonable constraints on spending and thwart efforts to balance national priorities.
The first shortcoming is that the federal budget works on a pay-as-you-go system with a limited "look forward" period, with Congress using arbitrary five-year and ten-year budget windows. So the long-term cost of existing entitlements is ignored in the annual budget cycle, and the potentially huge cost of proposed new legislation is also ignored - which is why the multi-trillion unfunded long term cost of the Medicare drug legislation did not even have to be debated. Steps must be taken to require Congress to address long-term entitlement costs and unfunded obligations during the annual budget cycle by including a measure of these obligations in the budget process.
In addition, entitlements have first claim on spending whether or not benefits for specific groups of individuals really should have top priority. For example, this means that Part B subsidies for retired millionaires preempt help for the homeless, or most education spending, in the struggle for federal funds. A key element of the solution to the entitlement spending problem is to enable Congress to make more rational trade-offs between the alternate uses of constrained future federal spending.
A two-step reform is needed to achieve these goals:
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