Delivered January 31,
2007
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:
- Medicare spending (including offsetting receipts) expanded 12
percent in 2006 and will grow 13 percent more in 2007. Combined
Medicare and Medicaid spending now exceeds Social Security
spending.
- The Medicare drug entitlement is now projected to cost $822
billion through 2017. It will cost $60 billion per year by 2012 and
$119 billion per year by 2017. Its annual expense will continue to
increase thereafter.
- Over the next decade, Medicare and Medicaid costs will surge by
nearly 8 percent per year, and Social Security costs by 6 percent
annually. These programs will rise from 8.5 percent to 10.7 percent
of GDP as the baby boomers begin to retire.
- Meanwhile, notes the CBO, the federal government is not
suffering from a dearth of revenues. Revenues are projected to grow
from today's above-average level of 18.6 percent to almost 20
percent in 2012 and then continue at record levels as a percent of
GDP.
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:
- The combination of the "big three" entitlements - Medicare and
Social Security and Medicaid - will double from the current 8
percent of GDP to 15 percent when today's newborn graduates
college, and reach nearly 20 percent of GDP when today's college
graduate reaches retirement in 2050.
- With conservative assumptions, CBO projects that under current
law the federal deficit will increase from today's 3.3 percent of
GDP to about 20 percent in 2050.
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:
- The total present value of unfunded federal obligations of the
federal government, or fiscal exposure, is now $50.5 trillion
($38.8 trillion of which is due to Medicare and Social
Security).
- This exposure translates into a financial burden of $440,000
for every household or, put differently, a mortgage of $170,000
placed in the crib of each and every baby born in America.
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:
- Falling tax levels are not the cause of the long-term
problem. Federal tax revenues currently are 18.6 percent, just
above the historical level of 18.2 percent - a reasonable level of
taxation that has helped the US economy perform consistently better
than other major countries. Moreover, as Chart 1 indicates, CBO's
long-run forecast projects that federal taxes under current law
will exceed their highest-ever level (20.5 percent in 1944 and
2000) by 2022 and rise to almost 24 per cent by 2050. That
unprecedented level means taxes as a percent of GDP would be
one-third higher than the burden today. Even if the Bush tax
changes were made permanent that would shave only about one
percentage point off this rising tax burden.
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.
- Raising taxes further would be damaging. Any increase in
taxes would be on top of this already record rise in the projected
tax burden. If we were to balance the budget without tackling
entitlements, and maintained discretionary spending at the same
proportion of GDP as today, federal taxes would have to rise to
almost 30 percent of GDP by 2050 - two-thirds higher than today.
Add in state and local taxes of approximately 10 percent, and our
children and grandchildren will face total taxes similar to
low-growth, high-unemployment Europe.
- Raising taxes on future generations would be immoral.
Raising taxes to address the long-term spending situation means
increasing tax burdens on future generations to fund the huge
future benefits this generation has voted itself. We in this
generation have voted to pay for these benefits by handing steadily
increasing credit-card bills to future generations. That is wrong,
and should be corrected. But the way to reduce borrowing money from
our children and grandchildren is not to take their money in new
taxes instead. Every dollar of new taxes imposed on younger
Americans to "fix" the long-term spending and deficit problem
simply takes the place of a dollar we would otherwise borrow from
the same people. If borrowing money from our children and
grandchildren to pay for our excessive spending is immoral, then
taking their money is even more immoral.
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:
- Step 1: Include long-term entitlement obligations in the
annual federal budget. A critical first step would be to amend
the budget process to include a present-value measure of long-term
entitlement obligations and special tax preferences in the annual
budget process and to specify changes in the present value in the
annual budget resolution.
The annual federal budget thus should prominently include a
measure of the long-term budgetary situation implications. In
addition, the long term budgetary implications of proposals to
expand or reduce entitlement programs should be included in the
budget, with a requirement that Congress go on record each year
with a vote agreeing to an increase or decline in that long-term
measure.
Last October the Federal Accounting Standards Advisory Board
issued a report calling for changes in financial reporting for
social insurance programs that might form the basis of such a
budget process change. As the FASAB emphasized, the nation must
have better financial information that will force Congress and the
President to address the mounting unfunded long-term costs of
entitlement programs.
- Step 2: Convert retirement entitlements into 30-year
budgeted discretionary programs. Building on the first step,
Congress also should begin to change the preferred status of
entitlement programs, especially retiree programs, so that spending
on some Americans is no longer mandatory while spending on other,
more needy individuals is discretionary.Today, retired millionaires
automatically preempt the homeless and our soldiers in Iraq in the
struggle for federal funds.
To be sure, while one group of Americans should not
automatically have first call on spending, it is true that even a
more affluent American planning for retirement requires a high
degree of certainty about such programs as Social Security and
Medicare. But this does not mean that we should continue to wall
off these programs from a fair and balanced consideration of the
needs of future retirees compared with other needs - including the
financial security of younger Americans.
A way to achieve balanced consideration and priority for the
needy with a reasonable level of future certainty would be to
convert all retirement spending entitlements into 30-year budgeted
programs that must be reviewed and re-authorized by Congress every
five years. This long-term spending and financing plan could be
explicitly and openly adjusted regularly every five years in light
of such things as changes in technology, demographics, and national
priorities.
To keep the programs within the approved long-term budget,
Congress would apply "triggers" to each program. Such triggers
would require default and automatic adjustments to features of the
program if the trend of current and future spending were projected
to move above or below the budgeted amount. The eligibility age for
Medicare benefits or payments to providers, for instance, could be
adjusted. Congress would always be able to maintain the agreed
budget glide path in another way. Indeed, Congress might utilize
the National Entitlement Adjustment Commission, proposed by Senator
Feinstein, to recommend ways in which Congress might deal with
departures from the 30-year budget.
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