Henry Aaron on the Case for Entitlement Reform

by Reihan Salam

The opening section of Henry Aaron’s essay in the latest issue of Democracy Journal includes a series of attacks on conservative entitlement reform proposals, e.g.:

Against this backdrop, the American public is being told that the cause of looming financial catastrophe is an “entitlement crisis.” Fiscal Jeremiahs warn that the only way to deal effectively with current deficits is to cut back Social Security, Medicare, and Medicaid years in the future.

This is a reasonable point. Reforms that will only impact Americans currently under the age of, say, 55 will not yield immediate fiscal benefits. Yet it is also true, for reasons that Aaron explains reasonably well later in the piece, that entitlement reform efforts will grow more politically challenging in the coming years as the population ages. Reforming old-age social insurance programs for current beneficiaries will likely meet with intense resistance, as indeed it has in the recent past. And so it is reasonable to argue that structural reform efforts need to be undertaken sooner rather than later, as it will difficult if not impossible to yield significant savings ten or even five years while also shielding current beneficiaries. Indeed, this is why the Clinton White House and the House Republicans of the mid-1990s were open to structural entitlement reform. There was an understanding that while the U.S. at the time had a very favorable dependency ratio at the time, that ratio would likely shift over the next twenty years. The problem, however, is that there was no political urgency for reform during an era of budget surpluses.

Aaron is objecting to the fact that congressional Republicans and conservatives more broadly are urging that the U.S. undertake long-term structural reform in the near-term — but of course the problem is that we haven’t done so sooner. Moreover, he is acknowledging that conservatives aim to curb the growth of health entitlements and old-age insurance programs “years in the future,” as if it would be better for conservatives to call for immediate cuts. He discounts the possibility that reform advocates, or rather Fiscal Jeremiahs, not all of whom are conservatives it should be stressed, believe that pursuing structural entitlement reform now will have the ancillary benefit of making it easier to make the case for continuing to allow somewhat fiscal deficits (also known as fiscal stimulus) in the near term. 

The full House of Representatives has twice passed budget plans, crafted by Budget Committee Chairman Paul Ryan, that would replace Medicare with a voucher that beneficiaries could use to buy either private insurance or a plan like traditional Medicare.

As we’ve discussed ad infinitum, the 2011 Ryan plan is a hybrid of defined benefit and defined contribution. That is, it guarantees that the current Medicare defined benefit will be preserved, and that premium support will be tied to the second-lowest bid to deliver this defined benefit in any given region. There are many legitimate criticisms of this approach, but a more careful description belies the misleading interpretations advanced by its critics. 

The Ryan plan would also convert Medicaid into a block grant at spending levels well below what is projected under current law. The grants would not increase during recessions when Medicaid enrollments tend to spike. States, pinched by falling revenues and rising service demands, would have to cut benefits just when they are most needed.

We have been very critical of the Ryan plan’s approach to Medicaid, and we have made the case for something akin to Paul Howard’s Medicaid block proposal. This is a fair and consequential point.

Having established his progressive bona fides, Aaron proceeds to … make the case for entitlement reform, in terms that conservatives would be wise to embrace. Early on, he provides context for longevity increases:

As mortality rates for young adults approach zero, most longevity gains have to occur among the old. As [Karen] Eggleston and [Victor] Fuchs show, that is just what has been happening. The share of longevity gains among those over age 65 has risen from one-fifth at the start of the twentieth century to 80 percent now, and the share is rising.

For the past couple of decades, these gains have been unequally shared. Research by University of Illinois at Chicago public health professor S. Jay Olshansky and his co-authors documents that most longevity gains have accrued to the well educated. Those with little education are actually dying younger than they were in the past. A pre-existing longevity gap is expanding with alarming speed. Between 1990 and 2008, life expectancy at age 25 among white men and women with less than a high-school education fell 3.3 years and 5.3 years, respectively. Part of the reason for this drop may well be that those with less-than-high-school education rank lower on the socioeconomic scale now than they did even two decades ago, but much of the shift is a mystery. Among white men and women with at least a college education, life expectancy at age 25 rose 4.7 years and 3.3 years, respectively, over that period. In 1990, life expectancy at age 25 for white men with at least a college education was five years more than it was for those with less than a high-school education; by 2008, the gap was 13.1 years. For white women, the gap shot up from 1.9 years to 10.5 years.

Aaron then offers a sophisticated take on the case for reform given these longevity increases, drawing on the work of Stanford economist John Shoven:

Males usually marry women somewhat younger and who have somewhat longer life expectancies than themselves. Shoven points out that roughly 30 years will elapse, on average, before both members of a couple consisting of a 62-year-old man married to a 60-year-old woman will die. Typically, they will have worked no more than 40 years. Shoven bluntly asserts, “You can’t finance 30-year retirements with 40-year careers without saving behavior that is distinctly un-American.” Whether one uses my arithmetic or Shoven’s starker version, it is surely fair to ask whether people will be willing to divert from current consumption enough to both support ever-lengthening retirements and pay for the rest of what they want government to do. [Emphasis added]

Shoven is currently pursuing a research agenda on series vs. parallel retirement strategies, with parallel strategies referring to the status quo in which retirement income derives from Social Security benefits and defined contribution assets and series strategies referring to drawing down defined contribution assets before drawing on Social Security benefits. Shoven suggests that for many if not most workers, a series strategy ought to be the preferred approach.

This brings to mind Jed Graham’s work on old-age risk-sharing, an approach that aims to encourage the delaying of retirement, Andrew Biggs’ proposed age-dependent reform of the Social Security payroll tax and his broader call for transitioning Social Security to a universal flat defined benefit combined with universal defined contribution retirement accounts, and, in a somewhat different vein, David Autor and Mark Duggan’s innovative proposal for reforming the Social Security disability insurance program by requiring that mandatory private disability insurance (PDI) be used from 90 days to 2.25 years before public SSDI benefits kick in. That is, Autor and Duggan propose a series strategy designed to encourage employers and workers to keep disabled workers attached to the labor force.

To return to Aaron:

Perhaps they will. After all, workers retire earlier in many other developed countries and receive pensions more generous than those in the United States, even though their life expectancies equal or exceed our own. Still, the reaction of U.S. elected officials to current and projected budget deficits suggests that the United States will not readily accept European-level taxes. Europeans are, to be sure, cutting back pension commitments, but they are doing so from levels much higher than those in the United States and facing elderly populations that, relative to total populations, are considerably larger than any anticipated in the United States. The Republican Party wants no tax increases whatsoever. Even most Democrats support permanent extension of most Bush-era tax cuts. [Emphasis added]

It is worth noting that even as European governments cut back pension commitments, it is far from obvious that current European-level taxes are adequate to secure long-run fiscal sustainability. That is, European-level taxes are a moving target. Even if U.S. voters were willing to sustain European-level taxes of 2012, it is not clear that they would be willing to sustain European-level taxes of 2022, hence the emphasis on structural reform. 

For this reason, supporters of the current social-insurance system—even as they fight against any cuts at all—must think about changes in Social Security, Medicare, and other elements of the social safety net that reduce spending in the least damaging ways and that may accomplish other goals. Prominent among such goals should be measures to put in place financial incentives to “nudge” those who can do so without undue hardship to work until later ages than they now do. [Emphasis added]

This, of course, is precisely the strategy that has been pursued by many of the Fiscal Jeremiahs Aaron criticizes.

Briefly, Aaron says that proposals to cut Social Security benefits are “particularly galling” because they were cut in 1983. He does not mention, however, that the trajectory Social Security benefit growth changed substantially during the late 1970s. Greg Mankiw provided historical background back in 2005:

This current system of indexing initial benefits to wages has not been part of Social Security since its inception.  In fact, it was introduced by the Carter Administration in 1977.  At the time, some leading experts on Social Security objected to this change, arguing that it would put Social Security on an unsustainable path.  In a prescient letter in the New York Times (published on May 29, 1977), Peter Diamond, James Hickman, William Hsiao, and Ernest Moorhead wrote, “the wage indexing method calls for a much larger growth in benefits for future retirees at a time when the country may not be able to afford it.…Only a Social Security system without a large deficit on the horizon can have the flexibility to deal with this and other needs.  It would be sad if the legacy of a particularly forward-looking President [Carter] were a political nightmare.”  Despite their advice, President Carter signed into law the indexation regime with which we are still living. [Emphasis added]

Perhaps it is galling that 1983 legislation aimed to address some of the fiscal challenges caused by 1977 legislation, but I do think it is worth keeping this historical context in mind. One wonders if the country might have been better off had the Carter administration embraced the recommendations of Diamond et al. and prevented the 1983 increase in the payroll tax, which had a direct impact on the disposable income of low- and middle-income wage-earners. All that said, Aaron’s recommendations for Social Security seem sound, and they resemble Jed Graham’s risk-sharing concept.

Aaron’s discussion of Medicare reform includes the following:

So was the claim that these competing private plans save money. In fact, even if one adjusts for diverse health needs and subtracts the extra payments that private plans received under the Medicare Modernization Act of 2003, the data show that competing private plans on average cost about 3 percent more than traditional Medicare does.

James Capretta and Yuval Levin have offered a somewhat different interpretation. And though Aaron is quick to scrutinize the claims made by the Affordable Care Act’s detractors, he almost entirely overlooks its structural flaws, like those raised by Eugene Steuerle, an advocate of universal coverage. 

Regardless, Aaron has done us a service by offering a window into how progressives are thinking about entitlement reform. 

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.