NR Digital

The Entitlement Crossroads

by Reihan Salam
Do we want a system based on centralization or competition?

Conservatives are taking the 2012 election very seriously, and there is a good reason for that: Having avoided the necessary structural reforms of Medicare and Social Security for years, Congress has essentially run out of time. The next presidential administration may well represent our last opportunity to modernize these programs in such a way as to allow current retirees to remain largely untouched. This is the subtext of the latest round of accusations being traded between the Obama-Biden and Romney-Ryan campaigns.

There is no question that reviving economic growth and spurring job creation are crucial, and President Obama’s failures on this front are reason enough to remove him from office. But it is his approach to entitlement reform that will do lasting harm to America’s economic well-being.

In 1953, the year the Korean War drew to a close, federal spending represented 20.4 percent of GDP. By 2007, before the housing bust and the subsequent financial crisis took their toll, federal spending represented 19.6 percent of GDP. Though the numbers look strikingly similar, the composition of federal spending changed over this period. Essentially, defense expenditures and infrastructure investment declined as a share of total expenditures while social expenditures increased.

This is important because all spending is not created equal: Some kinds of spending expand as a country’s demographics change. Most of us are familiar with the fact that over-65s represent a large and growing share of the U.S. population. Between 2010 and 2020, this share will grow from 22 percent to 28 percent, and between 2020 and 2030 it is expected to grow to 35 percent. Life expectancy at age 65 has been rising at an impressively rapid pace, and the share of Americans over the age of 85 is increasing even faster. As a result, federal spending on health-care entitlements for older Americans is set to explode in the coming decades. Even if we raise taxes considerably, there will be an almost irresistible pressure to cut defense expenditures and infrastructure investment to accommodate the growth of entitlements.

One of the reasons entitlement reform is so difficult is that Social Security and Medicare benefits have been presented to older Americans not only as entitlements, but also as a return of the contributions they have made over their lifetimes. This is an idea that has been embraced by Democrats and Republicans, including both of the major-party presidential campaigns. The problem, however, is that most Americans in fact get far more out of these programs than they put in.

Last year, Eugene Steuerle and Stephanie Rennane of the Urban Institute did the math. Consider, for example, a two-earner couple in which one spouse earns the average wage ($43,500) and the other earns a low wage ($19,500). Had this couple turned 65 in 2011, it would have paid $520,000 in Social Security and Medicare taxes but would be on track to receive $828,000 in Social Security and Medicare benefits. (These amounts are adjusted for inflation and a 2 percent real interest rate.)

More to the point, it is current workers who pay for current retirees, and the ratio of workers to retirees is expected to deteriorate from one retiree for every 4.6 workers at present to one retiree for every 2.7 workers over the coming decades. These future workers will have to meet far larger obligations than today’s workers, yet they will be no more educated than today’s workers and thus probably will not be much more productive.

The Romney-Ryan ticket is committed to addressing the growth of entitlement spending in a number of ways. On Social Security, the former Massachusetts governor and the Wisconsin congressman have both backed raising the retirement age and slowing benefit growth for affluent retirees. Ryan went farther in his 2010 “Roadmap for America’s Future,” calling for the creation of personal accounts that younger workers could use to pre-fund retirement expenses. Though it is not clear that these ideas are adequate to the task of addressing Social Security’s long-term fiscal imbalance, which has been exacerbated by the president’s recent payroll-tax holiday, they represent an admirable willingness to rethink the basic structure of the program.

What is far more ambitious is the Romney-Ryan commitment to rebuilding Medicare. Rather shrewdly, Paul Ryan’s most recent budget proposal uses the same growth target for Medicare embraced by the Obama White House, GDP plus 0.5 percent. The difference is that Ryan and Romney reject the Obama approach of using price controls, betting on competition to drive down costs instead. Insurers will submit bids that reflect how much they are willing to accept to offer the same benefits that Medicare offers. In each region of the U.S., the federal government will give beneficiaries an amount equal to the second-lowest bid, and seniors will use this money to buy insurance. Seniors can choose plans that cost more than the second-lowest bid, but they will have to pay the difference out of pocket. And if they choose a cheaper plan, they will receive a rebate. They can also choose to stay in traditional Medicare if they wish.

The great advantage of this approach is that it encourages productivity-enhancing business-model innovations. Providers will have a strong incentive to organize care more efficiently, as that will attract more Medicare beneficiaries. Traditional Medicare either will respond in kind, or will steadily lose customers.

Of course, if competition does not reduce costs, we will have to go back to the drawing board. It would be politically unthinkable for Congress to allow seniors to lose access to medical care, which is one of the many reasons why the scaremongering directed at the Romney-Ryan approach is so misleading. The real question we face is whether we want to bet on a centralized approach, as enshrined in Obamacare’s Independent Payment Advisory Board, or whether we want to bet on competition.

The Romney-Ryan ticket is not perfect on entitlement reform. There is a strong case for implementing competitive bidding sooner rather than later, yet the GOP nominee insists on keeping Medicare as is for those over the age of 55. In lambasting the Obama administration for mandating savings (that is, cuts) from the Medicare program over the next decade, Republicans have found a potent line of attack — yet they may well have made it harder for future conservatives to trim the growth of the entitlement state. But Romney-Ryan is the easy choice when compared with President Obama, his faith in centralized solutions, and his unwillingness to acknowledge that the current spending trajectory will necessitate either steep middle-class tax increases or a debt explosion.