Boomers and Entitlements: The Next Round

My proposal that the baby boomer generation take on the cause of rescuing entitlements from their unsustainable course – setting aside a share of the savings to invest in infrastructure, education and basic research – continues to draw a lot of mail, pro and con, as I noted in my last post. Today I’m kicking up my feet and cranking up the Beach Boys while two more authoritative advocates go at it.

James K. Galbraith is a professor at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin, and a prolific critic of American capitalism and foreign interventions. He articulates the view of many readers that Social Security and Medicare are secure. In particular, he attacks the findings of Third Way, a think tank of centrist Democrats, whose work on this subject I have cited as enlightening and alarming.

I invited Jim Kessler, the senior vice president for policy at Third Way, to defend the group’s work. He’s a co-founder of the group, and a former legislative director for Senator Charles Schumer, D-N.Y.

Not that it matters, but both Galbraith and Kessler are baby boomers.

Readers will not be surprised that I continue to find Kessler’s arguments more persuasive. But I welcome a chance to keep the conversation going. It doesn’t seem to be taking place where it SHOULD be taking place: in Washington and on the campaign trail.

Dear Mr. Keller:

I am writing this at the request of the Franklin and Eleanor Roosevelt Institute, which directed my attention to your recent Op-Ed on “entitlements.” As a former Executive Director of the Joint Economic Committee, and as an economist with experience studying budget and military matters, your column immediately engaged my interest.

The nub of your essay on why Social Security, Medicare and Medicaid must be cut is a graph – taken from a report by a group called Third Way – that compares federal “investments” with “entitlements,” showing that one is in decline and the other is on the rise.

But note, as you acknowledge, that the federal budget counts weapons systems as “investments.” Back in the 1960s, that was mainly what federal investment was. We were building nuclear bombers, submarines, missiles and warheads; today we are downsizing that arsenal, happily unused. Do you really think that those “investments” had anything much to do with economic growth? If so, you are misinformed.

Even today, military procurement is around 40 percent of total federal “investment” – $221 billion out of about $540 billion in 2011, according to the Analytical Perspectives in the Budget. Whatever you think of the F-35 and F-22, it’s silly to add that number to (say) federal aid to education. The sum is not a gauge of anything.

On the budget, you go on to assert that “the arithmetic simply doesn’t work.” If you mean that the federal fiscal position is unsustainable – a widely-held view – you are again misinformed. How do we know? Partly, because the markets clearly have full confidence in the US fiscal position – as evidenced by the record low long-term interest rates at which people with money are willing to lend to the US Government. And if you don’t trust the markets, you can also look at the numbers, as I do here. Either way, the conclusion is the same. Contrary to repeated scare- mongering, the United States public debt position is not unsustainable.

In reality, an older population results partly from the success of Social Security, Medicare and Medicaid over the years. Since the early 1970s these programs have protected elderly Americans from destitution. So protected, they live longer. And as the old become more numerous, the payout of the programs that support them must rise. There is nothing wrong with this, and nothing unsustainable. The right measure is the share of total spending on this population in total GDP; for Social Security (OASDI), which was under 4.5 percentage points in 2009 and projected to rise to 6.5 percent over the next 75 years.** Plainly we can afford that. Your proposal for a higher retirement age deserves a word. Today, a very large share of Social Security recipients take the early retirement option, beginning at 62. Raising the “retirement age” is just a benefit cut for these, most vulnerable, lowest-paid workers – especially those who take the option because they are already unemployed. It’s the cruelest and most dishonestly-presented of all so-called Social Security “reforms.” I would strongly urge you to repudiate it.

We agree that health care costs should be controlled. But to attack Medicare specifically is to target the elderly for cuts, simply because they happen to have a public insurance program. Again, there is no reason for this. Your actual proposals would (mostly) apply to Medicare and non-Medicare funded care alike, which is better. But since they apply to private as well as public insurance programs, they obviously aren’t a case for “entitlement reform”.

These are simple points, whose validity I believe anyone can judge. The FERI will publish a blog post closely related to this letter on its site, at http://tinyurl.com/c4zowz5 . I invite you to respond there, and to make appropriate corrections in a future column.

Yours sincerely, (s/)
James K. Galbraith

** For a detailed discussion of the question of “burden” see my testimony to the Federal Accounting Standards Advisory Board, February 25, 2009, co-authored with Warren Mosler and Randall Wray, available on request: Galbraith@mail.utexas.edu.

The response:

Mr. Galbraith has made important contributions to the discourse about the economy, but we simply don’t share his optimistic view about the financial health of Social Security and Medicare. In his testimony before the Bowles-Simpson commission, he called solvency arguments “complete nonsense” (http://bit.ly/aw0nFX). His criticism of Third Way’s paper (http://bit.ly/MXhAxA) is a continuation of his belief that these programs are doing fine and that in general, “there is no economic justification for deficit reduction.” We disagree and appreciate the opportunity to respond to Mr. Galbraith’s letter.

Mr. Galbraith’s first critique is that we included military investment in our overall measure of America’s federal investment spending. But we simply defined investments as the United States Government does. Had we chosen our own definition, it would have been criticized, fairly or unfairly, for being biased.

Moreover, does Mr. Galbraith really believe there is no economic value at all to any military investment spending? Here are just a few discoveries out of defense … the internet, Google earth, GPS, prosthetics, medical technology to treat wounds and administer trauma care, much of aerospace, high end computing (originally used for code breaking), satellite phones, SONAR, the device used to disarm the explosives in the killer’s apartment in Aurora, graphite bicycles, tennis rackets and golf clubs, digital watches, and so forth. Sure … not all military investment spending benefits the economy, but neither does some domestic investment spending.

But let’s take Mr. Galbraith’s assumption at face value. By any measure, investment spending has cratered. If military investment spending is eliminated from the calculation and only domestic spending is included (as Mr. Galbraith suggests), the peak year is 1966, followed by 1965, followed by 1967. Between 1963 and 1981, non-defense investment spending represented between 10.6 and 14.5 percent of all federal spending. After 1981 it never reached 10% again. That’s 31 consecutive years of domestic investment spending below 10% of federal outlays, following 19 consecutive years of plus-10%. That’s not good.

Mr. Galbraith next argues that deficits don’t matter and as proof he points to Treasury rates: “The markets have full confidence in the U.S. fiscal position – as evidenced by the record low long-term interest rates” for U.S. Treasuries. We cannot imagine a more dangerous way to judge our fiscal health. Look, we hate comparisons between the U.S. and Europe because they are overly simple, but….here it is anyway. Spain’s and Germany’s interest rates were essentially the same in 2008, only one-point apart in 2009 and 2010, and then they shot to three-points apart in 2011, growing to as much as 6 in 2012. Was everything fine in Spain in one year and off the rails the next? Of course not. The capital markets, in that case, had yet to recognize that Spain was in trouble. When they did the ballgame was over.

Our interest rates are low because 1) our economy is stuck right now, and 2) we are the calmest port in very stormy seas. Do we really want an economic strategy based on the belief that no other country or region (Europe or China) will ever get their act together? In 1992, America fielded the Dream Team and won the gold through lopsided victories. By 2008, through complacency, we won the bronze. Don’t bet on other countries not filling the vacuum.

The heart of Mr. Galbraith’s argument revolves around his view that entitlement spending is on a healthy trajectory. We believe this is wrong:

• On Medicare: Neither the column by Mr. Keller nor the Third Way paper attack Medicare or Medicaid (as Mr. Galbraith writes), but rather they both state the obvious – the rising cost of these programs is outstripping the ability to pay for them. By any measure, Medicare and Medicaid spending is growing too quickly. From 1975 to 2010, per person Medicare spending grew at roughly GDP plus 2 percent. That is far, far faster than inflation. Over a short period of time that’s sustainable. Over a long period of time it’s strangulation. Couple that with the fact that our Medicare population essentially doubles over the next several decades this is a financial crisis for the U.S. government. As we have said many times, the best way to reduce Medicare spending is not to slash benefits but to reward quality not quantity. For example, twenty-seven percent of all Medicare spending is on the last year of a person’s life. While some of that is necessary, a great deal is spent on procedures that don’t meaningfully extend people’s lives and many actually reduce the quality of their final weeks. This is just one reform idea to make the program perform better and cost less; it’s hardly an attack on the overall program.

• On Social Security I: There is a net-present-value shortfall of $8.6 trillion over the next 75 years, according to the Social Security actuaries. Let’s not pretend that this is chump change. The actuaries estimate that if Congress acts right away, they could close this shortfall by hiking payroll taxes by 21%, cutting benefits by 16%, or some combination of both immediately. Again, let’s not pretend this isn’t a ton of money. The payroll tax hike is close to $200 billion per year. In addition, every year Congress waits they have to reach that $8.6 trillion over a shorter time horizon. That means bigger tax increases or bigger benefit cuts. The only question, then, is when Congress fixes the problem and how much of the fix tilts toward benefit cuts versus revenue increases. Mr. Galbraith disagrees, but many believe it should be a balance between new revenue and cuts, and we should spread the solution over all 75 years, not a shorter time horizon. Many believe that people earning very high incomes should receive fewer benefits in retirement. Many believe that just as we gradually raised the retirement age in 1986 so that retirement ultimately reaches 67 by the next decade, we need to gently increase it again for those who are young today so that the amount of time that a typical person spends collecting Social Security stays constant – about 18 years. And many people think we should find solutions now so the next generation doesn’t have to do it alone.

• On Social Security II: Mr. Galbraith is correct that over the next 75 years, SS’s projected rise as a share of GDP goes from “under 4.5 percentage points in 2009” to “6.5 percent over the next 75 years.” He says “plainly we can afford that.” Let’s be clear that this measly little two-point bump is actually a 45% rise in the cost of Social Security relative to the size of our economy. To translate further, this is a 45% rise relative to the size and ability of working age people’s capacity to produce and pay for it. To translate further, 2 percent of GDP in today’s economy totals $300 billion. These are enormous sums of money masquerading as a point here and there.

Mr. Galbraith doesn’t believe that deficits matter and he believes that Social Security and Medicare are doing just fine. We disagree. Entitlements are growing by leaps and bounds; investments by any measure are not keeping pace, and the future shows an accelerating trend in the wrong direction. We need to be concerned about this.

Jim Kessler
Senior Vice President for Policy, Third Way