Greenspan: Social Security and Medicare Must Be Cut to Solve the Budget Deficit Problem

Can closing the barn door after the horses have left restore a reputation? Alan Greenspan discusses the growing pressures on the budget deficit and potential solutions to the problem. He starts by saying he believes a revised version of the Budget Enforcement Act of 1990 is needed to curtail government spending. Thus, while he opposes an explicit inflation targeting rule for monetary policy because it undermines flexibility, he supports budget rules that limit flexibility for fiscal policy.

Greenspan identifies the usual suspects as the cause of current and growing budget deficit problems, Social Security and Medicare, and discusses the usual solutions. First, while productivity growth will help, he does not think it will accelerate fast enough to solve the problem. The other two solutions are tax increases and cuts in spending. His view is that tax increases alone cannot solve the budget problem because the size of the tax increases required would severely curtail economic growth. Thus, cuts in spending will be necessary. He then takes this a step further and says the problems should be solved "primarily, if not wholly" with cuts in spending, and identifies Social Security and Medicare as the targets for the cuts. I disagree that cuts in spending alone can meet the challenge, just as Greenspan disagrees that tax increases alone can solve the problem. It seems he cannot admit that his call for tax cuts contributed to the budget problem and therefore cannot admit that at least a partial reversal of the tax cuts would be helpful.

Finally, he talks about the need to increase saving and says our ability to meet future budget challenges will be heightened if saving increases because it will fund increases in the capital stock and increase growth. I expected he would issue a call for private Social Security accounts at this point as a means of increasing saving, but he simply says that the current Social Security structure has not proven an effective vehicle for promoting saving leaving the call for private accounts implied rather than explicitly stated:

Budget Policy, by Chairman Alan Greenspan (videotaped remarks): The U.S. economy has delivered a solid performance thus far in 2005. ... However, the positive short-term economic outlook is playing out against a backdrop of concern about the prospects for the federal budget over the longer run. ...[T]he latest projections ... suggest our budget position will substantially worsen in the coming years unless major deficit-reducing actions are taken. As I recently testified, the necessary choices will be especially difficult to implement without the restoration of procedural restraints on the budget-making process. ... Reinstating a structure like the one formerly provided by the Budget Enforcement Act of 1990 would signal a renewed commitment to fiscal restraint and help restore discipline to the annual budgeting process. ... I do not mean to suggest that the nation's budget problems will be solved simply by adopting a new set of budgeting rules. The fundamental fiscal issue is the need to make difficult choices among budget priorities, and this need is becoming ever more pressing in light of the unprecedented number of individuals approaching retirement age. ...

To be sure, favorable productivity developments would help to alleviate the impending budgetary strains. But unless productivity growth far outstrips that embodied in current budget forecasts, it is unlikely to represent more than part of the answer. Higher productivity does, of course, buoy revenues. But ... because the long-range budget assumptions already make a reasonable allowance for future productivity growth, one cannot rule out the chance that productivity growth will fall short of projected future averages. ... [C]onsiderable uncertainty remains about the precise dimensions of the problem ... We already know a good deal about the size of the adult population in, say, 2030. ... Thus, forecasting the number of Social Security and Medicare beneficiaries is fairly straightforward. So, too, is projecting future Social Security benefits.... However, the uncertainty about future medical spending is daunting. We know very little about how rapidly medical technology will continue to advance and how those innovations will translate into future spending. ... As a result, the range of future possible outlays per recipient is extremely wide. ... These uncertainties ... suggest significant prudence when considering spending initiatives. ...

I fear that we may have already committed more physical resources to the baby-boom generation in its retirement years than our economy has the capacity to deliver. If existing promises need to be changed, those changes should be made sooner rather than later. ... Addressing the government's own imbalances will require scrutiny of both spending and taxes. However, tax increases of sufficient dimension to deal with our looming fiscal problems arguably pose significant risks to economic growth and the revenue base. ... [I]n my judgment, they are sufficiently worrisome to warrant aiming, if at all possible, to close the fiscal gap primarily, if not wholly, from the outlay side. In the end, I suspect that, unless we attain unprecedented increases in productivity, we will have to make significant structural adjustments in the nation's major retirement and health programs. ...

Raising national saving is an essential step if we are to build a capital stock that by, say, 2030 will be sufficiently large to produce goods and services adequate to meet the needs of retirees without unduly curbing the standard of living of our working-age population. Unfortunately, the current Social Security system has not proven a reliable vehicle for such saving. Indeed, although the trust funds have been running annual surpluses since the mid-1980s, one can credibly argue that they have served primarily to facilitate larger deficits ... and therefore have added little or nothing to national saving. ...

It falls to our elected representatives to determine how best to address the competing claims on our limited resources. In doing so, they will need to consider not only the distributional effects of policy changes but also the broader economic effects on labor supply, retirement behavior, and private saving. In the end, the consequences for the U.S. economy of doing nothing could be severe. But the benefits of taking sound, timely action could extend many decades into the future.

[Update: PGL at Angry Bear also comments].

Comments

[calmo]

I expect our regular in house expert, self acclaimed 'one trick pony', (also most self deprecated and most artful poster in our stable) will have a few words to say about this. But can I perform a warmup act for the mighty Bruce Webb?
I'll keep it short: Greenspan has some gall to talk about ANY measures that would "severely curtail economic growth" that is currently shedding more than $3B/day. Makes me grab for the clothes iron to put that forked tongue right.

[anne]

http://www.nytimes.com/2005/11/30/business/30pension.html?ex=1291006800&en=90c70e8876749d97&ei=5090&partner=rssuserland&emc=rss

November 30, 2005

A Secure Old Age in Australia From Investments Abroad
By WAYNE ARNOLD

It is the kind of problem most governments could only wish for: After several years of budget surpluses, debt is headed to zero and a huge privatization next year will add billions of dollars more to the treasury.

How to spend it: On public works? Tax cuts? A rainy-day fund?

The Australian government, faced with just such an embarrassment of riches, has elected to plow roughly $15 billion in surpluses, together with the $18.5 billion it expects to earn from the sale of the rest of its former phone monopoly, Telstra, into a professionally managed investment fund.

Called the Future Fund, this national nest egg would also absorb future budget surpluses and invest it in world financial markets. The goal is to raise the $103 billion that the government estimates it will need by 2020 to pay pensions owed to its employees.

Finance Minister Nicholas Minchin, referring to money held in the central bank, said by telephone from Canberra, "We're satisfied that a diversified and well-managed investment fund will be able to earn over the longer term considerably more, and build up to the requisite size in a much more likely fashion, than just leaving it with the reserve."

Having proposed the investment fund last year, the government plans to introduce legislation in the next two weeks to create it. The fund would soon become one of the largest in Australia and, at its peak, is likely to number among the world's largest public investment funds - joining the ranks of the $100 billion Government of Singapore Investment and the nearly $200 billion California Public Employees' Retirement System, or Calpers. And like them, analysts say, the Future Fund is likely to have a proportionate influence in global financial markets.

There was no immediate indication how its portfolio would be divided between Asian and other world markets....

[anne]

Though the point is never argued, and possibly it should not be, beyond tax cuts as a loss of revenue, think what has been spent on the war effort beyond what a policy of containment had entailed in the years before the war in Iraq.

[pgl]

If we went back to the fiscal policies of the past Administration, we would solve the budget deficit problem. OK, that means reducing defense spending a bit, eliminating the pork barrel garbage put in by DeLay et al., and not going ahead with Bush's bloated Rx bill. But when Greenspan dismisses using tax increases - he has gone over to the Kudlow-Laffer Dark Side.

[spencer]

Why should I pay any more attention to Greespan now then 5 years ago when he was projecting we would have such massive surpluses that it would cause all the bond traders to lose their jobs.

Maybe if he hadn't destoyed his credibility to get us in this mess he would be worth quoting.

[Uncle Jeffy]

The biggest phony in Washington, Alan Greenspan, strikes again. It was easy to look smart when he had breakfast every week with Robert Rubin and Lawrence Summers, and had people like Paul Krugman and Joseph Stiglitz (among many others) on call. He might even regain some of that Clinton-era reputation if he was willing to admit he was wrong to support a policy that has been shown to generate unsustainable budget deficits. He might even convince us that he's not a Republican hack if he argued that the budget should not be balanced on the backs of senior citizens and the lower and middle classes.

Alas, none of this will come to pass.

[OldVet]

I agree with Mr. Thoma and commentators above. It takes chutzpah to walk away from the deficits by saying, "Let the little people pay." Granted many programs could be trimmed. Granted we could try cutting our military budget in half, by $250 billion a year, and trim Rx benefits to "cost plus 1%" for Medicare patients.

We could reduce the overall social cost of healthcare by establishing a national health plan that could reduce administrative overhead costs from some 10% today to the 2% it costs through Medicare.

But saying that all the fruits of productivity growth should go to owners of capital? Flat real wages tell us this is happening, when corporate profits have hit historical highs.

Nobody wants taxes higher than absolutely necessary, but some increases now could put us closer to the Australian model. Deep cuts in certain kinds of spending would help as well - especially in the "defense" area. Maybe start by getting our money back for the Lincoln Group progaganda program, a $100 million boondoggle.

[Bruce Webb]

Wouldn't want to disappoint Calmo, so I am breaking my normal rules and posting from work.

Greenspan continues the old trick of conflating Medicare and Social Security while largely concealing the fact that they are on very different economic trajectories. Taken separately Social Security,even given the assumptions of Intermediate Cost is manageable. The current projected payroll gap under Intermediate Cost (if we acted today) was set at 1.92% in the 2005 Report while the Productivity figure needed under Low Cost was set at 2.1% It is laughable to suggest that we could not sustain a 1.92% boost in payroll tax. Do the math for any given income then compare that to the cost for privatization and then compare the promised benefits between the two plans. We don't have to show that all of the projected gap will be made up from productivity gains. Greenspan freely admits they will help, and the history of the last decade has shown a steady shrinkage in the tax gap despite ever more pessimistic assumptions. The gap was 2.23% in the 1997 Report, despite inaction (i.e. money left in my pocket) the gap going forward is 1.92% and given this year's economic numbers is likely to shrink again. (The bump from 1.89% in 2004 to 1.92% in 2005 was due to some rejiggering of teen and elderly earnings). The cost of inaction has been a shrinking gap. Doing nothing was a winning bet every year from 1996 to 2004, and at worst break even in 2005 (it would take 63 years of tax collections at 1.92% to offset the 1.89% I saved last year by doing nothing, not including the utility I got from spending or investing the money last year.)

Productivity may not do the whole deal, but the gap it leaves at worst will be small. As Barkley Rosser has pointed out 75% of promised benefits would still result in a benefit of 120% relative to current benefits.

Medicare is a different story, but using its possible problems (themselves exaggerated) to argue for Social Security cuts today is just not justified, particularly when you are increasing Medicare spending at the same time throught the Big Pharma giveaway, um I meant Medicare Drug benefit.

[anne]

http://www.nytimes.com/2005/08/20/opinion/20bilmes.html?ex=1282190400&en=e6842bf28ce308c3&ei=5090&partner=rssuserland&emc=rss

August 20, 2005

The Trillion-Dollar War
By LINDA BILMES

Cambridge, Mass.

THE human cost of the more than 2,000 American military personnel killed and 14,500 wounded so far in Iraq and Afghanistan is all too apparent. But the financial toll is still largely hidden from public view and, like the suffering of those who have lost loved ones, will persist long after the fighting is over.

The cost goes well beyond the more than $250 billion already spent on military operations and reconstruction. Basic running costs of the current conflicts are $6 billion a month - a figure that reflects the Pentagon's unprecedented reliance on expensive private contractors. Other factors keeping costs high include inducements for recruits and for military personnel serving second and third deployments, extra pay for reservists and members of the National Guard, as well as more than $2 billion a year in additional foreign aid to Jordan, Pakistan, Turkey and others to reward their cooperation in Iraq and Afghanistan. The bill for repairing and replacing military hardware is $20 billion a year, according to figures from the Congressional Budget Office.

But the biggest long-term costs are disability and health payments for returning troops, which will be incurred even if hostilities were to stop tomorrow. The United States currently pays more than $2 billion in disability claims per year for 159,000 veterans of the 1991 gulf war, even though that conflict lasted only five weeks, with 148 dead and 467 wounded. Even assuming that the 525,000 American troops who have so far served in Iraq and Afghanistan will require treatment only on the same scale as their predecessors from the gulf war, these payments are likely to run at $7 billion a year for the next 45 years.

All of this spending will need to be financed by adding to the federal debt. Extra interest payments will total $200 billion or more even if the borrowing is repaid quickly....

[ken melvin]

The real cost of war may be in the screwed up lives of veterans and their families, e.g., VietNam.

And oh,in re Kermit the Alan, them that gets is them that gots.

[Michael Cain]

My favorite summary of Bruce Webb's point is from a 2002 CBO report, shown graphically here:
http://home.comcast.net/~mcain6925/etc/gdp.cbo.gif

SS (using current formulas) stabilizes at an essentially constant fraction of GDP. Medicare/Medicaid do not. A repeat of this study would undoubtedly look worse today, since it was done before the Medicare drug benefit was created and assumes fiscal surpluses that pay the national debt off by about 2025. But the SS portion wouldn't look worse.

The Greenspan Commission recommendations for SS had two parts in 1983. Raise taxes enough to generate a surplus -- which happened. Use the surplus to pay off the then $1.5T national debt so that bonds held by the SSA could be rolled over into actual public debt to pay off the Boomers' retirement, leaving the balance sheet in the same state after the Boomers die as it was in 1983. If it's okay for Alan to say today that SS benefits must be cut, then it would have been okay for him to have been saying for the past 20 years that Congress wasn't holding up its end of the plan.

[ilsm]

Deep cuts are necessary and available in "defense".

The Navy and Air Force, utterly uninvolved in the misadventure in Iraq, are shedding people so the Army can get more soldiers, in a zero sum Army increase in manpower.

So, time to cut into the stuff developed during the Reagan defense industry welfare expansion, many are super expensive and not very useful. These, to name a few, are B-2, MV-22, F/A 22 (A added because there are no real fighters for it to dogfight with), 4 or 6 of the twelve aircraft carriers battle groups. There are a lot more.

Why is our "national security" establishment 5 times the share of GDP of any other "first world" nation?

Get our national security to key on real defense and not income security for the guys whom congressional charletans, like Cunningham, pander to and Greenspan's solution will be mix of cuts and taxes.

In 1987 there was the Gramm-Rudman defcit reduction act. Defense spending was cut in spite of the fact the Soviets were still in Afghanistan and keeping Lech Walenza under wraps in Poland.

[Lee A. Arnold]

Mr. Greenspan had a good job, and his retirement is not in doubt.

[Bruce Webb]

Michael Cain makes some valuable points (and thanks for the backup) but truth be told Medicare is not in such dire straits as it is made out to be. In 1992 Medicare's Trust Fund was projected to run dry in 1999. Today that date is 2016. Uncomfortably close to be sure but there is a difference between getting a nasty note from your lender and the repo man actually taking away your car. Medicare uses the same economic projections as does Social Security, explicitly so, and as such the income projections are equally suspect. My demand to separate the two is more tactical than strategic: the Right is gunning for Social Security while loading up Medicare and using the Medicare load as ammunition. This conflation of the battles has to be nipped in the bud.

Once the concept that Social Security is fully funded, and even over funded going forward, is fully planted in the American psyche can we turn our attention to Medicare. And there are at least four avenues of attack. First the income stream is being seriously underestimated by the adoption of Intermediate Cost projections. We can do nothing and yet we can still expect a pushback in Medicare Trust Fund exhaustion. Two as it becomes clear, and I think it will, that Social Security is in fact overfunded going forward, we have the opportunity to simply reshift that excess portion of payroll tax to Medicare. Three (and the drug benefit comes into play here) the notion that the dollar cost of treating any particular condition is rising is kind of suspect. You can buy a whole bunch of drugs for the cost of invasive surgery that defines success in cancer treatment as "being alive five years later", the medical standard 20 years ago. We are successfully treating conditions that were fatal two decades ago. An 80 year old breaking a hip meant a one-way trip to full time bed care at the nursing home and generally fade out, these days it means a couple of weeks of inconvenience while your body adjusts to the new artificial joint. We are treating so many more conditions these days that they fact that each individual treatment is actually getting cheaper is lost in the expansion. Four, and this is shared with Social Security, there is the odd assumption that we have the political will to cut future benefits now but will be strengthless in the future. In Medicare's case there is the assumption that we as a nation will not simply say "Stop" in the face of rising medical expenses. When and if we stop being able to afford them we could simply refuse to pay an ever increasing percentage of GDP. Republicans have full well established the fact that they will cut assistance for heating oil for seniors right here, right now. Yet every assumption underlying "Medicare Crisis" assumes that their hands are tied when it comes to capping expenses in the future. Are Boomers going to be so more cranky 20 years from now than they are today to expect them to buy into cuts now?

Social Security and Medicare reform alike are sold on the "Pay me now or pay me later" model. But it is not at all clear that the future bill will be as much as people are claiming. And my odds of reaching 84 years of age in 2041 are kind of shaky at best. This odd demand that Boomers act against their own economic interest is kind of odd from the "deficits don't matter" crowd when it comes to tax cuts.