by Paul Hewitt, National Taxpayers Union Foundation
Table of Contents/Entitlement Report/Introduction/Foreward/I/II/III/IV/V/VI
Americans are bound to hear a lot more about entitlements in the years just ahead -- and for good reason. These giant benefit programs, which make automatic payments to individuals who meet statutorily defined eligibility criteria, consume the lion's share of the federal budget .
They account for all of the net projected growth in programmatic expenditures. Their exploding costs are behind the ever rising federal debt and the soaring interest payments on that debt. Most importantly, entitlement programs are the root cause of the long-term decline in our savings and productivity growth rates. However politically controversial it may seem, entitlement reform looms on our horizon. It is essential if America is to be competitive in the increasingly capitalistic world economy of the 21st century -- and if future generations are to retire with anything approaching the financial security enjoyed by today's elders.
Entitlements come from a family of programs sometimes referred to as "social insurance." Included in this category are direct spending programs, such as Social Security ("Old Age, Survivors and Disability Insurance") and Medicare ("Hospital and Supplementary Medical Insurance"). Other social insurance provides public guarantees for private assets, such as bank deposits, corporate pensions, mortgage loans, crops, beach-front property, flood-lands, and student and business loans. As we saw recently in the savings and loan crisis, unfavorable events in any of these sectors can trigger massive expenditures.
The defining characteristic of social insurance is that it substitutes federal guarantees for private insurance, thereby reducing savings. It is possible to insure against almost any event -- for instance, to insure an athlete's knee against injury, or a tire against tread wear. But the greater the risk and the cost of the events one insures against, the larger the set-aside that is needed as a reserve to pay benefits. This is why private insurance is a major source of national saving. By contrast, the effect of federal guarantees is to reduce or abolish the reserve and/or premiums that fund private insurance. Thus, Social Security promises protect individuals against the risk of saving too little for old age; deposit insurance shields banks from the risk of low asset-to-liability ratios; pension insurance indemnifies businesses against the risk of underfunding their pension plans, and so forth. In each case, government subsidizes beneficiaries' consumption by enabling them to consume as though they had built up savings -- in other words, to save less than they would without the guarantee.
One result is that at the end of 1991 unfunded social insurance liabilities totalled an estimated $14 trillion. In accrual accounting, unfunded liabilities equal savings foregone. In other words, federal unfunded liabilities reflect national dissaving (over-consumption) of at least $152,000 per household. While the economic consequences of dissaving sometimes are disputed, it remains that had we saved the additional $14 trillion we should have, domestic borrowing costs surely would be lower and our industrial prospects brighter. It is quite likely, as well, that social problems like homelessness, crime, and hard core employment would be less vexing.
Savings affect prosperity through technology and the laws of supply and demand. The more plentiful is the supply of capital, the lower are the borrowing costs for American industry. When firms have access to cheap capital (money that can be borrowed at low interest rates), they invest more in technologies that increase output per worker. They can also create more jobs, since low interest rates make more investments economically viable at the margin. A manager facing a three percent interest rate is far more likely to invest in better plant and equipment than one with a nine percent cost of capital. This is why capital-intensive industry tends to thrive, and wages tend to rise in countries with high savings rates.
Conversely, industry tends to grow more slowly in economies with low savings rates. In the U.S., a Third World savings rate has saddled American industry with a long term comparative disadvantage in capital costs. During the 1980s this disadvantage deprived U.S. manufacturers of the full benefit of the opportunities presented by emerging technologies. Microwaves and video recorders are just two popular products that were invented in America, but whose assembly lines were established in high-savings countries, such as Korea, Taiwan, and Japan.
In the technological age, missed industrial opportunities can undermine prosperity with great suddenness. Products and processes are now being supplanted so quickly that economies that are slow to adapt will lose market share and national income to their more nimble competitors. When domestic policies minimize saving and investing in the face of fierce competition from high-savings economies, they foster industrial decline, joblessness, downward mobility, and social pathology. Progressive social outcomes, in other words, are more likely than ever to result from policies that promote, rather than restrict, saving and investing.
Entitlement reform will help increase our domestic savings rate, first, by curtailing the federal budget deficits that during 1991-1992 consumed 71 percent of domestic savings. Second, it will prompt the pre-funding of expected private liabilities through increased business and household saving. The natural response of markets to rationally assumed risk is capital formation. Any policy that reintroduces risk into economic calculations is bound to increase the savings rate.
The End of Ideology
Powerful ideological interests will, of course, oppose any scaling back of social insurance, in part because they view capital as the source of economic inequality. This philosophy, rooted in 19th century belief that capital exploits labor, holds that government control of capital through social insurance (and taxes, to fund government "investment") is the key to economic equity in market economies. Such policies did not greatly diminish national prosperity so long as the introduction of new technology was slow and competition from abroad was weak. Yet the experience of recent decades suggests that both the pace of technological change and the challenge of international competition for jobs and markets are increasing. The world economy is becoming more, not less dynamic. If anything, the economic and technological stresses that have caused the virtual stagnation of U.S. worker incomes since 1973 will intensify many times over.
Meanwhile, the economic logic for generous entitlement benefits today seems quaint in light of the economic facts documented in Parts III, IV and V of this Chartbook. Consider the remarks of Paul A. Samuelson, one of the most influential economists of the early postwar era, writing in Newsweek in 1967:
"The beauty about social insurance is that it is actuarially unsound. Everyone who reaches retirement age is given benefit privileges that far exceed anything he has paid in. And exceed his payments by more than ten times as much (or five times, counting employer payments).
How is this possible? It stems from the fact that the National Product is growing at compound interest and can be expected to do so for as far ahead as the eye can see. Always there are more youths than old folks in a growing population. More important, with real incomes growing at some 3 percent per year, the taxable base upon which benefits rest in any period are [sic] much greater than the taxes paid historically by the generation now retired...Social Security is squarely based on what has been called the eighth wonder of the world -- compound interest. A growing nation is the greatest Ponzi scheme ever contrived."
Today the prosperity of future generations can no longer be taken for granted. Compound interest on a ballooning national debt is working against, rather than for the taxpayers. The incomes of younger workers are declining. As a result, age based transfers, such as Social Security, Public Pensions, and Medicare, have become regressive. Moreover, official projections indicate that the cost of these programs could explode to more than 60 percent of total U.S. payroll by 2040. Just as the theological contention that the Sun revolved around the Earth yielded inevitably to the findings of astronomy in the 16th century, so too must ideological prejudice against capital capitulate to the 20th century triumph of capitalism.
Government policy in this new era must explicitly recognize that the nation's capital pool is a public good, like the environment, which benefits all, and to which all must contribute. The politics of saving must shift accordingly. Instead of viewing capital as exploitive of workers, we must acknowledge that labor without capital is unproductive and low-wage. Instead of viewing tax incentives for saving as socially regressive in intent -- to benefit the rich -- we should see them as progressive -- the key to upward mobility for the masses. Instead of viewing savers as selfish, we must stop penalizing them for committing socially responsible acts of self-denial that enable others to earn a decent living.
Anti-savings policy must also be stripped bare of its soothing Orwellian construct. The lexicon of social insurance -- words such as "trust fund," "insurance," "contribution," "account," and "financial independence" -- often describes the opposite of what it means. The government officially declares that Social Security expenditures do not contribute to federal deficits. Yet nothing could be further from the truth.
Entitlement reform is not just about restoring the thrift ethic in an aging society beset by aggressive foreign competitors intent on stealing our markets and earning capacity. It is about restoring the credibility and trustworthiness of our government. For years, politicians have been covering up the entitlement problem at the behest of powerful special interests. If we had the will to correct our anti-savings bias, we could easily follow the lead of Britain, Australia, New Zealand, Chile, and Argentina by replacing old age benefit promises to middle- and upper-income Americans with tax incentives for saving.
Perhaps Senator Alan Simpson's willingness to level with us in the preceding essay is evidence of a new era of honesty in government. Let us hope, for America's sake, that his clear vision quickly spreads to the rest of our leaders. For, as the data to follow illustrate, the costs of self-deception are compounding at a frightening rate.
Paul S. Hewitt, Executive Director
National Taxpayers Union Foundation
June 30, 1994
Table of Contents/Entitlement Report/Introduction/Foreward/I/II/III/IV/V/VI
