Entitlement Reform Without a Tax Hike

America is at a fundamental crossroads in regard to domestic economic policy. At stake is the root of the American Dream and our nation’s historic prosperity, our very capitalist economic system itself. Also at stake are the bedrock principles of conservatism involving limited government.

Federal spending as a percent of GDP has hovered around 20% since the early 1950s, over 50 years now. But the latest projections of the Congressional Budget Office (CBO) show that will soar to close to 40%, and possibly more, over the next 40 years due to exploding entitlement spending, particularly for Social Security, Medicaid and Medicare.

If anything even close to that happens, conservatives will have been completely routed and the whole notion of limited government will have been utterly defeated. Add in 10% to 15% of GDP for state and local government spending, and total government spending in the United States will be more than 50% of GDP. We will have traded in our blazingly successful capitalist system for outdated and defunct Swedish socialism.

Tax Collectors for the Welfare State

Worst of all, even some conservatives are now cracking in the face of this threat. The head of the federal General Accounting Office, David Walker, writes in an Oct. 31, 2006, e-mail, “Even conservative think tanks like the Heritage Foundation acknowledge that we will need to tax at levels above historical levels.” One former supply sider is now calling for adoption of a value added tax (VAT) on top of our current tax system. Others are arguing that a massive tax increase is inevitable and conservatives should join in designing it so they won’t be left out of the real policy game.

The strategy of this crowd is to negotiate a mega deal with Democrats and liberals for a massive tax increase in return for supposed entitlement spending cuts. But remember 1982, when Republicans thought that in agreeing to a tax increase they were getting $3 in spending cuts for every $1 in tax increases. The spending cuts never materialized. The 1990 budget deal negotiated by the first President Bush also resulted in tax increases we still have but no spending control.

Even under the best of circumstances, if we are going to negotiate a grand deal with Democrats and liberals what can we expect to get? How much is the left ever going to agree to cut entitlements? If spending is at 20% of GDP now and growing to 40%, surely the best deal we could expect will leave it at 30% to 35% of GDP.

The remaining resistance forces in Washington call this strategy The Doctrine of Preemptive Surrender. There is a better way, based on the work that conservative entitlement reformers have done for many years. The conservative movement urgently needs to rally around this agenda.

Entitlement Reform That Works

First, we have to recognize that the battle is not about unfunded liabilities and long-term deficits. It is about the total level of government spending and taxes, as Milton Friedman used to emphasize. We could balance the budget and eliminate all unfunded liabilities with federal taxes and spending at 40% of GDP, and that would represent a thorough, smashing defeat.

Moreover, we are never going to succeed in addressing the entitlements crisis by cutting entitlements. We could never hope to cut such spending enough to make much of a difference, and the effort itself would be political suicide.

What will work is fundamental reform of entitlement programs that would leave a basic safety net in place as the public demands, with the reformed systems, in fact, actually serving the public far better than existing, old-fashioned programs. Such reform can be accomplished while leaving a new system that costs only a fraction of the current system. The case for these positive reforms can then be taken over the heads of the old Washington establishment directly to the people, as Ronald Reagan, and the early Republican congressional majorities led by Newt Gingrich, did so successfully over on many occasions.

One key concept for achieving this is personal accounts for Social Security, giving workers the freedom to choose to substitute such savings and investment accounts for at least part of the current system. These accounts are critical because they don’t just limit the growth of federal spending. They also shift huge chunks of that spending from the public to the private sector, dramatically reducing federal spending over the long run.

These accounts can start at any size, and then can be expanded over time until workers can choose to substitute the accounts for all of their Social Security retirement benefits. The accounts could be expanded further to substitute eventually for survivors and disability benefits as well. Such accounts alone can reduce federal spending by close to 7% of GDP. The accounts could be expanded later as well for the Medicare payroll tax.

Workers would actually get much better benefits through these accounts because market investment returns are so much higher than what the non-invested, purely redistributive Social Security system can even promise, let alone what it can pay. Workers would accumulate large sums of personal wealth in such accounts over their careers, directly owned by each worker, which can be left to the family at death, unlike Social Security. The accounts would take over so much of the benefit obligations of the old system that all Social Security deficits would be eliminated in the process, as confirmed by the Chief Actuary of Social Security.

We know this can work politically because Republicans and conservatives won election after election on such accounts from 1998 through 2004, including President Bush. But instead of fighting for what he campaigned on so successfully, the President got lost in the swamps of Washington and ended up putting every bad, unpopular idea on the table as well, such as cutting the basic benefit formula, increasing taxes, delaying the retirement age, etc. As was predicted, this buried the positive, populist features of the personal accounts, confused the grassroots, and lost the appeal to the general public necessary to succeed in enacting the reform.

Block-Granting Programs

The second key concept in addressing entitlements is to block grant the remaining major federal welfare programs back to the states, as long advocated by Ronald Reagan’s welfare guru, the late Robert Carleson. This was already done so successfully in 1996 with the old Aid to Families with Dependent Children program (AFDC). Each state is now given each year the federal share of spending for the program for the state, with the mandate to use the money for the welfare program based on work they have designed. If the state program costs more than the federal grant amount, the state must pay the entire difference. But if the state reduces costs, it gets to keep the money.

These reforms dramatically changed incentives under the old AFDC program. Since recipients had to work anyway, they may as well take available jobs in the private sector, where they can get pay raises and promotions over time. But probably even more important were the changed incentives for state officials. Under the old system, the more recipients they signed up for the program, the more matching federal funds they got for their state. But under the new system, the state effectively pays for extra recipients itself. The more people they get off welfare and into work, the more money the state saves. This changed the whole culture of welfare administration. It soon became all about getting recipients off of welfare and into work.

These reforms were so successful that the old AFDC rolls declined by close to 60% nationwide, with declines of 80% where the work requirement was most strictly enforced.

The same should now be done most importantly with Medicaid, but also eventually food stamps, federal housing programs, and all the smaller federal welfare programs. Even if the states were allowed to keep all of the savings from reduced welfare rolls, just keeping the federal share of spending for Medicaid alone flat for 10 years, as was done for AFDC, would save $1 trillion. As long as the federal share of spending on these programs is limited to grow no faster than the rate of growth of GDP, these programs would no longer contribute at all to increasing federal spending relative to GDP.

Welfare reform based on work has always been highly popular and with the AFDC success it should be even more so. The new system also serves the poor far better by helping them get into work and on the ladder to the middle class.

If we add to this mix pro-growth tax reform and reasonable limits on the growth of federal discretionary spending, instead of increasing federal spending to 30% to 40% of GDP or more, we can reduce it to 15% of GDP or less.

No Substitute for Victory

The current challenge to conservatives on government spending is very similar to the challenge presented by the Soviet Union in the 1970s. At that time, the Soviets were on the march worldwide. They or their proxies were still taking over country after country in Africa, the Middle East, Southeast Asia, even Central America. We were not even keeping up with their development of nuclear missiles.

After Watergate destroyed Nixon, President Ford’s Secretary of State, Henry Kissinger, concluded that we couldn’t beat the Soviets. He set about to negotiate an accommodation with them on the best terms he thought we could get. But Reagan challenged this view, arguing there was no substitute for victory. We all know what happened. What we don’t remember now is how daunting and impossible Reagan’s challenge seemed in the mid-1970s.

Similarly, in regard to federal spending, are we going to try to just negotiate the best surrender to the coming crisis of big government? Are we going to just settle for 30% or 40% of GDP in federal spending, and be happy we didn’t go to 50% or 60%? Or are we going to fight for what we believe in and win?