Missing: Real Leadership on Entitlements

President Bush last Tuesday bravely pointed out early in his State of the Union Address the great challenge this country faces over our future exploding entitlement programs. But then he failed to propose any solutions. This is not true leadership.

The President said: “To keep this economy strong we must take on the challenge of entitlements. Social Security, Medicare and Medicaid are commitments of conscience, and so it is our duty to keep them permanently sound. Yet we’re failing in that duty. And this failure will one day leave our children with three bad options: huge tax increases, huge deficits or huge and immediate cuts in benefits. Everyone in this chamber knows this to be true, yet somehow we have not found it in ourselves to act. So let us work together and do it now. With enough good sense and good will, you and I can fix Medicare and Medicaid and save Social Security.”

Future Problems

The President seems to be looking to the liberal Washington establishment to come together and develop solutions to these exploding entitlement programs. But that will lead, at best, only to more big-government taxes and spending, not conservative, free-market solutions.

The President lamented a future with the three bad alternatives of huge tax increases, huge deficits or huge benefit cuts. But that will not be solved by adopting a package of benefit cuts and tax increases now. Such a package is the future problem to be avoided, not the solution to be adopted now.

Yet in 2005, the President went on television to announce support for a specific, huge cut in future promised Social Security benefits called “progressive price indexing.” That proposal would change the basic Social Security benefit formula so that future benefits to be paid to today’s workers would grow only with the slower rate of growth of prices over time rather than the rate of growth of wages. This change would apply in full to higher-income workers, would be phased in more slowly for middle-income workers, and would not apply to lower-income workers. That is what is supposed to make it progressive.

Bad Deal for Workers

The problem is that Social Security taxes grow with wages through the payroll tax. So if taxes are going to grow faster each year with wages, while benefits are growing more slowly with prices, the effective rate of return promised by Social Security will decline each and every year in perpetuity.

Social Security has already become a bad deal for workers today, with many workers to receive a negative real rate of return from the program, even if all currently promised benefits are somehow paid. Progressive price indexing would push more workers into the negative return range and more workers even farther down into that range, until the vast majority of workers are receiving negative returns from the program.

You can think of price indexing of Social Security benefits like this: Define the problem as “If nothing is done, by the time today’s workers retire, Social Security would have only enough revenue to pay 70% of promised benefits.” Price indexing says we are going to fix that by changing the basic benefit formula so that by the time today’s young workers retire the program will be paying them only 70% of currently promised benefits.

That is not the solution. That is the problem we should be trying to avoid. Yet some reformers try to recruit young people to fight for such reform on the grounds that we are going to save Social Security for them. This couldn’t be more brain dead.

The author of the progressive price indexing plan, Democratic Wall Street financier Robert Pozen, recently elaborated on the plan in the Wall Street Journal. (“PIN Money”, Jan. 9, 2007, p. A19). He called for adopting progressive price indexing and then abandoning it after 75 years. He called for reversing the price indexing to calculate future benefits if prices grew faster than wages for 30 years. He also called for cutting future promised benefits for increases in life expectancy.

Then he talked about tax increases. He talked about raising the cap on the maximum taxable income for the Social Security payroll tax, currently at $97,500, to somewhere between $150,000 and $170,000, a huge tax increase of as much as $9,000 a year for people in this income range. He also talked about adopting instead a new payroll tax surcharge of 2% on all income above the current cap, another enormous and economically counterproductive increase.

Liberals Hate Personal Accounts

It is so natural for Pozen to go from price indexing to tax increases because liberals and Democrats will never accept addressing the long-term Social Security deficit entirely through benefit cuts. They will insist on a “balanced” package including tax increases. As the New York Times editorialized last December 31: “Tax increases must be a part of any plausible Social Security reform mix….” In other words, benefit cuts through price indexing are joined at the hip with tax increases. Politically and practically, there is no way to have one without the other.

Finally, Pozen noted in his article that real personal accounts that substitute for part of the current Social Security framework will never be accepted by Democrats and liberals. Only add-on accounts on top of the current Social Security framework are still on the table.

It is a national tragedy that President Bush allowed himself to be led down the road into this dismal swamp, starting with the intellectual descent into price-indexing rather than focusing on the personal accounts. But this is where the President is headed if he insists on trying to bargain for a deal with the liberal Washington establishment. Pozen shows again this path leads nowhere else.

What the President needs to do is scrap this whole nightmare scenario and take the flag of real leadership on entitlements. He should propose a fully specific, highly positive, personal account reform plan designed to clearly benefit working people overwhelmingly, without tax increases or benefit cuts. Such accounts would eventually shift enormous, unprecedented amounts of federal spending to the private sector.

Block Grants for States

For Medicaid and other federal welfare programs, he should propose sending them back to state control through block grants, with the growth of federal spending on those block grants sharply limited in the future. The states would then have the flexibility to adopt welfare reforms that would save enormous sums over the long run, particularly through mandatory work for the able-bodied and extending Health Savings Accounts to the poor. Medicaid especially is destroying state budgets and is ripe for reform.

These reforms would enjoy broad populist appeal to the general public, which would allow the President to take the case for them directly to the American people over the heads of the Washington establishment. Such reforms would not pass in the next two years. But this effort would provide the foundation for passing them in the next administration — a true, enormous, historic legacy for the President.