Entitlement Reform Revolution


ACRU Staff


November 30, 2011

This column by ACRU General Counsel and Senior Fellow for the Carleson Center for Public Policy (CCPP) Peter Ferrara was published November 30, 2011 on The American Spectator website.

In New Hampshire on November 21, Newt Gingrich, who has just been endorsed by the Manchester Union Leader, unveiled sweeping entitlement reform proposals, discussed in a comprehensive, extensive campaign position paper now available at Newt.org. Those proposals reflect closely my own work over many years, discussed in detail in my recent book, America’s Ticking Bankruptcy Bomb.

These reforms taken together would reduce federal spending over an extended period of years by half from what it would be otherwise, solving America’s entitlement and fiscal crisis. Yet, these reforms are politically feasible, indeed even popularly appealing, because seniors and the poor would actually gain from them. In fact, they are all based on already enacted reforms, in the U.S. or elsewhere, that have been proven to work in the real world. Remember that even libertarian godfather Friedrich Hayek supported the concept of safety nets for the truly needy, as did Reagan.

The key is that the reforms are all based on modernizing our old fashioned, tax and redistribution entitlement programs to rely on 21st century modern capital, labor, and insurance markets instead. Through such fundamental structural reforms, changing the way the programs work and operate, we can achieve all of the social goals of these entitlement programs far more effectively, serving seniors and the poor far better, at just a fraction of the current cost of those programs. Consequently, we can actually achieve vastly greater reductions in spending than we could ever hope to achieve simply by trying to cut benefits.

These reforms all work more effectively to achieve their goals because they operate through market incentives, productive savings and investment, and competition, rather than simple tax and redistribution. They also all work to contribute to economic growth and prosperity today, rather than detracting from it.

Personal Account Prosperity to Replace the Payroll Tax

Gingrich proposes reforms that would empower workers with the freedom to choose to save and invest what they and their employers would otherwise pay into Social Security in personal savings, investment, and insurance accounts. My own studies with various colleagues over the years show that at standard, long-term, market investment returns, for an average income, two-earner couple over a career, the accounts would accumulate to close to a million dollars or more, depending on how big the account option is. Even lower income workers could regularly accumulate half a million over their careers.

Those accumulated funds would pay all workers of all income levels much higher benefits than Social Security even promises let alone what it could pay. That includes one earner couples with stay at home moms caring for the children. Retirees would each be free to choose to leave any portion of these funds to their children at death.

In retirement, benefits payable from the personal accounts would substitute for a portion of Social Security benefits based on the degree to which workers exercised the account option over their careers. This is where the spending savings come in. The personal accounts don’t just reduce the growth of government spending. They shift vast swaths of such spending from the public sector altogether, to the private sector.

Gingrich proposes to start the accounts focused on younger workers first. But over time the accounts would be expanded to take over financing for all of the benefits financed by the payroll tax today. That would ultimately amount to the greatest reduction in government spending in world history.

Moreover, eventually replacing the payroll tax entirely with personal savings and investment directly owned by each worker and his family would provide the greatest reduction in taxes in world history.

In 1981, the South American nation of Chile, then with a Social Security system just like ours, with the same problems, adopted such a personal account option, with astounding success. Virtually all workers chose the accounts within 18 months, and for 30 years now they have paid half the taxes of the old system, in return for at least twice the benefits, while their economy boomed with all the increased savings and investment. Those reforms included a safety net guarantee of former Social Security benefits, which has never suffered a loss or cost due to failure of a personal account to beat the old system. That is also included in the Gingrich plan.

In America itself, such a system was tried in 1981 as well, for local government workers in Galveston, Texas, who still enjoyed an option under the law then to choose an alternative to the current system. Just as in Chile, for 30 years now they have paid much less into their personal account savings and investment system than required by Social Security, but receive much more in benefits. The similar Thrift Savings Plan retirement system for federal employees has similarly worked spectacularly well now for nearly 30 years.

Model legislation providing for such accounts was introduced in 2004 and 2005 by Rep. Paul Ryan (R-WI), now Chairman of the House Budget Committee. I worked closely with Ryan in developing that legislation. A similar proposal is now included in the Ryan Roadmap. On September 12 of this year, Rep. Thaddeus McCotter (R-MI) introduced another model bill on which I worked closely as well.

Both bills were officially scored by the Chief Actuary of Social Security as eliminating all future Social Security deficits through the operation of the personal accounts alone, without benefit cuts or tax increases. Indeed, as discussed above, future retirees with personal accounts would enjoy higher not lower benefits. In the process, with full personal accounts the unfunded liabilities of Social Security, currently officially estimated at $15.1 trillion, would ultimately be eliminated entirely, as the personal accounts involve shifting to a fully funded retirement financing system. That would be the greatest reduction in effective government debt in world history. The Chief Actuary’s scores for both bills are still available at the official Social Security Administration website.

Under both bills, as well as under the Gingrich plan, workers would be completely free to choose to stay in Social Security as is without exercising the personal account option at all. There would be no benefit cuts or tax increases for these workers either. That is possible because as the Chief Actuary explicitly recognized in scoring the bills, the personal accounts would so obviously be a better deal for workers and their families than the current program that he concluded that 100 percent of workers would ultimately choose the accounts. Of course, under the Gingrich plan, as under both bills, there would be no changes in Social Security of any sort for anyone currently in retirement, or anywhere near retirement.

No other reform would do so much to promote equality of wealth among the American people, not through the economically counterproductive redistribution of existing wealth, but through the creation of new wealth more equally owned. Indeed, based on studies by Harvard Professor Martin Feldstein, full personal accounts would reduce the concentration of wealth in America by one half.

The personal accounts would also funnel mighty rivers of savings and investment into the economy today, promoting economic growth and more jobs and higher wages for working people now. That would also promote more equality.

Block Grant Welfare Back to the States

Gingrich’s entitlement reform proposals also include block granting all remaining federal m
eans-tested entitlement programs back to the states, following the model of the enormously successful 1996 reforms of the old New Deal era AFDC program, spearheaded by Gingrich when he was Speaker of the House. These programs are estimated to cost taxpayers $10 trillion over the next 10 years alone.

If any liberal reform had been as wildly successful as those 1996 welfare reforms, every schoolchild in America would have been forced to memorize the details by now. Those reforms involved the ultimate welfare policy dream of President Reagan and his long time welfare guru Robert Carleson, as explained in Carleson’s recent posthumously published book Government Is the Problem: Memoirs of Ronald Reagan’s Welfare Reformer. I worked directly for Carleson in the Reagan White House.

The reform returned the share of federal spending on the program to each state in the form of a “block grant” to be used in a new welfare program redesigned by the state based on mandatory work for the able bodied. Federal funding for AFDC previously was based on a matching formula, with the federal government giving more to each state the more it spent on the program, effectively paying the states to spend more. The key to the 1996 reforms was that the new block grants to each state were finite, not matching, so the federal funding did not vary with the amount the state spent. If a state’s new program cost more, the state had to pay the extra costs itself. If the program cost less, the state could keep the savings.

With these transformed incentives, the old AFDC rolls were reduced by two-thirds nationwide, even more in states that pushed work most aggressively. As a result, in real dollars total federal and state spending on the program by 2006 was down 31 percent from AFDC spending in 1995, and down by more than half of what it would have been under prior trends. Welfare spending could never be cut by 50 percent merely by trying to cut benefits.

At the same time, because of the resulting increased work by former welfare dependents, the poor benefitted as well. Child poverty declined every year, falling by 2000 to levels not seen since 1978, as Ron Haskins of the Brookings Institution reports in his 2006 book evaluating the 1996 welfare reforms, Work Over Welfare. “[B]y 2000 the poverty rate of black children was the lowest it had ever been. The percentage of families in deep poverty, defined as half the poverty level…also declined until 2000, falling about 35% during the period,” Haskins adds. The incomes of the poor formerly dependent on AFDC rose by 25%, now paid by their private employers in the labor market, rather than taxpayers.

Gingrich proposes to extend these same block grant reforms to all other 184 means tested federal welfare programs, including Medicaid, Food Stamps, 27 low income housing programs, 30 employment and training programs, 34 social services programs, another dozen food and nutrition programs, another 22 low income health programs, and 24 low income child care programs, among others. This would amount to sending welfare back to the states, achieving the complete dream of Reagan and Carleson in restoring the original federalism and state control over welfare. It also follows the spirit of the Tea Party movement in restoring power to the states and gaining control over government spending, deficits, and debt.

If the results are anything like those for the 1996 reforms, the total savings for taxpayers would be enormous, and the poor would be much better off. With the states experimenting and competing to put the able bodied to work, instead of taxpayers paying the bottom 20 percent of income earners not to work as today, private employers would be paying them to work, and contribute to the economy.

Repeal and Replace Obamacare

Gingrich’s proposed entitlement reforms include as well repealing and replacing Obamacare with Patient Power, as long advanced by John Goodman of the National Center for Policy Analysis.

The classic example of such policy is Health Savings Accounts (HSAs), which were also first recognized in federal law when Gingrich was Speaker. The concept behind HSAs is to start with an insurance policy with a high annual deductible, which reduces the cost of the insurance substantially. The savings are then kept in the HSA to pay expenses below the deductible. Generally, after one healthy year with little or no medical expenses, the patient by the second year would have more than enough in the account to cover all expenses below the deductible.

This transforms the incentives of third party payment. For all but catastrophic health expenses, the patient is essentially using his own money for health care. Whatever he doesn’t spend he can keep. So the patient will try to avoid unnecessary care, and look for less expensive care and alternatives for what he does need.

In turn, since patients would now be concerned about costs, doctors, hospitals and other providers would now compete to control costs, as well as maximize quality, as in all normal markets. This competition would become more intense and effective the more widespread HSAs and similar incentives become. These incentives would flow all the way through to the developers of new technologies. Since both patients and health providers are now concerned with costs, technology innovators would now have incentives to develop technologies that reduce costs, as well as improve quality.

Gingrich proposes to control health costs by expanding HSAs throughout the health care system. Workers would be empowered with the freedom to choose them in place of employer provided coverage, the poor would be empowered to choose them for their Medicaid coverage, seniors would be empowered to choose them for Medicare.

Gingrich supports extending similar Patient Power to the poor in Medicaid with designated sums for the purchase of private insurance coverage in competitive markets, resulting in incentives for cost saving choices among competing health insurance alternatives. That would greatly benefit the poor because Medicaid today is structurally an institution serving to deny the poor essential health care just when they are the sickest and most in need of such care. That is because Medicaid does not pay the doctors and hospitals enough to assure such care. But with the above reform, the poor would enjoy the same health care as the middle class because they would have the same private insurance as the middle class, paying market rates for care.

Gingrich supports doing the same for Medicare, with retirees free to choose premium support through the program for the purchase of the private health insurance of their choice, similar to Ryan’s proposal. The same approach for the drug coverage of Medicare Part D has proved quite successful in controlling costs. A personal savings and investment account for the Medicare payroll tax during working years would provide additional funds that can be used in retirement for the purchase of private health insurance of the workers’ choice, which would result from Gingrich’s proposed ultimate expansion of personal accounts.

Gingrich further supports replacing Obamacare with a complete health care safety net assuring essential health care for all, achieved with no individual mandate and no employer mandate. That safety net focused on the truly needy would cost just a fraction of the cost of Obamacare, actually sharply reducing government in the process.

That starts with the provision already in federal law, stemming from the Kennedy-Kassebaum legislation of the 1990s also enacted when Gingrich was Speaker, providing for guaranteed renewability. That means if you already have health insurance, you cannot be terminated because you become sick. That is what health insurance insures against after all, so such termination would actually be fraud, as state law across the country recognized even before Kennedy-Kassebaum. Under this regulation, insurers also cannot discr
iminatorily raise rates for those who become sick while insured. This law ensures that if you have health insurance, you will be able to keep it as long as you continue to pay the premiums.

The next component involves block granting and reforming Medicaid as discussed above, assuring that no one would suffer without essential health care because they were too poor to buy insurance. The final component would be a high risk pool in each state for the uninsured who never get coverage and then become too sick with costly illnesses like cancer or heart disease to buy it. The uninsured in this case would be able to get coverage as a last resort from the high risk pool, paying what they can based on their income, with taxes subsidizing the pool to keep it afloat. Because only 1-2 percent ever become actually uninsurable like this, this is the most inexpensive option for assuring an essential safety net.

What Gingrich has now proposed is the most cutting edge, advanced, sweeping, entitlement reform, sufficient to solve America’s long term fiscal crisis, while better providing for those in need, which is what makes it politically viable and so exciting.



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