This column by ACRU General Counsel and Senior Fellow for the Carleson Center for Public Policy (CCPP) Peter Ferrara was published December 15, 2011 on Forbes.com.

On Nov. 12, in Manchester, N.H., Newt Gingrich released his entitlement reform proposals in a 49-page, single-spaced, footnoted document to which I contributed heavily. Those proposals reflect my life’s work at such institutions as the Cato Institute, Heritage Foundation and John Goodman’s National Center for Policy Analysis, devoted to making government smaller, particularly through politically viable entitlement reforms. (You can read more about them in my book America’s Ticking Bankruptcy Bomb).

Taken together, Gingrich’s proposals would eventually cut federal spending in half, though they would admittedly take decades to fully phase in. But these proposals would provide a complete solution to the nation’s long-term entitlement and fiscal crises, particularly in conjunction with Gingrich’s pro-growth, supply-side, economic recovery plan, to which I also heavily contributed.

As I say in my book, “I do not believe in human suffering.” Gingrich’s proposals would cut federal spending by half — far, far more than could ever be achieved by just trying to cut benefits — they would achieve all the social welfare goals of current entitlement programs far more effectively. They would also better serve seniors and the poor.

Instead of taxes and redistribution, the reformed programs rely on modern capital, labor and insurance markets, highly productive savings and investment, and highly effective, pro-growth market incentives. And they all are based on already-enacted reforms in America or elsewhere that have proved to work in the real world.

Social Security Personal Account Prosperity

Gingrich proposes to empower young workers by allowing them to save and invest a portion of their taxes in their own personal savings, investment and insurance accounts. Over time, he would expand the accounts until workers have the complete freedom to finance all of the benefits now financed by the payroll tax through the personal accounts, displacing the payroll tax entirely. That would be the biggest reduction in taxes in world history.

The proposal is based on the enormously successful personal-accounts model adopted in Chile 30 years ago and the similar personal account system adopted at the same time for local government workers in and around Galveston, Texas. The Thrift Savings Plan for federal employees is a similar model that has worked extremely well for almost 30 years.

Gingrich offers as model legislation the personal account bills developed and introduced by now House Budget Committee Chairman Paul Ryan in 2004 and 2005, to which I also contributed heavily. That bill empowered workers to shift roughly the employee share of the payroll tax to the personal accounts.

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. That would not just trim the growth in spending; it would shift vast swaths of such spending from the public sector altogether, to the private sector. Once all phased in, in fact, it would reduce federal spending by 10% of GDP, which is the projected burden of future benefits now financed by the payroll tax. That would be the largest reduction in government spending in world history — far more than could ever be achieved by trying to cut Social Security benefits.

Yet, at the same time, the real long-term returns on market savings and investment earned through the personal accounts will pay retirees much higher benefits than Social Security even promises, let alone what it can pay. That is true for all family combinations at all income levels, including one earner families where the wife works at home caring for the children. That is because the personal accounts rely on real savings and investment, while Social Security involves no savings and investment, but just all tax and redistribution. With actually better benefits all paid through private savings, investment and insurance, there is no need or even place for Social Security benefit cuts, even if they were politically possible. That would just confuse the issue.

Moreover, through the personal accounts every worker would be accumulating substantial personal wealth over their career, close to a million dollars or more in real terms for a two earner average income couple, once the option is fully phased in. The Chief Actuary of Social Security estimated in scoring Ryan’s bill that the personal accounts owned by working people across America would total $7.8 trillion after the first 15 years, and $16 trillion after the first 25 years.

Based on a study by Harvard’s Martin Feldstein, full personal accounts would as a result reduce the concentration of wealth in America by 50%, achieved not by redistributing existing wealth, which would be economically counterproductive, but by the creation of vast new realms of wealth much more equally owned. No other reform would do so much to promote equality of wealth among the American people.

Indeed, it would do so by actually contributing to the economy as personal accounts produce mighty rivers of savings and investment channeled directly into the economy, creating jobs and bidding up wages and incomes for working people now.

Ryan’s bill was 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. This is because so much of the benefit obligations of the program are shifted to financing through private savings and investment rather than public tax and spending redistribution.

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. This is the full, real solution for Social Security.

The transition to the personal accounts would be more than financed by spending reductions achieved from the other entitlement reforms in the Gingrich plan.

Block Grant Welfare Back to the States

A historic turning point in welfare policy was achieved with the enormously successful 1996 reforms of the old Aid to Families with Dependent Children (AFDC) program. Those reforms, spearheaded by then Speaker Gingrich, implemented the ultimate welfare policies favored by President Reagan and his long time welfare guru Robert Carleson. (I worked directly for Carleson in the Reagan White House.)

The reform returned the share of federal spending on the AFDC 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 natio
nwide, 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% 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% 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.

With all the programs of the current welfare empire estimated together to cost $10 trillion over the next 10 years, the resulting savings to the taxpayers would be several trillion just in those first 10 years alone. Yet, just as with the 1996 AFDC reforms, the poor would be much better off, which is what makes these reforms politically feasible, as it made the 1996 reforms overwhelmingly bipartisan. With the states experimenting and competing to put the able bodied to work, instead of taxpayers paying the bottom 20% 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 with Patient Power

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 very first paper proposing HSAs was written by John Goodman and myself in 1981.

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 became. 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. Retirees will be free to choose premium support through the program for the purchase of the private health insurance of their choice, similar to Ryan’s proposal. But under Gingrich’s retirees could still choose today’s Medicare. A similar 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 enable retirees to purchase essential health insurance of their own choice, which would result from Gingrich’s proposed ultimate expansion of personal accounts. Over the long run, this would cut the cost of Medicare by more than half.

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. By focusing on the truly needy this safety net would cost just a fraction of Obamacare, and reduce government in the process. This would result in further trillions in savings in government spending.

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. Insurers also cannot discriminatorily 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, assuring that no one would suffer without essential health care because they were too poor to buy insurance. The final component is 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% to 2% ever become actually uninsurable like this, this is the most inexpensive option for assuring a safety net.

What Gingrich has proposed is the most cutting-edge, sweeping entitlement reform, sufficient to solve America’s long-term fiscal crisis while better providing for those in need. Do conservatives really want to send a candidate to do battle with the Obama political machine advocating cuts in Social Security and Medicare benefits, especially when more fundamental reforms would reduce spending far more? I should hope not.