The primary reason for the growth of big government in the twentieth century was social insurance. The idea behind Social Security, for example, is insurance against the risk of growing old and not being able to support yourself after you can no longer work. Medicare is insurance against reaching a point in life where you can no longer afford health insurance. Unemployment insurance protects you against the risk of being out of work. A whole host of “welfare” programs insure you against being down on your luck.
But do we really need government to do all these things? A new book by Peter Ferrara argues that we don’t. Individual prudence and the marketplace can solve these problems much better, he argues. The case is made in Power to the People: A New Road to Freedom and Prosperity for the Poor, Seniors, and Those Most in Need of the World’s Best Health Care. The book should be required reading for every member of Congress.
Government insurance for the elderly is invariably run like a Ponzi scheme. Payroll taxes paid by workers are not invested for future benefits. Those tax revenues are spent the very day, the very hour, the very minute they arrive in the Treasury’s bank account. The U S experience is not unique. Social insurance is run like a Ponzi scheme in most countries around the world.
In the United States, the Social Security Actuaries publish an annual accounting of the unfunded liability in Social Security and Medicare. Looking indefinitely into the future, the unfunded liability in Social Security is almost $28 trillion. That’s the difference between the promised benefits for future generations of retirees minus expected taxes dedicated to fund those benefits. That’s more than twice the size of the official outstanding debt of the U.S. government.
If you add to that the long term deficits in Medicare, Medicaid and dozens of other entitlement programs, Boston University professor Laurence Kotlikoff pegs the total unfunded liability of the federal government at a whopping $210 trillion. That’s more than 12 times the size of our national income.
So what is the alternative? Private savings accounts for starters. More than 30 countries have fully or partially privatized their social security systems with private savings, according to former World Bank economist Estelle James. For the United States, Ferrara endorses a Paul Ryan/John Sununu proposal to allow workers to put their share of the Social Security tax (7.65%) into accounts that would be invested in stocks, bonds and other assets. At retirement, people would buy an annuity.
Importantly, workers would get a guarantee, just as they do in Chile. If their annuity failed to provide the monthly benefit promised under the old system, government would make up the difference. Similarly, workers could save in private accounts for health care during the retirement years and government could guarantee that no one would be worse off. (Ferrara points to my own proposal on how to do that.)
If there is a fault in the book, Ferrara should be clearer about the fact that privatization isn’t free. To replace Social Security, we need a minimum savings rate of 4% of payroll. Replacing Medicare requires another 4%. Replacing Disability and Medicaid long term care insurance probably requires another 2%.
So to move from the Ponzi scheme approach (under which no one knows what benefits he will get because future unborn taxpayer haven’t told us what they are willing to pay) to a funded system (under which each generation pays its own way) we need workers to put aside 10% of their earnings over the span of their work lives. Where will that money come from? We could ask workers to cut back on other consumption or substitute other saving – and they might be willing to do that in return for a solid government guarantee that they can count on at the point of retirement. Or government could fund some or all of the contributions to the private accounts. But that would require cuts in other government spending or an increase in borrowing.
Ferrara is at his best in discussing welfare reform – perhaps because he was personally involved in the early years in actual reform that finally took place during the Clinton Administration.
America’s welfare state, he tells us, is a “vast empire” that spends a trillion dollars a year on 185 federal-state means tested programs. The total spending equals about $17,000 a year per poor person, or more than $50,000 for a family of three. And most of this is completely unnecessary:
For anyone who works full time in the United States — the minimum wage, augmented by the Earned Income Tax Credit and the Child Tax Credit equals or exceeds the poverty level for every possible family combination, including single persons with or without children.
In 1960, nearly two-thirds of the families in the bottom fifth of the income distributions were headed by someone who worked. By 1991, only one-third of these households were headed by someone who worked and only 11% worked full time. Early on in the War on Poverty, the federal government’s own studies showed the devastating effects it was having. In the guaranteed income experiments of the 1970s, for every $1 of extra welfare given to low-income persons, they reduced their labor earnings by 80 cents.
Ferrara reminds us that welfare reform has been phenomenally successful. The AFDC welfare rolls were reduced by two-thirds. Yet because of the increased work effort on the part of previous recipients, the total income of low-income families increased by 25%!
But this success only reflects the reform of the AFDC (cash welfare) program — where federal funds were block granted and work requirements were imposed. Ferrara wants to do the same thing with the 184 other means tested programs.
It’s an idea worth considering.