>Proposal on Entitlement Spending Reform

>I have to hand it to Rep. Paul Ryan (R-WI), his American Roadmap may be the first proposal from a sitting politician that would functionally fix the problem of entitlement spending growth. In my opinion, however, it fixes the problem by almost eliminating entitlements altogether, as well as shrinking the government to the size it was before 1930, while charging the same amount in taxes it does today:

Social Security gets private accounts similar to the federal worker Thrift Savings Program, and more than 1/3 of a worker’s contributions can be diverted permanently to them (they become the property of the worker and can be passed on to heirs). While the private citizen gets any market gains above the normal “returns” on Social Security, the Government has to guarantee the normal program benefits. Diverting current taxes to private accounts with no recapture at death results in additional trillions of spending required to pay for current benefits and diversion to accounts. Also, the growth rate of benefits is reduced, and the retirement age is “modernized”, which I assume means indexed to gains in life expectancy.

Medicare is essentially eliminated for those under 55, and instead you get an annual payment (let’s assume a refundable tax credit) of up to $9,500 per year based on income and “risk”. The assumption is that you’ll be able to go purchase private insurance with this money. Current Medicare average costs are $12,673 per recipient. I don’t think you’ll be able to find private insurance for this price without significant out-of-pocket costs (currently about 20% for most recipients, supplemented with other private insurance or VA benefits).

Medicaid (healthcare for the poor) is reformed to be essentially inflation-indexed block grants to states. This would give states a lot of flexibility in determining what benefits to give and to whom.

Health Care would no longer be part of the tax-free benefits provided by the employer. Instead, people not participating in Medicare or the military health care system would get $2,500 (or $5,000) for a family with which to purchase health care.* I think this is almost identical to John McCain’s healthcare plan.

Another part of the plan is an almost breathtaking reduction in non-interest primary spending from 9.8% of GDP today to only 6.1% in 2050 and 3.1% in 2082. Now those years are far off in the future, but remember what’s in that budget category: Everything other than spending on interest on the debt and on old people (Medicaid is not really “Old people” but it’s small in comparison). Defense, Transportation, Health Research, Education, All forms of “Welfare”, etc. I think you and I could debate the relative merits of the programs that make up this 10% of our economy and half of our government, but I think you’d be hard pressed to argue that we’re somehow politically going to shrink $1T in spending down to $300B, while keeping taxes at the same level they are today. I think the voters that are seeing 83% of their tax dollars in 2082 going toward the elderly and interest on the debt (it’s 48% today) will likely revolt. (calculations mine based on Congressman Ryan’s proposal).

The remaining part of the proposal is the tax reform you expect to see from Republicans. There’s a semi-flat tax that “fits on a postcard”, the elimination of taxes on capital gains, elimination of corporate taxes, a VAT that’s billed as a “corporate consumption tax” so it looks like it’s not regressive, and the elimination of the estate tax (or “death tax”, if you will). It also requires supermajority votes to raise tax revenues above 18.5% of GDP, as if that’s some sort of “magic number” (it’s the average post-WWII revenue). It’s interesting that 18.5% is the “magic number” for revenues, but somehow we’re running about 20.5% in terms of spending. When we last balanced the budget, we raised revenues to about 20.0% and cut spending to 18.5%.

Hat tip to Diane at EconomistMom

*I think this brings up an important point about healthcare insurance in general. The insurance market suffers from some market failures which are pretty important. One is called “moral hazard”, and the other is called “adverse selection”, and they’re both essentially defects in information, in this case the purchaser knowing more than the seller.

Moral Hazard occurs when someone doesn’t bear all the risks of their choices. In this case, someone with health insurance is less likely to be careful when it comes to health. Since the risks of poor health extend far more than the financial costs (e.g., people don’t smoke more when they have health care just because their cancer treatments will be paid for), I think this one is the lesser of the two failures.

The other failure, Adverse Selection, is when insureds have a choice whether to purchase insurance. In this case, people that have low risk sometimes decide not to purchase insurance, and therefore increase the average risk in the pool. This raises the price of insurance for everyone, and causes even more people with low risk to opt-out. Eventually, the pool becomes depleted so much that the insurance is a good deal only for the riskiest people, and the insurance companies go bankrupt because their costs are so high.

Imagine if insurance companies were required to offer life insurance to every person regardless of age. For young people this would probably be a terrible deal, but for the elderly, it would be a great deal.

Back to employer-based insurance. By having a lot of employees in the same risk pool that’s not pre-selected for risk, and by having the employer pay for some of the costs, the insurance policy prices are kept lower for the individuals, and more low-risk people are inclined to pay into the system.

One of the much-debated key differences between Obama’s healthcare plan and Clinton’s is the “mandate”, the government requirement that you have some sort of insurance. In this case, the mandate is a way around the adverse selection problem, and I think will be a key component of a successful reform. On the other hand, if you give people a tax credit, I think you’ll find that the risk pool dries up and you may even have more uninsured people out there.


About perkinsms

I'm an engineer and father interested in transit, parking and economics.
This entry was posted in budget, economics, entitlements, fiscal, politics, spending, tax. Bookmark the permalink.

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