Introduction

From Kentucky and the New Economy/Challenges for the Next Century: The Conference Proceedings
p. 81-82, published 2001

Daniel Hall, Chair
Kentucky Long-Term Policy Research Center

Again, I would like to thank each of you for coming this morning. We’ve had a wonderful conference so far, and we’re really delighted with KET for putting on the last session. When I saw the number of panelists up there, I said, how in the world is this going to work? But Bill Goodman did an excellent job of moderating and giving everyone an opportunity to have input. (Applause) We’ve had a few more legislators come in since we started this morning, so for any members of the General Assembly who are in the audience, if you would stand to be recognized. (Applause) Thank you.

My task now is to introduce our luncheon speaker who is a native of Louisville. Dr. C. Eugene Steuerle is a Senior Fellow with the highly respected Urban Institute, based in Washington, D.C. At the Institute, he has conducted extensive research on budget and tax policy, Social Security, charitable sector issues, health care, and welfare reform. Dr. Steuerle is the author of a weekly column, Economic Perspective, for Textnotes magazine. He has authored nine books, over 125 reports and articles, 500 columns and 45 Congressional testimonies or reports. Earlier in his career, he served in various positions in the Treasury Department under four different Presidents and was eventually appointed Deputy Assistant Secretary for the Treasury for Text Analysts. Between 1984 and 1986, he served as Economic Coordinator and original organizer of President Reagan’s administration’s tax reform effort.

Dr. Steuerle has had great impact on major changes in our tax laws and the principal improvements in tax compliance and administration. Dr. Steuerle has also served as Chair of the Technical Panel advising Social Security and has recently served as either an advisor, consultant, or board member for the National Commission on Retirement Policy, the U.S. General Accounting Offices, Advisory Panel on Social Security, the American Tax Policy Institute, the Joint Committee on Taxation, the U.S. Senate Finance Committee and House Ways and Means Committee, the International Monetary Fund, the IRS, the Entitlement Commission, the Department of Labor, the National Commission on Children, a technical panel on the Social Security Advisory Council, the National Committee on Aging, and I could go on and on. As a member of the International Monetary Fund, Fiscal Affairs Advisory Committee, Dr. Steuerle has undertaken tax assistance missions to China and has also assisted the government of Barbados in a tax reform effort. His previous positions include being a Federal Executive Fellow at the Brookings Institute, a Resident Fellow at the American Enterprise Institute and President of the National Economists Club Education Foundation. He is frequently cited in newspapers and magazines around the country, including The New York Times, The Washington Post, The Economist, Newsweek, Business Week, The Wall Street Journal, U.S.A. Today, Financial Times, and The Philadelphia Enquirer, and he has appeared countless times on TV and radio networks such as CNN, ABC, and NPR. He informs me that he graduated from St. Xavier High School in Louisville, Kentucky. He got his undergraduate degree at the University of Dayton and his graduate degree at The University of Wisconsin. All Kentuckians should take great pride in Dr. Steuerle’s many professional accomplishments, as well as his national and international influence in public policy. Please join me in welcoming Dr. Steuerle. (Applause)

Keynote Address: The Future of Social Security

Thank you for that very kind introduction. I am always reminded every time I come back to Kentucky how extraordinarily civil and polite people are. I remember one time when I was sitting in National Airport, for those of you a little older, not far from Howard Cossell, who at the time had a gigantic smirk on his face. I was noticing how impolitic or impolite everyone was; no one smiled at anybody. I remember the mood change when I was walking into the Louisville Airport as I arrived in Kentucky and these strangers were coming up to me and saying, “Hi, how are you doing?”

I was reminded again of that as I saw this last panel dealing with some very difficult problems, but dealing with it in an extremely civilized and a very intelligent fashion. In fact, I’m forewarned a little bit by something my father said. He said, “Whatever you do, when you speak before a highly intelligent crowd, don’t make that error that that University professor did when he stood before his class and said, ‘We’re going to begin this class with a prayer.’ And the prayer went something like this; ‘Dear God, please protect us from the sin of intellectual arrogance, which, for your purposes, means the following.’” (Laughter)

Well, it’s a very interesting time we’re in. I think it’s not just the beginning of a new century. I think even the presidential election indicates how interesting the time is; in some sense, by indicating how uncertain we are of where we’re going and how we are going to get there. Now, I don’t want to exaggerate the tension that’s caused as we wait for the outcome of the election. George Bernard Shaw once stated that the press can’t distinguish between an automobile accident and the end of civilization. But it is a time, I think, in which we are searching for that meaning. Where are we really headed?

Admittedly it’s arbitrary that we just turned the year 2000. It’s an arbitrary year but I think it’s a time in which society often has reflection of where it’s going. If you look back to the end of the last century, the closing of the frontier and a lot of other things, you’ll see a lot of similar pauses before stepping forward that society tried to make. I’m going to focus mainly today on national budget issues and how I think they are affecting the choices we’re making. I think they added confusion in part to the past election, and then I’m going to end with some reflections on how this affects state and local policy as well. In particular, what my focus is going to be on is what I’m going to call “an upside-down budget.”

And what do I mean by “an upside-down budget?” Well, like any age, our society is beset with many unique problems. They’re not necessarily worse than those we had in the past. We’re not confronted with war and depression. I’m not making a claim they’re worse than we had in the past, but they are problems.

They’re unique problems. Listening to the last panel and the problems that they listed as the problems of Kentucky they want to deal with, I heard drugs a couple of times. I heard education at least a dozen times brought up. I heard crime several times. I heard the number of prisoners who are incarcerated as being an issue for several people.

Certainly, one that a lot of my colleagues of the Urban Institute list is that we have a very large number of children in poverty and little gains in educational achievement. This is not just in this state, but across the nation relative to what we might have thought we could do over the last 10 or 20 years. Those are the problems people often bring up. When I appear before an audience like this, I’ll often ask them and those are the things they’ll bring up, but I’ll take advantage of the panel already having covered them to say that that’s likely to be the types of things that would be on your list, too.

But let me tell you what I never hear as being on people’s list of problems: as a society, we’re getting healthier. People don’t say that’s a problem for our society. We’re living longer. That’s really tough. Or even, we’ve gotten to a point where we have sustainable population growth. People don’t list better health or longer lives as being problems. But, for some reasons unique to industrial democracies—and it’s not just the United States—at this stage of development, we’ve managed somehow to turn our societal gains, this better health, this longer living into our budget problems.

In our societal weaknesses, the things we think we need to confront into problems, we say we can’t address, at least budgetarily. There’s no money to deal with them. It’s this remarkable set of circumstances, an upside-down budget, that is scheduled to devote increasingly smaller shares of our society’s resources to our greatest needs and increasingly larger shares of resources to these areas where we’re getting better off as a society. That is narrowly defined as the “Social Security” debate, and I say narrowly defined because as I go through this talk, I’ll try to point out why I think that’s somewhat of a misleading notion.

Maybe I can clarify what I mean by referring to a dream I have sometimes. Often when I’m in Washington, I’m sitting in the Ways and Means Committee room, occasionally testifying, often just sitting in the back and listening, and, in this dream, someone comes in from the National Institutes of Health and shouts, “Eureka! I have found this cure, though expensive, for cancer.” All the people in the audience are celebrating because they’re happy. They’re thinking of sick relatives that might be better off. They’re thinking of the longer lives they’re going to have. They’re quite happy with this announcement. And then, I look up behind the dais of the podium at the members of Congress, and they’re all sweating and wiping their brows and commiserating among themselves. And I ask myself in this dream, “What’s happening?” All of a sudden it hits me. Oh, my gosh, if people live longer and there’s expensive health care, the Medicare budget is going to be even more imbalanced. The Social Security budget is going to be even further out of kilter. What are we going to be able to do to deal with this horrible budgetary problem?

That’s, in part, what is actually going on with the government’s budget. But someone in the last panel said, “To know where we’re going, someway or another we have to know a little about history.” So let me start with a graph. This shows you roughly the history of government, the federal government expenditure policy throughout the post-World War II period. It covers from 1950 up to about the current day. What’s quite clear on there, if you look at it, is that we start off in 1950 spending about 5 or 10 percent of federal expenditures in the area of retirement and health. We made a decision in the latter half of the 20^th century, actually a little earlier, but mainly in the latter half of the 20^th century, that as we got richer as a society, we would spend substantial amounts of our increased resources on retirement and health care. That’s a decision we made as a society, and the path of growth is reflected there in health, Medicare, other retirement disability, things like military retirement and civil service retirement and OSDI (just another name for Social Security). So we made this decision to get on this path and you’ll notice we’ve been on that path for 50 years.

You also notice that we’re still on that path. These issues of Social Security and Medicare expenses are not issues that are just waiting for the baby boomers to retire. That’s a path we’ve been on for 50 years. As I will cover a little more later, it’s a path we continue to be on and in fact that path even accelerates. What you can see, as these retirement and health areas grow, they have an impact on other parts of the budget. But I don’t want to mislead you and think that it’s only the federal government, some naughty group of policymakers that decide what the government will spend. This was a societal decision. Let’s devote more of our resources to more leisure and retirement and to better health care. Those are the things we want now that we are a richer society. This shows you that in the private sector, there was a similar phenomenon. It shows you, in this case, some player contributions to retirement and health plans, which start off as being relatively modest about 1950 and grow quite remarkably into about the mid-‘80s. You’ll notice, by the way, that, when you get in the mid-‘80s, all of a sudden employers start to slow down this growth, unlike the federal government. That’s in part because employers provide more and more in the way of pension and health benefits. They eventually feel pressure upon what they can pay in cash wages, so you’ll see in some cases pension and profit sharing actually declining, in terms of employer contributions, or leveling out. Health care is not quite leveling out yet, but attempts to adopt HMOs and preferred organizations and all these other efforts reflect this attempt to try to get this growth at least somewhat under control. So it’s a societal decision we’ve made that we’re going to contribute more and more to retirement and health, but, at some point, as reflected in the private sector, that growth can’t continually grow faster than the economy as a whole. One prediction I’ll make for you is that the percentage of GDP spent, or the percent of our national income spent, on retirement and health will not grow forever, that it will not exceed 100 percent. As an economist, I can guarantee at least that much.

This path actually shows you what’s happening to taxes. Interesting enough, we’ve increased this amount of resources spent on retirement and health with very little in the way of tax increases, at least at the federal level. Federal taxes, if you will look at the grand total at the top, stay relatively constant as a percentage of GDP. Now, actually, they’re at a postwar high. So I’m not trying to take a liberal or conservative view here. They’re slightly at a postwar high, but they’re not that much higher than they were before. So if we go backwards here, just a second, and want to know what’s helping pay for it, you can see that in large part, instead of having tax increases to pay for retirement and health, in the federal government we have this remarkable decline in military spending. As a percentage of GDP, military spending post-Korea was about 13 percent of GDP. Today, it’s about 3 percent and 10 percent will soon be about a trillion dollars; that is, our GDP, our national income, is close to $10 trillion. So what we have been able to do at the federal level is this remarkable transfer annually of about a trillion dollars of military spending off to the domestic side of the budget without having to increase average tax rates, and most of that money went into retirement and health.

Now, this actually shows you that the tax that we’re projecting for the future doesn’t look like it’s going to be much higher. The bottom line there shows you what Governor Bush has proposed as a tax cut. The top line, the little dotted line, shows you what the Clinton administration proposed, which is probably somewhat similar to what Vice President Gore proposed in the way of a tax cut. It shows you the average tax rate, at least in the near future, is not projected to change at the federal level. So this raises some interesting questions. This retirement and health has been going up and up as a percentage of GDP, and defense has been coming down and down. We’re not paying for it through more and more taxes as the percentage of GDP, so something’s got to give and a lot of the budget pressures you see in Washington, despite the notion that we have this temporary surplus, reflect that very tension. How do you keep this growing line growing, if that’s what we’re promising, without having an impact upon everything else? Now there’s another way this issue plays out at the federal level, which I think is very interesting, and that is the extent of the federal budget that is called mandatory. Mandatory spending is that spending that does not go through a discretionary process. Those legislators that are here well know the difference between those things that happen automatically every year and that part of their budgets that occur automatically.

This is the federal government. This is the Clinton administration proposal as of about a year ago, but it doesn’t matter, since the Republican proposals are about the same. As long as we keep these mandatory programs, which are largely Social Security and Medicare, growing, the discretionary side of the budget continually declines as a percentage of GDP. And even the budget projections used by the Congressional Budget Office and the Office of Management and Budget and all these federal budget offices help pay for this mandatory growth by assuming that the discretionary side of the budget continues to decline as a percentage of GDP. Now sometimes they say it goes up with inflation, but think about it. If your discretionary budget only goes up with inflation and your discretionary budget is paying for military, or it’s paying to give aid to students who are hiring teachers and colleges like that, what happens?

Well, if you’re not growing as fast as GDP, or as per capita as GDP, something’s got to give with that military budget. Think of the military budget as largely payment to soldiers and sailors. It’s not mainly hardware and, even if it is hardware, it’s mainly payment to scientists and other people working these firms, payments to people. If your growth in that budget is not growing as fast as the average wage rate and the economy, then you’re going to continually reduce the pay to these soldiers, sailors, and educators, at least through these scholarships, or you’re going to decrease the number of soldiers and sailors and educators that you buy. That’s just what’s going to happen if your discretionary budget constantly declines as a percent of GDP. So that’s the budget that the federal government operates under. That’s when you hear these debates over whether they’re going to increase or decrease things. That’s what they call the baseline off of which they operate.

Now most people believe this is just not rational or feasible. At some point, discretionary spending can’t constantly decrease. As you’ll see there, domestic discretionary spending hasn’t quite taken the hard hit that it could take, and that is again because a lot of that drop in the discretionary budget historically was in this military budget which used to be a large portion of the domestic discretionary budget.

This shows you the same graph in a slightly different way. There you see Social Security, Medicare and Medicaid increasing. If you look down, you see defense and international spending paying for it. Look what happens to other domestic spending. It’s interesting to see that other domestic expenditures of the federal government have been in decline since the heyday in what administration? Richard Nixon. That’s right. Other domestic spending was in its heyday in the era of Richard Nixon and has been roughly in decline ever since then, and you see the net interest showing some of the debate deficits. Now if you ask me what primary reform is needed in Social Security and more generally in programs for the elderly, it is nothing more than the creation of fiscal slack. What do I mean by fiscal slack? I mean basically that governments, just like households, need to be able to have resources in future years which they have not allocated today.

What happens with this entitlement budget is, by putting into these programs so much built-in growth, we put into motion a set of policies that are then very hard to overturn. That raises all sorts of political hassle because cutting back on them becomes then a cutback in what people believe are promises made to them. Basically, if the federal government now wants to do things in a lot of domestic areas, they have to get this entitlement budget under control.

Now, I’m skipping over somewhat lightly here the fact that we have this current period of federal surplus. It is a temporary period. All projections show it to be temporary. It’s temporary because what’s happening essentially is that there is a group of people, birth generation in World War II and the depression, which is a small birth cohort, that has entered the ranks of the elderly. The baby boomers are still in the working age population. However, when the baby boomers start moving into retirement population, that’s where this growth in Social Security and Medicare and Medicaid really start taking off far beyond the rates that we see here.

And the debate over spending the surplus, mind you, is the surplus that’s projected for future years. Having a surplus for future years has been the normal course of any householder, any government, throughout the history of this nation. It’s only been in the last 10 or 20 years that we’ve come to believe that we should spend today all the revenues that we will have available over the next 10 or 20 or 30 years and decide today what those needs are. That’s reducing our flexibility.

Imagine if you and your job assume that you would get 3 percent wage growth every year for the next 10 years. That means that in 10 or 12 years, you might have 50 percent more in the way of your wages. Do you sign contracts today for the house you’re going to have 15 years from now, the cars you’re going to buy, the trips around the world, the trips to the next states, or wherever you vacation? No. You wait and you see a little bit what to do.

What’s happened at the federal level is the policymakers have got in this gigantic debate on both sides as soon as any inkling of some future revenues appear like they are going to be available. How do we spend them 10 or 20 years from now? And, in fact, if you look closely at the budget, we’ve decided how we’re going to spend our budget 200 years from now. The entire revenues of the government have already been pre-spent under current government policy. Imagine if our founding fathers had set a policy in 1789 as to what we’d spend in the year 2000. We’d find it ludicrous, but that’s exactly the type of budget we have now.

Again, despite this temporary reprieve during the next 10 or 15 years, why do we want to decide today what we’re going to spend 10 years from now if we don’t fully know what those needs are? I’m reminded of a delegate at the Constitutional Convention who moved that, as part of the Constitution, the United States should not have a standing army of more than 5,000 troops at any one point in time. George Washington apparently leaned over to one of his fellow delegates and said that he could support that amendment to the Constitution only if it was further amended to read that no foreign army would invade with more than 3,000 troops. (Laughter)

All right, I’m going to give you a little test, just to give you a little break here. Given what I’ve shown you about the budget and the history of the budget, I wonder if anyone might want to venture who were the biggest spending domestic presidents? Who were the presidents under whose tenure the domestic budget of the United States increased the most? Here’s the measure I’m using: the percent of GDP spent on domestic policy at the end of the President’s term minus the percent of GDP spent on the President’s policy at the beginning of the term. Anyone want to take a guess? Who are among the top five? Nixon. Nixon’s right. Nixon is number one, with more increase in spending than any president in our history. In fact, about 40 percent of all the growth in domestic spending in our entire nation’s history took place under Richard Nixon. Anybody else? Reagan’s down at the bottom. LBJ is in the middle.

Think about it. What did I say paid for the domestic spending increase mainly? What part of the budget went in decline? Under whose tenure did military go into decline? Somebody say Ike? Ike’s way up there. George Bush the first is one of them. Think of who got to spend the peace dividends, post World War II? Harry Truman. Post-Vietnam? Richard Nixon. Post-Cold War? George Bush. Post-Korea? Eisenhower. So if you rank the presidents by who’s up there, you’ll see that four of the top five are Republicans, interestingly enough. And, down at the bottom, we have an interesting mix of Ronald Reagan and Franklin Delano Roosevelt.

Now I usually get chastised for putting Franklin Roosevelt down here because most people note what happened is exactly the flip side of my military story in later years. The government turned from fighting the depression to fighting World War II. I think the expression people used was that Franklin Roosevelt went from “Dr. Feel Good” to “Dr. Win the War.” But I think that’s missing another part of the story, because think about what most of the domestic expenditures were under Franklin Roosevelt. Most of them were attacking the problem of the day. They were not spending for 20 years or 30 years from that day. They were attacking the problem of unemployed people.

Now you may agree or disagree with whether those policies were good policies and actually it’s a mixed record among most economists whether a lot of them were. A lot of economists believe the major problem was monetary policy, but the spending was directed to the problem of the day. And, when that unemployment went away, it wasn’t necessarily that we had to spend more on the military that forced the Congress to cut on all these programs. The programs automatically cut back on themselves because, in effect, the workers programs that had been created essentially were retracted in terms of value. So there is a difference. It’s not just whether one wants to spend more. It’s not just the issue that’s been classically defined as the liberal/conservative debate. It’s whether one wants to determine spending tomorrow by what we know today or whether one wants to leave some flexibility tomorrow for the purposes and the needs of tomorrow. We could still spend the same amount. We could have the same size government 10 or 20 years from now, but there’s a difference between whether we decide 10 or 20 years from now what that spending will be and what extent we decided today. And right now we’ve decided that it’s going to be largely through this growth in retirement and health policy.

Here’s just a little graph that actually shows you when huge domestic outlays took place roughly during the period from 1946-1973. The reason I bring that up is because we often think of budget fights at the federal level starting about the mid-‘70s and there’s a real nostalgia for this postwar period where we largely spent a good deal of this peace dividend. You could see that remarkable growth. You could also see that that type of growth in domestic spending just simply could not continue.

Well, let me move on now. This is a little more technical here. People ask me, “What is it about these old-age programs? I mean, I’m not someone who doesn’t like Social Security. I’m not someone who doesn’t like Medicare. I think they’ve done remarkable good for our population, but what is it about these programs that have this built-in growth?” Well, there’s basically four technical ways in which these programs grow that do not apply to most other programs of federal or state governments. One is there’s perpetual growth in annual benefits required of retirees. Two, there’s longer retirement spans. Three, it has to with the demographics. We just have fewer children, and that means there are fewer workers coming along to pay for these programs. And the final one is opened subsidies for health care.

I don’t have any graphs of the last one, so I’m going to cover the last one first. It’s sort of an interesting phenomenon if you again go back to this history of health in the United States. Basically, the federal, state, and local governments adopted a health care policy, which largely modeled after private policies that were adopted in the late 1920s and early 1930s when some of these early health policies came on board.

Remember, health insurance is a very, very modern phenomenon. People did not have health insurance. They might have had a doctor in the firm, if they were lucky, at the end of the 19th century, but it’s a 20th century phenomenon, even the development of health insurance. And what did we want to do? We wanted to provide everybody with all the health care that’s available to have. So we set up these insurance policies that essentially were designed so that, when you and I go to the doctor, we bargain over what everybody else will pay, whether it’s the federal government or the private systems. In the private system, you and I go to the doctor with a need, and ask if we can take care of it. Other people who pay into the insurance policy will essentially cover the cost and, if we’re in Medicare or Medicaid, we bargain with the doctor over what everybody else will pay.

When health care was a small percent of GDP, a small percent of the economy, it was doable, but this is not a question of whether that’s desirable or whether we like it. From an economic standpoint, when there’s no price to be paid, when there’s nobody in the system to control costs, it has enormous incentives for health costs to keep rising. Because, at zero price, aren’t we always going to demand more and more health care as it comes along? It also leads to an interesting development in the health industries because it leads them more towards what is often called “cost-increasing technology,” as opposed to other strong technological sectors. Our health sector, by the way, is one of the strongest sectors in the United States. It’s one of its great strengths, but other technological sectors have more cost-decreasing technology than you find in health care. So open-ended subsidies for health care are a tension that nobody has really quite solved. We keep trying things like HMOs and provider organizations at the private level, and the federal government often attempts to try to do the same things.

What they’re trying to do is create an intermediary to try to have some economic incentive to control costs. You’ll even find that the federal government has made a lot of proposals this way to states. President Clinton a few years ago proposed that Congress give a capped amount of Medicaid to the states. It would be like a voucher that you would get for the number of poor people you have, but then you, the state, get to be the lucky ones to figure how to get that cost under control because the federal government hasn’t figured out how to do it. That did not pass Congress but that’s an example of all these attempts—vouchers, fixed payments per states, HMOs, PPOs—to create some intermediary to keep that health cost under control.

What happens with an open-ended subsidy, though, is that we keep buying everything that’s new in health care that comes along and that adds to this remarkable growth in health costs that we haven’t quite figured out how to get under control. Now, in these other areas, I mentioned that there’s perpetual growth in annual benefit. This just shows you one aspect for low-wage, medium-wage, and high-wage persons and Social Security of how this growth takes place. Essentially, Social Security operates as following. If you’re scheduled, over your lifetime, to make 50 percent more than your parents, you’re scheduled on an annual basis to get 50 percent more benefits. So if they’re getting, on average, $15,000 in Social Security benefits and you’re the next generation coming along making 50 percent more, you’re scheduled to make $22,500 in benefits on an annual basis, and on and on, ad infinitum. In some ways, that’s not an unreasonable goal. That’s a goal that, as we get richer, we keep getting the same percent of our wages replaced as we get older.

But, mind you, we don’t do that again for military pay. We don’t automatically say 30 years from now the military will have to have the wage increases of everybody else, so let’s have automatic wage growth in military pay. Let’s have automatic growth in education pay. Let’s have automatic growth in civil service pay. Let’s grow everything as the economy grows. We don’t do that in other programs. We only do it in Social Security, thus leading to this type of growth, which keeps us constant as a percent of GDP.

Second, what happens in these old age retirement programs is life expectancy at the average retirement age keeps going up. We’re living about five years longer. We’re retiring about five years earlier. In fact, now the average adult retires for about a third of his or her adult life, and, when we retire, we do two things. One, we go into the beneficiary population often. That’s placing a burden upon other taxpayers, but the other thing that’s equally important and something you need to think about at the state and local level, when we have these many retirees relative to workers, we actually also decrease the taxpaying population.

This shows you what happens to the labor force. Let me move quickly through this. This shows you that men have been dropping out of the labor force like mad since about 1948. This is a nonemployment rate. This is the percentage of males who are unemployed, but what’s really saved us over the last 30 or 40 years has been the remarkable increase in female labor force participation. That’s saved us some of the effects of demography. However, as you move into the future, the total goes in reverse. So we’ve really scheduled a remarkable turnaround from our past economy in terms of more and more adults being employed to smaller and smaller percentages of adults being employed in the future. This is just another take on this labor force issue. This shows you men with 16 years of life expectancy and how many of them used to work. In 1940, when Social Security first started benefits, almost 85 percent of males with 16 years of life expectancy were working at that time. At that time if you had 16 years of life expectancy you were about age 60. Today, of men age 65, with 16 years of life expectancy, only about one third of them work. This is just a little bit of evidence that what we’re buying, as I indicated, is more and more goods in retirement, but we’re also buying more and more leisure time in terms of years of retirement, even relative to people who used to be able to work.

In this graph you just looked at, the right-hand column shows you how this adds up. Now, if you take more and more years of life expectancy and you add that to the annual benefit growth, it shows you that a typical, average-wage, one-earner couple—two-earner couples come out about the same today—gets a little over a quarter million dollars in Social Security benefits. Why is that? It is because the benefits are scheduled. For an average couple, the longer living of the two will live about 25 years, so that’s 25 years of payments under Social Security. It builds up to $275,000. The annual benefits are not that high, but it grows to that. By 2030, it grows to $400,000. When you add on Medicare, we’ve got even worse growth in terms of getting costs under control. And you get pretty close to the point where in the near future just for average wage couples, we’re promising close to a million dollars in Social Security and Medicare benefits.

Again, think of what we’re willing to pay for these other societal problems that we talked about earlier, say for a typical couple with children and some of their needs, and then think about what we’re thinking about scheduling for the future in terms of these annual benefits. But, all these annual benefits, this close to a million dollars in Social Security and Medicare payments that we’ve scheduled for the future for an average couple, that is only a growth which would take place that is independent of the demography that’s taking place.

What’s also happening, of course, is that the baby boomers are starting to work their way through the population. That’s the big hump there in terms of total fertility rate. The expression that’s often used is that the baby boomers have moved through the economy like a pig in a python. Think of a python swallowing a pig and how that pig starts affecting the python. The baby boomers first affected the demand for primary and secondary education, then the demand for housing, then the demand for higher education, and then an impact upon the labor force. Now apparently they are affecting the stock market with growth and pension payments, but coming to the end of this period of time, they will be affecting Social Security and Medicare.

It shows through in social numbers in terms of a worker-per-beneficiary calculation. We’re now at about three workers per beneficiary, declining to two workers per beneficiary, despite the fact that there is a very modest surplus in Social Security. Social Security has always been, and still is, largely a pay-as-you-go system. What comes in, goes out. If you have three workers each providing a dollar for a retiree and you drop off to two workers providing for the retiree you have two options. You can cut that retiree’s benefit by a third if you want to keep the taxpayers whole and not have to increase their taxes, or you can increase the taxes on those workers by 50 percent if you want to keep the beneficiary whole with the same level of benefits. That’s the demography alone, even independent of what I told you in terms of the annual growth in benefits in the more and more years of retirement. If you have that decline in workers per beneficiary, that’s the issue you face. This is largely caused not so much by the aging of the population, but by the decline in the birth rate.

So let’s take us back to where I was before. This is actually somewhat similar to a graph I showed you earlier in terms of Social Security, Medicare, and Medicaid as a percent of GDP. It’s including extraordinary pressure on the rest of the budget today, not just waiting until you get to 2020 and 2030. It’s already occurring and these are the types of issues that we have to face. It’s not necessarily a bad set of issues. If we’re living longer, if we get better health care, it’s just a matter of deciding how we’re going to pay for it or whether we’re going to pay for it by deciding that other domestic priorities are going to go into abeyance.

I want to go through just a couple of implications now for state and local governments as long as we’re in this audience. One is, if you look at that other domestic policy, part of the graph there, that’s where a lot of federal payments to states and localities fit in. Basically, if you are worried about state and local government assistance from the feds, you are the residual. You are at least in the residual and so there will be extraordinary pressure put upon states and localities to self-finance much of what they want to do in the near future. That’s implication number one.

Implication number two is that the story I told you about health care is also applying to the nonelderly budget here. This is a measure of federal public assistance spending as a percentage of GDP. You notice the brown or black area at the bottom is what used to be called AFDC, and now is called TANF, Temporary Assistance to Needy Families. That’s where we have our huge debate over public assistance policy. It’s a trivial portion of federal public assistance spending, public assistance being that spending that’s income-conditioned. It’s measured by your income and mainly goes to the poor. It’s all these other areas: food stamps, earned income credits, housing assistance, and others that have really become much more dominant, but look at what’s happening on the health care budget as well. The health care is taking a larger and larger portion of that pie and so we’re making decisions. We’re saying, “If you’re poor, we’ll buy the $200,000 or the $500,000 a year surgeon, but we’re going to have less and less to give you help at least at the federal level in terms of your other needs.” And that also plays through, not only in terms of the assistance for low income people in its states and localities but, of course, the Medicaid budget has enormous implications for your own budget.

A third implication has to do with the pressure upon state and local revenues. I don’t know how states and localities are going to resolve this issue. State and local revenues have actually been increasing quite substantially in the postwar era. In fact, it’s interesting we’ve had all these debates over federal taxes as a percent of GDP because it’s really been states and localities, mainly states, where the growth has taken place and largely in the income tax as opposed to the property tax, which has waned in importance.

The other area is a little bit of a funny area. I don’t know how much interpretation you want to give to it, but that’s the movement of states and localities assessing much more in the way of fees and charges and other things. So, it’s a little bit of a funny number and sometimes you want to count it and sometimes you don’t want to count it in terms of what states and localities are doing in terms of their tax collections. But I don’t know whether this tax collection growth will continue in the future. Most states right now, if you look closely at the data, are benefiting from an extraordinary increase in income tax revenues, both because there are a lot more capital gains in the economy, but also because in most states there’s a lot of what is called “bracket creep.” People are moving up into higher rate brackets.

I want to end with my last implication for states and localities on an optimistic note. If you look at federal domestic spending per household, you actually find out over the long course of this century, we have increased federal spending to over $8,000 per person. This actually goes to 1994; that is federal, state and local domestic spending was about $8,000 per person in 1994. Actually over $10,000 today, easily, per person is what we spend. And it will grow as economies expand in the future. So what I’m suggesting to you is that this pressure we feel, this budgetary pressure, is not a pressure that comes because we don’t have resources of a rich society to spend them. It’s a pressure of deciding how we want to spend this money, how best we want to allocate it to our most important needs. And for that reason I encourage you not to be pessimistic about these budgetary issues that I present to you. You know the definition of a pessimist is someone who, when he smells flowers, looks around for a casket. Thank you. (Applause)

Questions, Answers, and Comments

Thank you, Dr. Steuerle. We’re running overtime, but I would like to take just a few more minutes for maybe one or two questions from the audience. I don’t want you to get away without having an opportunity to have at least one or two questions addressed to Dr. Steuerle. Any question from the audience? We had a lot of data in the presentation, but it poses serious implications for our state and other states around the union. Any questions from the audience?

How about the idea of eliminating the cap on Social Security? Would that get us to about 98 percent?

Eugene Steuerle

I think for the long-term social deficit that it might cover a third of the deficit. The problem is whether you measure short-term versus long term. The long-term problem is more serious than the short-term, but the long-term problem can be exaggerated, too. If we would just be willing to work a little longer, those problems that start coming along as we go out to 2020, 2030, 2040 can be taken care of and then proposals like that would cover more of the difference. There is somewhat of a complication here and that is Social Security has long decided that, if you put more into the system, you get more back. If you totally eliminate the cap, we would face a situation where the Bill Gates’ of the world would be getting millions of dollars in Social Security benefits. Traditionally it’s actually been the liberals who have opposed that particular type of reform, in part because they fear if you do that then you lose the whole notion that it’s a social insurance system. You get something back if you put something in and if you go to that, then it will start becoming means-tested and become more like a welfare system, which I think would hurt the middle class. So, there’s a tension there, but I think the bottom line is that a Social Security reform would probably see some increase in this wage base.

What percentage of that $10,000 per person actually gets to the people?

Well, it depends on what you mean by “getting to the people.” Remember, you were talking earlier about the number of people in prison. You know we have this sort of funny system where there are times you can get a lot, but what you get, we don’t often think of. In terms of cash to the people, very little. What we provide people are often workers or education. There are ways to do things like vouchers, and I don’t just mean with education, which is highly controversial, but with health care and a lot of other areas. There are ways to get people the money to have some decisionmaking, but then still have the government come in and say, “OK, but you have to spend the money this way.” Maybe in education it still has to be in a public school or it could be at a public and a private school that do certain things. In health care, it’s a health care provider that meets certain minimum standards. That’s an attempt to try to provide a little more discretion to the people in these types of programs where we’re mainly hiring workers like educators and doctors and other things like this.

In the Greater Cincinnati area, over 700,000 people are being kicked off their HMOs. What are your thoughts as to how to fund the budget reasonably to extend the Medicare benefits?

I think that this system again, where we bargain over what other people will pay, is not viable. There has to be somebody who has concern over costs. And I think because we all want more health care, especially more health care for those of our families who are needy and sick, there’s always going to be a tension as to what we want and what we can get. I think that’ll play out in movements towards things like HMOs and PPOs; that will continue. There will be attempts more and more to provide vouchers. What I think will come in on the other side will be attempts perhaps to provide more government standards on what can be provided. I don’t think there is a pure answer. If some new health good or service becomes available, we want it. Can we pay for it? That’s the type of tension we’ve hidden in this other system and, as it becomes more explicit, we need to find ways in society we can face up to that tension without being so acrimonious about how it plays out. I think probably you will also see, directly or indirectly, that government starts providing these insurance payments to groups or providers that move a bit more towards community rating. I mean community rating either in the sense of not necessarily covering the whole community, but covering a large segment of the population to avoid small segments of the population who are relatively healthy, from avoiding some of the costs that they now bear in broader insurance policies. But I don’t have a pure answer here. As I say, this is a case of limited resources and unlimited wants and we’ve hidden it in this old system. Well, thank you very much.

Daniel Hall

Thank you, Dr. Steuerle. (Applause)