arly on in his presidential campaign Bill Clinton talked about the need for
Americans to pull together and "sacrifice." Later, in a State of the Union
address remarkable for its candor, he spoke to a raptly attentive nation about
how our ballooning federal deficits cloud our economic future. That was a
subject George Bush had found worthy of mention only once in his 5,000-word
State of the Union address the year before. The budget plan that Bill Clinton
then delivered to Congress not only used real numbers instead of rosy
scenarios; it shattered some paralyzing dogmas. The nonsense that we could put
our fiscal house in order without new taxes was laid to rest. Especially
commendable was the President's opening the door to energy taxes, which not
only raise revenues but also represent a means to curb a particularly toxic
kind of consumption. Even Social Security, our ultimate sacred cow, was put on
the budget-cutting table--if only at the table's edge. After years of empty
"Morning in America" and "Don't Worry, Be Happy" rhetoric, all of this was
welcome--even intoxicating--to us deficit hawks.
But in the end the actual sacrifice called for under the Clinton plan is so
mild and selective that it can hardly be said to address our long-term economic
challenges. The President's new taxes on the "rich" turned out to spare almost
entirely a much enlarged but fiscally misnamed middle class, excluding all but
the top one percent of U.S. tax filers. Despite all the talk of draconian
sacrifice, the Clinton plan's proposed energy tax amounted to little more than
a flea bite. As for entitlements, the thing that mattered most, the President
barely managed to crimp their growth. From 1993 to 2004 federal benefit
spending under the original Clinton plan, which, in its handling of
entitlements and its overall budget savings, differs only in detail from what
Congress approved, would have soared by some $730 billion--as compared with
$790 billion under the Congressional Budget Office's business-as-usual baseline
Without much broader sacrifice--and a presidential vision that truly explains
its purpose and inspires us to consume less today for a better tomorrow--we
will never cure America's economic ills.
The Clinton plan doesn't come close to balancing the budget, even in the near
term. According to the numbers developed by the White House itself, if the
President's entire original budget package had been passed and implemented, by
1997 the federal deficit would have declined by only $140 billion from what it
otherwise would have been. That would put it at $206 billion, or 2.7 percent of
gross domestic product--just a smidgen under where it was (3.0 percent of GDP)
in 1989 before the recession began. If 2.7 percent of GDP doesn't seem like a
lot, consider that in 1992 a deficit that size would have soaked up about half
of U.S. net private savings. And consider also that about three quarters of the
spending cuts that the President has proposed for 1994 to 1998--modest as they
are--are only to take place after the 1996 election, which, of course, raises
the risk that they will not materialize at all.
After 1997 the federal deficit will once again begin to rise rapidly. Under the
impact of continued growth in entitlement spending, by 2004 it will have
climbed to about $465 billion, or 4.6 percent of GDP. As the Baby Boom
generation begins to reach retirement age in the years that follow, a General
Accounting Office study indicates, the deficit could then soar to an
unthinkable 21 percent of GNP in the year 2020, when today's toddlers are
starting to raise their own families.
Economists disagree on many things, but almost none would disagree that it is
essential not to let our public debt grow faster than the economy. Yet under
the Clinton plan public debt is on track to grow far faster than the economy.
Today public debt is already at a higher level--55 percent of GDP--than it has
been at any other time since the mid-1950s, when we were still paying off the
costs of the Second World War. Because the Clinton budget plan leaves on the
table a full two thirds of deficits previously projected for 1993-2004, public
debt will grow to about 65 percent of GDP by the end of that period. And along
with the debt, needless to say, federal interest costs will soar.
Considering how ravenously a large deficit consumes national savings--and
Clinton has spoken eloquently about this--and how important the availability of
savings is to making the future-oriented investments that Clinton says he wants
(and that America surely needs), how can we possibly justify short-term
tweaking of the deficit in lieu of radical surgery to balance the budget?
I have asked the Clinton people this question. One answer they offer is that
the volcanic eruption of red ink projected for after 1997 will never occur,
owing to steps they will take to control that most intractable force driving
our deficits--exploding health-care costs.
The President is certainly right to go after health care. This is where much of
deficit reduction must occur. But as to whether Bill Clinton will find his
hoped-for health-care savings, I am more than a bit skeptical. As Charles
Schultze, a former chairman of the Council of Economic Advisers, put it, "God
couldn't design a program" that will achieve net savings in health care in the
near term. The President, after all, is proposing that we spend more on health
care--according to some, as much as $100 billion to $150 billion annually in
new public and private benefits, much of it picked up by the federal
government. In the longer term achieving real savings elsewhere in health care
will require real sacrifices--including, ultimately, selective rationing of
high-cost, low-benefit medical technologies and services. But the
Administration isn't preparing the American people for such sacrifices. Until
it does, it won't be able to come up with enough health-care savings to offset
the cost of the benefit expansions we are now talking about, much less
contribute to overall deficit reduction.
Bill Clinton warned of an economic Armageddon if we fail to change course--but
then all he was able to give us to cure our economy's ills was a few teaspoons
of syrupy medicine.
What happened? The President, according to senior aides, kept asking, "What is
politically feasible? I do not want this to be another budget that is D.O.A."
In the end his political advisers told him he couldn't ask for sacrifice where
he had to--from the great American middle class. Let me now speak the unpopular
truths that I am sure the President knows but believes are too politically
dangerous to act upon. Let me turn to the problem of the great American middle
class--and the absolutely essential role it must play in shared national
sacrifice if we are to reclaim our future.
The Brutal Truth
If you listen carefully to most economists and policy experts today, a
consensus emerges about the magnitude of America's economic challenges and what
sorts of reforms will be necessary to overcome them.
In particular, most would agree with the following: (1) To get American living
standards rising again, we must increase productivity growth. (2) To boost
productivity we must invest more--much, much more--not just in machines but in
research and development, in infrastructure, and in people. Making the new
investments we need if we are again to know the kind of rising living standards
we remember from the 1950s and 1960s will require a lot of money. Many, myself
included, think that at least $400 billion a year in new investments is needed
in order to boost our rate of investment back toward our long-term historical
average and put us in the ballpark of what other major industrial countries are
now managing to invest. (3) This in turn means that we must save much, much
more--at least $400 billion a year more (4) The surest and fastest way to
increase our savings is to reduce and eventually eliminate the federal deficit,
which is really just a form of negative public savings. (5) To reduce the
deficit and keep it down we must make major cuts in consumption spending, and
in particular in entitlements. But this, alas, requires us to confront a brutal
question: If we are to save more by consuming less, whose consumption growth do
we propose to cut?
It's at this point that agreement on what needs to be done, while not exactly
breaking down, comes face to face with a truth that remains politically
inexpressible. That truth is that the problem is all of us. Most
Americans--emphatically including the middle class--will have to give something
up, at least temporarily, to get back our American Dream.
We all remember the slogan that came out of the Clinton campaign: "It's the
economy, stupid." Well, when it comes to the budget, the watchword ought to be
"It's entitlements, stupid." From Social Security and Medicare to the vast tax
favors for home-mortgage interest and employer-paid health insurance (policy
wonks call these benefitlike subsidies in our tax code "tax expenditures"),
consumption-oriented spending dominates the budget today. And the explosive
growth of these entitlements will continue to rob our future. The budget
arithmetic is inescapable: we just can't get the spending cuts we need from
anywhere but entitlements. As big as it is, even defense spending isn't big
enough. We could shut down the Pentagon tomorrow and still not balance the
budget. Nor can we count on saving much on our huge interest bill unless we
first reduce other types of spending. Interest on the national debt is
something that we must pay to avoid a devastating financial panic--and it keeps
growing as our national debt grows, just as it would fall if we began to attack
the deficit. The rest of what government does represents just pennies out of
the overall budget dollar.
The Cost of Entitlements
Let's define some key terms and look at some key facts about entitlements.
Entitlements are any public-sector payments, received by a person or a
household, that do not represent contractual compensation for goods or
services. This definition obviously excludes large portions of the federal
budget, from defense procurement to interest on the national debt to purchases
designed for America's collective benefit (such as highway construction). But
it includes nearly everything else--most notably such dominating fixtures of
the American political landscape as Social Security, Medicare, Medicaid, food
stamps, unemployment compensation, veterans' benefits, and farm aid, to say
nothing of our lavish federal pension systems.
The most striking single fact about entitlements is their vast cost. Over the
course of fiscal year 1993 the U.S. Treasury will have mailed out benefit
checks (directly to individuals or to state agencies and insurance companies
that administer benefits) totaling some $800 billion, or about one eighth of
our nation's GDP. That amounts to more than half (53.5 percent) of the entire
federal budget--or about $6 million every minute of every working day, flowing
to one out of two American households. These figures, moreover, include only
direct outlays from the federal budget. The numbers would be even larger if we
included tax expenditures. If we count them and add the cost of administering
entitlement programs--as many economists argue we should in order to get the
full picture--federal entitlements now amount to more than $1 trillion annually
and flow to well over three quarters of all U.S. households.
Ten Myths About Entitlements
Myths about entitlements are everywhere. They are used--and abused--in the
political dialogue in ways that seem to make reasoned debate and reasonable
reforms impossible. Let's look at ten of the most common myths.
1. Most federal social spending goes to the poor.
It is important to remember what entitlements have done to reduce poverty.
Before the New Deal millions of Americans had no means of support in the event
of unemployment, disability, unexpected retirement, or the death of a parent or
spouse. Vast numbers of children grew up in destitute families. At great cost
to society and the economy, millions of workers could fall into poverty and
never recover. In 1937 President Franklin D. Roosevelt could say, "I see one
third of a nation ill-housed, ill-clad, ill-nourished." Today entitlements
prevent some 20 million Americans (half of them elderly) from falling into
This is clearly all to the good. However, keeping people out of poverty is not
the purpose toward which most entitlement spending is directed. In reality,
only about one out of eight federal dollars of social spending serves to lift
poor families above the poverty line. Only about one out of four federal
benefit dollars even flows through a program that uses financial need as a
criterion for eligibility. Counting both direct benefits and the value of
entitlements conveyed through the tax code, the aggregate amounts received by
people above the national median income are simply staggering. In 1991 nearly
half of all entitlements went to households with incomes over $30,000. One
quarter went to households with incomes over $50,000.
2. Entitlement spending helps to equalize incomes by giving more to the poor
than to the rich.
Few axioms of American political life find such uncritical acceptance as the
belief that social-welfare programs effect a dramatic redistribution of wealth
in favor of low-income households. It apparently makes little difference that
most experts, liberal and conservative alike, have never subscribed to this
axiom--and that recent data repudiate it altogether.
Back in the sixties the Nobel laureate economist Milton Friedman used to shock
audiences by asserting that Social Security was actually a regressive
program--since the program's mildly progressive benefit formula compensated
neither for its regressive payroll tax nor for the fact that the poor pay taxes
over more years (since they tend to start working at a younger age) and receive
benefits over fewer years (since they tend also to die at a younger age). Most
economists found Friedman's analysis at least plausible; no one has yet
disproved it. More recently the celebrated political scientist Mancur Olson
looked over the panoply of American entitlement programs and concluded:
"Most of the redistribution of government is not from upper-income and
middle-income people to low-income people. Most of the redistribution of income
in fact is from middle-income people to other middle-income people, or from the
whole of society to particular groups of rich people, or from one group to
another where the groups are distinguished not by one being poor and the other
being rich, but only by the fact that some groups are organized and some are
Income data from the Congressional Budget Office tend to bear out Olson's
critique. Total federal benefits to the affluent are at least as substantial as
those to the needy. Among Social Security beneficiaries, for instance,
households with incomes of $100,000 or more receive, on average, checks that
are twice as large as those of households with incomes of less than $10,000.
Even when we add in the cash and in-kind benefits disbursed by all of the other
federal sources for which we have income data--including "means-tested" welfare
and food stamps--we find that households in the top bracket ($100,000 and up)
received an average of about $5,700 in 1991, slightly more than the average of
$5,600 received by households in the bottom bracket (under $10,000).
But direct federal payments are not the only way in which the federal
government distributes benefits. We also have to take tax expenditures into
account. These loopholes, designed to favor certain households and bearing no
relationship to ability to pay, are the fiscal and economic equivalent of a
government check. Most tax expenditures are unquestionably regressive: many
poor households cannot qualify for them--and even when they do, what they
receive is smaller, relative to their income, than what the affluent get. This
year, for example, the Congress's Joint Committee on Taxation estimates that
the average value of the home-mortgage interest deduction for taxpayers with
incomes over $100,000 is $3,453 and that the same deduction is worth an average
of only $478 for taxpayers in the $20,000 to $30,000 bracket. Even these
figures include only those who qualified for the benefit. They exclude many
low-income families, including renters and those who opted for the standard
deduction, who do not qualify.
When we add together all the direct-benefit outlays and all the tax
expenditures, an unambiguous picture emerges. On average, a household with an
income under $10,000 collected roughly $5,700 in 1991. On average, a household
with an income over $100,000 collected $9,300. This distribution of benefits by
income became more--not less--skewed during the 1980s. Clearly, it has nothing
to do with economic equality. Let's phrase the issue a bit more bluntly. If the
federal government's purpose were to straighten out the national income
distribution, it would do a better job if it dispensed with all the
programmatic rules and simply scattered all the money by airplane over every
population center, to be gathered at random by passers-by.
3. Social Security and Medicare are an earned right: beneficiaries are only
getting back what they paid in.
Here the case is open and shut. Most currently retired Americans receive Social
Security benefits that are two to five times greater than the actuarial value
of prior contributions, by both employer and employee. The payback for the
Medicare Hospital Insurance program is five to twenty times greater. A typical
middle-income couple who retired in 1981 have already received back, with
interest, not only the total actuarial value of their previous Social Security
and Medicare taxes but also the total value of their lifetime federal income
And these calculations of actuarial value are conservative. They assume that
employer contributions "belong" to the beneficiary and that the public must
guarantee a "market" interest rate on all contributions, no matter what the
condition of the economy or the wages of those who are taxed to make good on
this claim. In fact, the Social Security Administration keeps no direct record
of how much each person contributes. It just keeps records of each person's
wage history, to which a politically determined formula is applied when that
The politically potent and disingenuous language adopted by the Social Security
Administration has contributed to the earned-right myth. The system is
described as an "insurance" program, although it is nothing of the sort.
References are made to contributors' "accounts," when no such accounts exist.
My father, helped along by years of such misleading nomenclature, went to his
grave thinking that he was simply getting back his money, by which he meant
what he had put into his "account" over the years. Since by this logic the
benefits belonged to him, any proposal to take any of them away was both unjust
and immoral. In truth, it was as though the government had a moral obligation
to provide a windfall forever. He could only wonder why his otherwise
well-educated son thought differently. I could never persuade him. It would
have depressed him to find out that in fact there was no Social Security
savings account in Washington with George Peterson's name on it.
Nor would I have wanted to depress him further with other unpleasant facts
about entitlements. My father was immensely supportive of my wife's work in
behalf of poor children at the Children's Television Workshop. He would have
been distressed to learn that in 1986, the last year of his life, the nation
was told that it could not afford to fund fully the much-admired Head Start
program. Yet merely the increases in Social Security's cost-of-living
adjustments that year would have fully funded Head Start. Had he known the
facts, I am confident he would have been happy to give up his sliver of the
huge entitlement pie for such a worthy cause.
4. The elderly, as a group, are poorer than young Americans.
In reality, the 1990 official poverty rate among the over-sixty-five population
was 12 percent, as compared with 21 percent among children. When we include the
value of all noncash benefits as income, the poverty rate for the elderly is
six percent, as against 15 percent for children. On this latter basis poor
children outnumber the poor elderly in America by more than five to one. In no
other major industrial nation is the poverty rate for children (using identical
definitions) anywhere near what it is in the United States.
Children are the truly needy in our society, but they certainly don't get most
of the public money. In 1990 of all direct federal benefits 63 percent went to
the 13 percent of all Americans over age sixty-five, while nine percent went to
the 26 percent of all Americans under age eighteen. On a per capita basis, and
including all federal outlays that might be called "child benefits," from
education to immunization, the ratio of average benefits received was eleven to
one $13,8930 to each elderly person and $1,271 to each child. Even adding in
everything spent by state and local governments (on schools, for instance), the
ratio still favors the elderly by at least three to one.
Some argue that entitlements for the elderly merely substitute for transfers of
wealth that the young would otherwise make to their parents. That might be true
if these programs weren't so lavish. Before Social Security and Medicare, young
families did sacrifice for older parents--if and when Mom and Pop were in need.
Yet because today's retirees are, as a whole, wealthier than the young, adults
aged twenty-five to thirty-four now report receiving from their parents twenty
times more support than they give to them; even for adults thirty-five to
forty-four, the ratio is five to one. Social Security and Medicare, far from
embodying traditional family values, have turned them on their head.
5. Social Security is building up a huge surplus that will be available to pay
for benefits promised to Baby Boomers.
It is true that Social Security receipts from payroll withholding taxes
currently paid into the retirement part of the Social Security system (not the
health-care or Medicare part) are higher than Social Security expenditures, and
will probably remain so until the Baby Boomers start retiring in large numbers.
But this surplus is temporary. What is more, the funds are not being saved or
invested. Instead they are being used to help offset each year's overall
federal budget deficit. Thus these surpluses are transformed into debts held by
the Social Security trust funds. Future taxpayers will become liable for the
principal and interest.
Let's peer into the future to see what the real financial status of our old-age
benefit programs is. In assessing their solvency actuaries tally up what are
known as unfunded liabilities--the amounts (in this year's discounted dollars)
by which future benefits promised to today's adults exceed all their future
payroll taxes plus the assets currently held in all the government's relevant
"trust funds." The federal government's unfunded liabilities
for just four programs--Social Security, Medicare, and federal civil-service
and military retirement--come to about $14 trillion. That's a sum several times
larger than the national debt, and one equivalent to roughly $140,000 for every
household. This is a system in surplus?
6. Today's younger Americans will eventually receive the same health and
pension benefits they are providing today's retirees.
Recently the Senate Finance Committee held a hearing on likely paybacks to
various generations. No expert disagreed on the trend (an unusual fact in
itself): the earliest beneficiaries got by far the best deal, and the deal has
been getting worse for each successive generation. By some calculations some
upper-income single males retiring this year may get less out of Social
Security than they put in.
Moreover, financing even the reduced returns that are promised to tomorrow's
retirees is unlikely to be economically or politically sustainable as America
ages. The Social Security Administration projects that, depending on
demographic and economic trends, the cost of Social Security and Medicare will
by 2040 rise to between 38 percent and 53 percent of payroll--unless we cut
benefits. I believe the only real question is when, not whether, we will change
course. We can make modest, fair-share sacrifices now. Or we can make wrenching
changes later, amid economic crisis and, as Paul Tsongas would say,
intergenerational war. The choice is not just economic but also moral. I can
imagine few ethical principles more important than fairness toward our
7. Retirement benefits are an "inviolable contract" between the generations.
No, Virginia, there is no sacred contract, at least not according to the U.S.
Supreme Court, which has repeatedly ruled that no covered worker retains any
rights, contractual or otherwise, over taxes paid into the Social Security
system. Perhaps I may be permitted a layman's less lofty legal opinion. As I
recall (from a college course in commercial law), one fundamental requirement
of a valid contract is a "meeting of the minds" of the parties to the contract:
between those who pay and those who receive. But no such meeting of the minds
exists. I am not aware that anyone has consulted my grandson, Peter Cary, now
aged three, about the staggering tax rates that our current entitlement
"contracts" will require him to pay when he enters the work force.
Simply repeating "inviolable contract," "mandatory," "nondiscretionary,"
"uncontrollable" payments, or some other disingenuous mantra does not change
certain truths. What Congress mindlessly gives can be taken away. A fundamental
reality is that the current system is not sustainable. If Social Security (or
Medicare) is a contract, it is an unenforceable one.
8. Tax breaks for health insurance primarily benefit people who otherwise could
not afford proper health care.
Maybe this one isn't really a myth, but the regressivity of our subsidies to
privately paid health care is too shocking not to mention. In 1994 exempting
employer-paid health insurance from taxes will cost the U.S. Treasury about $75
billion. Needless to say, of the 35 million or so Americans without health
insurance, who receive zero benefits from this huge tax break, most are poor or
low-income citizens. Among households that do have insurance, those with the
highest incomes and the most generous insurance plans receive several times as
much from this federal tax subsidy as those with low incomes and a
9. The federal government's major housing entitlement, the home-mortgage
interest deduction, promotes homeownership and stimulates the economy.
In 1994 the cost of the home-mortgage interest deduction in lost revenues to
the federal Treasury will be $46 billion, 80 percent of which will go directly
to households with incomes over $50,000. The main economic effect of the
home-mortgage deduction is to inflate the price (and size) of homes, while
diverting investment away from more productive sectors of the economy.
Our global competitors, who hear us publicly rail about our investment-starved
economy and the stagnation of our productivity, politely ask what conceivable
connection this tax subsidy for the relatively well off has with enhancing
productivity. Officials in Canada regularly chide me about the fact that Canada
has the same rate of homeownership as the United States without the benefit of
this tax subsidy.
Why, then, do we have it? The answer, of course, does not lie in any real
economic imperative. The subsidy exists because we all think we deserve it.
What's more, it props up one of our most powerful special interests: the
10. The only reason that Ronald Reagan could not keep his promise to shrink the
size of government was the huge rise in defense spending.
Judging by the cheers of his supporters and the jeers of his critics, we might
suppose that President Ronald Reagan cut everything but defense. And judging by
the similar partisan bickering over the policies of his successor, George Bush,
we might suppose that the "welfare state" was the victim of further slashing
and hacking for another four years after Reagan stepped down.
But the reality is very different: the cost of all direct federal benefits
today ($807 billion in fiscal year 1993) is considerably greater than the
entire federal Budget that existed when Reagan first took office ($696 billion
in fiscal year 1981). In fact, adjusted for inflation, federal benefits soared
by 54 percent from 1981 to 1993--while all other domestic spending showed zero
real growth, and defense, the one area where everyone supposed the Reagan and
Bush Administrations had gone hog-wild, showed real growth of only 15
Contrary to popular impressions, the advent of the Reagan-Bush era did not
signal a decisive shift in entitlement policy. With the exception of the 1983
Social Security amendments (designed by a bipartisan commission), both
Presidents left non-means-tested outlays and tax expenditures--that is, most
entitlements--on autopilot. Thus the Reagan-Bush years only reaffirmed that
these vast middle- and upper-class entitlements were politically
"uncontrollable"--a weasel word behind which Congress and the President can
hide their unwillingness to act, since together they can control any spending
The Middle Class: The Third Rail of American Politics
The middle class is at the heart of our budget problem--and must be at the
heart of the solution. Taken together, the major benefit programs for which we
have income data on recipients--spending roughly 80 percent of total federal
benefit dollars, and including everything from Social Security and Medicare to
AFDC and food stamps--deliver 99 percent of their benefits ($529 billion in
1991) to the 99 percent of American households with incomes under $200,000.
This is the upper boundary of what President Clinton has for political
convenience defined as the "middle class." (The income-tax increases proposed
by the Clinton Administration begin at $140,000 of taxable income, the number
most people have heard quoted. But that's really equivalent to about $200,000
of adjusted gross income from all sources.)
Yet 43 percent of such benefit dollars ($227 billion in 1991) go to households
that cannot possibly be considered poor: those with incomes between $30,000 and
$200,000. And note that the absolute dollar figure surely understates the total
since it reflects only 80 percent of all benefit dollars. What about the
remaining 20 percent? We cannot be sure. Some of it flows through programs such
as Medicaid, which mostly benefit lower-income households; some, too, flows
through programs such as student loans, farm aid, and veterans' health care,
which disproportionately benefit upper-income households. All told, it would be
safe to assume that total federal benefit outlays reaching the
$30,000-to-$200,000 income bracket amounted to at least $265 billion in 1991.
And what about our ocean of so-called tax expenditures--the subtle subsidies
that help the wealthy borrow huge sums for home mortgages and take unlimited
health-care deductions? More than two thirds go to tax filers with incomes
between $30,000 and $200,000. Just seven percent go to the Americans whom the
President calls "rich."
The top-earning one percent of Americans, it's true, receive 13 percent of all
income in the United States. Going after the rich to help balance the budget is
fine--as far as it goes. Unlike some of my Wall Street colleagues, I see
absolutely nothing wrong with imposing higher tax burdens on the wealthiest in
our society. But it does not require any arcane knowledge of fiscal arithmetic
to see that even with the substantial tax increases proposed by the Clinton
plan, trying to balance the budget is quite literally impossible on such a
narrow stretch of income territory. In fact, to meet this goal by the year 2000
by taxing the "rich," we would need to tax away all the taxable income of
everyone with more than $175,000 of adjusted gross income. Or, if we would
prefer a less draconian approach, we could merely double the income taxes of
"affluent" tax filers--but we would need to include everyone down to about
$50,000 of income. Even this kinder and gentler approach would amount to
something more like expropriation--hardly consistent with either free markets
As for direct entitlement benefits, here too not much help is available from
the rich. The maximum entitlement savings obtainable from the one percent of
households enjoying incomes of more than $200,000 are unfortunately limited to
the benefits that go to them--about $5 billion if we took away all their
benefits (something that even Bill Clinton, with his laser beam on the rich,
has never dreamed of suggesting).
But if we are willing to ask for even modest sacrifices from all Americans with
incomes above about $30,000, the picture changes entirely. Suddenly we're
talking about a whopping 73 percent of national household income. We're also
talking about a stunning 74 percent of all tax expenditures and 43 percent of
major federal entitlement benefits, which, taken together--and including our
estimate for all benefits--amounted to $372 billion in 1991. That's a sum we
simply cannot afford to ignore if we are at all serious about putting our
fiscal house in order.
Twelve years ago, when Ronald Reagan ascended to the White Louse, I hoped that
his politically candid talk about cutting the budget deficit would lead to
politically courageous action. But instead we found a convenient scapegoat. The
"poor," we learned, were bankrupting America. Just eliminate the "waste, fraud,
and abuse" in our welfare system--all those mink-wearing welfare queens driving
Cadillacs and buying vodka at taxpayers' expense--and a balanced budget would
be in reach. The premise, of course, was wrong from the beginning. Despite cuts
in programs for the poorest Americans during the Reagan years, the deficit kept
When Bill Clinton ascended to the White House, I was once again hopeful that
the President would seize the moment and make the tough choices needed to cut
the deficit and boost savings and investment. But we seem to be caught up in
another form of scapegoating. This time it's not the poor who are to blame;
it's the rich who are not paying their way.
To be sure, President Clinton will get further with his scapegoat than
President Reagan did with his. But both ways of dodging tough choices veer away
from the heart of the problem. We are all implicated in our budget deficits,
our entitlement ethos, and the overall consumption bias in our economy. And all
of us most particularly the broad middle class that is the backbone of America,
must now be part of the solution.
Let's pause for a moment to ask ourselves, what in reality is the "middle
class"? Ask any American if he or she is "middle class," and the answer will
almost always be yes. The truly poor will admit to being "lower middle class,"
and the rich will go along with "upper middle class," but few will forthrightly
call themselves "poor" or "rich." This is a characteristically American
self-perception, and it reflects our desire to live in a basically egalitarian
society. But in recent years it has allowed nonpoor Americans to believe that
they deserve universal federal entitlements--much of them windfalls--such as
Social Security and Medicare, which are often disingenuously called
"insurance," and which people mistakenly think of as the payback on their
contributions to "their accounts."
Next, ask any group of Americans to specify the annual income that defines
"middle class" and you'll hear responses ranging from, say, $20,000 all the way
up to $200,000--if we include the Clinton Administration's definition. But
there are more precise and realistic definitions. If nontaxable entitlement
benefits and other tax-exempt income are included with adjusted gross income
reported to the IRS, the median family in the United States had a total
adjusted gross income of $31,700 in 1993. If "middle class" is then narrowly
defined as comprising half of all American families equally distributed around
that $31,700 family, the statistical middle-class income turns out to range
from $14,040 to $55,880.
This exposition regularly startles those who are new to it. A family with
$60,000 of income invariably thinks of itself as "just getting by," but it
actually stands in the top quarter of families. A two-earner family with an
income of $120,000 may think of itself as just middle class. In fact that
two-earner family stands in the top five percent of American families. By the
time we reach those with incomes in excess of $200,000--the only households
targeted for significant sacrifices by the Clinton Administration's
proposals--we are left with a mere statistical sliver of the population:
roughly one percent.
Middle-class Americans today, it seems, suffer from what might be called a
"reverse Lake Wobegon" syndrome. As Garrison Keillor fans know, Lake Wobegon is
a wonderful fictional place where all the children are above average. When it
comes to incomes, however, most middle-class Americans, trying hard to make
ends meet, assume they must be below average.
Middle-class Americans today feel hard pressed and beleaguered--and they are.
Nobody could possibly argue that even a well-above-the-median $50,000 a year in
household income will put one on easy street. It's hard to make it on a typical
middle-class income today--when paychecks barely keep up with the cost of
homes, of college educations and even of necessities.
Working hard and trying to follow the rules, middle-class Americans have
adopted a kind of siege mentality in the face of evaporating expectations about
fixture income growth. The middle class is already making a de facto and
unplanned sacrifice in terms of the loss of upward mobility. But an organized,
planned, and temporary additional sacrifice can reverse that trend. Only if we
all give up something to reinvest in our future will we be able to rekindle the
rise in U.S. living standards. If we all just hunker down to protect what we
feel we're entitled to, we will condemn ourselves to a future that grows
bleaker each year. Evaporating and diminished expectations are not what America
is about. The willingness of middle-class citizens to sacrifice a little today
for a better tomorrow is, however, exactly what America used to be about and
ought to be about once again.
In spite of the recent stagnation of its living standards, the American middle
class is still the world's richest middle class, consuming far more than any of
its counterparts in Europe or Japan--and paying far lower taxes than most.
Indeed, Americans may think themselves overtaxed, but we pay some 10 to 20
percent less of our national income in taxes than do the citizens of most other
industrialized countries. The actual economic room for sacrifice exists; what
we are missing is the public understanding and the political will to recognize
such sacrifices as being in our long-term best interests.
We can't, of course, call on the middle class alone to sacrifice. The rich must
pay their fuller and fairer share. Many of the same people who argue that the
middle class is too beleaguered to contribute to solving our economic problems
stand by silently as the $30,000-a-year middle-class worker pays
ever-increasing payroll taxes (which in many cases come to more than his or her
income taxes) to subsidize the entitlement benefits of retirees who are getting
ten times their contributions in Medicare payments (tax-free) and who may be
earning $100,000 or more a year in retirement. This is unconscionable.
Relearning Our Endowment Ethic
These things are certain: we can't do it without the without the middle class.
And we can't do it without going at entitlements head on.
Bill Clinton's decision to skirt entitlements and to spare the middle class
from all but token sacrifice may have seemed a politically expedient course for
the short term, just as it has to the past several Administrations. (According
to the economist Benjamin Friedman, 74 percent of the burden of what deficit
reduction the Clinton plan does achieve through higher taxes or benefit cuts
will be borne by the small share of U.S. families earning more than $100,000.
But it has meant that his only feasible program is one that has no hope of
balancing the budget--or even coming close.
Bad economics may end up being bad politics as well. It is a matter of debate
whether the American public is actually ready for real change and tough
choices. And avoiding excessively rapid spending cuts or large tax increases in
the midst of a creeping recovery was an understandable concern--though for all
too many years it has never been the right moment in the business cycle or the
political-election cycle for decisive action on the long-term economic
predicament that by now also harms our short-term economic prospects. Any
responsible budget plan must be phased in gradually if we want to avoid too
bumpy a ride. But I believe that a clear goal of budget balance--and a
commitment to meeting it by the end of the decade--would ultimately go over
better with both the markets and the public than the course Clinton has chosen.
Indeed, if one adopts Richard Nixon's dictum that the economy that matters most
is the one that prevails three months before the next election, the President's
current approach is a dangerous one.
By not asking the public to swallow the bitter pills at the outset, Clinton
risks being forced to ask the public--and especially the middle class--to
swallow them later, closer to the 1996 election. At that point, having denied
the middle class its promised tax cut--and having created the impression that
Americans are already making the needed sacrifices when they're not--Clinton
may find the public wondering at the need for further sacrifice. Moreover, the
lift given to the bond market in 1993 by the early promise of deficit reduction
may by 1996 have reversed itself. With health care and other entitlements still
spiraling out of sight, and with private credit demands likely rising as we and
the rest of the world fully emerge from recession, the United States could once
again see soaring interest rates right around election time. As 1996
approaches, Bill Clinton not only inevitably faces a second major
budget-cutting exercise but also runs the distinct risk of being tagged the
Biggest Borrowing President in history--and he won't even have the excuse of
having presided over a divided government. It's easy to imagine a 1996
Republican campaign advertisement along these lines: "Bill Clinton raised your
taxes, still borrowed a million dollars a day, built a bunch of bridges to
nowhere--and this time you know who to blame."
My view is that everybody except the poor and near-poor must be part of the
solution to America's economic problems. But as we move through the various
strata of the middle middle class and upper-middle middle class, and on into
the upper middle class, the sacrifices called for in the form of higher taxes
or curtailed entitlement benefits should get much larger. By the time we reach
the genuine upper class, we should have increased the tax bite significantly
and cut deeply into tax subsidies and windfall entitlement benefits.
To help restore fiscal and moral responsibility to our entitlement system, the
budget plan I propose in my book Facing Up: How to Rescue the Economy From
Crushing Debt and Restore the American Dream therefore includes an "affluence
test," or a graduated entitlement-benefit reduction. This affluence test (along
the lines of the comprehensive means-testing idea discussed by Neil Howe and
Phillip Longman in "The Next New Deal," in this magazine in April of 1992)
would apply to all federal benefits, both cash and in-kind. No sacrifice would
be required of households with incomes below the U.S. median (generously
assumed to be $35,000 by 1995, when the test's phase-in would begin). For
families with above-median incomes a portion of total entitlement benefits
would be withheld on a steeply progressive basis. Under the test, households
would lose 7.5 percent of all benefits that cause their incomes to exceed
$35,000, plus five percent at the margin for each additional $10,000 in income.
For most types of entitlement benefits, the maximum benefit-reduction rate
would be 85 percent, applicable to household incomes greater than $185,000.
If this proposal doesn't silence those who rail that entitlement reform is
inevitably regressive and must ravage the poor, it should at least give them
pause. For families who are earning between $30,000 and $40,000, are receiving
benefits, and are subject to the test, the sacrifice called for would average
just $260 a year--or one percent of their benefits. Moreover, most who would
have to sacrifice are retired and have lower expenses than working-age adults
with similar incomes. For families earning between $50,000 and $75,000, the
sacrifice would rise to an average of $2,310, or 12 percent of benefits; for
families with incomes over $200,000, it would average $15,345, or 72 percent of
All told, the budget savings made possible by the affluence test are enormous:
at least $93 billion in 2004, on the basis of a conservative calculation that
takes into account only the 80 percent of entitlement benefits for which we
currently have detailed data on recipient income. Affluence testing alone,
however, does not add up to complete entitlement reform. Among other measures,
we will also need to cap our open-ended tax subsidies for retirement, housing,
and health care, accelerate the scheduled rise in Social Security retirement
ages, and trim the largesse of our federal pension systems.
All of these reforms involve structural spending cuts that will save
significant money in the 1990s and much more beyond. In a business-as-usual
budget scenario, entitlement costs could be closing in on a quarter of GDP by
2040. Under my plan we would already be saving about 1.9 percent of GDP in
entitlement spending by 2004; by 2040 we would be saving 5.3 percent of GDP or
some $690 billion in today's dollars--more than twice what we now spend on the
Pentagon. That's what I mean by structural spending cuts.
We must invent a new entitlement system that will not just pay us affordable
benefits when we need them but will also encourage us to save more for the
future, care better for our own children and parents, and take more
responsibility for our own health. As America itself grows old, perhaps the
most vital changes in our entitlement system will be those that encourage a
positive new vision of aging. Entitlements for the elderly must promote an
active, economically self-sufficient lifestyle for elders who are able. We will
no longer be able to afford a system that equates the last third or more of
one's adult life with a publicly subsidized vacation.
Getting our entitlements system back on a sound footing is the key to both a
balanced budget and a renewed rise in U.S. living standards in the next
century. But of course, putting our fiscal house in order will require much,
much more. There is still room for trimming in the small discretionary domestic
corner of the federal budget. I also believe that in this post-Cold War world
we can spend substantially less on defense, and I endorse the President's
proposed cuts. To balance the budget by the year 2000, and at the same time
spend more on worthy public goals, from more-generous targeted assistance to
the poor to productivity-enhancing investments in human capital, research and
development, and infrastructure, we will also need to raise new revenues above
and beyond the tax increases President Clinton has already proposed. Along with
a broad-based progressive consumption tax, I recommend higher "sin" taxes and a
fifty-cent-a-gallon federal gasoline tax phased in over five years, in order to
target a particularly profligate type of consumption. But in the end, unless we
are willing to touch the third rail of American politics and rein in the growth
in middle- and upper-class entitlements, our goal will elude us.
The worst aspect of our entitlement addiction is how it subtly fixes our
attention on how much we are going to get--and how it obscures any thought of
what we have received from others and what we wish to pass on in our turn. In
this sense our entitlement ethos pervades not just our public benefit programs
but our entire approach to deficit-financed consumption. It is time for America
to begin unlearning its entitlement ethic and begin relearning its endowment
ethic. At some point we must decide how much we are willing to give up today in
order to save for and invest in a tomorrow of rising living standards for
ourselves and, of course, our children. The alternative--a future without an
American Dream--is no alternative at all.
Peter G. Peterson is the chairman of the Blackstone Group, a private investment bank.
He is also a member of the board of the Federal Reserve Bank of New
York and co-founder of the Concord Coalition, a bipartisan economic policy group.
Earlier in his career Peterson served as the
U.S. Secretary of Commerce and as chairman and CEO of Lehman Brothers and Bell & Howell.
Copyright © 1993 by Peter G. Peterson. All rights reserved.