ith the coming of the Next New Deal, Americans will look back and marvel at
what became of our old welfare state--that tangle of inequity and dysfunction
once known as federal entitlements. Why did the public tolerate a system that
wound up distributing most of its benefits to the well-off? And how did the
economy survive its costs?
History books will no doubt concentrate on a few choice examples of the
conditions that finally forced a wholesale reform. Readers may learn, for
instance, that by 1991 the federal government's largest housing subsidy program
was providing an average of $3,000 a year to each of the six million wealthiest
households in America, while offering nothing to the 36 million Americans in
To qualify for this particular benefit, called the home-mortgage deduction, you
had to borrow using your first or second home as collateral. And the more you
borrowed, even if it was to finance a chalet in Aspen--or just a ski trip to
Aspen--the more subsidy you would receive from other taxpayers. By 1991 the
cost of the home-mortgage deduction had risen to $37 billion, of which 81
percent went directly to households with incomes over $50,000. Meanwhile,
economists bemoaned the anemic U.S. personal savings rate, which in the late
1980s fell to its lowest level since the 1930s.
The U.S. health-care system a quarter century after the announcement of the
Great Society will also provide future historians with rich examples of the
conditions that led to the next New Deal. How to explain that the U.S. economy
staggered under the highest per capita health-care costs on earth, and still 23
million Americans under the age of thirty-five were uninsured for any medical
care at all?
Stranger yet was what happened to these uninsured Americans, and to everyone
else, if they happened to live to be sixty-five. After that birthday a citizen,
regardless of income, became entitled to take part in a program called
Medicare, which would pay for everything from CAT scans to pacemakers, from
chiropractic to orthopedic recliners. In 1991 Medicare spent nearly $19 billion
subsidizing the health care of households earning $50,000 or more. That year
government experts projected that the mounting cost of Medicare would cause the
program to collapse within fifteen years, and that if current trends continued,
total health-care spending would rise to an economy-shattering 44 percent of
the gross national product by 2030. No one listened.
Gold-plated pensions for federal employees will also no doubt be held up by
future historians as emblematic of the decadence of late-twentieth-century
political culture. By what accident of history were military and civil service
retirees with incomes over $100,000 collecting $9.2 billion from the U.S.
Treasury in 1991? For half this sum the official poverty rate for all American
elderly could have been reduced to zero. At the very least, Congress could have
done something about the $1.4 trillion in unfunded federal pension liabilities
on the books. But the House of Representatives was busy with other business at
the time--such as voting itself a controversial pay hike that would later be
remembered for its explosive impact on pension costs. Retiring in 1991, a
typical congressman looked forward to $1,098,735 in lifetime benefits; by 1993
the figure had risen to $1,523,263.
Finally, there was the program originally designed to offer all Americans what
President Franklin Roosevelt's brain trusters called "a floor of protection"
against destitution in old age. But over the course of more than half a century
Social Security had evolved into something radically different. By 1991 the
system was distributing more than 555 billion a year, or more than a fifth of
its benefits, to households with incomes above $50,000 a year. For that much
money the government could have provided every American with cradle-to-grave
insurance against poverty--including the one American child in twenty who lived
in a household reporting a cash income during 1991 of less than $5,000.
For many years the worsening inefficiency and inequity of the U.S.
social-welfare system seemed to make little impression on American political
opinion. Political leaders as diverse as Newt Gingrich, George Bush, Bill
Clinton, and Daniel Patrick Moynihan expressed alarm at the moral hazard of
providing welfare benefits to poor unwed mothers. But few political leaders
worried about the moral hazard--and incomparably larger cost--of subsidizing
home-equity loans for rising young stockbrokers, granting free medical care, PX
cards, and half pay for life to ex-colonels at age forty-two, passing out farm
payments to affluent agribusiness owners, or writing checks to globetrotting
senior citizens which got forwarded to Bermuda. It was convenient to assume
that free lunches corrupted only the underclass.
As the 1990-1992 recession lingered, forcing local governments to cut teachers'
pay, ignore the raving homeless, and fence off sagging bridges, state governors
turned to Washington, where politicians shrugged their shoulders and pointed to
a budget bursting with entitlement programs running on auto pilot. Meanwhile,
ordinary Americans wondered what was happening to their nation's public sector.
It could afford neither to build for the future nor to care for the
needy--despite unprecedented borrowing, a near-record level of taxation, and
sinking defense outlays that by the fall of 1992 had reached their lowest share
of GNP since Harry Truman ran for President. With the vaunted post-Cold War
Peace dividend" evaporating, the United States found itself unable to invest
adequately in either its infrastructure or its children. Eventually people
began to talk of another Great Depression, before the coming of the next New
A Welfare State for the Affluent
Rudolf Goldscheid, the socialist economist, once observed, "The budget is the
skeleton of the state stripped of all misleading ideologies." By now federal
entitlement spending has become so pervasive in American life--not just among
the poor but most notably among the middle class and the affluent--that one
cannot make sense of our politics or the condition of our economy without
considering how this spending rearranges the nation's resources and defines our
choices as a society.
Ever since the early 1980s, when the United States lost control of its fiscal
policy, the term Entitlements--referring to all federal benefit payments to
individuals--has been part of the American political lexicon. Today the
twelve-digit numbers that first worried budget experts back in the late 1970s
look positively quaint--although events have proved that the growth of
entitlements is indeed the leading cause of the nation's long-term structural
deficits. This year the cost of federal benefits is larger than was the entire
federal budget when Ronald Reagan arrived in Washington with a mandate to slash
the welfare state.
All told, entitlements have become a trillion-dollar river. The main current
includes more than $700 billion in direct outlays, received by at least one
member of roughly half the nation's households. These expenditures account for
more than 45 percent of all federal spending, and are more than twice as large
as the amount consumed by defense. Another flow of nearly $200 billion is
distributed in the form of tax subsidies to individuals, such as the
home-mortgage deduction and the exclusion for employer-paid health care. These
explicit breaks in the tax code are the moral and fiscal equivalent of the
government's simply mailing a check. To pay for them, other people's taxes have
to be raised, other benefits have to be cut, or the deficit has to be
The accumulating burden is not about to ease. Our economy shows no sign of
"outgrowing" the cost of entitlements, as many partisans of Reaganomics, along
with many liberals, once hoped. Though the relative cost typically rises and
falls with the business cycle, it has always emerged from each new recession
larger than it emerged from the last. In fiscal year 1992 federal benefit
outlays alone u ill exceed 12 percent of GNP, the second highest level ever.
Including tax benefits, the total cost of federal entitlements amounts to well
over 15 percent of GNP, and Congress now projects that it will climb steadily
through the late 1990s. For the first time, the economy should not expect any
Who benefits from this spending? Until recently no one really knew. Budget
experts, to be sure, have always pointed to a few eyebrow-raising numbers.
Consider the fact that of all federal benefit outlays, only a quarter flows
through programs that require any evidence of financial need--and that even
this "means-tested" quarter includes such middle-class staples as student loans
and VA hospital care. Consider also that only one of every eight federal
benefit dollars actually reaches Americans in poverty. But reliable income
figures for all recipient households have simply not been available.
Cash-income surveys conducted by the Census Bureau are plagued by high rates of
underreporting (especially by the wealthy). Tax-return data from the Internal
Revenue Service are more accurate, but do not cover the entire population
(especially the poor).
Several years ago, however, growing curiosity on Capitol Hill persuaded the
nonpartisan Congressional Budget Office to try to unravel the mystery. By
merging the Census and IRS data sources, CBO economists ultimately arrived at
reliable and comprehensive estimates of benefits by household income. The
estimates were circulated behind closed doors during the 1990 budget summit and
have since been updated-- though they have never yet been published. The
benefit income statistics we cite throughout this article are based on these
CBO estimates, which cover about 80 percent of all federal benefit outlays.
These numbers destroy any ideological myths Americans may cling to about who
gets what from government. They offer an accurate glimpse of that "skeleton of
the state"--which has too long been locked in the political closet.
The CBO research demonstrates, in fact, that the most affluent Americans
actually collect slightly more from the welfare state than do the poorest
Americans. It shows that last year U.S. households with incomes over $100,000
received, on average, $5,690 worth of federal cash and in-kind benefits, while
the corresponding figure for U.S. households with incomes under $10,000 was
$5,560. Quite simply, if the federal government wanted to flatten the nation's
income distribution, it would do better to mail all its checks to random
addresses. The problem is not that poverty programs don't target the poor. More
than 85 percent of the benefits from AFDC, SSI, and food stamps do indeed go to
households with incomes under $20,000. But their impact is neutralized by all
the other programs, which tilt the other way and are, of course, much greater
The trend over time is also unsettling. Liberals sometimes attribute the
growing disparity of income in America to Reagan-era cuts in targeted poverty
programs. Among the very poorest households that is indeed one cause. From 1980
to 1991, in consent dollars, the average federal benefit received by households
with incomes under $10,000 declined by seven percent. Yet liberals typically
overlook the gentrification of America's untargeted nonpoverty programs, which
has been pushing even more powerfully to widen the gap between rich and poor.
During those same eleven years, among households with incomes over $200,000 the
real value of average benefits received (mostly Social Security, Medicare, and
federal pensions) fully doubled.
But thus far we have been considering only direct outlays. When we include the
value of entitlements conveyed through the tax code, the bias in favor of the
well-off becomes even more pronounced.
Tax Expenditures and Other Subsidies
Such tax subsidies date back to 1918, when patriotic fervor for U.S. troops in
Europe was running high. Political leaders in Washington felt they should do
something dramatic to reward the doughboys. Facing a tight budget, Congress
hesitated to raise veterans' benefits directly. But then someone on Capitol
Hill took a look at the five-year-old federal income-tax system and came up
with a nifty idea: Why not "raise" veterans' benefits simply by exempting such
benefits from the tax?
Over the years many more "tax expenditures" have followed, nearly all of
them--like the first--created entirely off budget, without estimating eventual
cost and far from the scrutiny that normally accompanies direct appropriations.
Several, including the exemptions for Social Security benefits and for
employer-paid health care, were created not by Congress but by offhand IRS
rulings in the 1930s and 1940s. At the time, no one paid them much notice,
because tax rates were low, Social Security benefits were modest, and company
health plans were rare. But in fiscal year 1992 these two rulings alone are
costing the federal government nearly $90 billion, which is more than the
Pentagon's total budget for weapons procurement.
Though tax expenditures as a political art were invented during the First World
War, the term itself dates back only to the mid-1960s, when it was coined by
Stanley S. Surrey, a Harvard Law don who served as assistant secretary of the
Treasury for Ox policy in the Kennedy and Johnson Administrations. In the
course of his battles with Congress over tax policy, Surrey was struck by the
fact that Congress w as increasingly using selective tax reductions for
specific groups of people, rather than direct appropriations, as a means of
distributing public resources.
Surrey's favorite example was the deduction for medical expenses. He explained
that this tax provision had precisely the same impact, both on the budget and
on the public, as a multibillion-dollar benefit program that heavily favored
the very rich (because they pay taxes at the highest rates) and that entirely
excluded the very poor (because they don't pay Axes at all). There was indeed
only one big difference: the same Congress that created the tax provision would
never dare to create the benefit program.
Although the tax-expenditure concept has been widely accepted by economists
over the past thirty years, it strikes many Americans the wrong way. A common
complaint is that the concept somehow assumes that government "owns" all your
income before doing you the favor of letting you keep part of it. This is not
the case. The concept simply assumes that each person owes the government
according to a general rate schedule superimposed on every person's ability to
pay. Whatever violates such equal treatment is deemed the equivalent of a
benefit outlay--the same, that is, as a check in the mail.
From the dogmatic insistence that there is no such thing as a tax expenditure,
any number of absurdities must follow: for instance, that a public policy
exempting all circus clowns from paying income taxes would not be a public
benefit to circus clowns--who would simply be keeping more of "their own"
money. Who cares if keeping more of "their" money means taking more of someone
else's? Or if it means bankrupting everyone's kids? The ultimate thrust of this
line of reasoning is to deny that a society can consent to and act upon any
equitable principle of public sacrifice. Accordingly, all taxation is
inherently unjust, and though cheating on your taxes may be legally wrong, it
cannot be morally wrong.
It is no surprise that many well-off Americans, uneasy about their nation's
loss of fiscal discipline, find consolation in this pugnacious illogic. What is
surprising is to hear conservatives leading the chorus. Back in the early
1970s, strange to say, many of these same intellectuals pushed Nixon's
ill-fated "negative income Ox," the very premise of which is that less tax is
the precise equivalent of more income. But during the 1980s they have become
the preachers of a selective civic virtue--austerity for targeted benefits to
the poor and indulgence toward shotgun tax favors to the affluent.
Today, even though the government publishes estimates of the cost of different
tax expenditures, this form of spending still attracts comparatively little
attention. But by now the numbers involved, and their social and economic
effects, are too large to ignore. Honest people can and do differ over what
constitutes a genuine tax expenditure, as opposed to "equitable"
treatment--say, for investment income or charitable donations. According to
some, ability to pay should be measured by what a person earns; according to
others, by what a person consumes. But even if we confine our list of tax
expenditures to those that contradict any principle of ability to pay--that is,
to those that nearly all economists can agree on--the total fiscal cost comes
to at least $170 billion. Those tax expenditures arbitrarily reward millions of
lucky people for such endeavors as financing a built-in sauna, hiring an au
pair, or getting the boss to pay for the therapist.
This spending is regressive in the strictest sense of the word. Even when
poorer households qualify for these benefits (and often they do not), what they
receive is smaller, relative to their income, than what goes to the affluent. According to the congressional Joint Committee on Taxation, for
example, last year the average value of the mortgage-interest deduction for
taxpayers with incomes over $100,000 was $3,469. In contrast, the same
deduction was worth an average of only $516 for taxpayers in the $20,000 to
$30,000 bracket who qualified to take the benefit--and of course many,
including renters and those who opted for the standard deduction, did not.
When we add together all the tax expenditures and all the direct outlays for
which we have 1991 income data-- and this is about 80 percent of each type of
entitlement--an unambiguous picture emerges. On average, households with
incomes under $10,000 collected a total of $5,690 in benefits. On average,
households with incomes over $100,000 collected $9,280. In terms of total
fiscal cost, moreover, the aggregate amounts received by the non-needy in 1991
were staggering. One half (at least $400 billion) of all entitlements went to
households with incomes over $30,000. One quarter (at least $200 billion) went
to households with incomes over $50,000. These are the facts--regardless of
what our political folktales might say.
How did our entitlement system wind up delivering most of its benefits to
people who are clearly not in need? Obviously, the overall spending pattern
does not conform to any master plan. Congress never passed a "Comprehensive
Welfare for the Well-Off Act." Rather, the system we see today is the
inadvertent legacy of thousands of why-not-please-everybody votes on Capitol
Hill--together with economic and demographic trends that no one anticipated.
Nor does any conspiracy lie behind the way Americans have chosen over the past
decade to finance the growth of entitlements. They have done so through deficit
spending--the result of a persistent ideological deadlock between cutting
spending and raising taxes. Each side, unfortunately, has reason to regret the
outcome. On the one hand, those who prevented significant reform in the welfare
state have worsened any prevailing trend toward inequity by income and class.
On the other hand, those who urged that it is better to finance the welfare
state through debt than through taxes have burdened Americans with a new layer
of inequity by age and generation.
These are the conditions leading to the coming of the next New Deal--a new deal
that is needed to restore both fairness and efficiency to our trillion-dollar
entitlement budget. The U.S. social-welfare system has by now come to resemble
a ramshackle mansion on a hill, with squeaky back stairways and barren hallways
leading to musty, sealed-off chambers.
Open this door and behold the federal railroad retirement system--a Christmas
gift from Congress to the railroad industry in 1935, still chugging after all
these years, at an annual cost of $7.8 billion. That crowing in the pantry is
the sound of $50,000, on average, in direct federal payments being snatched up
by each of the 30,000 biggest-grossing farmers in America. Not one of them
looks like Pa Joad. And down this hall you'll find the bonanza-baby nursery,
filled with Americans born from 1910 through 1916, whose Social Security
benefit levels are higher than those of anyone born before or after. Can anyone
remember why? What about that thumping noise? Maybe it's the so-called one
percent "kicker" from the 1970s, which still inflates civil-service pensions.
This is a structure, leaky and drafty and wildly expensive to heat, that was
tolerably suited to its previous owners but now requires radical remodeling.
What would FDR, architect of the original New Deal, have said if he had learned
that by 1991 a fifth of American children would be living in poverty--still ill
housed and ill nourished--while a fifth of the dollars spent by major federal
benefit programs went to households earning $50,000 or more?
Fortunately, the system can be made to work again. But before the next New Deal
can happen, Americans will have to start viewing entitlements as a whole, and
debating comprehensive reforms.
Welfare for the Well Off
Even if our current entitlement system were sustainable well into the
twenty-first century--and it is not--most Americans would still have good
reason to demand a new deal. Consider how little we as a nation are getting
back for the money we are spending: no national health insurance plan, no
maternity benefits or family allowances such as are available in Germany and
France, no guarantee against falling into poverty or even becoming homeless--
in old age or at any other time of life.
In 1990, for example, the federal government handed out an average of $11,400
worth of benefits to every American aged sixty-five or over--more than ten
times what it gave to each child--yet 3.7 million senior citizens still
languished below the poverty line. Many of the latter receive a "means-tested"
benefit-- Supplemental Security Income. But for an elderly person living alone
in 1990 the federal SSI program offered a maximum cash benefit of 74 percent of
the poverty level, or $4,632 annually. That same year, while 18 million
Americans earning less than $15,000 at full-time, year-round jobs "contributed"
their FICA dollars, a CEO and spouse could retire and expect to receive more
than $24,000 annually in tax-sheltered Social Security and Medicare benefits,
in addition to their corporate pension and "medigap" plan, and sundry forms of
private investment income.
Why doesn't the welfare state do a better job of actually insuring against
poverty? The bottom-line reason is that we divert too many resources to the
The most stunning illustrations of welfare for the well-off come in the form of
entitlements conveyed through the tax code. Consider, for example, the
exclusion from taxation of most Social Security income along with the insurance
value of Medicare benefits, which together cost the Treasury about $34 billion
last year. The households that receive the largest favor are those with the
most income. In fact both these tax expenditures may be regarded as especially
insidious forms of back-door spending, since they simply add to the already
top-heavy distribution of Social Security and Medicare benefits. For the 37
percent of senior citizens who regularly vacation abroad, these tax subsidies
are enough to pay for a few extra days of shopping in tropical ports of call.
But they do little for another 40 percent of senior citizens who owe no tax on
their Form 1040 because they aren't as well off. This is why every other major
industrial nation regards all or nearly all of its social-insurance benefits as
The same point applies to the child-care credit which cost the government more
than $3 billion last year. Households with incomes below $10,000 received
virtually no benefit from this tax subsidy. Those with incomes above $z0,000,
however, received $1.2 billion to help pay for nannies and other child-care
For the really big bucks, take a look at the exclusion for employer-paid health
care. Under this provision, those Americans fortunate enough to receives
health-care insurance from their employers are allowed to exclude the value of
their insurance from both income and payroll taxation. Last year this single
tax expenditure cost the U.S. Treasury $60 billion in forgone revenue.
Who benefited? Obviously, no one among the 35 million people not covered by any
form of health insurance or among the 32 million people who pay for their plans
out of their own pockets. These 67 million Americans are twice as likely to
live in poverty as are all other Americans. But that is only part of the
inequity. Among households that were covered by employer-paid health-care
plans, the average benefit for those in the highest income brackets was many
times larger than the average for those in the lowest income brackets.
Moreover, most economists agree that such large subsidies encourage their
beneficiaries to overconsume health-care services, and thus put even more
inflationary pressure on a system already in crisis. Who will argue with an
employer who offers a Gold Plan" package that provides generous coverage for
every medical contingency, from orthodontia to nose jobs to psychoanalysis, as
long as it's tax-free?
It is much the same story with most other entitlements conveyed through the tax
code. Not only are they inequitable in their distribution of benefits but also
they contribute to gross distortions in how the U.S. economy allocates
resources. In addition to overconsuming health care, for example, affluent
Americans tend to overconsume powder rooms and swimming pools and vacation
homes at the expense of more-productive investments-- thanks to the mortgage
deduction and other tax subsidies for owner-occupied real estate. One result of
all these tax favors: the hospitals and homes of Grosse Point and other
affluent suburbs of Detroit are far more luxurious than any to be found in,
say, the suburbs of Yokohama or Stuttgart. But only in Detroit do the suburbs
surround a burned-out, deindustrializing core. Not coincidentally, every major
industrial society except the United States pays for little (or none) of its
health care with tax-sheltered insurance, and tightly restricts (or prohibits)
any deductions for interest on home mortgages.
To the rule that says most tax subsidies go to the wealthy, there is one
exception: the Earned Income Tax Credit. First enacted in 1975, the EITC is the
closest America has ever come to a negative income tax. But its effect on the
overall picture is negligible. Even after including the EITC with all the other
tax expenditures mentioned above, the bottom line is still that the rich
receive by far the largest benefits.
Households with incomes below $10,000, for example, receive an average of $131
a year from all these tax-subsidy programs combined. Middle-class households do
better: those with incomes in the $30,000 to $50,000 range receive tax benefits
averaging $1,483. But it is the truly affluent who receive the greatest
subsidy: the average benefit for households with incomes over $100,000 is
$3,595 a year, or nearly thirty times what goes to households most in need.
The Weight of Reality Upon Ideology
Why have Americas put up for so long with such flagrant malfunctioning of their
social-welfare system? Part of the explanation must lie in today's political
culture, which by the standards of FDR's crusading generation has remained
exceptionally cautious in its thinking about the major institutions of the
welfare state, and preoccupied with mere process issues. Meanwhile, as the
decades have passed, the earth has been slowly shifting beneath the major
monuments of the first New Deal. The old assumptions will not hold.
When Social Security first started paying out benefits, for example, the
elderly were by far the most destitute age group in American society. As
recently as 1969,25 percent of American elderly were officially designated
"poor"--as were only 14 percent of children under age eighteen. Today the
relative positions of the very old and the very young are just about reversed:
in 1990, 12 percent of the elderly and 21 percent of children were poor. Other
indicators, such as noncash income, financial assets, and homeownership rates,
also show that the typical elderly household is now considerably better off
than the typical young family. At the same time, as we have seen, millions of
the elderly continue to live in poverty. And yet Social Security continues to
distribute none of its benefits on the basis of need.
We live in a world radically different from that of FDR's generation. How
touching it is for the historian to read that New Deal planners once projected
that Social Security's survivors' and unemployment benefits would steadily
reduce means-tested family assistance. The assumption, of course, was that
widows were the only single mothers struggling to raise children. That 13
million children would be living with single nonwidowed mothers in 1990 was
simply unthinkable. And how maddening it is for today's married woman to learn
that she won't receive Social Security benefits based on her earnings unless
she makes at least half her husband's salary throughout her working life. It
should come as no surprise that a social welfare system designed to serve the
America of Benny Goodman and Norman Rockwell now stands in need of serious
We also live in a world radically different from that of the Johnson and Nixon
presidencies, when the steepest increases in entitlement spending took place.
In that era renowned economists wrote books about the "challenge of abundance"
and testified before Congress about how Americans would soon enjoy a
twenty-two-hour workweek. In 1972, on the eve of Social Security's largest
single benefit hike, the system's actuaries projected that henceforth real U.S.
wages would forever rise at the rate of 56 percent every two decades--an
assumption that made almost anything affordable. Looking back, that sort of
economic euphoria seems as dated as 2001:A Space Odyssey. What has in fact
happened over the twenty years since 1972 is that real wages, as defined by the
actuaries, have grown by hardly more than four percent. Polls indicate that
most Americans are no longer confident that today's children will do as well
economically as their parents--and indeed they will not, unless the country
frees up the resources it needs to undertake wide-scale investments m improving
productivity. Sixty years after the New Deal there is virtually no connection
between the pattern of entitlement spending and any coherent public purpose. So
why is reform so often regarded as impossible?
Part of the reason is ideological. Throughout the Reagan years the allure of
supply-side economics persuaded many conservatives that reforming entitlements
was no longer necessary; with tax cuts and deregulation, the nation could
simply "outgrow" them. The party that once fought losing battles against the
New Deal could thereby dish the Whigs and painlessly rid itself of its
plutocratic reputation. Liberals, meanwhile, have been slow to grasp how an
ideal that was once taken as the nation's highest expression of community has
evolved into a system that serves the interests of economic royalists at the
expense of the common man.
Today reality is gradually wearing away these ideological misconceptions.
Still, the reform of any single entitlement program is blocked by highly
organized special-interest groups, from the graypower and pension lobbies to
the agribusiness, construction, and health-care industries. Even affluent
beneficiaries who may be uncomfortable accepting government money don't like
feeling singled out for sacrifice. The Palm Beach retiree, for example, won't
go along with higher taxes on his Social Security benefits just so that the
yuppie down the street can get another tax break.
What is needed is a comprehensive approach to entitlement reform--one that cuts
not only direct spending but also tax expenditures for the well-off. In this
way entitlement reform could avoid becoming a contest between generations. By
putting every form of government spending on the table, America could also end
that long-running, sterile debate between those who want to cut
spending and those who want to cut taxes. Genuine reform could at last be what
it should be: a more equitable and productive redirection of the nation's
The Peace Dividend Is Not Enough
But couldn't we get by, many readers will ask with just staying the course?
Won't the end of the Cold War free up enough resources so that we won't need to
take on entitlement reform?
The short answer is no. A world at peace won't be enough to right the nation's
As we mentioned earlier, benefit outlays accounted for 45 percent of all
federal spending in calendar year 1991. Yet this conventional measure of the
cost of entitlements, large as it is, underestimates their practical
importance. First, it includes only the benefits themselves, not the cost of
administering them. Add on a minimal five percent overhead, and the total rises
to 48 percent of the budget. Second, a fair measure would compare entitlements
only with other types of spending that are adjustable, not with spending that
is entirely beyond anyone's control. So let's subtract net interest payments on
the national debt ($199.4 billion) and last year's payments on the S&L
bailout ($101.8 billion). Both are obligations that must be met in order to
avoid a devastating financial panic. Now the total rises to 60 percent of the
budget. Finally, let's figure in the $170 billion in benefit-like tax
expenditures. This pushes the total up to just over 65 percent of the budget.
The bottom line might be summarized this way: Entitlements, defined as the full
cost of both direct and taxcode benefits, amount to two thirds of the federal
spending over which government has some control.
A large part of the remaining third is defense spending. The cuts now scheduled
will help, but alone they are clearly insufficient. Consider that even
eliminating the entire blaring Corps would not defray the annual cost of
military pensions. In fact, even if the Department of Defense were abolished
and all the armed forces disbanded, the U.S. Treasury would still not be able
to pay this year's bills without borrowing. As for the small corner of the
budget still dedicated to "discretionary" civilian projects--everything from
running parks, regulating polluters, and sheltering runaway children to
building highways, testing superconductors, and arresting drug traffickers--as
a share of GNP that corner has been smaller since the late 1980s than at any
other time since the late 1950s. It is unlikely that Americans could achieve
major savings in this catchall budget area without curtailing some of the vital
core services they expect from government. Most policy discussions instead
favor more of this type of spending, which no doubt would already be larger
today were it not perpetually crowded out by the metastasizing of universal
Another question, still sometimes heard in post-Reagan America, is "Why reform
entitlements or even worry about the deficit when we can always just raise
taxes?" But the answer is clear enough: The revenue option won't work because
it won't happen. One can find many polls showing that most Americans favor the
concept of a means test for benefits. But one cannot find any poll showing that
more than a small minority of Americans favor a large, general-purpose tax
This anti-tax sentiment is linked to widespread cynicism about government,
especially the federal government, which should make many liberals think twice
before dismissing entitlement reform. Quite simply, those who want more taxes
and bigger budgets must first demonstrate that government can apply commonsense
priorities to the money it is already spending. Anyone waiting for public
attitudes to change spontaneously should take a closer look at America's rising
generation of voters under thirty--not just at their Republican sympathies,
which incline them against taxes anyway, but at their intense distrust of
unkeepable promises, breakable chain letters, and crocodile tears. What the
typical new voter most distrusts, in short, is just the sort of rhetoric that
still enshrouds our welfare state.
Each decade since the first New Deal, from the 1930s through the 1980s,
entitlement spending has grown faster than the economy. Under our current
system it is certain to do so in future decades as well, especially once the
oldest members of the enormous postwar Baby Boom generation begin reaching
retirement age, just sixteen years from now. Today more than 60 percent of all
federal benefit spending flows to the 12 percent of Americans who are age
sixty-five or older. As long as the welfare state allocates most benefits on
the basis of seniority alone, the cost will grow geometrically as the size of
the elderly population increases. In combination with the aging of the
population, improvements in medical technology will likely cause per capita
health care costs to continue growing several times as fast as per-worker
Demographic data easily numb the mind, but one can gain an intuitive sense of
what all this means for government spending by considering just how favorable
demographic trends have been for the United States in recent years. During the
1980s the 76 million members of the Baby Boom generation moved into their prime
productive years--old enough to have mastered job skills but too young to
retire. The result was an automatic surge in federal revenue--especially since
the women of this generation have been far more likely than their mothers to
work for wages, and therefore to contribute taxes.
Meanwhile, demographics have also been favorable to the spending side of the
budget. The growth rate of the retirement-age population has actually been
slowing down since the mid-1980s, owing to the declining birth rates of the
late 1920s. Yet the United States is still running enormous budget deficits.
What will happen when these favorable demographic trends turn into unfavorable
trends, beginning around 2010?
Since 1960, federal benefit outlays alone have grown from roughly five percent
to 12 percent of GNP. No one knows, of course, what the future may bring. But
if one adopts the economic, demographic, and medical assumptions used by the
Social Security Administration and the Health Care Financing Administration.
the total cost will rise much further over the next fifty years, perhaps to 71
percent of GNP (best case) or to 30 percent of GNP (most plausible case). And
this assumes not a single new program or eligibility provision. Outlays of this
magnitude would threaten to crowd out not only all forms of public and private
investment but also any hope that government might respond to new social needs.
Ultimately, even huge tax hikes would merely cover the growing cost of programs
whose original intentions had long been forgotten.
Well before we reach such nightmare fiscal scenarios, moreover, the income
inequity of the U.S. welfare state will become painfully obvious. Look ahead to
the year 2000, when today's unusually affluent Americans in their fifties begin
to retire. This is a cohort of lifelong upward mobility whose average household
wealth in retirement (according to the economists Frank Levy and Richard
Michel) is likely to exceed that of all living Americans born either before or
after them. Then consider the position of today's young adults-- handicapped by
unstable family backgrounds, an inferior education, and stagnating entry-level
wages. By the year 2000, while raising families amid growing talk of yet
another hike in the payroll tax, they will cast searching eyes at the abundance
of their elders. In her recent book Social Insecurity the former Social
Security commissioner Dorcas Hardy does not hesitate to link the issues of age,
income, and race. "As we move into the next century," she asks, "will the
minorities of this country--immigrants and otherwise-- come to see the Social
Security system as a mechanism by which the government robs their children of a
better future, in order to support a group of elderly white people in a
retirement that is both too luxurious and too long?"
Take it from someone who once ran the system: the entitlement crisis is not
about to go away if we just ignore it.
A Comprehensive Reform
Overhauling the O.S. welfare state so that it serves our national goals will
entail enormous changes, most likely including a wholesale restructuring of the
U.S. health care system. But in the meantime we Americans can make federal
entitlements much more equitable and free up the resources we need to cut our
fiscal deficits and boost our national savings, by acting on a simple if
far-reaching principle. The principle is that one's benefits should be
proportional to one's need--whether the subsidy comes in the form of health
insurance or a farm subsidy or a mortgage-interest deduction or a Social
How might such a principle be applied to the existing welfare state and how
much money would it save? Any reform package should satisfy the three most
common objections to a cost-control effort. First, it should not reduce the
income of any household that is anywhere near the poverty line. More precisely
the half of all U.S. households that report incomes over $30,000 should be
asked to bear nearly all the extra burden.
Second, any reform package should adjust benefits according to a graduated
scale, so that middle- and upper-income households do not become net losers
just because they happen to rise a few dollars above a certain threshold. Nor
should earning a high income become a disqualification for receiving any
subsidy. To preserve the universal character of our major entitlement programs,
members of every household, regardless of income, should still stand to gain
some benefits, albeit in proportion to their needs.
Third, any comprehensive reform must take into account the quasi-contractual
nature of at least some entitlement programs. This last proviso is the toughest
to accommodate, but not as tough as is sometimes thought.
Strongly rooted in American political folklore, for example, is the idea that
Social Security recipients are only "getting their money back," that Social
Security is an "inviolable contract," and so forth. But such claims have no
financial or even legal basis, however much certain politicians and interest
groups may claim otherwise. True enough, the original Social Security Act of
1935 included a "money back" guarantee (with some interest) on all employee
contributions, and called for benefit levels to be calculated on the basis of
the lifetime covered wages earned by each individual. But the guarantee was
eliminated by Congress in 1939, and the link between benefit levels and years
of participation, after being weakened in 1939, was entirely discarded in
Ever since, the U.S. Supreme Court has repeatedly ruled that no covered worker
retains any right, contractual or otherwise, over taxes paid into the system.
In fact, the Social Security Administration keeps no direct records of how much
each person contributes. It just keeps records of each person's wage history,
to which a politically determined benefit formula is applied when that person
retires. Today's retirees, as it happens, receive benefits north two to ten
times what they would have earned had they invested all their lifetime Social
Security taxes (both their own and their employer's) in Treasury bonds.
Meanwhile, largely because of the very steep increases in Social Security taxes
in recent years. most economists agree that under current law Social Security
will not offer large categories of younger participants anything approaching a
fair market return on what they paid into the system.
So there is no reason that Social Security benefits for the well-off cannot be
reduced if a majority of Americans decide that their collective resources
should be used for different purposes. The same is true for civil-service and
military pensions, although here the case is much stronger that an implied
contract exists between well-off pensioners and the government.
Before the 1970s federal employees worked for lower wages than their
counterparts in the private sector. One reason they did so was the expectation
of receiving government pensions far more generous than any offered by
private-sector employers. Even today, no private pension offers benefits at
such an early age, at such a high percentage of pay, with such lenient
provisions for disability, or with such generous indexing. Moreover, because
these government pension programs were never funded on an actuarially sound
basis, current taxpayers are now unjustly stuck with a huge tab for yesterday's
Still, these benefits are part of the compensation that was promised at the
time--a distinction that makes a moral if not a legal difference and ought to
limit benefit reductions even to the most affluent federal pensioner.
Applying our simple principle would not require a big new bureaucracy. All
means-testing could be achieved exclusively through tax returns, much as we now
handle the limited taxation of Social Security for households with adjusted
gross incomes over $25,000. Each filer would be required to enter all benefits
received, which could be checked against federal records. Above certain limits
the total would trigger a "benefit-withholding" liability, which the filer
would send back to the IRS along with any outstanding income-tax liability. As
a practical matter, federal benefits could be withheld just as wages are
withheld, based on a tax filer's previous experience.
How would benefit-withholding rates be set? Here are a few illustrative
options, with estimates of how much money they would have saved in calendar
year 1991 alone. For all cash and in-kind entitlement programs except federal
employee pension plans: Withhold 7.5 percent of any benefits that cause total
household income to exceed $30,000, and withhold an additional five percent at
the margin for each additional $10,000 in household income. The maximum
reduction of benefits would be 85 percent, applicable to households with
incomes of $190,000 or more. Total savings: $33.5 billion.
For civil-service and military pensions: Same as above, but with a much lower
maximum withholding rate, in deference to the quasi-contractual nature of these
benefits. The maximum reduction of benefits would be 25 percent, for households
earning $70,000 a year or more. Total savings: $7.6 billion.
For all major entitlement benefits conveyed through the tax code except benefit
exclusions: Limit the amount of such tax expenditures received by upper income
households to the average expenditure per household within the $30,000 to
$50,000 bracket. In 1991, for example, this would have limited the total
allowable mortgage interest deduction to roughly $2,500. Total savings: $34.7
For benefit tax exclusions: Get rid of all income thresholds and make Social
Security just as taxable as any other cash income--except for 15 percent of pro
reform benefits. This untouched residual will offer, to even the wealthiest of
today's retirees, at least a five percent tax-free return on all contributions
they have personally paid into the system. Also, for households with incomes
from $30,000 to $50,000, phase out half of the tax exclusion on the insurance
value of Medicare (net of Medicare Part B premiums). Total savings: $16.9
Altogether, these provisions, if they had been in place in 1991, would have
freed up $93 billion in the federal budget. To be sure, no one would advocate
instituting all of them in one year, especially in a bad recession year. But
imagine that they were phased in over four years--starting, say, in 1993.
Assuming that income brackets were adjusted for inflation, and using official
budget and revenue projections, total annual savings would rise to $149 billion
by 1996. That would be enough to ensure that the next recovery is a genuine
investment-led expansion, not another borrow-and-consume bacchanalia.
The budget savings could be considerably higher. The figures noted here reflect
only about 80 percent of all federal entitlements and tax expenditures, those
for which income distributions are known. The extra 20 percent included, total
budget savings in 1996 could rise to more than $186 billion. Furthermore,
trimming subsidies to the affluent reduces their incentive to take advantage of
available benefits. Thus, to the extent that it would prompt middle- and
upper-income Americans to forgo benefits altogether--for example, by retiring
later, or by opting for less tax-sheltered health insurance and housing--the
measure would clearly save taxpayers more than the amount a static calculation
Because all the savings would be collected through the tax code, a single piece
of legislation, falling under the jurisdiction of the tax committee in each
house, would be sufficient to implement the reform. Imagine doing the same job
by amending every benefits statute: the process would snake through dozens of
committees, grind on for years if not decades, and ultimately be undone by
This approach also has the virtue of treating all Americans fairly, according
to their individual circumstances, unlike most other reform proposals--for
example, limiting all cost-of-living adjustments (COLAs). Even a COLA freeze
that discriminated against large monthly benefits would lead to obvious
inequities. For a widow receiving no income other than one large Social
Security check, a COLA may be essential to keep food on the table. For a
triple-dipping federal pensioner receiving the minimum Social Security benefit,
that same COLA may be just enough to cover the annual rise in greens fees at
the club. An income-based approach takes account of the difference. Unlike most
government agencies, moreover, the Internal Revenue Service is well trained in
tracking dollars no matter how far they Gavel. Even the farm subsidy that
filters down through five partnerships before appearing as personal income will
have to show up, earmarked, on someone's Form 1040.
Politically, this approach balances the sacrifices asked of elderly and
working-age Americans, without raising tax rates and without burdening the poor
or even most of the middle class. Moreover, the plan would reduce specific
programs in rough proportion to their overall size in the budget. Roughly half
the savings would come from Social Security and Medicare and the related
taxation of benefits. An additional 40 percent would come from other programs
and tax expenditures, especially employer paid health care and mortgage
interest. Another eight to nine percent would come from federal pensions.
Would such a reform in and of itself constitute another New Deal? Hardly. The
measures it would comprise are, however, the essential preconditions for the
next New Deal. Without them the United States will simply see more and more of
its options as a nation crowded out by the compounding costs of our subsidies
to the well-off.
As always, every area of federal spending should be scrutinized. Missionless
bombers must be cut. Porkbarrel waterways must be eliminated. Welfare programs
targeting the poor must undergo further changes, to require the able-bodied to
work and to reduce the cycle of dependency. But none of these areas is where
the big money is, and it is not by reforming them that the United States will
free up the resources it needs to build a more just and productive society in
the next century.
Whatever one's vision of that new society--whether it includes a national
health service or means-tested health vouchers, a negative income tax or a 15
percent flat tax, green cars running on hydrogen or mag-lev trains humming from
city to city--to get something new, one must give up something old. A society
that cannot find the resources to pay for sixty-cent tuberculosis vaccinations
for ten-year-olds must ask itself why it is offering subsidized health care and
housing to millionaires. Call it a rendezvous with destiny.
Copyright © 1992 by Neil Howe and Phillip Longman. All rights reserved.