PROJECT SYNDICATE – A Future-Oriented US Fiscal Policy

Glenn Hubbard Project SyndicateAt last, Republican candidates in the US presidential campaign have begun focusing on the economy.
At a time of rising anxiety among middle-income voters about wealth inequality, and growing awareness of the unsustainability of Social Security and Medicare, this conversation could not be more important. Unfortunately, not enough attention is being paid to the link between these two key issues.
In fact, tackling the problems with Social Security and Medicare is the key to addressing what ails the middle class. But fiscal-policy progressives, in particular, remain fixated on using higher tax rates on the wealthy to fund higher incomes for everyone else.
Income redistribution may be an attractive idea for some – including, to a lesser extent, the Republicans who support a watered-down version, in which relatively high marginal tax rates support expanded family assistance – but it is fool’s gold. As a recent Brookings Institution paper shows, higher marginal tax rates would do little to diminish income inequality in the US.
Likewise, higher taxes cannot resolve the problem posed by the mounting unfunded liabilities of Social Security and Medicare. Maintaining these programs in their current form would require growth-destroying tax increases on middle-income Americans, as well as continuing cuts in government funding for defense, education, and research.
There is only one way to ensure broadly shared prosperity in the US: a future-oriented fiscal policy aimed at boosting employment and productivity, maintaining low marginal tax rates, strengthening support for workers, and investing in education, innovation, and infrastructure. The alternative – allowing the past, in the form of interest payments on the national debt and entitlement spending, to continue dictating fiscal policy – would block prosperity among middle-income households, by requiring continuous tax increases and reduced public investment.
To fund this future-oriented policy, US leaders must implement reforms that enhance the long-run viability of the social safety net. As it stands, Social Security and Medicare are unsustainable, with the long-term gap between projected income and promised benefits reaching tens of trillions of dollars – well in excess of the official debt the federal government has accumulated over its history.
Closing the gap with tax hikes – the burden of which would be borne largely by middle-income households – would threaten both economic growth and living standards. And offsetting spending cuts provides no safety valve. Health care and Social Security already consume half of the US federal budget, up from one-sixth in 1965, and these outlays relative to GDP are projected to more than double by 2040. With no change in course, the programs’ “trust fund” balances will be depleted by the 2030s.
Avoiding that outcome will require US political leaders to constrain the growth of entitlement spending and bolster support for middle-income individuals. While Social Security and Medicare remain important to ensure wellbeing in retirement, their role must be updated to suit today’s needs.
For example, to ensure that no one who has worked for 30 or more years will live in poverty in old age, Social Security needs a higher minimum benefit for lower-income workers, with more affluent seniors seeing less growth in benefits over time. Adopting the chained consumer-price index for federal benefit calculations would ensure that benefits more accurately represent inflation, while slowing the rate of benefit growth for individuals.
Beyond stabilizing Social Security’s finances, US leaders should implement policies that place a higher value on work. Seniors working past the retirement age of 67 should not be subject to the payroll tax, and the retirement earnings test should be eliminated, so that seniors can work full-time without losing out on Social Security benefits. Finally, incentives for private retirement saving should be expanded.
A similarly honest and modern approach can also secure Medicare, without large tax increases on middle-income Americans. For starters, bipartisan proposals for premium support, with seniors receiving subsidies to purchase private health insurance, should be implemented.
To enable individuals to prepare to cover the associated deductibles and copayments, health savings accounts – funds which are not subject to income tax at the time of deposit, and can be used tax-free at any time to cover qualified medical expenses – should be expanded and strengthened. Premium support can significantly reduce Medicare spending, as it establishes a framework for more efficient spending on benefits, driven by competition and innovation in care and coverage.
So far, the only US presidential candidate who has recognized the need for such a future-oriented approach is former Florida Governor Jeb Bush, who has proposed modernizing reforms of Social Security and Medicare that avoid imposing high costs on middle-income Americans and a heavier debt burden on future generations. Two other Republican candidates, Ohio Governor John Kasich and Florida Senator Marco Rubio, have also raised constructive reform ideas.
By contrast, former Secretary of State and Democratic candidate Hillary Clinton and a leading Republican contender, Donald Trump, have opposed reform of Social Security and Medicare. Senator Bernie Sanders, Clinton’s Democratic rival, actually proposes to expand the programs’ unfunded liabilities.
With so few presidential candidates recognizing the link between reforming Social Security and Medicare and ensuring broadly shared prosperity, the US faces serious risks. The progressive redistributive agenda could continue to advance, or the conservative entitlement-reform agenda could fail. Either way, the US would face growth-limiting tax increases and limits on the contributions that public investment can make to the country’s future.
There is a fiscal path to enhancing prosperity for middle-income Americans. It requires support for growth, rewards for work, investment in opportunity, and, unavoidably, reforms to Social Security and Medicare. One hopes that, as the campaign progresses, honest and forward-looking fiscal-policy debates recognizing this fundamental truth gain traction.
This op-ed appeared on on November 24, 2015