How We Can Keep From Going Broke

John C. Goodman

3/17/2012 12:01:00 AM - John C. Goodman

Social Security, Medicare, Medicaid and other social insurance programs are bankrupting America. They will produce ever-escalating deficits for as far as the eye can see.

So what can we do about it? All we hear out of Washington are "eat-your-spinach" solutions — both from Democrats and Republicans. These involve cutting benefits, forcing doctors to ration health care, etc. Naturally, the beneficiaries resist such change.

My colleagues and I at the National Center for Policy Analysis have been thinking about a different approach. Reform of entitlement programs should be a win-win proposition. That is, it should be good for the individual who agrees to accept fewer government benefits as well as for the taxpayers.

Here is part of the idea. People of any age should have the choice to opt out of social insurance in favor of alternatives that better meet their individual and family needs. In particular, they should be able to substitute assets and arrangements they have voluntarily chosen, and that they own and control, for the government systems they are now forced to be part of. In particular:

• People should be able to substitute private savings, private pensions and annuities, and private insurance for participation in Social Security.

• They should be able to substitute private insurance and private health savings for participation in Medicare and for participation in the federalized health care system sometimes called ObamaCare.

• They should be able to substitute private disability insurance for participation in the federal disability program.

• They should be able to substitute private savings, private pensions and annuities, and private insurance for participation in Medicaid’s long-term care insurance.

• At their place of work, employees and their employers should be free to choose private unemployment insurance arrangements, private disability insurance and private alternatives to workers’ compensation.

There is only one general condition that must govern these choices: They must not increase the expected burden for other taxpayers. This means (1) there must be a reasonable expectation that the direct tax burden for others will not rise as a result of an individual’s opting out and (2) there must be a reasonable expectation that the individual will not try to return to the government program (thus creating an additional burden for everyone else) if the private option turns out to be disappointing.

How is it possible to enact reforms that make everybody better off?

Here is one way. When the Social Security and Medicare Trustees calculate the unfunded liabilities in those two programs, they discount future taxes and future benefits at a rate of interest equal to the federal government's long-term borrowing rate. Historically that has been about 3 percent. But when individuals borrow, they typically pay a much higher rate. Some people, for example, are paying double-digit rates on their credit card debt. If individuals evaluate Social Security's promised benefits at a higher discount rate than the government (on behalf of taxpayers) uses, then they will place a lower value on those benefits.

Take a man who has just reached the retirement age and has a life expectancy of about 20 more years. If he evaluates his expected Social Security benefits using a discount rate of, say, 6 percent, he will value a 20-year stream of expected benefits at about 60 percent of the cost to the government. If the retiree's discount rate is 9 percent, he will value the benefits at only one-third of its cost to the government.

Continuing with that last example, let's say the government offers the retiree a lump sum, upfront cash payment equal to half the present value of his expected future benefits (evaluated at a 3 percent real rate of interest). Since the offered sum is substantially more than the value the retiree places on the income stream it will replace (evaluated at 9 percent), the retiree is much better off. And the government will have cut its liability in half!

This is only one of a number of ways we have identified in which win-win changes are possible. Yet if people agree to take less from the government, what will the private alternative be?

More than 21 million workers have a defined-benefit pension plan and 46 million are building retirement assets in IRA, 401(k), 403(b) and other defined-contribution accounts. In addition to private employer-sponsored plans, many workers can look forward to a military pension or other government retirement benefits. About 27 million workers have a promise of post-retirement health care benefits from an employer and millions of veterans will have access to VA health care benefits. All of these programs can potentially substitute for promises made under Social Security and Medicare.

Take the 44 million workers who have private pension plans insured by the federal Pension Benefit Guarantee Corporation (PGBC). The assets of these plans are invested in stocks and bonds and other assets. However, should the investments fail to pan out or (a much greater risk) should the employers who sponsor these plans go bankrupt and become unable to keep making the required contributions, the PGBC promises a minimum benefit to the retirees. Could this minimum benefit serve as an acceptable substitute for whatever we hope to accomplish through Social Security? If the answer is yes, then we should consider making a lump sum payment to these workers today in return for their agreement to forgo Social Security benefits in the future. Alternatively, we could consider a permanent reduction in their payroll tax rates.

Could health care coverage from the Veteran’s Health Administration serve as an acceptable substitute for the minimum health insurance we want people to have under Medicare? Would an annuity from a major financial institution or a promise of pension or health care benefits from a state or local government count as acceptable alternatives? Again, if the answer is yes, then we could consider making these workers a financial offer to buy them out of their right to receive some or all of their Social Security and Medicare benefits.

What about private savings? If they are to serve as acceptable substitutes there would probably have to be some assurance that the funds would not be squandered or gambled away. Part of the requirement might be that the funds be held by reputable financial institutions and that they be managed according to prudent investment rules. There would also have to be rules governing the rate of withdrawal during the retirement years and a general prohibition against putting the asset up as collateral for loans or other indebtedness.

All of this is doable, however, if only Congress decides it is time to act.