Middle Ground for Social Security and Medicare Reform

Three meaningful reform ideas worth sending to the lame ducks in Congress.
by | November 10, 2010

This is the sixth and final column in a six-month series on the topic of Social Security and Medicare reform.

When I began writing on this topic last July, President Obama had just appointed his bipartisan commission on fiscal responsibility. In that first column, I outlined a dozen options the commission could consider. That was before last week's election, which featured the Republican sweep in the House and the swelling popularity of Tea Party activists in many states. Now we have divided control of Congress, and what looks to be a deepening partisan chasm in Washington.

As Congress reconvenes in its lame-duck session, the Commission on Fiscal Responsibility is scheduled to issue its report at the end of this month. Some news reports suggest that the commission has been unable to achieve consensus on what to do about Social Security and Medicare. Only time will tell, as the commission maintained radio silence during the elections.

The lame-duck Congress will likely spend most of its energy fighting over taxes. Several important provisions will expire this year unless they act. For example, dividend and capital gains tax rates will revert to pre-Bush levels unless Congress intervenes, and that will drive Wall Street investors batty if only because of the uncertainty. Even if Congress follows the President's plan to increase those tax rates from 15 percent to 20 percent, that would be better than watching them jump to top bracket levels which would push even more wealthy investors offshore to tax havens. The estate tax is in limbo and heirs of billionaires will reap huge tax breaks if nothing is done before year-end. Likewise the alternative minimum tax will bite into middle-class families unless it's patched -- again. So Republicans and Democrats must come to the table sooner rather than later, or look even more foolish than their opponents' dirty campaign ads made them out to be.

Meanwhile, the odds are stacked against any kind of comprehensive solutions to Social Security and Medicare funding during the lame-duck session. Republicans have no incentive to cut a deal before the new Congress is installed, and some Democrat constituencies are opposed to genuine benefits reforms. However, fiscal Band-Aids are possible, which would allow departing members to do something positive for the country as their legacy.

Politically, President Obama needs to show Americans that he is capable of bipartisan leadership and put some muscle behind his rhetoric about long-term fiscal prudence. He can prod the Democrats now controlling the House to take actions in December that they can't achieve in 2011 when control shifts to the GOP.

As I look back on my original suggestions for Social Security and Medicare and take stock of the message from voters, it is pretty obvious that two of my ideas are dead on arrival for a lame-duck breakthough:

  • Democrats have railed around the idea of privatizing Social Security, and they can block any effort in the Senate to partially "personalize" Social Security accounts as I suggested in September.
  • A VAT to fund these programs is off the table with the Tea Party people. Although some Republicans would favor replacing the income tax with a consumption-based value-added tax, that isn't going to happen any time soon.

So, where does this leave us? Is there any hope that Congress can achieve any kind of meaningful reforms? Can we move Social Security and Medicare reform to the front burner before year-end?

We'll see what the fiscal reform commissioners come up with in their formal report, but I think there are three ideas still worth sending to the lame ducks in Congress:

Adjust the retirement age for longevity. For those born after 1960, the Social Security age is now 67. We don't need to touch anybody born earlier than that, but it still makes sense to incrementally increase the normal retirement age for those born later, to reflect ever-increasing longevity. Americans now live five years longer than they did 50 years ago, and it would be a fair fix to raise the retirement age by one year for each decade after 1960, so that those born after 1990 would receive full benefits at age 70. We can keep age 62 for an actuarially reduced benefit. It's hard to argue against this sensible and practical reform, which has powerful actuarial benefits. That said, the French took to the streets to strike over higher retirement ages. Let's hope that Americans understand that it's one of the practical necessities of a longer human life span.

Align Medicare with Social Security. Along that same line, we need to raise the eligibility age for Medicare benefits to align it with Social Security. This will require that Baby Boomers work another year or two before we become Medicare-eligible. That's a sacrifice most of us can make in order to assure solvency.

Cap and trade-off. No, I don't mean carbon taxes. Congress needs to cap Social Security benefits levels and inflation allowances, and trade-off a short-term job-creating payroll tax holiday for modest offsetting longer-term payroll tax increases. For example, freeze benefits with no inflation increases for two years. Then put a cap of $300 each year on Social Security cost-of-living increases and proportional curbs on the escalating benefits levels for the highest-paid workers. A cap on cost-of-living increases actually plays to Democratic values, as their lower-income constituents are protected while benefits for the upper crust are frozen.

On the tax side, Republicans and the Chamber of Commerce must accept a balanced bipartisan approach and authorize small annual increases in the payroll tax in exchange for winning a two-year waiver of employers' payroll taxes as an immediate jobs-stimulus measure. So the trade-off looks like this: To encourage new jobs, employers should pay no payroll taxes for new hires in 2011-12. Then, a year or two later, we can begin to raise payroll taxes fractionally (0.1 percent) each year subject to a maximum rate of 7.95 percent for employees and employers in 2016 or beyond. I would also suggest a "tax-trigger" that says these tiny tax increases cannot begin until the economy is growing by 3 percent annually. Congress gets to claim credit for jobs creation. At the same time, it can act like a grown-up on the longer-term revenue side. A payroll tax holiday would only dig us a deeper deficit, so it must be paid back later.

Most Republicans are genetically opposed to tax increases, but the payroll tax is among the most regressive: increases in payroll taxes actually hit workers harder than capitalists. The sooner Republican strategists acknowledge this, the faster we can solve the Social Security and Medicare deficits. Democrats can't complain if the result is fiscal sustainability in their most sacred entitlement programs, especially if Congress raises the taxable earnings cap from $106,800 to a higher level like $125,000. President Obama won't like raising taxes on the upper middle class, but he can't have his cake and eat it too with the new two-party Congress. It's time for everybody to make a deal before the anti-tax Tea Party conservatives are sworn in and stonewall any measures the Democrats would favor.

My view is that 7.95 percent is the natural limit for the payroll tax. Anything more and we'll begin to reach confiscatory levels for self-employed taxpayers who will be nearing a 16 percent tax plus their normal income taxes and state taxes. With 9 percent of the workforce unemployed and even more underemployed, the Democrats in Washington would be foolish to discourage entrepreneurialism with confiscatory taxes. Republicans have every right to hold their ground at that point and yield no more, unless it's a trade-off for partial privatization as described in my previous column on "Personal-izing" Social Security. That is too complex a deal for the lame-duck session, that's for sure.

Obviously, either party can block this deal. Republicans can stonewall the inevitable long-term tax increases and Democrats can refuse to change the retirement ages. But leaders in both parties know that sooner or later, these measures are unavoidable. They are kidding themselves to think that a lopsided partisan solution can ever clear a divided Congress.

These reforms alone will not solve the entire problem. We still need a bigger fix, which will require months of debate and partisan bargaining. But at least we can stop the creeping insolvency of these programs, while Congress works next year to achieve a long-term bipartisan solution that will require much harder choices.

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