William Niskanen, chairman of the Cato Institute, recently delivered the fourth annual John W. Pope Lecture in Raleigh. He also discussed entitlement reform with Mitch Kokai for Carolina Journal Radio. (Click here to find a station near you or to learn about the weekly CJ Radio podcast.)
Kokai: The federal government has made trillions of dollars worth of promises to the American people in the form of Social Security and Medicare, but our next guest says he’s confident those promises will be broken at some point. First of all, that was a key theme that was brought out [in your lecture], that we’ve made all of these promises to people across the United States, and there’s just no way that those promises are going to be kept. Why?
Niskanen: Well, because the taxes that are necessary to pay for these promises in the future I think will not be supported by the American people. And these promises have huge debts. Social Security itself may be a debt of like $12 trillion to $13 trillion. That’s roughly equal to all of the output of the United States in a given year. And the debt for Medicare is on the order of $65 trillion. That’s on the order of five years of total output in the United States to meet that. It would take an increase in our tax rates of maybe 10 percentage points or more of Gross National Product to pay these debts. And I think that the American people and the American political system ultimately will not pay these debts. These two programs, in effect, are Ponzi schemes, in a sense that it is easy to make the promises to the current generation, that as long as the future generations are going to be willing to pay for it. And I think that that’s — it is not a sustainable situation.
Now, so I think that the promises will be broken. But I think that there are intelligent ways to do it, as distinct from just saying, “I’m sorry, you’re on your own.” I think that, for Social Security, the primary way that we ought to change the promises is to increase the age for full retirement benefits, to reflect the fact that Americans are living a great deal longer than they were when this program was established. Americans, importantly, are younger longer. They’re not older longer. They’re younger longer. And they ought to be staying in the labor force until they’re 75 or so.
Kokai: You say as a 75-year-old.
Niskanen: Yeah, tomorrow I will be 75 years old, and I have no plans whatsoever to retire. I told my staff several years ago that I will retire only under one of two conditions. One is if I’m bored, in which case I’ll tell them — or second is if I’m boring, in which case I expect them to tell me. But, otherwise, I have no plans to retire. I’m healthy and active. And that is the case of a lot of people.
I think one of the really tragic things that’s happening in American life these days is quite healthy, vital people retire and then are bored themselves with retirement because their life, in many ways, has been defined by their job. And so they figure out a way to get back into the labor force. We still have rules, both government rules and business rules, that I think discourage that. Typically, a business will not keep anybody on their board, the corporate board, after age 70. There are an awful lot of [people] out there in the United States who could serve well on corporate boards after the age of 70. And the age 65 for Social Security was originally set by Chancellor Bismarck in Prussia, at a time when few people lived that long, and of those who did, they only lived a few years longer.
So, I think the best way to change the premises on Social Security are two ways. One is to increase the age for full retirement benefits, maybe by say one year every 12 years, or one month a year, indefinitely, because people are living longer and will continue to live longer. The second, I think, is that we can change the indexing formula for Social Security. It is now indexed to current wages, which are growing faster than prices. And if we change the indexing formula from wages to prices, that will maintain the real benefits that people have been promised, but not the relative benefits, compared to people who are continuing to work. And I think those are the ways that are most acceptable to changing the promises that are made to Social Security people.
The other, for Medicare, is a more complex issue. The prices of medical goods and services increase very rapidly. And we clearly can’t sustain the kind of expenditures we have for Medicare. And I think the best way to do that is to have an income-tested deductible for Medicare payments, in which you can only — you pay an amount on your own up to a deductible, and then the Medicare payments come in only after the deductible is exhausted.
We do have a suggestion for what that deductible might be already in our tax code, in that we now can deduct from our taxes all medical expenses, over 7.5 percent of our adjusted gross income. I don’t know whether that’s the right number or not, but it’s that sort of thing in which wealthy people then would have a higher deductible than poor people. And it would be not much, if any, an increase in the burden for poor people, and rich people can afford it. Otherwise, the expense of this all gets transferred to our young people: our children and our grandchildren.
Kokai: I wanted to get back to the tax issue with you because you mentioned at the outset that the American people are just not going to accept the level of taxation [necessary to pay for entitlements]. We’re not talking about an extra 1 percent, an extra 2 percent. Major changes would be needed to pay for these things.
Niskanen: It would take, I think, an increase in our average tax burden, which is now about 30 percent of adjusted gross income, to 40 percent or 45 percent to make these two promises. And that, I think, would be both unacceptable, from the point of view of the taxpayer, and would have very severe consequences on the US economy.
Kokai: One of the things you pointed out in this John W. Pope lecture in Raleigh was the idea that the last tax dollar assessed takes out about $2.75 from the economy. If you can briefly explain that to us.
Niskanen: Well, it takes out a dollar for the amount of taxes that are raised. And the difference between a dollar and $2.75 is the reduction in pre-tax output and income that is a consequence of higher tax rates. Tax rates have a large, severe, adverse effect on the output of the economy. That operates through a reduction of work effort. Hours worked per person drop. Some people drop out of the labor force. And it has an even larger effect on productivity. Taxes severely distort the allocation of labor and capital and the division of efforts among different types of products and goods and services and so forth. And so the total cost to the economy of government spending that is financed by taxes is more than the taxes itself. It is the taxes plus the effect on the economy, which is quite large and significant and negative.
Kokai: And if we tried to raise the rates beyond where they are now, this effect gets even higher, greater, doesn’t it?
Niskanen: Yes, that’s right, in a sense that the adverse effects on the economy are a function of the level of the rates and conditions in the economy, which relate the amount of economic output to the level of the rates.