That’s the assessment of AEI resident fellow James Capretta, who indicates that the reckoning will mean big changes for mandatory entitlement programs whose spending has been running on autopilot for years, such as Social Security, Medicare, and Medicaid, which together represent the majority of future federal spending.

Spending, Capretta argues, will become even more difficult to sustain because of the mountain of debt the U.S. government has been accumulating to fund economic relief from the coronavirus pandemic and related government policies responses.

... forecasts of rising debt over the long run can effect economic performance even before the problem is on the doorstep. The U.S. is still viewed internationally as having the strongest economy, and the dollar is the world’s reserve currency. But perceptions can change, and will, if the U.S. remains on course to run up debt in excess of 200 percent of GDP, which is now a real possibility. Countries get into trouble when they struggle to extract sufficient revenue from their citizens to cover current obligations and service accumulated debt. The U.S. is not at that point, but could be soon. CBO estimates debt at 150 percent of GDP would necessitate net interest payments equal to 7.2 percent of GDP in 2050. These payments would come at the expense of the immediate needs of voters, and would benefit many foreign holders of Treasury debt instruments.

Capretta lists five steps that the U.S. government could take to close its wide budget gap, steps he believes could be phased in gently to put entitlement spending on a more sustainable path without greatly disrupting the lives of Americans who depend on these programs.

1. Automatically index the age for Americans to receive full Social Security retirement benefits, to stabilize the ratio of retirees to workers.
2. Progressively adjust Social Security benefits, by increasing the amount Americans with the lowest lifetime incomes receive and reducing the amount Americans with the highest lifetime incomes receive.
3. Establish personal retirement accounts for Social Security beneficiaries, to improve the solvency of the program by partially offsetting the amount of money that would otherwise have to be paid to retirees from taxes paid by working Americans.
4. Index the amount of Medicare premium support to the average cost of all competitive Medicare plan options, which the program’s beneficiaries can then use to pay toward the full cost of the coverage they choose each year.
5. Enroll Americans who are eligible for both the Medicare and Medicaid programs into a mandatory managed care program.

The last item is especially attractive because a disproportionate share of Americans killed by COVID-19 contracted the coronavirus in nursing homes, which house millions of Americans who qualify for both Medicare and Medicaid. Capretta argues that an effective managed care program would minimize the need for the expensive nursing home stays.

If that reform had been in place before 2020, these programs would be more fiscally sustainable and dually eligible Medicaid and Medicare beneficiaries would be getting better care. Moreover, fewer Americans would have been at put at risk of dying from COVID-19 because they wouldn’t have required longer stays in nursing homes.

Done right, reforms such as Capretta’s can both save lives and repair the U.S. government’s deteriorating fiscal situation.

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After years of promises by politicians—who, like public employees themselves, have done little to provide funds to pay for the generous retirement benefits—many public employee pension funds are now at increased risk of insolvency as the economy faces turmoil from the coronavirus lockdowns.

This long-festering problem has become so bad that some pension analysts think that several large public employee pension funds will become insolvent by 2028, if not sooner.

The Financial Times reported recently on the findings of Jean-Pierre Aubry at Boston College’s Center for Retirement Research (CRR), who singled out two large public employee pension funds with hundreds of thousands of members as being particularly at risk of insolvency, unable to pay the pensions promised to their members because they haven’t been putting enough money into them for years:

More than 320,000 members of the New Jersey Teachers and Chicago Municipal public pension plans face the biggest risks as severe cash outflows are draining the assets of these two schemes.

A slow recovery for the US stock market could result in Chicago Municipal’s funded position falling from 21 per cent this year to just 3.6 per cent by 2025. This would eave assets to cover just three months of the fund’s retirement payments, according to CRR’s analysis.

New Jersey Teachers is also burning through cash, with its funded position projected to decline from 39.2 per cent to 23.2 per cent over the next five years. By that time, New Jersey Teachers would have assets to cover 19 months of retirement payments.

That fate will come despite the intervention of central banks, who flooded markets with funds specifically to avoid pension losses.

The Organization for Economic Co-operation and Development (OECD) recently published a report showing how pension funds in OECD countries recorded a massive loss of approximately $2.5 trillion during the stock market meltdown in February through late March. Shortly, after that, central banks intervened with monetary cannons to rescue stock markets and other financial assets to avoid pension returns from going negative.

Although the stock market has since gone on to a remarkable recovery, thus limiting the damage that pension investments in stocks may realize, the economic damage from the lockdowns will weaken state and local government’s ability to fund public employee pension funds through their constriction of ordinary commerce.

There are three potential ways to solve this problem. First, the politicians and public employees could face up to reality and acknowledge their failures to fund their retirement benefits by cutting their promised benefits to sustainable levels.

Second, politicians and public employees could demand that taxpayers in their states and districts bail them out by paying higher taxes so the public employees can keep their generous pension benefits.

Third, the politicians and public employees could demand the federal government bail them out, which would require the government taking on trillions of dollars more in debt, on top of the trillions it has already racked up this year alone, following the economic damage caused by the shutdowns of so much of the U.S. economy in response to the coronavirus pandemic. Shutdowns of businesses that were ordered by state and local government politicians, who so clumsily implemented them, they were far more damaging than they needed to be.

Which of these options do you think state and local politicians and public employees will pursue to benefit their interests?

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While economists point to “sticky wages” that limit labor market adjustments in bad times, compensation packages can only remain sticky for so long. Not only have there been lay-offs in many cities, but now there are also pay cuts. Voters and leaders in other cities have noticed.

The latest California developments are auspicious and a clear departure from politics as usual. Most politicians have short time horizons. Always-looming elections tempt them to be generous with supporters and constituents; they are prone to invoking rosy scenario budgets that seemingly make it all work. And they have been able to get around the constraints imposed by budgets and borrowing restrictions by making commitments to city workers in terms of promised (but usually underfunded) pension benefits. The formal research corroborates this view. Chris Edwards has published a study (2010) which shows that public sector unions push up public sector labor compensation costs by eight percent on average. He argues that California is above average. In a recently published academic paper, U.S. Bureau of Labor Statistics economists Maury Gittleman and Brooks Pierce ask “Are state and local government workers overcompensated?” The authors acknowledge the complexities of the apples-vs.-oranges comparisons and work to overcome them. They find that, “After controlling for skill differences and incorporating employer costs for benefits packages, we find that, on average, public sector workers in state governments have compensation costs 3-10 percent greater than those for workers in the private sector, while in local government the gap is 10-19 percent.” John Matsusaka (2007) has found that, “When public employees are allowed to bargain collectively, wages are about 18 percent higher.”

Like most people, investors experience mood swings. They can be too sanguine in good times and too pessimistic in bad times. This accentuates the boom-bust cycles that markets experience. But the same happens in the public sector. Politicians see revenues grow and are happy to fund questionable programs and projects.

The boom-bust now being experienced here and abroad will some day sort itself out. But what then? Will local governments fall into the old trap of making foolish commitments to favored constituencies in good times? Or will voters as well as elected officials be a little chastened?

Size and scope have to be re-thought. Anything that can be metered can be privatized. Modern technologies make metering easier than ever. (The UCLA faculty senate recently voted to privatize that school’s MBA program.) This is the worst time to discourage private efforts in infrastructure or in social services. Over the past decade, California-based foundations gave away $6 billion—in spite of two recessions. There are many wealthy and generous people in California. Peter Diamandis and Steven Kotler (in their recent book) report a quadrupling of active foundations in the U.S. over the last twenty years. Philanthropists should consider social services innovations prizes, perhaps modeled on the X-Prize for scientific innovations. Charles Murray manages to end his doleful analysis in Coming Apart on an optimistic note, citing Nobelist Robert Fogel’s The Fourth Great Awakening (2000) which includes the rise of philanthropy in America geared to promoting equality of opportunity.

These trends point the way to a re-evaluation of state and local government size and scope. There are ways to separate various infrastructure and social services from politics.

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ODE TO THE WELFARE STATE

Mr. Truman’s St. Paul, Minn., pie-for-everybody speech last night reminded us that, at the tail-end of the recent session of Congress, Republican Clarence J. Brown (R-Ohio) jammed into the Congressional Record the following poem, describing its author only as a “prominent Democrat of the State of Georgia”:

Democratic Dialog

Father, must I go to work?
No, my lucky son.
We’re living now on Easy Street
On dough from Washington.

We’ve left it up to Uncle Sam,
So don’t get exercised.
Nobody has to give a damn—
We’ve all been subsidized.

But if Sam treats us all so well
And feeds us milk and honey,
Please, daddy, tell me what the hell
He’s going to use for money.

Don’t worry, bub, there’s not a hitch
In this here noble plan—
He simply soaks the filthy rich
And helps the common man.

But, father, won’t there come a time
When they run out of cash
And we have left them not a dime
When things will go to smash?

My faith in you is shrinking, son,
You nosy little brat;
You do too damn much thinking, son,
To be a Democrat.

With a fiscal train wreck looming ahead for Americans, will Republicans, Democrats and Independents today seek ways to dismantle the welfare state?

For all those seeking real change, please see the following for insights and superb holiday gifts:

Financing Failure: A Century of Bailouts, by Vern McKinley

Beyond Politics: The Roots of Government Failure, by Randy T. Simmons, foreword by Gordon Tullock

Against Leviathan: Government Power and a Free Society, by Robert Higgs

The Voluntary City: Choice, Community, and Civil Society, edited by David T. Beito, Peter Gordon, and Alexander T. Tabarrok; foreword by Paul Johnson

Out of Work: Unemployment and Government in Twentieth-Century America, by Richard K. Vedder and Lowell E. Gallaway; foreword by Martin Bronfenbrenner

Crisis and Leviathan: Critical Episodes in the Growth of American Government, by Robert Higgs; foreword by Arthur A. Ekirch, Jr.

HT: Gary Theroux

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