The Economy in the 1980s

A Program for Growth Stability

Michael J. Boskin

• Publisher: Routledge
• Year: 2019
• ISBN:
  9781351318747
• Edition: 1
• Topic: Política y relaciones internacionales
• Subtopic: Política

In the decade of the 1970s the U.S. economy experienced its worst performance in four decades. Rising U.S. inflation and stagnant productivity growth were responsible for the worst economic performance of any Western country. The institute has published a number of studies on specific economic problems—on energy, planning, health care, tax reform, international trade, and other subjects. This is our first attempt to present an integrated view of the economy as a whole, looking back at serious problems experienced in the 1970s as part of fashioning a systematic statement of what reforms are necessary to restore to the U.S. economy the growth and stability of prior decades.

VII

Potential Policy Problems of the 1980s

10

LAURENCE J. KOTLIKOFF

Social Security and Welfare: What We Have, Want, and Can Afford¹

The U.S. income transfer system. Shortcomings in equitable distribution. Intergenerational transfers. The social security earnings test. Poverty perpetuated. Redesigning the social security system. Six proposed reforms. The Unified Welfare Tax System.

The dismal economic performance of the U.S. economy in the 1970s and the prospects for continued stagflation in the 1980s have created a climate of adversity and accusation. Consumers increasingly question the integrity of big business, business protests “excessive” environmental and consumer protection, workers accuse welfare recipients of fraud and indolence, the young are alarmed by their increasing social security tax payments to the old, and everyone is pointing his fìnger at the government. The general growth of government and the intrusion of government in the day-today workings of the private economy highlight the chorus of concerns. Welfare and social security systems are particular objects of intense public criticism.

The fact is that in the past twenty years government has grown relative to the size of the economy, but that growth has been primarily in the area of transfer programs. In 1960 total federal, state, and local government budgets represented 27 percent of the gross national product (GNP); today the figure is 32 percent.² This 18 percent growth in government expenditures relative to GNP in the last two decades does not, however, reflect an increase in the purchase of goods and services by governments. Indeed, the ratio to GNP of real government purchases of goods and services was 20 percent in 1960 and is still 20 percent today. The ratio of government transfer payments to GNP has, in contrast, doubled since 1920 from 5 to 10 percent (Economic Report of the President, 1980, pp. 203, 289, 290). Twenty cents of every dollar spent by governments in 1960 was a transfer payment; today 32 cents of every dollar of government expenditure represents a transfer payment. Government is not consuming a bigger chunk of the collective pie; rather, it is increasingly engaged in a process of collecting and redistributing the pie.

Virtually every American will be directly affected by the income transfer system during his lifetime. In 1979 over a third of the population directly received an income transfer from the federal government, whether in the form of social security benefits, Medicare, welfare benefits, food stamps, Medicaid, general assistance, unemployment insurance, veterans benefits, or disability benefits. The large and growing income transfer expenditures have necessitated substantial tax increases in the past twenty years. The social security tax in particular has emerged as the major source of federal revenue after the federal income tax. Over half of the nation’s income recipients now pay more social security taxes than income taxes, and social security taxes are still on the rise (Campbell 1977, p. xiii). Between 1978 and 1982 the real value of these taxes paid by middle-income Americans will rise by 50 percent (Kotlikoff 1978, p. 127), as much as $1,200 in 1979 dollars. Even these impressive tax increases are insufficient to finance the program through the first half of the twenty-first century. Because of dramatic changes in demographics, tax rates may have to increase by an additional 8 percent by the year 2025 to meet currently legislated benefits (Robertson 1978).

The enormous growth of income transfers has greatly alleviated poverty, but it has by no means eliminated poverty. Since 1960 the number of persons remaining in poverty after cash and in-kind transfers has been reduced by almost 11 million (U.S. Department of Health, Education, and Welfare 1980, p. 3). Yet 20 million Americans, roughly one in every ten, still live below the official poverty line. As with the welfare system, some but not all of the goals of the social security system have been met. Despite massive efforts to redistribute to the elderly through social security, the relative income position of the elderly is lower today than it was thirty years ago (Kotlikoff 1978, p. 139).

This chapter will provide an overview of the social security and welfare systems, indicate their accomplishments, point out serious problems in their structuring and financing, and suggest ideas for reform. The response to mounting pressure to reduce the size of government, or at least to retard its growth, need not mean abandonment of the reasonable humanitarian goals of these programs. Both the welfare and social security systems can and should be more efficiently designed. The welfare system is a bureaucratic nightmare. The social security system is much more efficiently organized, but is still engaged in activities that are both costly and have nothing to do with its reasonable purpose.

The chapter proceeds with a discussion of the general objectives of the income transfer system as well as of the problems inherent in meeting those objectives. Any cogent analysis of what we have and what we need must be predicated on a clear view of what we want. The social security system in particular has expanded enormously, partly because its goals have never been clearly articulated.

The following section turns to the issue of equity, to the long-standing and serious inequities in welfare and social security that need to be addressed. Some of these problems are well known; others are apparent only after a close examination of the complex provisions in the enabling legislation.

Labor supply is the next topic. Both the welfare and social security systems contain major work disincentives that reduce the nation’s supply of labor and thus total national output.

The final two sections focus in more detail on specific problems and reform ideas for social security and welfare. A number of different methods for resolving the long-term funding problems of social security are considered, as is also an alternative to our current welfare system, which I describe as the Unified Welfare Tax System, that incorporates many features of our current system as well as the negative income tax.

GENERAL OBJECTIVES OF THE INCOME TRANSFER SYSTEM

Income redistribution, paternalistic control of the economic choices of individuals, and the provision of insurance appear to be the major objectives of our income transfer system. The desire to redistribute income presumably arises from a sense that income inequality is largely capricious, beyond the control of individuals, arising from differences in native ability and in financial and nonfinancial inheritances. While society wishes to redistribute resources to those truly in need, the practical problem is to distinguish those who are truly unable to earn a decent living because of inherent low ability from those who are able.

The inability to distinguish target recipients from a larger pool means that a second-best redistribution mechanism must be applied that redistributes on the basis of characteristics that are closely, but not perfectly, correlated with true inability to earn a decent living. These characteristics include earnings and assets as well as more immutable features such as an individual’s state of health, age, sex, and the presence of small children. Viewed in this light, it is hardly surprising that our current welfare system is characterized by earnings and asset tests as well as by categorical coverage. These are clearly imperfect sorting mechanisms, but they are the best one can do, given incomplete information.

The decision to use a particular sorting criterion must balance the gains from better identification of the true target recipient group with the costs arising from the incentive of individuals to alter their behavior to meet the criterion. The welfare system, for instance, redistributes substantially more to “single mothers with children” than to poor married couples with children. “Single mothers with children” are truly needier than others, given male/female earnings differentials and the time required at home to raise children. But using this criterion has the effect of encouraging single females with children to remain single, and of encouraging married females with children to become single to increase their transfer incomes.

On these terms, some criteria will be judged too costly to justify their use. One essential question is whether to use any criterion other than income. The negative income tax differs from the existing welfare system in its reliance on income as the sole sorting criterion. Under a negative income tax, each individual receives a lump sum payment independent of health, sex, age, marital status, etc.; this payment (plus other income) is then subject to tax—perhaps at graduated rates, but at rates that are uniform for all individuals. The negative income tax has not been adopted, presumably because most Americans judge that the benefits from using additional sorting criteria exceed the costs. Realistic welfare reform proposals must then accept categorical coverage as a political reality.

Paternalism is a second motivation underlying the U.S. income transfer system. In the case of social security, the government is, in part, attempting to force individuals to save for their old age. In the welfare area, the government supervises the goods consumers purchase with food stamps, Medicaid, and subsidized housing. In-kind transfers force the recipient to consume in a manner pleasing to the donor; they also serve as a sorting device, aiding the most those individuals with preferences similar to the donor’s.

Paternalistic in-kind transfers may be undermined by private behavior. Either food stamps themselves or food purchased with food stamps can be sold to permit the purchase of other commodities. Individuals may be able to consume at “excessive” levels when young by borrowing against future social security benefits, thus to arrive at retirement with the same level of resources as they would have had without social security. But government attempts to regulate individual decisions appear to be effective. Kotlikoff, Spivak, and Summers (1979, p. 27) concluded that “without social security and private pensions, consumption in old age relative to lifetime consumption would be about 40 percent lower for the average person.” This finding suggests that, because of either capital market constraints or myopia, social security significantly raises the level of retirement consumption.

I have also made use of the 1972–1973 Consumer Expenditure Survey to examine the effectiveness of the food stamp program. I find that families with food stamps allocate a significantly larger fraction of their total budgets to food. For low-income (less than $6,000), young and middle-aged (18–45), single-headed households with children, the budget fraction spent on food is 34.4 percent for those on food stamps and 25.9 percent for those not on food stamps. In addition, 37 percent of households without food stamps, but only 16 percent of households with food stamps, spend less than 20.0 percent of their budget on food.³

A third objective of our income transfer system is simply the provision of insurance against risks that are not insurable at reasonable rates in private markets. The provision of insurance, while conceptually distinct from the other objectives, often involves paternalistic supervision of individual choices and income redistribution. Government provision of insurance forces individuals, in effect, to buy insurance, and represents as such an in-kind transfer. Redistribution is also involved, because the premia for government insurance correspond to taxes levied on the more affluent members of society. The real distinction between the insurance objective and these other objectives is that the government is actually setting up the insurance market rather than simply paying the poor to purchase insurance privately.

Examples of government provision of insurance through the income transfer system are disability insurance, unemployment insurance, and insurance against abject poverty due to family dissolution, unintended pregnancies, macroeconomic fluctuations, etc. The problem of “moral hazard” is the principle reason that private insurance markets do not handle these risks very well. “Moral hazard” refers to the fact that the availability of insurance may, itself, influence the likelihood that an uncertain event will occur. Consider unemployment insurance as one example: given this insurance, an employed worker has less of an incentive to try to keep his job and an unemployed worker has less of an incentive to find a new job. Unemployment benefits both increase the probability that a worker becomes unemployed and reduce the probability of reemployment once he becomes unemployed. As the probability of the insured event increases, the premium that the insurance company must charge to break even rises as well. At some point the premium may be too high to justify the market. Again, the problem is fundamentally one of lack of information. Neither the insurance company nor the government can observe how hard the worker is trying to keep his job or to find a new one.

Both private insurance markets and the government try to combat the moral hazard problem through the use of deductibles, coinsurance rates, and experience rating. Unemployed workers, for example, generally receive less than their previous earnings in the form of unemployment benefits, and they must work for an extended period after becoming unemployed before they can requalify for benefits. The deductible here is the difference between previous earnings and unemployment benefits, while the inability to become reinsurable for a period of time reflects implicit experience rating.

Given the government’s imperfect information on the one hand and, on the other, its policy objectives of redistribution to the genuinely poor, paternalistic supervision of individual decisions, and provision of insurance, the optimal design of an income transfer system will most certainly involve categorical provision of benefits, in-kind transfers, work tests, and special work incentives to offset the moral hazard problem associated with transfers based on the extent of earned income. There is no simplistic design of the income transfer system that will satisfy all social objectives. However, more simple designs can eliminate the gross inequities, administrative overlap, excessive work disincentives, and incredibly complex benefit provisions that characterize current programs.

ISSUES OF EQUITY

Equity requires equal treatment of equals; it also requires, in the absence of persuasive ethical arguments to the contrary, equal treatment of unequals. Income transfers should be fair; they should not be capricious. The U.S. income transfer system is a long way from satisfying either of these principles. Still, it appears to be moving—albeit slowly—in the right direction. The 1977 Social Security Amendments earn points for preserving and strengthening the link between an individual’s tax contributions and retirement benefits. This relationship should be strengthened even further. Indeed, the Social Security Administration should be required to report to taxpayers on an annual basis their accumulated amount of taxes paid into the system and their level of expected retirement benefits based on those tax contributions. These social security tax account statements will permit each individual to more clearly understand from whom and to whom redistribution is occurring under social security.

The need for greater equity has also been addressed in past and current welfare reform proposals. The relative growth of the food stamp programs, and the introduction of Supplemental Security Income for the Aged, Blind, and Disabled (SSI) in 1972 and Earned Income Tax Credit (EITC) in 1975, reflect the need to standardize benefits across all states in the country. President Carter’s 1980 welfare reform proposal cal...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• CONTRIBUTORS
• PREFACE
• I U.S. Performance in Historical and International Perspective
• II Productivity and Economic Growth
• III Problems of Short-Term Economic Stability
• IV Regulation
• V The International Economy
• VI The Role of Government in the Economy
• VII Potential Policy Problems of the 1980s
• VIII Summary and Conclusion
• NOTES
• REFERENCES
• ABOUT THE AUTHORS
• INDEX
• PUBLICATIONS LIST