By James Kwak
“We do not believe that in this country, freedom is reserved for the lucky, or happiness for the few. We recognize that no matter how responsibly we live our lives, any one of us, at any time, may face a job loss, or a sudden illness, or a home swept away in a terrible storm. The commitments we make to each other – through Medicare, and Medicaid, and Social Security – these things do not sap our initiative; they strengthen us. They do not make us a nation of takers; they free us to take the risks that make this country great.”
Many liberals have been heartened by these words, spoken by President Obama during Monday’s inaugural address. Indeed, they represent one of the few times when anyone, including the president, has even attempted to defend our major social insurance and safety net programs. The usual posture among the type of centrist Democrats who make it into the administration is some combination of (a) simply attacking, as self-evidently evil, anyone who proposes benefit cuts and (b) saying in serious tones that we will have to cut spending one way or another.
Unsurprisingly, most Americans are split between various misconceptions of what Social Security and Medicare are. Many, particularly right-wing politicians and their media mouthpieces, see them as pure tax-and-transfer programs: they gather money from one set of people and give it to another set of people. This feeds easily into the makers-vs.-takers line, with payroll taxes on workers going to fund benefits for non-workers. From this point of view, they are bad bad bad bad bad and should be cut.
Many others, particularly beneficiaries and people who hope to see beneficiaries, see them as earned benefits. The common conception is that you pay in while you’re working, so you earned the benefits you get in retirement. You didn’t “earn” them in the moral sense that people who work hard should get benefits; you “earned” them in the accounting sense that you’re just getting back “your” money that you set aside during your career.
Both of these perspectives are wrong, the latter more obviously so. Most people, during their working careers, do not pay nearly enough in payroll taxes to pay for their expected benefits. This is most obvious for Medicare, since the Medicare payroll tax only covers a small fraction of total Medicare expenses; in addition, given health care inflation, payroll taxes from decades ago would make only a small dent in today’s medical costs. But it’s also true for Social Security: the way initial benefits are indexed (according to average wages, not average costs) pretty much guarantees that the average retiree in some generation will get back more than the average worker in that generation put in.
The problem with the tax-and-transfer argument is only slightly more subtle. Sure, at any given moment some people pay taxes and others collect benefits (and many do both, since Medicare is funded by general revenues). But most of us will both pay and receive at different points in our lives. So both programs are really more like income-shifting arrangements, where we spread income from our working lives into our retired lives—or like repeating intergenerational transfer schemes, which can continue indefinitely (making everyone better off) under the right conditions.
In chapter 6 of White House Burning, we devoted a fair amount of attention to the question of what these programs are. In the inaugural address, I think the president got it basically right. They are risk-spreading programs. You don’t get back exactly what you put in: they have a certain degree of progressivity (although less for Social Security than is commonly imagined). Their main function is to protect people against extreme outcomes by pooling a limited share of our resources.
Yes, rich people end up paying payroll taxes for insurance they end up not needing. But that’s how insurance always works: you pay the premiums hoping you won’t need it. And the key fact is that most young people, whey they start paying payroll taxes, don’t know what their own personal outcomes will be. Social Security and Medicare effectively transfer money from the futures where they turn out rich to the futures where they turn out poor, which makes them absolutely better off. Like any insurance scheme, you can make everyone better off simply by moving money around between different states of the world.
These particular insurance schemes, as the president said, have a moral element to them. They are a way of expressing out solidarity with each other as Americans, people united, however loosely, in a common endeavor. They also have an economic element to them. People protected against bad outcomes are more willing to take the risks needed for a vibrant and prosperous society. They are something to celebrate, not something to be embarrassed about whenever the Republicans come after them.