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March 04, 2005

The *Real* Elephants in Bush's Living Room

Morgan Stanley's Richard Berner talks about some of America's real fiscal problems--the one's that the Bush administration's "focus on Social Security" allows it to avoid talking about. He's mostly right, I think. However, I think he overestimates the importance of reforming the PBGC and underestimates the importance of figuring out what to do in the long run with Medicare:

Morgan Stanley: President Bush has pushed Social Security and tax reform to the top of the policy agenda.... In my view, however, there are three more pressing needs: securing the long-term stability of the defined-benefit (DB) pension system, taking first steps toward Medicaid reform, and returning to meaningful fiscal restraint.... America’s long-term challenges — including the broader healthcare and retirement saving conundrums, as well as those involving education and energy — all cry out for systematic and timely policy change... crafting solutions for those problems that are slightly less immediate will be far easier if policymakers can demonstrate the stewardship and resolve to fix the leakiest boats first.... [B]eginning to deal with pensions, Medicaid, and the budget effectively now could pave the way for other needed changes....

The hard truth is that real Social Security reform will reduce future benefits and/or raise receipts to pay for them.  More broadly, real reform of the retirement saving infrastructure must aim at increasing national saving, not just boosting personal saving at the expense of Federal deficits.... Fed Chairman Greenspan and Fed Governor Gramlich both strongly agree that increasing national saving is a critical ingredient for Social Security reform....

America’s defined-benefit pension system faces more immediate risks than other legs of the retirement saving stool.... Years of underfunding and overly optimistic assumptions about mortality and retirement have created economic mismatches.... [P]olicy should reduce the moral hazard in the pension safety net (represented by the Pension Benefit Guarantee Corporation for private plans) by requiring appropriate risk management.... DB plans are a key element in America’s system of retirement saving.  They offer economies of scale in management and administration, the ability to mutualize risks across generations of employees, and the investment discipline that most individuals lack....

Likewise, there is some urgency to slow the rapid growth in Medicaid outlays.... States share Medicaid expenses with the Federal government... The program has few incentives to economize.... With the Administration proposing to cut Medicaid spending by switching to block grants, state officials will either have to make up the difference or cut spending.  Medicaid outlays account for 20–25% of state budgets, and many states’ fiscal health is highly exposed to further outsized gains....

But the most urgent need is to prepare fiscal policy for the future.... [P]rudence dictates increasingly proactive policies to increase national saving.... [P]olicy should focus on getting the Federal budget back to balance in the next few years.... Most fundamentally, it would help restore the balance between domestic saving and investment that the U.S. will need as global rebalancing helps wean it from the saving it now imports from abroad.  In my view, there is no quicker way to increase national saving than to aim at lower deficits, and both cuts in spending growth and tax increases should be on the table...

Posted by DeLong at March 4, 2005 05:29 PM