How to Talk America Down From Impending Fiscal Suicide

Findings like this, from the Tax Policy Center, are as terrifying as they are ironic:

Three-quarters of Americans believe that entitlement programs such as Medicare and Social Security "will create major economic problems" over the next 25 years. But two-thirds are opposed to addressing these challenges by reducing benefits, and 56 percent are against raising taxes.

I believe the word for this is "ungovernable." Fix the deficit immediately, but don't you dare touch my entitlements -- never mind that entitlements are responsible for those deficits.

Consider this. The projected budget deficit in 2035 is $5.6 trillion. Yet even if spending on every government program except entitlements were cut to the lowest percentage of GDP since the 1940s, the deficit would still be roughly $5.4 trillion. When the topic of reining in government spending arises, the typical emotions-laced buzzwords always pop up -- pork, waste, TARP, stimulus. But these aren't even rounding errors against the 800-pound gorilla of entitlements:

Source: Congressional Budget Office. Y-axis is spending as a percentage of GDP.

The tragedy in this is that everyone is eventually eligible for entitlements, so mere talk of cutting the programs is political napalm. True fiscal responsibility means less retirement money than you -- you! -- are currently promised. Yet how many political candidates run on the "I'll-gut-your-retirement" platform? None. There's a reason for this. Very few of even the most hardnosed fiscal hawks are willing to part with their entitlement checks -- something that affects them directly -- in the name of a balanced budget -- more of an abstract concept.

Rolling Stone's Matt Taibbi, who has skillfully insulted everyone at least once, detailed this paradox by describing a recent austerity rally as "A hall full of elderly white people in Medicare-paid scooters, railing against government spending and imagining themselves revolutionaries." He went on: "The average Tea Partier is sincerely against government spending -- with the exception of the money spent on them." I want to keep this column as apolitical as possible, but the mentality Taibbi describes, which isn't unique to the Tea Party, is strongly backed up by the Tax Policy Center's poll.

Long-term spending needs to be curtailed. No one's denying that. Just don't pretend it's as easy as holding up a sign that says "stop the spending!" It's not. Look at France. It recently proposed overhauling public pensions to make them more financially viable, and the people went ballistic. They rioted. Airports were shut down. A quarter of the country's gas stations went dry. One French politician called it a "coup." People get angry when a gravy train they've grown accustomed to is taken away. Yes, France's entitlement system is more engrained than ours. But there's little doubt about it: We're going to freak out once we get around to fixing our entitlement programs. It's imaginary to think otherwise.

But how, exactly, do we fix these programs? Here are a few options.

Social Security
The Congressional Budget Office issues a report on policy options every few years with recommendations on how to keep Social Security afloat. One of the simplest recommendations is also the most effective. It boils down to this: Stop being so generous in the way initial retirement benefits are calculated.

Currently, initial Social Security benefits are determined with a calculation that considers how much you earned in the past adjusted for real wage growth. They call it wage indexing.

If Social Security switched to price indexing -- a process where initial benefits are calculated by adjusting past wages only for inflation, not real wage growth -- the Social Security trust fund would never become exhausted. Ever. The program becomes permanently viable.

What would the change mean for you? Your initial benefits would give you less credit for your early working years than currently promised (wages grow slightly faster than inflation over time). In English, it's a wage reduction. But it's a very reasonable reduction. About as reasonable as it gets.

Medicare
Medicare is a far uglier story.

Social Security's projected spending growth is the result of an aging population. But nearly all of Medicare's surge is due to explosive health-care costs:

There are dozens of reasons why curtailing these runaway costs is difficult. Longevity. Sue-happy patients. Better technology. But if you really want to nail it down in one sentence, I'd offer this: With Medicare spending -- a price-setter as major chunk of the overall health-care market -- we've pointlessly bedeviled the word "rationing."

That the word "rationing" became as feared as the word "communism" (death panels!) during the health-care-reform circus last year shows how deep a hole of denial we're in. Rationing comes from the Latin word for "reason," and it's easy to see how the absence of the former precludes the latter.

When you pay for medical care out of pocket, you ration. You weigh the costs against the benefits. Then you decide what's worth it, and what isn't. When private health insurers foot the bill, they ration. Procedures with little evidence of effectiveness are declined.

Medicare is different. It doesn't ration enough. All too often it simply pays for whatever is asked of it. What procedure do you want that has little evidence of working or preventing illness? Because we'll pay for it. This is music to Pfizer's (NYSE: PFE  ) and Medtronic's (NYSE: MDT  ) ears, but it bleeds taxpayers dry and does a number to ensure medical costs spiral higher. Former Comptroller General David Walker once discussed what makes Canada's public health-care system more viable than Medicare. "Canada doesn't give blank checks for their medical programs," he said. "No other countries do, in fact. Only us. Canada uses evidence-based medicine, without paying for heroic procedures that don't work."

As my colleague Seth Jayson put it, "It's not the death panel you need to fear, but the 'everything-if-that's-what-you-want' panel that already exists in government." He continued: "The solution is rationing. It has always been rationing. That's what the private insurers do already, and it's what any public insurer will have to do. Everyone can't have everything. It's that simple."

David Leonhardt of The New York Times has detailed Medicare's whatever-you-want culture better than anyone. He recently profiled a $50,000 Medicare-covered prostate cancer treatment that has no evidence of being more effective than a less-complicated $10,000 treatment, among several other examples. "Genentech has not shown that its expensive vision-loss drug is better than a cheaper alternative," Leonhardt says, "but taxpayers still pay the bill." Seth has profiled other instances of the government's we'll-pay-for-it-even-if-it-doesn't-work mentality.

Leonhardt offered a solution to this waste: Give new treatments a set period of time, say three to five years, to prove their effectiveness over alternatives. If no evidence arises, Medicare would stop paying beyond the cost of proven alternatives -- even when that means halting funding altogether for some issues. "The blank checks would not go on forever," Leonhardt says.

This is what private markets already do. They ration. Medicare needs to do more of the same. It's getting the market to work better than it does now. And it's part of how we'll get Medicare costs under control.

I don't pretend any of this will be easy. But I'm absolutely certain it's necessary. If not, there's an instructive path for where we're headed: Greece.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares of any of the companies mentioned in this article. Pfizer is a Motley Fool Inside Value pick. The Fool owns shares of Medtronic. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (17) | Recommend This Article (41)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 29, 2010, at 4:38 PM, TopAustrianFool wrote:

    Here is my plan: Take people like me under 33yrs old and tell us that there will be no social security for us. Then cut my FICA by 25% and tell me you have to invest an take care of your own 401(k), IRA, whatever...

    Then you'll see subscriptions to TMF letters skyrocket...

    Problem solved.

  • Report this Comment On October 29, 2010, at 5:09 PM, halbiz wrote:

    I agree with this article, basically. I am for the proposed California One Care system, but can't stomach some of the pithy comments in the little one minute ads that basically say "any doctor, any time, any procedure, for everything". Give me a break! Rationing (Reason -ing) must be used and it needs committees to do it. The problem with the private system we have is that it has been kidnapped and harnessed as a profit-making vehicle with laws passed by our compliant (and fund-seeking) government representatives that allow its patients to be re-classified into very high cost groups within 30-60 days when a severe illness "ACTUALLY IS DETECTED!" Then the family loses its insurance when it can't pay the new skyrocketing premiums....when one of the family gets really sick.....that is what we have to curb, plus dozens of other "tricks of the trade" of private insurers that forced other, more reasonable insurers, over the last generation, to have to play the same game and refuse to sell insurance to "marginal" customers.

    One of the problems with a government insurance program, which can be mostly solved, is it might be set up with a non-rational governing board that can't make changes when it needs to, but takes 25 years to do anything, and, heaven forbid, its members seek political donations all the time....or the rules for acceptance or payment change but the changes are not financed accordingly.

  • Report this Comment On October 29, 2010, at 5:16 PM, TMFKopp wrote:

    Great work Morgan!

    Matt

  • Report this Comment On October 29, 2010, at 5:21 PM, TMFTypeoh wrote:

    Simply the best columnist on fool.com......and that is saying something!

  • Report this Comment On October 29, 2010, at 6:50 PM, TheDumbMoney wrote:

    Eight thumbs up. (It's almost Halloween, and I'm going as an Octupus.)

  • Report this Comment On October 30, 2010, at 9:00 AM, output wrote:

    I would agree spending has to be reduced. But first we need to throw all the politicans in prison who have been stealing from social security over the years . I suspect if it had been undisturbed that there would be plenty of cash right now to pay benefits. Then we need to cut pay and perks for the remaning politicans and many government workers as well. This is just a reality. Then we need to eliminate many of the government grants, aid programs etc. that just continually bleed the peoples resources and redistribute as well (take from one and give to another). This is just the beginning but it would be something. Yes it will be hard and there would be much whining, crying, etc. but a bankrupt nation Im sure would be much worse!

  • Report this Comment On October 31, 2010, at 8:46 AM, ryanalexanderson wrote:

    Yes, excellent article! Reminds me of the scene in I.O.U.S.A where they show how bad the fiscal deficit is...and -then- they throw in SS/Medicare/Medicaid obligations.

    Morgan, do you think that the "sue-happy" part you mentioned is big? Do you see tort reform as a meaningful solution, or is it just another rounding error anyway? And would resistance to such reform be a significant lobby group?

  • Report this Comment On October 31, 2010, at 12:56 PM, Adam1226 wrote:

    Great article. I would add to the medicare argument that there should be an emphasis on rational end of life care. There are many many many people with very poor qualities of life who receive treatments that I would NEVER want b/c they are unable to make decisions on there own and their families often aren't capable or comfortable of making complex medical and ethical decisions surrounding this issue. Perhaps a Medicare a financial incentive for physicians to simply DISCUSS these complicated with families of patients with specific medical diagnoses or beyond a certain age.

  • Report this Comment On October 31, 2010, at 1:05 PM, Adam1226 wrote:

    RE: tort reform:

    The literature on this suggest that it's not as big a deal as physicians like to make it. At least, not in dollars paid on litigation and settlements. It's more that it changes the practice of physicians and supposedly encourages them to practice in a so-called "defensive" manner.

    The reality is that physicians have to man up and practice medicine in a rational manner regardless of the medicolegal environment. There is good literature to support the fact that over-testing does NOT protect a doctor in court, nor does it prevent bad outcomes. In spite of this, there is a cover-your-butt mentality that is now being passed from one generation of physician to the next...I suspect that many young physicians practice "defensive" medicine b/c they have been trained to do so, and not necessarily b/c they are scared of a lawsuit. In other words, it's become so ingrained in the medical culture that physicians simply think it's the right way to practice medicine.

    The reality is that just as much harm (if not more) is done by overtesting as by missing a rare diagnosis. Nothing in medicine is 100% and physicians and the public simply have to be comfortable with that.

    If physicans don't come to this conclusion on their own, someone will...and the last thing we need is an outside body (probably governmental) deciding what defines rational care.

  • Report this Comment On October 31, 2010, at 1:08 PM, Adam1226 wrote:

    TopAustrianFool--

    I would love to opt out of social security and have my FICA reduced...I think the problem is that if we did that, there wouldn't be any money to give to the people who are currently receiving social security (ponzi?).

    Although, I do think it's an interesting to cut the FICA of the young, rather than cancel it...then there would still be some money coming in. I wonder how that would work.

  • Report this Comment On October 31, 2010, at 6:27 PM, mickfooled wrote:

    I fail to see how a new rationing system put in place by the people who brought you Social Security and the U.S. Post Offfice will be effective in controlling costs. When has the federal government demonstrated a competence in any program to control costs and successfully meet the outcome targets for which the program was created? The only sentence that rings with me is "When you pay for medical care out of pocket, you ration." Why would be want to pass this responsibility on to yet another new bureacracy?

  • Report this Comment On October 31, 2010, at 6:50 PM, voelkels wrote:

    output wrote "I would agree spending has to be reduced. But first we need to throw all the politicans in prison who have been stealing from social security over the years."

    The question that I have for him is are you going to dig up FDR, LBJ, etc., etc. and send their dead bodies to prisons? Social Security was a Ponzi scam by FDR to get older workers during the Great Depression out of the workforce. If the money that both me and my employers paid into the great "Social Security trust fund" went into a tax deferred index fund, when I started drawing Social Security at age 63, I could have drawn at my present $1380/month for the rest of my life (assuming I live to 85 years old) and still have money left over to give to my kids & grandkids.

    Adam1226 wrote “I would add to the medicare argument that there should be an emphasis on rational end of life care. There are many many many people with very poor qualities of life who receive treatments that I would NEVER want b/c they are unable to make decisions on there own and their families often aren't capable or comfortable of making complex medical and ethical decisions surrounding this issue."

    I'll second that statement and add to it. Both myself and DW have living wills. Even so there are cases where the family and/or the doctors ignored them. The laws in all 50 states should be amended so that the wishes in a patient's living will must be obeyed. If the living will say "Do not resuscitate" and the patient's heart stops the doctors should be required Not To Resuscitate, under penalty of law! Maybe if the doctors and hospitals aren't getting paid from Medicare for ignoring living wills, it will stop (or at least slow down).

    C.J.V.

  • Report this Comment On November 01, 2010, at 8:56 PM, neamakri wrote:

    Privatize Social Security. Got to wikipedia and lookup Jose Pinera. Page down to Social Security Reform.

    Jose Pinera privatized Social Security in Chile years ago. Since then the Chilean economy doubled its rate of increased production. Plus, there are far fewer Chileans in poverty than before. Everything is positive, nothing negative.

    I have paid into the SSA fund for forty years, so, yes, I do feel entitled. I want my money back plus a little for the "time value of money".

    By the way, do NOT fall for talk from anybody that we can fix Social Security by some "tweaks". There are only two "tweaks" possible; (1) pay retirees LESS, or (2) tax workers MORE. Neither tweak is palatable to me.

    Social Security has two major faults; (1) it is not privatized, thus earns less interest than it should, and (2) it is controlled by politicians. Do you really want polticians to keep controlling YOUR retirement money? I didn't think so.

  • Report this Comment On April 07, 2011, at 11:06 PM, ershler wrote:

    neamakri,

    Social Security earns low returns because of what it is invested in, not because it is private or public. If Warren Buffet was in charge of investing our Social Security money everyone would be talking about how great of an idea Social Security was but since people are more scared of losing money than making money the money is invested in the safest possible option. You could set up individual accounts and run it like a 401K and still keep it public. Doing that defeats the entire point of Social Security in mind.

  • Report this Comment On April 08, 2011, at 12:07 PM, DJDynamicNC wrote:

    Couldn't we just raise taxes?

    Sweden, Denmark, Norway, and Canada all seem to be doing great. They all get much better health care outcomes than we do, for much less money - and they all have socialized health care and extremely healthy econonmies despite (because of?) higher tax levels (and the accompanying higher levels of service provision).

    I'd be more than happy to pay higher taxes, substantially higher. I don't ever have a problem investing in my country.

  • Report this Comment On April 14, 2011, at 9:21 PM, ajstudebaker wrote:

    "Sweden, Denmark, Norway, and Canada all seem to be doing great. " I suspect that all of those nations spend a much smaller percentage of their GDPs on their military forces.

  • Report this Comment On July 25, 2012, at 7:36 AM, bobbiesss wrote:

    Since when are medicare and Socail security ENTITLEMENTS...

    this form of thinking is setting a VERY poor mindset for folks who do NOT realise that we pay for these throughout ouyr working lifetime to have the government SAVE for our use upon retirement

    Wow what are you fellos doing? I always felt secure in your advice but now..well..I am hoping you are not part of the big establishement who is trying to once again change the path of government at the detriment of its constituents

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