January 12, 2009 10:49AM

Obama, Entitlements, and Political Courage

One has to give Barack Obama at least half a point for political courage. In warning that Social Security and Medicare are ticking fiscal time bombs, the president-elect took on one of his party's most prized shibboleths--the idea that there is nothing wrong with those programs that repealing the Bush tax cuts wont fix. After all, hardly any Democrat anywhere campaigns without attacking his Republican opponent for wanting to destroy Social Security and Medicare.

But to get full courage points, Obama would have to come up with an actual plan to reform the two troubled programs. So far, he hasn't. The Social Security plan he put forward during the campaign, a 4% payroll tax hike on those earning more than $250,000 per year, would give the United States one of the highest marginal tax rates in the world, with devastating economic consequences, but would do almost nothing to extend Social Security's cash-flow solvency.

In the end, there are only three ways to fix Social Security: raise taxes, cut benefits, or allow private investment. Moreover, as Cato has long pointed out, solvency is only one of the problems facing Social Security. Social Security taxes are already so high, relative to benefits, that Social Security has quite simply become a bad deal for younger workers, providing a low, below-market rate of return. In fact, many young workers will end up paying more in taxes than they receive in benefits. They will actually lose money under the program. And the single most important problem with the current Social Security system remains that workers have no ownership of their benefits. This means that workers are left totally dependent on the good will of 535 politicians to determine what they will receive in retirement. This lack of property rights also translates to poorer bequests. Since workers do not own the money they pay in Social Security taxes, they are unable to pass their inherited retirement savings on to their heirs. No matter how much a worker has paid in Social Security taxes, his benefits are reduced at death and then expire with the spouse.

Having bucked his party on whether Social Security needs to be reformed, will Obama have the courage to go further and allow younger workers the option of privately investing a portion of their Social Security taxes through personal accounts?

On Medicare, the president-elect has been equally lacking in specifics. During the campaign, he actually called for expanding Medicare, notably by increasing coverage under the prescription drug program, eliminating the so-called “donut hole.” Now he talks mostly about eliminating the Medicare Advantage program, the program’s private managed-care option. Managed care providers may indeed be overcompensated under that program, but the program’s real long-term problems lie in its open-ended indemnity-style, fee-for-service payments. Obama also suggests that his overall health care reform will reduce the growth in health care spending, thereby reducing Medicare costs. That’s more a prayer than a program.

But speaking of health care reform, it seems somewhat oxymoronic for President-Elect Obama to warn about the dangers of entitlement spending while calling for a massive new entitlement in the form of national health care.

Obama has shown the first signs of political courage. But the devil is in the details. Let’s see what he actually proposes. Only then will we know if his courage is more than rhetoric deep.