Late last year, the Congressional Budget Office (CBO) released a study on changes in the distribution of household income in America from 1979 to 2007. This study offered fresh insight into an intensifying debate in Washington and across America over income inequality—what causes it, how do government policies affect it, and what should policymakers do about it?
One underreported conclusion from the CBO study is that shifts in government transfer payments have contributed to increasing inequality over time. Government transfer payments remain progressive, of course, but the equalizing effect of transfers and taxes on household income was smaller in 2007 than it was in 1979.
This is mainly because the distribution of government transfers has moved away from lower-income households. For instance, in 1979, households in the lowest income quintile received 54 percent of all transfer payments. In 2007, those households received just 36 percent of transfers.
I find that statistic astonishing. There is something wrong with our government transfer programs if they are increasingly steering assistance to the wealthy, while at the same time growing at unsustainable rates. The looming bankruptcy of the federal government, which would shred the social safety net, is the greatest threat these programs face. Lamentably, this study shows that the threat is being intensified as a direct result of the government spending money it doesn’t have on higher-income Americans who don’t need it.
This shift reflects a growth in programs that focus on the elderly population and are not for the most part income-adjusted, such as Social Security and Medicare. In other words, the structure of some of our largest entitlement programs has decreased the share of government transfer payments going to lower-income households and increased the share going to wealthier seniors. According to the CBO’s findings, this trend, accelerated by the retirement of the baby-boom generation, contributed to an increase in inequality.
Even though Social Security benefits are progressive, neither Social Security nor Medicare is means-tested and the cohort that is eligible for these programs is the second-wealthiest cohort by age in the United States. This cohort has grown faster than the population overall, and the resulting demographic change has reduced the share of transfer payments received by lower-income households while increasing the share received by middle- and upper-income households.
This large increase in spending on non-means-tested programs for a relatively well-off demographic was less a result of explicit government actions than a combination of demographic and health care cost factors. A fixed retirement age, a lengthening of life expectancy, and the retirement of the baby-boom generation worked in concert to reduce the overall progressivity of government transfer payments during the period studied.
The rising cost of health care exacerbated this trend. As the CBO put it, “Rapid growth in Medicare, which is not means-tested (in other words, not provided to people based on a test of need determined by their income and assets), tended to shift more transfer income to middle- and upper-income households.”
The CBO’s finding that Medicare and Social Security are directing an increasing share of government transfer payments toward wealthier households touches on a key element of the federal government’s larger budget challenge. Absent fundamental reform, these entitlement programs – coupled with interest payments on the debt – are on a path to consume the entire federal budget. As demographics and runaway health care costs bankrupt these programs, younger generations face the prospect of severe health and retirement insecurity.
Those unwilling to make gradual reforms that put these programs on a sound footing too often posit prohibitively high tax rates as an alternative. I’ve actually asked the CBO what tax rates my children would have to pay to finance the federal government’s current unsustainable path of empty promises. According to the CBO, the tax hikes required would “probably not be economically feasible.”
A much less discussed form of inequality is the growing gap between old and young, with younger Americans on the hook for the trillions of dollars of unfunded liabilities that will be required to maintain the status quo. The younger generation is already starting from a tough position. Fresh Census data shows that the wealth gap between the elderly and the young has reached an all-time high as households over 65 have net wealth that is 47 times higher than households under 35.
A prudent course of action for policymakers would be to advance sensible reforms to the unsustainable benefit structure of these programs so that government is doing a better job of directing assistance to those that need it most, while giving less help to households that need it least. For Social Security, the Bowles-Simpson Commission on Fiscal Responsibility and Reform laid the groundwork by outlining reforms that would reduce the growth in benefits for higher-income workers. For Medicare, the House-passed budget, The Path to Prosperity, proposed no changes for those currently in or near retirement, but for future generations, it proposed a premium-support system that provides more help for the poor and the sick, and less help for the wealthy.
While these reforms speak directly to the CBO’s findings, policymakers must do more to promote broadly shared prosperity and economic growth. An opportunity society necessitates a thriving economy that makes it possible for all Americans to freely pursue their destinies. Streamlining job training programs, encouraging school voucher programs, and ending corporate welfare programs would promote upward mobility while preserving the right of every American to make the most of his or her talents and dreams.
Promoting the natural rights and the inherent dignity of the individual must be the central focus of all government policy. Washington is in urgent need of a course correction. A principled reform agenda – rooted in America’s core values – must have at its core the goal of making it possible for all Americans to reach higher rungs on the ladder of opportunity.
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