Bernanke Budget Warnings Are Likely to Fall on Deaf Ears

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A couple of thoughts on Federal Reserve Chairman Ben Bernanke and his testimony before the Senate Budget Committee today concerning the economic dangers that Social Security and Medicare pose if the programs aren't reformed.

First, a bit of what he said: "If early and meaningful action is not taken, the U.S. economy could be seriously weakened. Official projections suggest that the unified budget deficit may stabilize or moderate further over the next few years. Unfortunately, we are experiencing what seems likely to be the calm before the storm."

Bernanke noted that projected federal combined spending for Social Security, Medicare, and Medicaid will total about 15 percent of the gross domestic product by 2030, almost double what it is today. Now here is what popped out at me as I listened to the Fed chief, particularly about Social Security:

— Although "early and meaningful action" would make any entitlement fixes less dramatic and draconian–and Medicare is way tougher and costlier than Social Security–don't bet much on anything happening in the next two years. Conversations this week with White House and congressional sources put the odds of Social Security reform happening during this new congressional session as certainly being less than 25 percent–though not zero.

While the Bush administration has not ruled out the idea of raising the income limits on payroll taxes as part of a broad reform package, Democrats in Congress still seem dead-set against a deal that would involve diverting any Social Security funds into personal accounts. "They don't want to give Bush a win," said one Capitol Hill veteran. "They want to make sure he goes down as the worst president in U.S. history." Yet Bush would need something in return for agreeing to raise taxes.

— Bernanke also warned that America won't be able to grow itself out of this problem: "To some extent, strong economic growth can help to mitigate budgetary pressures. ... Unfortunately, economic growth alone is unlikely to solve the nation's impending fiscal problems. Economic growth leads to higher wages and profits and thus increases tax receipts, but higher wages also imply increased Social Security benefits, as those benefits are tied to wages."

But it was not always thus. Until 1977, initial benefits were linked to inflation rather than wages. A return to that system would do much to restore solvency at the cost of reducing higher expected benefits. One option Bush has floated is progressive price indexing, where higher-earning Americans would lose more in projected benefit increases.

According to an analysis by the Center on Budget and Policy Priorities, someone earning $36,000 today and retiring in 50 years would see benefits cut by a fifth, while someone earning $90,000 would see close to a 40 percent cut. Obviously, this would make Social Security a worse deal for younger workers than it already is, which is why Bush also proposed private accounts as a higher-return offset.