Time to Tackle Social Security, Medicare

30 years ago, a bipartisan commission (yes!) helped fix these entitlement programs. Let's try it again.

Bitter winds have been whipping down the Potomac, but there are signs of a spring thaw in the rancorous partisan struggles between Republicans and Democrats. Republicans have delayed a showdown on the debt ceiling, there has been progress on immigration reform, and House majority leader Eric Cantor reportedly has called for a rethinking of the GOP position on the debt issue. Republicans have decided to make their stand against government spending when mandated budget cuts kick in and Congress must vote to continue funding government projects.

Some people fear that if the GOP softens its stance on spending cuts, the rating agencies will further downgrade U.S. government bonds. When Standard & Poor's downgraded U.S. debt in August 2011, the Dow Jones industrial average fell 635 points.

I explained why downgrading Treasury debt would be wrong two years ago, before S&P did it, and it would still be wrong now. The Federal Reserve will always lend the Treasury whatever money it needs to fulfill its debt obligations. The danger to bondholders is inflation, not default, and although rising prices may be a threat down the road, there are no signs of it now.

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In 2011, the stock market feared that China would dump a sizable portion of its Treasury securities — a fear that proved to be unfounded. In fact, the demand for U.S. Treasury issues soared. Investors rightly believed that Treasury bonds were still the world's safe haven and flocked to them as stocks plunged.

No impact. The situation is no different today. Even if the credit-rating agencies downgrade Treasuries again, I predict no negative impact on the bond market. And the dollar will remain strong because the U.S. economy is growing faster than Europe's or Japan's.

That doesn't mean we should forget about the deficit. Economists agree that, in the long run, Social Security and especially Medicare are unsustainable in their current form. The financial crisis and Great Recession have greatly worsened the long-run projections for these programs, and there is no question that taxes will have to be raised, benefits cut, or both.

But most of the current trillion-dollar annual budget deficit is caused by our sluggish economy operating well below full employment. If the U.S. economy begins growing at 3% to 4% a year again — the rate at which I believe it will be growing by year-end — the deficit will be cut significantly. In 2012, the deficit was 7% of gross domestic product, but the Congressional Budget Office believes it could fall to 2.5% of GDP by 2015. That would keep debt growth below the growth rate of the economy.

Entitlement changes. The problem is that stabilizing the ratio of debt to GDP is not enough. As more baby-boomers enter retirement and draw Social Security and Medicare benefits, deficits will balloon once again. The sooner substantive work is done on these entitlements, the happier markets will be.

I recommend that a bipartisan commission be appointed to propose changes to our entitlement programs. Such action worked before. In 1981, President Reagan appointed a commission to make recommendations to bolster the Social Security trust fund, which at the time was scheduled to run out of money in a few years. In its 1983 report, the commission proposed, among other things, that tax rates and the retirement age be increased, and its recommendations sailed through Congress. There is no reason why, on the 30th anniversary of the commission's report, we cannot do it again — and this time we can include Medicare.

Columnist Jeremy J. Siegel is a professor at the University of Pennsylvania's Wharton School and the author of Stocks for the Long Run and The Future for Investors.

Jeremy J. Siegel
Contributing Columnist, Kiplinger's Personal Finance
Siegel is a professor at the University of Pennsylvania's Wharton School and the author of "Stocks For The Long Run" and "The Future For Investors."