federal government growth: leviathan or ......peacock and wiseman (1979) have ar- less there were...

FEDERAL GOVERNMENT GROWTH:LEVIATHAN ORPROTECTOR OF THE ELDERLY?**

RUDOLPH G. PENNER*

ABSTRACT spending growth relative to potential GNP

During the 1980s, federal noninterestsince the period just preceding World War

spending declined relative to the GNP,II. However, most theories of government

casting considerable doubt on theogrowth should apply to other spendingfunctions as well. That is true whether the

plying inexorable government growth. theory involves imperfections in the po-Spending on the elderly has continued to litical system, such as those based on thegrow relatively, however, and now absorbs distorting effects of special interest groupsalmost one-half of federal noninterest, do- and the perverse incentives facing bu-mestic spending. reaucrats,- or those based on more ra-

Indeed, almost all relative federal tional mechanisms, in which governmentspending growth since before World War growth occurs because the demand of me-If can be explained by the growth of pro- dian voters for most public programs isgrams focused on the retired. There are deemed to rise faster than their incomes.good normative reasons for these pro- A serious flaw in past theorizing aboutgrams, but the myths surrounding them vermuent growth is that spending hasmay have resulted in overexpansion. The goprograms require a re-examination before

not been disaggregated properly. Relative

the baby boomers retire early in the 21stgrowth in total spending can only be ex-

century.plained if we know which functions causedit.

This paper briefly reviews the entirehistory of the federal budget and de-

rpHERE is no shortage of theories ex- scribes the evolution of pension and healthJL plaining the growth of government program spending for the elderly in some

spending.' Books and articles on the topic detail. It then uses the evidence on bud-have accumulated to the point that it is trends to speculate on the relevancedifficult for any one individual to read of selected normative and positive theo-them all. There is, however, an extreme ries of government growth.shortage of books explaining declines in It is important not to confuse an anal-spendin

irelative to GNP. In fact, I know ysis of federal spending trends with an

of none. analysis of the growth of the economic costYet, if the federal budget of the United of the public sector as a whole. In recent

States is dissected, expenditures on most years, the United States has seen a de-nondefense functions of government have volution of public financing responsibili-been in secular decline relative to GNP ties from the federal to the state and localfor more than a decade. There are only two sector and probably, a relative increase inimportant exceptions. One involves inter- the cost of federal off-budget activity. Theest on the debt, which has risen rapidly latter is hard to measure and no precisein the 1980s because of large recent def- estimates are attempted here. Such off-icits and the high real interest rates that

3 budget activity has taken many forms, butthey have engendered. The other, whichthe most important involve governmentis much more important, involves assis-regulation and credit programs, with thetance to the elderly, rich and poor alike.latter relying heavily on the creation ofIt is no exaggeration to say that if thegove,nment sponsored enterprises out-growth of spending on the elderly can be

explained, then it is possible to explain the side of the budget. By focusing only on

bulk of federal noninterest, civilian federal spending, this paper will admit-tedly miss other significant developments

*The Urban Institute, Washington, DC 20037. in the importance of the public sector.

437

438 NATIONAL TAX JOURNAL [Vol. XLIV

Moreover, the paper only examines a can War nor World War I had a lastingportion of federal spending in detail-that effect on the relative size of the civilianwhich is not war-related. War-related ex- budget.penditure is defined broadly to include di- The fiscal history of the 1920s is re-rect military spending, benefits for vet- markable. In fiscal 1927, the unified bud-erans, foreign assistance, and interest on get surplus, as it would be measured to-the public debt. It is more legitimate to day, amounted to 40 percent of outlays! Indefine the last as being war-related be- fiscal 1929, the surplus fell to 23.5 per-fore the Great Depression than after, since cent of outlays or to about 0.7 percent ofbefore that time, the nation seldom ran GNP. That would be equivalent to run-deficits except during wars. More re- ning a surplus today of about $40 billion.cently, peacetime deficits have become the The public debt at the end of 1929 wasrule rather than the exception, but I con- considerably less than 20 percent of thetinue to exclude interest because of a de- GNP. It was a time when the nation stillsire to focus on program spending. felt a strong moral imperative to pay off

any debt acquired during wars and reces-

A Sketch of Long-Run Spending sions. If the federal government was a

7@-ends leviathan before the Great Depression, itwas a puny representative of the species.

Prior to the Great Depression, federal The Great Depression fundamentallyspending that was not related to wars was changed the role of the federal govem-trivii(I relative to the size of the economy, ment in American society in three ways.seldom amounting to more than one per- First, the Keynesian Revolution changedcent of the GNP. (See Table 1.) According attitudes toward deficits. Althoughto Kendrick's (1955) estimates, it was at Keynesian economics may, at firs@, haveabout 0.2 percent of national income by been used as a post hoe excuse for deficits1799 and moved upward in erratic spurts that could not be avoided as the economyto about 1.1 percent of national income collapsed, it did destroy the strong moralfollowing the Civil War. rule that budgets should be balanced un-

Peacock and Wiseman (1979) have ar- less there were very strong arguments forgued that democracies become accus- doing otherwise.' Second, there was a one-tomed to higher tax rates during wars and time, large surge in total noninterest do-then substitute civilian for war-related mestic spending relative to GNp.7 Third,expenditures after the war has ended, the federal government began to provideThere seems to be considerable evidence the population with significant amountsfavoring this hypothesis during the nine- of social insurance. The two most impor-teenth century. The share of domestic tant social insurance programs, measuredspending in national income grew rapidly by the long-term commitment of re-after the War of 1812, the Mexican War, sources that they implied, were Social Se-and the Civil War. It is more difficult, curity and unemployment insurance.however, to sustain the hypothesis into the However, Social Security did not add sig-twentieth century. nificantly to spending until after World

For the period after the Civil War, War B. Once unemployment insurance wasKendrick (1955) compares spending to initiated, it, of course, varied up and downGNP rather than national income, and he with the business cycle, but there is nois forced to use a somewhat inconsistent long-term upward trend in its share ofestimate of GNP for this purpose.' Using GNP. Therefore, it will not be consideredthis new measure, the ratio of domestic in detail in this analysis.spending to GNP declines from 1.2 per- The surge in noninterest domesticcent in 1869 to 0.8 percent in 1920 before spending began in the Hoover Adminis-rising slightly to 0.9 percent in 1929. Much tration, long before the New Deal started.of the post-Civil War expansion was re- Between 1929 and 1933, purely civilianversed, and neither the Spanish-Ameri- spending tripled while the GNP was

No. 4, Part 21 FEDERAL GOVERNMENT GROWTH 439

TABLE 1FEDERAL GOVERNMENT SPENDING RELATIVE TO NATIONAL

INCOME AND GNP, SELECTED YEARS, 1799 TO 1939(PERCENT)

Thtal War-Related CivilianYear Spending Spending Spending

(Percent of National Income)

1799 1.4 1.2 0.21809 1.1 0.9 0.21819 2.4 2.0 0.41859 1.5 0.8 0.71869 4.6 3.5 1.11889 2.9 1.8 1.1

(Percent of GLIP)

1869 5.0 3.8 1.21883 2.2 1.5 0.7189Q 3.6 2.7 0.91906 2.1 1.3 0.81913 2.0 1.3 0.71916 2.8 2.3 0.51918 23.7 23.1 0.61920 6.7 5.9 0.81929 3.0 2.1 0.91939 10.4 2.1 8.3

Note: War-related spending includes direct military spending,interest, veteran pensions, and foreign assistance.

Source: M. Slade Kendrick, A Centu@x and a Half of FederalExpenditures, occasional Paper No. 48, National Bureau ofEconomic Research, 1955, pp. 10-11, 74-77.

halved. By 1939, civilian spending had penditures actually declined absolutelyalmost tripled again while the nominal between 1940 and 1945.' The decline rel-GNP had not yet reattained 1929 levels. ative to GNP was from 6.8 percent to 2.5As a result, noninterest domestic spend- percent (Table 2).ing relative to GNP increased almost ten- After World War II, domestic expendi-fold, from 0.9 percent in 1929 to 8.3 per- tures again soared. By 1950, their sharecent in 1939. of GNP was 4.5 percent, of which Social

With the economic recovery and the Security was still only 0.3 percent. Clearly,growing burden of war-related expendi- the federal government was now playingtures, the nominal value of civilian ex- a very different role in the economy than

TABLE 2FEDERAL SPENDING AS A PERCENT OF GN

FOR SELECTED YEARS AND PROGRAMS1940-1989

1940 1945 1950 1962 1965

Total 9.9 43.6 16.0 19.2 17.6

National defensea 1.5 38.6 4.6 8.8 7.0Interest 0.9 1.5 1.8 1.2 1.3Veterans 0.6 0.1 3.3 1.0 0.9international

affairs 0.1 0.9 1.8 1.0 0.8

Total non-interestciviliana 6.8 2.5 4.5 7.2 7.6

social Security 0.0 0.1 0.3 2.6 2.6Medicare 0.0 0.0 0.0 0.0 0.0civil Service

retirement 0.1 0.1 0.1 0.2 0.2

other civiliari@k 6.7 2.3 4.1 4.4 4.8

Sources: U.S. office of Management and Budget, Historical Tables,Fiscal Year 1990 (Washington, D.C.: U.S. Government Printing ottice,office of jeag-e-ment and Budget, Met of the United States GoverrmenU.S. Government Printing office, 1990), pp. A-295, A-296, A-303; andfunctional definitions have been altered slightly for the purposes ofoutlays have ben moved 3.nto the defense budget from the income securfuture retirement costs, now charged to the military, has beenfunction 950 where it appears as an offsetting receipt.

aoutlays for military retirement are included in the national deiense


it played in 1929, when the share was 0.9 in 1962 to 13.5 percent in 1976. Otherpercent. The surge in noninterest domes- western democracies witnessed similartic spending immediately after World War growth and academics around the worldIl might be considered an illustration of became interested in the causes of this vastthe Peacock-Wiseman substitution effect, expansion. There was a tendency to viewbut I believe that it is better understood this growth as being a long-run feature ofas a return to the philosophy of govern- western democracy and various theoriesmental activism established during the were created to explain it.Great Depression. That philosophy could The rapid relative growth of U.S. fed-not be sustained given the enormous eco- eral civilian spending came to an abruptnomic demands of the war, but it reas- halt in the late 1970s and during the de-serted itself soon after the war ended. cade of the 1980s. By 1989, noninterest

Noninterest domestic expenditure con- domestic spending had shrunk to 12.2tinued to grow relatively during the 1950s percent of GNP from 13.5 percent in 1976.and by the first budget fully controlled by Outside of the growth of civil service andthe Kennedy administration-that for Social Security pensions, disability pay-fiscal 1962-it was absorbing 7.2 percent ments, and the Medicare program, whichof GNP. But, despite major domestic ini- had been established in 1965, the shrink-tiatives, such as the construction of the age was even more dramatic. Subtractinginterstate highway system, initiated by Social Security, civil service pensions, andEisenhower, over 80 percent of the growth Medicare from total noninterest domesticin civilian spending's share of GNP be- spending, the remainder declined rela-tween 1950 and 1962 can be attributed to tively from 7.7 percent of GNP in 1976 tothe maturing and expansion of the Social 5.5 percent in 1989. Deflated by the GNPSecurity system. Social Security benefit deflator, the growth in such spendinglevels were made slightly more generous amounted to only 0.2 percent per year overrelative to income in the 1950s, but much the period.9 This contrasts with ex-of the growth resulted from a broadening tremely rapid growth between 1962 andof the system to bring in new workers, such 1976, when civilian spending outside ofas farm workers and the self-employed, pensions and Medicare grew over 7 per-and from the creation of disability insur- cent per year. The effects of that rapid pe-ance in 1956. The system was also ma- riod of expansion relative to GNP were notturing as retirees had more years of cov- reversed by 1989. Over the entire perioderage. Between 1950 and 1962, Social 1962 to 1989, annual growth in absoluteSecurity grew from 0.3 to 2.6 percent of civilian spending levels outside of SocialGNP. Absent Social Security, noninterest Security, federal civilian pensions, anddomestic spending grew from 4.2 to 4.6 Medicare averaged 4 percent per year.percent of GNP. Reviewing the post-Depression history

Deflated by the implicit GNP deflator, of spending, I find it remarkable that ifthe absolute level of non-Social Security Social Security, Medicare, and civil ser-domestic real spending had not yet re- vice pensions are removed, remaininggained its 1940 level by 1950. But, be- noninterest domestic spending fell signif-tween 1950 and 1962, such spending grew icantly as a share of GNP, from 6.7 per-at an average annual rate of 4.5 percent. cent in 1940 to 5.5 percent in 1989. ThatNevertheless, over the entire period, 1940 surprise is not much diminished by the factto 1962, the average annual growth rate that a comparison of 1940 and 1989 is awas only 2.2 percent, and so, such spend- comparison of apples and oranges. Theing fell considerably short of regaining its economy in 1940 was still depressed by theprewar share of potential GNP. lingering effects of the Great Depression,

The period from the early 1960s to the while in 1989 the economy was essen-mid-1970s saw both Social Security and tially operating at full employment.other forms of domestic spending grow It is difficult to adjust 1940 spending forrapidly. Relative to GNP, total domestic the effects of high unemployment and tospending almost doubled from 7.2 percent estimate precisely full employment GNP


growth since 1940. But even if appropri- necessary to make international compar-ate adjustments were made, it is unlikely isons of health spending for the elderly.that noninterest civilian spending outside The United States has explicitly chosenof pensions, disability payments, and to target the elderly, the disabled, and theMedicare has grown very much relative poor with Medicare and Medicaid, but mostto potential GNP. Deflated with the im- other countries provide universal cover-plicit GNP deflator, the average real age.growth in actual spending amounted to3.1 percent per year between 1940 and A Brief History of Programs for the1989. Adjusting for the state of the cycle Elderlyover such a long period does not alter thatgrowth rate significantly. A potential GNP Before social insurance was federalized,growth rate slightly less than 3 percent it was provided by a variety of public andimplies that cyclically adjusted noninter- private institutions. The extended familyest, nonelderly spending absorbed less than provided a great deal of assistance, but notone percentage more of potential GNP in without creating severe interpersonal1989 than it did in 1940. tensions. Unions, private charities, and

When Social Security, Medicare, and state and local governments were also ac-civil service pensions are added back in, tive in providing economic support to thethe share of total noninterest civilian aged and destitute." In the late nine-spending in actual GNP rises signifi- teenth and early twentieth century, therecantly, from 6.8 percent in 1940 to 12.2 was an important movement within thepercent in 1989. The average annual corporate sector to provide pensions,growth rate of real spending rises to 4.8 workmees compensation, and other ben-percent per year, thus showing the enor- efits, but this movement was squelchedmous importance of the nation's commit- by the Great Depression. 12 Unfortu-ments to the elderly. nately, it is impossible to judge the quan-

Of course, it is important to emphasize titative importance of nonfederal socialthat the rates of growth of various forms insurance from available data, but it isof spending are not unrelated. It is very clear that the portion of the system deal-probable that the growing cost of our ing with retirees would have come undercommitments to the elderly has made us severe stress even without the Greatless willing to finance other forms of Depression.spending. Moreover, this analysis is not More people were surviving to age 65complete because it has only focused on and more of those were working in the in-noninterest domestic spending. In addi- dustrial sector where retirement wastion, interest on the debt has recently be- common, rather than in the agriculturalcome a major burden and that too has sector where people tended to work untilprobably acted as an indirect restraint on they were too feeble to do so. In the periodother types of spending. 1900-02, only 39 percent of white males

It is interesting to note that public pen- could expect to survive to age 65. By 1929-sions have been important in explaining 31, the survival rate had risen to 60 per-public sector spending growth in most cent. As the need rose, other forms of fed-OECD countries. On average, public pen- eral support, mainly veteran's pensions,sion growth explained 26.9 percent of the became less important as fewer were el-increase in the share of GDP absorbed by igible.the spending of all levels of government President Roosevelt responded to thein the entire OECD during the period situation with a two-pronged initiative.1960-85. But the relative importance of He wanted, first, to respond to the im-public pension growth was higher than mediate economic emergency with var-average in the United States, accounting ious forms of assistance to the unem-for 32.2 percent of the increased share of ployed and the destitute aged and hethe spending of all levels of govern- wanted, second, to put a long-term formment." It is difficult to obtain the data of assistance in place for the elderly. It was


the latter initiative that led to the estab- was intended when the new indexinglishment of Social Security in 1935, but technique was invented. The error wasthe first benefit was not paid until 1940. corrected in 1977 and after rising a bitIn the debate leading up to the establish- during a transition period, the replace-ment of Social Security, there was much ment rate was lowered to about 42 per-discussion of the extent to which it should cent by 1990.be redistributive. But the proponents of The other major change of the 1960s wasthe current system argued convincingly the creation of Medicare in 1965. Thisthat unless considerable support was pro- represented an enormous commitment, asvided to the middle classes, the system improved technology and the increasingwould lack political strength and stabil- relative price of health care services haveity." President Roosevelt personally be- continually increased the cost of servinglieved that Social Security should not be each beneficiary.regarded as a welfare program. Why were the elderly suddenly treated

Although this analysis focuses on So- so much more generously in the 1960s andcial Security, civil service pensions, and early 1970s? The answer may be providedMedicare because of their overwhelming by the characteristics of the economic en-importance, it is important to note that vironment of the late 1960s and earlythe elderly also receive a disproportionate 1970s. Economic growth was unusuallyshare of Medicaid, housing subsidies, and high in the period, 1962-66. An illusionnutritional assistance, and that an im- existed that comparable growth wouldportant welfare program, Supplementary continue. Economists felt that the busi-Security Income, is also focused on the el- ness cycle had been conquered, and untilderly. In all, almost one-half of the non- the Vietnam War turned sour, the nationinterest civilian budget goes to the el- was brimming with self-confidence. Thederly and other pensioners." But this elderly had been among the nation'sanalysis will continue to focus on Social neediest in the early 1960s, and a strongSecurity and Medicare, because they so consensus developed that the nation coulddominate all other programs. afford to do more to assist this merito-

As already noted, much of the growth rious group.of Social Security outlays in the 20 years Indeed, other spending grew as well, asfollowing World War II was due to the the nation launched a more generalizedmaturing of the system, its various ex- "war on poverty" and the Great Societypansions involved covering a greater pro- flourished. Although the recession of 1970portion of the workforce, and the creation and stubborn inflation reduced the con-of disability insurance in 1956. The ratio fidence of economists that the businessof benefits to the previous year's in- cycle had been conquered, the peace div-come-i.e., the replacement rate-for the idend from Vietnam continued the illu-single worker retiring at age 65, who had sion that the nation could afford to doalways earned the average wage, re- more. Past rapid economic growth en-mained roughly constant between 30 and hanced the resources of the trust funds35 percent over the entire period, 1950- that finance Social Security, but major65. In the late 1960s and early 1970s, there payroll tax increases were also enacted towere several increases in real benefits, finance benefit increases. Between 1965culminating in a massive 20 percent and 1973, the maximum employee OASDInominal increase in 1972. In that same payroll tax payment tripled, from $174 toyear, benefits for the already retired and $524. But income taxes were cut to offsetthe formula used to determine initial this increased burden, and- by 1971 thebenefits were indexed for inflation. The overall tax burden relative to GNP wastechnique used to index the latter proved returned to approximately pre-war levels.unintentionally generous as inflation ac- Spending growth seemed to confirm thecelerated, and it soon became apparent Peacock-Wiseman hypothesis, but taxesthat the replacement rate would soon soar did not. Thus the nation made an impor-beyond 50 percent, a level far higher than tant misjudgment. A permanent increase


in our promises to the elderly was fi- changes in national priorities. If the the-nanced with a source of resources-the ories work, they either work very differ-peace dividend-that was certain to be ently for different forms of spending ortemporary. other forces are at work that are more im-

The economic problems of the 1970s, portant.combined with the overly generous method In studies of the growth of governmentof indexing chosen in 1972 and the un- spending, social insurance is often lumpedexpected growth in the costs of the Med- with welfare spending and other entitle-icare program, made the burdens ac- ments, and because it involves transfercepted during this period far more onerous payments, it is often seen as part of gov-than was anticipated. Social Security re- emment's efforts to redistribute income.forms in 1977 and 1983 lowered benefits Social Security does, in fact, have a sub-and the rate of growth of Medicare costs stantial redistributive element. For ex-was trimmed slightly in a number of ways ample, employer-employee payroll taxesduring the 1980s. But the nation still had paid for 85 percent of the real presentnot come to grips with the conflict be- value of retirement benefits that can between fulfilling promises made to the el- expected by a single male, 1990 retireederly, satisfying other demands for spend- who earned the maximum payroll tax baseing, and an apparently fervent desire to throughout his working life. For someonekeep tax rates close to the levels of the always earning the average wage, theearly 1960s. Of course, President Reagan "earned annuity" was only 72 percent ofintensified the conflict by cutting taxes and the present value of benefits, and for a low-accelerating the growth of defense spend- income worker it was 53 percent." Buting, but even in the absence of this strange social insurance is very different from ashift in fiscal policy, a conflict would have typical redistributive program. You do notexisted that would have bedeviled any have to be poor to get it. It is designed toadministration. protect against reductions in wage in-

come resulting from retirement, disabil-ity, or unemployment and against claimsImplications for Normative Theories on income resulting from health expen-

of Public Choice ditures. It does not matter from what levelWhen federal spending is disaggre- wage incomes fall. Protection is provided

gated, it is dffficult to sustain theories that to the affluent and non-affluent alike. Itimply government is a leviathan that does have a redistributive element in thatgrows inexorably. The federal govern- programs are often designed to replace ament took on huge new responsibilities in higher proportion of lost income for lowerone great leap during the Great Depres- wage earners, but this is not its most im-sion and, of these, providing financial as- portant characteristic.sistance to the elderly was, by far, the most In Musgrave's (1959) normative theoryimportant; its growth explains most of the of government activity, three roles are de-growth of total spending relative to GNP. fined for the public sector. It should al-This history casts considerable doubt on locate resources to the production of goodsthe importance of theories of government that, for a variety of reasons, cannot begrowth that claim an upward bias to most provided in optimum quantities by thetypes of spending because of imperfec- private sector. It should, through its tax-tions in the system for making political transfer system, produce a more equalchoices. Obviously, the historial record distribution of income than would be pro-does not prove definitively that such the- vided by an unfettered free market, andories are wrong, because spending can be it should stabilize the economy. As notedupwardly biased while still declining rel- before, social insurance does redistributeative to GNP for significant periods. It only income to some extent, and by protectingsuggests that the power of such theories against reductions in income, it also servesis not -overwhelming, and in particular, as an automatic stabilizer. But it wouldsuch forces have not prevented massive seem to fit best into Musgrave's allocative


function. To the extent that social mech- way. After retirement, CPI indexing keepsanisms, other than government, exist for the benefit constant in real terms. But theprotecting against reductions in income, indexing technique for initial benefits,whether through the family or other in- combined with demographic projections ofstitutions, it has often been pointed out a retired population that grows faster thanthat individuals will be tempted to be free the total population and lives longer inriders and not provide enough security for retirement, insures that Social Securitythemselves through personal saving. They will absorb a growing proportion of na-can also get a free ride on whatever pub- tional income in the long run. (The 1983lic welfare programs exist. That is why reforms altered the social contract some-social insurance is compulsory. Moreover, what by raising the normal retirement agethe protection offered by social insurance in the twenty-first century and taxing awould be difficult to duplicate through portion of benefits, but this will not pre-private insurance because the very pro- vent total Social Security benefits fromvision of insurance alters behavior in a growing faster than incomes after a shortway that increases costs. (The moral haz- respite lasting through the beginning ofard problem.) To-the extent that families the 21st century because of low birth ratesand other collective private institutions during the Great Depression.)attempt to protect themselves against Baumol (1967) explained the relativemoral hazard and to compel working growth of local government spending bymembers to contribute to the less fortun- arguing that government is essentially inate, painful personal tensions multiply. For

the business of providing services, andall of these reasons, the creation of a com- since productivity in the service sector lagspulsory system of federal social insurancethe average for the whole economy, thehas much political appeal as a substituterelative cost of government is bound tofor mechanisms that can only be run im-

perfectly and with considerable paiii by rise. Combined with reasonable assump-

the private sector. None of this provides tions regarding the sensitivity of the de-

much guidance as to how generous the mand for public services to prices and in-system should be, and it was the broad- come, the share of income spent onening and the increase in the generosity government will rise continuously.of the system in the 1960s and 1970s that This theory does not do well explainingled to its growth relative to GNP since that total federal government growth or Socialtime. Security growth. Between 1960 and 1990,

Although most federal spending func- federal civilian employment has growntions do not confirm "Wagner's Law" that much more slowly than the total popu-public spending inevitably grows faster lation or the labor force while total spend-than private income," the indexing tech- ing and the number of programs havenique chosen for Social Security in 1977 grown faster than the economy. Social Se-very explicitly adopts a philosophy that curity is largely a check writing opera-implies that total Social Security outlays tion whose administrative costs are min-will grow faster than incomes in the very iscule relative to outlays and whoselong run. It tries to keep the replacement productivity has been aided significantlyrate constant for each successive cohort of by the computer.retirees, so that the real value of individ-

Baumol's theory, however, does haveual benefits grows as the economy grows.It also has the effect that a member of a some relevance to the growth of Medi-

later cohort of retirees that has exactly the care. Productivity growth in providingsame real absolute earnings over a life- health care service is hard to define be-

time as some earlier retiree will never- cause Of quality change and changes in thetheless enjoy a higher replacement rate composition of the product, but certainlyreflecting his or her lower relative posi- the cost per recipient has soared and istion in the income distribution. Only the responsible for a large share of the rela-initial benefit, however, is indexed in this tive growth of the program.


Social Insurance As A Distortion of government regulation. But it is less

The Elderly as a Special Interest successful in explaining spending trends.

Group. The pure theory of special inter-It does not, for example, explain why the

ests suggests that small groups can ac- Iron Triangle has been so successful with

quire significant benefits concentrated on programs for the elderly and, in recent

their members while diffusing the costs years, so unsuccessful with almost every-

so widely across the population that the thing else. Nevertheless, it must be ad-

majority does not find it in their interest mitted that the development of Social Se-

to oppose the special interest program. curity has been greatly influenced by the

Certainly, the elderly are well organized Social Security bureaucracy." The Con-

politically and politicians live in fear of gress has relied heavily on the expertise

the AARP and other more militant el- of a devoted band of long-time civil ser-

derly groups. vants in the Social Security Administra-

But the cost of Social Security is so large tion whenever they have altered the pro-

and so apparent in the form of earmarked gram, and those civil servants are

payroll taxes that it is hard to believe that certainly advocates for the elderly. But I

the elderly could have captured such a believe that their role is much like thatof the elderly special interest groups. Theylarge share of the GNP without the will-are important and powerful, but they coulding acquiescence of the rest of the popu- not possibly have been so successful with-lation. In fact, the evidence from one pub-out the willing acquiescence of an over-lic opinion poll after another suggests thatwhelming majority of voters.assisting the elderly is overwhelmingly

Misinformation and Inertia. Havingpopular among all segments of the pop-argued that there are good normative ar-ulation, including the very young." It is, guments for providing social insurance toof course, particularly popular with those the elderly and that such support is over-near retirement and those who might whelmingly popular, it is still difficult tootherwise have to contribute privately to understand why the support need be sothe elderly. The latter include the chil- generous, especially to the more affluentdren of the elderly and businesses who elderly. Has the nation overcommitted it-might otherwise have to finance more self to the elderly in the sense that thegenerous pension and health plans. Just system has proved more burdensome thanadding up those groups that have a directanticipated when it was expanded? Put-and immediate interest in the program ting the question another way, would theprobably yields a majority of voters and Social Security system have been ex-there are few who oppose the program in panded so vigorously in the late 1960s and

the minority that remains. Whether the 70s and would such a generous Medicarestrong support given Social Security is well program have been designed if it had beeninformed is another matter, and that point known that future economic growth wouldwill be discussed later. fall so short of the expectations prevailing

Maximizing Bureaucrats. Some, nota- at the time and that the cost of health carebly Niskanen, see the growth of govern- would rise so much faster than otherment spending as the result of the actions prices?of selfish bureaucrats who gain power by If not, are we now victims of what Rosemaximizing their bureau's budgets. With (1984) calls "the inertia of establishedwilling allies in the Congress and among commitments"? Obviously, once a socialinterest groups, combined in the so-called insurance commitment is made, it is very"Iron Triangle," they are said to impose a difficult to rescind. It becomes part of thegovernment on the voter that is far larger social contract and individuals plan theirthan anything that would be chosen will- lives around it, That does not mean thatingly. the social contract can never be renego-

There may be a grain of truth to this tiated. But renegotiations are alwaystale, and I find it especially appealing in painful and when they occur, as in 1983,explaining the rapid and expensive growth benefit cuts are likely to be limited.


Renegotiations are made even more dif- come more motivated to understand theficult because of a lack of voter knowl- system.edge of the characteristics of the current Whatever the degree of understandingsystem. It is, in fact, a system surrounded of the structure of the Social Security sys-by myth, as individuals are encouraged to tem, I think it clearer that few under-think of it as a contributory pension sys- stand its size relative to other programstem. The payroll tax payment is officially in the budget. More generally, few un-labeled a "contribution" and it goes into derstand the vast size of the current com-a "trust fund." Individuals can check up mitment to the elderly when other pro-on their "account" or earnings record in grams that provide the elderly withthe system. Voters are, in other words, benefits are added to the burden impliedencouraged to think that they purchased by Social Security. Most are surprised totheir pension rights, that they own them, learn that almost one-half of civilian,and that no one has the right to alter them noninterest spending now goes to the el-in any way. derly and that that share will grow rap-

Suspicions should be aroused among idly when the members of the baby boomcurrent recipients because of the gener- of the 1940s and 1950s begin to retire earlyosity of their benefits relative to their in the 21st century, although this fact hascontributions. The rate of return enjoyed recently been getting a bit more attentionby past retirees on employer-employee tax from the media. Few realize that the el-payments far exceeds what could have derly are now more affluent on averagebeen earned on private investments. But than the rest of the population. Indeed,it is not clear that their good fortune is most still think that the elderly are amongwidely recognized. the nation's most needy groups .21 If Such

The present value of the ratio of ex- things were better understood, it wouldpected benefits to lifetime tax payments not guarantee that a majority would wishwill be falling rapidly in the future. For to cut benefits significantly. But if theythe average single male retiring in 1990, did wish to mitigate the rapidly-growingthe expected present value of benefits dis- burden to be faced in the next century, nowcounted at a real rate of 2 percent exceeds would be a good time to do it, so that thethe present value of tax payments by over retirement plans of those now working$32,000, or by almost 40 percent. By 2010, could be adjusted accordingly.the present value of tax payments will ex- There have, in fact, been significant re-ceed that of benefits by almost $12,000, or forms in Medicare in almost every yearby 8 percent. For those earning the max- since 1983. Most of the changes have in-imum wage base over a lifetime, the de- volved reducing payments to providers ofterioration will be even more rapid. For health care, but such reforms often indi-the 1990 retiree the present value of ben- rectly raise the share of costs borne by re-efits exceeded tax payments by 17 per- cipients. Social Security has, however, be-cent, or by almost $23,000. By 2010,. the come more difficult to reform. The budgetpresent value of tax payments will exceed agreement of 1990 puts it off-budget andcost4 by 43 percent, or by more than its outlays and receipts no longer count in$96,000.'9 computing the official budget deficit.

Will the political popularity of the sys- Ironically, to the extent that Social Se-tem erode as the most affluent and most curity cuts would automatically increaseinfluential taxpayers subsidize it more and spending in on-budget welfare programs,more? Certainly, it is difficult to see much the official deficit is increased by Socialchange in support as the net gain fi- Security benefit cuts. Gramm-Rudman hadnanced by labor force growth, productiv- earlier put Social Security off-budget fority growth, and payroll tax increases has procedural purposes. That implies thatbeen diminished." But it may be that the Social Security reductions can no longerpolitics of the program will change more be considered as part of any package re-radically when the net gain is converted ducing other entitlements. (Such bills areinto a net loss. Participants may then be- called "reconciliation bills@' by the Budget


Act of 1974.) Social Security reductions spending and played some role in forcingmust be voted on in isolation and that the cuts in defense and international as-makes it much more difficult to contem- sistance that occurred in the late 1980s.Plate cuts. Even without this added pro- Yet, there is no denying the Politicaltection, Social Security would be difficult popularity of the elderly programs. Willto cut because of its status as an "entitle- their popularity wane in the 21st centuryment." It takes an explicit legislative ac- when costs soar and the rate of return totion to cut an entitlement, whereas dis- lifetime payroll tax payments falls far be-cretionary programs cannot be continued low the levels enjoyed by current retir-without explicit actions to fund them. That ees? Some believe that the programs willdoes not mean that entitlement reforms become ever more difficult to cut, becauseare impossible, as our discussion of Med- retirees and those near retirement willicare just proved, but it may help to ex- constitute a growing share of the votingplain the relatively harsh treatment of population. On the other hand, the claimsdiscretionary programs since the late of the elderly will become less legitimate1970s. if their relative affluence continues to

grow, and with growing affluence, they

Summary and Conclusions may defend the programs less vigorously.Because of the strength of the myth that

When federal government spending is Social Security is a contributory pensiondisaggregated, it becomes difficult to sus- system, the perceived financial health oftain the hypothesis that the government the Social Security trust funds plays anas a whole is a leviathan that continually important role in the politics of the sys-gobbles up more and more of the GNP. tem. Those trust funds will continue toThrough history, civilian spending's share grow relative to outlays until about 2015.Of the GNP waxed and waned until it took After that they will begin to shrink rap-a significant jump upward during the idly. Even before 2015 computations of theGreat Depression, Since that time, the actuarial deficit in the system will be-growth in the federal government's share come more and more alarining.of the GNP can be entirely explained by I suspect that, because of all of thesesocial insurance programs for the elderly factors, there will be some successful at-started in the Great Depression and ex- tempts to limit the growth of programs forpanded significantly in the 1960s and 70s. the elderly early in the 21st century. Pol-

The share of GNP of other types of ci- iticians feared even debating Social Se-vilian spending also grew rapidly in the curity cuts in public in the 1970s. More1960S and early 1970s, and that inspired recently, there is a growing perceptiona large literature that seemed to imply among legislators that the elderly arethat government's share would expand crowding out more important spendinginexorably. But nonelderly, civilian pro- priorities from the budget, and the issuegrams have declined in relative impor- is debated publicly. The reform of 1983 didtance since the late 1970s, and there is a prove that it was not impossible to cutPaucity of theories explaining that phe- benefits in that it extended the normalnomenon. The new budget agreement of retirement age for Social Security and1990 treats such spending more gener- taxed some of the benefits for the firstously through 1993 than it has been time. True, it took a financial crisis in thetreated over the last decade, but never- trust funds to accomplish these things. Buttheless, its share of GNP will not rise if even without an immediate crisis, thethe agreement is enforced. President's budget for fiscal 1992 advo-

The elderly programs do, however, ap- cates cutting the Medicare Part B subsidypear to be a true leviathan. It is reason- for those earning above $125,000 per year.able to speculate that it is their growth, Subjecting a higher portion of benefits tocombined with public hostility to higher taxation is getting more favorable noticetaxes and concern over the deficit, that has from academics and legislators.crowded out other forms of domestic I doubt, however, that such reforms will


be sufficiently dramatic to lower the share gregate, which is much larger because it includes en-

of GNP absorbed during the 21st century titlements for the nonelderly.loholtzmann (1989).

by programs serving the elderly. The "in- "Fischer (1978).ertia of established commitments" is too "Mitchell (1989).powerful for that. "Arthur J. Altmeyer (1966). While the theory that

universal Programs would have more political strengththan programs targeted to the poor and so are a bet-

ENDNOTES ter way of assisting the poor may have had merit inthe 1930s, the 1980s have seen an expansion of many

**The author is indebted to the Andrew W. Mellon targeted programs while Social Security and Medi-ations for fi- care have been cut back. See Greenstein (1991). It isand the Lynde and Harry Bradley Found also possible for universal programs like Social Se-nancial support. He would like to thank Eugene curity to become so popular that they begin to squeezeSteuerie and anonymous referees for helpful com- out attempts to increase targeted assistance for thements without implicating them in the end product. poor. See Sawhill (1989). For the opposite view, see'An excellent review can be found in Larkey, Stolp, skocpol (1991)

and Winer (1984). "Not all pensioners are elderly, especially many re-'Musgrave (1981), however, has severely criticized ceiving civil service pensions. I have also oversimpli-theories of government as a leviathan. fied by discussing all of Social Security as though it'Some will object that the evidence linking the fed- goes only to the elderly. Payments to the disabled anderal deficits to higher real interest rates is shaky. For to younger survivors of deceased workers are signif-a review, see Barth, Iden, Russek, and Wohar (1990). icant, but the statement that almost one-half of the'Niskanen (1971). noninterest civilian budget goes to the elderly is true'The estimate of GNP that is used is lower than the even when such payments are excluded. I have keptestimate of national income during overlapping pe- payments to the disabled and survivors jumped in withriods. Social Security, because various legislative actions'The importance of this change is analyzed in changing the generosity of payments have typicallyBuchanan and Wagner (1977). treated all recipients similarly, and so changes in at-'The importance of spending growth during the titudes to the elderly are closely tied to changes inGreat Depression has been emphasized by Tanzi (1983). the government's generosity to other Social SecurityBAt this point in the analysis, I shift from using recipients. None of the conclusions of this analysisKendrick's valuable estimates and I begin to use data would be changed significantly, however, if it had onlyprovided by the Office of Management and Budget. focused on pensions.The data from 1940 on are on a true fiscal year basis, '5The low-income worker is assumed to have al-whereas Kendrick had to estimate calendar year ways earned 45 percent of the average wage, and inspending totals to correspond to the calendar year es- all cases, retirement is assumed to occur at age 65.timates of GNP that were available to him. There are The calculations assume a real discount rate of 2 per-some other minor differences between the budget ac- cent and utilize the II-B economic and demographiccounting definitions implicit in Kendrick's data and assumptions of the 1990 Annual Report of the Boardthose used by OMB. I have also altered OMB func- of Trustees of the Federal Old-Age and Survivors In-tional definitions slightly. Actual military retirement surance and Disability Insurance Trust Fund. Thereoutlays have been moved into the defense budget fi-om is also a substantial redistribution of Social Securitythe income security function, and the accrual charge wealth from single retirees and two-eamer couples tofor future retirement costs, now charged to the mili- married couples with a dependent spouse, I am grate-tary, has been removed from the defense budget and ful to Eugene Steuerle and Jon Bakija of The Urbanfrom function 950, where it appears as an offsetting Institute for providing these calculations from un-receipt. None of these changes is important enough published tables.to affect the conclusions regarding budget trends. "Adolph Wagner's nineteenth century theory is ex-'Cogan and Muris (1990) have argued that the true cargrowth of domestic discretionary spending is under- pted in R. A. Musgrave and Alan T. Peacock (1958).

stated during this period because of a number of ac- "See the evidence cited in Shapiro and Smith (1985)

counting anomalies. For example, user fees are treated and Yankelovich, Skelly and White, Inc. (1985)as negative outlays and spending financed by such fees '8Derthick (1979).does not show up in the aggregates. Such fee@rose "Steuerle and Ba"a (1991).significantly during the period, but I regard th s in- 'McKenzie (1990) believes that the 1977 and 1983crease as a symbol of fiscal stringency. More selnous, reforms of the system already indicate a diminutionthere was a strong tendency at the end of the period of support. He argues that the system could operatefor loan guarantees-which are not recorded in the as a classic special interest program before the mid-budget until claims must be paid-to rise, and for di- 1970s, but since that time it has become too large andrect loans-whose gross amount is initially recorded can no longer extract rapidly increasing quantities ofas an outlay-to fall. Ideally, my figures would adjust resources fiom the majority of voters. As ah-eady noted,for this last anomaly, but this is difficult, given that I believe that it was far too large to be regarded as aoutlays associated with guarantee claims are aggre- special interest program long before the mid-1970s.gated nowhere in the budget. While an appropriate It is tautological to argue that it was a special inter-adjustment would have a significant effect on the re- est program while it was expanding most rapidly, butcorded growth of domestic discretionary spending, it it has not been one since the expansion was slowed.would have much less of a relative impact on my ag- "This result comes from a poll taken in 1989. It

460

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