Suggestions for Income Testing in Social Insurance Programs 
Jeff Lemieux
October 27, 2003

On reflection, the debate over income testing in Medicare is much larger than the prescription drug bill in Congress -- it raises fundamental questions about how Americans want social insurance programs to work.  In general, all beneficiaries of the social insurance programs should be assured of basic insurance protections against poverty or lack of health care due to insufficient retirement income or health insurance.  Beyond those most basic protections, however, means testing would be appropriate in many cases. 

Recent press reports indicate that Congressional negotiators preparing the drug bill for final passage are likely to include an income-tested Medicare premium.  On the one hand, this is a much better idea than the income-tested drug benefit included in the House-passed bill.  (It would be much easier to administer and would cause fewer privacy concerns.)

 

On the other hand, even an income tested premium will inject new controversy into the drug debate.

 

Many liberals and social insurance advocates denounce income testing of any kind.  The social contract should be clear at the beginning, they say:  Work this much, and you will get these benefits, regardless.  They worry that income testing of any kind will cause the entitlement programs to lose political support and become more like welfare.

 

Some conservatives have complained that an income-related Medicare premium would be a new "tax."  (In fact, it's not a tax -- Medicare premiums are for optional, voluntary benefits.)

 

Either way, opponents of income testing are being shortsighted.  Income testing will probably be necessary to sustain the entitlement programs.

 

However, there is a good reason to approach income testing in a careful, even strategic way, not just as an ad-hoc cost-saving mechanism added to a drug bill that would otherwise cost too much.

 

Reasons for Income Testing:  A new vision for social insurance must begin with harsh budgetary reality.  The current social insurance promises are putting an increasing strain on the federal budget, and that strain will become severe after the baby boom generation retires and joins the entitlement rolls, beginning around 2010.

 

At the same time, many low-income workers retire with little savings or wealth.  They need extra assistance from Social Security and Medicare -- the prescription drug debate is a perfect example of an unmet need, especially for low-income seniors.

 

But expanding benefits is expensive, especially if all beneficiaries -- rich and poor -- are subsidized equally. 

 

Moreover, the idea that the federal government could easily expand its tax base to pay for broad-based entitlement expansions is almost certainly wrong.  After national security -- which is clearly a federal responsibility -- the most pressing social needs are items funded largely by state and local governments:  education, law enforcement, transportation.  It makes sense that state and local tax collections may have to increase over time.  But it seems less likely that taxpayers will also be willing to shoulder an ever-increasing federal tax take.

 

Therefore, income testing the entitlement programs in some manner will almost certainly become a budgetary and moral necessity.   The goal should be to keep the entitlement programs' overall costs within reason, and to help provide funds for improvements in benefits for low-income beneficiaries.

 

However, there are right and wrong ways to income test in a social insurance program.

 

Here are three suggested principles for income testing entitlement programs.  Social insurance programs would be split into "core" insurance protections and "optional" benefits.  The social contract would be clear:  Work, and be eligible for core insurance.  However, the Medicare and Social Security programs would also provide optional benefits to help needy beneficiaries.  Abiding by these guidelines would not break the fundamental social insurance contract, and would not risk a strong backlash against the programs from high-income beneficiaries.

 

1.  Universal "Core" Insurance Protections.  Guarantee basic, standard insurance protections for all.  These protections should ensure that retired workers would not live in poverty or be denied essential health care.  Examples would be a basic, minimum Social Security benefit, disability insurance for workers, and fundamental or "catastrophic" health coverage.

 

2.  Optional Benefits, With Income Tested Premiums or Contributions.  Make optional benefits available to all, if possible, but target subsidies for those benefits to low-income beneficiaries.  For example, catastrophic health benefits alone would not provide many low-income seniors with the means to get proper health services.  Optional benefits in Medicare could include "up-front" coverage for health services like prescription drugs or physician visits, which are very important to good health care, but for which low-income beneficiaries may not be able to pay very much.

 

3.  No Income-Based Reductions in Core Benefits.  Do not reduce the basic insurance benefits for high-income beneficiaries.  High-income beneficiaries should not be singled out for reductions in the basic insurance protections, but can legitimately be asked to pay more for optional benefits.

 

Universal Core Insurance:  The first guideline defines the social insurance contract.  Basic insurance benefits are intended to reduce poverty and hardship in retirement.  Society should be comfortable granting this basic standard to all workers.

 

This concept of insuring retirees against poverty or undue hardship -- due to low retirement income or high health care expenses -- will require a change of thinking in many cases.  It is a potentially controversial clarification of what social insurance should mean. 

 

For example, the core Medicare benefit could be redesigned to ensure that all retired workers had "catastrophic" coverage for all types of potential health care:  hospitalization, physician and outpatient care, prescription drugs, and so on.  This would be the new standard -- technically the new Part A of the program -- that would be available automatically.

Making core Social Security benefits more like insurance would be very controversial.  However, Social Security's disability program already behaves more like insurance than automatic benefits.  Over a long period of time, and in the context of Social Security reform, guaranteed benefits could be trimmed for retirees who had high earnings when they were working, while the minimum benefits for all workers were raised.

 

Optional Benefits, With Income Tested Premiums or Contributions:  The second guideline is also controversial.  Social insurance programs should be allowed to offer optional benefits, which could be subsidized heavily for low-income seniors, but not for those with higher incomes.  If possible, optional benefits should be available to all, and free (or close to it) for poorest beneficiaries.  However, there may be no reason to subsidize optional benefits for higher income seniors.  Ideally, low-income seniors would get heavily subsidized benefits and high-income seniors would get better choices.  That is a fair deal.

 

In the context of Social Security reform, income testing would be fairly easy.  Income testing could take place during pre-retirement years, with low-income workers receiving extra grants or matching funds in personal retirement accounts designed to supplement their core social insurance benefits.  High-income workers would be eligible to invest in personal accounts as well, but would not receive extra subsidies. 

 

Extra premiums for optional benefits in Medicare could be collected efficiently and without controversy, either through the tax code or through a voluntary enrollment process.

 

No Reductions in Core Benefits for High-Income Enrollees:  Third, social insurance programs should not single out high-income retirees for reductions in the core insurance benefits of high-income beneficiaries, except in a budgetary emergency.  This is both a political concern and a practical matter.  Although it is fair for the universal core benefits to be progressive, it would be intrusive and highly controversial to seek out high-income beneficiaries for additional benefit reductions.  The government would be forced to calculate which beneficiaries had incomes above a threshold, notify them that their benefits would be reduced, and coordinate with a health plan or benefit administrator to ensure the proper benefits were paid.  This process could be fraught with errors and misunderstandings.  It would not seem fair or loyal to the basic social contract.

 

What is the Right Balance Between Core and Means-Tested Optional Benefits?  This suggested framework does not answer a key question:  How generous should core social insurance be? 

 

Imagine the government's finances 20 or 30 years from now.  Of course, we don't know what will happen that far into the future, but given the current demographic outlook, it seems possible that the entitlement programs could swamp the federal budget, forcing economically untenable deficits, draconian spending cuts, or burdensome tax increases.

 

Suppose the retired population in 2020 or 2030 is healthier than ever, and able to work well past the retirement ages of 62 for partial Social Security benefits (67 for full benefits) or 65 for Medicare.

Suppose that most retirees 20 or 30 years from now fall into two income categories:  affluent and just getting by.

 

Under those entirely reasonable assumptions, it might make sense to question whether or not the levels of core insurance should be reduced, and that more emphasis should instead be placed on optional, means-tested benefits.  This sort of decision would be a political calculation, based on the budgetary pressures and the financial and health status of retirees in the future.

In any event, Americans would have greater confidence in the long-term viability of the social insurance programs if they knew policymakers were facing these tradeoffs in a straightforward manner, and that Social Security and Medicare decisions were not being made in an ad-hoc or politically irresponsible manner. 

Link:
CentristPolicyNetwork.Org 2003 Medicare and Prescription Drug Resource Page