new america foundation

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N EW A MERICA F OUNDATION

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10

Every Baby a Trust Fund BabyMandatory, Affordable Health Insurance

A Universal 401(k) Plan

Tax Consumption, Not Work

An Energy Efciency Trading System

A College Access Contract

Closing the $700 Billion Tax Loophole

Universal Risk Insurance

Instant Runoff Voting

A Capital Budget for Public Investment


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Executive Summary

The recent turnover in Congress, combined with a wide open presidential election cycle, createsa rare opportunity to bring new ideas into the political process. The spirit of this new era will becaptured by thosefrom either party or no partywho embrace innovative yet pragmatic solu-tions to the foremost challenges facing our nation. We offer this collection of Big Ideas as fuel foran overdue bipartisan debate about how to update our national policies for the common good.

Every Baby a Trust Fund Baby An American Stakeholder Account (ASA), established for every child at birth, would build a sav-ings and ownership culture in America, promote nancial literacy, and fortify the American econ-omy for the long haul. Every child would automatically receive a $6,000 deposit into an ASA atbirthand also be eligible for dollar-for-dollar matching funds for voluntary contributions up to$500 a year. Over time, ASAs will evolve into a broad system of saving accounts that all Ameri-cans, and especially low-income Americans, can tap to meet their asset needs throughout theirlives, enabling them to invest in higher education and lifelong learning, purchase a rst home,start a small business, and build a nest egg for retirement.

Mandatory, Affordable Health Insurance We need both universal health coverage and a more efcient delivery system. These are not com-peting objectives; achieving each of these goals is necessary to make the other possible. The mostpromising and politically feasible path to universal health coverage is to make an adequate level of insurance mandatory and affordable for all individuals. The new system would be citizen-basedinstead of employer-based, thereby making health insurance fully portable from job to job. Onceall patients are insured, providers can be expected to assistrather than resistthe efcient re-design of our delivery system. This will entail an electronic health information superstructure,performance-based payments, and comparative technology assessment that will enable us to buy and deliver high-quality health care far more efciently than we do today.

A Universal 401(k) PlanFor those with access, Americas private pension system provides powerful saving incentives: taxbreaks and employer contributions, as well as the convenience and discipline of automatic payrolldeduction and professional asset management. Unfortunately, this employer-based system cov-ers only half of all workers. Moreover, two-thirds of the tax breaks for retirement saving go tothe most afuent 20 percent who would save anyway. The solution is a Universal 401(k) plan. All workers would have the option to contribute automatically to their own account by payroll deduc-

tionand the government would match voluntary deposits with refundable tax credits depositeddirectly into the workers account. This supplemental system would make retirement saving easier,automatic, fully portable, and fair.

en Big Ideas for a New America


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ax Consumption, Not Work For more than 70 percent of American families, the payroll tax is the largest tax they pay. Yet theax is regressive, inefcient, and insufcient to fund the programs it nances. As a 15.3 percent

wage tax levied on employers and employees, it deters job creation and depresses wages at the lowend of the scale. By replacing the payroll tax with a national and progressive consumption tax, theUnited States could stimulate job creation, higher wages, and higher levels of personal saving at thesame time, all in a revenue-neutral manner. Families would pay taxes on what they spend each year,rather than on what they earn. Higher levels of spending would be taxed at higher rates, encourag-ing saving, strengthening the economy, and increasing the overall progressivity of the tax code.

An Energy Efciency Trading SystemReducing the economic and environmental risks of excessive energy use must become one of Americas most important national goals. The most promising way forward is to reduce energy demand by spurring a revolution in energy efciency. Indeed, efciency is Americas largest andmost cost-effective potential energy resource. Phasing in tough new energy standards for Ameri-cas biggest energy users and making energy efciency tradablemuch the way we now trade oiland natural gaswould quickly reduce total energy consumption while limiting carbon emissions. A market for standardized efciency credits (white tags) will give utilities, builders, and vehiclemanufacturers exibility in meeting strict efciency goals while stimulating new technologies,creating jobs, and improving the nations overall productivity and competitiveness.

A College Access Contract Americas nancial aid system imposes too much debt on college graduates, provides too much

axpayer support to banks making college loans, and demands too little of students assuminghem. A new College Access Contract would allow low-income students to graduate with zero

federal student loan debtand middle-class students to graduate with interest-free federal stu-dent loan debtif they: (1) work hard in high school to prepare for collegeas evidenced by completing a college prep track or scoring college-ready on a placement exam; (2) work or engagein community service while in college an average ten hours a week; and (3) evidence a minimumlevel of competency in an academic area upon completing college. The programs cost can bepaid for by reducing excess lender subsidies and embracing market mechanisms in the delivery of federal student loans.

Closing the $700 Billion Tax Loophole While it appears the federal government will spend around $2.8 trillion this year, there is another$700 billion that is spent through the tax code in the form of tax expenditures. This shadowbudget represents subsidies disbursed by way of taxesnot collected. While politically popular, tax

expenditures are an inefcient, poorly targeted, and needlessly expensive way to achieve the pro-rammatic goals of government. Tax expenditures need to become part of the regular budget and

appropriations process. They should be dramatically reduced, consolidated, and capped. The result would be a simpler, fairer, more efcient tax code. Equally important, hundreds of billions of dol-lars in potential savings can be freed up and redirected to meet the nations most important needs.

Executive Summary


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Universal Risk InsuranceIn recent decades there has been a massive transfer of economic risk from shared institutionalarrangements, such as unemployment insurance and basic benet coverage provided by employ-

ers, onto the fragile balance sheets of families. Yet public programs have largely failed to respond.Universal Insurance is a new response to this growing problem. It would provide short-term,stop-loss protection to families whose income (after taxes and public benets) suddenly declinesby a fth or more due to job loss or catastrophic health expenses. All but the richest families would be eligible, but the program would be most generous for low-income families. This typeof broad-based insurancecovering a range of risks but focused on substantial income drops orlosseswould provide a exible new platform of security in a world of rapidly changing risks.

Instant Runoff Voting Americans want a more representative and responsive government capable of addressing the na-tions challenges, yet our electoral system is founded on antiquated practices that inhibit voterchoices and encourage a politics of polarization and paralysis. Its time to bring our electoralsystem into the 21st century by adopting instant runoff voting (IRV). IRV elects winners withmajority support in a single election by allowing voters to rank a rst, second, and third choice ontheir ballots. If no candidate wins a majority, and a voters rst choice is eliminated, the vote goesto the voters second-ranked candidate as his or her runoff choice. IRV encourages more electoralcompetition, solves the spoiler problem, enables voters to choose the candidate they really want,and encourages candidates to win by building coalitions rather than tearing down opponents.

A Capital Budget for Public Investment The federal budget needs to prioritize spending that will make our economy more productive inthe future. Yet, over the last several decades, the portion of the federal budget going to current con-sumption has increased, while that devoted to public investment has declined. As a result, the fed-eral government does not adequately fund either the physical infrastructure or knowledge capitalupon which a more productive economy rests. We are underinvesting not only in traditional infra-structure, but also in high-speed broadband networks, in basic science research and development,and in training skilled workers, scientists, and engineers. Just as private businesses and most statesuse capital budgeting, a federal capital budget would allow us to separate our nations public invest-ment, which expands our capacity to grow, from our governments current consumption outlays.


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The 2006 elections opened the door toa new political era. The conservativedomination of Congress that began in1994 has come to an end. However, thepolitical pendulum has not swung back to traditional liberalism. Rather, it hasbeen reset to a new centrism character-ized by a profound public desire for realsolutions and bipartisan reform. Theelections made clearer than ever beforethat Americans are fed up with partisanpolitics as usual. The spirit of this newera will be captured by thosefrom ei-ther party or no partywho embraceinnovative yet pragmatic solutions to theforemost challenges facing our nation.

As the recent elections also illustrated,increasing numbers of Americans arenow part of what we at the New Amer-ica Foundation have called the RadicalCenter. They understand that most of our national problems require activeovernment intervention, yet they are

wary of complex government programsthat are full of hidden subsidies. They are scally responsible yet want the gov-ernment to invest wisely in our coun-

trys future. They demand greater fair-ness in both our political and economiclife but also insist upon greater personalresponsibility and respect for traditional

American family values. They acknowl-edge the benets of globalization but donot believe they should come at the ex-

ense of a domestic social contract thatives all Americans their fair share of he American dream.

Since its founding in 1999, the New America Foundation has tried to give voice to this yearning for a new center

n American politics by advancing bold yet pragmatic solutions to our nations

roblems. With this publication, wehave distilled the wide-ranging work of New Americas programs and Fellowsnto ten Big Ideas that can help meet our

countrys most serious challenges, yetcan be readily implemented with bipar-isan support. A number of these proposals t to-ether into a vision of the next social

contract, a new approach to the rela-ionship between government, employ-

ers, and individuals that is better suitedo the profound transformations the

American economy, workforce, andfamily have undergone in recent de-cades. Each of the following ideas fallsnto this category: Len Nicholss out-

line of the elements of a successful ap-roach to health care for all; Michael

Calabreses plan for automatic 401(k)accounts open to anyone; Jacob Hack-ers proposal for universal insuranceagainst devastating drops in income;Ray Bosharas proposal to jump-start

widespread asset building by establish-ng a matched savings account for every

Introduction

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child at birth; and Michael Dannenbergs descrip-ion of a College Access Contract. The challenge of sustainable and broadly shared

economic growth is the other side of the coin, andseveral of our Big Ideas therefore focus on expand-ing the economy and extending its benets. SherleSchwenningers proposal to promote public in-

vestment through a federal capital budget, Maya MacGuineass plan to replace the burdensome andregressive payroll tax with a progressive tax onconsumption, and Lisa Margonellis idea to reduceenergy demand by trading efciency gains are allhoughtful and provocative components of a newrowth agenda.Finally, the 2006 elections demonstrated that

he American people are demanding not just achange in what government does, but also how itdoes it. The American political process has createda vicious circle in which the absence of competi-ive elections, the role of money in politics, and the

lack of transparency reinforce and compound oneanother. Fundamental reforms to the processesof representative democracy are a necessary steptoward meeting the other challenges. Here Maya

MacGuineass idea of bringing the vast expendi-tures hidden in the tax code into public light, andrestructuring them so that hundreds of billions of dollars in revenue can be reprioritized and spentmore wisely, is essential, as is Steven Hills proposalto make elections more open and more competitivethrough Instant Runoff Voting.

The emerging new era of American politicallife should not be a time of partisan politics, butan era of bipartisan creativity and accomplishment.

We offer these ideas in the hope that they can helppoint the way.

Ted HalsteadPresident & CEONew America Foundation

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Introduction


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Every Baby a Trust Fund BabyRay Boshara

An American Stakeholder Account(ASA), established for every childat birth, would build a savingsand ownership culture in America, pro-mote nancial literacy, and fortify the American economy for the long haul.Every child would automatically receivea $6,000 deposit in an ASA at birth andbe eligible until maturity for dollar-for-dollar matching funds for voluntary con-tributions up to $500 a year. Over time, ASAs would evolve into a broad system of savings accounts that all Americanses-pecially low-income Americanscouldtap to meet their asset needs through-out life to pursue higher education andlifelong learning, purchase a rst home,start a small business, and build a nestegg for retirement.

At present, about a quarter of all whitekids and half of all other kids grow up inhouseholds with zero or negative assets,apart from possible equity in a house. This means that there are no availableassets for any sort of investment. Theprospects for achieving economic suc-cess of children growing up in such

households are pretty dim. Therefore,imagine what it would mean for suchkids to have an investment account withtheir name on itearmarked for theireducation, their rst home, their retire-ment. Imagine the enormous effect sucha program would have on our failed ef-forts to educate our kids about nancial

basics. And just imagine the effects onour economy: it doesnt take an army of economists to tell us that we would reaphuge rewards if virtually all young peo-

le became owners, savers, taxpayers,and entrepreneursand if fewer peopledepended on the state, local charities,heir communities, and their parents forheir livelihood and well-being.

Is this pie in the sky? Actually, no.Starting last year, each British baby born after September 1, 2002, receivesa child trust fund of 250 (about$460), with the poorest third of chil-dren receiving twice that amount. The

overnment will make similar top updeposits when a child reaches age seven.Parents, relatives, and others can con-ribute up to 1,200 tax-free every year.

With compound interest and ongoingcontributions, the account could growo 40,000 (about $70,000) at maturity

on the childs 18th birthday. So far, al-ost 2 million such accounts have been

opened. The idea is to give all kidsre-ardless of their backgroundsa shot at

economic success, to reduce their reli-

ance on the state, and to foster a savingsculture in the U.K.

Whether Britains Child Trust Fundcan deliver all this remains to be seen.But it is already apparent that the pro-

ram is spurring signicant savingseven among poor families. Moreover,he accounts are serving as magnets for

1


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contributions. The head of Childrens Mutual, one of he main providers of the accounts in the U.K., tells

of a Child Trust Fund voucher that came back with

30 baptism checks attached to it. British prime min-ister Tony Blair launchedthe trust fund to addresschallenges that are remark-ably similar to those facing Americans. Like us, Britishparents worry deeply abouthow their children will everafford to buy a hometheaverage age of a rst-timehome buyer in the U.K. is34and how they can helptheir kids pay for college.

The potential of ourproposed stakeholder ac-

counts is embodied in a 2005 front-page story inThe Washington Post, which tells of ve-year-old Austin Sambrano, whose own savings account is

eaching him and his family about saving and fam-ily nances:

Three weeks shy of his rst day of kindergar-ten, Austin Sambrano is the only person inhis family who has a savings account. Living with his parents and older brother in a trailerpark near Pontiac, Michigan, he is part of an xperiment called the SEED Initiative thatis opening investment accounts for children,in an effort to ensure them a college educa-tionand teach their families the habit of putting aside money for the future. AustinSambranos mother, Christine Albertson, hada humbler reason for signing up her son for aSEED account. Neither she nor her partner of 12 years, Steven Sambrano, has any savings.

On the $400 a week he brings home from hisnew job driving a truck, we are barely makingthe bills as it is, she said. Austins account, shesaid, makes him feel special. Hes excited. Heknows this is for college.

The Post also tells the story of young Brianna Jones. She and her parents have a new attitude

about saving and spending because of Briannassavings account:

Some parents say that they are learning new

habitsand that their children are learningimportant lessons. This program here givesme a chance to save. I know its there. I cantmess with it, said Almedia Jones, of Lexa, Ark., who opened an account in May and madea $20 deposit in June and July. She took herdaughter, Brianna, 5, to a SEED class wherethe children decorated two cans, labeled sav-ings and withdrawal, with buttery stickers.Brianna began to put her allowance into a can.One day, Jones took Brianna along when she went shopping for a present for another daugh-ter, Brittney, who had just had surgery. Briannaspotted a pretty purse and turned to her oldersister. If you buy me this purse, Brianna said,when I turn 18, you know I will have money in the bank, and if I go to college, Ill have evenmore money, and Ill pay you back.1

As these stories vividly show, the one-two punch of a owning a savings account, combined with nancialeducation, changes savings habits and the attitudesand aspirations of both children and their parents.

Why American Stakeholder Accounts? The broader case for American Stakeholder Ac-counts is compelling.

First, stakeholding, as a public policy, has a longand successful history in the United States andaround the world. In postwar Japan, land was redis-tributed to millions of farmers, laying the founda-tion for broad-based economic success. Singaporehas achieved one of the highest rates of savings andhome ownership in the world through its Central

Provident Fund. In the United States, at least aquarter of adults can trace their family legacy of asset ownership to the Homestead Act, signed intolaw by Abraham Lincoln, which awarded land inthe American West to those pioneers with thecourage to settle it. The GI Bill, passed in 1944, has

enerated returns of up to seven dollars for every dollar invested. And there is the nearly $400 billion

Americans

accept inequality

f outcomes,

but they do not

accept inequality

f opportunity.

Every Baby a Trust Fund Baby


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Security number was issued. Children from house-holds below the national median income wouldalso be eligible to receive dollar-for-dollar match-

ing funds for voluntary contributions up to $500 a year. These matching contributions could be depos-ited directly into the account, or delivered directly on tax returns through a larger earned income

tax credit or childtax credit. To encour-age good perform-ance in school, as wellas community or na-tional service, meritand service depositsshould be offered as well. After-tax volun-tary contributionsfrom family mem-bers, churches, corpo-rations, foundations,etc.should be en-couraged, but limitedto $1,000 a year fromall sources. All funds would grow tax-free.

A typical low-in-come kid, saving or leveraging about $20 a monthand earning about a 7 percent annual return would have over $38,000 by the time he or shereached 18an amount that would set genera-ions of kids on a lifelong path of saving, invest-

ing, and ownership. Withdrawals from the account prior to age 18

would not be permitted, but kidsin conjunc-ion with their parents and nancial educators at

schoolwould participate in investment decisionsand watch their money grow. An ASA Fund and its

overning board, modeled after the highly efcientFederal Thrift Savings Plan for government em-ployees, would be established within the U.S. Trea-sury Department to hold and manage the accounts.

At age 18, the beneciary could choose to keepaccumulated savings in the ASA Fund (the defaultoption) or roll it out to a nancial institution of hisor her choice. However, to preserve the accountand a lifetime platform for saving, a $500 mini-

mum balance would have to be retained withinthe ASA Fund (that is, rollouts to private nancialinstitutions would be permitted above the $500

threshold), with additional contributions governedby existing Roth rules. ASAs could be used tax- and penalty-free for

postsecondary education or for the purchase of arst home, or retained in the account for retirement.If the assets were used for one of these purposes,the account holder would keep all the government-provided funds (those deposited at birth and all thematching funds); if the assets were withdrawn forany other purpose, the account holder would keepall voluntary contributions (minus some taxes andpenalties) but lose all the government funds. Andto signal that ASAs were not something for noth-ingas well as to help endow the next generation of kidsthe account holder would have to begin pay-ing back the $6,000 at-birth deposit at age 30, al-though payments could be spread out over ten yearsand exceptions would be permitted for hardship.

A Fresh Opportunity for Each Generation Theres no doubt that the American Stakeholder Account program would be costly. But as the sto-ries of Austin and Brianna show, and given the his-torical returns on asset building in America, this would be money well spent. If we ever hope to ad-dress the growing problem of inequality of incomeand wealth, we must embrace such a program.

It is important to note, however, that ASAs arenot meant to combat inequality of outcomes , butinequality of opportunity: Americans accept in-equality of outcomes as a by-product of how wereward the hard work, initiative, and creativity thatunderpin our much envied economy. But they donot and should not accept inequality of opportu-

nity. Expanding the ownership of assets by meansof American Stakeholder Accounts would help toensure that the inequality of wealth in one genera-tion will not result in inequality of opportunity inthe next.

1 Amy Goldstein, Initiatives to Promote Savings fromChildhood Catching On, Washington Post,August 20,2005.

We dont need an

army of economists to

know the U.S. would

reap huge rewards

if virtually all young

people became owners,

savers, taxpayers, and

entrepreneuers.

Every Baby a Trust Fund Baby


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Mandatory, Affordable Health InsuranceLen Nichols

Americas health care system isbroken and cannot be repaired with timid half-measures. Weneed both universal coverage and a moreefcient delivery system. These are notcompeting objectives; achieving eachof these goals is necessary to make theother possible. If we do not make healthcare more affordable and our delivery system more efcient and sustainable, amajority of Americans will be uninsuredby 2020. At the same time, the growingnumber of uninsured impedes the ef-ciency gains we must achieve to makehealth care and health insurance afford-able for all. Thus, contrary to conven-tional wisdom, both universal coverageand delivery system reform must be pur-sued simultaneously.

Health care costs continue to growfaster than incomes, and more andmore working families and employersare nding health insurance unafford-able. Four million Americans have lostprivate coverage since 2000bringingthe total number of uninsured above46 millionmostly because they can-

not afford the higher contributionstheir employers require each year forever less generous offerings. We may be near the breaking point of our mid-0th-century employer-based system.

Forward-thinking labor leaders like Andy Stern, president of the ServiceEmployees International Union, are

voicing the compelling reality: the em-loyer-based health insurance system as

we have known it is unsustainable in a1st-century economy. Understandingheir impotence to reverse these trends,any employers agree. Corporate lead-

ers like Lee Scott, CEO of Wal-Mart,are searching for ways to jump-starta national conversation about feasiblealternatives.

There are only three credible universal nancing arrangements: (1) a

ax-nanced single payer system, suchas Medicare for all; (2) employer-plus-ndividual mandates for the purchase

of private health insurance; and (3) in-dividual mandates alone. (The last two

would require subsidies for low-incomehouseholds.) Medicare for all is tech-

ically feasible but would require a levelof trust toward government decision

aking that simply does not exist atresent, nor is likely to be seen in theear future. In addition, most of the ad-inistrative efciencies of a single payer

system could be obtained with any pro-ram of mandatory coverage that elimi-

ated the prot from refusing coverageo high-risk patients. The most promising and politically

feasible path to universal coverage iso make an adequate level of insuranceandatory and affordable for all indi-

viduals. Without purchase mandates, nonsurance system can approach the level


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of efciency we need because insurers and provid-ers will continue to use up scarce resources tryingo avoid high-risk patients, as they do today. Thus,

beyond the moral casethe Institute of Medicineestimates that 20,000 uninsured Americans die each year because the lack of health insurance prevents

hem from obtaining timely routine carethere isa strong economic case for universal coverage.

Among the private in-surance alternatives, theindividual mandate alone

option is by far the mostcongruent with the 21st-century U.S. economy,

which must remain ex-ible and reward mobile

workers. Therefore, ty-ing insurance to citizen-

workers rather than rmsakes perfect sense. The

U.S. economy will con-inue to generate many

jobs with productivity lev-els that simply cannot sup-

port compensation that includes both employer-provided health benets and a market wage. Forhis reason, mandated employer-provided coverage

would be counterproductive to efcient and sharedeconomic growth, for many low-wage jobs wouldbe lost. Finally, the individual mandate is consis-ent with individual responsibility, a centralbut

by no means the onlyelement of a new socialcontract that could promote opportunity and well-being through redened social responsibilities.

Universal Coverage Is Not Enough While mandating universal coverage is an ambi-

ious goal, it is not enough. Our health care systemis so inefcient and prone to unsustainable cost

rowth that to pursue universal coverage withoutsimultaneously seeking to contain costs would very soon add to our mounting scal problems.

We spend at least twice as much per capita onhealth care as our major trading partners, and wenance far more of it through employers, which

puts us at a signicant competitive disadvantagein the global economy. This is why health caresystem reform has become a C-suite issue:

CEOs, COOs, and CFOs are focused on it asnever before. Moreover, the health gains from ourspending are mediocre compared to the rest of the

world. The United States ranks an embarrassing37th in the World Health Organizations evalua-tion of health systems worldwide, next to Sloveniaand Costa Rica.

We compare poorly because our three linkedproblemshigh costs, mediocre quality, and un-equal accessdo not yield to the incrementalreforms we have tried to date. Despite our highspending, Americans get appropriate care only about 55 percent of the time. Individuals at thehigher income levels get appropriate care only 2percent more often, while individuals at the low-est income level get appropriate care 2 percent lessoften. Thus money actually buys very little quality per se. Geographic variation in the quality of careis stunning: an individual living in Utah has a one-third higher chance of surviving cancer than a per-son living in North Carolina. Ineffective care addsunnecessarily to costs, which reduces coverage andsties access.

We also suffer over 150,000 unnecessary deathseach year from avoidable errors and substandardcare. The average person in Canada, Australia, orFrance is healthier and will live longer than theaverage American, and far more equitable accessto high-quality primary care is a big part of theexplanation. The total economic costs of the un-insureddue to belated care and shifted medicalcosts, lost productivity from extra absenteeism, andpremature deathhave been credibly estimated tobe roughly equal to the cost of low-income subsi-

dies necessary to nance universal coverage. It istime we made a smarter health economic bargain.

A Changing Political Climate The rst step is to recognize that comprehensivehealth care reformachieving universal cover-age and cost growth containmentis not only necessary, it is possible. We can provide better

Mandatory, Affordable Health Insurance

Universal coverage

and a more efcient

delivery system

are not competing

bjectives; each is

necessary to make

the other possible.


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care for more people, we can afford the necessary subsidies for our low-income population, and wecan bridge the divides in our polarized nationaldebate and politics. It will take leadership, com-promise, and hard work, but political leaders in

Massachusetts have shown us that it is indeed do-able. There, a Republican governor and presiden-tial aspirant was willing to use the word all, andthe Democratic legislature accepted the wordlimit, and together they are taking a giant steptoward universal coverage by making it manda-tory and affordable.

Politically, the possibilities for national reformare greater today than ever before, not least be-cause the barometers of system stress are worsethan they were when Bill Clinton became presi-dent and health reform was on the agenda. In1992, there were 33 million uninsured Americans;more than 13 million people have been added tothe rolls of the uninsured since then. The average

family health insurance premium today claims 19percent of median family income, compared to 10percent then.

Three qualitative differences may matter evenmore.

First, employers are increasingly determined toforce politicians to address the question of reformbecause high health costs make it harder for themto compete in international markets.

Second, as cost growth forces companies toreduce benets and shift costs to workers, moreand more workers worry about losing coverage al-

together, even in a strong economy. This is a seachange from the early nineties, when the fear of coverage loss was recession-based. Now it is basedon cost growth outstripping income growth, withno end in sight. As presidential aspirants in bothparties are learningin their home districts, inIowa, and in New Hampshirevoters are deeply

worried about unaffordable health care.

HEALTH STRESS INDEX

30%

25%

20%

15%

10%

5%

0%

1 9 8 7

1 9 8 8

1 9 8 9

1 9 9 0

1 9 9 1

1 9 9 2

1 9 9 3

1 9 9 4

1 9 9 5

1 9 9 6

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

Uninsured Spending Growth

ource: New America Foundation tabulation of U.S. Census Bureau data and the National Health Expenditure Data from the Center

for Medicare and Medicaid Services, Ofce of the Actuary.

Note: Intensity increases once the Health System Stress Index rises above 21.


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Third, and most importantly, growing publicawareness of the linkages between cost growth,quality gaps, and losing coverage makes the reform

discussion different this time around. The Clin-on-era debate was mostly about covering the un-insured and the income redistribution that wouldhave been required to accomplish this. That argu-ment was largely zero-sum: some would gain cov-erage, and others would have to pay higher taxes tonance it. But if none of us are assured of gettingquality care, and if all of usincluding employ-ersare vulnerable to rising costs, then there is apositive-sum or win-win dimension to comprehen-sive reform now that makes it far more likely.

A Win-Win Formula for ReformPositive-sum reform provides something foreveryone and demands shared responsibility as

well. Essentially, it entails building a universalcoverage nancing system on the backbone of asustainable delivery system. Therefore it has nu-merous elements.

It must be bipartisan. Effective reform will requirefeatures that moderates in both the Democraticand Republican parties can embrace, a programthat preserves enough of the core values of eachpartys base to permit each side to recognize itsown narrative in the outcome. To achieve this,there must be individual responsibility as well asshared responsibility, cost-containment as wellas universal coverage.

It must create an effective health insurance market or purchasing pool. Individuals and groups

without good options today will benet fromadministrative economies of scale and risk pool-

ing. Market rules must be fair to individuals andreasonable for insurers, like those that govern

very large employers, employer coalitions, andfederal or state worker purchasing pools today.

Individuals must be required to purchase health insurance. Even with subsidies and a functioningmarketplace, some individuals will be unlikely

o buy health insurance on their own, thereby shifting costs onto others in the event of theirneed for expensive care. To avoid such free rid-

ng, individuals must be required to pay theirfair share toward health access for all. Purchaseandates are therefore essential under any for-ula for achieving universal coverage. Individu-

als could purchase insurance through their em-loyers or efcient purchasing pools.

There must be substantial subsidies for low- income individuals and families. Insurance mustbe required, but in exchange it must also be af-fordable. This is essential for reasons of equity and efciency alike. We cannot force peopleo buy policies they cannot afford. Even if this

were politically feasible, it would force themo forgo other necessities, which could have

bad health consequences. If we try to man-date insurance without subsidies, some will re-

ain uninsured, and we will continue to pay for their late, inefcient care as we do now.

ousehold subsidies should be nanced by a dedi- ated and limited new tax. These subsidies can

be partially nanced, especially over time, withsavings from the reform program, but there

will need to be additional revenues dedicated tohem, at least in the short run. It would be besto ll the gap with a dedicated stream from a

new tax (e.g., a progressive consumption tax),hat would also serve as a budget constraint.

Budget constraints and tax rates can and shouldbe revisited over time as circumstances war-ant, but annual budget limits on subsidies may

be necessary to construct a majority coalitionfor comprehensive reform.

The new system should be citizen-based, phasingut the employers role. There are a number of

options here, but it is important that employersshould be seen as only one among many possiblenancing sources for health insurance coverage,

with the understanding that they are not likely o be able to continue indenitely in that role.



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The goal ought to be to keep current employermoney in the game while relieving employers

of the burden of negotiating health premium in-

creases every year. A new insurance market pooland subsidy structure could aid such a transition.For example, rms might enroll their workers ina plan through a purchasing pool in year one,

while maintaining their historical premiumcontribution levels. In year two, they could givetheir workers a raise at least equal to the previous

years premium contribution, plus some agreed-upon ination factor, and from that higher basethe worker would be expected to purchase in-surance on his own unless eligible for a subsidy.(Tax preferences could also be converted at thatpoint, perhaps from todays open-ended incomeand payroll tax exemption for employers and em-ployees, to a xed tax credit that might vary by income and/or risk class.) This transition wouldkeep the right amount of money owing tohealth insurance in year two; thereafter cost

rowth and affordability would be worked out inthe political arena between citizens, the govern-ment, health care providers, and insurers, withthe employer out of the picture.

Delivery System Reform This brings us to delivery system reform, which iscentral to the success and sustainability of the entirereform enterprise. In short, we urgently need to re-organize our delivery system to yield far more healthvalue per dollar spent. There are three critical ele-ments to a delivery system culture of value.

An electronic health information system. This would give any clinician anywhere instant accessto a patients medical history, plus diagnosis and

treatment options. The system would include Web-based electronic health records, as wellas medical decision support tools so that bestpractices could be applied to every clinician-pa-tient encounter. Today, a Las Vegas casino candetermine the precise details of an individualscredit worthiness in real time, but no emergency room doctor in that city (or anywhere else in the

United States) can nd out what medications anunconscious person is on (unless that individualis being treated in the Veterans Administration

system). An electronic information system willhelp us monitor care, protect patients, and im-prove the overall quality of health care in theUnited States.

Turbo-charged incentivesfor evidence-based decision making. We neednew payment incentivesfor both patients andproviders. Today, wepay providers for con-ducting tests and car-rying out proceduresthat may or may not benecessary or effective.

And patients are oftenrequired to pay no morefor expensive tests andprocedures than for lessexpensive but equally effective treatment. This system encourages un-necessary treatments and results in low-valuecare. Smarter incentives would encourage pa-tients and clinicians to use resources prudently

while promoting high-quality, cost-effectivecare. Incentives for patients and providers shouldbe mutually reinforcing, and they can be if they incorporate the same performance targets. Forexample, clinicians should be paid more if dia-betics under their care obtain all appropriatetests each year, and the patients co-payment forsuch cost-effective, evidence-based tests shouldbe zero. We will also need to reform our dys-

functional malpractice legal system. Evidence-based medicinestatistically supported bestpracticesmust be a safe harbor against spuri-ous malpractice claims. Guidelines can be de-

veloped and disseminated by private specialty societies and public research agencies to ensuretheir effectiveness and a smooth transition toevidence-based safe harbors.

The most politically

feasible path to

universal health

coverage is to make

an adequate level of

insurance mandatory

and affordable for

everyone.


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Comparative technology assessment. Advancesin medical technology have saved lives and im-proved the quality of life for many, and future

advancements are likely to be nothing short of breathtaking in their possibilities. However, theoveruse of new technology has been the mainculprit in driving up costs. Future advancementsare likely to push health system costs even high-er, to a level that could be catastrophic for thehealth of the U.S. economy. We need to establishprocesses for assessing the clinical value-addedof new technologies compared to existing treat-ment or diagnostic options prior to their wide-spread adoption and use. The Food and Drug

Administrations drug approval process is a casein point. Today, to get a drug approved for aspecic use, a manufacturer must simply provethat the proposed new drug did not manifestserious side effects and is more effective than aplacebo. We should require a higher standard forapproval: new and more expensive drugs shouldbe shown to be better than the best existingtreatment for any given patient subpopulation.

To compensate for the longer and more expen-sive trials this would require, we would probably need to lengthen the life of drug patents. Weshould apply the same logic to medical devicesand new diagnostic or surgical techniques. Then

we can become far smarter purchasers of costly new technologies.

he Political Groundwork Is Being Laid The good news is that a critical mass of stakehold-ers, opinion leaders, CEOs, union ofcials, andpoliticians agree that our health care system is onan unsustainable trajectory and must be reformed.

Massachusetts has shown that comprehensive and

bipartisan compromise is possible, and the Ameri-can Medical Associations recent call for an indi-

vidual mandate approach to universal coverage is

proof that former adversaries of wholesale reformnow see its necessity.

The incoming Congress and forthcoming presi-

dential campaign provide opportunities to renewthe debate over larger visions for transforming Americas broken health care system. A large majority of voters are willing to pay to ensure thatall Americans have access to at least basic healthinsurance. Announced and potential presidentialcandidates have heard the rumblings of discontentand fear among the electorate. Our political sys-tem can nd a bipartisan way for those fears to beaddressed and the publics preferences to be trans-lated into affordable and effective heath care for all

Americans. The leaders who facilitate this trans-formation will be highly regarded indeed.


How to Fix Our Broken HealthCare System

Create a Health Insurance Market

Require Everyone to Buy HealthInsurance

Subsidize Low-Income Americans

Dene a Transitional Role for Employers

Improve Outcomes Using an ElectronicInformation System

Offer Turbo-Charged Payment Incentiveso Lower Costs

Provide High-Quality Care Based on

Comparative Technology Assessment


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A Universal 401(k) PlanMichael Calabrese

With over $12 trillion in assets,traditional pension trusts and401(k)-style saving plans ac-count for the vast majority of nan-cial assets accumulated by householdsin recent years. For those with access, Americas employer-based private pen-sion system provides powerful savingincentivesboth tax breaks and em-ployer contributionsas well as theconvenience and discipline of automaticpayroll deduction. Unfortunately, em-ployer-sponsored plans cover less thanhalf of all workers. More than 70 million American workers do not participate in atax-subsidized, payroll deduction savingplanand therefore they tend to save very little for retirement. As a result,a projected 40 percent of todays baby boomers are likely to depend almost en-tirely on Social Securitys poverty-levelbenet after age 70.

As a nation, we are saving too littleand not doing enough to give lower-paid workers the combination of opportunity and security they need to cope with ac-celerating technological and economic

change. We need to facilitate pensionportability while simultaneously shift-ing the burden of subsidizing basic ben-ets from American business to society as a whole.

The solution is a Universal 401(k)plan that gives every worker access to anautomatic, professionally administered

etirement saving planan IndividualCareer Account (ICA). The plan wouldsupplement, not supplant, the existing

rivate pension system. All workers notarticipating in an employer plan, in-

cluding recent hires and part-time em-loyees, would be signed up to contrib-

ute automatically by payroll deduction,although an individual could choose noto save. The government would match

voluntary contributions by workers andheir employers with refundable tax cred-ts deposited directly into the workersaccount. Workers participating in theiremployers plan would receive strongerax incentives to save, but otherwise seeo difference. Contributions for work-

ers not participating in an employer plan would be forwarded to a federal clear-

nghouse, which would manage smallaccounts at low cost and could even convert account balances into guaranteed

ncome for life at retirement. Individu-als could maintain the account through-out their careers, since it would remainopen as they moved from job to job. Thissupplemental system would make saving

easier, automatic, and fair.

imitations of our Industrial-Eraension System

Americas postwar pension system hasbeen a great success in many impor-ant respects. From 1945 to the late

1970s, the percentage of private-sector


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workers covered by pension plans grew rapidly from0 percent to just above 50 percent. The working

and middle classes became shareholders and, with

Social Security, accumulated the foundation for asecure retirement. Pension funds also steadily be-came the worlds largest pool of patient capital,boosting U.S. growth and innovation by underpin-ning the worlds most sophisticated, liquid, and dy-namic capital market.

When the landmark Employee Retirement Se-curity Act (ERISA) became law in 1974, its du-ciary, funding, vesting and other provisions weredesigned to perfect what was then a system of em-ployer-sponsored dened-benet (DB) pensions.Employers made all the contributions and shoul-dered all the investment risk, managing pooled

trusts subject to government oversight at relatively low cost. Workersat least those who clockedmore than 20 hours per weekwere automatically

covered and received, at retirement, guaranteedmonthly income for life. The federal governmentinsured these traditional pension benets againstemployer bankruptcy through the Pension BenetGuarantee Corporation. Combined with SocialSecurity, these pensions allowed workers who re-mained at a rm for 30 or more years to replace well over half of their pre-retirement income, withthe primary risk being that ination could reducethe purchasing power of their xed pension ben-et over time (particularly as, in recent years, mostrms have stopped giving regular cost-of-livingadjustments).


PARTICIPATION IN RETIREMENT PLANS BY ANNUAL EARNINGS

PRIVATE-SECTOR WAGE AND SALARY WORKERS EMPLOYED YEAR-ROUND, FULL-TIME, AGES 2564

80%

70%

60%

50%

40%

30%

20%

10%

0%

1990 1995 2000 2001 2002 2003 2004 2005

Highest Earnings Quartile Second-highest Earnings Quartile

Third-highest Earnings Quartile Lowest Earnings Quartile

ource: Congressional Research Service Analysis of March 2005Current Population Survey.


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13


This industrial-era system was based on assump-tions of career-long job tenure, stable corporatestructures, pressure from strong unions, and largedoses of employer paternalismconditions, liketraditional DB plans themselves, that have beenrapidly disappearing over the past two decades.Since the rst 401(k) plan emerged out of an un-intended tax loophole in 1981, the number of U.S.rms with DB plans has plunged from 100,000 tofewer than 30,000 now. Today, we are a 401(k) na-tion. More than 60 percent of private-sector work-ers lucky enough to have any pension benet work at rms that sponsor only a 401(k)-type contribu-

tion plan.Even as 401(k)s and other dened-contribution

accounts emerged as the dominant plan type, thenations fundamental approach to encouragingpension coverage and retirement saving has notchanged. It continues to rely entirely on voluntary plan sponsorship by employers who are offered taxcarrots in the form of deductions that dispropor-

tionately benet high-wage earners and are subjectto regulatory sticksantidiscrimination, duciary,and reporting requirementsthat, however rea-sonable, discourage small employers in particularfrom helping their employees save.

What Is Needed A renewed and updated effort to facilitate savingand retirement security for all Americans should bedesigned to address the following unmet needs:

Improve individual retirement security. Americasreal retirement security crisis is not about Social

Security or the many big companies freezing theirtraditional pension plans and switching to 401(k)s. The larger problem is that a minority of Americanadults are participating in any retirement plan whether DB or 401(k) plans or Individual Retire-ment Accounts (IRAs). Participation in employerplans peaked during the 1970s and has remained ona plateau since. Only 45 percent of all private-sector

27.90%Earnings

33.20%Social Security

23.45%Pensions

13.10% Assets

2.40%Other (incl. Public Assistance)

2.00%Earnings

83.00%Social Security

5.25%Pensions

3.05% Assets

6.75% Other(incl. Public Assistance)

Source: Social Security Administration,Income of Population 55 or Older, 2004 released May 2006.

SHARES OF U.S. RETIREMENT INCOME BY SOURCE, POPULATION 65 AND OVER, 2004

TOP TWO INCOME QUINTILES (HIGHEST 40%) BOTTOM TWO INCOME QUINTILES (LOWEST 40%)


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workers participated in a retirement plan in 2005,according to the Congressional Research Ser- vice. While participation is slightly higher among

full-time workers (52 percent), it is also strikingly low among workers who are low-income, young, work part-time, or work at small rms. A General Accounting Ofce study found that 85 percent

of Americans without aension benet at work

shared one or more of thesefour characteristics. Thus, whereas 65 percent of full-

ime workers at rms withore than 100 employees

articipate in retirementlans, that rate sinks to 45ercent at rms with fewerhan 100 employees, and

it plunges to 25 percentfor rms employing fewerhan 25.

Fewer than 60 percentof todays older workers,hose aged 47 to 64, are

on track to maintain evenhalf of their pre-retirement standard of living dur-ing retirement. Too many individuals and familiesare headed toward retirement age with little morehan Social Securitys safety net. A great deal of he opposition to partial privatization of Social Se-

curity undoubtedly related to the average citizenskeen awareness of how many elderly desperately depend on the programs meager but guaranteed(and ination-adjusted) monthly payment. Amonghe elderly, 40 percent rely on Social Security for

90 percent or more of their incomea dependency ratio that is even higher for widows and unlikely to

improve for the baby boomer generation, accord-ing to government projections.

Boost national saving and investment. Despite thefact that baby boomersthe largest segment of theadult populationare in their prime saving years,he personal saving rate in 2005 was actually negative

(-0.4 percent) for the rst time since 1933, during

the Great Depression. If we truly want to promotenational saving, reduce dependency on social insur-ance, and create an inclusive ownership society, we

will need new mechanisms that extend the advan-tages of private pensions to everyone. After all, re-tirement plans are how America saves: tax-deferredpension plans (of all kinds) have accounted for morethan 80 percent of personal saving in recent years.

Not surprisingly, pension participation is low-est among workers whose savings would truly add to net national saving: workers who earn less thanthe median wage. While the afuent can respondto tax incentives for saving by shifting rather thanactually increasing their net saving effort, house-holds that would not otherwise save generate netnew national saving. Indeed, a majority of middle-to-low-income households are not responding tocurrent incentives. Among the bottom 60 percentof all workers by incomethose earning less than$40,000only about a third (36 percent) partici-pate in employer plans, according to the Congres-sional Budget Ofce.

We might at least expect the workers lucky enough to participate in 401(k)-type plans to be ac-cumulating signicant savings. Among the subsetof high-tax-bracket earners with steady access to a401(k), this is the case. But participation rates inthe bottom two quintiles of the earning distribu-tion are far lower, and the average amount accumu-lated is barely above $10,000. Even among 401(k)participants in the middle-earning quintile, theaverage account balance was only about $30,000in 2001. One reason for the low participation ratesand accumulations is that even if a worker has cov-erage today, he or she may not have access to a plannext year in a new job. Even if the new employersponsors a plan, new hires are not eligible to par-

ticipate for at least one year. The result is gaps incoverage. What is needed is a seamless, lifelongsaving system.

Even when lower-wage workers have consistentaccess to an employer plan, the tax incentives forsaving are upside-down. The tax break for retire-ment saving is one of Washingtons most expensiveprograms, costing a projected $134 billion in uncol-


A projected 40

percent of todays

baby boomers are

likely to depend

almost completely

on Social Securitys

poverty-level benet

after age 70.


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15


lected federal tax revenue this scal year alone. Yetabout 70 percent of that subsidy goes to the mostafuent 20 percent of taxpayersand virtually

none (2 percent) goes to encourage saving by thelowest-earning 40 percent. The reason is simple buttoo often overlooked even by liberal policymakers:a program subsidized by tax deductions , as opposedto refundable tax credits , is highly regressive.

Qualied retirement saving today reduces tax-able income, a deduction that is worth 35 cents onthe dollar to high-bracket taxpayers who need littleincentive to save. In contrast, a tax deduction forsaving is worth zero to the 35 million low-earninghouseholds who pay 15.2 percent in payroll taxesbut dont have income tax liability to offset. Indeed,even median-income families in the 10 and 15 per-cent income tax brackets receive a weak subsidy compared to the 35 percent subsidy rate that ap-plies to those earning over $200,000 a year.

Another way to deliver a subsidy through the taxcode is through a credit, which directly reducestaxes due. In fact, the Savers Credit, enacted in2001, creates this incentive, although it is limitedto very low-income taxpayers with income tax li-abilities to offset. The most powerful way to en-sure that low-income workers receive an incentiveat least as generous as an afuent worker is to makethe Savers Credit efundable, as the Earned Income Tax Credit (EITC) is, so that the low-wage workerreceives it even if she has only payroll tax and notincome tax liability.

Increase benet portability and workforce exibility.In yesterdays more stable, goods-producing econ-omy, traditional pensions were designed to rewardseniority and to retain older, long-tenured work-ers with rm-specic skills. Domestic rms were

more insulated from foreign competition, unions were stronger, job tenures were longer, and a muchhigher share of the (predominantly male) work-force occupied standard full-time jobs.

The 21st-century workforce is very different. The service and information technology economy puts a premium on younger, more educated work-ers with transferable skills. Competition, both

foreign and domestic, creates enormous volatil-ity for companies and workers alike. Median jobtenure has declined signicantly over the past two

decades. Even at rms with retirement plans, anincreasing number of workers cycle through jobs without earning employer-paid benets, since ittypically takes one year to be eligible to participateand ve years to vest. A combination of two-in-come families and just-in-time labor strategies by rms has increased the share of nonstandard work arrangements. Nearly 30 percent of U.S. workersare working in part-time, temporary, or contractarrangements that rarely include pension coverage. While this emerging free agent workforce may be good for exibility and productivity, it makesthe current employer-based pension system in-creasingly inadequate.

Lighten the social benet burden on business. Itsclear that most small and start-up companies eithercannot or prefer not to shoulder the administrativeburden and nancial risk of sponsoring a pension

lan. Indeed, despite the carrot of tax subsidiesfor pension plans, a majority of rms with fewerhan 500 employees do not offer one. In addition,

even very large companies with a predominantly low-income workforcethe Wal-Marts and Mc-Donalds among employershave little incentiveo sponsor a plan for workers who (a) receive little

or no nancial benet from a tax deduction and (b) without a strong incentive would prefer a higher wage now to an employer contribution for retire-

ent. In contrast, big, high-wage employersthe Microsofts and Intelsuse retirement plans tosteer tens of millions of dollars in pension tax sub-sidies to their employees every year.

This creates the anomalous situation whereby

he federal government provides more than $100billion in compensation subsidies to the employ-ees of a minority of companiesmost of whichare large rms with workers paid above-average wages. Meanwhile, companies with a substantial

ercentage of low-wage workers that dooffer goodbenets (employers like Starbucks) are paternalis-tically shouldering a cost that should be borne by


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16

society as a wholeand which will need to be if we want to achieve universal retirement security. If,instead, contributions by both workers and rms

were matched by a refundable federal tax credit,henas with the EITCthe after-tax value of benets paid to low-wage workers would be less ex-pensive, rather than more so.

ndividual Career Accounts: A Universal 401(k) Todays private pension system works well for those workers who have consistent access to a plan andchoose to save. One big reason retirement plans areeffective in generating saving is the powerful in-centives provided by immediate tax deductions andemployer matching contributions. Another reasonis infrastructure: employer-sponsored plans createhe positive inertia of automatic payroll deductions

while also managing the complexities of investmentmanagement at relatively low cost. These two key attributesincentives and an infrastructure forautomatic savingis what needs to be replicatedfor all Americans.

An essential step is to give every working Ameri-can access to a tax incentive and portable savingsaccount whether or not his current employer spon- sors a retirement plan. The fact that so few workers(less than 10 percent) save regularly in IRAs rein-forces what demonstration projects in asset-build-ing have found: it is not primarily access to a sav-ings account that spurs participation, but the threeIsIncentives, Infrastructure, and Inertia. The

proposed Individual Career Account would recastfederal pension policy by adding:

A tax ncentivefor saving that is more inclusiveand potentby expanding the Savers Credit,making it refundable and directly deposited intoan ICA.

An account-based nfrastructure that is citizen-based, rather than strictly employer-based, yetenables every worker to opt for regular contribu-tions by automatic payroll deduction.Default options that convert myopia into posi-tive nertia, through automatic enrollment, auto-matic payroll deduction, automatic asset alloca-tion, and automatic annuitization.

Basic Program Elements: Incentives, Infra-structure, Inertia A Universal 401(k) system can accomplish the vari-

ous national policy objectives described above by combining the following basic elements:

. Incentives: matching, refundable, and depositedredits for new saving. Just as most employers match

contributions to 401(k) accounts, the government would match voluntary saving by providing a re-fundable tax credit that would be deposited directly into the workers account. This would create a farmore powerful saving incentive for middle- and low- wage workers than current law. As noted above, atax deductionis neither an effective nor an equitablemeans to encourage pension saving among lower-income and younger workers, whether or not they participate in an employer plan. And although thecurrent Savers Credit provides (most commonly) a10 percent tax credit for retirement saving by low-income taxpayers, the lack of refundability meansthat millions of working-poor familieswho havepayroll tax but no current income tax liability tooffsetreceive no credit at all.

Instead, a refundable credit would operate justlike an employer match in a company 401(k) plan.Studies show that workers are far more likely tosave if given generous matching creditsand oncethey develop the habit of saving by payroll deduc-tion, most continue even when the match rate isreduced. A sliding-scale credit could give a greaterincentive to low-income workers who are least like-ly to save. For example, workers in families earn-ing below $40,000 could receive a $1 per $1 (1:1)matching credit on their rst $2,000 in savings; whereas workers in families earning above thatlevel could receive a $0.50 per $1 (1:2) matching

credit on their rst $4,000 in savings. This wouldive all workers the opportunity to receive as much

as $2,000 each year in matching deposits to theiraccounts, but the higher-wage earners would needto make twice the saving effort.

Like the current Savers Credit, the refund-able credit should apply equally to contributionsto 401(k)s and other employer-sponsored plans.



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17


Eligibility for the credit would be reconciled annu-ally through the income tax return process, which would also be used to encourage taxpayers to save

all or a portion of their tax refunds. Matching credits should be available for both in-dividual and employer contributions. This wouldgive employers a greater incentive to make depositson behalf of their low-wage workers. Yet, by ex-tending pension saving incentives to all workersas individuals, employers would have the optionto provide a pension benet without the need toadminister a pension plan. Employers could decidefrom year to year whether to contribute to their workers accountsalthough in doing so, they should be required to contribute either a at per-centage or a at dollar amount for all their pay-roll employees (otherwise ICAs could undermineERISA antidiscrimination rules to ensure that em-ployers are not using the tax subsidies to favor only their higher-wage employees).

2. Infrastructure: automatic payroll deduction and account administration. Equally important is replicat-ing the retirement plan infrastructure that is key to the success of employer-sponsored 401(k) plans. As with 401(k) plans, every worker should have ac-cess to the convenience, discipline, and protectionsprovided by automatic payroll deduction and pro-fessional asset management. When a worker llsout the required IRS Form W-4 (used to calculatetax withholding), he or she can simply specify amonthly saving deduction. Thats the only decisiona worker needs to makea choice to save.

The sole burden on employers would be toforward this automatic payroll deduction to theemployers own retirement saving plan (if there isone and the employee participates) or to a govern-

ment clearinghouse. Since most employers today use automated payroll processing services, there would be virtually no cost to forward the deduc-tion to a central clearinghouse. Even employers who do not automate payroll must forward in-come and payroll tax withholding to the IRS, soincluding withholding amounts for saving wouldbe a minor burden.

A new entitya clearinghouse akin to the Feder-al Thrift Savings Plan (TSP), which manages very low-cost 401(k)-style saving accounts for 3 million

federal military and civilian personnelwould re-ceive all deposits and be the default administratorfor small accounts. Recordkeeping would be central-ized, but the investmentmanagement would becontracted out to privateinvestment rms, as with TSP. The clearinghouse would strive to keep costsand complexity to a mini-mum. As with TSP, partic-ipants should have at most achoice among a small num-ber of very low-cost indexfunds. Although payroll-deducted savings and matching tax credits wouldow through the clearinghouse, the assets shouldbe fully portable and transferable at any time at the workers request to another qualied nancial insti-tution, or to a future employers pension plan.

3. Inertia: default options for enrollment, investment and annuitization. The W-4 form required of every worker would provide a simple means of indicat-ing how much an individual wanted withheld andsaved each pay period. Even better, the Universal401(k) system could convert myopia into positiveinertia by making participation the default option.(Studies have shown that automatic enrollment hasboosted 401(k) participation rates among low-in-come workers from 13 to 80 percent.) Unless the worker decided to opt out, the W-4 would give no-tice of the amount to be deducted and saved each

pay period. The initial default contribution couldbe modest3 or 4 percent of each paycheckin-creasing by 1 percent a year thereafter, as pay in-creased, until it reached a level likely to achieve anadequate accumulation over time.

If a worker did not wish to participate in hisemployers plan, the payroll deduction would owautomatically to the federal clearinghouse and into

Individual Career

Accounts would

supplement,

not supplant, the

xisting private

pension system.


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18

his Individual Career Account. Although the work-er should be able to switch, periodically, between a very limited number of broad and low-cost index

funds, there would be a default asset allocation for workers who made no choice at allmost likely alife-cycle fund that would automatically adjust themix of stocks and bonds to match the workers ageand years until retirement age.

Finally, at retirement age, the default optionshould be monthly payments rather than lump-sum withdrawals to ensure that retirees do notoutlive their benets, replicating the great advan-age of a dened-benet plan. Although individu-

als could choose to withdraw (or roll over) all orpart of their nest egg, there should be incentiveso encourage and facilitate annuitization. This an-

nuity benet could be contracted to one or severalprivate insurers, or taken on by the Pension Ben-et Guarantee Corporation, the federal pension

insurer that currently manages guaranteed annu-ity payments each month for millions of private-sector retirees who were participants in a defaultedemployer plan.

While Americans clearly support retaining So-cial Securitys dened-benet safety net, neitherSocial Security nor the inadequate coverage of todays private pension system is providing enoughincome in retirement. Thus, a citizen-based, por-table, and automatic systemproviding those whond it most difcult to save with powerful right-side-up tax incentivesmay be exactly the retire-ment revolution we need.



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Tax Consumption, Not WorkMaya MacGuineas

T he payroll tax takes a bigger biteout of the incomes of more than 70ercent of American families thanany other tax. Yet the dedicated tax forSocial Security and Medicare has many shortcomings. It is regressive, inef-cient, and insufcient to meet the needsof the programs it supports. It makeslittle sense to attempt only incrementalchanges in such a problem-plagued taxprogram. Addressing its shortcomings will require wholesale reform. By elimi-nating the payroll tax and replacing it with a progressive consumption tax, wecould combine the economic benets of a tax on consumption with the fairer taxstructure that comes with progressiveratescreating a rare win-win situationin tax reform.

When the payroll tax was introducednearly 70 years ago, the tax rate was 2percent on the rst $3,000 of wages. To-day, the tax rate is 12.4 percent on the rst$94,200 of wages for Social Security, and.9 percent on total wages for Medicare. This regressive tax is levied only on

wages, kicks in at the rst dollar of earn-

ings, and since it is capped, higher-in-come earners face lower effective taxrates. Interest, dividends, and capital

ains, as well as many forms of nonwagecompensation such as health care andpension benetsall of which go dis-proportionately to upper income earn-ersare not taxed.

Nor is the payroll tax adjusted forfamily size or situation. The income taxs structured to reect individual fam-ly circumstances through dependent

deductions, child credits, and numer-ous other adjustments, but the payrollax makes no such accommodations

for differing family needs. Take twobreadwinners, each earning a salary of $75,000. The rst is a single, young per-son, and the second is a working parent with a stay-at-home spouse raising threechildren. Each faces the same payroll taxliability of $11,475, split equally betweenemployer and employee, irrespective of heir strikingly different nancial situ-

ations. This is one of the least family-friendly tax policies on the books.

Not only is the payroll tax unfair, its inefcient and creates economic dis-ortions. It is a tax on wages, with half aid by the worker and half paid by the

employer. This provides an incentive for workers and employers to place greater value on nontaxable forms of compen-sation, such as health care benets, andfor employers to skew salary compensa-

ion in favor of workers earning over theaxable maximum (since each marginal

dollar of pay is not subject to the 12.4ercent Social Security levy). Although

t is generally believed that the portionof the payroll tax paid by employers is

assed along to employees in the form of lower wages, this is not necessarily the


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20

case at the bottom of the income scale and dur-ing certain periods in the business cycle. Requiringbusinesses to shoulder half the burden of the pay-

roll tax deters job creation, particularly for entry-level and low-income workers. Above that level, ithides the true cost of the tax from those who actu-ally bear the burden. Neither is desirable.

Finally, the payroll tax will not be sufcient tomeet the needs of the programs it funds. Social Se-curity spending is expected to surpass revenues in017, and Medicare is currently running cash de-

cits. Ensuring that the revenue base for these twoprograms is sufcient to meet payments is essentialo any reform program.

A Win-Win Tax Swap While the shortcomings of the payroll tax are ap-parent, most proposed reforms are incremental innature and offer only a partial x. Instead, the pay-roll tax should be eliminated and replaced with aax that is both fairer and better for the economy.

However, the payroll tax accounts for over a thirdof the federal governments revenues, and guringout how to raise revenues to replace close to $1 tr il-lion in payroll taxes will be a challenge. Generally speaking, the larger the tax, the larger the damagecaused to the economy.

Emphasizing what is taxed, however, can help mit-igate the negative economic effects. There are only ve basic things that can be taxedpeople, incomes,

wages, wealth, and consumption. The current fed-eral system primarily taxes incomes and wages.Given that the low level of domestic saving is a

serious economic problem, we ought to considera consumption tax. A higher tax on consumption would encourage citizens to save more and spendlessa change that would have profound and per-sistent positive effects on the economy.

Individual saving is necessary for people to pre-pare for large outlays over their lifetimefor buy-ing a home, funding their childrens education, andretirement, as well as for the unexpected costs of illness or unemployment.

The cumulative savings of individuals, busi-nesses, and government are also profoundly impor-tant in macroeconomic terms. Net national savingprovides the capital for productive investment, andover time low saving rates can lead to lower stan-dards of living. In countries where domestic sav-ing is low, either domestic investment will declineor capital has to be borrowed from abroad, leavingthe country indebted to overseas creditors. Ourdependence on other countries to supply us withinvestment capital leaves us economically vulner-able. The only way to overcome this vulnerability is to increase domestic saving levels.

The problem with most consumption taxes, how-ever, is that they are extremely regressive. Lowerearners spend most, if not all, of their earnings onbasic necessities, leaving them with little left over tosave, while those with more disposable income have

reater exibility in choosing how much to spendand how much to save. While switching to a atrate consumption tax would have positive effects

on the economy, it would do little to address theunfairness of maintaining the regressive payroll taxduring a time of increasing earnings inequality.

Making Consumption Taxes Progressive There is nothing that says a consumption tax mustbe a at rate tax. A progressive consumption tax isa much better idea.

THE PAYROLL TAX AS A SHARE OF FEDERAL REVENUES


ource: Congressional Budget Ofce.

Payroll Tax 37%

IndividualIncome Tax 43%

CorporateIncome Tax 13%

Other7%


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income tax base where they already exist. Thebroader the tax base, the fewer distortions there would be. The creation of a new tax should not be

an excuse to start pepper-ing the tax code with newargeted tax breaks.

In order to spread outhe cost of large outlays

for housing and consumerdurables, taxpayers wouldbe able to pay the tax onsuch items in installmentsover a longer period of ime. It would be prefer-

able not to subsidize hous-ing under a progressiveconsumption tax in thesame way as we now dohrough the income tax, inhat the current structure

leads to overconsumptionof housing and underinvestment in other areas. The home mortgage interest deduction, whichsubsidizes borrowing for purchasing a home orusing it as collateral, would have to be redesignedo avoid creating a huge loophole whereby indi-

viduals could borrow more money than neededo purchase a home and deposit the excess funds

in saving accounts, thereby reducing the level of consumption that would be taxed under the pro-

ressive consumption tax. The tax would be adjusted for family size, provid-

ing a consumption deduction for each family mem-ber. In order to avoid situations where individuals were left with tax liabilities they could not afford at

he end of the year, there would be monthly with-holdingmuch like that for income taxbased on

he previous years level of consumption.In order to avoid any abrupt economic disrup-

ions, the transition from a low-saving to high-sav-ing economy should be managed by gradually phas-ing in a consumption tax over a number of years.

While the tax is not as simple as a at sales tax,most of the information needed to calculate the taxis already provided for the income tax, and the ad-

vantages in terms of both compliance and progres-sivity make this approach to taxing consumptionfar preferable.

he Advantages of a ProgressiveConsumption Tax Replacing the payroll tax with the progressiveconsumption tax offers a number of distinct advantages. It will almost certainly increase nationalsaving, probably by a signicant amount. Giventhe economic challenges the country currently faces, from highly overleveraged individuals torecord budget decits, few macroeconomic objec-tives are more important.

At the same time, the progressive nature of thisconsumption tax proposal would be a vast improve-ment over the distributional effects of the payrolltax. If payroll taxes were used to nance individualsaving accounts, a at or even a regressive pay-roll tax structure might be justiable, since individuals would receive the full benet of their owncontributions. However, a regressive tax structureused to nance a large portion of entitlement pro-

ramsincluding a number of subsidies that owfrom low to high incomeas well as other govern-ment spending programs, hardly makes sense.

Finally, a progressive consumption tax offersthe potential for a workable political compromise. There is an ongoing divide between conservativesand liberals over the priorities and structure of desirable tax reform. Conservatives tend to favora more efcient consumption base, which is gener-ally associated with at tax rates, as being betterfor the economy, while liberals favor a progressive

tax structure and place less emphasis on the eco-nomic effects of taxes. A progressive consumptiontax would allow the more efcient base to be com-bined with a fairer tax structure, giving both sidessomething to support.


Replacing the payroll

ax with a progressive

consumption tax

would stimulate

job creation, higher

wages, and higher

levels of personal

saving.


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An Energy Efciency Trading SystemLisa Margonelli

T he United States consumes en-ergy so lavishly that the cost isequivalent to nearly 10 percent of our GDP, reducing our competitive-ness, constraining our foreign policy,and producing a fourth of the worlds

reenhouse gases. And because the U.S.economy is far more energy dependentthan the economies of other advancedindustrialized nations, American indus-try and families are far more vulnerableto natural catastrophes like hurricanesor political upheavals in oil- and gas-producing countries than industry andfamilies in Europe and Japan. In thecoming decade that vulnerability willonly increase, as more and more of ourenergy supply will be concentrated inpolitically unstable regions. Reducingthe economic and environmental risksof excessive energy use therefore mustbecome one of Americas most impor-tant national goals.

Nearly a century of government ef-forts to make energy abundant has ledmany Americans to see cheap energy asa virtual right, creating political rigor

mortis with respect to energy policy.Higher energy taxes are unpopular, andmanufacturers have fought the imposi-tion of tighter energy standards for ap-pliances and automobiles. So the gov-ernment has abdicated responsibility forreining in energy use to market forces.But low prices in the 1990s encouraged

consumers to use morenot lessen-ergy. Consequently, they are now spend-ng more money on fuel without being

able to cut back. The government needs to make a

fundamental change in the way it ap-roaches energy policyinstead of

simply trying to ensure supply, it needso begin reducing demand by spurring

a revolution in energy efciency. Set-ing tough energy standards for Amer-cas biggest energy users, and mak-ng energy efciency tradablemuchhe way we now trade oil and naturalaswould quickly reduce our total en-

ergy consumption while limiting carbonemissions, stimulating productivity, andcreating jobs. Higher taxes on gasolineare political poison, but tougher energy standards have overwhelming supportamong both Democrats and Republi-canswell above 70 percent. Adding a

arket mechanism to trade efciency ains would make energy efciency

standards more palatable to industrieshat have resisted them in the past, athe same time raising economic growth

and providing incentives for technologi-cal innovation.

ethinking the Old Supply-Side Bargain The American way of using energy isbased on a grand bargain dating back o the 1930s, in which the government


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focused on energy supply rather than demand. Theoal of American policy was to secure new cheap

supplies of energy by providing tax incentives and

other forms of government support for produc-ers and by pursuing oil diplomacy internation-ally. Using military powero protect shipping lanes

and pipelines, and makingspecial deals with key pro-ducers like Saudi Arabia,allowed the United Stateso promise cheap energy o the world, while offer-

ing energy markets to ourrading partners. This ap-

proach virtually sanctioned waste, with the resulthat more than 40 percent of the energy the United

States uses is lost as waste heat.Increasing competit ion for global oil and natural

as supplies, on the one hand, and declining U.S.reserves, on the other, mean that the old bargain isno longer effective insurance against either pricespikes or the exercise of market power by the Or-

anization of the Petroleum Exporting Countries(OPEC). Despite some gains in efciency in the1980s, the U.S. economy remains vulnerable tohigh oil prices. Any increase in gasoline prices actsas an almost instant regressive tax on Americandrivers, who rely on the automobile much morehan their counterparts in other advanced indus-rialized economies. It also creates an increasing

scal burden for the American economy, drivingup Americas international decit. In the rst twoquarters of 2006, petroleum imports accounted fornearly a third of the U.S. trade decit.

Despite higher prices, both oil and electricity demand continues to grow fast. Overall U.S. elec-

rical demand is expected to grow by 19 percent by 015, while new power generation will expand by

only 6 percent. To manage the gap, utilities willhave to consider reducing demand. Another barriero meeting Americas expanding need for energy ishat the domestic infrastructure for delivering oil

and electricity is old, and in some areas pipelinesand grids are operating near capacity. Expanding

them to carry more energy will be costly and timeconsuming. Some isolated sections of the electrical

rid are actually facing supply shortfalls within the

next two years. In these and other cases, reducingdemand would solve the bottleneck more quickly than increasing supply.

Reducing energy demand is both cheaper andfaster than is the alternative of securing new sup-plies by exploring new oil elds or building morepower plants. Efciency is Americas largest andmost cost-effective potential energy resource, andit has already provided three-quarters of our newenergy needs since 1970. There is much more ef-ciency to be found. Conservative estimates sug-

est that buildings and vehicles could halve theirenergy use without radical changes in design andconstruction. Emerging technologies, like sensorsand supercomputing, nanotechnology, computa-tional uid dynamics, and bioengineering hold thepossibility of radically changing our relationship toenergy and improving standards of living.

Promoting efciency, however, has been an un-derutilized policy option. In fact, many current

overnment policies do not reward conservationor, worse, encourage waste. The Internal RevenueService, for example, creates a perverse incentiveto waste energy by allowing commercial landlordsto write off their energy costs every year. At thesame time, it requires building costs to be depre-ciated on a 30-year schedule, effectively devaluinginvestments in energy efciency. Removing suchperverse incentives would help encourage greaterefciency but alone would not be enough to spurthe efciency gains we need. Without positive gov-ernment incentives, it often does not make sensefor individual purchasers to spend more on a moreefcient car or building, either because they can-

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