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Means Testing Senior Entitlements is Harder than It Sounds

July 21, 2008

Will Wilkinson echoes Tyler Cowen’s endorsement of means testing testing for Medicare. However, Greg Mankiw makes some pretty good points that prompt a mysterious accusation of misreading by Tyler.

The significance of Mankiw’s points are that advocates of means testing need to say much more for several reasons:

  • First, means testing has all of the disincentive effects of a tax because it reduces a benefit as one’s income rises.
  • Second, to the extent that assets are measured, you run into serious practical problems with how to verify or measure assets because assets can be easily hidden or transferred to a relative.
  • Third, it is not obvious why equal benefits should not be given to all and the income tax made generally more progressive to accomplish whatever redistribution we would like to achieve; why focus on other elderly people (those people who would have Medicare benefits reduced by means testing) as a mechanism for finding more funds to take care of poor elderly people (those who would not have their benefits reduced and would benefit from a solvent system).

The standard way to address the first point is to phase out the benefit gradually as one’s income rises. This decreases marginal disincentives to earn more income, but at the cost of a much larger program than I suspect Will would like. It begins to look a lot like the program described in the third point.

The second point could be addressed by ignoring assets when means testing, but that seems intuitively unappealing if our aim is to direct funds to the neediest. Basing the program on income alone would both (i) skew the results of the program away from that aim as those with large assets but little income benefitted at the expense of those without accumulated assets, and (ii) create an incentive for people to convert income producing assets into non-income producing assets (e.g. skewing investments toward growth stocks and away from bonds) creating both evasion of the purpose of the test and deadweight losses due to the people’s assets being allocated not in accordance with their economic preferences. Perhaps you could address the problem of hiding assets through appropriate regulations, but that approach seems likely to underestimate human ingenuity and overestimate the acumen of those writing regulations (not a common mistake for most libertarians!). Further such an approach is potentially quite intrusive, for example it may involve the government second-guessing transfers among family members.

With respect to the alternative in the third point, presumably we would want to shy away from such a system as it would require the government to be involved in the healthcare of all seniors, not just the needy. This doesn’t seem desirable for most of the standard (and persuasive!) reasons: the poor feedback mechanisms government systems have, their capture by interest groups etc.

All of this being said, however, it is possible that the magnitude of these practical difficulties may be less than the gains from instituting such a system. Maybe.

I suspect that a better solution would be to eliminate Medicare as a separate program and just fold it into a system of a guaranteed minimum income for the elderly combined with forced savings that would replace both Social Security and Medicare (much like Cato has proposed)? Of course that may be harder than it sounds too…


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