Character Test.

Eduardo Porter has argued that Americans have been guided by a shared disdain for collective solutions and a belief individual responsibility. The conservative argument offered by Charles Murray and others is that the welfare state has undermined the character of its beneficiaries. The liberal argument offered by Eduardo Porter and others is that America has relied on continuing prosperity instead of a real welfare state. When long-term economic troubles hit, many Americans plunged through the cob-web of a “safety net.”[1]

On the right, in line with the moral corruption argument made by Murray, Republicans propose to repeal the Affordable Care Act and cut a bevy of other programs for the poor. This will end the culture of dependency that many conservatives blame for creeping social pathologies that came to light after the recent Baltimore riots that followed the arresting-to-death of Freddy Grey. The Republican budget plans seem like a dead-end. For one thing, they target relatively low-cost programs aimed at the poorest Americans. In reality, defense, Medicare/Medicaid, and Social Security are the big drivers of government spending. As Willy Sutton explained when asked why he robbed banks, “That’s where the money is.”

For another thing, these categories of spending are widely popular with the American middle class. Once again, as with opposition to gay marriage and to immigration reform, Republicans are picking the losing side of an argument. Takes Social Security as an example. As the Baby Boom retires, it places a mounting pressure on the system. When current revenue through withholding is inadequate to meet obligations, the System draws on the Social Security trust-fund (built up from revenue surpluses in the past). At the moment, the trust-fund is expected to be exhausted by 2033. After that happens, retiree benefits will be reduced to perhaps 75 percent of expected benefits.[2] Senators Elizabeth Warren and Bernie Sanders favor raising or removing the cap on Social Security withholding to greatly increase revenue for the supplemental retirement income system. However, they favor going beyond stabilizing the finances of the present system to create an expanded national pension system.[3]

This seems likely to emerge as a powerful issue in future elections. In 2005, 26 percent of still-working Americans expected “to rely on Social Security as a major source of income” in retirement. In 2015, 36 percent of still-working Americans “expect to rely on Social Security as a major source of income” in retirement. Among currently retired people, 73 percent are receiving reduced benefits because they retired early.

There are several possible explanations for the growing place of Social Security in the retirement income of Americans. One explanation could be that the Great Recession devastated both the savings and the income of ordinary Americans. Another explanation could be that a decade of aging forced many Baby Boomers to confront their own lack of thrift over the course of a lifetime. Similarly, the huge number of people who took early retirement could be explained by either the moral corruption argument or by the ravages of globalization over the last 25 years.

If conservatives want to sustain the moral corruption argument, they will have to openly apply it to middle class entitlements. Of course, cannibalizing the Affordable Care Act could provide some of the revenues to shore up middle class entitlements. However, this would require the middle class to turn its back on the poor. So, a test of character.

[1] Eduardo Porter, “Income Inequality Is Costing The Nation on Social Issues,” NYT, 29 April 2015.

[2] “Social Security worries mount,” The Week, 22 May 2015, p. 32.

[3] This strikes me as equivalent to the sort of defined-benefit system that American companies found to be unsustainable and abandoned in favor of the defined-contribution systems. Perhaps I’m wrong.

Toward the cliff.

In brief compass, the “supply side” theories of the Reagan administration de-stabilized the traditional budget by cutting taxes without cutting expenditures.[1] Deficits expanded. However, observers were more concerned about the budget deficits that would be driven by the cost of entitlements—Medicare, Medicaid, and Social Security—for Baby Boomers. If one takes as a given that government can only account for some fixed share of GDP, then the growth of entitlements will crowd out spending on other areas: defense and the wide range of government functions labeled as “discretionary spending.”[2] These entitlements are so popular and the mythology surrounding them so powerful that the elected representatives in a democratic polity were unwilling to address them. The problem festered.

Then came the Great Recession. In 2009, the government’s deficit peaked at over 10 percent of Gross Domestic Product (GDP). By 2013 the Congressional Budget Office (CBO) projected that the deficit would fall to 2.1 percent of GDP. Moreover in September 2013 the CBO projected that short-term government deficits would shrink, thanks to the economy’s recovery from the Great Recession and the cuts enforced by “zee zequester.” So, the deficit has been mastered. We’re good, right?

Well, no. The deficit arising from the Great Recession has been mastered. However, that was a matter of course. Counter-cyclical deficit spending has been the normal response to recessions for half a century. Economic activity revises, spending falls, and tax revenues increase, so the deficit goes away.[3]

However, the deficit arising from entitlement programs has not been mastered. Or addressed. Or even acknowledged. Social Security, Medicare, and Medicaid are about to rise sharply in total cost as the fabled Baby Boomers begin to retire in droves. From 1973 to 2013, spending on Medicare, Medicaid, and Social Security averaged 7 percent of GDP per year; the CBO projects that they will rise to 14 percent of GDP by 2038. By 2023, government spending will rise to 3.5 percent of GDP; by 2038 it would reach 6.5 percent. The trouble is that the economy will not grow as much as does government spending. Moreover, federal revenues are projected to rise by only 2 percent of GDP over the same period. Hence, this will drive up the deficit from the 38 percent of Gross Domestic Product (GDP) that formed the average from 1968 to 2008 to 100 percent of GDP in 2038.

Neither Republicans nor Democrats have shown any willingness during the Obama Administration to address this important long-term problem. The administration has concentrated tis efforts on raising taxes on the higher income groups, rather than on trying to contain or reduce costs. The Republicans have concentrated on trying to repeal the Affordable Care Act, rather than on trying to address the ballooning costs of entitlement programs.

Nor is it likely to emerge as a major issue in the 2016 presidential election. Older people vote in larger percentages than do younger people. No one has yet formulated a way to deliver the same quality of medical care or retirement income at a much lower cost. No one yet has formulated a way to raise substantially larger tax revenues from all Americans.

[1] Jackie Calmes, “Budget Office Warns That Deficits Will Rise Again Because Cuts Are Misdirected,” NYT, 18 September 2013.

[2] Obviously, one does not have to agree that some fixed share of the economy should be devoted to government spending. Certainly Senator Sanders does not.

[3] See Paul Krugman’s terse, withering evaluation of President Obama’s performance in this regard in NYT, 8 May 2015.

Long Term Trends 3.

In 2010 and 2011, New York Times correspondent David Leonhardt turned to the problem of the long-term deficit.[1] In his analysis, that deficit arises from “the world’s highest health costs (by far), the world’s largest military (by far), a Social Security program built when most people died by 70—and to pay for it all, the lowest tax rates in decades.” By Leonhardt’s estimate, we will need about $500 billion a year in annual deficit reduction for the next decade. The money will have to come out of the three big spending categories and from more revenue.

The Medicare budget is the “linchpin of deficit reduction.”  Leonhardt recommended introducing incentives for people to choose cost-effective health-care. In practice, that will mean taxing employer-provided health-care benefits like the income they really are. The cost has risen massively since 1975. This encourages spending on health-care, rather than using the market to restrain price increases. Also, it is a benefit available only to people with employer-provided health-care. So, Americans get taxed differently for no good reason. This cost the government $264 billion in revenue in 2010. The federal tax subsidy created by sheltering them from taxes benefits drug makers, hospitals, and insurers.[2] He also wanted Medicare to refuse to pay for health care that cannot demonstrate that it makes people healthier.

Test social programs for actual effectiveness. Lots of them just exist, rather than achieving anything. Doubtless, many Republicans would say the same thing about the encrustations of regulations on business and industry that have grown up over the decades without ever being sunsetted.

Last, cut military spending by $100 billion a year to reverse the post-9/11 expansion.

Some leading conservatives—Mitch Daniels, Glen Hubbard, Gregory Mankiw–have endorsed means-testing Social Security and Medicare benefits. That is, shove more of the cost of their own care and retirement off on people who can afford to pay it.

Leonhardt also favored higher taxes on the middle and upper classes. The mortgage-interest deduction chiefly benefits people in the higher income brackets. Tax breaks for investors (IRA exclusion, $12.6 billion; lower tax rate for dividends, $31.1 billion; lower tax rate for capital gains, $36.3 billion; not taxing capital gains on items left to people in wills, $39.5 billion; and the 401(k) exclusion, $52.2 billion) total $171.70 billion in ‘lost” revenue.

Social Security and Medicare are essentially about paying for the past. (Often an improvident past.) Spending on education, research, and infrastructure are about paying for the future we desire. Leonhardt argues that we should actually be spending more on the future.

However, it isn’t clear that American democracy has the ability to confront powerful and well-entrenched interest groups. Reforming Medicare would involve taking money away from doctors, insurance companies, hospitals, pharmaceutical companies.  Stabilizing Social Security will involve raising the cap on withholding, so that upper income groups get gored and means-testing benefits at the cost of upper-income groups. Raising the taxes on the upper income groups to sustain benefits for lower income groups invited push-back in the past and will do so again. Cutting defense spending has never been as easy as increasing it, especially in the midst of dangers. The refusal of Democrats to define “fair share” makes rational discussion difficult.

Still, laying out the problems and some possible solutions makes it possible to think about the implications.

[1] David Leonhardt, “The Deficit: Real vs. Imagined,” NYT, 22 June 2011.

[2] David Leonhardt, “Health care’s obstacle: no will to cut,” by NYT, 10 March 2010; David Leonhardt, “The 3 Biggest Tax Breaks—and What They Cost Us,” NYT Magazine, 17 April 2011.

Red ink as far as the eye can see.

The US government has been running deficits almost continuously since 1970.[1] So we’re used to them. Things even started to look like they were improving during the late 1990s. Hi-tech industries went through a rapid run-up in value. This produced a lot of extra tax revenue without anyone complaining about it. Bill Clinton left George W. Bush a budget surplus of $236 billion in 2001. By early in 2002 the government was back in deficit by $150 billion.[2]

What we’re not used to are the immense deficits of recent years: the 2009 deficit was $1.4 trillion, the 2010 deficit was $1.56 trillion.

Where did these gigantic deficits come from? They came from a combination of the Bush-era tax cuts with a massive expansion in government spending. Some of the spending could have been avoided: the Iraq war and the Medicare prescription drug benefit proposed by President Bush and passed by Congress in 2003. Some of the spending could not be avoided: enhanced national security after 9/11, the invasion of Afghanistan. However, the biggest source of the deficit is related to the 2007-2008 recession. On the one hand, tax revenues fell during the slow-down by $400 billion (17 percent of revenues). On the other hand, the government pumped money into the economy: $154 billion for the TARP under the Bush administration and $202 billion for the stimulus bill under the Obama administration. That is a total of $756 billion added to the deficit without even counting the lost revenue from years after 2007.

Things got better as the recession ended: government revenue rose while spending fell. Soon, things will get worse again. According to Congressional Budget Office (CBO) forecasts in January 2015, the deficit will start to rise in 2017 as the costs of Social Security, Medicare, and Medicaid increase.[3] The CBO projects that deficits will bottom-out at $467 billion in 2016. Then deficits are projected to rise: $486 billion in 2017; $953 billion in 2023; over a trillion dollars in 2025. The real burden of these rising deficits will depend on the growth of the economy. Here again, the CBO has bad news: projected growth rates for 2014-2018 are at 2.5%, while those for 2020-2025 will fall to 2.2%.

How large a share of the Gross Domestic Product (GDP) will be represented by the deficits? Between 2016 and 2025, Social Security will rise from 4.9% to 5.7% of GDP; health-care spending will rise from 5.3% to 6.2%; and paying the interest on the debt will rise from 1.5% to 3.0%. Discretionary spending—everything else—will fall from 9.2% to 7.4%.

Still, the absolute dollar amounts don’t matter. Ratios between debt and GDP do matter because it is the ability of the underlying economy to support the debt and maintain the credibility of the government’s ability to service the debt that makes deficits supportable. The 2009 deficit amounted to 10% of GDP and the total debt amounted to almost 100% of GDP.

Why does this matter? The government has to borrow the money from private lenders in order to cover a part of our national expenses. IF there is a fixed pool of private savings (capital) from which to borrow, then expanding government borrowing reduces the amount of capital that is available for all other borrowers. (Capital in-flows from the rest of a troubled world can off-set this in large measure–in the US.)  People investing in business or buying homes will compete with the government. The government can and will pay whatever interest rate it needs to in order to not go bankrupt. As a result, interest rates will go up and the total pool of capital available for private investment will go down. Capital is one of the factors of production determining the state of the economy. High interest rates slow down the economy.

[1] “Deficits as far as the eye can see,” The Week, 16 April 2010, p. 11.

[2] So the Bush tax cuts cost the United States Government about $400 billion a year in revenue.

[3] Jonathan Weissman, “Budget Forecast Sees End to Sharp Deficit Decline,” NYT, 27 January 2015.