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Archive for the ‘Budget Deficit’ Category

The Congressional Budget Office has released its updated budget projections.

Good news:

CBO now estimates that if the current laws that govern federal taxes and spending do not change, the budget deficit in fiscal year 2014 will be $492 billion. Relative to the size of the economy, that deficit—at 2.8 percent of gross domestic product (GDP)—will be nearly a third less than the $680 billion shortfall in fiscal year 2013, which was equal to 4.1 percent of GDP. This will be the fifth consecutive year in which the deficit has declined as a share of GDP since peaking at 9.8 percent in 2009.

Bad news:

But if current laws do not change, the period of shrinking deficits will soon come to an end. Between 2015 and 2024, annual budget shortfalls are projected to rise substantially—from a low of $469 billion in 2015 to about $1 trillion from 2022 through 2024—mainly because of the aging population, rising health care costs, an expansion of federal subsidies for health insurance, and growing interest payments on federal debt. CBO expects that cumulative deficits during that decade will equal $7.6 trillion.

Bottom Line: Few legislators read the CBO’s documents. Fragments are cherry picked and appended to talking points when convenient. But the larger argument that the CBO, the GAO and the OMB have been making consistently for the past decade is met with silence.

For an overview of the CBO’s budget projections, see the National Journal.

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This week the Congressional Budget Office released The Budget and Economic Outlook: 2014-2024. From the press coverage, one would have guessed the report was either entitled Obamacare: the Job Killer that is Almost as Bad as Benghazi or Obamacare: Ending the “Job Lock” and Opening the Door to Leisure. In reality, the impact of the Affordable Care Act was only a small part of the report—largely restricted to the appendix—and arguably the least troublesome.

Here are a few highlights. I will quote from the CBO report, since most of the media coverage will only address the shiny objects connected to the Affordable Care Act (for an exception, see Ron Fournier’s piece in National Journal).

Economic Growth

  • “[T]he economy will grow at a solid pace in 2014 and for the next few years…Beyond 2017, CBO expects that economic growth will diminish to a pace that is well below the average seen over the past several decades. That projected slowdown mainly reflects long-term trends—particularly, slower growth in the labor force because of the aging of the population.” (p. 1)
  • “The unemployment rate is expected to edge down from 5.8 percent in 2017 to 5.5 percent in 2024.” (p. 5)

The Debt

  • “[T]he deficit is projected to decrease again in 2015—to $478 billion, or 2.6 percent of GDP. After that, however, deficits are projected to start rising—both in dollar terms and relative to the size of the economy— because revenues are expected to grow at roughly the same pace as GDP whereas spending is expected to grow more rapidly than GDP.” (p. 1)

The Consequences (p. 18)

  • “The nation’s net interest costs would be very high (after interest rates moved up to more typical levels) and rising.”
  • “National saving would be held down, leading to more borrowing from abroad and less domestic investment, which in turn would decrease income in the United States compared with what it would be otherwise.”
  • “Policymakers’ ability to use tax and spending policies to respond to unexpected challenges—such as economic downturns, natural disasters, or financial crises—would be constrained. As a result, unexpected events could have worse effects on the economy and people’s well-being than they would otherwise.”
  • “The likelihood of a fiscal crisis would be higher. During such a crisis, investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow funds at affordable interest rates.”

Beyond 2024, things only get worse

  • “Although long-term budget projections are highly uncertain, the aging of the population and rising costs for health care would almost certainly push federal spending up significantly relative to GDP after 2024 if current laws remained in effect. Federal revenues also would continue to increase relative to GDP under cur- rent law, reaching significantly higher percentages of GDP than at any time in the nation’s history—but they would not keep pace with outlays. As a result, public debt would reach roughly 110 percent of GDP by 2038, CBO estimates, about equal to the percentage just after World War II. Such an upward path would ultimately be unsustainable.” (pp. 25-26)

Of course,  the core driver in these projections is the aging of the population.  Policymakers have the ability to reform key policies to reduce the long-term impact of the demographic shift, and the earlier these reforms are introduced, the less dramatic they need to be. But given the endless campaign and the struggle over the news cycle, who can even contemplate serious entitlement and tax reform.  It is far easier to focus on the shiny objects than to acknowledge the core message of the CBO’s report.

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As you likely know, the Congress seems poised to pass a $1.012 trillion omnibus spending bill to avoid another shutdown (see coverage from the Wall Street Journal, the Washington Post, the Hill).  It appears that both the Democrats and Republicans will get things they hold dear in the spending provisions and the riders (Ed O’Keefe has a list of winners and losers). The GOP seems to have won this round–more money for the Pentagon, riders preventing NLRB e-Card Check for unions and the enforcement of the incandescent light bulb ban. There is even mention of Benghazi and “Operation Fast and Furious.” Score!

Of course, the spending bill deals with discretionary spending, and from a long-term perspective, discretionary spending is not driving the long-term budget problems. This chart, based on data from the Office of Management and Budget’s Historical Tables (table 8.4) gives a sense of the long-term trends.

Spending

Mandatory spending and interest have dominated the budget for some time, increasing from 6.2 percent of GDP in 1962 to 15 percent today, and within the mandatory programs, Social Security, Medicare and Medicaid have grown the fastest.  The Congressional Budget Office’s 2013 Long-Term Budget Outlook projects that Social Security and the major health care programs will grow from 9.5 percent of GDP (2013) to 14.2 percent of GDP (2038). Indeed, by 2038, the CBO projects spending to be at 26.2 percent of GDP, with revenues of 19.7 percent of GDP. All of this is under the extended baseline scenario. Obviously, 2038 is a long way away, and these are but projections (I can offer my own prediction: in 2038, no one will remember Operation Fast and Furious).

None of this is impacted at all by the new omnibus spending bill, which from a long-term perspective is trivial despite the heavy press coverage.

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Taking Credit

Given the events of the past several years—and, most certainly, the past few weeks—one should not be surprised that Fitch has threatened to downgrade the nation’s credit rating (as you may recall, S&P issued a similar warning in 2011, and followed through). Although Fitch believes that Congress will raise the debt limit, it observes that “the political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default.”  Fitch seems positive on the US economy: “the U.S. economy (and hence tax base) remains more dynamic and resilient to shocks than its high-grade rating peers.” The key problems are political and institutional:

“The prolonged negotiations over raising the debt ceiling (following the episode in August 2011) risks undermining confidence in the role of the U.S. dollar as the preeminent global reserve currency, by casting doubt over the full faith and credit of the U.S. This ‘faith’ is a key reason why the U.S. ‘AAA’ rating can tolerate a substantially higher level of public debt than other ‘AAA’ sovereigns.”

While Fitch applauds the stabilization of gross debt following the Budget Control Act of 2011 (i.e., the sequestration), it warns:

“public debt stabilisation at such elevated levels still render the US economy and public finances vulnerable to adverse shocks and in the absence of additional spending reform and revenue measures, deficits and debt will begin to rise again at the end of the decade. The U.S. is the most heavily indebted ‘AAA’ rated sovereign, with a gross debt ratio equivalent to double that of the ‘AAA’ median.”

As many Pileus readers will correctly remember, the credit rating agencies played an important role in the lead up to the financial crisis by issuing higher than warranted ratings (arguably a product of the incentives created by the “issuer-pays” compensation model) and often failing to verify the quality of the data they were plugging into their models. But the overall assessment of the US system issued by Fitch and earlier by S&P) seems spot on.

Ezra Klein and Evan Soltas have a fine piece on the situation. As they note: “What you see with the Fitch and S&P calls is that the market price on the U.S. political system doesn’t reflect what market participants are coming to believe about it: that a once capable and reliable system is now dysfunctional and unpredictable.”

Given the challenges facing the nation in the next several decades (massive unfunded liabilities, demographic changes that will increase the pressure on entitlements while reducing the tax base) one can only expect that the dysfunctions will only multiply.

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Forgive me if I am confused.

On May 13, 2013, the Social Security Board of Trustees released its annual report on the Old-Age and Survivors Insurance, and Disability Insurance (OASDI) Trust Funds. A few salient points:

  1. In 2012, the OASDI Trust Funds had $840 billion in income, including $509 billion in contributions, $27 billion from taxation of benefits, $109 billion in interest on trust fund assets, and $114 in reimbursements from the General Fund of the Treasury (a product of the payroll tax reductions that were used as a stimulus)
  2. Total expenditures were $786 billion. That leaves a surplus of $54 billion. As a result, at the end of 2012, the assets of the OASDI Trust Funds were $2.73 trillion. With an effective annual interest rate of 4.1 percent, it would appear that things are in good shape.

Indeed the Trustees report:

“The combined trust fund reserves are still growing and will continue to do so through 2020. Beginning with 2021, the cost of the program is projected to exceed income.”

“The projected point at which the combined trust fund reserves will become depleted, if Congress does not act before then, comes in 2033 – the same as projected last year. At that time, there will be sufficient income coming in to pay 77 percent of scheduled benefits.”

But now, we are told that a failure to raise the debt limit could have devastating consequences for Social Security. As the WSJ reports:

The Social Security Administration has begun warning the public it cannot guarantee full benefit payments if the debt ceiling isn’t increased.

When asked by the public, the agency is notifying beneficiaries that “Unlike a federal shutdown which has no impact on the payment of Social Security benefits, failure to raise the debt ceiling puts Social Security benefits at risk,” according to a person familiar with the agency directive.

The same kinds of warnings were issued in 2011. (more…)

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Ezra Klein has an interesting piece (Wonkblog) on the collective-action problem facing the GOP with respect to Obamacare. Stated concisely:

Here’s the Republican Party’s problem, in two sentences: It would be a disaster for the party to shut down the government over Obamacare. But it’s good for every individual Republican politician to support shutting down the government over Obamacare.

These smart-for-one, dumb-for-all problems have a name: Collective-action problems.

As Klein correctly notes, ideally,  party leadership plays a critical role in managing these problems through the use of various carrots and sticks (“Threats, flattery, fundraising money, and plum committee assignments are all deployed to keep members of Congress from undermining the group in order to help themselves”). But the GOP leadership appears to lack the power to control the behavior of its members, particularly those who are aligned with the Tea Party.

It should prove interesting to watch the collective-action problem unfold in the next few weeks as Congress turns to the continuing resolution and the debt ceiling (not to mention broader issues like immigration reform). (more…)

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The Economist thinks so, and has dedicated a good deal of space to the question in the newest issue (here  and here). A few quotes:

Other states and cities should pay heed, not because they might end up like Detroit next year, but because the city is a flashing warning light on America’s fiscal dashboard. Though some of its woes are unique, a crucial one is not. Many other state and city governments across America have made impossible-to-keep promises to do with pensions and health care. Detroit shows what can happen when leaders put off reforming the public sector for too long.

The Economist sites an interesting statistic: the total pension gap for the states is $2.7 trillion (or 17 percent GDP).  In Connecticut, my adopted home state, the pension shortfall is 190 percent of annual tax revenues (Illinois is even worse, at 241 percent). Of course, this does not include the pension gap in the cities and, more importantly, the health-care benefits for state and municipal retirees.

There are some obvious fixes going forward (e.g., substituting defined-contribution pensions for existing defined-benefit pensions). But this does nothing to address the current unfunded liabilities that are largely the product of politics (e.g., to win the allegiance of public sector workers, promise glorious benefits at some time in the future when someone else will have to foot the bill). As recent events have revealed, efforts to force reform can carry high political costs.

When one considers the huge unfunded liabilities at the federal level, the additional problems in the states and municipalities may prove even more difficult to address. It is hard to imagine the federal government providing much in the way of assistance when it is being forced to draw increasingly on general revenues to cover its own obligations.

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The Economist provides a concise discussion of the debates surrounding the impact of debt on economic growth. The focus is on the work of Carmen Reinhart and Kenneth Rogoff, drawing on some of the research they conducted for their fine book This Time is Different.  The Reinhart/Rogoff paper (link here) had a simple takeaway point: debt seems to have little impact until it reaches 90 percent of GDP, at which point there appears to be a sharp reduction in the rate of growth.  As one might guess, this conclusion attracted a good deal of attention given the implications for fiscal policy decisions and the stakes in stabilizing debt (e.g., Paul Ryan cited it when framing his case for the GOP budget). Critiques have engaged issues ranging from coding errors (acknowledged by the authors) to the direction of causality.

The debate is by no means over and it may prove of some interest as the budget battles heat up and policymakers turn their attention to the vexing issue of entitlement reform. For a recent installment in the discussion over the growth-debt relationship, see Martin Wolf’s column (“Austerity loses an article of faith”) in the Financial Times.

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The Washington Post reports on some of the details of the Obama administration’s budget proposal, which is to be released next Wednesday. There are several important proposals (the largest of which have appeared before in the negotiations with the Speaker). Although the devil is in the details, a few salient points:

  • $200 billion cut from defense and domestic budgets
  • $400 billion cut from Medicare and other health programs via negotiation over pharmaceuticals and means testing
  • $230 billion (combined cuts and revenues) in Social Security via changes in the formula for calculating cost of living adjustments (from CPI-W to chained CPI)
  • $200 billion from farm subsidies and federal retirement benefits
  • Elimination of a loophole that allows people to simultaneously collect unemployment and disability payments.

All of this (and more) in exchange for $580 billion in new tax revenues largely through ending various tax expenditures. As the Washington Post notes: “The budget is more conservative than Obama’s earlier proposals, which called for $1.6 trillion in new taxes and fewer cuts to health and domestic spending programs.”

If one were serious about achieving long-term fiscal stability, this would appear to be a proposal worth serious consideration. Of course, there will be predictable challenges from the Left and the Right.

  • On the Left, entitlement reform is simply off the table. Senator Bernie Sanders (I-VT) is quoted as proclaiming: “Millions of working people, seniors, disabled veterans, those who have lost a loved one in combat, and women will be extremely disappointed if President Obama caves into the long-standing Republican effort to cut Social Security.” The same might be said of Medicare. And one can expect the claims that one should not pursue austerity when economic recovery has proven so elusive.
  • On the Right, many in the House GOP will scoff at any more taxation, even if it is accompanied by major concessions on entitlements.  After all, that $580 billion will be stripped from the corporate welfare larded on the oil and gas industry and tax expenditures that currently place no cap on the size of retirement funds (the administration wants to cap tax subsidized retirement accounts at $3 million).

Presidents’ budgets rarely survive the congressional budget process, so the document to be released on Wednesday might be little more that a symbolic gesture that will allow the administration to signal its commitment to fiscal restraint under the assumption that it will be declared DOA before the ink is dry.  But what if the President is serious?

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Yesterday the Senate approved a continuing resolution. One of the casualties was NSF funding for political science, at least political science that cannot be certified “as promoting national security or the economic interests of the United States.” The amendment was proposed by Senator Tom Coburn (R-OK) who questioned whether public financing of political science research was truly a good use of taxpayer money. As the Chronicle of Higher Education reports:

Mr. Coburn sent a letter last week to the NSF’s director, Subra Suresh, listing a series of agency-financed projects he considered a waste of taxpayer money. His list included several involving political science, including studies of voter attitudes toward the Senate filibuster and of the cooperation between the president and Congress.

Such subjects “may be interesting questions to ponder or explore” but aren’t necessarily the best use of taxpayer money, Mr. Coburn told Mr. Suresh. “Studies of presidential executive power and Americans’ attitudes toward the Senate filibuster hold little promise to save an American’s life from a threatening condition or to advance America’s competitiveness in the world,” he wrote.

As one might expect, the American Political Science Association is not pleased. As Insider Higher Education reports, APSA “called the ban a ‘devastating blow,’ ‘an exceptionally dangerous slippery slope’ and a ‘remarkable embarrassment for the world’s exemplary democracy.’”

I am skeptical. When rank ordering “remarkable embarrassments for the world’s exemplary democracy,” I would place restrictions on NSF funding somewhere near the bottom, particularly when compared with genuine embarrassments like GITMO (which is being considered for a $150 million upgrade despite the President’s promises of its immediate closure) and the use of drones to execute US citizens abroad.

Much (not all) of the research that goes on in political science is quite important and I have enjoyed some relatively modest NSF support in the past (and I appreciated it greatly). But given the constraints on federal research funds and the need to put our fiscal house in order, this seems to be a prudent decision. Many of the decisions that will inevitably come will be devastating blows to citizens who are forced to pay a larger percentage of their income in taxes, extend their working years, and face some form of rationing in health care. In this context, NSF funding seems like relatively small change.

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Congressman Paul Ryan has completed his work on the new budget proposal, one that he claims will leave the nation with a budget surplus by 2023. Lori Montgomery (Washington Post) has a decent piece reviewing some of the details. The budget looks like very much like the last one (e.g., reductions in future spending on Medicare and the Affordable Care Act; little specificity on Social Security reform; more cash for the Pentagon). The big difference: revenues.

The one big new development: Ryan’s latest blueprint would balance the budget… a goal achieved not primarily through deeper spending cuts, but by the addition of more than $3.2 trillion in new tax revenue.

The tax hike is already in effect. Ryan (R-Wis.) merely adopts new revenue projections laid out by the nonpartisan Congressional Budget Office in the wake of a year-end deal to raise rates on income over $450,000. But the impact on his budget is huge.

One can imagine that retaining the tax increases that emerged from the fiscal cliff will enrage some Republicans. But it is difficult to arrive at a balanced budget without those revenues (some $40 trillion over 10 years).  There are better ways to raise revenues, of course. In my perfect world, fundamental tax reforms that eliminate the largest tax expenditures would be combined with a carbon tax. Moreover, there is a strong case for cutting rather than increasing defense spending. But those are different topics that are best put off for another day.

What proves more interesting than Ryan’s budget is the fact that the Senate is finally entering the game.

Senate Budget Committee Chairman Patty Murray (D-Wash.) is working on her own blueprint, the first Senate budget since 2009. That framework proposes to reduce future borrowing by about $2 trillion, split evenly between tax increases and spending cuts.

If Murray’s budget is adopted by the Senate, congressional leaders see a Ryan-Murray conference committee as the most likely forum for negotiations over a new deficit-reduction package.

Imagine that: a return to the old politics of budgeting. Two chambers, two bills, conference committee deliberations, compromise and [insert drum roll here] accountability.

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Grasping at Shadows

So it looks as if the sequestration is upon us. The past few weeks have witnessed claims about the catastrophic implications of sequestration and ongoing efforts to assign responsibility (it was the GOP’s idea…unless it wasn’t). It has been quite the circus.

My chief concern: we are so busy grasping at shadows that we are missing the substance.

Examine the two charts below. Both report inflation-adjusted outlays and revenues (expressed in 2005 dollars) from 1940 to 2013 using OMB data (Historical Tables, table 1.3).

The first chart includes the estimated outlays (the blue line) and revenues (the red line) for 2013 without sequestration.

Outlays and Revenues

The second chart includes the estimated outlays and revenues for 2013 with sequestration.

Outlays and Revnues with sequestration

As we approach midterm exams at our fine university, let me offer a simple multiple choice question:

As you examine these charts, what are the most striking features?

  1. The magnitude of the cuts under sequestration
  2. The significant growth in inflation-adjusted federal spending
  3. The growing gap between outlays and revenues

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As we approach midnight February 28 (tick..tick…tick…) and March 1st arrives, the nation appears to be headed toward a cataclysm. There is an ever-growing number of stories informing us how bad things could get.

The sequestration will force a sharp drop in the economy. It will kill the surging stock market. It will delay tax refunds. It will prevent entrepreneurs from starting new small businesses. It will compromise meat inspection. It will hamper airport safety and Homeland Security more generally. It will prevent assistance for Hurricane Sandy victims.  It will disproportionately harm women, and poor women in particular. Mother Jones expands on this claim to note that it will simply “screw the poor” (e.g., by undermining education, Title I finding, rural rental assistance, the processing of Social Security disability claims, unemployment benefits, veterans services, nutritional assistance, special education…you get the idea).

The Washington Post has provided a user-friendly guide to the White House data on how sequestration will effect each state . Of course, the categories have been nicely selected to construct a politically useful alternative universe (i.e., one where government is seemingly restricted to supporting teachers and schools, Head Start, job-search assistance, child care, vaccines for children, preventing violence against women, etc., etc).  Core message: what government does is universally good and necessary. There is no room for cuts.

Things seem quite dire, until one recalls that the $85 billion will not be sucked out of the economy as the clock turns to 12:00:01 on March 1 and, more than likely, there will be some agreement in the waning moments of February or the first few days of March to avoid this self-inflicted sequestration.

But even if there isn’t, one might question whether $85 billion is all that significant when the President’s budget request for 2013 is $3.803 trillion. Subtract that $85 billion, and the budget would fall to $3.745 trillion.  Placing things in historical context, that would be the largest budget since…(insert drum roll here)… 2012.

Placing things in a broader historical context, the budget (in nominal terms) would be over 160 percent of what it was a decade earlier, around 135 percent if we adjust for inflation.

The most striking thing to contemplate: If this is the political firestorm that arises out of a $85 billion reduction in discretionary spending out of a $3.8 trillion budget, imagine what will occur when focus turns—as it must—to the issue of entitlements.

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Beyond Sequestration

The next few weeks will undoubtedly witness the old back-and-forth on budget cuts and revenue increases combined with claims that this side won’t bargain and that side won’t bring anything specific to the table.

The CBO’s Budget and Economic Outlook: Fiscal Years 2013 to 2023 suggests that we should not focus on the shiny objects. Assuming that the sequestration occurs (the extended baseline), the news remains bad. After some short-term reductions in deficits, they will once again continue to increase, with publicly held debt reaching 77 percent of GDP by 2023 (a product of  “the pressures of an aging population, rising health care costs, an expansion of federal subsidies for health insurance, and growing interest payments on federal debt”).

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The CBO provides discusses the ramifications:

Such high and rising debt would have serious negative consequences: When interest rates rose to more normal levels, federal spending on interest payments would increase substantially. Moreover, because federal borrowing reduces national saving, the capital stock would be smaller and total wages would be lower than they would be if the debt was reduced. In addition, lawmakers would have less flexibility than they might ordinarily to use tax and spending policies to respond to unexpected challenges. Finally, such a large debt would increase the risk of a fiscal crisis, during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates.

The CBO report is relatively brief and worth reading in its entirety.

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Now that the fiscal cliff has been averted  delayed, we move on to the debt ceiling. Critics are correct in noting that there is no principled reason not to raise the debt ceiling, since it is nothing more than the sum of past spending and taxing decisions.  One can hardly blame the credit card bill for the patterns of spending that created it. Nonetheless, the House GOP skillfully used the debt ceiling in 2011 to extract the agreement that led to the fiscal cliff (and we all know how well that worked out for the GOP).

In the wake of the fiscal cliff, President Obama struck a hard position regarding the debt ceiling. As he proclaimed:

“I will not have another debate with this Congress over whether or not they should pay the bills that they’ve already racked up through the laws that they passed, Let me repeat: We can’t not pay bills that we’ve already incurred. If Congress refuses to give the United States government the ability to pay these bills on time, the consequences for the entire global economy would be catastrophic — far worse than the impact of a fiscal cliff.”

Of course, the President will bargain. As George Sargent notes in todays Plum Line:

The idea appears to be that the White House and Democrats will only engage in conversations over the sequester, tax reform, and spending cuts, and simply won’t confer any legitimacy on GOP threats not to raise the debt ceiling. But it’s unclear to me how this will work in practical terms. Unless Obama is prepared to go into default — or to pull some other ace out of his back pocket, such as the 14th amendment or “platinum coin” options — he will inevitably be negotiating over the debt ceiling. And he doesn’t appear prepared to do any of those things.

One can doubt that the President would be willing to go into default, so he will bargain (or more correctly, he will proclaim, campaign, disengage, and send in Biden). But is there any reason to take the House GOP seriously at this point regarding its willingness to stand its ground?  Given its recent track record, does the President have any reason to believe that the House won’t blink?

I remain skeptical.

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I agree with pretty much everything Marc has to say on the deal below. (For my own thoughts, see here.) Nevertheless, from a political point of view, something very like this deal was inevitable.

First, the Republicans held a bad hand. All the Bush tax cuts were going away, so they had very little leverage. The only leverage they had was over letting unemployment benefits, stimulus tax credits, and corporate welfare expire, and letting the sequester take effect immediately. However, Republicans are scarcely fonder of the sequester than are Democrats, both because of its cuts to defense and because of the blunt, across-the-board nature of the domestic discretionary cuts. As soon as the negotiations turned to dealing with taxation and spending separately, Republicans were never going to get significant spending cuts out of a taxation deal, because they had very little to offer Democrats on taxation. In the end, Republicans got a higher income threshold for tax increases, but paid for it with extensions of the foregoing expenditure programs.

Why were Republicans not willing to give a little more on tax increases on the rich in exchange for cuts in tax expenditures? Here the optics play a role. Pushing hard to let the low-income and higher ed tax credits expire could easily be demagogued. Letting extended unemployment benefits expire when Republicans continue to insist that the economy is weak would also be jarring. On the corporate welfare side, the diffuse-costs, concentrated-benefits logic applies in full force. Besides people who read sites like this one and the concentrated interests who benefit from such programs and spend literally hundreds of millions of dollars a session lobbying for them, no one cares about corporate welfare, and many even think of it as “pro-business” (as I’ve read journalists oh-so-neutrally describe them in articles on the deal) and therefore somehow pro-recovery.

Now, if this analysis is correct, then in two months when the spending side of the fiscal cliff is dealt with, Democrats will hold a similarly weak hand, and we should look for essentially zero Republican concessions on taxes. If the outcome deviates from this prediction in either direction, then we will have good reason to think that extraneous factors, such as “negotiation skills,” played some kind of role.(*) But I would look for the Nash Equilibrium to obtain.

(*) Another possibility, of course, is that I misread the (House) GOP’s preferences. They may hate defense spending cuts so much that they are willing to allow more tax increases to prevent them. That would, of course, be a perfectly awful outcome from a limited-government perspective — and therefore very much within the realm of possibility.

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The Fiscal Cliff has been averted postponed, if not made worse.

Big takeaways:

  1. Senate Majority Leader Harry Reid has once again proven himself to be incapable of leading the Senate.  Is there any stronger rebuke than McConnell’s appeal to Biden as he searched in vain for a negotiating partner in the Senate?
  2. The Democrats have done what was once unimaginable: they made permanent the much-decried Bush tax cuts for all but the wealthiest households. The talking heads spent much of the last few months noting that if Obama had any mandate from the 2012 elections, it was the mandate to raise taxes on those making about $250k. So much for mandates.
  3. A Republican controlled House is not much of a counterweight. Let us assume that McConnell was successful in getting the best deal he could out of this Senate (recall the tax cuts). The GOP-controlled House could have responded with a bill that combined the tax cuts with significant spending cuts, thereby forcing a compromise. But Boehner et al blinked (and Ryan, once believed to be a force for fiscal stability, no longer has a claim to this title). Ah yes, but they lived to fight another day. Of course, is there any real evidence that their capacity to fight will improve with a reduced majority?
  4. In terms of long-term fiscal sustainability, the Congress arrived at the worst possible solutions: tax cuts and increased spending. Although there were early discussions of entitlement reforms—ranging from means testing Medicare to changing the calculation of the cost of living adjustment for future benefits—in the end, Congress made matters worse by preventing scheduled reductions in rates paid to doctors under Medicare. And although there were early discussions of cutting tax expenditures, a series of existing expenditures were extended.
  5. By placing a two-month hold on forced sequestration, Congress not only made things worse but also assured that the winter and early spring will look remarkably like the past few months. I am somewhat surprised that Biden negotiated, and Obama accepted, this decision.  Whatever chances the President had to make some significant policy changes in the early days of his second term seem diminished greatly. Immigration reform, assault weapon bans, etc., will be difficult to achieve when all attention is focused on the next fiscal cliff and the debt ceiling. Moreover, if there were any belief that this would somehow help the economy, it is ill founded. There is little to suggest that the credit rating agencies, investors, or firms looking for regime stability will find anything resembling a silver lining in this deal. Quite the opposite.

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The Prologue

The protracted negotiations over the fiscal cliff suggest how difficult things will actually become once we begin to address the simple fact that existing entitlements cannot continue to exist in their current form.

The one significant reform that was proposed earlier by President Obama during his discussions with the Speaker involved using the chained CPI rather than the CPI-W to calculate the cost of living adjustment for future Social Security benefits. This change would reduce the rate at which benefits would increase in the future.  This would not solve Social Security’s problems, but it would be a movement in the right direction. There are better options in my opinion (including progressive indexing that would retain the CPI-W for low wage workers, adopt the CPI for high wage workers, and blend the two for those who fall in the middle). But adopting the chained CPI would be more palatable than other options (e.g., raising the retirement age could have devastating consequences for African American males, who have a shorter life expectancy).

But none of this matters at this juncture, since the political response was precisely what one might have anticipated. Reportedly, Senator McConnell, at one point willing to trade higher taxes for the changes in Social Security, has now taken it off the table. Democrats rejected the proposal and the majority of the GOP caucus in the Senate supported excluding it from any deal on the fiscal cliff. The GOP may find tax increases abhorrent, but the largest entitlement programs—unlike taxes—remain politically untouchable.

The Obama administration, the House, and the Senate clearly understand (or should understand) three things: (1) the largest entitlement programs are both unsustainable and the drivers of long-term fiscal instability; (2) reform is inevitable; (3) the sooner reforms occur, the less pain will be imposed on taxpayers and beneficiaries. If they don’t understand these things, they should simply turn to the reports by the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds (currently chaired by Treasure Secretary Geithner and including HHS Secretary Sebelius and Labor Secretary Solis).

From the 2012 report’s overview:

“The dollar level of the combined trust funds declines beginning in 2021 until assets are exhausted in 2033. Considered separately, the DI Trust Fund becomes exhausted in 2016 and the OASI Trust Fund becomes exhausted in 2035.”

The projected unfunded liabilities have grown considerably in the past few years:

“The open group unfunded obligation for OASDI over the 75-year period is $8.6 trillion in present value and is $2.1 trillion more than the measured level of a year ago.”

Of course, there are many options for reform identified by the Trustees, including increases in the payroll tax (from 12.4% to 15.01%), reduction in benefits “equivalent to an immediate and permanent reduction of 16.2 percent,” or a decision to draw on general revenues. This last option is not a real option given the magnitude of our deficits and debt.

Medicare, which is projected to grow from 3.7 percent GDP (2011) to 5.7 percent of GDP (2035) is even more of a challenge. According to the Trustees:

“The Medicare HI Trust Fund faces depletion earlier than the combined Social Security Trust Funds, though not as soon as the Disability Insurance Trust Fund when separately considered.”

“The drawdown of Social Security and HI trust fund reserves and the general revenue transfers into SMI will result in mounting pressure on the Federal budget. In fact, pressure is already evident. For the sixth consecutive year, the Social Security Act requires that the Trustees issue a “Medicare funding warning” because projected non-dedicated sources of revenues—primarily general revenues—are expected to continue to account for more than 45 percent of Medicare’s outlays, a threshold breached for the first time in fiscal year 2010.”

The Trustees strongly support immediate action:

“Lawmakers should not delay addressing the long-run financial challenges facing Social Security and Medicare. If they take action sooner rather than later, more options and more time will be available to phase in changes so that the public has adequate time to prepare. Earlier action will also help elected officials minimize adverse impacts on vulnerable populations, including lower-income workers and people already dependent on program benefits.”

One wishes that the Obama administration and Congress had used the self-imposed fiscal cliff as a window of opportunity to address the unsustainability of our long-term entitlements. There were some early indications that they were moving in this direction. But short-term incentives prevailed. Is anyone surprised?

In the next few days (or at most, the next few weeks), Congress will find a fix for the fiscal cliff without addressing the long-term drivers of our fiscal problems. At best, the drama of the past few weeks will be little more than a prologue to the far more significant battles in the future.

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The fiscal cliff debates seem to be at a standstill as we approach the end of the year.  On the spending side, the proposal to change the indexing for Social Security seems to be quite positive. The use of the CPI-W has fueled growth in the real value of benefits and the substitution of a more realistic measure of inflation (or some kind of progressive indexing) is a change that could make a significant difference over time.  Republicans are likely correct in their dissatisfaction with tax increases today in exchange for significant cuts in the future since no Congress can effectively bind the hands of a future Congress.

The tax side is particularly interesting, and I wonder if the GOP understands what a victory any agreement would be that made the Bush tax cuts permanent for the vast majority of the population. Regardless of whether the taxes increase for households making $250k, $400k or some other number, the overwhelming fact is that the significant tax cuts introduced under George W. Bush are likely to become permanent. For the GOP, this is no less a victory than the 1996 elimination of AFDC, which essentially consolidated many of the reform efforts of the past 15 years.

Zachary Goldfarb (Washington Post) has an interesting article reinforcing this position. A few excerpts:

R. Glenn Hubbard, dean of the Columbia Business School and an architect of the Bush tax cuts, said it is “deeply ironic” for Democrats to favor extending most of them, given what he called their “visceral” opposition a decade ago. Keeping the lower rates even for income under $250,000 “would enshrine the vast bulk of the Bush tax cuts,” he said.

And, due to the progressivity of the US tax system, even the wealthy would continue to reap benefits when compared with the expiration of the tax cuts when taken as a whole.

The first $250,000 earned by even the wealthiest families is subject to lower rates. For this reason, Obama noted last month that under his proposal, “every American, including the wealthiest Americans, gets a tax cut.”

For instance, an individual taxpayer earning between $200,000 and $500,000 a year would pay an average of $515 more in taxes next year if the Bush tax cuts for the wealthy expire, according to the nonpartisan Tax Policy Center. But if all the Bush tax cuts were to vanish and the rich had to pay higher rates on all their income, their tax bills would shoot up by an average of $6,000. The very richest — the top 1 percent of earners — would pay much higher taxes if solely the upper-income tax cuts expire, because the savings from extending the rest of the rates would be relatively negligible.

Bottom line: regardless of where you draw the line on taxes for upper income earners, the proposed deal on the fiscal cliff locks in the Bush tax cuts—a clear victory for the GOP, particularly given the poor Republican performance in the 2012 elections, candidate Obama’s commitment to reversing the Bush tax cuts,  and the fact that the Democrats are firmly in control of the White House and the Senate.

Of course, I would not argue that a victory for the GOP is a victory for the nation given the long-term fiscal imbalances. In my view, we need higher taxes (let’s begin with the elimination of all tax expenditures, beginning with those that lavish subsidies on the top two quintiles). We also need significant reductions in expenditures, particularly in our largest entitlements, the defense budget, and various forms of corporate welfare (including agricultural subsidies).

But there is little question that the Obama administration is willing to hand the GOP a significant victory. It only has to accept the gift.

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For some time, the Institute for Truth in Accounting has been beating the drum of “accounting truth” in government finances. Recently USA Today picked up on their claim that true federal deficits and debt are several times larger than the official numbers. They ran the numbers and found that “the government ran red ink last year equal to $42,054 per household — nearly four times the official number reported under unique rules set by Congress.” In addition, “Federal debt and retiree commitments equal $561,254 per household. By contrast, an average household owes a combined $116,057 for mortgages, car loans and other debts.”

The reason for the difference between these numbers and the official ones is that the official numbers exclude the cost of promised retirement benefits: Social Security and Medicare. From the story: “Jim Horney, a former Senate budget staff expert now at the liberal Center on Budget and Policy Priorities, says retirement programs should not count as part of the deficit because, unlike a business, Congress can change what it owes by cutting benefits or lifting taxes.”

Yes, but will they? It seems to me that the “real” set of numbers is some weighted average of the official and full numbers, where the weight is the probability that Congress will act to reform retirement entitlements before they drag the official deficit even further into the red. Medicare is already losing money.

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As we approach another round of debt-ceiling debates–conveniently timed to land after November–Speaker John Boehner made his position crystal clear at Peter G. Peterson’s Fiscal Summit.  As the Speaker proclaimed:

Yes, allowing America to default would be irresponsible. But it would be more irresponsible to raise the debt ceiling without taking dramatic steps to reduce spending and reform the budget process. We shouldn’t dread the debt limit. We should welcome it. It’s an action-forcing event in a town that has become infamous for inaction…. When the time comes, I will again insist on my simple principle of cuts and reforms greater than the debt limit increase. This is the only avenue I see right now to force the elected leadership of this country to solve our structural fiscal imbalance.

 As one might guess, such talk drew the fire of Democrats. As the Christian Science Monitor reports, Senate Majority Leader Harry Reid issued a clear judgment on Boehner’s position:

“American people have had enough of this brinkmanship,” Mr. Reid told reporters Tuesday afternoon. “It’s pretty clear to me that the tea party direction to the Republican Party is driving them over the cliff.”

It looks as if the nation is ready to witness another principled battle over the issue of fiscal responsibility, each side driven by a commitment to responsible government, albeit a commitment that is shaped by deep philosophical differences regarding the role of the state.

At the same time, we can question the depth of these convictions.

The Speaker, for example, has been working to secure $150 million in federal transfers to a uranium enrichment plant in Ohio. Since the corporation in question is headquartered in Kentucky, Minority Leader Mitch McConnell has been a strong source of support. And in a fine example of bipartisanship in the name of fiscal responsibility, the Obama administration has been supportive (there is no better was to secure the gratitude of a swing state than to provide transfers). Jonathan Allen provides the details on this story here.

So, it appears that the Speaker’s heroic embrace of fiscal responsibility is only limited by the appeal of ladling corporate welfare to a firm in the fine state of Ohio (insert expression of shocked disbelief here).

As for Senator Reid, one has reason to question his sincerity as well. In a stunning profile in courage, the Democratic majority has failed to propose or pass a budget in three years.  As Scott Wong explains:

The Democratic-led Senate on Wednesday is expected to reject all four GOP budget plans, including the contentious House-passed proposal authored by Rep. Paul Ryan (R-Wisc.). A fifth budget, offered by Republicans and based on President Barack Obama 2013 spending blueprint, also will likely fall short of the 50 votes needed to pass, dealing the White House an embarrassing election-year blow.

But Democratic leaders have defiantly refused to lay out their own vision for how to deal with federal debt and spending, arguing that last summer’s debt-ceiling deal essentially serves as an actual budget. While a budget resolution is non-binding, they say, the Budget Control Act was signed into law.

So while Senator Reid has described the GOP budget as “ridiculous,” “absurd,” and “all just for show,” he has countered with…nothing. If Senator Reid is convinced (as the earlier quote suggests) that the tea party dominated GOP is driving the economy off the cliff, one can only question why he, as leader of the world’s greatest deliberative body (insert snicker here), refuses to take the wheel. The answer is clear: fear of the political repercussions of passing a budget since it would force attention on entitlement reform.

If one is in search of fiscal responsibility, it is clear that it may be a difficult quest at least until capital markets turn on our debt. On one side, we can achieve fiscal balance as long as we eschew tax increases and nod and wink as we work around the so-called earmark ban when politically advantageous. On the other side, we can achieve it as long as we reject entitlement reform and refuse to pass budgets.

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Actually, it appears to be accelerating. The train is the impending insolvency of the large entitlement programs. The news today: Social Security. A summary of the latest trustee report (as presented in the Christian Science Monitor):

The trust funds that support Social Security will run dry in 2033 — three years earlier than previously projected — the government said Monday.

There was no change in the year that Medicare’s hospital insurance fund is projected to run out of money. It’s still 2024. The program’s trustees, however, said the pace of Medicare spending continues to accelerate. Congress enacted a 2 percent cut for Medicare last year, and that is the main reason the trust fund exhaustion date did not advance.

Setting aside the fiction that the trust funds constitute a store of wealth, there is nothing genuinely surprising here given the economic conditions and the policy response. Many of those who have exited the workforce (those “discouraged workers” whose exit has helped mask a sluggish recovery) have simply retired. Many who remain employed are working fewer hours and thus paying less into the system. At the same time, efforts to prop up demand by providing payroll tax cuts have further reduced the flow of revenues into the system.

There is also little new (other than the accelerated timetable for fund insolvency). Analysts have been projecting this for decades, urging reform. Of course, myopia reigns in Washington. Few would ever engage in a serious and sustained consideration of reform if doing so would require that they sacrifice the short-term political advantages that might be derived from framing reform as “balancing the budget on the backs of the elderly” or “an ideologically-driven assault on two of government’s finest programs.

Of course, fixing Social Security is not a technically difficult task. There are a few key leverage points (e.g., increase revenues by raising the earnings cap, changing the indexing formula, means testing benefits, etc.). Medicare is more complicated, but only marginally. Each of the alternatives have costs and benefits and should be subjected to vigorous analysis and debate. The problems, alas, are political and can be reduced to a simple fact: elected officials (and those who seek to join their ranks) place a high discount rate on the future.

As we approach the 2012 presidential campaign, we have the opportunity, once again, to address the impending entitlement crisis. If the past is any guide, both major party candidates will choose instead in a conspiracy of silence.

And why not? A decade or two is an eternity in politics.

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President Obama has moved on from constitutional history (his warning that a Court decision to overturn a statute would be unprecedented) to American history more broadly. His remarks focused on the Ryan budget:

“Disguised as [a] deficit reduction plan, it’s really an attempt to impose a radical vision on our country. It’s nothing but thinly-veiled Social Darwinism. It’s antithetical to our entire history as a land of opportunity and upward mobility for everyone who’s willing to work for it — a place where prosperity doesn’t trickle down from the top, but grows outward from the heart of the middle class. And by gutting the very things we need to grow an economy that’s built to last — education and training; research and development — it’s a prescription for decline.”

We have discussed the Ryan budget on this blog in passing. For the upcoming year, Ryan proposes $3.6 trillion in spending and revenues of $2.4 trillion, for a deficit of $1.2 trillion. This is in sharp contrast to the Obama proposal, which would place spending at $3.8 billion, with revenues of $2.5 trillion, for a deficit of $1.3 trillion.

Is Ryan’s budget a “thinly veiled Social Darwinism?” It is, only if Social Darwinism can be cast as a decision to retain spending above 20 percent GDP.  It has been a while since I read Spencer and Sumner, but I don’t recall either making the case for spending in this range (or any range, for that matter).

Is Ryan’s budget “antithetical to our entire history,” as the President claimed? Once again, we have some empirical problems.

Ryan hopes to achieve federal spending reductions to 20 percent GDP by 2015. By way of comparison, average spending during the George W. Bush presidency was 19.6 percent GDP. During the Clinton presidency, average spending was 19.8 percent GDP.

If Ryan’s goal of reducing government spending to 20 percent GDP is radical, the empirical record seems to argue otherwise.

But perhaps we have not reached far enough back in time. Of course, the President’s remarks focused on “our entire history.” We could go back to 1968, the peak of Johnson’s Great Society and the war in Vietnam when government spent 20.5 percent of GDP. If we go earlier, the record might suggest that Ryan’s budget is radical, but not in the way  suggested by Mr. Obama. In recent weeks, the President has sought to channel Franklin D. Roosevelt. During the domestic phase of the New Deal, government spending peaked at 10.5 percent GDP (1935), approximately one-half of the level of spending proposed by Ryan. And let us not forget that 10.5 percent was a radical departure from the Hoover administration (3.4 percent GDP in 1930). The historical timeline of spending can be easily verified by the Office of Management and Budget (see OMB historical table 1.2).

I find it fascinating that a “conservative” proposal to reduce spending to slightly above the average of the Clinton-Bush years, approximately to the level attained during the peak of the Great Society and Vietnam War (1968) can be framed as an exercise in Social Darwinism.

Imagine what would happen if Ryan wanted to spend like FDR?

Of course, the President may have meant to covey a somewhat more complicated argument regarding the role of social policy and tax expenditures in shaping after-tax income–an important argument that needs to be made and given some serious scrutiny. But the breathless turn to hyperbole and the broadly brushed generalizations don’t do much to further serious debate, even if they provide quick talking points.

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The Ryan Budget

There has been much coverage of the Ryan budget plan (details here), most of it is quite predictable. Robert Reich (Christian Science Monitor) tells us that it is an expression of  “pure social Darwinism. Reward the rich and cut off the help to anyone who needs it.” Paul Krugman (New York Times), always cautious about issuing ad hominem attacks, devotes most of his discussion to Ryan, who he describes as a “clown,” a “flim-flam man,” a “charlatan” and a “fraud.”  Of course, he also notes that the budget is “a plan to savage the poor while giving big tax breaks to the rich.” Heather Boushey (Center for American Progress) describes it as “austerity on steroids.”

Of course, all of this is sound and fury, signifying nothing. The Ryan plan will never survive the budgetary process (not that there is anything resembling a budgetary process in the Senate). With respect to the overall fiscal impact, Nick Gillespie (Reason) lays out the stark differences:

The Ryan plan says that we will spend $3.6 trillion this year while bringing in $2.4 trillion in FY2012. In contrast, President Obama’s budget says that we will shell out $3.8 trillion in FY2012 and bring in $2.5 trillion.

Certainly, there are some interesting components–most notably, taxes and Medicare–that demand careful scrutiny. But it is difficult to make the case that a budget plan that calls for a $1.2 trillion deficit is a plan for austerity, not to mention “austerity on steroids.”

Gillespie continues:

Ryan’s plan is weak tea. Here we are, years into a governmental deficit situation that shows no sign of ending. How is it that Ryan and the Republican leadership cannot even dream of balancing a budget over 10 years’ time? All of the discussion of reforming entitlements and the tax code and everything else is really great and necessary – I mean that sincerely – but when you cannot envision a way of reducing government spending after a decade-plus of an unrestrained spending binge, then you are not serious about cutting government. If Milton Friedman was right that spending is the proper measure of the government’s size and scope in everybody’s life, then the establishment GOP is signaling what we knew all along: They are simply an echo of the Democratic Party.

There was a day when the GOP could make the claim of offering “a choice, not an echo.” Unsurprisingly, the GOP learned that offering a choice was often counterproductive. With respect to fiscal responsibility, those days seem to be a thing of the past.

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David Corn’s soon-to-be released new book Showdown examines the pivot to address deficits in the summer of 2010-11. Many Democrats were bewildered that the administration would move on to the GOP’s turf and begin addressing the problem of deficits and debt (one might pause for a moment and ask whether there is any empirical evidence to suggest that the GOP—or either of the major parties—can make a claim to being the party of fiscal responsibility).  After all, there were many on the left that were making a powerful argument that the stimulus was insufficient and now was not the time to move to anything remotely resembling austerity (one might pause again and ask how reducing the pace of expansion can be cast as austerity, but again, I digress).

The answer, as revealed in some excerpts in Greg Sargent’s Plum Line (WaPo) was strictly poll driven:

Plouffe was concerned that voter unease about the deficit could become unease about the president. … voters needed to know — or feel — that the president could manage the nation’s finances. The budget was a test of government competence — that is, Obama’s competence.

And on a meeting of February 2011:

With Sperling sitting in on the presentation, Garin reinforced the White House view that Democrats had to up their game on deficit reduction. His firm had conducted extensive polling and focus groups. He told the senators that voters saw jobs as the most pressing priority. This might seem to support those Democrats who believed Obama had gone too far overboard on the deficit-reduction cruise. But when asked what the president and Congress should do to boost job creation, most voters said reduce the deficit and the debt. They had imbibed the GOP message; the problem with the economy was governmental red ink.

What I find particularly disturbing—even if unsurprising—is the following:

  1. We have an extraordinarily devastating problem: the slow pace of recovery and job creation.
  2. Those with a seat at the table understand the problem in Keynesian terms. They have a clear understanding of causality grounded in Keynesianism and a set of clear policy prescriptions that are drawn from theory.
  3. They nonetheless cast aside these policy prescriptions because—drum roll—voters embrace a faulty understanding of the economy and assume that deficits lead to unemployment.  They will not buy anything the Democrats have to say about the recovery if they do not believe that the administration is committed to deficit reduction.

Note: I am not concerned here with whether Keynesianism provides the best guidance to economic policymaking. Rather, it is the willingness of elected officials to embrace policies that they believe will be counterproductive simply because it sells before focus groups.

As Edmund Burke noted when arguing that representatives should be trustees rather than mere delegates: “Your representative owes you, not his industry only, but his judgment; and he betrays, instead of serving you, if he sacrifices it to your opinion.” One would only wish that elected officials of both parties would spend less time with focus groups and more time with Burke, at least when thinking about representation.

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A few days back I posted (here) on an article in the NYT that focused on recipients of welfare (usually Social Security, Medicaid, disability) who are dependent on the state but also seem without options. My post ended on a somber note: “the expansion of the safety net has been accompanied by changes in social norms and the displacement of private institutions. At one time, people…might have been confident that their extended families and congregations would never let them fall into abject poverty in the absence of public programs. But it is difficult to imagine that a significant reduction in entitlement spending would lead to a revivification of a world that has long passed.” As a result, reform in entitlement programs—which I see both as inevitable and desirable—will induce a lot of pain, and this should be a source of concern, particularly if it makes incremental reform impossible in a democratic system.

At Ace of Spades, one commentator linked to the post (with the tag: “Americans seem to have difficulty imagining a time when there was no pervasive government-run welfare state”).

“There was a time when the arm of the federal government did not reach far at all, and citizens had to rely on themselves, their friends, their families, and their communities for help and support. And you know what? It worked, mostly. … Misery and hardship is the lot of humanity on this earth. Yet our forbears managed to not only get by, but to build the greatest nation in the history of the world…and they did it without an overbearing, interfering, smothering nanny state monitoring their every breath.”

Of course, it is not difficult to imagine a time when there was no welfare state. That is, in fact, quite easy (no more difficult than imagining a time when dinosaurs ruled the earth). The difficulty comes in charting a course back to that original position. Moreover, I would not deny that there was a time pre-welfare when citizens relied on “themselves, their friends, their families and their communities for help and support.” One may be justified in longing for a return to these times (although these claims are often tinged with a bit of romanticism).

The key point of my original post is there have been significant changes in social institutions and norms in the postwar period. Arguably, much of this has been driven by policy decisions that have altered individual behavior and displaced private institutions. It was once a norm for extended, multi-generational families to live together and pool resources. It is no longer.  Indeed, procreation outside of marriage will soon be the rule. Private pensions and savings once provided the primary sources of retirement income; now two of the three legs have disappeared for many, leaving them dependent on Social Security. Private institutions that once had a mission to provide others in times of need have in many cases been starved for resources (“Why tithe when I pay taxes?”) or coopted by the state,  becoming quasi-private service delivery organizations that would  wither on the vine without a flow of public funds.  If one believes that political and social development is path dependent, one should not expect an instantaneous return to a previous branching point. Indeed, the path may prove arduous.

One could argue—and I think persuasively—that elements of the old order may reassert themselves in the future. But the future is a big place. Changes will not come quickly and not necessarily in ways that one may hope. Significant reforms in entitlements will impose a fair amount of pain in the interim. For some, the pain will be minimal (e.g., readjusting the timing of retirement, deleting costly items from the bucket list). But for others, it will be devastating (e.g., selling the family homestead for rent and food, foregoing medical procedures that could extend life or improve the quality of life).

The observation that there once was a time when welfare did not exist is a bit too easy. We can all imagine a world without welfare. Yet, it tells us nothing about whether a return to this original position is possible (or likely) and whether individuals will willingly accept the sacrifices it will entail.

The characters described in the NYT article referenced in the original post were working class or lower middle class individuals who were sympathetic to the Tea Party but were simultaneously fearful of how they could survive (in some cases, literally) without their existing entitlements. They were not Reagan’s mythic welfare queens, exploiting the system for a life of ill-gained luxury. One can only wonder whether their embrace of small government will prove all too thin once they understand the short-term consequences?

Ideally, reform would occur in a deliberate and reasoned manner. But if broad support for reform is difficult to create or maintain, an incremental path to reform will be politically impossible. Ultimately, fiscal crisis could open the door to changes that are far less compatible with liberty than one might hope. This too, is not difficult to imagine.

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Binyamin Appelbaum and Robert Gebeloff had an interesting piece in the NYT this weekend entitled “Even Critics of Safety Net Increasingly Depend on It.”  An early quote provides the context:

 The government safety net was created to keep Americans from abject poverty, but the poorest households no longer receive a majority of government benefits. A secondary mission has gradually become primary: maintaining the middle class from childhood through retirement. The share of benefits flowing to the least affluent households, the bottom fifth, has declined from 54 percent in 1979 to 36 percent in 2007, according to a Congressional Budget Office analysis published last year.

Rather than restating a host of projections that many of us know all too well, the remainder of the piece works through a variety of vignettes of individuals—largely middle class or lower middle-class–who depend on various parts of the welfare state (e.g., Medicare, Social Security disability). In most cases, they  recognize the problem of fiscal imbalances and they detest liabilities being passed on to future generations; many seem like rank-and-file tea party advocates who advocate cutting the size of government.  At the same time, they have few alternatives to the safety net. There comments are in many ways tragic. Here is one example:

She [Barbara] believes that she is taking more from the government than she paid in taxes. She worries about the consequences for her grandchildren. She said she would like politicians to propose solutions.

“We’re reasonable people,” she said. “We’re not going to say, ‘Give it to me and let my grandchildren suffer.’ I think they underestimate seniors when they think that way.”

But she cannot imagine asking people to pay higher taxes. And as she considered making do with less, she started to cry.

“Without it, I’m not sure how I would live,” she said. “With the check I’m getting from Social Security, it’s a constant struggle on making sure that I pay my rent and have enough left for groceries.

“I haven’t bought a Christmas present, I haven’t bought clothing in the last five years, simply because I can’t afford it.”

While I doubt that there is anything approaching a random sample in this piece, the stories are touching and worth reading as you reflect on the long-term liability crisis. The long-term fiscal imbalances cannot be addressed without significant reform in the largest entitlement systems and increases in revenues. But several of the characters in this article (1) recognize this fact but (2) clearly have no sense of how they could survive without the current levels of support.

Obviously, the expansion of the safety net has been accompanied by changes in social norms and the displacement of private institutions. At one time, people like Barbara might have been confident that their extended families and congregations would never let them fall into abject poverty in the absence of public programs. But it is difficult to imagine that a significant reduction in entitlement spending would lead to a revivification of a world that has long passed, at least on a timeline that would be relevant to current beneficiaries.

Reform will come—the status quo simply cannot be maintained. But reform will impose a great deal of pain in a nation where so many have come to depend on the state for so much and there are few live alternatives.

EDITORIAL UPDATE: Those interested in more of Marc’s thoughts on this subject should look here as well.

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The House seems ready to vote down the Senate bill extending the payroll tax cut for two months while requiring the President to decide on the Keystone XL oil pipeline within 60 days (see coverage here and here). The bill—apparently negotiated with the Speaker’s blessings—seemed to be a strategic coup. Passed (89-10) by a bipartisan majority in the Senate, it seems to work against the dominant narrative of the Republican obstructionism. By extending payroll tax cuts for two months, it would limit the GOP=Grinch meme that will undoubtedly fill the airways. By forcing a decision on the pipeline, it will force the administration to alienate one of its two core constituents: organized labor (which strongly supports the pipeline) and environmentalists (who strongly oppose it). The president wanted to delay a decision until after the election to avoid having to reinforce fissures in his support base.

The House GOP rank-and-file wants a one-year extension to take the issue off of the table until after the elections. At the same time, it wants it paid for via spending cuts rather than tax increases. Speaker Boehner, who supported the Senate bill, seems once again incapable of reigning in the rank-and-file.

There is a strong case to be made against extending the payroll tax cut. Our entitlement programs are already on life support; cutting the flow of revenues will only hasten their collapse. And given the need to reduce the size of the deficit, there is a strong case for spending cuts.

Good politics often makes bad policy. But the political benefits of the Senate bill appear too good to pass up.

Or am I missing something?

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This is the underlying message from Bruce Bartlett (FT). Basic argument: unlike Europe, the US already has the policies in place to stabilize the debt-to-GDP ratio.  On the revenue side, the Bush/Obama tax cuts are scheduled to expire and the alternative minimum tax continues to affect more taxpayers. Absent an extension of cuts and annual fixes to the AMT, revenues would rise significantly.

On the spending side, consider Medicare. The sustainable growth rate formula was enacted in 1997 by Congress to constrain the growth of Medicare via controls on payments to doctors. Since 2003, “doc fix” legislation has been used to avoid imposing the cuts. This, combined with the forced $1.2 billion sequestration (thank you super committee) could help restrain budgetary growth.

When combined, Bartlett concludes that the 10 year impact would be to reduce the deficits by $5.5 trillion and save an additional $1 trillion in debt service, thereby stabilizing the debt-to-GDP ratio at 60 percent.  Obviously, there are better ways to stabilize the debt-to-GDP ratio, but they may be far more difficult politically than to simply stand back and allow existing laws to play out.

The “do nothing” Congress has become a talking point in recent weeks. What are the odds that Congress will “do nothing” if the end result is to bring us closer to fiscal stability?

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Events in the Eurozone are unfolding at a more rapid pace than ever, with even the normally staid Economist warning that the Eurozone might break up, with “horrible” consequences. Indeed, while a Greek default might not spell disaster for global finance and might not even require Greece’s exit from the euro, Italy is the third-largest sovereign debtor in the world. Interest rates on Italy’s ten-year debt have leaped past thresholds some economists consider “unsustainable.”

Arguably, Italy is, unlike Greece, not insolvent, merely illiquid. It enjoys a primary surplus (revenues minus non-interest expenditures). The problem is that interest-rate rises themselves will push Italy into bankruptcy, as it cannot afford to float new debt to pay off old debt. From one perspective, Italy is suffering from (irrational?) investor contagion, a speculative attack based on a self-fulfilling prophecy. Another point of view is that investors are rationally anticipating an ECB “firehose to the Italian treasury.” The firehose, of course, is merely default in another form – but it may allow Italy stay in the Eurozone and keep European taxpayers off the hook (even as consumers get the shaft).

Furthermore, the Italian crisis came about principally because the Greek crisis has forced investors to update (more…)

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Senator Chuck Schumer (D-NY) seems pretty convinced that the Super Committee is going to fail and the blame will fall with the Republicans. As he predicted recently:

“I don’t think the Super Committee is going to succeed because our Republican colleagues have said ‘no net revenues…When Democrats move too far left, we lose. We’re now — the basic mainstream of Democrats…we’re willing to move to the middle,” Schumer said. “They are not willing to do any revenues.”

There is news, contra Schumer, that Republicans on the Super Committee may be willing to accept some tax increases (or revenue enhancements, if you will). As NPR reports:

GOP aides said Tuesday that a plan floated by Republicans, including Tea Party favorite Sen. Pat Toomey of Pennsylvania, is one that would place sharp limits on the total amount of tax deductions and credits that a person could claim, in exchange for significantly lower income tax rates. At the same time, Republicans are willing to accept an about $300 billion net increase in individual income tax revenues.

Eliminating tax expenditures would simplify the tax code while reducing the role of the “hidden welfare state.” Despite the fact that the largest tax expenditures overwhelmingly benefit top earners, the Left so often opposes cutting expenditures (except those for “big oil,” of course), and fetishizes marginal rates. As the story notes: “Aides to supercommittee Democrats pushed back sharply, saying the GOP plan for a top individual tax rate of 28 percent would give wealthier earners large tax cuts while many middle income taxpayers would lose tax deductions important to them.”

Given the long-term debt problems, I am hesitant to support cutting marginal rates at this point. But one thing I know for certain, if you raise marginal rates without cutting tax deductions, credits, etc., you only increase the incentives for tax avoidance and the ultimate impact on revenues. Congress could claim that it had finally created jobs. Alas, they would be for accountants and tax attorneys.

I have to wonder (1) whether Toomey et al are serious about tax reform or simply engaging in tactical maneuvers; (2) whether any package that included tax increases would be DOA in the House and Senate, and (3) whether forced sequestration would prove more appealing to a majority of House Republicans than tax hikes without meaningful entitlement reform.

The next few weeks should provide answers to these questions.

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As the 12-member, bipartisan, deficit-cutting super committee spins its wheels in search of $1.2 trillion in deficit reductions, there is a growing sense of skepticism over whether it will reach its goal. The stakes are high. As the Washington Post notes:

failure to produce a measure would trigger painful across-the-board cuts to the Pentagon budget and a big slice of domestic programs. Programs like Social Security, food stamps and the Medicaid health care program for the poor and disabled would be exempt from the automatic cuts, but farm subsidies could bear cuts and even politically popular Medicare could too, though any cuts would be limited to 2 percent of the Medicare budget. The idea behind this so-called sequester was to force the two sides to come together because the alternative is too painful.

Fortunately, nothing focuses the mind like the hangman’s noose, and so we should expect the GOP’s reluctance to raise taxes and the Democrat’s steadfast refusal to cut entitlements to dissipate as the deadline approaches.

Indeed, there is already evidence of bipartisanship is search of a serious solution.  As Anna Palmer (Politico) reports, the solution involves the legalization of online betting.

Conservative firebrand Rep. Joe Barton (R-Texas) and New England liberal Rep. Barney Frank (D-Mass.) are talking up members of the powerful deficit-slashing committee, arguing that virtual betting could boost tax revenue and even create jobs.

And the pair isn’t alone in its support of the industry. Senate Majority Leader Harry Reid (D-Nev.) tried to slip legalizing language into a must-pass tax package last year. And even supercommittee member Sen. Jon Kyl (R-Ariz.), who has opposed the idea, appears to be softening. …

“Several of us are trying to get it into the supercommittee,” Frank told POLITICO. “It would create $40 billion [in revenue] over 10 years.”

There are some interesting dimensions to this story. For example,  in what appears to be a classic case of mud farming, Kyl and Reid have been pressuring the Justice Department to pursue illegal internet gambling while collecting donations from the industry as they promote legalization. And they are not alone in extracting support from the industry.    According to Palmer, Frank and Barton have both received campaign contributions from Full Tilt Poker, a company that has been accused by the Justice Department of running “a $440 million Ponzi scheme” (the Justice Department has already charged Full Tilt and others with bank fraud, money laundering, and illegal gambling). As one might expect, Rep. Frank “has put the $18,500 he received from Full Tilt and others related to the company in trust either to reimburse people who lost money or to donate to a cause related to online gambling.” Other congressional recipients of Full Tilt money are doing similar things (for those who are interested, the Boston Globe’s coverage can be found here).

There is, unsurprisingly, a lot of money to account for. As the Las Vegas Review-Journal notes: “Executives of FullTilt and the Poker Players Alliance PAC spent more than $500,000 in federal political contributions since supportive lawmakers began efforts four years ago to legalize online gambling, according to federal records.”

Undoubtedly, this is little more than a sad little sideshow in the larger circus of government. But there is something rather ironic when, in the face of concerns over the implosion of entitlement trust funds that seem to be remarkably Pozi-like in their funding mechanisms, the best we can do is draw on a stream of revenues from online gambling. It seems equally ironic that Rep. Frank who minimized the risks of a collapsing housing bubble and proclaimed “I want to roll the dice a little bit more in this situation towards subsidized housing” once again turns to the tables for a solution.

Deficit Reduction—You  Can’t Win If You Don’t Play.

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The Can Has Been Kicked…

Today the President announces his $3 trillion deficit plan. First reaction: meh.

We get to count (once again) a trillion from the drawdown in Iraq and Afghanistan. That will be combined with $1.5 trillion in revenue and another $500 billion in cuts. Let’s start with revenue. We are going to hear—endlessly—about the Buffet rule. The Oracle of Omaha notes that his secretary pays at a higher marginal rate than he does. Of course, the top marginal rate for income over $379k is 35 percent. I don’t know what the Oracle pays his secretarial staff, but I know that the Oracle can only achieve a lower rate by taking his compensation primarily as investment income rather than salary. Fine.  The president could not have gotten a millionaire tax passed when the Democrats controlled both chambers. He most certainly is not going to get it now. Indeed, there is no plan to do so. As the NYT reports:

Administration officials said Sunday night that they were not including any revenue from the Buffett Rule in Mr. Obama’s overall $3 trillion proposal, adding that it was more of a guiding principle the president will adopt as budget negotiations with Congress advance.

And

Under Mr. Obama’s proposal, $800 billion of the $1.5 trillion in tax increases would come from allowing the Bush-era tax cuts to expire. The other $700 billion, aides said, would come from a combination of closing loopholes and limiting deductions among individuals making more than $200,000 a year and families making more than $250,000.

So the millionaire tax is only a rhetorical ploy designed to warm the populist heart.  It will play well—it is hoped—to frame the 2012 election as a choice between the millionaire-coddling GOP and the Hope and Change populism of the Democrats. Since the millionaire tax is not part of a deficit program, it is nothing but a campaign meme.

Even if the millionaire tax were serious, the real revenue isn’t to be extracted from the Oracle of Omaha, it must be extracted from the upper-middle class. And as the above quote suggests, that is precisely the goal. I remain astounded that the media still refers to this as the Bush tax cut. The Obama administration negotiated an extension of these very tax cuts on December 17, 2010, before the start of the current Congress. As you may recall, the President still held majorities in both chambers. Given that the extension was passed with unified Democratic control of the House, Senate, and presidency, I remain somewhat puzzled that they are still described as the Bush tax cuts. One might quibble about the applicability of the misnamed Pottery Barn rule (“you break it, you bought it”). But most certainly, if you pass a bill when you control majorities in both chambers of Congress, you own it…until you don’t.

The $700 billion in closing loopholes and deductions could be a good thing if part of comprehensive tax reform designed to eliminate the extraordinarily dense network of tax expenditures that comprise the tax code. Many of these are the instruments used in our de facto industrial policy driven, in large, by successful transfer seeking. They distort market signals and provide significant benefits to the top quintile of income earners. Even if their elimination is foolishly prohibited by Grover Nordquist’s tax pledge, anyone who has respect for market mechanisms should welcome their elimination. But my guess is, there will be significant cherry picking in identifying which loopholes and expenditures to target. But even if the elimination of some of these expenditures could be considered a net change, the post Tax Reform Act (1986) decades proved that there were no expenditures that could not be taken back and then resold to the highest bidder.

As for spending cuts, it appears that any hopes that the fiscal crisis would create a foundation for entitlement reform were misplaced. No hope, no change. The President would like to claim $248 billion from Medicare and another $72 billion from Medicaid, with the bulk of the cuts coming from providers. Given that so much of the savings from the Affordable Care Act were to come from these same sources, I find the claim that even more savings are to be found—without forcing the wholesale defection of providers from Medicaid, for example—to be a bit questionable.

There are no proposals for entitlement reform. No announced plans to increase the retirement age and nothing specific (thus far) on means testing of benefits. To the extent that this is the case, it may be little more than another hunt for “waste, fraud, and abuse.” Given the the GOP has long promised to eliminate the same “waste, fraud, and abuse,” it appears that there is room for a bipartisan snipe hunt.

The President has chosen not to promote entitlement reform and has promised to veto any legislation that seeks cuts in spending without increases in taxes. Following the debt ceiling circus from this summer, the President clearly cannot anticipate that the GOP will suddenly embrace tax increases. So there only seems to be a single conclusion one can arrive at: the deficit-cutting plan has little to do with deficits or reforming the key drivers that will lead, ultimately, to the fiscal crisis that the OMB, the GAO, and the CBO have been predicting for well over a decade.

Since we are entering election season, the lesson should be framed by using the lightly edited words proclaimed by JFK at his inaugural, “the torch has been passed can has been kicked to a new generation of Americans — born in this century, tempered by war, disciplined by a hard and bitter peace, proud of our ancient heritage, and unwilling forced to witness or permit the slow undoing of those human rights to which this nation has always been committed, and to which we are committed today at home and around the world.”

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This morning’s email brought a frantic request from a department chair in Boston anxiously awaiting a promotion review that was sent USPS from Connecticut a mere 9 days ago. I responded by sending the materials as pdfs via email (I am assuming the total transmission time could be measured in seconds). I am sure many of us can share similar anecdotes. They often lead us to puzzle as to what justification, if any, exists for the USPS.

There have been a few interesting pieces in the last few days on the plight of the USPS. The case for allowing the USPS to slip quietly into the night seems rather compelling. Drawing from a fine piece by Steven Greenhouse (NYT), the salient facts are as follows:

  • In an age of electronic communications and private carriers like UPS and FedEx, the demand for the USPS’ services has fallen: “Mail volume has plummeted with the rise of e-mail, electronic bill-paying and a Web that makes everything from fashion catalogs to news instantly available. The system will handle an estimated 167 billion pieces of mail this fiscal year, down 22 percent from five years ago.”
  • The USPS is far less efficient than its competitors: “Labor represents 80 percent of the agency’s expenses, compared with 53 percent at United Parcel Service and 32 percent at FedEx, its two biggest private competitors. Postal workers also receive more generous health benefits than most other federal employees.”
  • The USPS has little flexibility to manage its costs: “the agency has had a tough time cutting its costs to match the revenue drop, with a history of labor contracts offering good health and pension benefits, underused post offices, and laws that restrict its ability to make basic business decisions, like reducing the frequency of deliveries.”
  • The USPS cannot meet its existing contractual obligations to its workers: “the agency is so low on cash that it will not be able to make a $5.5 billion payment due this month [to fund the future health care costs of retirees] and may have to shut down entirely this winter unless Congress takes emergency action to stabilize its finances.”

Undoubtedly, if we told the story of a private firm that was encountering flagging demand, an uncompetitive cost structure, and an inability to make the necessary adjustments to become competitive, we would welcome its collapse. These are precisely the kids of enterprises that the market is supposed to eliminate. As the story notes, Postmaster General Donahoe is asking Congress to provide greater discretionary authority to address the costs (e.g., through layoffs, closing of offices, placing postal services through stores like Wal-Mart). But if the past is any guide, Congress will prove unwilling to allow the USPS the freedom to act like a private enterprise even if it is forced to compete with private enterprises.

I am trying in vain to think of a cogent argument for maintaining the USPS.  Yes, it employees 653,000 people. But the justification must go beyond its payroll (even if we accepted the claim that maintaining government employment was valuable in a recession recovery, one would still have to make the difficult argument that these 653,000 are somehow more deserving than another sample drawn from the long-term unemployed). At least in my household, if I could convince the letter carrier to deliver directly to the recycling bin, it would save me some time. If there is a physical object I need delivered, I turn first to UPS and FedEx—and they have never let me down. If it can be transformed into an electronic format and sent via email, all the better.

The key question: Is there any reason why we should not allow the USPS to pass into the history books?

 

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There is an all too predicable Op-Ed in today’s NYT (“Cameron’s Broken Windows”) by Richard Sennett and Saskia Sassen. The core argument: the riots in London are a product of austerity and if the Tea Party has its way, the same riots may be heading our way.

According to the authors, “Mr. Cameron’s austerity program is the Tea Party’s dream come true” and the spending cuts “have led to the neglect and exclusion of many vulnerable, disaffected young people who are acting out violently and irresponsibly — driven by rage rather than an explicit political agenda.”

The authors conclude:

Britain’s current crisis should cause us to reflect on the fact that a smaller government can actually increase communal fear and diminish our quality of life. Is that a fate America wishes upon itself?

Obviously, there is any number of explanations one could develop for the riots in London.  One should not be surprised with the general argument and the suggestion that efforts to reduce the growth of federal spending could lead to a similar outcome in the United States (indeed, I would have been shocked if this argument did not emerge in the NYT).

While I think the argument is a bit tortured when addressing the current problems in London, it seems to me that the kind of changes necessary to address the long-term structural deficit and debt and the $54 trillion in unfunded liabilities could be quite destabilizing.  Of course, a failure to make the necessary reforms could also prove quite destabilizing, as generations are consigned to confiscatory tax levels, stagnant growth, and little hope of prosperity.

Is London our future?

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The response to the S&P downgrade of the US credit rating has been quite interesting thus far. Those who for several weeks spoke in apocalyptic terms about what would happen if the US defaulted on its debt are now filled with shock: “A credit rating should reflect the probability of default, and the probability of the US defaulting on its debt is zero.”  Hmmm….

Beyond this 180 degree pivot, another response has been to shoot the messenger. As Austin Goolsbee, outgoing CEA Chair, stated:

“They made a $2 trillion math error, and they didn’t check their work.”

This line has been repeated like a mantra by members and supporters of the administration (is anyone noting a pattern in White House rhetoric? A few weeks ago, the President comparing Congress to his children and their homework and later making comments about “eating our peas?”)

Economist John Taylor has an interesting piece that clarifies things a bit.  Two key points:

First: the dispute did not arise from a simple arithmetic problem (e.g., “S&P failing to check their work”) but in a dispute over basic assumptions.  As Professor Taylor explains:

“if you examine the details of the S&P–Treasury–White House dispute, rather than a “math error” you will find what is better described as a “difference of opinion” about a forecast for future government spending.  In other words, the issue is about the appropriate “baseline” for government spending in the absence of more actions. Since when did different views or assumptions about the future become a math error?

In their original draft report, S&P evidently assumed that discretionary government spending would grow by about 5 percent per year over the next 10 years if no further action were taken (beyond the Budget Control Act of 2011). In the final draft, at the urging of the Treasury, they assumed that discretionary spending would grow at about 2.5 percent per year if no further actions were taken.  The first assumption leads to a higher level of debt than the second.  Over 10 years the difference is about $2 trillion.”

It should be noted that the Treasury concedes this point in its release on the “S&P’s $2 Trillion Mistake.”

“The error came about because S&P took the amount of deficit reduction CBO calculated from the Budget Control Act and applied it to the wrong starting point, or ‘baseline.’ Specifically, CBO calculated that the Budget Control Act, including its discretionary caps, would save $2.1 trillion relative to a “baseline” in which current discretionary funding levels grow with inflation.”

Second, as Taylor notes and the Treasury concedes in the above quote, the disagreement over assumptions revolved on whether to adopt the CBO’s alternative fiscal scenario, the scenario that the CBO and many others view as being far more credible than the “extended baseline scenario.”

Ultimately, the math error seems to have come down to a difference in opinion regarding long-range scenarios. Elected officials—insert gasp of surprise here—tend toward Rosie Scenario. Those who are not nearly as interested in spinning and framing tend toward more realistic scenarios.

For our elected officials who combine the “math error” with statements about S&P’s past errors in assessing the risk of the mortgage backed securities in the years leading up to the financial collapse, one quick reminder: S&P was never indicted for being too pessimistic—quite the opposite. If anything, it seemed to understate the magnitude of the risks.

Given the $54 trillion+ in unfunded liabilities currently on our books, it might be difficult to overstate risk. If you have any doubts, take a few minutes and read the most recent CBO Long-Term Budget

 

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As Pileus readers know, the spending cuts Congress and the President agreed to in future budgets are a drop in the bucket of future deficits. Nevertheless, the cacophony of protest among partisan hacks is deafening. Jacob Weisberg has a particularly incoherent piece at Slate today. Two selections:

But for the federal government to spur growth or create jobs, it has to spend additional money. The antediluvian Republicans who control Congress do not think that demand can be expanded in this way. They believe that the 2009 stimulus bill, which has prevented an even worse economy over the past two years, is actually responsible for the current weakness. Their Hooverite approach—embedded in the debt-ceiling compromise—demands that we address the risk of a double-dip recession by cutting public expenditure now rather than later.

The deal that President Obama and House Speaker John Boehner tentatively agreed upon in early July was far from perfect, imbalanced in favor of spending cuts over revenues by a ratio of 4-to-1. But that $4 trillion “grand bargain” would have constituted a serious down payment on the deficit, and sent a strong signal to financial markets that our political establishment took the problem seriously. Instead we got this week’s sad bargain—a much smaller, deferred, and contingent reduction in spending projections. This sends quite a different signal: that our political system cannot, in its current configuration, cope with difference between what comes in and what goes out.

So let’s get this straight: the cuts in spending were both too large and too small for Weisberg. Bigger cuts would have been better, and so would no cuts – in fact, increases! Perhaps he means that there should be increases now, bigger cuts later – a respectable position. But that’s not what he says, nor does that position correspond to any recognizable negotiating position taken by either side in the debt ceiling debate. So why does all the blame accrue to “antediluvian Republicans”? (Never mind the ignorance about Hoover’s massive increases in federal spending.)

But the reliably behind-the-curve New York Times editorial board takes the cake with their proposal to abolish the debt ceiling altogether. So let’s get this straight: Politicians in DC are such irresponsible spenders that the only thing that could force them to get together and make even small cuts in future spending growth was the risk of financial annihilation. And the solution is? Take away the very risk of financial annihilation that finally forced them to exercise a modicum of fiscal responsibility!

Of course, if you abolish the debt limit, then under divided government we’d have the same game of chicken played at budget time, when the hostage would be the operations of the federal government. And I’m sure we can count on the Times editorial board to scream about not holding our economy hostage when the federal government shuts down or comes close to it. Maybe we should abolish annual budgeting too. Just let departments set their own budgets. It’s safer that way.

The right blogosphere is little better. Looking ahead to the super-committee, the only concern on the right seems to be that – horrors of horrors – the committee might try to raise some revenue by eliminating tax expenditures and deductions! So the GOP should have forced default instead! Because if you want long-run spending cuts, the right strategy is to gain control of one house of Congress and then maintain a position of complete and total intransigence on the only thing you can reasonably offer the other branches in exchange for spending cuts! Oh, and frighten as many independents as you can before the next election.

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This is a comment that I have heard a few times in the past few weeks regarding the issue of austerity. The Tea Party forced the GOP to embrace austerity, and we know that when FDR mistakenly listened to Treasury Secretary Morgenthau in 1937 and cut back on expenditures, the economy entered a rapid decline. The lesson, of course, is that austerity can impose a terrible cost on an economy that has not yet recovered.

As most Pileus readers will undoubtedly note, 1937 may be rich in lessons. As we know, the Federal Reserve imposed significant increases in reserve requirements. FDR’s rhetoric (remember that delightful phrase from the state of the union: “In spite of our efforts and in spite of our talk we have not weeded out the overpriviledged”) and efforts to introduce confiscatory tax rates created extreme regime uncertainty. As for fiscal policy, I am uncertain that there are great lessons to be learned.

I was updating some data I have generated on per capita domestic spending. The figures exclude defense spending, not because defense isn’t important but rather to get a sense of the trend line absent international crises, wars, etc.  The figures are adjusted for inflation (all presented in 2005 dollars) and the raw data is drawn from the typical sources (e.g., OMB Historical Tables, Census Bureau population figures). These figures are presented graphically below.

The most striking thing about these figures is how miserly the New Deal was by contemporary standards. The peak level of New Deal domestic spending in the 1930s was $809 per capita. This occurred after the “War Springs conversion” when FDR embraced active fiscal policy. The much cited austerity occurred after 1936, when per capita spending fell from $658 to $580. Remember, these figures are in 2005 dollars. In other words, the change in fiscal policy reduced federal domestic spending by approximately 21 cents per day per person.

A second striking thing about these figures is now much federal domestic spending per capita has increased overtime. Many look longingly to the good old days when the Gipper told us that government was the problem, not the solution. During his watch, domestic spending per capita increased from $4670 to $4951 (once again, in 2005 dollars). Once again, to place things in perspective, per capital domestic spending in 1988 was 6.12 times greater than the peak for the 1930s, in inflation adjusted dollars.

Moving forward, this year, the federal government’s per capita domestic spending is $7936. This is 9.81 times greater than peak per capita spending during the New Deal. Even if per capita spending were reduced to the levels of the last year of the George W. Bush presidency ($7066), it would be 8.73 times the New Deal peak (and for those who would rather look to more contemporary examples, 2.57 times greater than the peak of Great Society spending ($2746 per capita, 1968).

It is difficult to determine what the fiscal policy lessons of 1937 are when domestic spending per capita has increased so dramatically in the intervening decades. The biggest lesson is one that is often ignored. As much as many love to wag their finger at Lyndon Johnson or FDR, the levels of spending they engaged in was miniscule by today’s standards.  Critics may label any reduction in current spending as an exercise in austerity, but one wonders if we have any idea what austerity would really look like.

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There once was a man who, by every possible measure, had reached a girth that was too great to be compatible with a long and flourishing life. One could have considered any number of indicators if one had wished—percentage of body fat, body mass index, blood pressure—and they all pointed in the same direction and carried the same dire consequences. Although the man usually shrugged them off (“My mother always told me I was a husky boy with big bones,” he would tell himself), in his heart he knew the truth and understood the consequences of continuing the habits that had left him in this awful state. Indeed, he did not have to look too far to see others with similar weights suffering from sclerosis and, in some cases, facing a premature death. He decided to seek out advice from some of his most trusted friends.

One day a friend dropped in for tea to discuss the situation.  The fat man sighed and said: “Perhaps after years of eating too much and exercising too little, it is time again to get on the scale and face up to my situation.” The friend put down his cup of tea and scolded: “We have been down this path before. Every few years you get on the scale and each time you weigh more. This time will be no different.  Do not get on the scale until you are fully committed to a new fitness regimen. To do so, would simply make you fatter.” The fat man didn’t quite understand the logic. “The scale does not make you fat, no more than any other indicator I have read about.” The friend looked sternly across the table and replied: “This is the very thinking that you into this situation. Follow my advice and refuse to get on the scale. Make it a pledge.”

The logic seemed to escape the fat man. Fortunately, another friend dropped in and offered a glass of chardonnay and some competing advice. “Three things, my friend. First, don’t even use words like ‘fat’ since they are often a hallmark of intolerance. There are many large people—far larger than you—who are very happy. Who ever heard of a jolly thin man anyway? Second, throw the scale away altogether. Eat, drink and be merry! As long as you have credit, you can enjoy a wealth of world pleasures. In the long run, we are all dead! Finally, think about how your decisions will affect others—the most vulnerable among us. The minute you stop eating dessert, the poor people who cook your pastries and scoop your ice cream will find themselves with less demand for their services. Do you really want to pursue health on the backs of the food service industry?”

The conflicting counsel confused the fat man. Fortunately, a third friend came to the door and offered a quick critique of the earlier pieces of advice. “You must get on the scale. It only tells you what you already know and however much you want, you can’t change your past decisions about eating and exercise. Just jump on and jump off. If you don’t like what you see, you can always start planning your New Year’s resolutions.”  The fat man frowned: “I have tried the resolution route before. It never ends well.” The third friend winked and lit a cigarette. “Well then, get on the scale. But do so with a commitment to stop ordering cheesecake after dinner. In a few months, you can commit to getting on the scale again but only if you combine that with a further decision to stop drinking milkshakes.” Fatman looked a bit puzzled. “I don’t like cheesecake and rarely drink milkshakes.” His friend smiled once again: “Even better. Those things are high in calories—they have been scored as such by the nonpartisan USDA—even if you don’t normally consume them, even if you gave them up years ago, there is no reason why you shouldn’t view these commitments as important steps toward a new healthy lifestyle. There is an additional advantage: if you frame your commitments with care, you might even bring your other two friends aboard. We have found consensus in the past.”

Regardless of which advice he followed, the fat man finally concluded, he would still be fat, and most likely fatter as the years progressed. He had read the reports on the long-term consequences of morbid obesity; the projections of the health problems he would face in future years were sobering. That day he made an important decision. The first step to good health was clear: get a new set of friends.

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The WSJ has an editorial today entitled “Entitlement Nation” in which it outlines America’s political history that has led to so many millions of us today receiving, even living off, payments of money, goods, or services from the government. The numbers are shocking: “50.5 million Americans are on Medicaid, 46.5 million are on Medicare, 52 million on Social Security, five million on SSI, 7.5 million on unemployment insurance, and 44.6 million on food stamps and other nutrition programs. Some 24 million get the earned-income tax credit, a cash income supplement.”

The Journal rightly argues, “Congress has made so many promises to so many Americans that there is no conceivable way those promises can be kept.” It is because the current debt-ceiling negotiations are not even discussing the drastic changes to Medicaid, Medicare, and Social Security that would be needed to keep us fiscally afloat that they are really just playing pretend. We are still looking for the proverbial Adult In The Room. 

When the subject of reforming the Big Three entitlement programs arises, one often hears, especially from people receiving payments from them, some version of: “I paid into those programs, so I’m entitled to get my money back.” It seems like a reasonable position: people should get what they paid for, especially when they were promised to get what they paid for.

The problem is that what you paid is long gone. The money you paid over your working career was spent immediately on all manner of government cornucopia—programs, benefits, bureaus, agencies, institutes, centers, initiatives, divisions, projects, expenditures, studies, commissions, summits, departments, and on and on. You may not have noticed, or may not have been paying attention, but every single penny that was taken from your paychecks was spent. Not saved, not invested: spent. So it is now gone. Indeed, it is more than gone, since what has been spent is a lot more than what came in—which means that not only was every penny they took from you spent, but they’ve promised others a lot more of your, or someone’s, pennies.

The obvious question must now be asked aloud: If all that money, and then some, has already been spent, what is funding those entitlement programs right now, today? Answer: it is being extracted from other people’s paychecks, and financed by debt that other people will have to pay in the future. People receiving entitlement payments now are living off the money taken, or promised to be taken, from other people.

Should it be this way? Should the government have made promises it could not keep? Should it be the case that the government actually spent the money they took from you instead of saving or investing it? No, no, and no. Alas, what should be often is not.

The moral status of some people living off wealth taken from others, as so many millions of us Americans now are doing, is a separate question. I have my own view about it, but coming to a correct moral judgment about it requires first coming to a proper understanding of the situation.

It might well have been your money that was taken from you all those years, and, especially in retrospect, it might well have been wrong of the government to take it from you. But the money you are receiving now is not that money: it is someone else’s, someone who no doubt also would claim ownership of it. If you accept the money, you have to face that fact squarely.

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