Author Archive
The Folly of Dismissing the Effects of Entitlements on Fertility
Steve Entin recently wrote in the Wall Street Journal (“The Folly of ‘Family Friendly’ Tax Policy,” April 9, 2008; Page A15): “…proponents of greater family tax credits also claim that society owes families a big child credit because the children will face huge payroll taxes to support childless retirees who never paid to rear the next generation. Another claim is that payroll taxes make it hard for families to afford children, and we need families to have more children to pay for Social Security and Medicare. These arguments don’t wash. Most people have children because they want them, not because the state needs future taxpayers to fund social programs.”
On the 1st claim of the child tax credit proponents: Higher child tax credits today would strengthen the defense against cuts in future benefits by everyone, and especially by childless retirees. But that goes in the wrong direction relative to what’s required–cutting future benefits because they’re not payable, even under today’s high payroll taxes.
On their 2nd claim: If payroll taxes are a hurdle to procreation by young adults, the correct remedy should be to lower them rather than introduce yet another entitlement for young adults in their children’s names — which they would use to extract resources from those children in the future by way of retirement benefits. But today’s high payroll taxes on parents are not for saving and investing for their own future retirements. Those taxes are for paying benefits to today’s retirees under our pay-as-you-go Social Security system. Cutting payroll taxes, therefore, would require today’s retirees, in turn, to accept smaller benefits—which is, of course, a big no-no for proponents of child-tax credits.
According to Mr. Entin, however, both of these claims don’t wash because of the rather tepid idea that people have kids because they want them, not because they (or the state) wants more future taxpayers.
However, according to studies on the potential links between fertility and entitlement spending, (for example, Michele Boldrin’s) it appears that fertility rates correlate negatively with generous government entitlement expenditures across countries. They also correlate negatively with better access to financial markets which enables people to securely transfer purchasing power to old age. So positive fertility seems to reflect, however indirectly, a desire to “save/invest” for the future in the absence of other public and private vehicles of achieving economic security during old age.
The bottom line: Along with its well-established negative impacts on saving/investing and labor supply, unfunded entitlement promises potentially erode yet another pro-growth factor–fertility. An estimate of net benefit promises to current adults under current entitlement policies — compiled from various tables of the latest Social Security and Medicare Trustees’ reports — shows that such underfunding amounts to $44 trillion in present discounted value! That’s a promise of almost $200,000 in today’s dollars of future Social Security and Medicare benefits for each person aged 15 and older today. Why would you, then, work, save, and have children to safeguard your future?
Filed under: General; Health Care; Social Security; Tax and Budget Policy
The Fed’s “Central Planning” Woes
Given the financial/regulatory system that we have — which is a very important pre-condition — I grant the Fed and Treasury a TEMPORARY “coordinating” role to help tide over the current crisis. However, the initiatives and actions implemented so far appear unlikely to succeed.
I agree only with its role in the Bear buyout by JPMorgan. It is, by nature, a one-time action that does not protect Bear’s shareholders and operators but protects the financial system from unraveling further — similar to it’s actions re: LTCM. Even if it is repeated for another investment bank, it does not raise the issue of moral hazard because no such bank wants to end up like Bear.
However, the Fed’s new and almost direct support of mortgage backed securities through its primary dealers introduces another moral-hazard potential — likely to be a huge problem down the road, and especially because of the interest rate policy it is adopting.
Interest rate cuts are being overdone. Large cuts are continuing the Fed’s past mistakes of introducing greater uncertainty in market participants’ expectations. It is using the wrong (inflation fighting) tool to achieve its goal of systemic stability which has arisen from poorer visibility of asset quality. The added uncertainty will prolong the resolution of current credit/liquidity shortages.
The longer that credit/liquidity problems last, the more likely is the introduction of PERMANENT new financial market regulations — which would hinder efficient operation — in the very function that is key to resolving current credit shortage problems — the generation of price information.
Finally, Prof. Cowen’s recent NYT oped (“It’s Hard to Thaw a Frozen Market“) compares market pricing under capitalist and socialist systems. In brief, the argument is that socialist systems’ poor market pricing abilities appear to be reflected in the current credit-market woes of the American “capitalist” system. This comparison appears misplaced to me. The general U.S. economy may be relatively free and capitalist — but financial and credit markets are not quite so free.
Current credit market problems are not the result of pure and free market operation/competition. We have a fiat currency whose supply and purchasing power is controlled by Fed interest rate policies. And it appears to have made serious mistakes in the process. This involves larger issues of whether asset prices should be objects for setting Fed policy and whether and how the Fed should respond to supply/oil shocks. Fundamentally, however, financial market participants naturally don’t look to “the free” market to set their expectations about the dollar’s future purchasing power. Those expectations are set by a “central planner” — the Fed.
The Spin on Medicaid
The Administration claimed this week that Medicare and Medicaid spending has slowed, but a close look at the overall picture tells a different story. My colleague Michael Cannon has already posted his opinion about Medicare spending. Here’s the low-down on Medicaid.
The official spin:
Medicaid cost projections are once again declining, reflecting … a slowdown in Federal Medicaid spending growth from over 12 percent per year in fiscal year 2000-2002 to 7.2 percent from 2002-2005, down further to 4.6 percent projected for fiscal year 2006-2007.
And the complete story:
Summary budget tables — updated during the release of the Administration’s Mid-Session Review of the Budget this week — indicate that federal Medicaid and SCHIP (State Children’s Health Insurance Program – also a part of Medicaid) outlays would grow from $129 billion in 2001 to $213 billion by 2008. That’s a cumulative (geometric) annual average growth rate of 7.7 percent during the Administration’s full tenure. The nation’s Gross Domestic Product, on the other hand, would grow at a much slower pace — just 5.2 percent per year during the same period.
Much of Medicaid spending growth resulted from the substantial surge in enrollments and benefits per enrollee during the aftermath of the 2001 recession. Medicaid outlays would be expected to surge during recessions but should abate when growth picks up. The latter did not occur during the 1991 and 2001 recession episodes. During the later recession, changes in federal regulations made it easier for states to expand coverage to broader groups and claim federal matching grants against such coverage. And evidence from micro-data surveys indicates that it was not the poorest groups that received most of the latest increases in Medicaid coverage and benefits.
The reasons for the current slower growth in Medicaid spending are the transfer of the fastest growing prescription drug coverage to Medicare and robust economic growth. However, according to the Administration’s projections, faster Medicaid spending growth – at 7-plus percent per year — is projected to resume after 2007.
Providing greater power to states to redesign their programs while persisting with a federal financing mechanism of matching grants (rather than block grants with capped growth) promotes states’ incentives to spend more. That will cause…you guessed it…more spending on our middle-class Medicaid entitlement.
Sorry, We Can’t ‘Grow’ Our Way out of the Social Security Problem
Many economists and lawmakers — especially conservatives — argue against tax hikes as solutions to entitlement shortfalls, saying the hikes would be counterproductive. According to this argument, higher taxes would retard growth, reduce federal revenues, and worsen entitlement shortfalls.
For example, Stephen Moore in his June 12 Wall Street Journal column “Don’t Know Much About History…” alludes to a presumed beneficial impact of faster (wage) growth on the financial problems of entitlement programs. Unfortunately, that presumption is incorrect, especially as regards Social Security.
The claim that faster wage growth would reduce Social Security’s financial shortfall is an artifact of the standard (but flawed) 75-year-ahead Social Security financial projections that count payroll taxes through that period but ignore benefit obligations those taxes would create beyond the 75th year. The projections make it look as though robust wage growth would shrink the gap between Social Security revenues and obligations. But the picture changes over a longer timeframe.
A Key Reform for Budget Process Reform
Senate Budget Chairman Judd Gregg’s “Stop Over-Spending” (SOS) plan, announced last week aims at reinstating tight fiscal controls — after letting them erode over many years by gutting pay-as-you-go budget rules and pushing through massive supplemental spending outside of the regular budget process.
The proposal includes a line-item veto for the President to cut wasteful spending and a bipartisan commission for devising solutions to entitlement program shortfalls.
Its main focus, however, is to set deficit caps tied to mandatory spending cuts similar to the Gramm-Rudman-Hollings Deficit Control Act from the mid-1980s. That act, however, proved ineffective and had to be revised multiple times.
The key to whether lawmakers are really serious about budget process reform is whether proposed changes are based on short-term deficit measures or forward-looking long-term unfunded obligation measures.
Spending control laws based on short-term budget measures are likely to mislead policymakers into adopting inadequate or inappropriate reforms. Imagine if we were to determine the need for Social Security reform based on its net cash flow today–which is in surplus.
And we’ve been here before–we thought the pay-as-you-go constraints from the Budget Enforcement Act had done their job and turned them off in 2002–only to see a federal spending spree like never before. If adopted (which appears unlikely) SOS may work for a time, but history is likely to repeat itself.
The key to a budget process is the budget measures on which spending constraints are based. Using the same old budget measures will not deliver a new process. It’s time to make fundamental changes by adopting more appropriate fiscal yardsticks. Unless budget measures fully reflect the budget problems that lie ahead and correctly reflect the consequences of policy changes, we will continue to lurch from one reform to the next without making any improvement–at best.
A Tale of Two Accounts
According to a prominent news report today, U.S. household net wealth was $53.8 trillion at the end of the first quarter of 2006. That’s an increase of almost $5 trillion since the same time last year, and four times as much as the nation’s entire output (GDP) for 2005.
The fact that U.S. household net wealth has consistently increased during recent years provides a comforting counterargument against those who bemoan the decline in U.S. saving. That decline, which commenced during the early 1980s, achieved an important milestone recently: U.S. personal saving dipped below zero for the first time in 2005.
Why, then, is household wealth increasing? The simple answer is that our existing assets are becoming more valuable. Those capital gains are not counted in the income base (worker compensation plus asset income) for calculating saving.
Unfortunately, looking just at household wealth provides false comfort. The point is simple: Take the economy-wide account and split it into two parts: the government account and the household account (private firms are owned by households). Looking at just the increase in household net wealth and congratulating ourselves for how rich we are (collectively) misses the 800-lb. gorilla in the room: the government account.
What does that account look like? The recently released annual reports by the Social Security and Medicare trustees suggest that the total unfunded obligations of those two programs alone account for $84 trillion, also an increase of $5 trillion over one year ago. That doesn’t count Medicaid, whose costs are escalating rapidly (for both federal and state governments) and the rest of government operations including the growing costs of homeland security, border control, anti-terror efforts, and wars abroad. Curbing the size of government along these dimensions is clearly crucial to achieving greater wealth. Without this, much of the household wealth will have to be devoted to paying future taxes.
How rich do you feel now?
How Much to Trust the Medicare Trustees’ Projections?
The recently released Medicare Trustees Annual Report [pdf] contains a stark reminder of the Alice in Wonderland nature of Medicare’s financial projections and policy-making. Page 219 of the report carries the chief actuary’s “Statement of Actuarial Opinion.” Its contents should be mandatory reading for those worried about the program’s future. The statement’s second paragraph is reproduced here:
…the Board of Trustees has emphasized the strong likelihood that actual Part B expenditures will exceed the projections under current law, due to further legislative action [emphasis added] to avoid substantial reductions in the Medicare physician fee schedule. While the Part B projections in this report are reasonable in their portrayal of future costs under current law, they are not reasonable as an indication of actual future costs. Current law would require physician fee reductions totaling an estimated 37 percent over the next 9 years—an implausible result.
In other words: Despite Medicare being in a deep financial hole, don’t expect policymakers to stop digging for a while yet.
The funny part is that the actuarial method used in making projections is perfectly legitimate; it makes projections by completely ignoring future policy changes—no matter how likely they are. But the chief actuary is also correct to point out that certain aspects of current Medicare law are ridiculously out of touch with political reality.
Most official budget analysts have thrown a fit whenever I’ve used the words “debt” or “liabilities” to describe current-law Medicare obligations to future retirees. “We don’t ‘owe’ anyone anything because Congress can change current laws!” they’ve protested.
The chief actuary’s statement exposes the hypocrisy: His statement means that we are also obligated to pay future medical providers MORE than current laws stipulate. And, oh, by the way, don’t call that “debt” either because, in this case, Congress can choose NOT to change the laws!
Who’s More Myopic?
Here’s a partial view of the range of issues that needs to be scaled in order to constrain the future size of the federal government. In what follows, A = widely appreciated by the public, N = not widely appreciated, and A-N = appreciated by a few.
- Waiting to reform will mean that the median voter will be older — and tend to vote for tax hikes rather than benefit cuts as a solution to entitlement shortfalls (A).
- Waiting to reform entitlements makes the cost of fixing them increase as a percentage of GDP — and last year, we decided to postpone Social Security reform until who knows when. Just for Social Security, each year brings an additional $600 billion in cost (official Social Security Administration estimate). Note, the economy adds only about $450 billion in additional output each year (N).
- When analyzing the merits and demerits of reforms, we do not consider their full cost because we make policies based on short-horizon fiscal measurements — the 10-year cost of prescription drugs, for example (A-N).
- Recently emerged needs for countering terrorism and international nuclear blackmail means the peace dividend has evaporated and cutting other government spending is less viable as a means of releasing resources for entitlement outlay needs (A-N).
- Private saving has declined and remains low (zero percent on personal saving) precisely because of the types of entitlements we have adopted (my finding from past research on why national saving declined in the U.S.). We’re lucky to be able for borrow capital from abroad today, but all such borrowing will have to be repaid with interest — perhaps just when we need to distribute more for retiree support (A-N).
- We just enacted a massive new and irreversible entitlement — Medicare prescription drugs — the constituency for which will grow more solid by the year (A).
Most of these issues ARE known to policymakers and federal budget practitioners within the beltway. In fact, they have been known since the early 1990s. Despite recognizing these problems, Congress has repeatedly settled into postponing action on entitlement reforms.
What does that tell you?
Those who believe that the government should come to the aid of “myopic” individuals who don’t save enough for the future, think again.
The Social Security Side-Step
In describing the contents of the Social Security Trustees’ latest annual report, most reporters have described the changes as “minor.” That impression rests, however, on a comparison of a large number with a gigantic number—the present value of Social Security’s financial shortfall over 75 years to the present value of total payrolls, also projected over the next 75 years.
Note that according to the report, an additional 2 percentage points must be added to payroll tax rates immediately and must be kept in place permanently. That’s unlikely, and precisely because we are describing the shortfall as “no big deal.”
Problem is, the cost escalates the longer we wait. How long would we wait? When it becomes as large as four percentage points? Six? No, if it becomes that large, chances are taxpayers would revolt and the system would have to face benefit cuts.
Benefit cuts? At a time when beneficiaries are more numerous and politically powerful? Unlikely. Then what? Read the rest of this post »
Cato on Facebook
Cato on Twitter
Cato on Google+
Cato on YouTube
