Paul Krugman has taken some rather interesting stances on the fiscal situation here in the U.S. First up is a piece entitled Fiscal Train Wreck from March 2003,

With war looming, it’s time to be prepared. So last week I switched to a fixed-rate mortgage. It means higher monthly payments, but I’m terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits.

[…]

Last week the Congressional Budget Office marked down its estimates yet again. Just two years ago, you may remember, the C.B.O. was projecting a 10-year surplus of $5.6 trillion. Now it projects a 10-year deficit of $1.8 trillion.

And that’s way too optimistic. The Congressional Budget Office operates under ground rules that force it to wear rose-colored lenses. If you take into account ? as the C.B.O. cannot ? the effects of likely changes in the alternative minimum tax, include realistic estimates of future spending and allow for the cost of war and reconstruction, it’s clear that the 10-year deficit will be at least $3 trillion.

[…]

That may sound alarmist: right now the deficit, while huge in absolute terms, is only 2 ? make that 3, O.K., maybe 4 ? percent of G.D.P. But that misses the point. “Think of the federal government as a gigantic insurance company (with a sideline business in national defense and homeland security), which does its accounting on a cash basis, only counting premiums and payouts as they go in and out the door. An insurance company with cash accounting . . . is an accident waiting to happen.” So says the Treasury under secretary Peter Fisher; his point is that because of the future liabilities of Social Security and Medicare, the true budget picture is much worse than the conventional deficit numbers suggest.

What does he say today (well at least in August 2009)? Well, lets take a look,

I respect Jim Hamilton a lot, so I take his criticism seriously — and he raises questions that others raise too about my relatively sanguine assessment of the debt situation. Yet I think that he and others are quite wrong, on several counts.

[…]

But let’s take a slightly later start date: in 1950, federal debt in the hands of the public was 80 percent of GDP, which is in the ballpark of what we’re looking at for 2019. By 1960 it was down to 46 percent — and I haven’t heard that anyone considered America a debt-crippled nation when JFK took office.

So how was that possible? Was it through drastic cuts in defense spending? On the contrary: we’re talking about the height of the Cold War (with a hot war in Korea along the way), and federal spending actually rose as a share of GDP. So yes, it wasn’t entitlement programs, but it wasn’t exactly discretionary either.

How, then, did America pay down its debt? Actually, it didn’t: federal debt rose from $219 billion in 1950 to $237 billion in 1960. But the economy grew, so the ratio of debt to GDP fell, and everything worked out fiscally.

[…]

Jim gets scary numbers about the debt burden by assuming that we’ll have to pay off the debt in 10 years. But why would we have to do that? Again, the lesson of the 1950s — or, if you like, the lesson of Belgium and Italy, which brought their debt-GDP ratios down from early 90s levels — is that you need to stabilize debt, not pay it off; economic growth will do the rest. In fact, I’d argue, all you really need to do is stabilize debt in real terms.

Note that in 2003 Krugman was just fine looking at the 10 year budget predictions. Now, why that’s silly we just need to alter our perspective. And the new post mentions nothing about Social Security and Medicare whose fiscal/actuarial position has not changed appreciably since 2003.

Now some might argue, and indeed in the comments to other posts people have argued, that during the fat years you trim the deficits or best of all run surpluses and in the lean years run the deficits. Sure, that is a some what simplified version of Keynesian fiscal stimulus. My response is lets make a list of the two situations,

View from 2003:

1. The economy was in recovery.
2. The fiscal outlook was a $1.8 trillion deficit.
3. Social Security and Medicare were in serious actuarial imbalance (tens of trillions of dollars).

View from 2009:

1. The economy is in recession.
2. The fiscal outlook is $9 trillion deficit.
3. Social Security and Medicare were in serious actuarial imbalance (tens of trillions of dollars).

The view in 2003 terrified Krugman, so much so that he took personal action regarding his own finances. Switch to 2009 and, meh guys like Prof. Hamilton are just being alarmists. The view from 2009 is pretty much worse than it was in 2003, and it seems to me that yes, if one was worried about the fiscal outlook in 2003, then in 2009 it is even more worrisome. I agree with James Hamilton,

If the government tries to double taxes on people like me, it’s in real political trouble. If it doesn’t try to double taxes on people like me, it’s in real solvency trouble.

It looks like we may have a problem here.

Thanks to Scrivner.net for the links, and their article is also well worth reading. And yes, I know that this stuff is rather old, but…well Krugman is basically saying the samethings today he did in August, “No worries, we’ll grow our way out of it.”

In a front piece story in today’s NYT, Edmund Andrews warns that the bill is about to come due on the massive borrowing the federal government has engaged in.

Treasury officials now face a trifecta of headaches: a mountain of new debt, a balloon of short-term borrowings that come due in the months ahead, and interest rates that are sure to climb back to normal as soon as the Federal Reserve decides that the emergency has passed.

[...]

With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.

In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan.

[...]

Americans now have to climb out of two deep holes: as debt-loaded consumers, whose personal wealth sank along with housing and stock prices; and as taxpayers, whose government debt has almost doubled in the last two years alone, just as costs tied to benefits for retiring baby boomers are set to explode.  The competing demands could deepen political battles over the size and role of the government, the trade-offs between taxes and spending, the choices between helping older generations versus younger ones, and the bottom-line questions about who should ultimately shoulder the burden.

[...]

The problem, many analysts say, is that record government deficits have arrived just as the long-feared explosion begins in spending on benefits under Medicare and Social Security. The nation’s oldest baby boomers are approaching 65, setting off what experts have warned for years will be a fiscal nightmare for the government.  “What a good country or a good squirrel should be doing is stashing away nuts for the winter,” said William H. Gross, managing director of the Pimco Group, the giant bond-management firm. “The United States is not only not saving nuts, it’s eating the ones left over from the last winter.”

Emphases mine.

This sounds ominous and unsustainable.  But Paul Krugman, recent winner of the Nobel Prize in economics, say these fears are overblown.

As Dean says, the numbers don’t fit the scare story — a decade from now interest payments will reach a level not seen since … 1992. And the market seems unworried, since long-term rates remain low.

The “Dean” is question is Dean Baker of The American Prospect.  He sarcastically titles his post, “In Just a Decade the U.S. Interest Burden Could Be as High as It Was in 1992!!!!!!!”

There is no evidence presented in this article that the rise in interest rates will place the U.S. government in a situation where it will be unable to pay its bills and no one cited in this article makes such a claim.

The article is also completely unbalanced in not presenting the views of any economist who could put the deficit/debt issue in perspective for readers.

Krugman makes the same charge but, oddly, neither of them bother to actually present a counterargument.

Andrews argues that most of the debt is in short-term loans whose price will go up as there becomes more competition for money.  He makes what strikes me as a plausible case that higher interest rates, growth in entitlement spending, and a smaller tax base will make servicing the debt very, very difficult.   Countervailing factors could offset this but neither Krugman nor Baker tell us what they might be.

It’s true that we had gloom and doom forecasts during the 1992 recession.  But we only solved those through the dual magic of the dotcom bubble and the post-Cold War defense drawdown.  It’s not likely that those events will repeat themselves.

Photo by Flickr user kandyjaxx under Creative Commons license.

Time features an article on the “Five Things the U.S. Can Learn from China” that I can only characterize as surreal. Here are the five lessons:

1. Be Ambitious
2. Education Matters
3. Look After the Elderly
4. Save More
5. Look over the Horizon

For the details you’ll just have to read the article.

On ambition, the article’s author, Bill Powell, returns to a theme often sounded by Tom Friedman which I would summarize as how much you can accomplish when you’ve got an authoritarian government.

On education, the United States spends more on it than any country in the world, more per student, and more as a percentage of GDP than France, the United Kingdom, or China. Whether the money is well spent is another question entirely. We misspend. It is the American way.

However, when you’re a country of more than a billion people you’re bound to have a lot of smart, talented people and the Chinese authorities see the future of a lot of those smart, talented people being in science and engineering so they’re emphasizing it. In the United States opportunities in science and engineering are doubtful, Americans are savvy readers of the market, and, consequently, American students aren’t pursuing science and engineering (except in healthcare where there is clearly a future).

However, China’s elite don’t represent the whole story. China has millions and millions of people who are illiterate and are likely to stay that way, perhaps 30% of the population or more (there are some claims that the rate of illiteracy in China is much, much higher). How should we learn from the Chinese on education? Should we abandon universal education?

Look after the elderly! Forsooth. China has no national system of social insurance. In China looking after the elderly means in the family. Were we to emulate China in this we’d abolish Social Security and Medicare outright. Note: I don’t advocate this. I think that properly constructed social insurance and subsidizing healthcare for the elderly is freedom-enhancing. Needless to say what we’ve got now is not properly constructed.

And that’s intimately related to why the Chinese save. The Chinese save because they’re afraid of the future and because they have little choice. Were we to heed the lesson of the Chinese in this we’d reduce our social safety net rather than extend it.

I do think that there are lessons we should learn from China and many of them are object lessons. China is a great country with great people hobbled by cultural baggage and a corrupt, evil, authoritarian government whose oligarchs hoard the bulk of China’s wealth for themselves and their families. The notion that China is to be emulated is nuts.

While I share Michael Tomasky’s disdain for people carrying signs about “the blood of tyrants” while protesting democratically elected leaders, he goes too far here:

There was an election. One guy one, another guy lost. It wasn’t disputed. It wasn’t decided by an ideologically divided Supreme Court, which gave the win to the guy who won fewer votes. This election wasn’t even particularly close. It means that the side that won is entitled to try to pass its agenda. But the protesters don’t respect the result of the election.

To be sure, there are people, like the Birther conspiracists, who don’t in fact respect the result of the election.  But so what?  So long as they don’t actually engage in criminal conduct to express that disrespect, they’re entitled to be sore losers.

But winning an election doesn’t mean you get to do whatever you want for the term of your office.  Not in America’s system with it’s complicated checks and balances and divided government.  No, winning merely means you have better leverage on the wheels of power, not complete control.

George W. Bush was re-elected in 2004 by a comfortable margin and his party had control of both Houses of Congress.  Rather quickly, with the Katrina debacle and the emergence of a full-blown insurgency in Iraq, his administration got stuck in the mire.  His vaunted “political capital” was gone and he was unable to enact such things as the massive Social Security reforms on which he campaigned.

Beyond the practicalities of enacting public policy, the very idea of a “mandate” is rather silly.  Yes, Barack Obama won and yes, he was and is quite popular.  Yes, he campaigned on fixing health care and yes, fixing health care is popular.  But those who voted for Obama did so for a wide variety of reasons.  Similarly, those who like Obama and who want to “fix” health care may nonetheless disagree, vehemently even, with the particular set of fixes that are being bandied about.  Surely, they’re entitled to let that be known?

Just as surely, those who lost the last election are entitled to try to rally the troops and persuade independents to give them another chance.  That’s the essence of free speech.

Ezra Klein and Steve Benen are recirculating this somewhat interesting chart on political polarization in America by political scientists Nolan McCarty, Keith T. Poole, and Howard Rosenthal.

Ezra argues that “this level of polarization makes it virtually impossible to govern in a system that is designed to foil majorities and require a constant three-fifths consensus. It’s not good if the country is virtually impossible to govern.”  Steve says this is especially true when, pace Harold Meyerson, the opposition party “is dominated by Southern neo-Dixiecrats.”

Given this situation, Ezra observes, “Problems don’t stop mounting while we try and figure things out. We could respond to this by making it easier for the majority party to govern and thus less likely that we have some sort of massive crisis that totally realigns our politics.”  He’s not talking about amending the Constitution but rather implementing unspecified rules changes in Congress that would strip power from the minority to get in the way.

Newt Gingrich made a bunch of changes in 1994. Democrats made a bunch of changes in 1975. John F. Kennedy made some big changes in the early 1960s. FDR changed the way Congress worked, and so too did Woodrow Wilson. This isn’t something invented by a bunch of bloggers in the early 21st century.

My recollection of both the Gingrich and post-Watergate reforms is that they were aimed at breaking down the power that came with seniority and to deal with public perception that Members were unduly influenced by outside interests rather than the ability of the opposition party to shape or block legislation.   And I’ve got no idea whatever of what Kennedy did to reform Congress; indeed, I’m not sure how he would have done that from the White House. In the cases of FDR and Wilson, they simply seized power for the presidency during extreme national crises with the acquiescence of Congress.

Regardless, as Thomas Mann and Norman Ornstein document, there have been numerous and nearly-continuous efforts to reform Congressional rules over the years.  And I’d be quite happy, for example, to do away with or seriously limit the use of the filibuster, secret holds, and various other measures which make it easy for the minority to block even relatively minor legislation.  Those are extra-constitutional at best and are not supposed to be used routinely as they now are.

At the same time, however, I disagree with the underlying premise of Ezra and Steve’s complaint.  The fact that we’re more polarized on politics as a nation than we have been in decades, by definition, means that there’s little national consensus.  That’s simply not a time for radical policy changes.  Ramming through unpopular programs in a very polarized nation is a recipe for more polarization.

George W. Bush was re-elected in 2004 along with Republican majorities in both Houses of Congress.  Among the signature programs he ran on was a radical overhaul of the Social Security retirement system that included a private option.   Once we got to the legislative phase, however, and the public saw the actual program rather than an abstract notion, it became decidedly less popular.  And the Democratic minority in Congress was able to block it.   We may well be on the road to the exact same thing happening on health care reform, with the public option failing to catch on for now.

That is how our system is supposed to work.  It’s precisely designed not to allow big change based on a small majority.

Furthermore, the Democrats have a reasonably comfortable margin in both the House and the Senate.  To the extent that they’re failing to get things done, it’s not because “Southern neo-Dixiecrats” in the minority party are using dastardly tricks to foil the popular will but because of fissures within the Democratic coalition.   Which, incidentally, the Republicans faced, too, back when they had the majority.

The nature of putting together a governing coalition in a politically polarized country is that getting over the top requires winning seats in states and districts that are either closely divided or are usually won by the other party.  “Blue dog” Democrats are no more in line with the Progressive wing of their party than the Northeastern Republicans of yore were with the Southern Conservative wing of theirs.

Alex Massie argues that the current inability of the Democrats to pass meaningful health care reform, one of their signature issues, despite overwhelming control of the government shows the system is broken.

It’s more difficult than it was in LBJ’s day, mind you. All the horse-trading that once went on in private now takes place in a world of Twitter and blogs and email and 24/7 news and a permanent campaign that is exhausting to follow, never mind survive. Everything is judged prematurely, nothing has time to settle and there’s very little opportunity for proper contemplation.

[...]

Of course, that broken system is very useful when the other party is in power. Democrats didn’t mind that the system helped defeat George W Bush’s social security reforms. Now, however, the boot is on the other foot. And it’s fair to say that plenty of smart liberal commentators are feeling pretty bad about it.

[...]

Congress, of course, is massively unpopular regardless of which party controls it. The public wants Congress to do stuff but also wants Congress to frustrate the bad or scary ideas the other mob propose. That’s a recipe for confusion and, in the end, legislative constipation. It’s like trying to brake and accelerate simultaneously.

There’s an argument to be made, then, that the United States is currently in the midst of an experiment that will go some way towards demonstrating the limits of liberal democracy. Or, to put it another way, how scaleable is democracy? And how scaleable is it in a country as diverse and disputational as the United States? Can you actually govern a country of 300m people effectively while also operating within the framework of enlightenment thought?

His solution: Send it to the states.

If everyone gets to supply ingredients for a cake baked by Congress it’s hardly a surprise that the end result is indigestible. Fewer ingredients and more, but smaller, cakes might produce a better result. National legislation, almost by definition, must ignore local tastes and preferences. Nor, in a country as vast as the US, does national legislation necessarily offer efficiencies of scale that outweigh their drawbacks.

It makes a lot of sense.  Indeed, the bluest states, the ones that want it most, would presumably pass some sort of state-run or state-option system rather quickly whilst the reddest states would remain holdouts.  Everyone, excepting perhaps blues living in red states and vice versa, would be happy.

Patrick Ruffini has used considerably fewer than 140 characters to make an interesting point: “Obama Health Care = Bush Social Security.”

The analogy is a strong one.

You will recall that President George W. Bush, fresh off re-election in 2004 pledged to use his “political capital” to pass a major reform of the Social Security system that included a private option.  Despite having a Republican majority in both Houses of Congress, the deal fell apart owing to united opposition from the Democrats and division among the Republicans.

Fast forward four years and we seem to be having a re-run.  Fresh off a historic election, President Obama pledged a massive reform of the health care system that included a public option.  Despite having a Democratic majority in both Houses of Congress, the deal seems to be falling apart owing to united opposition from the Republicans and division among the Democrats.

Rick Moran argues that “Obamacare” is floundering because Obama is taking his leadership cues from Jimmy Carter.

This president apparently doesn’t know how to govern. He has handed responsibility for getting this bill passed to Pelosi and Reid while he stands on the sidelines kibitzing.

Bottom line: No one is in charge. Committee chairmen have their own ideas about what should be in the bill while Blue Dogs and liberals are rejecting their formulations and want to substitute massively.

Then again, Bush had a plan and allowed himself to be the target of public criticism and still failed miserably.  It may simply be that massive reform efforts are ridiculously hard, especially once there’s an actual bill to shoot at.  There may be mass agreement in theory that we need to Do Something about the problem but there’s much less consensus on What To Do about said problem.  Republicans are mostly against the effort, both for ideological reasons and because killing Obamacare would seriously wound Obama politically.  Democrats, meanwhile, are going to either be disappointed that the bill doesn’t go far enough or think it goes to far.

Kevin Drum patiently explains to the folks at Townhall and NRO that holding a three day convention in a central location for $1071 a person is far from a boondoogle.

That’s unbelievable.  SSA must have some world class penny-pinching accountants and event planners on their staff.  I doubt there’s a corporation in America that would even try to budget less than two grand a head for something like this.

Considering that said figure includes transportation, meals, entertainment, and whatnot, it is indeed quite the bargain.

One wonders, however, whether the taxpayer got $750,000 worth of value added out of the convention.  What sort of “organizational training” do Social Security Administration managers need that involves dancing, skits, and casino gambling?

This isn’t an anti-government rant, per se.  This sort of thing happens in the private sector all the time and, as already noted, at higher cost.  I’m just generally dubious of retreats, conventions, and the like as productive enterprises.

Photo by Flickr user platinum under Creative Commons license.

Since well before I thought the matter one for serious consideration, Andrew Sullivan has been making insightful, compelling arguments in favor of same-sex marriage.  This, alas, is not one of them.

A reader makes an excellent point:

One thing that struck me about the DOJ’s argument that DOMA does not violate the equal protection clause since homosexuals are still able to marry people of the opposite sex, is that this ignores the existence of same-sex marriage on the state level. If two women get married in Iowa, they can no longer enter into opposite-sex marriages, even though they still don’t have federal recognition.So right now, there exist a specific class of people (those who are married to a person of the same sex) who are totally excluded from federal marriage benefits.

Yes. That would be me and my husband. And we may be forced to separate as a result.

So . . . absent the right to marry the man he loves, Andrew would marry a chick in order to get “federal marriage benefits”?  Really?  What benefits are those, exactly?  The right to pass on half his Social Security check some decades hence to some random woman he’s not in love with?

Why would he want to do that?

The only other benefits that come to mind for someone who isn’t a military retiree, disabled veteran, or the like — which Andrew isn’t — are the right to leave property without a will and deathbed hospital visitation.  The first of those is a matter for the states and the second a matter of hospital policy; both are easily remedied.  But even if we grant artistic license here, I’m not sure what a sham marriage to an unspecified woman would accomplish.  I suppose having someone visit you in the hospital is better than no one; but it’s hardly the same as having your life’s partner there.

And this has them seriously considering abandoning their marriage?

Being unable to form a legal union with the person you love and/or being denied the benefits that traditional marriages convey is a legitimate gripe.  I’m not sure, however, that the fact that being legally married — with all attendant benefits — to that person  in one’s state denies one the right to also be married to someone one doesn’t wish to marry is a substantial additional burden.

Photo: Australian News and Information Bureau

Mohamed El-Erian points out that there are good reasons for Bernanke to be worried about the future with regards to fiscal policy.

Mr Bernanke acknowledges that, despite the ”green shoots”, there are still question mark over which components of demand will kick into gear once the cyclical inventory pick-up runs its course, as it will inevitably do so over the next few months. Indeed, the chairman notes that ”businesses remain very cautious and continue to reduce their workforces and capital investments.”

Concerns about a sustainable recovery are not limited to the dynamics of the immediate cyclical recovery. Mr Bernanke also notes that ”even after a recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilisation will increase further.”

Yet he stops short of addressing what, increasingly, will be on many people’s minds going forward. Specifically, the longer-term question goes well beyond the notion of a prolonged period of below-potential growth. The level of potential growth itself is likely to decline. Indeed, this is a central element of what we, at Pimco, call the ”new normal”.

The “New Normal” refers to lower potential growth due to constraints from the increased national debt.

When it comes to fiscal issues, the chairman is not timid about worrying about longer-term questions – and rightly so. He is explicit about the need for greater clarity on how fiscal sustainability will be restored after this period of emergency policy actions.

Mr Bernanke states that ”even as we take steps to address the recession and threats to financial stability, maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance. Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby-boom generation and continued increases in medical costs.”

He does not stop here. He goes on to warn that ”near-term challenges must not be allowed to hinder timely consideration of the steps needed to address fiscal imbalances. Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth.”

Almost all projections show the U.S. national debt doubling by 2019 and that the outlook in terms of deficits goes from declining as a percentage of GDP to increasing after 2013. Significant parts of the problem are the fiscal imbalances caused by Social Security and Medicare with Medicare being the much larger contributor. And there is nothing even hinting at how these issues will be handled. The claim that President Obama is going to reduce the deficit by half by the end of his first term is offset by the worsening fiscal projections after that.

The chairman’s challenges on this count are neither easy nor amenable to quick solutions. Moreover, as markets increasingly look into the underlying factors, as inevitably they will, they will recognise the difficulty that the government faces in credibly committing to the needed primary fiscal adjustment in the absence of high economic growth.

The bottom line is that we should come away from Mr Bernanke’s testimony with at least two conclusions: the chairman seems more cautious about the growth outlook when compared with other recent public statements; and he wants to push fiscal sustainability issues clearly away from the Fed’s domain and back where they belong, with Congress and the administration.

Indeed, there is little the Fed Chairman can do regarding the fiscal situation. If the Congress and the Administration do not step up and start to show some signs of moving towards a sustainable fiscal policy economic growth could be considerably lower for quite some time.

Tyler Cowen has three health care fallacies and the first one is something I’ve mentioned before (and tooke quite a bit of heat for),

Today’s report is this:

The financial outlook for Medicare and Social Security has significantly worsened, as the bad economy and mounting job losses have pushed both programs years closer to insolvency, according to a grim report issued Tuesday by the Obama administration.

Maybe you once argued that “Social Security is fine,” but dollars are fungible and the budget must be judged as a whole. The consumption tax is coming, I am sorry to say.

In other words, we can’t simply ignore Social Security in trying to get a handle on the long term fiscal imbalances facing the country. While in isolation Social Security might be “fine” and need only some minor adjustments, the entire budget is looking rather bleak. So, taking Social Security off the table might make the problem intractable.

I also like this part as well,

I’m seeing nascent signs of a new (but actually old) fallacy, namely that since health care costs can (will?) crush the budget, we don’t have to worry so much about other expenditures. The mental story runs something like this: “if we don’t cure health care cost inflation, it doesn’t matter; if we do cure health care cost inflation, we can afford it.” That’s exactly the kind of false mental framing that behavioral economics identifies as irrational in other settings.

Pascal-Emmanuel Gobry has a brilliant idea for saving Social Security: Make people work forever!

Old age is a period of long, gradual, inevitable decay, but I think it is self-evident that the more active you are, the more these effects are postponed and mitigated. I don’t have many statistics to quote on this but I think it’s out there and this is one of the cases where anecdotal evidence convinces me. I think we all know at least one elderly person whom, once settled into retirement, has gradually but markedly become less alert, in the broadest meaning of the word. Any doctor will tell you that the best way to postpone the effects of aging is to remain active.

[...]

Old premise: work sucks, and after decades of toil, one has “earned the right” to get paid to do nothing. New premise: work is self-defined, self-led and empowering. Small-scale and global-reach entrepreneurship is a reality and this will make work a joy rather than a painful necessity.

Old premise: most work out there is physically taxing, shortens our lifespans, and can’t be performed well after a certain age. New premise: most work out there is/will increasingly be intellectually engaging, will lengthen our lifespans, and can be performed on a part-time and/or at-home basis.

Gobry doesn’t advocate forcing people to work, simply changing the expectation. He figures that people will take frequent sabbaticals and choose more flexible schedules later in life.

This is all sensible, really, for people who remain healthy and whose jobs require no activity more physically stressful than hammering out an email, clearing a jammed copier, or lugging a mug of coffee back from the break room.   I don’t envision myself ever quitting work; even if I won the lottery or otherwise became independently wealthy, I’d still want to engage myself in mental challenges.

Then again, I’m not a coal miner or construction worker or house mover.   Not to be too terribly condescending, but I’m guessing those people get far less empowerment and joy out of their jobs than your average public intellectual or  graduate of France’s top law school currently enrolled in France’s top business school. Further, while my technology crystal ball is cloudy, I’m guessing those jobs won’t allow telecommuting.

It seems to me that we need to figure out a way to ensure that people who work physically demanding, psychically unrewarding jobs are taken care of in old age without creating perverse incentives for the rest of us to quit work a decade too soon.

Photo by Flickr user 1Sock under Creative Commons license.

Ari Fleischer’s WSJ column “It’s Bad for Our Democracy to Exempt Half the Country From Income Taxes” is attracting widespread commentary, mostly along predictable party lines.

While I agree with the basic premises (see, for example, “Class Warfare: Framing the Debate“) I am rather dubious of his actual programmatic prescription:

I favor the abolition of all Social Security, Medicare and estate taxes. In their place, we should create a simple income tax system that has no deductions or credits at all. The result would be a progressive, multitiered income tax in which everyone pays.

Abolishing the separate Social Security and Medicare taxes probably makes sense. He’s right: the idea that these are set-asides rather than simply paid out of general revenues is a fiction.

But, surely, we don’t actually want to have everyone pay taxes based on gross income with “no deductions or credits at all“?

That would be devastating, indeed, for those of us who declare income as sole proprietors of businesses.  While there’s room for quibbling on implementation, it’s almost unfathomable to tax “income” that is paid out for legitimate business expenses.  For many, this would quite literally leave them owing more in tax than they earned.

Amity Shlaes tells NPR’s Kai Ryssdal that the current tax system reverses the problem that the founders faced.

Taxation without representation. That’s what our nation’s founders rebelled against. Subjects in the colonies were sending money home to the crown without getting say in their own government. The course of U.S. history can be seen as progress by those who are taxed to get representation. Think of women with the 19th Amendment.

Along the way we began to pay out money to groups that paid no income tax at all. There’s Medicare, of course, for senior citizens, even if they never worked; welfare for the poor and struggling, at least through the 90s. And, more recently, there’s the earned income tax credit, a break for low income workers. The credit was designed to make people want to work and to offset their heavy pension payments for Social Security. The result of expanding it, however, is that many people who work don’t pay income tax. Instead, they get money back.

Do we want to help weaker citizens, especially in downturns? Totally. In fact, both parties have plans that relieve yet more taxpayers of their burden. Republicans like payroll tax holidays. And the Obama administration is zeroing out the income tax obligations of yet more citizens.

But a tipping point does come when too many are paying out and too few are paying in. Maybe that tipping point is now. Today, households in the bottom half of earners pay only 4 percent of the income taxes. One tiny group, the top 1 percent, pays close to 40 percent.

There’s an argument to be made here but, sadly, Shlaes doesn’t make it well aside from the catchy turn of phrase.    It makes no sense to talk about the percentage of taxes paid by various income brackets without comparing their relative earnings.   And it’s unfair to talk about the tax burden while excluding the taxes that hit lower income folks hardest, like the payroll tax and sales taxes.

The better argument for ensuring that everyone pays their fair share of taxes is one that predates the founding of the United States, namely that of stake-in-society.  Essentially, what we now term skin in the game.  Everyone who gets the right to vote should have some measure of the burdens of society, including payment of taxes, service on juries, answering the call to arms during wartime, and so forth.  Under that principle, all adults living in the United States should pay some taxes to the federal government.

Everyone who buys things pays something to state and local governments because of sales taxes.  Everyone who draws a paycheck pays into the federal Social Security “trust fund,” of course, but that’s at least theoretically a retirement fund rather than a contribution to the general welfare.  Since we fund the federal government primarily through income taxes, we should ask even those of very modest income to pay something, even if it’s essentially a token amount.

In response to my last post on Social Security, Medicare and the medium to long term fiscal outlook for the U.S. Bernard Finel has another response. In this post Bernard looks at the deficits from 1950 to 2007 and writes, in part,

(Warning: Biiiiig Post Below the fold.)

And indeed, a shallow assessment of the federal budget supports Steve’s argument. After all, from 1950 to 2007, the budget was in deficit 50 times and only ran 9 surpluses.

[…]

So, at first glance, Verdon has a point. 85% of U.S. federal budgets since 1950 have been in deficit, and we are looking at addition deficits from 2008 to 2015 at a minimum. But is a “deficit” the best measure of an improvement or decline in the fiscal position of the nation?

I can’t help but feel that this response is to my comment in this post replying to something Bernard wrote. Bernard wrote,

But, even in the worst case scenario, Social Security never runs a deficit of worse that 2% of GDP in any given year even out 75 years. In short, Social Security, by itself, won’t bankrupt the country. If the rest of the budget was in balance, even in the worst years, paying for the Social Security shortfall out through pure deficit spending would actually reduce our net debt burden over time due to normal economic growth.–emphasis added

I replied that I thought that was a wildly optimistic assumption since in looking at the last 50 to 60 years we see that most of the time our government runs a deficit. To this Bernard runs to the historical data and pronounces me silly since many of those deficits during that time frame were small. He is right that many of those deficits were small (as a ratio of GDP and in some cases even in absolute terms). However Bernard has made an implicit assumption: that the next 20 years or so will, from a budgetary stand point, look like the 1950s and 1960s.

I think this is an overly optimistic assumption. Why? Because we are going into a very bad recession which even absent stimulus spending is going to drive up our deficits and debts. For example, not too long ago I linked to this article by Carmen Reinhard and Kenneth Rogoff that talks specifically about recessions that arise due to financial crises. One thing Reinhard and Rogoff note is the following,

Perhaps the most stunning message from crisis history is the simply staggering rise in government debt most countries experience. Central government debt tends to rise over 85% in real terms during the first three years after a banking crisis. This would mean another $8 trillion or $9 trillion in the case of the U.S.

In other words, Bernard’s look at the historical data is largely irrelevant. I should point out that I do forecasting as my day job. The kind of analysis that Bernard does isn’t bad, but it is rudimentary to the stuff I do. And yes, I rely on historical data. However, there are times when I and those I work with know that the historical data are not going to provide a good indicator of what the future will be. Here is an example from my work. A rate option open to customers is now closed. Existing customers can remain on the rate, but if they move they lose the option and new customers cannot get the option either. Prior to this change the number of customers on this rate option was rising at a steady pace of say 20 to 30 thousand a year. Should we expect this trend to hold given the historical data and more importantly what we know about the rate schedule being closed? Absolutely not. We’d expect a slow decay in the number of customers on that rate option. So I can’t just look at the historical data and use that as a guide as to what to expect from the future.

We have good reason to believe that the financial crisis and the recession are going to cause large deficits for a number of years and come close to doubling our national debt. And to be frank, I think I’m going to go with the Harvard and University of Maryland professors who have made it a significant part of their life to study this topic than with the expert in international security issues.

Further more, as Bernard has agreed, we have a serious problem with the growth rate of health care costs. Health care costs are growing at a rate that is 2 to 2.5 percentage points higher than GDP. To be clear on this, if GDP grows at 2% health care costs will grow at 4% to 4.5%. Clearly this is unsustainable. Further, the revenues for the entire budget are likely to grow at the rate of GDP, in other words we will eventually have far more in commitments than we do resources. So this too will result in a budget/deficit/debt situation that is not like the 1950s and the 1960s.

In short, Bernard’s appeal to the historical data is based on a faulty recollection of why I brought up the issue of the high frequency of deficits in the past—i.e. it was to show that politicians often do not have the stomach to be fiscally restrained and in fact, one could argue that the opposite is true, that politicians have an incentive to fiscally irresponsible. Further, taking into consideration where we are today, it does not seem like the 1950s and 1960s are going to be even a remotely close proxy to our fiscal situation for the next 20 years.

So when I consider the above I see a serious problem in the not too distant future. The U.S. is or has borrowed and will likely increase borrowing to such an extent that investors in U.S. government debt may become worried about the ability to repay that debt. After all what do you do if a sovereign nation declares that it isn’t going to pay on its debt obligations in one form or another? Invade? Send a collection agency after them? Sure it would be bad for the country that does this, but it would also be bad for holders of that country’s debt. So if this happens the U.S. might have to offer debt at a higher interest rate. What is the implication of this? Well all investment projects that are no lower than the new higher interest rate for government debt will be crowded out. In other words, investment goes down. Investment is really what drives growth in the future. You spend money now so you can have even more in the future. With less investment today we’ll have lower growth in the future. And this is one of Bernard’s key assumptions: that growth in the future will be like it was in the past.

[Aside: Does anyone get the impression Bernard is stuck in the 1950s and 1960s?]

But if one looks carefully at the rate of growth in GDP one will notice that it has been steadily declining. Not a lot, but it is there in the data. Basically the peaks of the business cycle have become less high. The business cycle has flattened out to some extent. One can argue about why, but the empirical finding is that this is case. So when Bernard calls assuming GDP growth is 2% on average for the next 50 years is mind bogglingly pessimistic, to one who has been reading the literature on this (that would be me) it isn’t so pessimistic. It appears to be the case.

[Technical Note: For example, if one were to download the percentage change in GDP from the NIPA tables at the BEA and include a trend variable as well as a recession dummy variable the resulting regression explains about 31% of the variation observed in the data and the trend and recession dummy are both statistically significant and negative. In other words, economic growth rates are declining, and no it isn’t just a function of the low GDP numbers from recent data.]

We can see this in the data in the following graph:

And this brings up another curious point that Bernard uses to support his claim that there is no reason to even consider making changes to Social Security. He argues it is quite sustainable by itself as is.

And the elderly population is slated to grow by about 2% a year from now until, I believe, something like 2045. (I will post full details shortly.) It varies from year to year of course, but the average increase is 2%. So… if you assume that the economy grows at 2% per year, then then social security should cost about what it does now.

In other words, if GDP increases by 2% and the elderly population increases by 2% then what’s the big deal? Everybody else out there working will just have to make do from now until 2045 with no additional shares of the increased GDP. Lets not worry about the implications of short terms losses in GDP (by short term think the next several years of below potential growth) and with Medicare eating up a larger and larger portion of GDP. And the significant portion of the budget is going to have to go towards servicing the debt.

And finally we have this rather smug condescension,

With all due respect… I don’t think you fully understand how the CBO does projections.

But look… can we use common sense here? The CBO projection for Medicare and Medicaid is that it will eat up something like 16% of GDP. Right now, Medicare and Medicaid represent 1/3 of U.S. health care spending — the rest is private sector. Keep the ratios the same. Do you really think it is even possible for nearly 50% of GDP to be devoted to health care. Even if we do nothing about it… how is that possible? Yet, that is what the CBO projects will happen.

I’ve already noted that such trends as the CBO and other have noted for our fiscal outlook likely wont reach the point Bernard has noted above. In fact, it was in the post Bernard is replying too. I wrote a hypothetical example to show the problem with exponential growth rates that are out of synch,

However, there is a second cause. Health care costs have been rising at an unsustainable rate. Here is a simple exercise to show the problem. Suppose today you are spending $1 on health care and that you have $2 in income. Further you income grows at 3% per year and health care expenditures grow at 5% per year. How long until you can no longer afford health care? At about the 37 year mark your expenditures on health care is just about equal to your income. In short you’ll have no more money for food, housing, transportation, and entertainment. Clearly that is not sustainable. In reality, something would “give” well before you got to that point.

And it isn’t just me that Bernard is insulting here with his views, but all the economists at the CBO, the Urban Institute, the Brookings Institute, the Heritage Foundation and in various universities and such around the country. You see, there is a fairly broad agreement that our fiscal outlook is not good that spans the political spectrum. Where you get most of the disagreement is on how to deal with it. I have little doubt that most of the economists working on this are quite aware that things would likely not get to the point where 50% of our GDP goes towards health care let alone 100%. However, if you have a situation where if things were to hold on course and in say 45 years 100% of GDP would have to go towards some specific part of the economy…it really underscores that something is off the rails, no? What Bernard is asking for is what will happen in an economy where you have one sector using up GDP at a rate of 4% while GDP grows at 2%. Unfortunately that is a far, far more difficult question to answer than merely making some reasonable assumptions about certain parameters in a model and then projecting the outcome out 75 years. Such models would have to have all sorts of dynamic interaction effects which Bernard scorns as “being down in the weeds“. Yes, the interanational security expert is going to tell experts in an completely different field where they are doing it wrong.

To sum up, Bernard is using historical data that is unlikely to be a good indicator of the next 2 or more decades of in terms of economic growth and what the budgetary situation will look like. Further, he is ignoring the work of experts in the area of financial crises and the recessions that follow.