Tag: Social Security

Another Tax-Hike Scheme from Another ‘Bipartisan’ Group of Washington Insiders

I’ve already commented on the proposal from the Chairmen of President Obama’s Fiscal Commission (including a very clever cartoon, if it’s okay to pat myself on the back).

Now we have a similar proposal from the so-called Debt Reduction Task Force. Chaired by former Senator Pete Domenici and Clinton Administration Budget Director Alice Rivlin, the Task Force proposed a series of big tax increases to finance bigger government. I have five observations.

  1. Notwithstanding a claim of $2.68 trillion of “spending cuts” during the 2012-2020 period, government gets a lot bigger during the decade. All of the supposed “cuts” are measured against an artificial baseline that assumes bigger government. In other words, the report is completely misleading in that spending increases get portrayed as spending cuts simply because government could be growing even faster. Interestingly, nowhere in the report does it show what total spending is today and what it will be in 10 years, presumably because the authors realized that the fiction of spending cuts would be hard to maintain if people could see real-world numbers showing the actual size of government now and in the future.

    This chart shows what it would actually take to balance the budget over the next 10 years – and these numbers assume all of the tax cuts are made permanent and that the alternative minimum tax is extended.

  2. The Task Force proposes a value-added tax, which is estimated to generate more than $3 trillion between 2012 and 2020. They call this new tax a “debt reduction sales tax” and I can just imagine the members giggling as they came up with this term. They may think the American people are a bunch of yokels who will get tricked by this language, but one can only wonder why they think making our tax system more like those in Europe will lead to anything other than more spending and less growth.
  3. The Task Force proposes to dramatically increase the scope of the Social Security payroll tax. Since this is something Obama called for in the campaign and also something endorsed by the President’s Fiscal Commission, this proposed tax hike should be viewed as a real threat. I’ve explained elsewhere why this is bad tax policy, bad fiscal policy, bad entitlement policy, and bad Social Security policy.
  4. To add “stimulus” to the package, the Task Force proposes a one-year payroll tax holiday. The good news is that they didn’t call for more spending. The bad news is that temporary tax cuts have very little pro-growth impact, especially if a tax cut will only last for one year. Unfortunately, the Task Force relied on the Congressional Budget Office, which blindly claimed that this gimmicky proposal will create between 2.5 million-7.0 million jobs. But since these are the geniuses who recently argued that higher tax rates boost growth and also claimed that Obama’s faux stimulus created jobs, those numbers have very little credibility.
  5. While the Task Force’s recommendations are unpalatable and misleading, there is a meaningful distinction between this plan and the Obama Administration’s fiscal policy. The Task Force assumes that government should get even bigger than it is today, but the Obama Administration wants government to grow at a much faster rate. The Task Force endorses massive tax hikes, but generally tries to avoid marginal tax rate increases that have especially large negative supply-side consequences. The Obama White House, by contrast, is fixated on a class-warfare approach to fiscal policy. One way of characterizing the different approaches is that the Task Force represents the responsible left while the Obama Administration represents the ideological left.

Debt Commission Reform Proposals – What Are Their Chances?

It’s kudos to President Obama’s Debt Commission co-chairs for clearly outlining the gargantuan size of the fiscal problem facing the United States.  The reforms will re-direct the exploding debt trajectory downward by reforming taxes and cutting spending – reminiscent of recent fiscal reforms in the United Kingdom. Unfortunately, history is likely to repeat itself: Even if they are enacted soon – which seems unlikely – chances are bleak that we’ll stick with them for long enough to achieve their stated goals.

The Debt Commission co-chairs have done a stellar job in framing the nation’s fiscal challenge and placing it squarely before the American public. The contrast between the current trajectory that increases the national debt beyond 80 percent of GDP by 2040 and one of declining debt under their reforms likely to be consistent with long-term economic growth because the Commission also proposes limiting government spending to 21 percent of GDP – is striking.

The Commission has marked wide-ranging reforms – to broaden the federal tax base, reduce income tax rates and simplify the tax system; cut discretionary expenditures that are unaffordable and antiquated in all spheres; reduce long-term health care cost growth, and restore Social Security to financial solvency through a combination of benefit cuts and revenue measures.

It’s sad but true that the political barriers stacked up against this promising approach appear to be insurmountable.  Given the make-up of Congress and with Obama as President, the chance that something even remotely resembling the Commission’s proposals would be enacted is negligibly small.  With the Democratic majority in the Senate, President Obama is unlikely to even have to use his veto.

But what if my conjecture is proved incorrect and a roughly similar set of reforms is enacted in 2011?  Remember that our fiscal problem is of a long-term nature.  It is produced by an aging population; rapid health care cost growth; slower revenues from a flagging economy as a large cohort of experienced workers retires; slowing education and skill acquisition by younger workers; and slower capital formation as more resources are consumed by an aging population.  The commission’s reforms have to be enacted and maintained for at least 30 years to deliver its “target” debt-to-GDP ratio of 40 percent.  History tells us that such an outcome is quite unlikely.  For example, the Budget Enforcement Act of 1990 – that helped President Clinton accumulate his now much touted laurel as a fiscal conservative – was maintained for just 12 years – until Congressional Budget Office projections revealed “budget surpluses as far as the eye could see” in 2002.  With those projections in hand, lawmakers raced to the exits: the BEA was abandoned and federal spending shot through the roof.  Even as conservative a policy maven as Alan Greenspan shone a green light to adopt budget busting tax cuts.

To improve the chances that history does not repeat itself, the commission’s proposals need to be combined with proposals to reform the budget process.  The first thing to consider on that score is to use better budget measures to assess if reforms are achieving their goals. Stating those goals in terms of the national debt and annual cash flow deficits is unlikely to work – just as those measures have not worked for the European Union in the context of their now defunct Stability and Growth Pact.

Federal debt and the current budget deficit that is reported on the government’s books is the result of past policies and outcomes.  They summarize where we came from, not where we’re going.  If the commission’s reforms are enacted, a better method would be to anchor judgment about their success on the size of prospective debt—the value in today’s dollars of all future deficits that the federal government would incur under the new policies; alternatively under premature abandonment of those policies – as happened in 2002 when the BEA was abandoned.  It is also important to know whether the sacrifices that the commission’s policies require from today’s generations are fairly distributed and are being invested for the future rather than being dissipated.  For example, will the Social Security surpluses that the reforms generate be effectively saved and invested, or would they promote additional government spending as in the past? Without a budget process that delivers real investments for the future, and without metrics to measure their operation properly, chances are that even if Congress and the President enact them into law next year, the reforms will be abandoned too soon.

Obama’s Fiscal Commission: The Good and Bad

The co-chairs of President Obama’s National Commission on Fiscal Responsibility and Reform released a draft report yesterday on how to reduce federal budget deficits.

Despite the liberal savaging the report is taking as some sort of conservative plot, its proposals are really center-left in orientation. That said, there is some good stuff in the report, which will be useful for incoming Republicans looking to tackle the budget mess.

Good Ideas and Positive Directions

The report provides a menu of possible spending cuts for incoming Republican members of Congress to consider, particularly Tea Party members, who proposed to cut the budget during their campaigns.

The report proposes to reduce spending from 25 percent of GDP currently to 21 percent over the long run. That’s a good start, but we need to pursue deeper cuts, as discussed on www.downsizinggovernment.org. After all, federal spending was just 18 percent of GDP in President Clinton’s last two years in office.

I like that the report suggests a broad array of budget cuts, including defense, nondefense, and entitlement programs. Everything needs to be cut, including programs traditionally defended by both liberals and conservatives.

The report proposes to cut $200 billion from discretionary spending by 2015 from Obama’s proposed spending that year of $1,309 billion. That’s a 15 percent cut. However, the word “cut” needs to be qualified because discretionary outlays were $1,041 billion in the pre-stimulus year of 2007, and they were just $615 billion in the pre-Bush year of 2000.

The report recommends an array of Medicare and Social Security cuts. That’s great, but the report doesn’t include the fundamental structural reforms—such as Social Security individual accounts and Medicare vouchers—that are needed to reduce costs and provide benefits to the broader economy, such as boosting savings and improving health care quality.

The direction of the proposed tax reforms is positive. The co-chairs propose to reduce or repeal narrow deductions and other special tax benefits, while reducing marginal tax rates. The idea to treat capital gains and dividends as ordinary income, however, reveals a faulty understanding of the proper tax treatment of capital.

The report proposes to cut the corporate tax rate from 35 percent to 26 percent, while moving to territorial treatment for foreign investment. It suggests making “America the best place to start and run a business and create jobs.” That’s a laudable goal, but to fulfill it we need to bring the rate down to, say, 15 percent.

The report’s goal of reducing the damaging buildup of federal debt is laudable. Government overspending is the nation’s primary fiscal problem, but spending financed by debt creates an array of problems that are additionally troubling.

Bad Ideas and Shortcomings

The report proposes to raise taxes by $1 trillion over the next decade. But the federal budget crisis is caused by overspending not undertaxing. The election results showed that most Americans understand that, but the message hasn’t penetrated the beltway yet.

The report’s discretionary spending cuts are timid. For example, farm subsidies are cut by just $3 billion, just a fraction of their annual cost of about $20 billion. Farm prices and farm incomes are at high levels these days, so now would be a good time to repeal farm subsidies completely.

The report characterizes tax deductions and exemptions as “spending in the tax code.” That is becoming common parlance in Washington, but it is incorrect. Yes, the mortgage interest deduction and other narrow benefits distort the economy and ought to be abolished, but they also reduce the flow of revenues to Washington, which is a good thing.

The report makes faulty and naïve arguments often heard from centrists about government “investments.” While we need to cut spending, we also need to “invest in education, infrastructure, and high-value R&D” the report says. But why does the federal government need to be involved in education? Why can’t we privatize infrastructure investment? If certain R&D is so “high-value,” wouldn’t the private sector do it?

Along the same lines, the report calls for the creation of a “Cut-and-Invest Committee” to move spending from “outdated” programs to “high-priority long-term investments.” That’s just naïve. The government will never be an efficient allocator of resources, and that’s why we need to shrink it, not just make it run better.

Finally, the commission should have placed more emphasis on fundamental restructuring of government, and not just spending trims. This is true with the entitlement proposals. But also with areas such as infrastructure spending—we don’t need higher gas taxes and government spending for infrastructure, we need privatization.

The Correct Perspective on Social Security Privatization

In today’s WSJ, William Shipman and Peter Ferrara have a column criticizing President Obama’s recent and vehement rejection of Social Security private accounts. I agree with Shipman and Ferrara — it’s rather shabby logic from a president of all Americans.

Shipman and Ferrara correctly note that Social Security privatization options provide participants with a choice — opt for private accounts or stay with the traditional system. In other words, people can choose their preferred risk set — political or market.  The lesson here is that there’s no avoiding risk.

Shipman and Ferrara suggest that all investments in private Social Security accounts do not have to be in stocks; people can choose bonds as well.  Better yet, they can hold the market basket of all stocks and bonds through low-cost index funds and hold some cash.  They can select the mix between these elements to optimize the risk-return trade-off given their abilities/preferences on the two. This investment strategy is transparent and easy to learn; it requires only a modicum of financial literacy.

However, I find their ”Joe the Plumber” example unpersuasive. Who cares if investing on the planet Mars yields 50 percent annual returns if we cannot do it unconditionally — that is, without incurring costs that would neutralize its higher-than-Social Security returns?  Those additional costs arise from having to borrow to pay existing Social Security beneficiaries their “promised” benefits, and from carrying market risks on personal account portfolios of Martian investments. 

Market risk represents a real cost, even if investments are for the long term.  The Shipman/Ferrara calculations take account of the recent financial crisis.  But they don’t take account of the potential for fat tails in the distribution of financial crises going forward.  The recent crisis could have been less severe.  But what if it had been more severe and had wiped out all savings for many more people?  Is there zero risk of such an outcome? A generalization on the basis of just one 40-year record of investment returns is inappropriate and insufficient for ruling out the importance of market risk.

In the authors’ defense, however, is the fact that the historical evidence of market returns is conditional on the existence of Social Security (and Medicare and the rest of the government’s panoply of welfare programs, regulations, etc.).  Without such broad and deep government interference in markets, the history of capital returns may have been different: returns may have been smaller (because the economy may have been better capitalized) but also more stable. And correlations between worker average wage growth and capital market returns may also have been smaller, yielding important diversification benefits from a privatized system of retirement saving.  But the bottom line is that we just don’t have adequate data of the correct type to make the “analytical” arguments that the authors attempt in their op-ed.  

Shipman and Ferrara (jointly and individually) have never explicated this latter argument clearly. They persist with their “higher-and-sexy-market-returns” argument in support of private Social Security accounts.  As such, I’m compelled to say that their argument continues to exhibit a real and serious deficiency.

On balance, however, when faced with two extremes — 1) political risk that the government will muck things up so badly that we and our children will suffer considerably reduced living standards, and 2) market risks that could devastate retirement savings because a recession/depression wipes out the value of lifetime savings — I would recommend an “interior solution” that straddles both worlds.  That is, continue a strictly limited government-run Social Security system and supplement it with a privatized element as many other countries have done, the UK and Australia being important examples. 

Some would say that we have such a system already, in the form of 401k, IRA and other tax-qualified saving plans. However, not all workers have access to 401k plans.  And the evidence is that despite those plans, national saving has declined considerably over the last three decades.  My analysis suggests that the reason for the decline in saving is the very existence of (supposedly) government-guaranteed Social Security (and Medicare) benefits that lull us into a false sense of security.  The key shortcoming is the lack of a system of universal Social Security personal accounts wherein a minimum amount of saving is mandatory (despite government mandates being bad in general). Such a system would provide a vehicle for the rich and the poor alike to partake of the wealth creation process that capital markets can and do provide. 

We’re not there today, and the correct direction from where we are is toward, not away, from Social Security personal accounts.

Topics:

Liberal Dogma on Social Security Redux

Liberal posturing on Social Security reform continues unabated – betraying nervousness that Obama’s Deficit Reduction Commission will recommend Social Security benefit cuts. 

Left-wing voices also continue to repeat the mantra that introducing private Social Security accounts would be a bad idea. Ronald Brownstein’s recent recent column in the National Journal is a case in point. However, Brownstein’s readers may come away thinking that he believes breaking promises is a good idea.

Brownstein concedes that “Social Security indeed faces a long-term imbalance between expected revenue and promised benefits.” I consider this to be progress — at least relative to the erstwhile “there’s nothing wrong and nothing to fix” mantra adopted by liberal adherents of the status quo on Social Security.

Notice Brownstein’s use of the term “promised benefits.”  A promise implies a commitment and obligation to make good on future benefit payments.  But the solution that Mr. Brownstein points to is as follows:

Instead [of private accounts], Obama argued, the two parties could emulate the Reagan model and arrive at a sensible solution… [T]he program’s long-term shortfall could be eliminated just by trimming benefits for the top half of earners [JG note: breaking the Social Security benefit promise here], linking the retirement age to lengthening life spans [JG note: breaking the promise here too], and imposing a partial payroll tax on earnings above $250,000 [JG note: that is, promise more benefits by expanding the definition of covered earnings and increasing payroll taxes on high earners].”

But all that the last element may achieve is to stave of the program’s insolvency for a few more years. 

My comment:  Please don’t drag Reagan into this “solution.”  The 1983 reforms were implemented under the gun, at a time when there was no way out of Social Security’s imminent revenue shortfall. If President Reagan had enjoyed the luxury of a couple more years to plan changes to Social Security, he would have adopted a different approach, and be much better off today. According to broad market indexes such as the S&P 500, total returns averaged well above 10 percent per year during the 1980s and 90s – so, well above inflation. (The first decade of the 2000s yielded a negative 1 percent return.)

Finally, Brownstein writes:

[T]he gap between the system’s revenues and obligations, relatively speaking, isn’t that daunting–less than 1 percent of the economy’s expected output over the next 75 years. 

Does Mr. Brownstein really appreciate how large that is? In present value terms, the Social Security actuaries report that the present value of Social Security’s shortfall over the next 75-years equals $5.4 trillion. That’s one-third of current annual GDP. In other words we have to devote that sum to earning interest each year for 75 years to cover Social Security’s financial gap.

Alternatively, since payrolls equal only one-half of national output, it means that payroll taxes would have to increase by an average of about 2.0 percent per year if they are levied over all wage earners.  However, the tax increase is to be levied only on those earning $250,000 or more.  There are about 3 million U.S. taxpayers with incomes above $250,000, with average income of about $500,000. (I’m rounding up based on information for 2006 available here.)  That makes a tax base of $1.5 trillion. (Actually, this is likely to be too large because I’m counting total income, not taxable income, which would be much smaller.) Raising the equivalent amount of revenues from these high earners (who face the highest marginal income tax rates already and are likely to alter their work effort in response to still higher taxes) would imply increasing their average tax rates by almost 11 percentage points. Of course, because some of the adjustment will be through benefit cuts and indexing the retirement age to increasing longevity, the tax increases that must be levied on high earners would be smaller. 

But are those benefit cuts politically realistic? Americans already face a normal retirement age of 66, and it is scheduled to increase to 67 in little more than a decade. Extrapolating from the French response to increasing their pensionable age from just 60 to 62, Americans’ would probably end up opening a third war front to resist further increases in Social Security’s retirement ages – a “generational war” here at home.

So where do we go from here?  One answer may be to first introduce “add-on” personal accounts using the 2.0 percentage points of payrolls – the amount required to plug Social Security’s current shortfall. This would not be a “tax” as the funds would be invested in personal accounts – and it would enable low earners an opportunity to partake in the long-term wealth creation mechanism that they have heretofore been unable to exploit.  As I have argued here, if this amount is effectively saved and invested – by insuring that the government does not borrow and spend those savings – it would create space for a “carve-out” addition to the “add on” personal accounts, increasing retirement wealth even more.  Finally, with the stock markets relatively stable and current P/E ratios of broad market indexes close to historical averages, now would be the right time to begin such a reform program for Social Security. 

Would liberal policymakers and analysts take on this approach?  No prizes for guessing the answer.

The Something-for-nothing Quandary

Most of the debate over extending the Bush tax cuts has focused on whether to extend slightly lower marginal rates for higher earners who already bear a huge burden. But at the other end of the income spectrum, a growing share of Americans don’t pay income taxes. Indeed, the Bush tax cuts increased the share of U.S. households that pay no income taxes.

From the Wall Street Journal:

Efforts to tame America’s ballooning budget deficit could soon confront a daunting reality: Nearly half of all Americans live in a household in which someone receives government benefits, more than at any time in history.

At the same time, the fraction of American households not paying federal income taxes has also grown—to an estimated 45% in 2010, from 39% five years ago, according to the Tax Policy Center, a nonpartisan research organization.

A little more than half don’t earn enough to be taxed; the rest take so many credits and deductions they don’t owe anything. Most still get hit with Medicare and Social Security payroll taxes, but 13% of all U.S. households pay neither federal income nor payroll taxes.

As the price of something drops, the demand increases. For a growing share of Americans, government services are effectively “free,” so they are demanding even more and policymakers are giving it to them.

As the following chart shows, federal payments to individuals as a share of the economy have reached an all-time high after seventy years of steady growth:

George Bernard Shaw said that “A government which robs Peter to pay Paul can always depend on the support of Paul.” In order to head off the coming fiscal train wreck, Paul is going to need to be convinced that robbing Peter is no longer in his best interests. However, by foisting a larger share of the burden of government onto a smaller and smaller group of taxpayers, policymakers will make it more and more difficult for Paul to see the error of his ways.

A Fannie Mae for Intrastructure?

Like President Bush before him, Obama has a knack for taking the worst ideas of his opponents and making them his own.  It is truly bipartisanship in the worst of ways (think Sarbanes-Oxley, the TARP or No Child Left Behind).  The newest example is the President’s proposed “infrastructure bank.”  A bill along those lines was introduced a few years ago by then Senator Hagel, although the idea is far from new.

First, let’s get out of the way the myth that we have been “under-funding” intrastructure.  Take the largest, and usually most popular, piece:  transportation.  Over the last decade, transportation spending at all levels of government has increased over 70 percent.  One can debate if that money has been spent wisely, but there’s no doubt we’ve been spending an ever-increasing amount on infrastructure - so there goes one rationale for an infrastructure bank.

The real rationale for an infrastructure bank is to transfer the risk of default away from investors, bankers and local/state governments onto the federal taxpayer, but to do so in such a manner that the taxpayer has no idea what they are on the hook for.

If there are truly great projects out there that will pay their own way, then they should have no trouble getting private funding.

Of course, we will be told that the bank will charge an interest rate sufficient to cover losses and that the taxpayer won’t be on the hook.  Again, if it is charging an appropriate rate, then why does the bank need to be chartered (and backed) by the taxpayer?  We’ve heard this story before…with Social Security, flood insurance, FHA, Fannie/Freddie…the list goes on, that all of these programs would pay their own way and never cost the taxpayer a dime.  If there are truly outstanding infrastructure needs, then appropriate the money and pay for them.  An infrastructure bank is just another way to allow Wall Street to line its pockets while leaving the risk with the taxpayer.  If bankers aren’t willing to actually take the risks, then why exactly do we need them?