Topic: Social Security

FYI Memo for Senator McConnell: Medicare Is Already Means-Tested

Speaking of the “fiscal cliff,” a November 11 Wall Street Journal interview of the Senate minority leader asked, “What kind of a deal would Mr. [Mitch] McConnell accept? The senator’s top priority is long-term entitlement reform. ‘Changing the eligibility for entitlements is the only thing that can possibly fix the country long term.’ He wants means-testing for programs like Medicare. ‘Warren Buffett’s always complaining about not paying enough in taxes,’ he says. ‘What really irritates me is I’m paying for his Medicare.’”

In reality, means-testing entitlements would be a nonsensical “top priority” in fiscal cliff negotiations because (1) the fiscal cliff is not about fixing long-term problems but about preventing rather than postponing an imminent $536 billion tax hike, and because (2) the U.S. already imposes means-testing for both Social Security and Medicare.

With Social Security, the ratio of benefits to “contributions” is lowest for those who paid the most payroll taxes for the most years and highest for those who paid the least.  Making matters much worse, up to 85 percent of benefits are now taxable for seniors who either saved for retirement or keep working, but tax-exempt for others.  That highly-progressive 1993 tax on benefits is another devious way of means-testing after-tax retirement benefits.

Thanks to new redistributionist rules from the Obama administration, monthly Medicare premiums now rise from $99.90 on single seniors with less than $85,000 in income to $229.70 (including drug coverage) at incomes from $107,000 to $160,000, and to $386.10 above $214,000.   Since President Clinton removed any ceiling on income subject to Medicare payroll tax, those who had relatively high salaries while working paid many thousands more in Medicare taxes than they can ever expect to receive in benefits – assuming they are foolish enough to sign up (as I did not) for benefits that also cost nearly four times as much as others pay.

The most money that Medicare might save by denying benefits to the “top 1 percent” would be roughly 1 percent.  That would leave 99 percent of Medicare spending untouched.  If high-income people were denied benefits, however, they would also be relieved of the steeply-progressive new Medicare premiums.  Medicare would then lose all that revenue they are now expecting to collect by charging much higher premiums at higher incomes.    The net effect of eliminating both benefits and premiums of high-income seniors offers no solution to the nation’s long-term fiscal problems.  It is certainly no solution to the very-near-term threat of a series of massive tax increases on January 1.

 

 

 

Major New Study about the Top 1 Percent… And Much More

This new Cato Institute Working Paper by Senior Fellow Alan Reynolds confirms recent studies which find little or no sustained increase in the inequality of disposable income for the U.S. population as a whole over the past 20 years, even though estimates of the top 1 percent’s share of pretax, pretransfer (market) income spiked upward in 1986-88, 1997-2000 and 2003-2007.

It has become commonplace  to use top 1 percent shares of market income as a shorthand measure of inequality, and as an argument for greater taxes on higher incomes and/or larger transfer payments to the bottom 90 percent.  This paper finds the data inappropriate for such purposes for several reasons:

  • Excluding rapidly increased transfer payments and employer-financed benefits from total income results in exaggerating the rise in the top 1 percent’s share between 1979 and 2010 by 23 percent because a growing share of other income is missing.
  • Using estimates of the top 1 percent’s share of pretax, pretransfer income (Piketty and Saez 2003) as an argument for higher tax rates on top incomes or larger transfer payments to others is illogical and contradictory because the data exclude taxes and transfers.
  • Using highly cyclical top 1 percent shares as a measure of overall inequality leads, paradoxically, to describing most recessions as a welcome reduction in inequality, because poverty and unemployment rates typically rise when the top 1 percent’s share falls, and fall when the top 1 percent’s share rises.
  • Top 1 percent incomes are shown to be extremely sensitive (“elastic”) to changes in the highest tax rates on ordinary income, capital gains and dividends.  Although estimates of the elasticity of ordinary income for the top 1 percent range from 0.62 (Saez 2004) to 1.99 (Moffitt and Wilhelm), those estimates fail to account for demonstrably dramatic responses to changes in the highest tax rate on capital gains and dividends.

Reynolds estimates that more than half of the increase in the top 1 percent’s share of pretax, pretransfer income since 1983, and all of the increase since 2000,  is attributable to behavioral reactions to lower marginal tax rates on salaries, unincorporated businesses, dividends and capital gains. After reviewing numerous data sources, he finds no compelling evidence of any large and sustained increase in the inequality of disposable income over the past two decades.

You Shouldn’t Have to Give Up Your Health Insurance When You Take Social Security

This blogpost and the amicus brief it references were co-authored by Trevor Burrus and Kathleen Hunker.

When Brian Hall, former House Majority Leader Dick Armey, and other over-65 retirees requested to opt out of Medicare’s hospital insurance coverage (because they preferred their existing private coverage), the Social Security Administration didn’t thank them for saving taxpayers’ money. Instead, the SSA explained that, because of a guideline in its “Program Operations Manual System”—essentially a manual that explains how to operate the Social Security system—anyone who declined Medicare benefits would lose Social Security.

That is, Hall and the others could disclaim their Medicare hospital insurance coverage, but only if they forfeited all of their future claims to Social Security and repaid whatever benefits they already had received — roughly $280,000 altogether. The plaintiffs challenged the linking of Social Security and Medicare as being beyond the SSA’s statutory authority. Neither the Social Security Act nor the Medicare Act allows administrative agencies to precondition benefits under one program on acceptance of benefits from other. Instead, the plain language of both statutes states that petitioners are “entitled” to benefits, which according to legal and general usage describes someone who is “legally qualified” and thus has the option of claiming benefits.

The district court disagreed and the U.S. Court of Appeals for the D.C. Circuit, in a split decision, affirmed the trial court’s result but declined to grant the POMS rules deference. The court then unanimously denied a petition for rehearing. Recognizing that the D.C. Circuit ruling, if left in place, could encourage future encroachments on congressional power by administrative agencies, Cato filed an amicus brief supporting Hall’s request that the Supreme Court take the case and enforce the statute as it was written.

We note that administrative agencies have no powers not granted to them by Congress and that regulations must be anchored in the operative statute—as well as the agency’s fair and considered judgment—in order to warrant judicial deference. The POMS regulation fails this standard because Congress’s use of the word “entitled” was clear and unambiguous. Combined with the fiscal irresponsibility of forcing citizens to accept costly benefits in an economic recession, the POMS rule appears to be an arbitrary power grab rather than a faithful effort to implement the will of Congress. We conclude by reminding the Court that agency overreach imperils the separation of powers and therefore liberty.

When Congress fails to counter an unauthorized expansion of power by an administrative agency, the judiciary has a duty to uphold the Constitution by enforcing the relevant statute as written.

The Supreme Court will decide later this fall whether to take the case of Hall v. Sebelius.

The Road to Ruin

I have often warned against the dangers associated with conventional wisdom. With the onset of the financial crisis and the corresponding plunge in asset prices, I noted that people who were wealthy or who were close to retirement were the ones getting clobbered. New evidence now confirms this: Americans nearing retirement took the biggest hit after the financial crisis.

The sad truth is that their road to ruin was, in many cases, paved by conventional wisdom about investing.

That wisdom had many believing that, over the long run, stocks produce the highest returns; that a diversified stock portfolio protects you against loss; and that the risk of owning stocks is small, if you hold them for a long time.

While the number of decades in which U.S. equities underperform other asset classes may be small, the size of the shortfalls, when they occur, can be huge. For those who are near retirement, the shortfalls can be devastating. As a recent study from the Pew Research Center shows, the plunge in asset prices that followed the financial crisis has resulted in “a lost decade of the middle class,” with the median real net worth in America now resting roughly where it was in 1983.

And if that’s not bad enough, those folks might not ever get a shot at making up the loss in their lifetimes. As Catherine Rampell’s recent reporting in the New York Times shows, median household income has fallen most sharply among 55–64 year olds, since June 2009.

Diversification is useful, in varying degrees, most of the time. But there are occasions when all stocks dive simultaneously, and in these cases a diversified stock portfolio won’t save you.

Beware of conventional economic wisdom. Some 95% of what you read in the financial press is either wrong or irrelevant.

Big Government Cripples Incentives to Save, Promotes Risky Culture of Immediate Gratification

America’s political elite is nauseating for many reasons, but perhaps most of all when they blame others for problems that are caused by misguided government policies. A stark example is the way they attacked the Facebook billionaire who moved to Singapore because of punitive taxation and class-warfare policy.

Today, let’s look at an example that affects almost everybody rather than just a handful of rich people. Many people in Washington sanctimoniously say that American households and businesses are too focused on the short term and that we don’t save enough.

But as I explain in this CBNC interview, tax and spending policies from Washington have undermined the incentive to save.

Allow me to elaborate on three of my examples.

1. Look at this post comparing the red ink from America’s bankrupt Social Security system with the huge levels of private savings generated by Australia’s system of personal retirement accounts.

Good politicians would respond by copying Australia and reforming Social Security. But good politicians are like unicorns.

2. Or look at this chart showing the extensive double taxation in our tax code, as well as these international comparisons of how America over-taxes dividends and capital gains.

Good politicians would respond by junking the tax code and adopting a flat tax, which has no double taxation of income that is saved and invested. But good politicians are like the Loch Ness Monster.

3. And consider the fact that the Obama Administration has just imposed a regulation that will discourage foreigners from depositing money in American banks, thus driving capital from the U.S. economy.

Good politicians would minimize the damage of anti-savings policies by keeping America a haven for foreign capital. But good politicians are like Bigfoot.

The moral of the story, just in case you haven’t picked up on the theme, is that bad things happen because politicians can’t resist expanding the burden of government when they should be doing the opposite. Which is why this poster is funny, but in a painful way.

P.S. I should have mentioned that some politicians think that we can boost savings by imposing a value-added tax! This is not only a perverse example of Mitchell’s law, but it’s also completely illogical.

A VAT does not change the incentive to save since current consumption and future consumption are equally taxed. But it does reduce the amount of money people have, thus reducing both private consumption and private savings.

Statists would argue that a new tax will reduce the budget deficit and thus reduce the amount of private savings that is being used to finance government debt. That’s only true, though, if you’re naive enough to think politicians won’t spend the new revenue. Good luck with that.

Note to Larry Summers: The Government Borrows for Transfer Payments, Not Investment

“It is time for governments to borrow more money,” according to former treasury secretary Larry Summers.  He is not peddling this advice to Greece and Spain, but to countries like the United States and Japan that can still sell long-term bonds at very low interest rates. Summers urges the United States, in particular, to borrow more for “public investment projects” that are presumed to raise the economy’s future output. He offers the hypothetical example of “a $1 project that yielded even a permanent 4 cents a year in real terms increment to GDP by expanding the economy’s capacity or its ability to innovate.”

Even if such promising projects were easy to find, however, that is not the way the current government has been inclined to spend borrowed money. Despite all the rhetoric about “shovel-ready projects,” about 95 percent of the 2009 stimulus bill consisted of government consumption (salaries), refundable tax credits, and transfer payments which, as Robert Barro notes, “dilute incentives to work.”

Summers says, “Any rational chief financial officer in the private sector would see this as a moment to extend debt maturities and lock in low rates — the opposite of what central banks are doing.” Locking-in low borrowing costs would indeed make sense if the money from selling long bonds were used to retire short-term Treasury bills, but that would not involve borrowing more as Summers proposes.

For both government and households, it is certainly more prudent to use borrowed money to finance investments that will yield a stream of income in the future—either actual income (such as toll roads) or implicit income (the benefits from living in a mortgaged home).

Apostles of the Keynesian doctrine, such as Larry Summers, Paul Krugman, and Alan Blinder, invariably use hypothetical public works examples to make the case for more and more national (taxpayer) debt. Keynesian forecasting models, used by the Congressional Budget Office (CBO) to warn of the looming fiscal cliff and defend the fiscal stimulus of 2009, likewise assume the highest “multiplier” effect from tangible government investments.

In the real world of politics, however, Congress and the White House use borrowed money to placate constituencies with the most political clout. Federal spending on investment projects has essentially nothing to do with the huge 2009-2012 budget deficits (only 29 percent of which can be blamed on the legacy of recession, according to the CBO).

The Table shows that transfer payments and subsidies account for 63.8 percent of estimated spending in 2012, while federal purchases account for 28.4 percent. Also, most federal aid to states is for transfer payments like Medicaid.  Within federal purchases, only 7.6 percent of the spending ($152.5 billion) was counted as gross investment in the first quarter GDP report, and two thirds of that was military equipment and buildings. Net investment, minus depreciation, is smaller still.

If borrowing more for investment was a genuine political priority, rather than an academic conjecture, the government could do that by borrowing less for government payrolls, transfer payments, and subsidies.  At best, Larry Summers has made an argument for spending borrowed money much differently, not for borrowing more.

Dealing with Fiscal Challenges

I was recently asked the following:

You gotta figure:

  1. States defaulting on pension obligations through bankruptcy and/or action by legislatures. Some de facto defaults will likely be to promise payment at age 90 or whatever.
  2. National governments, including the US, also likely defaulting on everything, gov’t bonds and so-called “entitlements.”

So, pensioners, city, state and national get at least a huge haircut on what they expected and Medicare and Medicaid just aren’t viable over time.

What are the economic implications and possible other implications?

Here’s my response:

Many US states are facing pension fund insolvency and will have to impose heavier burdens either on taxpayers, employees, or retirees, or some combination thereof. There is a precedent, although not a direct one, for a federal bailout of state and local governments: The Emergency Relief and Construction Act of 1932 provided $300 million to be lent to the states (and onward to cities and counties) for relief. Everybody understood that these loans probably would never be repaid and, in fact, they were eventually written off. This statute was the first breach of the federal “relief dam” – one that burst after FDR took office in March 1933. Despite it, three states-Arkansas, Louisiana, and South Carolina-defaulted on their debts. By the end of 1933, approximately 1,300 local governments also had defaulted and many other state and local governments verged on default.

Recently, Ben Bernanke has ruled out a bailout of states via the Fed (who believes him, given what he’s already done?) and Eric Cantor recently wrote that the states have the tools to deal with their fiscal challenges, including renegotiating agreements with public-sector unions. In his opinion, there is no reason for federal involvement in state government fiscal problems, but how policymakers will respond when the chips are down (or there’s “blood on the streets”) is anyone’s guess. Some states are in pension trouble because they assumed highly risky investment strategies that failed when asset values sank during the 2001 and 2008-09 recessions. One favorable element for some states - Arizona, Utah, Texas, NM, etc. – is their favorable demographics that could help them to slowly improve their pension and fiscal conditions.

At the federal level, the default must also occur through a “renegotiation” of entitlement promises. The Medicare actuaries have clearly indicated that the so-called Medicare fix enacted through ObamaCare is untenable. So, whether or not ObamaCare is repealed, we’re still at square one and a renegotiation must happen soon. The problem is that we always wait for the people to deliver a “clear verdict” through elections, and elections usually don’t. Leadership on this issue is sorely needed but is not forthcoming for understandable reasons. The political game is to push the adjustment costs out into the future – but eventually it will imply significantly reduced living standards for future generations. How that will come about – whether through a crisis as in Greece and Spain, or through a gradual erosion of living standards is difficult to say. The inevitability of one or the other is not in doubt. All we could say is that the probability of a resolution through a violent crisis increases the longer we continue to push the costs out.

I’m placing a high probability on the dissolution of the Euro by the end of this year. With the election results in France, Greece, and Germany, the debt roll-over requirements that Greece, Spain and Italy are facing, and the impossibility of external sources of credible “bailouts” I don’t see how it can be any other way. Some people wonder whether the periphery states will opt out first or whether Germany and stronger northern states will move first to kick them out. There are no formal exit strategies included in the European Stability and Growth Pact. I think, though, that it will be the former – the southern countries are facing austerity with, or chaos without, the Euro and now the perceived difference between the two is not very large.

To answer the last question “And then what?” I would simply say that the developed nations will all be poorer – have lower living standards, more unemployment, less growth, etc, until the boomers pass away. I predict as much in my book that examines the implications of demographic and economic trends in developed nations (it does not deal with business cycle related events). Future generations will have to re-think the state-citizen relationships – a process that we can influence.