Earlier this week, Centers for Medicare & Medicaid Services (CMS) raised its estimate of Medicaid’s improper payments from $36 billion (9.8 percent of federal Medicaid expenditures) to $57 billion (14.9 percent of federal Medicaid expenditures). Actually, the situation is far worse than these estimates suggest. As we discussed in a Wall Street Journal op-ed after the numbers were released, Medicaid’s improper payments now almost certainly exceed $75 billion – or more than 20 percent of federal Medicaid expenditures.

This year’s report shows not only a significant increase in CMS’s estimate of improper payments. Its methodology also shows the agency has been hiding even larger improper payments for years. CMS estimates improper payments in the Medicaid program by auditing each state and DC once every three years and then using the most recent estimate available for each to construct a three-year rolling average. The 2018 report therefore covered fiscal years 2015-2017, while the 2019 report covered fiscal years 2016-2018.

There’s one important caveat, however. The Obama administration did not perform Medicaid eligibility audits for fiscal years 2014-2017. Instead, it simply plugged the eligibility rate from the pre-Obamacare era into its improper payment calculations. This change would tend to hide any increases in improper enrollments that may have accompanied the implementation of ObamaCare’s Medicaid expansion. Indeed, other evidence suggests severe eligibility errors and problems accompanied the Medicaid expansion. As a result, the 2015, 2016, 2017, 2018, and 2019 reports likely underestimate the true extent of Medicaid improper payments because they use pre-ObamaCare data to describe what was happening under ObamaCare.

So it’s a very big deal that CMS’s 2019 report showed a 5.1 percentage point increase in the three-year moving average—from 9.8 percent to 14.9 percent—compared to the 2018 report. Note that while both reports’ averages use imputed improper payment rates for fiscal years 2016 and 2017 based on pre-2014 (i.e., pre-ObamaCare) data, the newest three-year average replaces the pre-ObamaCare rate used for 2015 with the actual, post-ObamaCare estimate for fiscal year 2018.

Mathematically speaking, in order for the overall three-year average to rise by 5.1 percentage points, the improper payment rate estimate for FY 2018 must be 15.3 percentage points higher (5.1 x 3 years) than the FY 2015 estimate. Given that the true improper payment rate in 2015 was almost certainly at least 8 percent, then the true improper payment rate in Medicaid (or more precisely, the real three-year rolling average from FYs 2016-2018) would then exceed 23 percent (15.3 percent + 8 percent). In other words, as long as the improper payment rate in FY 2016 exceeded 5 percent -- and Medicaid’s improper payment rate has never been below 5 percent -- the true improper payment rate exceeds 20 percent.

Even this much higher three-year rolling average is likely too low. CMS surveys the 50 states and DC in cycles – with 17 jurisdictions each year. The 2019 report updates the payment rate with “Cycle 1” states – which includes Arkansas, Connecticut, Delaware, Idaho, Illinois, Kansas, Michigan, Minnesota, Missouri, New Mexico, North Dakota, Ohio, Oklahoma, Pennsylvania, Virginia, Wisconsin, and Wyoming. Recent OIG government audits of newly eligible Medicaid expansion enrollees known as “new adults” in California, New York, Colorado, and Kentucky, as well as non-newly eligible enrollees in California, New York, and Kentucky find serious program integrity issues and high improper payments during the 2014-2015 initial implementation of Obamacare. None of these states with well documented issues with their expansions were included in Cycle 1. Neither are Louisiana or Oregon, where state audits showed significant problems with how those states were conducting eligibility reviews.

In a forthcoming Mercatus paper, we find that the 12 expansion states with the largest rates of improper eligibility were New Mexico, California, Kentucky, Rhode Island, West Virginia, Oregon, Washington, Arkansas, Colorado, Louisiana, Montana, and New York. Yet, the CMS report only includes two of them (New Mexico and Arkansas). The result is that the 2019 estimate uses data that are not only not up to date, but also unrepresentative. An estimate employing up-to-date and representative data would show an even higher improper payment rate. Moreover, the sheer size and extent of improper enrollment problems in California will raise the cycle-specific rate for the 2020 report.

Looking across the entire country and fully accounting for eligibility problems, it is possible, if not likely, that the improper payment rate is as high as 25 percent of federal Medicaid expenditures, or nearly $100 billion a year. That’s more than the entire $70 billion CMS actuaries estimate the federal government spend on ObamaCare’s Medicaid expansion in 2018.

Improper payments in Medicaid are a real problem for policymakers, and it is imperative that CMS finally take this problem seriously. Next week, the Mercatus Center will publish a new paper we authored that explains the problem in greater detail, including which states have the highest rates of improper payments, and makes a series of recommendations for reform.

One of the more ill-advised federal activities is trying to micromanage local economies with tax and spending programs. Democrats tend to favor subsidies on things such as public housing and community development, while Republicans often support both spending programs and narrow tax breaks.

The Republican Opportunity Zone program enacted in 2017 used capital gains tax rules to expand federal control over local economies. The program divided the nation between winner and loser investment zones, as I discuss here.

Another GOP micromanagement scheme is HUBZones, which are the subject of a new Washington Post investigation. Businesses in these zones receive preferences in federal procurement. Reporter John Harden notes, “The HUBZone program was the brainchild of now-retired senator Kit Bond (R-Mo.), who chaired the Senate Small Business Committee from 1995 to 2001.”

With HUBZones, federal politicians have Balkanized the nation, as shown on this map. As if we don’t have enough divisions in this country already, the politicians keep adding more. They’ve done the same with O Zones, as shown here. As a believer in equal justice under law, I find this sort of top-down and purposeful division to be a disgrace.

The Post’s previous piece on HUBZones found, “A federal program created to boost small companies in disadvantaged areas has funneled hundreds of millions of dollars into some of Washington’s most affluent areas.” Nonetheless, Kit Bond thinks they are “worth keeping around.”

The new Post article discusses the government ineptitude in operating the program:

A federal program that funneled millions of dollars into the District’s richest neighborhoods at the expense of poorer areas it was created to help used unadjusted and outdated data for years that failed to capture the city’s rapid economic growth.

The Washington Post reported in April that hundreds of millions of dollars in federal contracts were awarded to District businesses enrolled in the Historically Underutilized Business Zones program from 2000 to 2018. Almost 70 percent of the money went to a dozen businesses, mostly in areas such as Dupont Circle, Navy Yard and downtown Washington.

… A new Washington Post analysis found that the HUBZone program’s use of outdated and unadjusted data allowed businesses in wealthy areas to qualify for more than $540 million in federal contracts meant for firms in underserved neighborhoods. Rather than improve inequalities, critics say, the program has exacerbated disparities, and they question whether its calculations fit the program’s mission.

The Post’s most recent analysis found that the program relied on 1999 data to designate poverty levels for 16 years, which did not account for the city’s economic expansion. Furthermore, poverty levels in some areas that received millions of dollars are inflated by a large number of college students, who are concentrated in more-affluent areas but have little or no income.

The Small Business Administration, which operates the program, did not dispute The Post’s findings, but declined to comment further.

… Since 1999, federal agencies have entered contracts that obligate them to pay District firms about $2 billion, with companies pocketing about half that amount so far, and slated to receive the rest as part of contracts that extend into the future. Of the $2 billion, Ward 2 — which includes well-to-do Georgetown, Foggy Bottom and downtown Washington — is set to receive more than $1.4 billion. In poorer areas, such as those east of the Anacostia River, HUBZone opportunities have been slim.

This CRS report describes the legislative history of HUBZones and is suggestive of the large administrative complexity of such schemes.

A growing number of political leaders consider wealth inequality to be a major economic and social problem. They complain that wealth is being shifted to the top at everyone else’s expense.

Is wealth inequality the crisis that some people believe it is?

A new Cato study examines six aspects of wealth inequality and discusses the evidence for the various claims being made. Here are some findings:

1. Wealth inequality has risen in recent years but by less than is often suggested. Faulty data from economists Piketty, Saez, and Zucman are behind many exaggerated inequality claims. Furthermore, wealth estimates overstate inequality because they do not include the effects of social programs.

2. Wealth inequality tells us nothing about poverty or prosperity. Inequality may reflect innovation in a growing economy that is raising overall living standards, or it may reflect cronyism that causes economic damage.

3. Most of today’s wealthy are business people who built their fortunes by adding to economic growth, and some have created innovations that benefit all of us. The share of the wealthy who inherited their fortunes has declined sharply in recent decades.

4. Cronyism is one cause of wealth inequality which may have increased as governments have expanded subsidies and regulations. Some countries with high levels of wealth inequality also have high levels of cronyism or corruption.

5. The growing size of the U.S. welfare state has crowded out or displaced middle-class wealth-building, and thus likely increased wealth inequality. Some countries with large welfare states, such as Sweden, have high levels of wealth inequality. Numerous presidential candidates want to expand social programs, but that would likely increase wealth inequality.

6. Wealth inequality has not undermined U.S. democracy despite frequent claims to the contrary. Research shows that wealthy people do not have homogeneous views on policy and do not have an outsized ability to get their goals enacted in Washington.

Wealth inequality by itself is not a useful metric, but the underlying causes should be considered. U.S. wealth inequality has risen modestly, but mainly because of innovation and growth that is raising all boats. Policymakers should aim to reduce inequality by ending cronyist programs and removing barriers to wealth-building by moderate-income households.

The new study by Chris Edwards and Ryan Bourne is here.

Other Cato commentaries on wealth inequality are here, here, here, here, here, and here.

The government says that America’s poverty rate is 11.8 percent. It also says that the poverty rate has hovered around 11 to 15 percent since 1970 suggesting little or no progress against poverty in decades.

But the Census Bureau’s official poverty rate is biased upwards and kind of meaningless. In terms of material well-being, families near the bottom are much better off today than in past decades because of general economic growth and larger government hand-outs.

In a Cato study, John Early recalculated the U.S. poverty rate using more complete data and found that it fell from 19.5 percent in 1963 to just 2.2 percent in 2017. (The study’s charts are updated here.) Early is a former Assistant Commissioner of the Bureau of Labor Statistics.

Bruce Meyer and James Sullivan perform a similar exercise in this new study. They find that the poverty rate fell from 13.0 percent in 1980 to 2.8 percent in 2018. Meyer-Sullivan calculate their figure based on consumption rather than income, but the general idea is the same. Meyer is at the University of Chicago and Sullivan is at the University of Notre Dame.

The Early and Meyer-Sullivan estimates are charted below. Both estimates reflect a large reduction in material deprivation for less fortunate Americans. Unfortunately, this great news about the American economy is usually ignored in media reports and political discussions.

Both Early and Meyer-Sullivan use a more accurate inflation measure than the one used for adjusting the official poverty rate each year. And they both correct for the fact that the Census—in its main poverty series—excludes numerous government benefits including Medicaid, food stamps, and earned income tax credits. Both studies make a number of further adjustments.

The charts below show the Early and Meyer-Sullivan poverty rates compared to the official Census series. Note that all poverty rate calculations stem from essentially arbitrary poverty thresholds measured in relation to a chosen base year. John Early anchors his series to the official rate in 1963. Meyer-Sullivan anchor their series to the official rate in 1980.

The important thing is not the calculated poverty rate in any particular year but the trend over time. The official series shows no sustained improvement in poverty in recent decades, while the better estimates from Early and Meyer-Sullivan suggest large gains for households near the bottom.

In sum, using somewhat different methods, Early and Meyer-Sullivan both show that the official poverty data is far too pessimistic.

I interpolated the value for 1982 in Meyer-Sullivan.

Federal and state governments run many social programs that support lower and middle-income households. One cost of such programs is that they undermine the incentives and the means for households to accumulate savings. Effectively, they displace, or “crowd out,” private wealth-building, particularly for non-wealthy households.

As government programs for retirement, healthcare, and other needs have expanded, more private wealth has likely been displaced, and wealth inequality has grown. Leftists decry wealth inequality, but their efforts to expand government likely increases it. Larry Summers made this point at the Peterson Institute last week notes Ryan Bourne. Summers was likely influenced by Martin Feldstein’s pioneering studies that found Social Security substantially displaces private savings.

This displacement, or crowd-out effect, was explored in a 2016 study by Baris Kaymak and Markus Poschke. They built a macroeconomic model of the U.S. economy to untangle the causes of changing wealth inequality over recent decades. What they found is that the main factor raising U.S. wealth inequality has been increased wage dispersion generated by technological changes.

In addition to that effect, Kaymak and Poschke found that the expansion of Social Security and Medicare has further boosted wealth inequality:

By subsidizing income and healthcare expenditures for the elderly, these programs curb incentives to save for retirement, a major source of wealth accumulation over the life-cycle. Furthermore, since both programs are redistributive by design, they have a stronger effect on the savings of low- and middle-income groups. By contrast, those at the top of the income distribution have little to gain from these programs. We argue that the redistributive nature of transfer payments was instrumental in curbing wealth accumulation for income groups outside the top 10% and, consequently, amplified wealth concentration in the U.S.

The economists estimate that the expansion of Social Security and Medicare caused about one-quarter of the rise of the top one percent share of U.S. wealth in recent decades.

Social Security and Medicare spending increased from 3.5 percent of GDP in 1970 to 8.3 percent by 2018. Those are the two largest federal social programs, but other programs have likely added to displacement and wealth inequality effects as well.

In an upcoming Cato Institute study, Ryan Bourne and I explore these relationships. Ryan has also discussed this theme here and here, and I have here and here.

An article in the New York Times the other day was titled “The Rich Really Do Pay Lower Taxes Than You,” and one in Bloomberg was subtitled “The Wealthiest 400 Americans Have the Lowest Rates.”

It is not true.

Both articles were prompted by the release of figures from economists Emmanuel Saez and Gabriel Zucman, which in turn builds on work with their colleague Thomas Piketty. Despite garnering vast media coverage for their estimates of income, wealth, and tax distributions, this trio of economists (“PSZ”) have become known for publishing dubious data.

In a 2018 report, economist James K. Galbraith found that data on the trio’s “world inequality database” is “sparse, inconsistent, and unreliable” and “not very consistent with other reputable sources.” Furthermore, the data is based on assumptions that are “beyond heroic.”

Economist David Splinter has a new critique of the Saez and Zucman data behind the NYT and Bloomberg stories. He found that the authors made numerous flawed assumptions, which threw their estimates way off.

The figure below from Splinter shows estimates of average tax rates by income group for 2018, including federal, state, and local taxes. Average tax rates are taxes paid divided by income within each income group. The figure shows Splinter’s estimate with Gerald Auten (red line), the new Saez-Zucman estimate (purple line), and the PSZ estimate (blue line) on which it was partly based. The income groups along the horizontal axis are percentiles—for example, “P0-50” means the bottom 50 percent of taxpayers.

Auten and Splinter find that average U.S. tax rates are highly graduated, ranging from 12 percent for the bottom half of taxpayers to 50 percent for the top 0.01 percent of taxpayers. By contrast, Saez and Zucman claim that tax rates are similar across income groups at between 25 and 34 percent. In the figure, the red line is the accurate one in my opinion, while the blue and purple ones are not.

Splinter discusses the flaws in the Saez and Zucman data. One error is that they distribute the very large amount of income that is unreported on tax returns in a way that greatly inflates top-end income, which in turn substantially reduces estimated tax rates at the top. Splinter and Auten provide a detailed critique of PSZ estimation methods here.

The NYT got its headline from the Saez-Zucman tax rate estimate for the top 400 taxpayers, who are a subset of the top 0.01 percent. Without the 400, the NYT and Bloomberg would not have their incendiary headlines. Auten and Splinter do not estimate the top 400, but the Saez-Zucman tax rate for that group is still far above Auten and Splinter’s estimate for the bottom group.

Also, as Splinter notes, the estimates shown in the figure do not include the huge refundable portion of tax credits, which would further push down average tax rates at the bottom end.

In conclusion, reporters and columnists should be much more skeptical of Piketty, Saez, and Zucman data. Economists make many assumptions when preparing estimates, and the trio always seem to choose the assumptions that inflate their figures for income and wealth inequality while underestimating top-end tax rates.

A 2017 Cato book discusses Piketty’s data follies, and this recent study examines how PSZ inflate their U.S. wealth inequality estimates.

Further notes on the top 400 are here and here.

A recent corruption story in rural Virginia is rather stunning. The state is usually thought to have relatively clean government, but a Washington Post investigation by Antonio Olivo reveals something far different. The story—excerpted below—describes a wide-ranging scandal surrounding the Economic Development Authority (EDA) of Warren County, VA.

Local governments across the nation have EDAs, a key purpose of which is to hand out subsidies to favored businesses. EDAs are structured as quasi-independent from city and county governments to reduce transparency, and so they are ideal platforms for cronyism or corruption.

In a broad sense, subsidizing specific businesses is corruption in itself, even when local politicians and bureaucrats don’t line their own pockets. But they often do. This article regards an EDA official in Maryland stealing $6.7 million. In both the Virginia and Maryland scandals, it took years for the corruption to be uncovered. Why aren’t state governments auditing EDAs?

I have two solutions for this sort of local government corruption:

First, state legislatures should abolish EDAs and ban local governments from handing out narrow tax credits, loans, and other subsidies to companies. Having an in-government agency to help local businesses navigate tax and regulatory compliance might be a good idea, but having a secretive outside entity with little oversight handing out special favors is asking for trouble.

Second, Congress should repeal the tax exemption for municipal bond interest. These bonds create a strong incentive for businesses to lobby EDAs for loans rather than getting them in private markets. I understand that tax-exempt muni bonds are a core mechanism used by EDAs, and they create a bias favoring local government socialism over private enterprise.

Here are portions of the excellent Washington Post story:

Twenty-five years later, with the land cleaned up and Front Royal increasingly attractive to tourists and former city dwellers, officials announced plans for a data center and retail complex that would bring 600 jobs and act as a catalyst for other projects.

… The deal was brokered by Jennifer McDonald, a longtime Front Royal resident who directed the Warren County economic development authority. Washington-area developer Truc “Curt” Tran pledged to finance it with $40 million from wealthy immigrant investors and a $140 million federal contract his technology company had secured. As an added bonus, Tran would fund a police training academy overseen by longtime Sheriff Daniel T. McEathron.

But those were lies, documents in Warren County Circuit Court allege.

Tran never had the money to build the data center project on the 30 acres his company bought from McDonald’s agency for $1, a civil lawsuit alleges. And the training academy was one of several hoaxes that, prosecutors and civil lawsuits claim, allowed Tran, McDonald, McEathron and others to siphon away millions in public funds, which they allegedly used to buy properties, pay bills and gambling debts, and enrich relatives and friends.

… Now McEathron is dead, Tran is being sued by the economic development authority and there are state and federal investigations underway. McDonald faces 28 state counts of embezzlement, money laundering and obtaining money through false pretenses. She has denied the allegations and did not return interview requests, while Tran declined to comment through his attorney.

The claims against them, industry groups say, reflect the perils of weak oversight in economic development agencies — quasi-public entities that oversee large, complicated transactions, and whose boards often lack the financial savvy and investor scrutiny that protect their corporate counterparts. In Montgomery County, Md., an economic development official pleaded guilty this year to embezzling $6.7 million. The head of economic development in St. Louis pleaded guilty to steering lucrative contracts to the county executive’s political donors. In New Jersey, a grand jury is investigating how $500 million in tax incentives went to firms that, in part, allegedly lied on their applications.

… On Tuesday, the Virginia State Police announced that 14 current and former local officials — including all five county supervisors — were charged with misdemeanor misfeasance and nonfeasance “based on the individuals’ knowledge of and inaction [regarding] the EDA’s mismanagement of funds.”

… A soft-spoken resident of upscale Great Falls, Va., whose website boasts of contracts with the U.S. Office of Management and Budget, Tran wanted to turn part of the former Avtex Fibers manufacturing campus into a hub for cloud computing, with a three-building, $40 million complex that according to its business plan would include a restaurant, a coffee shop and a music store.

McDonald’s board approved a $10 million, 90-day loan. Tran promised funding from 80 foreign investors enrolled in the federal EB-5 visa program, which offers applicants and their families a path to citizenship in exchange for the jobs their money helps create. Officials and residents gushed over the plan.

“This is our first step into a new era,” then-Mayor Timothy Darr said at a 2015 groundbreaking, as McDonald, Tran and [Rep. Bob] Goodlatte smiled nearby.

The regional Criminal Justice Training Academy was announced the following year. McDonald said an anonymous donor would provide $8 million, and told her board the donor was Tran, the civil lawsuit says. McEathron, a fellow Rotarian, would be in charge.

… It all seemed in­cred­ibly fortunate. Until late 2016, when some town officials and residents looked up Tran’s company online.

They found it hadn’t yet been allowed to solicit investments under the EB-5 program. The $140 million federal contract appeared to be a mirage, with Tran receiving no payments from it. Skeptics asked increasingly pointed questions at public meetings, sparking warnings from Town Council members that the naysayers would blow Front Royal’s big chance.

… The Town Council authorized $1.7 million of infrastructure improvements for the Avtex site, and according to the lawsuit, McDonald allegedly paid Tran at least $1.5 million for construction costs without informing her board.

… In 2018, Front Royal’s finance director discovered a bigger red flag: The authority had overbilled Front Royal nearly $300,000 for its portion of debt service related to the Avtex site and a road improvement project. At a meeting about the discrepancy, McDonald nonchalantly said she had mistakenly falsified some invoices, Town Attorney Doug Napier recalled.

“She was not at all contrite,” Napier said. “It just shocked me.”

The revelation prompted a call to state police and an independent review of the authority’s books that uncovered a dizzying array of phony invoices, phantom projects, secret land deals and bank wire transfers to entities controlled by McDonald or her friends, according to a copy of the review completed in May by the Cherry Bekaert accounting firm. The probe was commissioned by the authority and is the basis of the criminal and civil proceedings.

McDonald allegedly billed the authority more than $50,000 to pay for renovating a vacant inn, then used those funds to pay credit card bills, according to the review. She is accused of doctoring invoices to secure $4.6 million for purchasing tax credits, then embezzling that money.

A plumbing company owned by her husband, Sammy North, allegedly collected at least $66,200 in secret payments, the review found. North has also been arrested, as was Donald F. Poe, a family friend accused of conspiring with McDonald to funnel $841,409 to his solar panel installation company for work the board didn’t authorize.

North did not return messages seeking comment. Ryan Huttar, an attorney for Poe’s company, said that his client performed the work it was hired to do and that it reimbursed the authority $335,000 when one job was canceled.

Attorneys in the civil lawsuit say McDonald allegedly convinced the authority to buy land from her aunt and uncle for a workforce housing project without disclosing that they were her relatives, and billed the authority an additional $130,000 in the transaction, most of which went to pay off what appeared to be her mortgage.

… McEathron wasn’t charged. But he may have felt the tide turning against him. He and McDonald had launched a real estate investment company called DaBoyz LLC in 2016, shortly after they announced the police academy. The firm used $3.5 million in authority funds to buy four properties, the independent review found. McDonald and McEathron also bought a three-bedroom home in Virginia Beach, which they rented to McEathron’s son and daughter-in-law, court records in the civil lawsuit show.

In one curious transaction, which lawyers for the authority say may have been an attempt to launder money, DaBoyz paid Rappawan, a construction company, $1.9 million for a large tract of land and then sold it back a month later for $1.3 million. Rappawan owner William T. Vaught Jr. declined to comment, citing the criminal investigations.

… McDonald was charged this summer with additional counts of money laundering and grand larceny. Her husband was arrested on counts of money laundering and obtaining money by false pretenses. The local grand jury, which was initially set to finish its work this month, requested another six months to investigate.

… Local activists, who had called for the state and federal investigations to be expanded, rejoiced at Tuesday’s announcement. “Somebody is finally listening,” said Salins, co-founder of the Warren County Coalition watchdog group. “It’s not every day that your entire government gets arrested. It’s so shameful.”

… And they had been demanding answers from Supervisor Tony Carter (R-Happy Creek), another of the people charged in the recent indictments. Carter works for his mother’s insurance company, Stoneburner-Carter, which holds insurance policies on four properties owned by the authority and has collected about $46,000 in premiums since 2015, according to records obtained through a Freedom of Information Act request.

For years, the local government “has been skewed [in favor] of the elite and the ‘good ol’ boys’ club,’ ” [Kristie Atwood] said. “With luck, and these indictments, our community is going to turn around for the good.”

I hope she is right. But to make sure the “good ol’ boys’ club” is gone for good, Warren County citizens should press to abolish their EDA and to rely on clean and efficient government with equal and low taxes for all businesses to encourage growth and development.