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Would the Rich Really Spend Less of Their Tax Cuts?

August 31st, 2010 . by economistmom

use-of-child-credit-by-income-coronado-fed-paper

(Figure above from Federal Reserve Board discussion paper by Julia Lynn Coronado, Joseph P. Lupton, and Louise M. Sheiner, 2005.)

Catching up on some reading this week, and had this few-days-old post by Dylan Matthews on Ezra Klein’s blog pointed out to me.  Dylan asks if the conventional economic wisdom on the “marginal propensity to consume” of richer vs. poorer people (that it’s higher for the poor mainly because they are too constrained and can’t afford to save) is really true.  He points to a couple empirical studies based on the lump-sum-type rebate/refundable credit portions of the 2001 and 2003 tax cuts that suggest that the higher-income households were more inclined to spend their tax cuts than the lower-income ones were.

If these studies reflect today’s reality about how rich vs. poor would spend extra money, then this would weaken the argument that we should let the tax cuts for the rich go ahead and expire because they wouldn’t provide effective stimulus compared with tax cuts for lower- and middle-income households (and especially compared to other forms of deficit-financed stimulus).

But I have a couple of problems with leaping to such conclusions based on these earlier studies.  First, the highest-income categories in these studies are much broader than the definition of “rich” being used in the debate about the Bush tax cuts–the latter being confined to households with incomes above $250,000.  One thing I suspect is that households with income above $75,000 or $100,000 (the highest-income groups in these studies) don’t just have more than median incomes, but also have more than median household sizes.  (There is a strong income effect in moving from middle- to upper-income levels in terms of the number of kids people have; not everyone can afford to have four children, trust me.)  It is not at all surprising to me that if one does not control for family size, that households with higher incomes are more likely to spend most of their lump-sum, windfall-type tax cuts than households with lower incomes who also happen to be (at least I strongly suspect) smaller in size.  If you compared the spending propensities of households with incomes over $250,000 with those of households with incomes between $100,000 and $250,000, holding constant family size, I bet we would see the latter has a higher propensity than the former.

Second, economic circumstances have really changed since the tax episodes in those studies.  Everyone (the truly rich included) had been in high consumption mode at the time of the 2001 and 2003 tax cuts, because wealth effects (via housing values and investment portfolios) encouraged consumption and borrowing against that wealth.  A little extra cash in the form of a tax rebate would be likely to be treated like an additional windfall, and hence spent.  But the subprime mortgage and then general credit crisis shocked households into changing their borrowing and spending habits.  Now households cannot count on the wealth in their homes or retirement funds as a reliable source of savings, so their propensities to consume out of any extra money (like from a tax cut) are going to be substantially lower now. So now it is not so much that the rich can just afford to save more than the poor, so that they will in fact save more of their tax cut. Today it is more that the rich can afford to pay down more of their debt (versus need to use for immediate consumption)–i.e., reduce their “negative saving.”  But reducing debt or “negative saving” is the same thing as “saving more.”   So I think the rich still will tend to spend a lower fraction of any non-targeted tax cut than lower-income households and that the conventional wisdom–that tax cuts for the rich aren’t great short-term stimulus (to boost aggregate demand)–still applies.  (The issue of what types of tax cuts are the best for longer-term economic growth–to increase aggregate supply once the economy is at “full employment”–is a different matter entirely.)

The NY Times and Len Burman on “A Real Debate on Taxes”

August 25th, 2010 . by economistmom

Why do I need to think/write this week, when I have friends like Len Burman doing it for me?  Here’s a New York Times editorial on the Bush/Obama tax cuts from earlier this week.  There’s absolutely nothing in it that I do not wholeheartedly agree with.  I suspect the NY Times may have gotten some of their ideas from Len, given Len’s July 14th testimony before the Senate Finance Committee.

Thanks, Len!  :)

On a Pause This Week

August 24th, 2010 . by economistmom

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I am taking a break this week from my EconomistMom blog while my family life is especially busy–squeezing in what we can for the last two weeks of summer (and the last two weeks of living with my Princeton-bound daughter, Allie–pictured with me above) while I try to work on an issue brief for the Concord Coalition on–guess what?–the Bush/Obama tax cuts!

Because I can’t stand being quiet for so long, I thought I’d post a link to something I wrote earlier this year for a newsletter of the “Committee on the Status of Women in the Economics Profession” (CSWEP)–which is part of the American Economic Association.  It’s an article called “I Blog, Therefore I Am (EconomistMom),” and you can find it here along with articles by Len Burman and Doug Holtz-Eakin.

I may come back a little bit over the next week but mainly to point out some things other people have written rather than provide any of my own original thoughts.

A Little Joke About the Bush/Obama Tax Cuts - Part 2

August 19th, 2010 . by economistmom

No fair, “Brooks” has known me here too long and gave away the “baselines matter” punch line to yesterday’s “joke”:

“Could you loan me ten dollars but just give me five? That way you’ll owe me five, I’ll owe you five, and we’ll be even.”

Conveniently, today the Congressional Budget Office released their update to their budget and economic outlook, so I have some updated numbers for my Bush/Obama tax cuts version of that joke:

President Obama: “Could you loan me ten dollars $2.65 trillion for 10 years’ worth of all of the Bush tax cuts but just give me five about $2 trillion for the “middle-class” ones? That way you’ll owe me five, I’ll owe you five, and we’ll be even about $700 billion, and I’ll say “no problem, keep it,” and I’ll claim to have reduced the deficit by that $700 billion.

Some footnotes to that joke:

Note Table 1-7 on page 24 of the CBO report–the table showing policy alternatives not included in the CBO current-law baseline (which assumes the full complement of the Bush tax cuts–and AMT relief–expire at the end of this year).  Extension of the Bush tax cuts (EGTRRA and JGTRRA) in full costs $2.65 trillion over ten years, without counting the cost of AMT relief or any interaction with AMT relief.  In their previous Analysis of the President’s Budget, CBO said President Obama’s proposed extensions of the Bush tax cuts would cost $2.15 trillion, but that included the interaction with AMT (not the cost of extended AMT relief itself though), so I figure it’s maybe still around $2 trillion for the apples-to-apples comparison–implying the difference of around $650-$700 billion that President Obama claims to “save” by not extending the upper bracket tax cuts.

My main point in relaying this little “joke” is to say that President Obama is proposing to deficit finance (increase the deficit by) $2 trillion in extended Bush tax cuts rather than $2.7 trillion; he is not proposing to reduce the deficit relative to current law in forgoing extension of the upper-bracket tax cuts. And those figures don’t even count associated net interest costs, by the way.

….

And here are a few other things I found interesting in today’s CBO report:

  1. Summary Figure 1 on pg. xii: always my favorite chart, but it strikes me how it shows how far off the average revenues and average outlays are from current reality now–and how even over most of the time series going back (1970-now) neither revenues nor outlays stay that close to those averages, even though those are the historical averages!  There are pretty wild swings, and maybe the political and policy tendency is to not let the deficit get in the unsustainable range (>3%) for too long, rather than not let revenues get too far from 18% or outlays too far from 21%.
  2. Summary Figure 2 on pg. xiii:  maybe my second-favorite chart from this report, on net interest and its determinants in the baseline — it actually contains three charts (variables).  The top chart shows interest rates rising over first five years but pretty level over next five; the second shows debt/GDP rising over next couple years but then stabilizing (under baseline policies); and yet the third shows interest spending/GDP continuing to rise throughout the ten-year window.  The latter trend puzzled me at first (given the first two), but then I realized that I think it reflects what happens as the debt is rolled over, as we start rolling in higher-interest debt and rolling out (retiring) the lower-interest debt.
  3. Table 1-3 on pg. 5:  revenue growth rates are very dramatic and reflect both expiring tax provisions (”largest tax increase in American history”, baby!) and recovering economy.  I think it’s worth pointing out that only with this dramatic “catch up” in revenues do we get the more sustainable situation where revenues are projected to grow faster than outlays over the rest of the ten-year window (even if not lasting for long in terms of the longer-term outlook), allowing the gap to close to more sustainable levels of the deficit (<3% of GDP).
  4. Page 36 in the economic outlook chapter:  This provides a very clear illustration of how CBO’s alternative fiscal scenario, where most of the Bush tax cuts (the ones Obama proposes) are extended, would increase GDP level and growth over the baseline forecast but only in the first 2-3 years of the window.  It underscores how the economic effects of deficits differ in the short-term vs. longer-term–why deficits (and deficit-financed “stimulus”) may be helpful now but harmful if they persist beyond the next couple years–and hence why the current weakness in the economy does not justify permanent deficit financing of even Obama’s “middle-class” portions of the Bush tax cuts (which are the only portions CBO now includes in their “alternative fiscal scenario”).

…which brings me to an important fiscal policy lesson (”teachable moment?”) to the Obama Administration and Congress that comes out of the CBO report: the current-law baseline shows us a path (not the only path, but at least a path) to sustainable budget deficits within the ten-year window.  We don’t literally have to stick to current law to get there, but we need to stick to PAYGO (without exemptions) relative to current-law revenue and spending levels to get there.  We need to literally pay for things as we go along, including paying for continued policies, if those policies aren’t already continued under current law.  And if we can’t or aren’t willing to pay for extending these policies, then perhaps we shouldn’t extend them–especially when it doesn’t make economic sense to extend them.

A Little Joke About the Bush/Obama Tax Cuts

August 18th, 2010 . by economistmom

A few weeks back one of my colleagues relayed an old joke to me which he was reminded of in the context of a fiscal policy issue we had been discussing.  Except as soon as he said it, I immediately thought it was an even better analogy to the (then-)Bush(-soon-to-be-Obama) tax cuts.  With that clue, let’s see if some of you readers can “see” this, too–solve the riddle:  how is the joke below reminiscent of what President Obama proposes to do about the Bush tax cuts?

“Could you loan me ten dollars but just give me five? That way you’ll owe me five, I’ll owe you five, and we’ll be even.”

I will follow up with my answer later (just for dramatic effect).  It will involve citing CBO reports, so don’t get your hopes up about it eliciting a lot of yuks from you.  ;)

No Jive from Clive on the Then-Bush-Soon-Obama Tax Cuts

August 16th, 2010 . by economistmom

I love the back-to-back columns on the Bush tax cuts and fiscal responsibility that Clive Crook of the Financial Times wrote earlier this month.  He really tells it like it is: we simply can’t afford to permanently extend even the so-called “middle-class” portions of the Bush tax cuts–for several reasons.

His first column (“Obama must break his tax promise”) points out the hypocrisy of the Obama Administration in adopting the Bush tax cuts as the centerpiece of their own tax policy agenda (my emphasis added):

What a commentary on the US approach to tax policy. The tax cuts are due to expire in the first place only because the Bush administration was cooking the books. The idea was to disguise the cuts’ long-term cost, which is colossal. Making them permanent would cost nearly $4,000bn over 10 years. The Republicans always wanted the changes to be permanent. The sunset provision was just a feint to make them look affordable.

Democrats deplored the tax cuts as reckless – which they were – yet want mostly to preserve them. The middle-class part of the tax cuts, which they like, account for roughly three-quarters of the forgone revenue. Talk about having it both ways. Barack Obama organised his election campaign around this position. He complained of fiscal irresponsibility with one breath, then promised even lower taxes for most Americans – households making less than $250,000 a year, some 97 per cent of the total – with the next.

To the Republicans, fiscal responsibility is a fantasy sunset provision. To the Democrats, it is a tax increase confined to a sliver of the undeserving rich.

And he makes it clear that raising revenue to reduce the deficit doesn’t have to involve trading off economic efficiency and growth–but pursuing such fiscally-responsible but economically-wise tax policy does require the President to break his troublesome campaign promise:

So broken is the US tax system – especially the federal income tax – that raising more revenue without increasing rates of tax is technically, though not politically, easy. The income tax base has been whittled away since the last big reform in 1986. Rates are not low by international standards, and their structure is already quite progressive; yet because they are applied to a slender base, the US income tax raises barely 8 per cent of gross domestic product. A broader base with lower, flatter rates could easily raise more revenue.

In addition, new taxes such as a value added tax and/or a carbon tax would be needed to bridge the remaining fiscal gap. These would make sense in their own right as part of the mix, even if there were no revenue shortfall. But the politics is so poisonous that these can barely even be mentioned. Instead, the debate is stuck in the mud of class warfare. All anybody cares about is whether the rich are paying their share. More than their share, say conservatives. Not nearly their share, say liberals. It is like Britain in the 1970s – not a good model.

The leadership that Mr Obama could provide on this is desperately needed. No doubt he understands what ought to be done, but the promise he made in 2008 has tied his hands. He will have to break that promise, and the sooner he does it the better.

And then by the next week, apparently Clive had gotten harassed by readers with arguments that I am well-familiar with (”but why would we raise taxes while the economy’s still weak?”…”but the problem is spending is too high, not taxes are too low”), so that his next column clarified that “Obama has to cut–and raise taxes”:

Last week I argued that sooner or later Barack Obama will have to break his election promise and raise taxes on the US middle class. It would be better not to renege just yet, I said: a double-dip US recession remains a distinct possibility and fiscal policy needs to stay loose for the time being. However, before much longer, restoring fiscal control is going to require higher taxes – and not just for the rich.

Many readers took issue with the article and they often started the same way: “What about public spending? You didn’t say a word about spending.”

No, and I should have. To control borrowing without ever-rising rates of taxation, Congress will have to curb currently projected spending. But that will not be enough by itself. It is delusional to think the US can get from here to a sustainable fiscal balance with spending cuts alone.

The problem with plans to reduce the deficit by spending-side changes alone?  Clive explains there’s just not enough spending to cut unless you really go after the big (dare-I-say) “entitlement” programs of Medicare and Social Security.  The only plan out there that very clearly follows that strategy is Paul Ryan’s “Roadmap” plan.  But no one is really willing to live with such large cuts to Medicare as implied by the Ryan plan, not even Ryan’s fellow Republicans:

What about Medicare? The recent healthcare reform includes some payment-system experiments intended to curb costs, though it would be rash to expect very much from these. Mr Ryan’s plan is far more radical. Again he calls for privatisation. He wants to replace the government-run insurance scheme with vouchers, which recipients would use to buy private insurance. The plan then imposes a far slower rate of increase in the vouchers’ value than in projected healthcare costs.

After many years, this wedge would drive Medicare spending way down – but unless costs fell commensurately, the vouchers would buy fewer treatments. No doubt, in this world, patients would force doctors and hospitals to supply services more economically. It is hard to believe that this could curb spending as sharply as Mr Ryan expects with no loss of healthcare quality.

In a way, Mr Ryan is right: dismantling Medicare and social security is what it takes if you rely on spending cuts alone. Can it be done? No. Republicans remember what happened to the Bush plan for social security and do not intend a rerun. During the healthcare debate, they furiously opposed cuts in Medicare. Do not trust Democrats to honour these government promises, the party says. So much for Mr Ryan’s plan.

And Clive concludes his second column with a simple reminder that the fiscal math is simple but the choices hard:

You cannot hold Medicare and social security unscathed, oppose all tax increases and close the fiscal gap. The big entitlements plus defence and interest amount to some 80 per cent of federal spending. With those off the table, there is not enough left to cut.

That ain’t no jive, Clive!

Social Security Will Be There (and Should Be There) for My Children

August 15th, 2010 . by economistmom

I was just on CNN’s “Your Money” show with host Ali Velshi this weekend, and among the topics was Social Security on its 75th anniversary, as they interviewed Michael Astrue, the Social Security commissioner.  Michael made all the right points about how “exhaustion” of the Social Security trust fund in 2037 does not mean Social Security goes away, but it does mean we have to consider ways to bring the program into better balance–the hard choices between benefit cuts, tax increases, or some combination of both.   But I wish he (and the Social Security Administration as an institution) had not emphasized the program being able to cover a bit over three-fourths (78 percent to be exact) of promised benefits even after trust fund exhaustion, because it puts still too much emphasis on the trust fund balance (which even now is only filled with IOUs and not real money) as determining how sustainable the program is.  The point I tried to make in my remarks on the CNN program was that I am optimistic that Social Security will be there after 2037 and should be there to serve a social insurance function (not a private, high-return-but-high-risk investment function that Stephen Moore suggested), that Social Security is not “broken” but simply underfunded which just means it will start costing us money on net (like the rest of government, I suggested), and that we could easily choose to continue to fund 100 percent (not just 75-78 percent) of promised benefits–or any other level and distribution of benefits–with the policy choices we as a society are willing to make.

The President’s weekly address (video above) also emphasizes that Social Security can be counted on, but that there’s work to be done to “strengthen” the program if we want to keep the program self-sustainable–more work for the fiscal commission again, by the way.  ;)

The President also rightly stresses that privatizing the program is not the answer, because Americans value the safety of Social Security–especially given the current economic climate that puts so much fear in people (and which was the opening topic on the same CNN Your Money show this weekend).

“Spinning” the VAT

August 13th, 2010 . by economistmom

spinning-class-disco-lights

I don’t mean putting a falsely-positive “spin” on the idea of a value-added tax–but rather: could the VAT be to tax policy what “spinning” has meant to the group fitness industry?

A few weeks ago at a Brookings event featuring Congressman Paul Ryan (R-WI) speaking on his “Roadmap” plan, I made an analogy between effective strategies to reduce the budget deficit and effective ways to lose weight.  I argued that the problem with the Ryan plan was that it was like an “all diet but no exercise” approach, which would be unsustainable because it would make us feel deprived of the “sweets” (e.g., special-interest government spending) we want along with the good healthy food (e.g., our critical social insurance programs) we need.  (We’d end up binging and purging, is what I was thinking but didn’t get to elaborate on.)

A week after the Ryan event, the New Republic’s Jonathan Chait made the same analogy in talking about supply-side ideology as it has been displayed recently in discussions about extending expiring tax cuts (the routinely expiring variety as well as the “mother” of all tax extenders, the Bush tax cuts):

Imagine a man who has to lose weight. Either he needs to eat fewer calories or burn more of them. Conservatives are arguing that he should exercise less, because this will force him to eat less food. [The Heritage Foundation's J.D.] Foster writes, “Lower taxes are evidently what the American people want, which is especially galling to the tax-increase crowd.” And it’s true — Americans want to keep their spending and tax cuts too. Diets that promise to let you spend all day on the sofa and still eat lots of delicious food are also popular.

So I think we need to exercise more and exercise more efficiently.  We need to change the way we exercise, not just repeat the same old tired step aerobics classes of the past.  We need the equivalent of “spinning”

If you read what all the best minds in tax policy are writing, you come to realize that whether they lean left or lean right, they’re all talking about the real value of a tax that could change the way we raise revenue–like “spinning” changed the way we exercised–the value-added tax (VAT).

Here’s what the Brookings Institution’s Bill Gale and Ben Harris have to say about it.  They go through the full list of major concerns and criticisms of the VAT and explain how each could be fairly easily addressed.  The VAT is not perfect, but it could be the most “relatively attractive choice” available to us, in terms of ways to raise badly-needed revenue.  They conclude:

The VAT is not the only tax or spending policy that can constructively help solve the fiscal problem, nor will it solve the problem by itself. Nevertheless, to oppose the VAT is to argue either (a) there is no fiscal gap, (b) ignoring the fiscal gap is better than imposing a VAT, or (c) there are better ways than the VAT to make policy sustainable. No one disputes the existence of a fiscal gap, though, and the economic costs of fiscal unsustainability are enormous. As to the notion that there are better ways to put fiscal policy on a sustainable path, we would be excited to learn about them. In the meantime, policy makers should not let the hypothetical—and to date undiscovered—ideal policy get in the way of the time-tested, more-than-adequate VAT.

And here’s the whole intellectual journey Bruce Bartlett’s been on regarding the VAT–spanning more than 25 years!–and what he concluded in one of his more recent pieces published in Forbes (my favorite line emphasized, speaking of good analogies):

[E]ventually I decided that it was stupid to oppose something because of its virtues. Opposing a VAT because it’s too good is like breaking up with your girlfriend because she is too beautiful.

In my opinion, opposing a VAT means implicitly supporting our current tax system, which imposes a dead-weight cost equal to a third or more of revenue raised–at least 5% of GDP–according to various studies. This is insane. The idea that raising taxes in the most economically painful way possible will hold down the level of taxation and the size of government is obviously false. It just means that the total burden of taxation including the dead-weight cost is vastly higher than it needs to be. If we raised the same revenue more sensibly we could, in effect, give ourselves a tax cut by reducing the dead-weight cost.

Those who oppose big government would do better to concentrate their efforts on actually cutting spending. The idea that holding down taxes or insisting that we keep a ridiculously inefficient tax system because that will give us small government is juvenile. If people want small government, there are no shortcuts. Spending has to be cut. But if spending isn’t cut, then I believe that we must pay our bills. I think it’s better to do so as painlessly and efficiently as possible. That’s why I support a VAT.

And coincidentally (and to come full circle), Shawn Tully of Fortune very recently interviewed a drywall-hanging-while-on-August-recess Paul Ryan about the idea of a VAT:

I asked Ryan to handicap the probability of another legislative landmark that would forever change the course of the U.S. economy: The adoption of a European-style value-added tax, or VAT.

Right now the VAT appears so radical that it’s gained little support in Congress and isn’t even endorsed by the Obama administration. But Ryan told me that a VAT is far more likely than most Americans imagine. The reason isn’t the one that many experts are forecasting — that the Fiscal Commission appointed by President Obama will recommend the controversial levy. “I don’t believe the Commission will advocate a VAT,” Ryan told me, adding that he doesn’t speak for his fellow members.

On the contrary, Ryan fears another path to the VAT. “It cannot pass without a fiscal crisis,” he warns. “Our leaders are now courting one with big spending and by adding new entitlements. They know in the back of their minds that if a fiscal crisis comes, they can throw a VAT on top of that.”

Ryan concluded by saying that the economy now faces two layers of uncertainty — the threat of a debt debacle that’s already well known, and the added danger that the solution will be the heretofore unimaginable and largely unforeseen: a VAT. With that, the congressional carpenter signed off: “I’ve got to go back to hanging drywall.”

One way or another, I think some form of a VAT is inevitable, and that’s not a bad thing.  It’s probably one of the best forms of “exercise” we could get into right now.  It’s not something we would necessarily choose to do for the heck of it, if we didn’t need to “lose weight.”  But given that yes, we have to endure some “pain” to get some “gain” (uh, loss in this case), it’s better than the boring treadmill of just raising marginal tax rates, and certainly more effective than the “thighmaster” (while eating in front of the TV) Bush tax cuts.

And Even on Medicare, It’s Not Yet “Mission Accomplished”

August 12th, 2010 . by economistmom

A few days ago I wrote about the Trustees’ report and the relatively light (but growing) work we need to do on the Social Security program to get it to self-sustainability–assuming the goal of having Social Security income adequately cover Social Security costs.  (Note to touchy readers:  my answer is not to eliminate the costs nor to immediately raise the income.)

My boss, Bob Bixby, took on the larger task of deciphering what the Trustees’ report tells us about the future of Medicare.  In his post on Concord’s “The Tabulation” blog, he explains:

Good news comes and goes rather quickly in the 2010 Medicare Trustees’ Report. It begins with the optimistic news that Medicare’s finances have improved substantially as a result of this year’s health care reform bill, the Affordable Care Act (ACA). However, the report then goes on to explain in great detail why this apparently good news is probably not as good as it sounds.

According to the trustees, “actual future Medicare expenditures are likely to exceed the intermediate projections  shown in this report, possibly by quite large amounts.” A separate memo prepared by the Center for Medicare and Medicaid Services (CMS) Office of the Actuary bluntly states that “the projections in the report do not represent the ‘best estimate’ of actual future Medicare expenditures.”

For one thing, it is important to keep in mind that Medicare’s finances remain very problematic, even with the improvements assumed to occur as a result of health care reform. If total expenditures increase as projected to 5.76 percent of GDP in 2040, it will represent a 60 percent increase from today. Increasing amounts of general revenues will be needed to pay promised benefits. This will put a growing strain on the rest of the budget, crowding out other priorities or forcing higher taxes. Even the extra dozen years of Part A trust fund solvency leave that part of the program insolvent by the time people who are now age 46 and younger qualify for benefits.

It is also important to note that the improvement in Medicare’s finances resulting from the health care reform legislation does not translate into a substantial improvement in the federal government’s long-term budget outlook. Most of the ACA’s Medicare savings and added payroll tax income have been dedicated to an expansion of Medicaid and to subsidies for those who need help purchasing mandated health insurance. In other words, the health care legislation does not “bank” its Medicare reforms for future Medicare expenses.

However, the most significant caveat noted by the trustees is that two key assumptions in the official projections are not realistic.

The first of these assumptions is that Medicare’s current law Sustainable Growth Rate (SGR) for physician payments will be followed, starting with a 30 percent cut over the next three years. The ACA did not change this requirement, even though Congress has routinely overridden it and is widely expected to do so again.

The second questionable assumption is that annual adjustments to non-physician provider payments will be limited to the growth of economy-wide productivity. This change was a major cost-saving initiative in the ACA. However, productivity gains in the health care sector have generally not kept pace with economy-wide gains. So maintaining this new standard would necessitate substantial and continuous efficiencies. The CMS actuaries estimate that payments would be 28 percent lower after 30 years than under the pre-ACA law and 56 percent lower after 75 years.

In the actuaries’ view, “neither of these [payment] update reductions is sustainable in the long range and Congress is very likely to legislatively override or otherwise modify the reductions in the future to ensure that Medicare beneficiaries continue to have access to health care services.”

In short, much of the apparent improvement in Medicare’s finances may prove to be illusory…

Bob goes on to highlight the Office of the Actuary’s “alternative scenario” in which physician payments are allowed to increase with medical inflation, and the changes in non-physician payment updates are phased out after 2019.  Much like the warning from CBO’s “alternative fiscal scenario” (in their long-term budget outlook) about both tax policy and health reform, the Medicare actuaries’ alternative scenario provides a good cautionary tale about the policy choices that would veer us off the path to fiscal sustainability.

Allan Sloan on the “Funny Money” in the Social Security Trust Fund

August 10th, 2010 . by economistmom

geithner-social-security-bond-dominguez-fortune

In today’s Washington Post, Allan Sloan provides a very cute but very clear explanation of why having “money in the bank”–if we’re talking “money” in the Social Security trust fund–isn’t nearly the same as having positive net income coming into the program:

Here’s why the trust fund is funny money. Let’s say I begin taking Social Security when I hit the full retirement age of 66 later this year. Because its tax revenue is below its expenses, Social Security would have to cash in about $3,400 of its trust-fund Treasurys each month to get the money to pay me. The Treasury, in turn, would have to borrow $3,400 from investors to get the money to pay Social Security. The bottom line is that the government has to borrow money to pay me, regardless of how big the trust fund is.

Allan sniffs out an interesting change in this year’s Trustees’ report from last year’s:

[A quote from the introduction of the 2009 Trustees' report] says:,  “Neither the redemption of trust fund bonds, nor interest paid on those bonds, provides any new net income to the Treasury, which must finance redemptions and interest payments through some combination of increased taxation, reductions in other government spending, or additional borrowing from the public.”

In other words, the trust fund is of no economic value.

This sentence wasn’t in the 2010 introduction, released last week. Treasury says that it stands by the statement but that the Social Security trustees decided not to include it this year because it reiterates the obvious.

And he explains what the trouble is with the “Geithner bond” depicted above, created by Allan’s Fortune colleague, Robert Dominguez:

Now, to the “Geithner bond,” which shows how easy (and useless) it would be for Treasury to stick as many bonds as needed into the trust fund, and then declare Social Security to be sound forever.

You know, of course, why this wouldn’t work — at least, I hope you know. It’s because the U.S. government ultimately has to pay its bills with cash, not with its own IOUs. In the long run, you need cash — real money — not funny money. Other than being a send-up, this hypothetical Geithner trust-fund bond is no different than the Treasury bonds the trust fund owns, except that it carries a higher interest rate.

By the way, this issue is the same one the Concord Coalition raised earlier last week, just prior to the release of the Trustees’ report.

None of this is meant to suggest that Social Security is a “funny” (unreal) program.  To the contrary, it is to urge that we get some real money really into the program.  As Allan concludes:

There are ways, even at this late hour, to begin turning the trust fund from funny money into real money without unduly stressing the government’s finances. (I’ve discussed them before, and will do so again, but not today.) Given that taxpayers are bailing out the most imprudent companies and people in the country, we damn well should bail out Social Security, the mainstay of low- and middle-income people.

But let’s not kid ourselves that a fat trust fund is the solution. When Social Security’s cash deficits begin running more than $100 billion a year within a decade, it’s going to take a lot of money to keep the checks coming. And it sure won’t be funny.

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