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The Way Out of the Fiscal Hole: An Economist Mom’s Perspective

October 2nd, 2010 . by economistmom

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The paper I was invited to write for a spring conference (the William B. Ruger Chair Workshop on “Economics and Security: Resourcing National Priorities”) at the Naval War College has been published.  (Right after attending the conference I had written only about what I learned about defense/national security spending.)  The entire monograph can be found here, and my paper appears on pages 81-88.  Some of my favorite parts (leaving aside my never-ending rants about the Bush/Obama tax cuts):

As parents, many of us baby boomers make “investing” in our kids a priority in our household budgets. We pay for our kids’ music and dance lessons, team sports, and after-school academic enrichment and health-promoting (fitness) programs. We make sure they go to the doctor and dentist regularly, and we even pay to give them perfectly straight teeth as a warm-up to paying for college. And we pay for tutoring and test-preparation classes and encourage them to do their best with their studies in the hopes that they will get into a good college that we can manage to pay for and will turn out to be a “good investment.” What makes all of our parental efforts worthwhile isn’t always measured in purely monetary terms, but all of us certainly hope that we help set our kids on a path to a high “quality of life.” And I think most of us hope that our kids’ lives will be of even higher quality than ours have been.

That is why any parent should be particularly concerned about the budget outlook: it directly undermines all of our personal efforts to provide for our kids and set them on that good path. We contradict ourselves if on the one hand we are saving for our kids’ college educations but on the other hand are clamoring for more deficit-financed tax cuts or benefits for ourselves.

I consider myself a “deficit hawk,” but I certainly don’t think the goal should be a perfectly balanced budget with a zero deficit in every year. Running a debt can be valuable, because it can allow us (whether as a society or as a family) to achieve a higher standard of living than what is possible if relying on current income alone, particularly when the borrowing makes possible investments that increase future income. But if we borrow too much and use it to buy things that do not increase our future income, we can get into an economically “unsustainable” situation where the burden of the debt we carry grows faster than our income—and we cannot keep up. (Examples from the family budget: borrowing for college is less worrisome if college boosts future income; borrowing to buy a home is not a problem if the interest rate will not “balloon” in the future and if the home’s value is expected to rise; borrowing for a flat-panel TV because you don’t have a job right now to pay for it . . . not so smart!)

Advocating for “fiscally responsible” government is not the same thing as arguing for a smaller government. Often people who say they want a smaller government really don’t want a smaller government; they just want lower taxes. The “right” size of government from a fiscally responsible perspective is that which we are willing to pay for in taxes. And the “right” level of taxes is that which is adequate to cover the cost of the government programs we deem worthwhile.

Americans have lost sight of this connection between the government we desire and the taxes we are willing to pay, because we have become too accustomed to persistent budget deficits as the norm, and too often our political leaders mislead us into thinking that there are no budget constraints and that deficit financing is “free.”

Those who argue for lower taxes often claim that the historical evidence shows that taxes are not the problem, spending is, because the level of federal taxes as a share of GDP has been around 18 percent of GDP over the past forty years and is projected to remain at or above that level under either current law or even current policy extended. But maintaining a level of revenues consistent with the past proves nothing about their adequacy for the future.

Certainly we must do all we can to control the growth in government spending, however, particularly where higher spending does not translate into higher-quality goods and services. On health care reform, we must learn from the demonstration projects and improve the flow of information in the health care market so that wiser public and private decisions can be made and wasteful spending eliminated. But the longer-term challenge will not be solved by cutting only the spending that is genuinely or even sounds like “waste, fraud, and abuse.” Tough choices on what kind of health care the public sector can subsidize and for whom (in other words, decisions about how to “ration” publicly provided health care) will have to be made. Because those choices are tough both economically and politically and will likely take a long time to both be implemented and to make a difference, health care and entitlement reform cannot be our only strategies to close the fiscal gap. Tax policy has to be a big part of the solution, too…

And my conclusion:

Conclusion: Moving from “Budget Scolds” to “Fiscal Inspirers”
As an economist and a mom, I believe that getting our nation back on a fiscally sustainable path is one of the most important ways we can ensure a bright future for our kids. To encourage this, fiscal policy experts need to do more than present the numbers and charts that warn of a scary but hypothetical future for the U.S. economy as a whole. We need to bring the issue down to the level of the family in order to make it immediately relevant to people right now. We need to remind parents that as they are working hard every day to provide for their kids, they need to demand that their politicians do the same for all our kids. Public education and engagement are crucial to not just sound an alarm but create a movement to promote fiscal responsibility as a duty to our kids and grandkids and make the “crisis” salient now. Instead of allowing our leaders to perpetuate the irrational notion that everything will be fine without having to make any tough choices, we need to tap into the inherit optimism of the American people to prove that what Paul Tsongas said (as he started the Concord Coalition in the early 1990s) was and still is right—that “we are better than what we are being asked to be by our leaders.”

27 Responses to “The Way Out of the Fiscal Hole: An Economist Mom’s Perspective”

  1. comment number 1 by: Gipper

    Economistmom,

    You wote:

    “That is why any parent should be particularly concerned about the budget outlook: it directly undermines all of our personal efforts to provide for our kids and set them on that good path. We contradict ourselves if on the one hand we are saving for our kids’ college educations but on the other hand are clamoring for more deficit-financed tax cuts or benefits for ourselves.”

    Well, let me say as a dad, of two (son 22, daughter 17), that my main concern is that my kids will be getting these great jobs and then paying marginal tax rates exceeding 45% (over 50% in CA)— if we do what Obama and the Democrats want.

    I’m concerned that the values I instilled in them are not shared by the majority of voters who think they are entitled to receive benefits, regardless of their prior history of tax payments. I’m afraid that unionized government employees have ridiculously inflated pension and health care benefits that my children will be stuck paying over the next 50 years.

    I’m outraged that I pay taxes for atrocious public schools in Los Angeles (as many of you do in other urban centers) that are merely expensive baby sitting services for a large number of students who graduate with few if any employable skills. As someone involved in recruiting and hiring folks for customer service positions, I speak with great authority on this matter.

    I’m afraid of the other children being raised by parents who think someone else owes them a living. I’m afraid of the other parents who have no shame in using the political process to reach into the wallets of strangers to pull money out for themselves and their own children.

    I tell my son that if he doesn’t save at least 30% of his income, that he’s a profligate bum. But then, I get worried when so-called economic experts urge more consumption to save our country.

    How much are the Chinese saving? How much is the US saving? Which nation has a higher growth rate?

    I worry when idiocy like this passes for common intelligence in our government’s economic policies.

    I worry when people claim they are virtuous when they expound the necessity of using other people’s money to assuage their moral passions. I worry when people stop leading by example, but instead follow the leader who makes them feel good.

    The budget, our deficits, our profligacy are all symptoms of a culture that denigrates the delay gratification.

    The demand that taxes not increase under Obama is a demand by many for cuts in spending programs. If these programs are not cut, and cut deep, then I worry for my children.

  2. comment number 2 by: Arne

    39.6+9.5 is close to 50 percent, but not over. If my kid is making over $250K, I am not going to be very worried for her.

  3. comment number 3 by: SteveinCH

    You left out the additional ACA taxes and the phaseout of deductions. A marginal rate of over 50 is easy to achieve.

  4. comment number 4 by: Arne

    Phasing out deductions does not raise the marginal rate. It increases the effective rate toward the marginal rate.

  5. comment number 5 by: AMTbuff

    >Phasing out deductions does not raise the marginal rate. It increases the effective rate toward the marginal rate.

    That’s incorrect. The actual marginal rate is the amount by which your tax liability increases per dollar of income increase. Most mortals cannot compute this due to the complexity of the tax code. However tax software makes it easy. Add $1000 to your wage income and see how much your taxes increased, both state and federal. Divide the total increase by $1000 and you have your actual marginal rate as a fraction. In virtually all cases, this will be higher than the advertised rate, also known as the statutory rate.

    If it makes you feel better to believe that the statutory rate has any real significance, be my guest. However any economist will tell you that only the actual marginal rate matters to your wallet. The effective rate is the integral of the actual marginal rate (also known to economists as simply the marginal rate) from zero up to your total income. The effective rate is useful for deciding to earn taxable income or to quite work and live off the money you buried in your back yard. The marginal rate is useful for deciding whether to work overtime or to take unpaid vacation, and for deciding whether to sell as asset that has an unrealized capital gain.

  6. comment number 6 by: Arne

    My bad, I forgot the entirety of payroll taxes.

  7. comment number 7 by: AMTbuff

    >As an economist and a mom, I believe that getting our nation back on a fiscally sustainable path is one of the most important ways we can ensure a bright future for our kids

    Right. The best policy for our children is to admit that we should never have changed the safety net into a hammock to be paid for by our children. We need to return that hammock immediately and be content with a simple safety net. Either we do it voluntarily now or our children will rip the hammock away from us later when they have the votes. I will vote with them to help that day arrive sooner.

    We need to give up all government health care guarantees in order to assure that basic welfare programs can continue. Otherwise the most likely outcome is that the Chinese will rip away both the hammock and the safety net by ending the bond bubble. Ironically, progressives will have been done in by their own greed, a passion they denounce above all other sins (although they rarely use the word “sin”). In this case it’s wanting a completely unsustainable level of government transfers, especially for health care.

    Progressives have made “better” the enemy of “good”, even though they don’t yet realize it. Conservatives have been complicit in this process, from Social Security to Medicare Part D. There are no good guys in this story: certainly not the voting public.

  8. comment number 8 by: xbalance

    Great article, I will share on FB. I have been a contributor to Concord Coalition, off and on, since it was founded. I wish more people would stop talking (see above) and start listening and thinking about how we need to navigate off of the road to fiscal disaster. I would love just once for those that say they have the answer on how the government should slash spending and the USA will be all better to put some numbers down (other than tax rates) and explain the long term consequences of their proposal. I find it hard to believe anyone would make such half-baked important suggestions at their job and expect to keep their job at the same time (unless they are the owner and have a monopoly).

  9. comment number 9 by: Gipper

    xbalance,

    We’ve been collectively challenging Economistmom and/or the Concord Coalition to do exactly what you suggested. Stop talking and put some numbers down on the spending and tax side that significantly reduce the deficit.

    The conclusion I’ve reached is that Economistmom and the Concord Coalition see the solution are that 90% of the deficit should be reduced by increasing taxes and 10% by reducing defense spending. Control federal healthcare expenditures by adopting a Canadian model and leaving all other social programs untouched, or perhaps increase them.

    Unfortunately, Economistmom and Concord refuse to be “outed.” This way they can preserve an air of non-partisanship that many of us commenting on this blog see as a sham.

    I don’t see that as a politically viable compromise to reach a long-term solution. Many of us want to see significant spending reductions in entitlements along with significant tax increases — not one or the other. Something closer to a 50-50 net change to reduce the deficit where we have a target of, say 21% of GDP spent at federal level with tax rates set to balance the budget in 20 or 30 years.

    That would represent a compromise with real pain for both parties. Are you on board?

  10. comment number 10 by: SteveinCH

    OK xbalance, here you go.

    1. Allow the Bush and Obama tax cuts to end but keep the AMT patch

    2. End all industry specific breaks in the corporate tax code

    3. Means test all transfers so that no transfer is available to an individual or company as long as either has over $750,000 in net worth/retained earnings

    4. Cut defense spending by an amount equal to the current Afghanistan and Iraq deployments.

    5. Freeze other spending in nominal terms until the budget is balanced.

    Should take 5 years or less.

    For extra credit although it doesn’t affect the Federal budget much.

    6. Hold government salary package increases (including perks and retirement) to the rate of inflation until the voluntary attrition rate reaches 5% per annum

    7. Eliminate bureaucracies until there is only one bureaucracy (state/local/federal) per issue. In other words, no Federal Dept of Ed, State Dept of ed, city dept of ed, local school board. Pick one and go with it.

    8. Institute a 5% challenge for compressible costs in the government…reduce cost by 5% without hurting quality or level of service. Private cos do it all the time, how about the government.

  11. comment number 11 by: AMTbuff

    Here’s one possible answer: Eliminate Medicare. Maintain Medicaid for the destitute, but at a rationed level of care that would make Britain’s NHS seem generous. Maintain welfare programs and something similar to today’s Social Security benefits.

    Result: no more spending hundreds of thousands of tax dollars on futile care for 80-year-olds. Families who believe that expenditure is worthwhile can use their own money if they have created enough economic value through their own work in the past and saved the money for it.

    Heartless? Yes, in comparison with utopia that we cannot afford. I claim that it’s better than what will happen when the government becomes unable to borrow. It’s also better than what we had before enacting the unsustainable Great Society programs in the 1960s.

  12. comment number 12 by: Arne

    There has to be an answer between Steve, who did not include healthcare expenditures and therefore did not solve the problem and AMTbuff, who eliminates something that is needed but needs much better cost controls.

  13. comment number 13 by: SteveinCH

    Umm Arne, what do you think Medicare is. It’s a transfer program that should be means tested.

  14. comment number 14 by: Arne

    In order to maintain total program cost by means testing you will need to keep setting lower and lower levels. Unless you control the growth of per beneficiary costs, you have not solved the root problem.

  15. comment number 15 by: AMTbuff

    >In order to maintain total program cost by means testing you will need to keep setting lower and lower levels. Unless you control the growth of per beneficiary costs, you have not solved the root problem.

    Right. Eliminating third party payment is the answer. Brutal but effective. Families are in the best position to weigh cost vs. benefit. No formula-driven payment can avoid wasting hundreds of billions of dollars.

    There is no way the public will accept this until an overwhelming crisis occurs. Therefore, according to Stein’s Law, the crisis will occur.

  16. comment number 16 by: SteveinCH

    But the point is not “to maintain total program costs”. The point is to lower total program costs to give us time to solve the problem without going bankrupt, killing the program entirely, or hoping that the ACA is somehow going to save us.

    I get it’s not a long term fix but it solves the problem for the next 15 to 20 years. From my point of view, relative to the options, that’s a pretty good one.

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  18. comment number 18 by: Gipper

    SteveinCH,

    Great suggestions. I’d also eliminate itemized deductions for mortgage interest and state income taxes. Make employer-provided healthcare benefits taxable. Doing that would probably allow tax rates to be set between current rates and new rates.

  19. comment number 19 by: SteveinCH

    Gipper,

    I’m largely indifferent between rate changes and taking on deductions and exemptions. Philosophically, I favor your approach. Practically, I think just letting the law stay the law is a much easier way to go.

  20. comment number 20 by: Arne

    “But the point is not “to maintain total program costs”. The point is to lower total program costs”

    Had I proofread more carefully I would also have said control rather than maintain. Control does not require reduce, though. There seems to be room to reduce, but maintaining current levels would be more than enough to control the problem.

  21. comment number 21 by: Arne

    “Eliminating third party payment is the answer”

    I think I must not understand what you are saying. You mean no insurance industry. Anyone with catastrophic health care costs will just have to die?

  22. comment number 22 by: AMTbuff

    >Anyone with catastrophic health care costs will just have to die?

    That’s the default, unless you bought your own insurance with your own money. Or unless you have produced enough and foregone enough consumption to pay for your care out of savings. Or unless you can find charity care. Or unless you spend everything on care and fall back onto Medicaid, and unless Medicaid’s harsh rationing does not cut off your care.

    In other words, you get the very same deal every American got before Medicare, plus you have a minimal safety net from Medicaid. Is that worse than complete collapse of the welfare state?

  23. comment number 23 by: SteveinCH

    My point Arne is that controlling the rate of growth is very hard…cutting and allowing it to grow back over the course of a number of years is a more realistic solution than “controlling”

  24. comment number 24 by: SteveinCH

    At least in the short term

  25. comment number 25 by: Jim Glass

    “My point Arne is that controlling the rate of growth is very hard…cutting and allowing it to grow back over the course of a number of years is a more realistic solution than ‘controlling’”

    Probably the only possible solution. Economic fundamentals of health care:

    * Health care is a ’superior good’, meaning that as income rises people voluntarily spend a greater portion of their income on it. They want to. (As they spend a declining % of income on basics such as food, closthing, housing, etc. they spend more on ‘quality of life’ items like health care.) So if the economy keeps growing health care costs will continue to rise as a % of GDP. There is no way to reverse this rising trend but brute force — and people won’t want to reverse it, so they won’t vote for that brute force.

    And as Andew Biggs has documented, US health care costs are rising at only the average rate for OECD countries. (IIRC, a tad less!) So that’s not the problem.

    * Because of the above, richer countries spend more of GDP on health care than poorer countries. There’s pretty much a straight-line relationship. Here’s the chart of it, from a great series on health care costs, well worth reading.

    The US is the richest country, so it spends more of GDP on health care than any other country, and it should. So spending more than anyone else is not the problem, per se.

    * The problem is that the US is the only advanced economy that is off the line in that chart — way above it. While we should be spending more than anyone else, we’re spending way more than we should.

    So the realistic objective should be to cut back spending to get down closer towards that line, then let the growth of spending resume.

    But a lot easier said than done. That series runs through the whole series of proclaimed “magic bullet” cures for the health care system to reveal the data showing they are all blanks. The cost problem *isn’t* pharma, or aging population, or insurer profits, or obesity, or bad health habits, or malpractice insurance costs, or any other one thing. They are all red herrings.

    Or more accurately, it is all those things a little bit each. The problem is everything costs too much. That’s not going to be easy to fix.

  26. comment number 26 by: Jim Glass

    >>Eliminating third party payment is the answer. Brutal but effective.

    >I think I must not understand what you are saying. You mean no insurance industry.

    That’s the default, unless you bought your own insurance with your own money.

    My problem isn’t with third-party insurance and govt payments per se, it’s that these are used today for the wrong things.

    “Heath care” is a huge part of the economy, about a sixth. It has a whole lot of very different components. It could be considered a dozen or more different industries. There’s no “one fix” for all of them. Third-party payment and govt socialization of risk can contribute positively to some.

    The problem is that the entire health care sector of the economy has been restructured by politicians to meet their political needs rather than for economic sense.

    For instance, common sense tells us that routine out-of-pocket costs should be paid for out of pocket, that keeps the competitive market functioning fully to maximize productivity and innovation and reduce costs … large, statistically predictible expenses should be paid for by insurance, with medium market benefits … unforseen catastrophic expenses can be socialized with minimal loss of market efficiencies, because there’s not much of a market in dealing with catastrophies.

    Now look at how Medicare is structured — exactly the reverse! It provides first-dollar coverage for routine doctor visits and entirely predictible out-of-pocket costs … but if one suffers a true medical calamity and needs full nursing home coverage, it provides zip, squat, nada. There go your home and life savings. (I have first-hand personal experience with this, so I know.) The result is that the free competitive market for routine care is destroyed, even beyond that costs go up because every small predictible routine expenditure has to be burearcratized … while one is left nakedly unprotected against calamity.

    Imagine if the govt imposed “auto care” the same way. Everybody gets free gas, oil, maintenance, and normal repairs, new tires and all that, for their cars at taxpayer expense. But if you total your car head-on, it is destroyed and you fly through the windshield, you get nothing. What would the economic result be?

    That’s Medicare! Yet Medicare is proclaimed a *huge success*, Krugman wants a “Medicare for Everyone” system?!?

    Well, Medicare is a huge success politically, because everyone approaching 65 knows they are going to have a lot of predictible expenses, but most people grossly underestimate their risk of needing nursing home care, etc. So they are happy to give their votes to politicians who give them “free care” by picking up the costs they expect, but not the ones they don’t.

    It is economic lunacy, but makes perfect political sense. IMHO, in all the talk of problems in the health care system, this one example stands out like an elephant next to a gerbil — but nobody talks of it.

    The way it illustrates how political incentives run entirely contra to sensible economics in health care IMHO explains all the *worst* malformations of the entire health system, all driven by politicians: the employment tie to insurance (only in the USA), such insurance having to pay for everything no matter how little, mandates forcing expensive benefit coverage most people don’t want, the exemption of health insurance from anti-trust creating hugely expensive cartels and anti-competitive regulation in many states (what other major industry lacks a national market?), the hugely costly & inequitable & inefficient tax deduction for medical expenses, etc. etc.

    And what has Obamacare done? Further institionalized all of these — following the political incentives.

    Until the politicians see they have to get out of the medical industries as much as they are out of other industries, I can’t see how things will get better. That’s why I despair.

  27. comment number 27 by: SteveinCH

    Excellent posts Jim.

    I’ve said it before and I’ll say it again. There are only two ways to reduce health care spending. Reduce the number of treatments performed or reduce the cost per treatment. One could include mix of treatments as a third source of saving although this effectively reduces (or increases) the average cost of treatment.

    To the last point in Jim’s first post, the primary driver of why the US pays more with worse outcomes is because our cost per treatment is higher.

    That in turn is higher for two primary reasons. First, we pay people a lot more in medicine than do most other countries. I’ll look up the link if needed but there are a number of studies that demonstrate this for both GP/FPs and specialists. In addition, we spend a lot more on end of life care because we don’t ration this care the way that (many) other countries do.

    And why do things cost more in America. Well, I’m sure there are lots of reasons but one of the big ones is the crazy system of insurance that Jim describes. It isn’t insurance, it’s a transfer payment and it pays for the wrong things and messes the system up mightily.

    So to come back to solutions. We either need to lower the number of treatments or lower the price per treatment. That’s it. No other choices. And now sadly we come down to it. The one thing the US government seems to be incapable of is lowering the number of treatments so we’re basically left with price and the only way to do that is to massively cut the salaries of health care workers and the price of pharma and med device products. Any of these actions will impact quality and quantity supplied in ways that we cannot truly understand.

    That’s why I default back to means testing. At least it improves the government’s finances around health care without requiring changes that I simply cannot see coming from our political process.