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Ordinary People to Politicians on Taxes: Grow Up, Already!

August 19th, 2011 . by economistmom

Here’s an encouraging article in this morning’s (Friday’s) Washington Post, about the conversations politicians are having with their constituents back at home this summer.  Seems that Republicans are getting scolded, and Democrats are feeling a little less wimpy these days, on the topic of tax policy’s role in deficit reduction (emphasis added):

SANDWICH, Ill. — On Wednesday morning, as his tinted black bus pulled into Randy Hultgren’s congressional district, President Obama told residents that Republicans like Hultgren must be willing to raise taxes to reduce the deficit.

A few hours and 90 miles away, Hultgren’s own constituents had picked up the message, repeatedly hectoring the freshman congressman at a town hall meeting to raise taxes on the wealthy and corporations.

“We have clear information that tax cuts, especially to the super rich, has not increased any more jobs,” one man told him. “I want to know under what conditions you would be willing to consider increasing taxes, especially on those who can afford it? ”

“I just have one question for you tonight,” said another. “Did you sign Grover Norquist’s pledge to never raise taxes?” — referring to the promise that has been signed by most congressional Republicans, including Hultgren.

“Don’t you have the confidence in your own ability in Congress to make up your own mind? You need Grover Norquist to tell you?” the man continued.

The article makes a similar point to one I made in this blog post for the Concord Coalition.  At Concord we believe there’s nothing that will work better to steer tax policy in a better direction than ordinary Americans telling their politicians to “grow up” about taxes.  (Join our mini “movement”–explained in our video–if  you want to learn and do more.)  And it’s not just the Republicans held to the “no new taxes” pledge who need to grow up about it, by the way.  The Democrats are still living in a bit of a fairy tale about tax policy in thinking that we only need to consider tax increases on (very) rich households and on certain types of not-so-highly-regarded (as well as very rich) corporations.

There’s “growing up” on entitlement reform that’s needed, too–”not gonna lie” (to use one of my 14-year-old daughter’s favorite expressions).  Any “grand bargain” would have to involve some plans to improve Medicare, Medicaid, and Social Security as well as to reform the tax system.  But I think the time is right for tax reform to go first, especially given the lack of taxes in the first round of the debt limit deal, the relative mechanical and economic ease of raising revenue versus cutting entitlements or other spending within the first ten years (to which the $1.5 trillion deficit reduction target applies), and the clamor of the American public (even from some of those really rich people who would surely pay higher taxes) for policymakers to just raise revenue.

29 Responses to “Ordinary People to Politicians on Taxes: Grow Up, Already!”

  1. comment number 1 by: Arne

    Apparently taxpayers need to be a little better informed about growing up on taxes. The man who asked “under what conditions” is taking a step in the right direction, but he is still showing a bias to have other people pay more. When the question becomes “how much is my share” we will have seen some meaningful progress.

    On SS the question should be do you want to pay a little more or do you want future benefits to increase by a little less than currently scheduled.

    On healthcare it needs to go farther, but it is still about costs can not go up as fast as projected. We need people to understand that all keeping their part of the cost down means not having all those procedures. This is not what politicians are saying to people.

  2. comment number 2 by: AMTbuff

    Tax increases merely kick the can down the road unless they are _preceded_ by cuts in promised benefits sufficient to make those programs fully sustainable. It’s better to save those revenue increases for the day when voters get serious about cutting spending. Then and only then will tax increases make fiscal sense.

  3. comment number 3 by: Underwriterguy

    The only way to overcome my cynicism about politicians’ willingness to make hard choices is if the tax increases and the spending cuts occur in the same time frame. More taxes now and cutting “down the road” just doesn’t play for me. And the whole policy versus law dance just adds smoke to the mirrors.

  4. comment number 4 by: Arne

    “unless they are _preceded_ by cuts in promised benefits”

    SS and Medicare Part A cannot spend once their trust funds are depleted. That means that there is a huge misunderstanding about “promised benefits”. Being honest about that would be a big step in politicians growing up, but it would seem that many of them need to be educated about it before they try to be honest about it.

    We need to raise taxes now because we already obligated ourselves for the expenses - Iraq, Afghanistan, paying back the SS TF. Preventing ourselves from accepting new obligations (trying to keep up with providing new medical procedures for everyone) should be a separate issue.

  5. comment number 5 by: Dave

    It seems to me that the basic issue here is: is there such a thing as a free lunch.

    The populist sentiment to tax the other guy (perhaps the wealthy one) and provide the little guy with enormously expensive ‘promised benefits’ is at the heart of the problem.

    At present, some 47% of Americans on the lower end of the income spectrum have no income tax liability, hence the operation of federal government is ’someone else’s problem’ . Their advocates proclaim ‘…but we pay payroll taxes!’

    No, actually, you are subject to payroll deductions, which are intended to cover the actuarial cost of promised benefits.

    But payroll deductions do not pay for national defense, border control, highways, or the Treasury bonds (even if the Treasury does sort of filch the trust fund monies).

    The bottom line is, half the population doesn’t wish to fund this government. At all.

    Warren Buffet has observed that he doesn’t think firms change their investment behavior based upon tax rates. I generally agree, at least retrospectively. But that retrospection is over a period exhibiting some degree of tax equity.

    However, when you look at latin american examples of nations which collect no taxes from the majority and instead soak particular (mostly immobile) industries, yes, then investment and human capital go offshore.

    Part of growing up has got to be that when you propose a federal expenditure/benefit, you are also implicitly proposing to participate ratably in paying for it.

    If the populists go for the ‘free lunch’ concept by soaking the rich or the successful, they may well kill the golden goose.

    If you were to ask most Americans if they want a set of medical/retirement benefits with the proviso that they must (all) pay in the actuarial value of their expected benefits over a period of time, I suspect they will tell you ‘No, thanks. I thought it was free.’

  6. comment number 6 by: AMTbuff

    >If you were to ask most Americans if they want a set of medical/retirement benefits with the proviso that they must (all) pay in the actuarial value of their expected benefits over a period of time, I suspect they will tell you ‘No, thanks. I thought it was free.’

    I think the answer would vary depending on the probability and size of the potential financial loss and the cost of protection from that loss. In other words, people will choose to pay the relatively low cost to protect themselves from high and unlikely losses.

    Losses that are moderate or likely cannot be affordably covered by insurance or by universal government benefits. Those losses can only be covered for the poor. That’s the reality that advocates of middle class entitlements cannot face.

  7. comment number 7 by: Dave

    Yes, yes, by all means, concave Von Neumann Morgenstern utility and all,… my point was that when you ask them about paying for their government, they point to payroll deductions. When you then explain that those monies are (more than) spoken for if they expect entitlement benefits, they will claim that these are rights. So they are willing to pay taxes OR payroll deductions, but not both, and they believe they are DUE their entitlements The American middle class is still looking for that free lunch.

    I very much advocate enlisting their consumer preferences to make the hard choices about savings, retirements, and healthcare, but once you put them in the driver’s seat, you’ll quickly find that the middle class abandons the risk pool associated with low income and high risk insureds.

    an aside on income transfers disguised as social insurance:

    Obamacare is not about actuarially fair insurance; it’s about creating income transfers out of fabricated insurance pools with involuntary participation. That’s why so many reacted violently to Obamacare. If you make it voluntary and actuarially fair (ie. nonsubsidized), then a) the middle class will cease objecting, b) the middle class will opt out, and c) the programs will be unaffordable to the low income and adversely selected participants in the pool.

    Far better (and more transparent) to simply propose an income transfer by check, with which market rate insurance may be purchased.

  8. comment number 8 by: Jim Glass

    Warren Buffet has observed that he doesn’t think firms change their investment behavior based upon tax rates.

    Yet he constantly urges people to invest in tax favored accounts — and built his own empire through the mechanism of an insurance company making massive use of tax deferral.

    But I’m not knocking Warren, since I saw him say entitlements should be means tested, his tax increase would be only on persons making over $1 million a year (not $250k), and going forward revenue should be held at 19% of GDP and spending at 21% of GDP.

    Warren’s OK with me.

  9. comment number 9 by: Jim Glass

    Underwriterguy wrote:

    The only way to overcome my cynicism about politicians’ willingness to make hard choices is if the tax increases and the spending cuts occur in the same time frame. More taxes now and cutting “down the road” just doesn’t play for me.

    Exactly correct. But don’t think it is cynicism. People respond to incentives. *All* the incentives tell *all* the elected politicians “make promises today, kick the costs off to somebody else later”. They really have no choice. Recognizing reality isn’t cynicsm.

    It has always been so. And it is entirely bipartisan.

    In 1940 Congress turned SS from funded to paygo, to provide bigger benefits at lower tax cost up front, over FDR’s veto and with FDR’s people protesting that this would only drop a big cost on the future. The Congressional leaders told Altmeyer, FDR’s head of SS, “we’ll be gone by then” … Then indeed SS went bust in 1983, was restructured, and they did it again — spent the $2.5 trillion surplus up front, letling somebody else figure out how to raise $2.5 trillion of taxes on a later generation to make up for it … Obamacare is created with funding from “A Committee to Find Medical Savings Later”, but the savigns are scored as being realized *now* … The Republicans create a debt ceiling crisis demanding big spending cuts — then claim victory saying they got them *today* via heavily back-loaded cuts to be found by “A Committee to Find Spending Cuts Later”.

    Point is, it is a big MISTAKE to attribute this to “lack of political leadership”, “lack of political will”, “refusal to make hard choices” or anything like that. The result is institutionally built into the political system. (Not just ours, all the big western democracies are in the same fiscal boat for the same reason.)

    Consider a business. There are a lot of groups in it that could gain by making decisions that loot its future. But there is a countervailing force in the institution of “ownership” — any cost dropped on its future lands on its owners today, immediately, at a cost that is discoutned to present value. They don’t like it, and they have the power to stop same (usually).

    No institution like this has existed in government since the demise of Kings who owned their realms. I’m not for brining back old-style monarchs, but until some equivalent mechanism is built into the constitutions of modern democracies, nothing is going to change for the better. I’m sure some such mechanism *will* be built in eventually, as a matter of political natural selection — but it won’t happen until the fiscal excrement blows through the fan world-wide around 20 years from now.

    Thinking the problem is that our politicians “lack the character and will” to face hard problems is unrealistically optimistic. We can always hope to elect politicians with better character and greater will later. But if the problem is institutional, hard-built into the system, then there is no hope at all that the politicians will change their behavior before it is too late.

    AMTbuff wrote:

    Tax increases merely kick the can down the road unless they are _preceded_ by cuts in promised benefits sufficient to make those programs fully sustainable. It’s better to save those revenue increases for the day when voters get serious about cutting spending. Then and only then will tax increases make fiscal sense.

    Exactly correct as well. Revenue increases before the crisis hits will just be blown through for short-term political gain (say “Social Security surplus”) then when we really need them they will be gone, and where will we be then? Look at all the European nations that put in major VATs — they are heading off the fiscal cliff as soon or sooner than we are, all that extra revenue hasn’t changed that a bit … and now as they face their fiscal crunches, their VAT money already shot. At least the USA has a VAT in reserve, if need be. Raising taxes now to blow through them now will only make the future *worse*.

    No deal to fix the long-term budget is serious unless it includes both spending cuts *and* tax increases, up front, in real dollars in real time. None that is not serious in this way should be considered anything but political posing.

    And given that (1) *all* the political incentives are to minimize pain short-term hile shifting it into the future, and (2) no “deal” Congress makes today is enforceable against it tomorrow, with shifting coalitions any deal made today can be renegged upon or double-crossed by politicians to come, alas, the only logical result is brinksmanship at the last minute. Either side that makes a “reasonable” early comprise offer to the other can be very confident of getting rolled and regretting it dearly.

    We’ve seen this before too. When Social Security went bust in 1983, neither side gave an inch until the very last moment when the alternative of not giving would have been even worse for them. Then they came up with a last-second deal that was near exactly a 50% tax increase and 50% benefit cuts compromise.

    The only politicial difference between then and now is that the fiscal gap we have ahead of us is maybe 30 times larger than then. Which is awful. But the political incentives are exactly the same, so we are going to do down the same political course.

    Brinksmanship it will be — and it *should* be, because that’s the course to the best result with the institutional structure we have.

    Of course, it is also an *awful* way to risk the welfare of the nation. But to paraphrase the Evil Mr Spock, “It is not enough to have a responsible intention, one must also have the means in the form of the required instutitional structure.”

    Now, if people want to adopt my proposed constitutional reform and make me King and Owner of the USA, I’ll have this whole mess straigtened out in a week. Just let me know.

  10. comment number 10 by: Vivian Darkbloom

    “*All* the incentives tell *all* the elected politicians “make promises today, kick the costs off to somebody else later”. ”

    I agree that this is a structural problem, that it is bipartisan, and that it has been the biggest cause of the fiscal mess we are now in. But, there is one factor that might, just might, turn this around before that can hits the wall.

    You can’t kick that can down the road forever. What we mean by kicking the can down the road is that someone else or some future generation is going to pay the price for our recklessness. Until recently, that “future generation” consisted of persons who were not yet born, or were at least not of voting age. The consequences of kicking that can down the road were not so clearly in sight.

    We’ve reached the point now in which the consequences of our fiscal irresponsibility are visible. There is no longer a need to look very far down that road, or around the bend of that road, to see what’s coming. This might change the structural political incentives as younger voters become more aware of what the current and recent generations, including the so-called “Greatest Generation”, have done to our finances.

    Young people today are growing up in an environment quite unlike the one I grew up in. The consequences of over-leverage, both public and private are constantly in the news. I think they feel, and some even understand, that their lack of opportunity and economic prospects are the direct result of our profligacy. A lot of them resent picking up the bill.

    Right now, demographics favor the retiring boomer generation. But, I see the real prospect that a coalition of young voters, and some sentient and unselfish older voters, might just change those political “incentives”.

  11. comment number 11 by: Arne

    “In 1940 Congress turned SS from funded to paygo”

    False. SS has always been primarily paygo.

  12. comment number 12 by: centerist cynic

    I question the assumption that 50% of Americans are unwilling to pay for the cost of Government. I do not believe these people are somehow exempt from paying sales tax or federal taxes on things like gas.
    A large portion of those not paying federal income tax are retired and presumably have finished paying taxes on their income. Another large portion of them are low income. Many of them are making on average about $16k per year. Still another portion are the rich who have managed to defer the taxes on their income.

    Additionally, It is misleading to use the 47% of Americans pay no income tax to condemn the tax system. Since Reagan, the US has used the federal tax system to funnel aid to the working poor by using tax credits and deductions. It is these tax credits that reduce the working poo’rs tax bill to zero or less.
    Even though tax credits and deductions reduce the working poor’s tax bill to zero or less, people in the upper 20% of income earners still receive over 2/3rds of of total tax credits and deductions.

  13. comment number 13 by: SteveinCH

    Then again, the top 20 percent pay about 85 percent of Federal income taxes so receiving 2/3rds of credits and deductions is not really all that surprising now is it?

  14. comment number 14 by: Arne

    If you are married with two kids and have a total income less than $40K, the standard deduction with the personal expemptions and EITC push your tax down to zero - even though $40K puts you above the median income. (Childcare credits could push that up more.) This tax structure is why you can have so many people with no tax. It does not mean they are “unwilling” to pay taxes.

    Having kids is a temporary condition, so it is fair to say it is unlikely that there are very many taxpayers who will stay in the category of paying zero income taxes.

  15. comment number 15 by: Jim Glass

    “In 1940 Congress turned SS from funded to paygo”

    False. SS has always been primarily paygo

    False. The original SS Act of 1935 was primarily funded. FDR made an explicit point of making sure it dropped no cost on future generations as a paygo system must do. To the point where he had a famous fit when he discovered some people had slipped into a draft benefit promises that were to be funded from general revenue in the 1960s, and making them pull it from a presentation to Congress and re-write it.

    If only *any* any politician today cared so about the finances of 30 years from now!

    Each cohort of workers under FDR’s progam paid for its own benefits through a payroll tax that was designed to quickly rise to 6%, building up a huge trust fund (paying down the national debt, increasing national savings) that by the 1980s was projected to hold trilllions of dollars (2011 dollars, $500 million 1935 dollars, IIRC).

    Full retirement benefits weren’t payable for 30 years. The average return on contributions was the federal bond rate (expected at 3% real) for *all* generations to come — this was an *explicit* promise during political the campaign to enact SS.

    Progressivity came from those with the higher wages *within* each cohort getting a smaller benefit relative to wages than those with lower wages — *not* from having the young pay the benefits of the old.

    This is why FDR described SS as “actuarially sound and out of the Treasury forever”. He meant it.

    Then the *very first Congress* to meet after the payroll tax revenue started coming in felt the **irresistable institutional pressure for short-termism**.

    The left said, “Why use all this tax revenue coming in just to pay off bonds held by the rich? What’s liberal about that? Let’s spend it today!”, and drew up plans for all kinds of vast 1930s-socialist-type spending.

    The right said, “We can’t possibly save this money, the left will just spend it all. Let’s give it back to the workers by cutting the tax!”

    Sound familiar? So, of course, they compromised by doing *both* — stopping most of the planned increase in the payroll and greatly increasing benefits for retirees.

    FDR’s head of SS, Arthur Altmeyer, protested vehemently, saying that by arithmetic this was certain to both subvert the future solvency of SS and cause future retirees to suffer a much lower return than current retirees, or even losses, which would be both unfair and subvert political support for SS. (I’ve quoted him on this is these comments before.)

    Altmeyer reported that the Congressional leaders told him: “Maybe so, but we’ll all be gone, it will be somebody else’s problem”.

    Short-term incentives *rule* Congress, there are *no* incentives supporting long-term responsibility.

    Congress passed the changes over FDR’s veto. SS became paygo and actuarially unsound forever from then on. Result:

    Stage I: Huge benefit for first retirees relative to contributions.

    Paul Samuelson *praises* SS for being “actuarially unsound, every generation gets back 10 times its contributions… a Ponzi game that works!”

    Stage II: SS goes broke in 1983, exactly as Altmeyer predicted. The “bailout” enacted protects all the benefits of the older while dropping its cost on the younger.

    Short-termism rules! *No* pain shared up-front, *all* the pain dropped on the future.

    Stage III: Workers today pay 12.4% payroll tax compared to 2% in the 1940s … on a wage base almost 2.5 times as large in inflation-adjusted dollars compared to FDR’s … and owe income tax on up to 85% of benefits — this “tax” being remitted back to the SSA, *not* to Treasury general revenue like all other income tax, revealing it to be a disguised benefit means test … with the base level of the tax not indexed for inflation, so the tax becomes bigger every year.

    This is all part of today’s workers taking a $17.4 trillion loss relative to their contributions, as per the SS Actuaries. (So much for Samuelson’s Ponzi Game that works!)

    And this $17.4 t doesn’t include the extra $2.6 t they are going to have to pony up to cover the surplus that Congress consumed since 1983 — Short-termism rules! — without getting a penny more of benefits for it.

    That makes their loss a nice round $20 trillion.

    Stage IV, still to come: Today’s workers start eating that $20t loss …. their politicial reaction towards SS is … ????

  16. comment number 16 by: Arne

    Text of SS Act of 1935
    http://www.ssa.gov/history/35actii.html

    Refer to section 202 and assume a beneficiary made $1000 annually from 1937 through 1942. He will have paid in $60 and will receive $230 per year. This is paygo, NOT fully funded.

    “payroll tax that was designed to quickly rise to 6%”
    Per section 801, it topped out at 3 percent after 12 years and would have stayed there. Congress did cut it back from that when income exceeded expections when the Depression ended. FDR did veto the 1943 bill that cut back SS tax increases, and he did use the opportunity of the veto to warn against the cut back, but the veto was for other reasons.

    Samuelson was wrong about SS in 1968. If he had looked at the SS reports it should have been clear that Congress was thinking too short term in the 50s and 60s.

    As long as people keep living longer, the costs of SS will keep going up and so there will be a continual need for adjustments (small increases). Congress and Samuelson should have figured out long before 1983 that it was not just the Baby Boom.

  17. comment number 17 by: Arne

    The $17.4T number, Table IV.B6 of the report, “Unfunded obligation for 1935 through the infinite horizon”, which is up to $17.9T for 2011, is not an indication of a loss. It really has no useful meaning other than as a political scare tool.

    Since SS is paygo, it does happen to represent the startup cost to date. However, it does not even represent to transition cost to a fully funded program. The fact that it goes up every year tells us two things. 1) Each cohort does come out ahead. 2) In the event SS ends (because a comet hits the Earth), if there are more years between now and then, there will be more people who never get their SS benefits.

  18. comment number 18 by: SteveinCH

    No Arne, it tells us that each generation has come out ahead so far. The CBO can tell you this is no longer the case should you care to look.

  19. comment number 19 by: Jim Glass

    Stan Collendertells us

    “Federal budget agreements have seldom, if ever, gone the distance. Instead, they have always been changed, waived, ignored or abandoned long before they were scheduled to expire.”

    Another part of how brinksmanship is forced by the political institutional arrangements.

    Once a deal is reached “looking to the future” — consisting of the long-term planning we’d all like to see — there is no way to hold the other side to it.

    With a slight change in the political currents, your side’s “final compromise final terms final deal” becomes just the start of what you give up, as the other side uses it new power to rip off as much more as it can get.

    Logical conclusion: Don’t settle until the very last second, when it will be impossible to change the deal later. Until then, take the hardest “no-compromise” stance possible, to strengthen your bargaining position then.

    The problem is Congress has no way to commit itself to follow a current agreement in the future. Thus both sides must assume they will be effectively double-crossed if they reveal or agree to their true bottom lines now. Thus they would be stupid to do it … thus brinksmanship.

    Hoping for more “leadership”, “character”, “foresight”, “responsibility” in the members of Congress is of no point –lack of character isn’t the problem.

    Lack of a commitment mechanism is the problem. If they had one, the most scabrous lot of them could reach an effective budget deal looking well ahead, if only to save their own scurrilous political necks.

    Well, it’s one of the problems.

  20. comment number 20 by: Vivian Darkbloom

    I think one of the problems with this discussion on social security is that no one is drawing a (clear) distinction between the intention of social security and the reality of that program. In specifically citing section 202, I think Arne is hinting a bit more at reality and a little less on the theory.

    For example, I agree with Jim Glass that the original *intent* of FDR and the program was that have each generation would fully fund its own benefits. But query: what is a “generation” or a “cohort” here? The original Act did not create a separate trust fund for each “generation” or “cohort” such that benefits would stop if the funds ran out for that cohort or generation. That may have been the intent, but whether that intent translates into reality is quite another matter. Admittedly, the original vision didn’t have much of a chance because it was changed, but it could never precisely live up to live up to its purpose due to its actuarial assumptions. Did FDR foresee that people would live as long as they now do? (The fact that the original benefit formula contained no COLA adjustment mitigated this somewhat, though). As Jim states, one important assumption is with respect to real interest rates. And, Arne is correct that one’s assumptions on longetivity are also important. The intent of the original program was only as good as its actuarial assumptions. As they say, “the road to hell is paved with good intentions”.

    I think I’ve commented here before that the SS system should have a mechanism by which these actuarial assumptions are periodically tested and subject to automatic adjustment (on the contribution and benefits side) rather than leaving it up to the political process, which has historically been the case. Only then, could we assure that any SS trust fund be “fully funded” by each generation. Of course, that would not remove the short-term politics, but it would lessen the influence. Even section 202 of the original act did not have a self-correcting mechanism. In this sense, Jim Glass is also right–the system is subject to the political process, but the original act was subject to that same problem in respect of its actuarial assumptions, too, which it left to future politics to correct, only to a lesser degree than the current version.

    Or, we could move to individual accounts, which I think Gipper has been hitting on here, to solve that problem. Interestingly, the original act did, in some ways, have features of an individual account. For example, if a person died before reaching age 65, his or her estate would get a portion of their contributions on lifetime earnings refunded.

    Unfortunately, it’s too late to retroactively fix those massive mistakes of the past.

  21. comment number 21 by: Jim Glass

    The original actuarial assumptions for FDR’s SS program ran 50 years, to the mid 1980s, and proved remarkably accurate. It’s not so hard to predict population only two-thirds of a lifetime ahead.

    By the mid-1980s SS was projected to have a very significant balance in the trust fund, representing national savings from paying down the national debt (when in reality, due to all the program changes, it was empty and SS couldn’t pay its bills).

    Such was the original intent. In retrospect, many might argue that the “trust fund invested in T-bonds” mechanism couldn’t have worked in the original plan any more than it did when it was brought back — entirely by accident — in the 1983 reform.

    That was an argument right from the start, in the debates over the 1935 Act. Many (including many in Congress) said Congress would just spend the surplus payroll tax revenue. There was no way to hold Congress to paying down the debt, it could just consume the money as it came in (as we’ve seen $2.6 trillion of with the surplus since 1983). The people on the right saying this, and the people on the left saying Congress *should* just spend the money, formed the left-right alliance that every quickly turned SS paygo over FDR’s objections.

    FDR and Altmeyer recognized this issue right from the start, but what could they do? FDR very strongly wanted a funded program rather than a paygo one. In 1935, the only way to fund a program of this size was with government bonds.

    My point here isn’t to start another argument about SS — it’s about the course we are on today.

    It is that the “short-termism” political incentives and dynamics in Congress are so powerful that even FDR himself, at the peak of his power, with his own party having overwhelming majorities in both houses, couldn’t resist them for even *one* session of Congress to keep his signature social program funded.

    If FDR at the peak of his power couldn’t preserve the sound long-term funding plan for the SS program that he created and designed — wasn’t able to get it through even *one* Congress — what chance is there that today’s politicians will straighten out our vastly worse and bigger fiscal mess by taking unpopular actions up-front today to create long-term benefits for a better future?

    Again the problem isn’t lack of character or leadership, or too much ignorance, in our politicians. It’s that *everyone* in Congress feels pleasure and pain — up to the point of being eliminated from the job — from what happens in the very short run, while NOBODY in Congress gets a reward for improving the future, or feels pain as the result of harming it.

    So they do what they must to survive — subvert the future. Until this institutional defect in our political system is changed, they are going to keep doing it all the way until the credit rating of the USA is on the verge of falling to a lot lower than AA+, as per the market, not some rating agency pencil pushers — or something just as bad is about to happen. When that pain becomes *short run*, they’ll do something about it.

    I don’t think this is being cynical, but realistic. Being realistic is good when seeing a big problem coming at you and looking for ways to mitigate it.

  22. comment number 22 by: Jim Glass

    Keith Hennessey applies my point, about Congress being unable to commit itself,to the recent budget deal…

    The big risk to the Debt Control Act is that policymakers might believe that the back-end threat will be undone just before it bites…

    The Joint Committee has a deficit reduction target: a range of $1.2 T – $1.8 T over 10 years … If the Joint Committee fails, an across-the-board sequester will be triggered, automatically cutting spending by $1.2 T …

    The fear of these spending cuts creates an incentive for the Joint Committee to reach agreement. If the trigger is going to bite, then the pain is certain and the only question is whether the Committee can find an alternative distribution of that pain which is preferable to the automatically triggered spending cuts.

    The problem is that the first triggered spending cuts wouldn’t happen until January 2013, after a Presidential and Congressional election. The risk is that the Joint Committee fails to reach agreement and the election happens.

    With or without a new political configuration in DC, policymakers in both parties might look at the now-looming spending cuts and agree:

    “We can’t allow a 10% cut in defense, an 8% cut in education and health research spending, and a 2% cut in Medicare to take effect next month. That’s too sharp and severe of a cut. Let’s renegotiate a new 10-year budget deal and change the law. This new deal will reduce the deficit even more than current law would over the next ten years, but it will phase it in more gradually, so that we cut little to nothing in early 2013. We’ll turn off, reduce, or delay the triggered spending cuts, and in exchange deficit hawks and spending cutters will get even more promised reductions in the future.”

    … a future Congress and the President can unwind any hard choice made by their predecessors.

    As we look now at the Joint Committee before it begins, it matters less whether this post-election cop-out will happen, then whether the negotiators on that Committee and other elected policymakers *think* it will happen.

    If they *think* Congress will renegotiate post-election, then the pain threatened by the sequester is diminished. This reduces the expected cost of a Joint Committee failure and makes it even more difficult for them to reach agreement.

    Here’s the irony. What we need from the Joint Committee is for the parties to agree on a solution. They may not reach agreement now on a hard choice, because one or both sides anticipate they will instead reach agreement 15-16 months later on a mutually agreed upon cop-out.

    You can already see signs of this. Washington insiders are expressing skepticism about the sequester and Congress’ and the President’s willingness to enforce it later.

    They argue “Don’t worry, we can always renegotiate the X cuts we oppose after the next election.”…

    We shall see.

  23. comment number 23 by: Vivian Darkbloom

    Jim,

    It is instructive to actually read the legislative history. True, FDR, in his submission to Congress, articulated in a self-serving and somewhat hypocritical manner his intent to have a “self-sustaining” program”. Here’s FDR in his submission to Congress:

    “Three principles should be observed in legislation on this subject. In the first place, the system adopted, except for the money necessary to initiate it, should be self-sustaining in the sense that funds for the payment of insurance benefits should not come from the proceeds of general taxation.”

    Right off the bat, FDR admits the program would not be “fully funded”. He exempts “the money necessary to initiate it”, which was significant. Second, he does not say that each generation or cohort will pay its own way as you’ve asserted. His concern was that funds not be coming from general revenues, not from future generations. Here, there is a big difference between the terms “fully funded” and “self-sustaining”. The key is “by whom”? Social security can always be “self-sustaining” if that merely means raising funds from future generations. Furthermore, the bill he actually put forward (HR 4132 through Congressman Doughton) did not even purport to achieve that. So much for “intent” and here comes the “reality”.

    The bill he actually proposed (the Doughton bill) and the version that eventually passed Congress was never “fully funded” or “self-sustaining”, no matter how you might define that. FDR sent two persons to Congress to testify in support of his proposal: The first was Edwin E. Witte. Witte, was the Executive Director of President Franklin D. Roosevelt’s Cabinet Committee on Economic Security. Mr. Witte was one of the primary architects of the program and had been given the responsibility by Frances Perkins, the secretary of Labor, of drafting the Report of the Committee that was subsequently approved by President Roosevelt on January 15, 1935. The basic framework of the Social Security Act was formulated in just 5 months. And, 7 months later, in 1935, it was enacted into law! Witte was sent before the House to explain the proposed Act to Congress and to sell it for the administration. Perkins also testified for the bill on behalf of the administration.

    While at certain points both these witnesses expressed the same intent to have a fully funded or self-sutaining program, at various points in their testimony they readily admitted it wasn’t. Nor, could it be if the goal was to provide more or less immediate benefits to persons who had paid only 5 years into the program. They basically stated “this program is not fully funded (or even self-sustaining”), but if you want a program that is fully funded or self-sustaining, feel free to change the proposal”. To do that, the program would have to be changed to either increase the initial contribution rates or delay benefits. These were difficult choices that no one, including FDR, was willing to make.

    Here’s Witte:

    “The compulsory contributions are to be collected through a tax on pay rolls and wages, to be divided equally between the employers and employees. To keep the reserves within manageable limits, we suggest that the combined rate of employers and employees be 1 percent in the first 5 years the system is in effect; 2 percent in the second 5 years; 3 percent in the third 5 years; 4 percent in the fourth 5 years, and 5 percent thereafter. If it is deemed desirable to reduce the burden of the system upon future generations, the initial rate may well be doubled and the taking effect of each higher rate advanced by 5 years.”

    Those percentages are combined and therefore consistent with the Doughton bill. Roosevelt and his team were concerned that if the SS trust fund were fully funded, they would have no where to invest all those funds. So, they intentionally chose not to fully fund it for this (and other) reasons. And, it’s not correct to say, as you have done, that FDR proposed a combined rate of 6 percent—his proposal was 5 percent and that rate kicked in much later.

    Here’s Perkins:

    “Now, we have thought it best to recommend to you that the Government borrow from the contribution of those who are now young, in any one year a sufficient sum to pay this supplemental benefit to those who, we will say at the age of 50, can only build up a reserve that would entitle them, at the age of 65, to something like $9 a month. We have recommended that the Government borrow from the contributions, from the funds collected from the taxes and assessments of the younger members of the group, an amount sufficient to pay for the aged person who has only been contributing for a short time.”

    That, of course, is a matter of policy.

    A self-supporting system in every detail can be provided if you are willing to fix the contribution into the fund at 4 percent instead of 1 percent, the 4 percent to be divided equally between the employer and the employee, with a gradual working up to 6 percent instead (9 of 5 percent, and the time within which we go from 4 percent to 6 percent to be only 10 years instead of 20 years. In other words, if you ever buy insurance, it all depends on what you pay how much of a benefit you can receive, benefit in actual cash allowance or time of maturity. All insurance policies, particularly the endowments, that feature, whereby you may increase the cash allowance or shorten the maturity by increasing your payments.

    So, by increasing that contribution, you can build a system which will not only pay full benefits to persons who are now 20 to 30 years of age when they become 65, but will also pay not quite full benefits, but only slightly lower benefits, to persons who are now 40,45 and 50, when they become 65.

    But you cannot have such a system actuarially sound unless you are willing to face the fact of a pay-roll. tax at this time or beginning, we will say, in 1937, of 4 percent instead of 1 percent. That, of course, is a matter of policy for this committee of yours, but in studying this whole matter, our Committee thought that it was wiser for us to recommend the imposition of a 1 percent pay-roll tax on the theory that we are now in a period of recovery, and that the lesser tax would be more suitable to the lesser industrial income.”

    Perkins said, in essence, several times, pretty much the same thing. Future generations would pay for the initial one(s).

    And, here’s Witte:

    “The plan is designed so that people who start contributions after the 2.5 percent rate is in effect will pay their own pensions. People who are now past middle age will not pay their own pensions entirely. These unearned pensions will in the long run be paid by the United States Government, but the United States Government will not be required to make any contributions for many years to come-for 30 years; not until 1965, according to the actuarial calculations-and for this reason, that in the early years, even at the low rate we propose, the receipts will very considerably exceed the disbursements. There will be relatively few annuities payable, and in these early years you will annually have larger receipts than disbursements, but by 1965 that condition will be reversed. Beginning in 1965, the current receipts from the taxes will be less than the current disbursements.

    Mr. KNUTSON. A year?

    Dr. WITTE. A year. If you prefer to finance that currently, you have to raise that amount of money or you will have to pay interest in subsequent generations.

    The President, in his message, outlined that he desires a self- sustaining system. This system is not self-sustaining. This system is self-sustaining for a long period of time, but in the next generation the Government will in effect pay the interest on the money which is paid in these next 30 years as an unearned annuity to people who are now middle-aged or beyond. That is what it amounts to. That is the age clause. If you pay that currently, that cost will average, in the next 30 years, half a billion dollars.

    As stated, this plan does have this very distinct difficulty, that it is not self-sustaining, and that in future generations there will be a considerable cost in connection with the plan.

    So, what actually happened? The bill went through pretty much as the Committee recommended with contributions not equaling 3 percent until 1948 (see section 801). Nota bene here, Jim, that the bill actually put forward by FDR called for the contribution rate to only reach 2.5 percent, and then only in 1957. His version was actually less solvent than the one that passed.

    What happened later, of course, only made things even worse.

  24. comment number 24 by: Vivian Darkbloom

    As to the actuarial assumptions made, I’m not aware of any study that has attempted to go back and reconstruct the original contribution and benefit formula in that 1935 Act and try to estimate where we would now be if those formulas had never been changed. If you are aware of one, I’d be interested. But, here, Professor White has more to say:

    “Men who reach 65 still have on the average 11 or 12 years of life before them; women, 15 years. A man of 65 to provide an income of $25 per month for the rest of his life (computing interest at 3 per- cent) must have accumulated approximately $3,366; a woman nearly $3,600. If only this amount of income is allowed to all of the people . of 65 years and over, the cost of support of the aged would represent a claim upon current national production of $2,000,000,000 per year. Regardless of what may be done to improve their condition, this cost of supporting the aged will continue to increase. In another generation it will be at least double the present total.”

    And

    “In 1930 there were 6,500,000 people over 65 years of age in this country, representing 5.4 percent of the entire population. This percentage has been increasing quite rapidly since the turn of the century and is expected to continue to increase for several decades. It is predicted, on the basis of the present population and trends, that by 1940, 6.3 percent of the population will be 65 years of age; by 1960, 9.3 percent, and by 1975, 10 percent. In 25 to 30 years the actual number of old people will have doubled, and this estimate does not take into account the possibility of a decrease in the mortality rate, which would further increase the total.”

    The first quote indicates some implicit assumptions about life expectancy and the second quote about the percentage of population over 65. In the context of the hearing, the latter was important as a selling point because one of the purposes of social security was to provide protection for what they saw as a growing number of elderly and these statistics were, in part, intended to make that case. They were afraid future elderly would just end up on the general dole (or under a bridge). But, the first quote combined with the second leads me to believe that those actuarial assumptions assumed a static post-age-65 longevity period that prevailed at the time (“this estimate does not take into account the possibility of a decrease in the mortality rate). So, it strikes me that the assumption on the growing number of elderly was not based on increased longevity and, even if it was, any such assumption was not built into the contribution/benefit formula. Of course, since then, there have been very, very significant increases in longevity. I’m not an actuary, but actually, it strikes me that you cannot even hope to have an actuarially sound program if you rely on a static life expectancy. In order for the original program to have been sound, the bill would have had to have built into it a provision that increased the annual contribution rate to account for increased longevity (or reduce the payout rate). Isn’t that what private insurance companies do? They don’t set their annuity contribution and payout rates and then leave those rates constant indefinitely. Doing that is financial suicide. But, that’s exactly what the original FDR proposal and the initial Act did. They left it to future politics.

    FDR and his people were undoubtedly aware of the issue and the longer-term problem. But, they did not actually create or even propose a program that would be actuarially sustainable as you’ve argued. The fact that they didn’t proves your point about the short-term politics, but sure cuts against your argument about the soundness of the original scheme.

  25. comment number 25 by: Jim Glass

    Right off the bat, FDR admits the program would not be “fully funded”.

    Of course. I never said it was fully funded. I said: “The original SS Act of 1935 was primarily funded.” Which it was.

    The best history and analysis of the 1935 Act is in Schieber & Shoven’s _The Real Deal, The History and Future of Social Security_, but any other decent one will present this clearly enough too.

    Suffice it to say that program created by the 1935 Act was sufficiently funded to produce a very substantial trust fund 50-years hence.

    As to the actuarial assumptions made, I’m not aware of any study that has attempted to go back and reconstruct the original contribution and benefit formula in that 1935 Act and try to estimate where we would now.

    My faulty memory is Andrew Biggs said something about this once, but a quick look didn’t find it — and if such a study does exists it will be a mere curiousity in light of all the ways that both the world and SS have changed since the beginning.

    What I said on the subject was than when devising the 1935 plan they made projections 50-years forward from there, for the 1980s, and that the actuarial assumptions they used in those projections proved remarkably accurate. But that’s not so extraordinary, it was only 2/3rds of a lifetime ahead, and they knew full well that lifespans were getting longer, etc.

    For the record, the projection for 1980 was a $47 billion balance in the trust fund in 1935 dollars, which is $283 billion 1980 dollars or $775 billion in our 2011 dollars. But over multi-decade periods CPI isn’t a very good indicator of worth, by percent of GDP that $283 billion would have been equivalent to about $1.5 trillion today — which is a heck of lot better than being broke, as SS in fact was in 1983.

    And I’d suspect the big demographic changes-to-come they didn’t see in 1935 were the Baby Boomer generation of post-WWII, and the big surge of women into the workforce starting with the Boomers. Being that they both served to significantly increase the number of young workers — age 34 down to 16 in 1980 — who’d be paying contributions for many years to come before collecting benefits, it seems likely the trust fund would only have grown from there for another generation to come, just as it did in real life.

    But that is just an aside, for curiousity — the world had changed so, no social program was going to stay the same in the 21st Century as it was in 1935.

    Again, I’m not debating Social Security here. My point here is not that the changes Congress made in SS were for better or worse, but that they were *always* driven by short-term political gain obtained by making the most of current cash flow — NOT considering actuarial balance.

    Starting with the 1939 amendments when Congress took over the design of SS from FDR, *no* Congress *ever* was concerned with actuarial balance, *at all*. They didn’t bother even projecting it.

    When Samuelson praised SS with, “The beauty of social insurance is that it is actuarially unsound”, he sure as heck wasn’t concerned with actuarial balance!

    When SS went broke in 1983 (because of all the previous disregard) the fix that Congress came up with *didn’t* consider actuarial balance — just the cash flow cost of protecting seniors’ benefits and making sure the new payroll tax hike was big enough so they wouldn’t have to go through the pain of increasing the tax again in the next few years. (As I’ve previously here quoted Robert Myers, executive director of the Greenspan Commission, as saying, “It just isn’t true” that the Commission created the trust fund to prefund retirement benefits — the idea that it did is the biggest urban legend in US politics).

    When the shift from the bust economy of 1973-82 to the boom economy of 1984-onward created the surplus “by happenstance” as Myers put it, Congress neither cut the tax rate back to the paygo level the Greenspan Commission and 1983 reform intended it to be at (as Moynihan repeatedly sought) nor did it save the surplus. It simply spent the cash flow, clearly compromising the fiscal future.

    “Short-term cash-flow politics *always* rulez!” has clear implications for SS’s future, but that’s not the point here.

    The point is the much bigger one that for the entire budget, Medicare and everything else, until we find some mechanism to *change* “short-term cash-flow politics *always* rulez!”, well, … it always will. Which is very bad. Things will only get worse until a crisis hits. Until then, all talk about “long term baselines” and long-term everything else will prove futile. Nobody in Congress will care at all about actuarial balance of anything — any more than they have in the past.

    So people should be talking about finding such a mechanism. But I don’t see anyone doing it, anyhwere. Which is a basic problem, IMHO. Not that I know what to do about it.

  26. comment number 26 by: Jim Glass

    BTW, FDR’s insistence that Social Security prime benefit be fully self-funded via worker contributions is illustrated by this famous incident, as related by Schieber & Shoven. Quoting (from p. 36)…

    [The final report on the proposed Soccial Security law] was to be submitted to Congress on January 17. 1935, and the press materials announcing the proposal had already been distributed.

    On the afternoon of January 16, President Roosevelt was reviewing the final package when he discovered a table in the report showing that the old-age insurance program would run significant deficits after 1965 that would require government contributions sometime later, around 1980. He immediately suspected an error in the report and summoned Secretary Perkins and Edwin Witte to sort out the matter. Upon being informed taht this was an element of the package as designed, FDR insisted that it had to be changed.

    Perkins quotes FDR as saying, “This is the same old dole under another name. It is almost dishonest to build up an accumulated deficit for the Congress of the United States to meet in 1980. We can’t do that. We can’t sell the United States short in 1980 any more than in 1935″.

    This statement ties in directly and consistently with FDR’s feelings at the time he signed the old-age assistance law in New York while serving as governor…

    The staff members who had worked on the old-age insurance provisions came up with a new set of provisions and cost estimates to go along with it. J. Douglas Brown identifies the projections for the new plan as the “M 9 tabulation”, which he translates as Robert Myers’s “ninth shot at it”.

    The modified plan and projected financing indicated that the old-age insurance element of the program would be self-supporting, as Roosevelt clearly intended.

    Roosevelt’s demand that the proposal be modified to comply with his wishes so late in the game is an indication of how strongly he felt about the matter….

    Imagine a politician of today being so upset about dropping an unfunded liability on general revenue in the year 2056.

    If only!

    Where would that put FDR on today’s political scale of attitudes towards unfunded entitlement liabilities?

  27. comment number 27 by: Jim Glass

    Since I’ve got the S&S book open, a few more amusements from the argument over funded v paygo that resulted in the 1939 start of the conversion of the contributory retirement benefit to paygo…
    ~~~

    (1) “The trust fund was expected to grow to $47 billion by 1980 [and] was to invest only in government bonds … For many the thought of an accumulation of this size was too fantastic to comprehend. After all, the government had accumulated a total of only $27 billion of debt in its first 159 years of operations. How could it accumulate another $20 billion in only 45 years?”

    ‘Nuff said. :-)
    ~~

    (2) “A reason for accumulating the fund was to keep the cost of financing benefits reasonably level across generations. The designers of the program knew that there were limits to the payroll tax rates that could reasonably be leveled on workers … by 1980 benefits were expected to cost as much as 10% of covered pay — a percentage that virtually everybody perceived as too high to suppport with a regressive payroll tax, one that cost more to low-wage workers than those with high wages.”

    a) The actual cost rate for 1980 was 10.74% of covered pay. So while in real life the 1980 mix of benefits was very different than the mix under the 1935 law, their total amount was quite close to as projected in 1935.

    b) “Reasonable across generations” became 2% for the first generation then up to to 12.4% (on a far higher wage base) post-1984 … *plus* further cost reaching about 1.5 points of GDP annually about 15 years from now (or an equal-sized cut of benefits, or some combination.)

    c) It’s interesting that the *cost* of the tax was a serious consideration at the start, and it could be too high (10% payroll tax was too high) — while in today’s debates the concern is almost exclusively “save the benefit”, whatever tax it takes.
    ~~~

    (3) “Possibly the clearest difference in the two perspectives was articulated when Edwin Witte confronted J. Douglas Brown with the prospect that moving from reserve funding to pay-as-you-go funding would create tremendous cost obligations for future generations.

    “Brown responded, ‘We will all be dead.’

    ‘Nuff said. :-(

  28. comment number 28 by: Vivian Darkbloom

    But, Jim, your first reply and your second BTW sort of contradict each other and fully support what I’ve said all along—there was the intent and then there was the reality. Even FDR’s original proposal was not fully funded or self sustaining or provide “primary funding” whatever that last term means. The very proposal FDR put forward did not even meet his own stated criteria! The one that hit his desk was better in that regard than his own legislation! For him to be shocked when told that it didn’t suggests to me that he was either completely detached or he knew what was going on and his shock was political theater. The whole thing was flawed from the get go.

    Altmeyer, in particular, was a supporter of the “reserve” system, but even he said that the use of the terms “pay-as-you-go” and “reserve” were woefully inadequate and un-nuanced. He always admitted that their proposals were only a “partial reserve”, at best.

    As to whether the 1935 study would have created a substantial trust fund, I don’t recall Biggs saying that; however, I suspect that even if he did, he’s never done the math. It would be a huge project. For anyone now to say it “would have created a huge reserve” is like saying we spent $800 billion of stimulus which had a GDP multiplier of 1.5 and created 2 million jobs or whatever. Using the same model to both predict results and also prove that they came true just doesn’ work—for me at least.

    I will grant you the short-term politics point and, of course, what happened in 1939 probably made matters worse (but see below). This is a fascinating story and has many, many lessons to tell about our current predicament. In particular, the PAYGO and reserve debate was not one about long-term fiscal irresponsibility versus fiscal prudence. Quite the contrary. PAYGO proponents such as Vandenberg were concerned that with such a large reserve Congress would just go out in spend it. They thought PAYGO was a sort of early version of “starve the beast”. In this respect, history shows their concerns were well founded.

    If I had to speculate, I would guess that if the original system had been continued, we would have a larger SS trust fund today. But, I’d also guess that Congress would have squandered that trust fund in other ways. The only advantage I can see is that we would probably look more today like Japan—our federal debts would be owed more to our own citizens than to the Chinese. Of course, all this is speculation, but interesting nonetheless.

  29. comment number 29 by: Vivian Darkbloom

    Jim,

    Just read your latest which was submitted apparently while I was working on mine—it seems that I”ve already addressed your latest before I even read it.

    Nuff said?