Here’s issue #10 of my Policy and Politics Newsletter, written 12/9/11. The previous newsletter discussed Social Security and the fact that 1) it has no impact on the deficit, 2) the shortfall is relatively small, and 3) there are a number of straightforward ways to address the shortfall. This newsletter will begin to address Medicare and Medicaid, the other two entitlement programs that are consistently raised during deficit discussions.

Medicare and Medicaid present much greater challenges than Social Security, both because they do have a significant impact on the deficit and because the solutions are much more difficult.

Medicare is our universal health insurance program for seniors. It spent $502 billion in 2009. Medicaid is our health insurance program for low income, low wealth individuals. It spent $374 billion in 2009. Note that more than a quarter of Medicaid spending is for seniors. [1]

Medicare and Medicaid are NOT socialized health care. (Neither is the health care system under the recent reform legislation.) In a socialized health care system, the health care providers (e.g., the hospitals, doctors, and nurses) are government facilities or employees. Our Veterans’ Administration’s health care system and theUnited Kingdom’s health system are socialized health care. Both are highly regarded, although not perfect.

Medicare is a single payer system for our seniors (with some twists). Most other advanced countries’ have single payer health care systems that cover all residents (not just seniors).

Medicare and Medicaid, as parts of our overall health care system, face the same challenges of rapidly increasing costs that the overall system is experiencing. In the US, we spend over $7,500 per person per year on health care; almost two and a half times the average of other advanced countries. And yet our outcomes are worse: we have the highest infant mortality rate, many people with no health insurance or under insurance (where they pay significant costs and/or are exposed to significant risk), and a shorter life expectancy (77.9 years versus 79.4 years). [2]

Health care costs are high and growing rapidly in the US. Our system creates incentives to spend money on unnecessary tests, drugs, and procedures. Our privatized system includes marketing costs and profits. Our fragmented system has high administrative costs of 15 – 30%; twice the rate of other advanced countries. (Medicare is very efficient; its administrative costs are roughly 3%.) Our overall health system has high drug costs because there is no central entity that can negotiate with drug companies for cost control as other countries’ single payer systems do. This is why drugs are cheaper in Canada. Our Veterans’ Administration and some large health insurance companies do negotiate and get much better drug prices. (Medicare was prohibited from negotiating drug prices by the drug coverage law enacted by the Bush administration.)

Medicare, because of its size and role as the single payer for seniors, offers a means to controlling health care costs, if our politicians would let it. Medicaid, because of its size, also has significant leverage. (They can also address quality issues more effectively than our fragmented private payers.) Furthermore, Medicare’s clout could be enhanced by allowing non-seniors to join. Estimates of the potential savings of an expanded Medicare program range from $58 billion to $400 billion per year.

Medicare and Medicaid aren’t the problem. They only reflect the problems of our overall health care system. They have the potential to lead the way in solving our health care system’s problems, if our politicians will let them. Cutting back on Medicare and Medicaid will only exacerbate the problems by further complicating and fragmenting the system, while leaving many more people without affordable, decent health insurance – on top of the 50 million without insurance today.

Here’s issue #9 of my Policy and Politics Newsletter, written 12/4/11. A topic that is receiving quite a bit of attention in the deficit reduction discussions is Social Security, although it has no impact on the deficit. Sorry this is a bit long, but the complexity is tough to abbreviate further.

Social Security does have an imbalance between available resources and projected benefits over the 75 year time horizon that is typically used for analysis of it. There is a trust fund that the Social Security deductions from wages go into. It currently has a surplus, but it is projected to run out in 2037 as more people, i.e., the baby boomers, begin collecting benefits. After 2037 and until 2086, the on-going payments from workers would be able to pay about 75% of the benefits Social Security recipients are currently promised. So even in a worst case scenario, beneficiaries over the next 75 years will receive significant Social Security checks.

Social Security is the country’s most effective anti-poverty program. Poverty among seniors is roughly 10%, but without Social Security it would be 45%. Social Security lifts 13 million seniors out of poverty. [1]

Note that Social Security does not have an impact on the deficit. It is funded through the dedicated payroll tax and Social Security Trust Fund. Therefore, discussions of Social Security’s long-term solvency should be kept separate from the deficit reduction discussions.

Social Security’s imbalance can be fixed by reducing the benefits it provides or increasing the revenue for it or a combination of the two. Key options include the following: [2] [3]

• Increase revenue
  • Currently, Social Security tax is paid only on earnings up to $106,800. If this cap were increased, some or all of the shortfall would be eliminated. The Social Security tax was designed to cover 90% of all wages and is adjusted for wage growth. But because of the dramatic rise in very high wages, only 83% of wages are currently taxed. If the cap were increased to cover 90% of wages, it would be roughly $180,000. If this were done without increasing future benefits for those who paid more into the Trust Fund as a result, the shortfall would be eliminated.
  • The current payroll tax is 12.4% with half paid by the employee and half paid by the employer. If the rate was increase by 2% to 14.4%, the shortfall would be eliminated. This would have a negative impact on low wage workers, for whom the Social Security tax is their biggest tax burden. An increase of this amount or less could be phased in over time to lessen the impact, but this would also reduce the amount of the shortfall eliminated.
  • If part of the current Trust Fund balance were invested in stocks, presumably a privately managed index fund, the earnings would likely be significantly greater than the current earnings from the Treasury Bonds in which the Trust Fund is invested. This could reduce the shortfall by up to a third.
  • Various other sources of revenue could cover part or all of the shortfall. Possibilities include Social Security taxes on high incomes that are above the current or future tax cap and using some or all of the estate tax for Social Security.
• Reduce amounts paid to current or future beneficiaries
  • Reduce the annual cost of living increase that is linked to inflation. Reducing the increase by 1% each year, would reduce the shortfall by 78%. However, well into the future, this would mean that Social Security benefits would be much less than they are today in relation to the cost of living. Furthermore, some data suggest that the current cost of living increases are less than the typical increases in expenses for seniors.
  • Raise the age at which full benefits can be collected. Currently, this age is increasing from 65 to 67 by 2022. This increase could be accelerated or the age could be increased to 68 or 70, but would reduce the shortfall by less than a third. Arguments for this are that we are living longer and healthier on average and, therefore, could work longer before collecting Social Security. However, this is less true for minorities and for those in physically demanding jobs.
  • Reduce the dollar amount paid to future beneficiaries. If, for example, benefits to new enrollees were cut by 5% starting immediately, the shortfall would be cut by about 30%.

Note that given that these projections go out 75 years, the assumptions that are made about economic growth and the growth of the labor force have a significant impact on the estimates of the shortfall and the impact of possible solutions. Small differences in the assumptions of annual growth have large impacts over 75 years.

In conclusion, relatively modest changes to Social Security can put it on a solid financial basis for the next 75 years. A variety of options for increasing revenue and/or reducing benefits are available, and could be carefully crafted and implemented to shield the neediest recipients from harm and provide amply advance notice of changes to participants. [4]

Here’s issue #8 of my Policy and Politics Newsletter, written 12/1/11 . Having reviewed historical income tax rates in the last newsletter, this one will take a look at the flat tax, which is being proposed by a number of the Republican presidential candidates.

The flat tax – a simplified federal income tax with one tax rate for everyone – is a favorite tax reform of many of the Republican presidential candidates. It is almost always designed to be a “revenue neutral” option to the current, more complicated income tax, meaning that it would raise the same amount of revenue for the federal government as the current tax.

To produce the same amount of revenue, the flat rate has to be somewhere in the middle between the highest rate (now 35%) and the lowest rate (now 10%). Because the flat rate is lower than the current rates for high income filers, high income people would pay less. As a result, to be revenue neutral, middle and low income people will have to pay more. [1] 

Some of the Republican presidential candidates have proposed variations on the flat tax to ensure that no one would pay more income tax than they do currently or to reduce the negative impact on low and middle income filers. Because these variations would reduce the total revenue to the federal government, they would not be revenue neutral and would increase the federal deficit substantially.

For example, under candidate Herman Cain’s 9-9-9 plan, the flat income tax rate of 9% is lower than all the current rates. (Note that the lowest income filers actually currently pay no income tax because of the personal exemption [$3,650 per person] and the Earned Income Tax Credit.) To make the overall plan revenue neutral, he proposes a 9% national sales tax that would apply to all purchases, including food and clothing. As a result, it is estimated that the highest income 1% of filers would pay $210,000 less in taxes and the lowest income 60% of filers would pay on average $2,000 more. [2] (Note candidate Cain has since said that his plan would include a provision to ensure that those with the very lowest incomes wouldn’t pay more.)

The flat tax is often promoted as being “fair,” because everyone pays the same rate. However, many people believe “fair” means a graduated or progressive income tax, where people with higher incomes pay a higher percentage of their income because they can afford it, as a smaller portion of their income is needed to pay for basic living expenses. In other words, higher income people have more discretionary income and therefore can afford to pay more in taxes. This is the concept behind our graduated federal income tax system and has been since the income tax was first implemented in 1913. If you believe a graduated income tax is “fair,” then the flat tax, by definition, is not “fair.” [3]  And as you know from the previous newsletter, today’s income tax rates are less progressive than they used to be: today’s highest rate for the highest income filers is 35%, while in 1980 it was 72% and in 1950s and early 1960s it was 91%.

Here’s issue #7 of my Policy and Politics Newsletter, written 11/27/11. As you probably know, the Congressional Super Committee failed this week to reach an agreement on a recommendation for reducing the federal deficit. One of the key sticking points was income tax rates. The Republicans insisted on reducing income tax rates along with reducing some deductions, while the Democrats refused to lower tax rates for the wealthy and supported rolling back the Bush cuts in tax rates for the wealthy.

The federal income tax went into effect in 1913. The income tax rates have always been progressive, meaning that the tax rate for lower income tax filers has always been lower than the rates for higher income filers. The rates are much less progressive today than they have been historically and they have been simplified by reducing the number of steps between the lowest rate and the highest.

A summary of federal income tax rates: [1]

During most of the post World War II economic boom in theUS(1946-1964), the wealthy paid at a 91% rate while the lowest income filers paid at 20%. For the next 18 years, the wealthy paid at a 70% or higher rate while the lowest income paid at roughly 15%. Since then the rates for the wealthy have been reduced dramatically. The threshold for paying the top rate has been between $200,000 and $400,000 of income since 1964.

Note that if your taxable income is $1 million, a 1% rate reduction reduces your taxes by $10,000. If your taxable income is $50,000, a 1% rate reduction reduces your taxes by $500.

The argument typically advanced for reducing tax rates for the wealthy (or for not increasing them) is that if they have more money they will invest it and that, therefore, the economy will grow, jobs will be created, and everyone will be better off. However, in the 1990s, when President Clinton increased income tax rates on the wealthy, the economy performed very well. And in the 1980s and the 2000s, when tax rates were cut, there was no economic boom. Furthermore, over the last 30 years, as the income tax rates for the wealthy have been cut in half, income inequality in the US have widen considerably and middle and low income households have seen very little growth in their incomes (see newsletter #4, 11/13/11).

In summary, both the performance of the economy and changes in household incomes over the last 30 years do not support the argument that cutting income taxes for the wealthy will lift all boats, trickle down to middle and lower income households, or stimulate the economy.

Here’s issue #6 of my Policy and Politics Newsletter, written 11/20/11. As you probably know, the US House voted on and rejected a Balanced Budget Amendment to the US Constitution this week.

Consideration of a Balanced Budget Amendment (BBA) to the US Constitution by both houses of Congress was required as part of the agreement that raised the debt ceiling back in August. The House and Senate will probably vote on different versions of the BBA. (See below for more detail.) A BBA, if ratified, would constitute a dramatic, some say radical, shift in policy making.

The biggest concern about a BBA is that in a recession, when government revenue falls, the BBA would require cuts in expenditures. Therefore, government likely would have to cut safety net programs, such as unemployment compensation, food stamps, heating assistance, and subsidies for health care when they are most needed. It would eliminate the ability of the government to serve as a counter weight to recessions by spending when other sectors of the economy are on a downswing. Seven Nobel Prize-winning economists have stated that a BBA would “mandate perverse actions in a recession” and would harm economic growth. Norman Ornstein of the conservative American Enterprise Institute has called a BBA “about the most irresponsible action imaginable.” [1]

An argument advanced in support of a BBA is that states have and have managed to live with requirements for balanced budgets. However, because of this, during the current recession, state and local governments have been cutting jobs nationwide by roughly 10,000 a month and have been making painful cuts in services and programs. They have been helped through this crisis by federal government support and federal deficit spending, where they get roughly a third of their revenue, and especially by the stimulus funding in 2009 that explicitly supported states. Moreover, states can borrow for capital spending outside of their balanced budgets, something the federal BBA would prohibit.

Possible provisions of a BBA include: [2]

• Super majority votes in both houses of Congress are required for:
  • Deficit spending (most likely a three-fifths [60%] majority)
  • Tax increases (most likely a two-thirds [67%] majority)
• Cap on overall spending at 18% of gross domestic product (GDP, the size of the overall economy) (Note: Under President Reagan spending averaged 22% of GDP)
• Capital spending (i.e., long-term investments in infrastructure and human capital) would be included under the cap and spending controls (Note: Generally not the case at the state level)
• Exemptions for national emergencies and Social Security

In summary, the BBA makes for great politics for some but is lousy policy. Please note that President Reagan promoted and popularized the BBA while the budgets he presented to Congress were the eight most out of balance budgets since WWII. And that for many of those pushing the BBA today, it was not a priority for them when George W. Bush was president and significant surpluses inherited from President Clinton became large deficits.

Here’s issue #5 of my Policy and Politics Newsletter, written 11/17/11. Another piece of the debate on how to reduce the deficit is whether defense spending should be cut. Here’s some context.

Defense spending has more than doubled from 2001 to 2011, increasing 121%, more than any other component of the federal budget (all other discretionary items together increased 60%). It now stands at $733 billion, 58% of discretionary spending. [1]  In 2011, theUS spent $51 billion on the war inIraq and $122 billion on the war inAfghanistan, together representing 24% of the defense budget.

If the Super Committee of Congress cannot present a deficit reduction compromise that is approved by Congress, defense spending will be automatically cut by about $1 trillion over 10years, a 17% reduction. For the sake of comparison, after the Korean War ended defense spending declined 31%, after Vietnam28%, and after the Cold War 31%. [2]  Both of the bipartisan deficit reduction commissions, which if anything tilted to the conservative side, recommended cutting defense spending by $1 trillion over 10 years and said this could be done responsibly. Therefore, substantial cuts in defense spending should not only be possible, but are appropriate.

Some people are arguing against cuts in defense spending because of their negative effect on employment. Ironically, this argument is coming from many of the same people who have argued against federal stimulus spending, saying the government spending doesn’t create jobs. Many of them have also supported government budget cuts that reduced jobs for teachers, construction workers, police officers, and firefighters. [3]  So these arguments against defense cuts ring hollow.

Furthermore, a study from the Political Economy Research Institute at the University of Massachusetts Boston by Pollin and Garrett-Peltier found that for every 12 jobs created by defense spending, the same spending for education would create 29 jobs, or in health care would create 20 jobs, or in clean energy would create 17 jobs. [4] 

The USnow spends more on defense than all our top rivals in the world combined. We spend 5.4% of our overall economy, our Gross Domestic Product (GDP), on defense, while our European allies spend 1.7% of GDP on the military. They, Japan, Korea, and other countries around the world no longer need tens of billions of dollars in USmilitary support. “We can still maintain the superiority of our own security, … for two-thirds of what we now spend.” [5] 

All indications would seem to be that we can safely cut our defense spending, particularly as the wars inIraqandAfghanistanwind down. Furthermore, cuts in other areas are likely to be more painful both in terms of jobs and in the reductions in the services or support people receive, such as through Social Security, Medicare, Medicaid, Head Start, education programs, etc.

Perhaps the question should be, “Can we afford NOT to cut defense spending?”

In the previous newsletter on corporate taxes, I mentioned that having corporations pay their fair share of taxes would help reduce the deficit. The deficit is a hot topic with the federal Super Committee required to submit its recommendations on how to reduce the deficit in 2 weeks. (This is issue #3 of my Politics and Policy Newsletter, written 11/10/11.) 

The deficit does need to be addressed, especially over the long term. However, the strategies for reducing the deficit are hotly contested. The context and rational debate on the deficit often get lost in the heated rhetoric and political posturing. So here’s a first piece of perspective on the deficit.

In 2001, President Clinton turned over to new President George W. Bush a federal budget with a substantial surplus: [1]

• 2001 federal budget: a $127 billion surplus (asClinton left office)
• Projected surplus over the next 10 years of $5.6 trillion

When President Bush left office 8 years later, he had turned this surplus into a substantial deficit:

• 2008 federal budget: a $455 billion deficit (as Bush left office)
• Projected deficit for 2009 of $1.2 trillion and many trillions of dollars of deficits over the next 10 years

The surpluses turned into deficits due to three major reasons:

1. Large tax cuts that particularly benefited high income individuals and corporations
2. Increased military spending (including wars in Afghanistan and Iraq)
3. An economic recession (largely caused by a lack of regulation of the financial industry)

To reduce the deficit, therefore, it only makes sense to reverse the policies that caused it in the first place:

1. Reverse the Bush tax cuts. If all of them were allowed to expire at the end of 2012 as scheduled, future deficits would be cut roughly in half. [2]
2. Reduce military spending. Military spending more than doubled from 2001 to 2008 ($332 billion to $686 billion). All other federal spending increased less than 50% ($332 billion to $494 billion), excluding Social Security and Medicare, which have their own funding separate from general revenue. [3] (Figures are not adjusted for inflation.)
3. Improve the health of the economy, most importantly by increasing jobs and reducing unemployment. (More on this in a subsequent newsletter.)

I hope this is helpful context as you hear coverage of the Super Committee’s work to reach recommendations on deficit reduction. If you are so inclined, I encourage you to contact yourUSRepresentative and Senators by phone, email, or regular mail to share your thoughts on deficit reduction.