Center for Business & Public Policy
Collaborative blog exploring the relationship between market forces and public policy.

In 2010 the United Nations Environmental Programme (UNEP) published a report titled “Assessing the Environmental Impacts of Consumption and Production” that tackles the complex issue of sustainable development including fossil fuel consumption and land use (report).  However, one passage of the 100+ page report garnered particular attention from the media: “Impacts from agriculture are expected to increase substantially due to population growth increasing consumption of animal products. Unlike fossil fuels, it is difficult to look for alternatives: people have to eat. A substantial reduction of impacts would only be possible with a substantial worldwide diet change, away from animal products [emphasis added].”

The British newspaper The Guardian took the above passage and published a story that begins “A global shift towards a vegan diet is vital to save the world from hunger.”  For those unfamiliar with veganism, it is a strict form of vegetarianism that excludes not only the eating of meat, but also any food derived from animals such as milk, cheese, and eggs.  Vegans – people that follow a vegan diet – often decide to follow a vegan diet for ethical reasons as a protest for animal rights and welfare.  Other people are vegan for health reasons or to minimize the environmental impact of their food consumption (the same rationale as the UNEP’s report).  Interestingly, the UNEP report never uses the term “vegan” to describe its conclusions in the actual report.

While The Guardian probably used the term “vegan” for sensationalism the environmental impact of an animal intensive diet is quite severe.  The same article quotes the lead author of the UNEP study, “Animal products cause more damage than [producing] construction minerals such as sand or cement, plastics or metals.”  Indeed, it takes lots of resources to produce meat.  For instance, it can take up to 16 pounds of grain and 4,000-18,000 gallons of water to produce 1 pound of beef according the U.S. Geological Survey.  Thus, it is no wonder that the UNEP sees reducing reliance on animal products as a key focus for sustainable development.

It seems clear that the Earth cannot support an American-style, meat-centric diet for the entire global population without creating great stress on the natural resources.  Furthermore, the factory farming of meat and the monoculture of feed grain concentrates these environmental impacts from manure and fertilizer run-off.  Popular author and novelist Jonathan Safran Foer in Eating Animals, his non-fiction account of factory farming, states the concerns voiced in the UN report succinctly “Someone who regularly eats factory-farmed animal products cannot call himself an environmentalist without divorcing that word from its meaning.”

Since the 1960’s, Medicare has the authority to conduct pilot studies to determine whether particular innovations might reduce the cost of providing healthcare services to Medicare beneficiaries.  The 2010 health reform law (PPACA) expanded this power, giving Medicare the authority to expand nationally any program that has been shown to reduce projected spending and improve quality.  While many of us were disappointed by PPACA’s lack of attention to cost reduction (and quality improvement), there was reason to hope that, out of the garden of demonstration projects, a few flowers might bloom.  Unfortunately, while the first group of demonstration projects has taught us something about what kinds of demonstrations we should look at in the future, none successfully reduced overall Medicare spending (including the costs of implementing the pilot programs).

Broadly speaking, the Center for Medicare and Medicaid Studies (CMS – note the government did successfully save money by removing the second “M” from the acronym!) has focused on two types of programs: disease management programs aimed at improving care for patients with chronic conditions and reduce costs by decreasing the likelihood of costly complications and hospital admissions, and value-based payment programs that attempt to reward providers for quality and efficiency of care rather than paying them for providing more care (as is the case in the standard Medicare fee-for-service model).  Earlier this month, the Congressional Budget Office (CBO) released a series of reports (here and here, and summarized here and here. 

 The results on the disease management programs were uniformly disappointing.  Quoting from the CBO Issue Brief on the topic:

 The evaluations show that most programs have not reduced Medicare spending: In nearly every program involving disease management and care coordination, spending was either unchanged or increased  relative to the spending that would have occurred in the absence of the program, when the fees paid to the participating organizations were considered.

 The results for the Value-Based Payment initiatives were somewhat mixed.  One of the four programs considered, in which CMS made bundled payments to providers to cover all hospital and physician services for patients receiving coronary artery bypass surgeries, rather than paying for each service (and each additional service) that the hospitals and physicians chose to provide, reduced overall spending by about 10 percent.  The other three programs were less successful, and on average the savings generated by the four programs were far less than the costs and fees associated with running them.

 So, does this mean that the demonstration projects were a failure?  Not necessarily.  No reasonable person thinks that reducing Medicare spending is going to be easy.  If it were, we would have done it already.  Even in the failed demonstration projects there are lessons to be learned about where we should look for cost savings in the future.  In its issue brief, CMO lists several of these.  In my mind, the two most important are the need to limit the costs of interventions and the need to move away from the fee-for-service model of care delivery.

Regarding the costs of interventions, a number of the projects CMS implemented actually did improve quality and efficiency of care.  However, they were unable to generate savings sufficient to offset the fees paid to service providers and the other costs associated with the programs.  It is possible that if these costs could be reduced, perhaps through a competitive bidding process, disease management programs might prove to deliver the savings we suspect they can.

Regarding the need to move beyond the fee-for-service model, the CBO issue brief sums things up as:

Demonstrations aimed at reducing spending and increasing quality of care face significant challenges in overcoming the incentives inherent in Medicare’s fee-for-service payment system, which rewards providers for delivering more care but does not pay them for coordinating with other providers, and in the nation’s decentralized health care delivery system, which does not facilitate communication or coordination among providers. The results of those Medicare demonstrations suggest that substantial changes to payment and delivery systems will probably be necessary for programs involving disease management and care coordination or value-based payment to significantly reduce spending and either maintain or improve the quality of care provided to patients.

In light of this, the next thing to keep your eye on are is Medicare’s experiment with so-called “Accountable Care Ogranizations,” a program that will offer comprehensive provider groups bundled payments for taking care of all of a group of patients’ healthcare needs, where these payments will be based in part on how well the ACO meets certain quality goals.  The Medicare ACO experiment is just getting under way now. We’ll see whether it is more successful in bringing down costs than CMS’s earlier experiments.

In recent months, there has been a spirited debate about the value of teachers and whether they are undervalued or overpaid.  The point of this post is to explain how both statements can be simultaneously true.    

 Before continuing, I should disclose that I come from a family of teachers.  My mother and father were both public high school teachers.  My niece, who I adore, is about to enter the profession after she graduates later this year.  If that were not enough to bias me in favor of teachers, I count myself among the millions who attribute much of my success in life to a handful of incredible educators who really made a difference in my life.  And I am impressed on a daily basis with the phenomenal teaching that my children receive. 

 Many of those in the teaching profession feel that they are under-valued by society.  And given some of the recent political rhetoric, their beliefs are not unfounded. 

 At the same time, my good friend Andrew Biggs of the American Enterprise Institute has written a number of highly interesting and provocative pieces arguing that public school teachers are over-paid.  And, as an economist, I find many of his points quite persuasive.        

 So how do I reconcile these views?  After giving this issue much thought, I have concluded that teachers are undervalued.  But this does not necessarily mean that they are underpaid. 

 Let me begin in a roundabout way by reminding readers of what economists call the “diamond water paradox.” 

 Water is critical for life.  Yet in the United States, we treat water as virtually free: when was the last time you were required to insert a few quarters to get a drink from a water fountain? 

 In contrast, diamonds serve very little practical purpose to individuals (I am ignoring industrial uses of diamonds as well as any romantic purposes).  They certainly do not help keep us alive.  And yet they are enormously expensive. 

What is going on here?  In a nutshell, water is plentiful, while diamonds are scarce.  Thus, while water creates enormous social value, it is relatively inexpensive “on the margin.”  This does not mean it is not valuable overall!  To put it in the language of economics, water generates enormous amounts of “consumer surplus.”  This means that, overall, the value that water creates for society far exceeds its market price. 

Yet few would argue that we should have to pay diamond-like prices for water just to prove to water that we understand how much more important it is to our lives than those silly, useless diamonds.

Like water, good teachers add enormous value to society.  This is not just a “feel good” statement written by the son of teachers:  there is strong empirical evidence to back it up.  Most recently, a new NBER working paper by three brilliant economists (Raj Chetty, John Friedman and Johah Rockoff) is able to link school district data on 2.5 million kids to the tax returns of these children many years later (after they have grown up and entered the labor force).  Their results show that good teachers create enormous social value.

The authors state:  “Replacing a teacher whose [value-added] is in the bottom 5% with an average teacher would increase students’ lifetime income by more than $250,000 for the average classroom in our sample.”

Think about that for a moment:  in a single year, an average quality teacher (relative to a low quality teacher) can create a quarter million dollars of economic value!  Needless to say, that is far above what we pay our good teachers.  Like water, teachers are generating enormous “consumer surplus” for the students and communities that they serve.

Those who advocate for teachers sometimes use data like the above to argue that teachers are underpaid.  Indeed, in a recent NYT piece, David Hambrick wrote “where I live, the average starting pay for a teacher is about $20 per hour.  A bartender can make double that.  Which job is more important?” 

While the NBER researchers referenced above did not measure the lifetime economic value created by good bartenders, I am going to simply assert that “teachers are more important.” 

But does that mean teachers are underpaid? 

Not necessarily. 

Just like we do not pay diamond-like prices for water even though water is more important, neither should we necessarily pay teachers more than plumbers, bartenders, or professional athletes. The reason, to be blunt, is that we do not have to, because we have plenty of smart, dedicated individuals that are willing to teach at current compensation levels.

My father – who dedicated 30 years of his life to teaching high school social studies – once reposted a quote on Facebook along the lines of “teachers are not in it for the income, we are in it for the outcome.”  

I believe that.  Indeed, many of the best teachers that I have had in my life were teachers because they loved the job.  They believed what they were doing made a difference in the lives of the students and their communities.  And they were right.

But, in the cold, hard logic of economics, these intangible benefits to teaching are precisely why we have so many people willing to teach, even though the compensation is far below the value-added to society.  The same is true for other professions that attract passionate, selfless, and altruistic individual, such as social work or those who work in the not-for-profit sector.  Fortunately for society, but perhaps unfortunately for those in these professions, there are plenty of people motivated to do these jobs in spite of the pay. 

Some will say this is “not fair.”  That may or may not be true, depending on one’s definition of fairness.  But is it rational?  Absolutely.  Almost nobody likes to pay more than necessary to obtain the goods and services they value, and that includes education.  And if the calculations of Biggs and Richwine http://www.aei.org/papers/education/k-12/assessing-the-compensation-of-public-school-teachers/are even approximately correct, taxpayers may be paying more than necessary to attract and retain the teachers that we have.            

Like water, good teachers are critical for meaningful human life.  They create tremendous value for society.  And we should respect and honor them for what they do.  But it does not necessarily mean that we should pay them like diamonds.    

At the Republic debate in Myrtle Beach, SC last night, in response to a question by Gerald Seib of Wall Street Journal, three of the candidates weighed in on Social Security reform.  Their responses revealed strikingly different approaches to economic policy.

Governor Romney took the practical approach.  After pointing out that he would protect everyone over the age of 55, he laid out two very specific changes to the benefit formula that would substantially reduce Social Security expenditures in the decades to come.  The first change would change the way that initial retiree benefits are calculated.  Under current law, benefits from one cohort of retirees to the next rise with average wages in the economy.  Governor Romney suggested, instead, a plan similar to what Social Security policy experts call “progressive price indexing.” This would continue to index starting benefits to wage growth for those at the bottom of the income distribution, but would index benefits at the top end of the income distribution to price inflation instead.  Because prices tend to rise less quickly than wages, this would reduce expenditures relative to current law.  The impact would be gradual – and thus the short-term cost savings would be limited, but over many decades can be quite substantial.  Second, Governor Romney indicated a willingness to increase the full retirement age by one or two years.  Importantly, increasing the full retirement age does not actually require that anyone work longer: rather, it simply moves the age at which one receives “full” benefits back by one to two years.  Variants of both of these reform proposals have been floating around Washington over the past decade.  In essence, this is a fiscally responsible approach that recognizes there is no pain-free way to fill in the fiscal gap.  While this is good fiscal policy, whether or not it is good politics remains to be seen.

In sharp contrast to Romney’s “eat your spinach” approach to reform, Speaker Gingrich suggested that we follow the “all dessert” approach to Social Security.  Rather than being upfront about the need for politically difficult changes to taxes or benefits, Speaker Gingrich suggested that the government can guarantee retirees that they can receive full promised benefits without paying a dollar more in taxes, despite the existence of a multi-trillion dollar shortfall.  How does he propose we do this?  By allowing workers to shift 100 percent of the employee payroll tax contribution (currently 6.2 percent of payroll) into personal accounts, leaving the 6.2 percent employer contribution going into the existing system.  Citing the examples of Chile and Galveston, Speaker Gingrich argues that people will not have to sacrifice any benefits.  As I discussed last week, however, he fails to acknowledge the huge implicit liability he is imposing on taxpayers by essentially guaranteeing that stocks will perform close to their average historical values.  They might, but to guarantee this without acknowledging the real economics cost is both fiscally reckless and intellectually dishonest.

Former Senator Rick Santorum used most of his response to correctly point out another fact about the Gingrich proposal: namely, that by diverting 6.2 percent of payroll into the personal accounts, we will have to borrow additional money to back-fill the missing payroll tax revenue, nearly every penny of which is now going to pay current retirees.  And the Speaker’s statement that we can somehow fill this gap by eliminating the overhead associated with consolidating anti-poverty programs is mathematically ridiculous.  Those numbers don’t even come close to adding up.

This is quite a different situation than we faced a decade ago when the President’s Commission to Strengthen Social Security (on whose staff I served) recommended personal accounts at a time when Social Security was projected to have another 15-plus years of surpluses.  One of the key rationales for personal accounts a decade ago was to ensure that those surpluses were saved, rather than redirected to underwrite other government spending.  The Commission plans also envisioned smaller accounts, further reducing the need to fund a transition investment.  Even so, the plan still had to come up with substantial short-term revenue to cover the transition, an aspect that contributed to the proposal’s demise.  Unfortunate, “carve-out” personal accounts – which I have supported in the past – is an idea whose time has come and gone.

Aside from criticizing Speaker Gingrich, Senator Santorum offered few specifics.  He did endorse means-testing, noting that we should reduce or eliminate benefits for the 60,000 retirees who earn over $1 million per year.  This is a perfectly reasonable suggestion, albeit with two problems.  First, if high earners receive no benefit whatsoever for paying into Social Security, then this converts the 12.4 Social Security payroll contribution into a pure tax, with all the associated efficiency losses.  Second, the money saved is a “drop in the bucket” compared to the size of the projected Social Security shortfalls.  Assuming that every one of those 60,000 millionaires gave up 100 percent of their benefits, this would save only a few billion dollars a year.  This is real money, but when one looks at the size of the expected annual Social Security shortfalls that we will face in another 20 years, we need dozens – if not a hundred – money saving ideas of this magnitude.

Thus, what we have witnessed are three fundamentally different approaches to Social Security reform.  One candidate who puts forward real meaningful solutions and is therefore criticized for not being sufficiently bold, one candidate who promises a free lunch at taxpayer expense, and one candidate who appears not to have put together a plan sufficient to the task ahead of us.  Only time will tell how voters respond to these three different narratives.

Disclosure: Over the past few weeks, I have begun to offer informal, unpaid advice to the Romney campaign’s policy staff on issues related to Social Security.  All opinions expressed in this blog, however, are mine alone.

This blog is cross-posted, with permission, at www.forbes.com

Taxes are bad, on that we can agree.  So not paying taxes must be good, right? 

Wrong.  A reform to cut taxes for everybody might be a good idea (or not).  But having millions of individuals cheat to reduce their own taxes is never a good idea.  It is a tax cut without reason, without fairness, and without the incentive or cost advantages of a cut in tax rates.

Just to focus on that last point, note that some people have to go to a lot of trouble to re-arrange their affairs to be able to cheat on their taxes, and they have to take on extra risk to do so – the risk of getting caught.  So their net “advantage” from cheating is much less than their dollars of tax savings. That cost of tax cheating does not apply to the case where Congress and the President agree to cut taxes for everybody, because then all those dollars stay in the private sector instead of being wasted.

The IRS has just released new numbers on the “tax gap” in the United States, the amount of U.S. tax liability that goes unpaid.  From 2001 to 2006, as you can see in the table below, the tax gap increased from $290 billion to $385 billion.  Just to reverse the increase in unpaid tax would gain the much-discussed and much-needed $100 billion revenue per year, or $1 trillion over ten years.  The percent of tax voluntarily paid has fallen from 83.7% to 83.1%.  After expected small amounts are recovered by our meager enforcement efforts, the “overall net compliance rate” has fallen from 86.3% to 85.5%. 

The average taxpayer cheats on about 15% of their tax liability, but almost nobody is “average.”  Rather, the huge majority of Americans earn wages and salaries that are reported by their employers to the IRS, on which tax withholding is paid by the employer to the IRS.  Workers cannot cheat on that income, and so the huge majority of Americans pay all of their tax due.  The cheating is highly concentrated among other Americans, especially those who are self-employed and get paid in cash that is never even reported to the IRS.   In fact, the IRS estimates that noncompliance or misreporting is 1% of  wages and salaries, but a huge 56% of proprietor income!

This issue is covered nicely in the blog by Bruce Bartlett, who also points out that “The number of IRS employees fell to 84,711 in 2010 from 116,673 in 1992 despite an increase in the population of the United States of 53 million over that period.” Fewer auditors chase large numbers of tax cheaters, so of course compliance falls.  When I worked at the U.S. Treasury Department, in the Office of Tax Analysis, I used to hear about revenue/cost ratios of ten to one!  That is, one additional dollar spent on enforcement could generate an additional ten dollars of revenue.  And the problem has only gotten worse since then.

We don’t want a huge number of IRS enforcement agents to strike fear into the hearts of average law-abiding Americans who do pay their taxes on time.  But a lot of us might feel better about our country if a few more IRS agents struck some fear into the hearts of those who are supposed to pay their taxes and don’t!  And those cheaters don’t have to bear extra cost of getting caught, if they just paid taxes instead of cheating.

 As 2011 draws to an end, the Euro crisis appears to have taken a rest from the headlines. Perhaps it is just that the holidays have commanded our attention. But my first prediction for 2012 is that Europe will return to the headlines, soon. Given the pause, maybe it is time to reflect on what exactly the crisis is all about. I believe that the crisis needs to be re-framed. We have deluded ourselves about the exact cause and this inhibits progress to a solution.

Start with the idea that for every complex crisis there has, at base, a simple explanation, a simple cause or simple delusion. In the financial crisis of 2007-8 the simple explanation was that the populace of the US and elsewhere deluded themselves with the idea that real estate prices would keep on rising and could never fall. If you were conservative perhaps you thought that price increases could pause, but even the most conservative never thought that prices could, yikes, drop. From that simple “popular delusion of the crowd” lots of poor behavior decisions emanated – most notably taking on too much debt – to finance, and to take advantage of, ever rising real estate prices. When the delusion met reality all sorts of blame, shame and pain was passed out. Truth to tell, we were all to blame, and that includes everybody from house flipper to Investment banker. We deluded our selves.

Interests Rates on 10-year Goverment Bonds (in percent):

The question for the Euro crisis is what was the analogous popular delusion of the European crowd? The first graph contains the answer. (The graph is borrowed Atlantic Magazine’s Best Graphs of 2011.) When the Euro was introduced, the idea that took hold, by governments and consumer alike, was everyone using the same currency should be able to borrow at almost identical interest rates. The borrowing rates of the Euro zone members would converge. “Convergence” was the European crowd’s popular delusion. Greece could borrow as cheaply as Germany. As the graph shows, this delusion lasted for almost seven years from 2001 to 2008 and during this period Greece did borrow as cheaply Germany. So did Portugal, Ireland, France and all the rest. But as the graph also shows, prior to 2001 and the introduction of the Euro as “legal tender” the markets discriminated between the creditworthiness of Greece and Germany. They are beginning to do that again. Greece’s 10 year borrowing rate was 16% in 1996. It is again now. (Actually at the end of 2011 it’s probably almost double that; the borrowed graph was drawn mid 2011.)

The big difference between 1996 and 2011 is that Greece no longer has the ability to redeem its debts in Drachma. It has to now generate Euros, and obtaining those is harder than printing Drachmas. In fact to generate Euros the country has to manufacture and sell more goods to customers who pay in Euros, or buy fewer Euro-denominated imports. That is proving to be difficult because the price of Greek goods in Euros is too high. That is true of Greek holidays, Greek labor, Greek shipping, Greek cotton, Greek olives and the rest. The only solution is to cut labor costs, or equivalently, raise productivity. That is hard to do when you have had seven fat years.

Imagine if you once had to pay 16% on your debts and suddenly some people start lending to you at 5 %. (It was even less by 2006, around 3.5 %.) Well the traditional economic response from the rational buyer of credit, i.e. borrower, is to use more of it. Greece borrowed a lot. It was not alone. All the major countries with higher credit risk in the pre- 2001 period, including Portugal and Ireland took advantage of the largess of lenders. Shame on them! They should not have done it. But they did, so they must pay it back. As long as they could roll the repayment through further debt sales, it was well and good. However after the financial crises the largess of lenders became more rationed. It cost more to refinance. In fact it has got to the point where the refinance rates are usurious. Greece and the rest may not be able to redeem their debts. They may default. Shame on these profligates!

But why chastise them alone?

Isn’t the opprobrium more sensibly shared with the lenders? Didn’t the lenders just mess up? As a credit analyst why would you ever lend to Greece and the rest at 5%, if you previously thought 16% was the correct rate?  It was true that they could no longer print their own currency, but that did not mean that could not spend money inappropriately if it was poured upon them. Surely the lenders were the deluded ones.

Exactly who were those irrational lenders? That is the significance of the second graph. (This graph is borrowed from the New York Times, May 2010, and based on then-current BIS data.)

The big lenders were Germany, France and the U.K. Between them they lent the Greek Government $135 Billion (33% Germany, 56% France and 11% U.K.). Collectively those three countries lent a total of $2 Trillion (35% Germany, 45% France and 20% U.K.)  to Portugal, Ireland, Italy, Greece and Spain, also known as the PIIGS, at incredibly low rates. The mechanism for the loans was buying the sovereign bonds of those countries. They made bad lending decisions; they should accept the consequences by marking their bonds to market, by accepting the loss. Bad lenders, shame on them!

Why did conservative and sensible Germany lend so much to Greece? Well we are suggesting here that they deluded themselves into the convergence scenario that would magically appear with the introduction of the Euro. Certainly the Euro was not the only vehicle for “Convergence” expectation, cross-country and cross-product subsidization had always been part of the EU, but the fantasy really took flight with the introduction of the Euro. But perhaps there is even more to it than that. Germany is the number one country that Greece imports from. France is number five. One way to think of the whole Euro crisis is therefore as a giant “vendor financing” scheme that went wrong. It will not be the first time that vendor financing schemes went awry – General Motors, Toyota and Ford car leasing programs among others have been prime examples. When those schemes went wrong however the managements (and eventually the shareholders) had to take their lumps and move on. They didn’t stop leasing cars they simply recognized the mis-pricing, re-priced and moved on. Germany and France seem less inclined to do the same.

France strongly resisted taking any kind of haircut (diplomatic-speak for marking to market) and German tax payers do not want to pay for their governments mistakes.  European banks who hold European sovereigns don’t want their capital to be impaired through mark to market.

 So, shame on whom?

To move forward it’s not shame that needs to be apportioned it’s the pain. The seven fat years don’t have to be followed by seven lean (depression?) years. Re-price and move on. If there were no transfer-union entanglements the lenders, be they governments or private banks would write off the bad loans and then make a decision at what price they were prepared to now lend to a bad credit. Greece and the others could then calculate whether or not the price of still using the Euro at market rates was worth the cost. They may decide to leave the Euro, as might other countries. That does not necessarily kill the Euro. It can still exist for those who want to use it, just as some countries e.g. in Central America, have chosen to use the Dollar as their official currency. A country that uses the Euro in the future will know two things, a) that it surrenders the printing press to the ECB and removes that lever from domestic politicians, and b) that it will face difficult and expensive borrowing unless it keeps its fiscal house in order.

The Euro need not die, but the delusion of “Convergence” will, or already should have. Instead the Germans and French lead other Euro-Zone nations to cling to the delusion. They have proposed even greater mutualisation of fiscal policy among Euro-Zone members. Lectures are forthcoming with regularity from those who made bad credit decisions to those who were deemed to be profligate. This is a posture that might be acceptable from a bank that was setting new loan conditions and rates to a previously recalcitrant borrower, but was still willing to provide finance. Instead what is offered is a “my way or the highway” policy from a collective of lenders who refuse to recognize their own mistake, refuse to mark down their past errors and continue to cling to the “Convergence” objective. It ain’t gonna happen, but if it did it has a greater chance of success as a voluntary consequence of the cost of profligacy, i.e. countries paying market credit rates, than from the demeaning business of being bailed out and lectured to by the very people who pushed cheap credit in the first place.

Enough already! Taking losses is never pretty, for borrower or lender, but it is surely the best and quickest way to correct errors and faulty assumptions. As they say in the bond market, there are no such things as bad bonds, just bad prices. Sovereign credits were badly mis-priced; re-price and move on. Or, to non bond market mavens, when you are in a “Convergence” hole, stop digging.

Given that current Presidential candidate and former House Speaker Newt Gingrich has long been an outspoken critic of government bureaucrats, it may surprise readers to learn that his Social Security reform plan shares an intellectual flaw with public pension accounting.   Namely, a belief in a “free lunch” from the stock market.

Let me explain.  It is widely understood that the U.S. stock market has performed quite well over long time horizons in comparison with other assets, such as bonds.  Nearly all economists agree that the reason stocks have higher expected returns is because stocks are riskier.  Investors need to be compensated for bearing this extra risk.

Most people intuitively understand that stocks are inherently risky, especially after they have witnessed the volatility of the past few years.  On the other hand, many people mistakenly believe that stocks are not risky as long as one is willing to hold them long enough.

This is a great fallacy, and acting upon it is financially reckless.   While there is a long-standing debate in the economics literature about whether stock returns are “mean-reverting” (i.e., somewhat less risky) in the long-run, no serious financial economist would ever suggest that the risk of stocks is zero, even at an infinitely long time horizon.

What does all this have to do with Newt Gingrich and public pension accounting?

Gingrich has offered up a Social Security reform plan that would replace the existing system with a system of personal retirement accounts.  There are many reasons to like personal retirement accounts.  But the most important thing to understand about personal retirement accounts is that they are NOT a substitute for raising revenue or cutting benefit growth to restore fiscal sanity to Social Security.  Newt and his advisors mistakenly think they are.

Gingrich’s campaign policy white paper extols a central virtue of the Chilean system and the old Ryan-Sunnunu reform option by noting that “the government guarantees that all workers with personal accounts will receive at least as much in retirement as they would under the current Social Security system” (emphasis added).

It is the guarantee that is problematic.  Newt seems to believe – in the face of all theory and evidence to the contrary – that a multi-trillion dollar shortfall in the Social Security system can be eliminated by investing contributions in stocks.  He is so confident that it will work, that he is willing to guarantee the return required to provide the same benefits as under the current Social Security formula.

This is a recipe for fiscal disaster.  As has been noted by numerous economists – including a number of pro-accounts conservative economists – a government guarantee of investment returns imposes a potentially enormous unfunded contingent liability on taxpayers.  To paraphrase a quip I once heard:  rather than reducing our entitlement state, Newt Gingrich appears content to become the portfolio manager for the entitlement state.

But Newt Gingrich has plenty of company.  Government accounting standards for public pension plans allow public sector DB plans to engage in this same economic deception.  And, ironically from a political perspective, this approach is eagerly defended by liberal think tanks and labor unions – strange intellectual bedfellows for candidate Gingrich - who want to hide the true cost of public sector pensions.

Let’s take my state of Illinois, home to three of the ten worst funded public pension plans in the nation.  Reform efforts here are severely hampered by the existence of a state constitutional guarantee against the impairment of retirement benefits for public workers.  Newt proposes providing similar guarantees to Social Security recipients.

As I have written elsewhere, the Government Accounting Standards Board (GASB) standards allow states and localities to assume they will benefit from the high returns of having part of their portfolio invested in equities, without accounting for the increased risk.  This allows public pensions to hide the true cost of public pensions from taxpayers, contributing to the massive pension funding crisis which we now face in the U.S.

Newt’s plan and GASB rules are both the direct result of a failure to accurately account for risk when valuing financial guarantees.

Taxpayers are not well-served by government accounting and budget-scoring rules that allow politicians to grow government without being honest about how we will pay for it.  The public should insist that government guarantees be accounted for accurately and honestly.

In the meantime, I look forward to seeing the mental gymnastics performed by both liberal and conservative pundits who try to defend one position while criticizing the other.

Here is an interesting article, in the Washington Post, entitled “Payroll tax cut raises worries about Social Security’s future funding“.  It points out that the recent payroll tax cuts are intended for short term stimulus, but they muck with the way that social security benefits are funded.  Instead of coming frm payroll taxes, that money now will haveto come from general revenue. 

As it points out: “For the first time in the program’s history, tens of billions of dollars from the government’s general pool of revenue are being funneled to the Social Security trust fund to make up for the revenue lost to the tax cut. Roughly $110 billion will be automatically shifted from the Treasury to the trust fund to cover this year’s cut, according to the Social Security Board of Trustees. An additional $19 billion, it is estimated, will be necessary to pay for the two-month extension.” 

As it goes on to say, “The payroll tax cut changes that. Instead being a protected program with its own stream of funding, Social Security, by taking money from general revenue, becomes more akin to other government initiatives such as Pentagon spending or clean-air regulation — programs that rely on income taxes and political jockeying for support.”

With crude oil prices hovering near $100 per barrel, the issue of energy independence is sure to be a frequent topic in the upcoming presidential election. Don Fullerton, a finance professor and energy policy expert at Illinois, spoke with News Bureau Business and Law editor Phil Ciciora about whether the goal of energy independence is a viable one or just another pipe dream.

Is energy independence a realistic goal for the U.S.?

It seems like it’s mostly senators from oil-rich states who want to talk about oil and energy independence, because they want subsidies for the oil industry. So it’s really only for political reasons that energy independence has been hyped as an important or worthwhile goal.

If we really are concerned about reducing our dependence on foreign oil, then the implication is to tax oil, not to subsidize it! A tax on oil would discourage its use, which would have three good effects. First, it would discourage imports. Second, it would reduce drilling in the U.S., and thus help keep more oil in the ground for future contingencies. Third, it would encourage the development of other energy technologies such as biofuel, solar power, wind power and better battery technology. Those other technologies are the only realistic route to true energy independence.

Plus, there’s absolutely no way we’re going to achieve energy independence through oil because we’ve basically used up most of our oil. For all practical purposes, we don’t have much more oil. That’s why we either have to rely on other countries or switch to new technologies.

An attempt to achieve energy independence would also be a bad move for energy security, because it just says, “Let’s drain America first.” If so, we’ll be in an even worse situation later. Whatever we still have in reserve should be left there for its option value. If we did have another serious war where we really needed oil that we couldn’t import, those reserves might be good to have.

Do the new sources of domestic energy in the Dakotas and the Gulf of Mexico hold much promise for solving our energy problems?

Sure, there are some new sources of energy in the U.S. – really, natural gas and shale oil – but however much we have won’t bring us any closer to energy independence. Even if we do discover a few new fields of crude oil, it’s not going to make much of a difference.

As the price of crude rises even higher, the oil companies can go back to old and existing fields and drill a little deeper. That extraction is expensive, but it’s worthwhile if the price of oil is back near $100 per barrel. It wasn’t worthwhile earlier because the extra drilling cost was more than the oil was worth. But now that the price of crude is high enough, they can make money if they drill deeper on these old wells.

What happens to energy prices if the European economy continues to sputter?

If Europe experienced, say, a 10- to 20-percent drop in gross national product, then you might actually notice a dip in the price of oil in the U.S. But economic growth in the U.S. would also slow. So just because the price of oil might fall a little bit doesn’t make their troubles good for us, since we would be affected, too. We certainly don’t want to hope for a recession in Europe to make oil cheaper. First of all, the price wouldn’t fall that much. Second, there would be a whole host of negative implications for the U.S.

What (if anything) will bring the price of oil down again?

The only ways to get a significant change in the price of oil would be through a major recession, a major technological breakthrough, or huge policy changes. If the whole world got together and agreed to a new, stringent version of the Kyoto Protocol to reduce carbon emissions, that would have an impact. If the whole world were to reduce the burning of fossil fuels by 20 percent – that would also have an effect. But we don’t want another recession, nor will all nations agree to such a treaty.

Christmas lights are a funny thing.  Many people hang lights on the outside their homes during the holiday season.  The light displays run the gambit from small affairs around a door to enormous light extravaganzas on every surface, tree, and shrub.  The quality of a display varies greatly depending on the skill and effort exerted by the homeowner.  It is curious though–Since the lights are on the outside of the house where the owner cannot see them, why do they exist?

To begin, I list (some) benefits of Christmas lights.  One, to be fair, the owner does see the lights for a brief moment when she comes home at night, providing an aesthetic joy.  Two, a religious homeowner can be use a holiday light display to advertise her beliefs.  Three, passer-bys and neighbors receive the enjoyment of looking at the display (if it is well done, of course)!  This last benefit is a classic positive externality, where non-displayers receive benefits without incurring the cost directly.

Next, I list (some) costs of Christmas lights.  One, the displayer holiday lighting increases their electricity bill compare to normal electricity usage.  For large displays the electricity cost can be quite high, and I have seen houses that never turn off their Christmas lights from Thanksgiving until Easter!  Two, the extra electricity usage requires more production from power plants that likely burn coal, leading more air pollution and greenhouse gases.  Three, excess lighting creates a phenomenon called “light pollution” that impedes car driver sight-line at night, disturbs nocturnal animals, and blots out the stars.  These last two items are negative externalities.

On net, it is hard to say if Christmas lights are “worth it” for the displayer.  It is even harder to determine if they are a net benefit for society when the externalities are added-up.  Regardless, Christmas lights are an ingrained tradition in America, and will be around for foreseeable and likely distant future.  Hopefully with increasing awareness about the costs of holiday lights, people will consider lower impact decorations such as low-wattage bulbs, or putting existing lights on timers so that they turn off over night.   Happy holidays and joyous New Year!