Performance Incentives for Higher Education: You Get What You Pay For

Filed Under (Other Topics) by Nolan Miller on Oct 12, 2011

The Daily Illini ran a story today about a change to the way public universities will be funded in the future.  This year’s higher education bill, HB 1503, contains provisions instructing the Illinois Board of Higher Education to come up with performance measures that will be used, in part, as a basis for funding public colleges and universities in the state.  Let me begin by saying that, in general, holding government bodies accountable for their performance is a good idea.  The people of the state have a right to know that their money is being well spent.  I encourage the adoption of performance measures in all areas of public expenditure.

Having said that, I encourage (e.g., warn) the Illinois Board of Higher Education to keep in mind that when you pay someone to do something, they’re going to do exactly that.  So, you need to be careful what wish for.  If you increase a school’s funding when they increase their graduation rate, you should expect them to increase their graduation rate, and in many cases they’ll adopt the lowest-cost approach to doing so.  Sure, they may increase advising and keep closer tabs on students as they work their way through their educational careers.  That would be great.  But, they might also be more lenient in counting credits toward graduation, lowering their standards, or they might be more reluctant to admit students who seem unlikely to graduate on time, decreasing access.  While increasing advising effort costs money, relaxing standards and not admitting students who are unlikely to graduate (assuming there is another student waiting to take his place) are relatively costless.  We should not be surprised if, in the face of increased incentive, public universities make use of the latter two tools to increase graduation rates, because we paid them to do it.

To be sure, legislators and the IBHE are aware of these possibilities.  In fact, the bill suggests that there should be both overall performance measures (e.g., graduation rates) as well as measures that look at how well the school serves at-risk students.  However, incentives are complicated, so-much-so that social scientists have a name for what happens when they go awry.  We call it the “Law of Unintended Consequences.”  Further, there is increasing evidence that when you create explicit, monetary incentives to do a thing, you crowd out intrinsic incentives.  So, while you may have student advisors who today go the extra mile to get a student through to graduation out of a sense of altruism or duty, once you put a price on performance, this sense of duty seems to take a back seat.  People start to say “if I go the extra mile to help this student, it isn’t going to affect our overall graduation rate, which is what the state really cares about, so why bother.”  In an environment where people generally do their jobs, and do them well, because it is the right thing to do, putting a price tag on things can significantly reduce their intrinsic motivation.

The next point of concern comes from the funding structure.  It is unclear whether the incentive payments will be “new” money in addition to that already allocated to public colleges and universities, or whether it will be a reallocation of current money.  Much ado is made regarding government funding from the idea that people can do more with less.  We often hear cries to reduce “waste, fraud and abuse.”  But we need to keep in mind that public colleges and universities in Illinois have just been through a years-long belt-tightening process.  The easy cuts have already been cut.  Trying to squeeze the incentive payments within current budgetary allocations encourages “robbing Peter to pay Paul,” pulling resources away from other functions in order to meet performance goals, and the tighter the budget gets the more schools will be tempted to increase their performance scores through the cheapest way possible (i.e., lowering standards) rather than through the “right” way (i.e., increasing learning).

Finally, in setting up the pool of money available for performance bonuses, the IBHE needs to be careful not to exacerbate competition between public schools.  If the bonus pool is fixed and awarded to schools based on how well they meet performance goals, this may increase incentives to compete with other public schools.  Perhaps they will increase marketing expenditures in order to attract better students.  However, if all public schools do this, in the end you might have a lot of money going to marketing firms that would otherwise go to student services, and students more-or-less ending up in the same places they would have gone before.  Or, schools may spend money on improving student services such as the quality of the gym and/or the dorms, which make students happy but do not contribute to educational attainment.  The stronger the incentives offered by the new system, the more temptation there will be to engage in expenditures of this sort.  If competitive incentives are strong enough, forcing public schools in Illinois to compete more intensively over students may actually leave less money available for education and reduce overall attainment.  More unintended consequences.

Let me finish by saying that I’m not necessarily against performance incentives. But, incentives are complicated things, and the unintended consequences of incentive payments are often as important, if not more so, than the intended ones.  Designing incentive schemes that induce the behavior you want without encouraging the behavior you don’t want is a very difficult task.  I hope the IBHE is up to it.

Are U.S. physicians overpaid?

Filed Under (Health Care) by Nolan Miller on Sep 28, 2011

Let me begin by stating that the answer to this question is “no.”

Now that I’ve headed off the slew of angry calls from my family, the reason why I’m writing about this question is a recent article in the journal Health Affairs by Miriam Laugesen and Sherry Glied entitled “Higher Fees Paid to US Physicians Drive Higher Spending For Physician Services Compared to Other Countries.”  The study compared fees paid to general practitioners and orthopedists in the US with those paid in Austrailia, Canada, France, Germany and the UK.  They summarize their findings as:

“Public and private payers paid somewhat higher fees to US primary care physicians for office visits (27 percent more for public, 70 percent more for private) and much higher fees to orthopedic physicians for hip replacements (70 percent more for public, 120 percent more for private) than public and private payers paid these physicians’ counterparts in other countries. US primary care and orthopedic physicians also earned higher incomes ($186,582 and $442,450, respectively) than their foreign counterparts. We conclude that the higher fees, rather than factors such as higher practice costs, volume of services, or tuition expenses, were the main drivers of higher US spending, particularly in orthopedics.”

In light of this finding, one might be tempted to conclude that physicians in the US are overpaid relative to other countries.  However, while it is true that physicians in the US make more than physicians in other countries, in order to interpret this finding it is critical to note that high earners in the US in general make more than high earners in other countries.  Relative to other countries, the US income distribution is more skewed, meaning, for example, that the highest 1% of earners in the US make more than the highest 1% of earners in other countries.

Now, we might ask ourselves, what is the relevant comparison group for a US physician?  A US college student who is deciding whether to be a physician doesn’t compare the income that could be made as a physician in the US with the income that could be made as a physician in German.  He or she compares the income to be made as a US physician with the income to be made as a US lawyer or MBA.  In other words, the right question isn’t whether US physicians are paid too much relative to German physicians, but whether US physicians are paid too much relative to others at the top end of the US skill/eduction/income distribution.  With respect to this point, the answer seems to be that incomes for US physicians are largely in line with incomes to other high earners in the US.  (Not to be too hard on Laugesen and Glied, they discuss this point at the end of their article.)

The issue of how physician incomes fit into the broader income distribution is discussed in a paper from earlier this year by David Cutler and Dan Ly that appeared in the Journal of Economic Perspectives.  They compare incomes for general practitioners and specialists to the income of “high earners,” (people in the 95th to 99th percentile of the income distribution) in 13 other OECD countries.  In the US, this ratio is about 1.37 for specialists.  In the other OECD countries, the ratio ranges from 2.56 in the Netherlands to 0.8 in the UK, with the average being 1.45.  For GPs, the ratio of income for US physicians to that of other US high earners is 0.92.  In the other countries, this GP ratio ranges from 0.68 in Norway to 1.41 in Canada, with the average being 0.98.  Thus, in both cases, US physician earnings seem to be in line with earnings of high earners, with the US being slightly below the OECD average for both GPs and specialists.

So, what do we make of the two studies?  Well, Laugesen and Glied have a point that high physician incomes appear to drive the high cost of healthcare in the US relative to other countries.  But, the reason why US physicians earn so much isn’t because “the system is broken,” they “take advantage of the system” or some other nefarious motive.  Rather, US physicians earn a lot because high earners in the US earn a lot.  So, the skewness of the US income distribution is in part responsible for the high cost of health care in the US.

This point is potentially important for understanding how we might reduce healthcare costs in the US.  Often, proposals to reduce Medicare spending focus on reducing provider payments.  However, if this reduces physician incomes we might expect that in the long run, as physician incomes drop relative to other professions, we’ll have fewer physicians and more lawyers, MBAs, etc.  As long as wages in these competing professions remain high, it will be difficult to squeeze down on physicians too much without driving them out of medicine.  If the highest-ability students are the most likely to move to a different profession, we might find that those who still choose to be doctors are not as good: the overall quality of the talent pool of young physicians might drop.  At the same time, to the extent that this reduced physician supply leads to shortages, it will put upward pressure on physician fees, and we’ll be right back where we started from.  In short, it is unclear that we can reduce healthcare costs too much by reducing payments to physicians.

How to tell your Leaders from your Legends.

Filed Under (Uncategorized) by Nolan Miller on Sep 22, 2011

I’ve had ample time to get over what I like to call “worst-division-names-ever-gate,” i.e., the Big Ten’s announcement last December that starting this year its teams would be split into two divisions, the “Legends” and the “Leaders.”   It is difficult to imagine coming up with something worse than this, but perhaps one should have low expectations for a twelve-team Big “Ten,” anyway.  They should have just gone with Division A and Division 1, which would have been equally as informative and no less random.  At least they could have gone with any two seven letter words with fewer than five letters (including the first and last) in common.  But, what are you going to do?

The time to complain is gone.  Now there is nothing left to do but try to figure out which division is which.  Here’s a helpful guide:

First: what are the divisions?

The Leaders: Indiana, Illinois, Ohio State, Purdue, Penn State, Wisconsin.

The Legends: Iowa, Minnesota, Michigan, Michigan State, Nebraska, Northwestern.

Next: how do I remember who goes where?

1.  The “Leaders.”  The leaders division forms a smile on the map (maybe even an “L” shape), from Wisconsin down to Illinois to Purdue and Indiana to Ohio State and finally to Penn State.  If you’re not smiling, you’re probably a Legend.

2.  The “Legends.”  The Big Ten tried its hardest to make sure there was no rhyme or reason to the divisions. But, it missed one.  Alphabetical order.  By some twist of fate, the Legends are the six teams in alphabetical order, starting with Iowa: Iowa, Michigan, Michigan State, Minnesota, Nebraska, Northwestern.  Also, except for Iowa, they all start with M or N.  So, you may just want to remember “MNMNMIowa!” as your rallying cry.  As many of our leaders have trouble with alphabetical order, it is a good thing they’re not Legends.

Now, that may help you remember which teams are grouped together, but it still doesn’t help you remember which ones are the Legends or which ones are the Leaders.  To that I respond: Really?  Who cares?

But, maybe you do.  So, here are some tips.  First, the Leaders actually lead the alphabet, with Illinois and Indiana.  Next, the Legends (which has a “n” in it) contains the teams that start with N.

I have a feeling this may be the most important post I write this year.

Sensible Talk on Ponzi Schemes

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Nolan Miller on Sep 16, 2011

  of the Washington Post has an excellent piece today on the “Great Ponzi Scheme Debate” over whether Rick Perry is correct when he calls Social Security a Ponzi scheme.  It’s not fancy or technical, but it is right on point.  Here’s the link.

In Crashes, a Grandparent Safety Factor? Not so fast!

Filed Under (Health Care) by Nolan Miller on Sep 14, 2011

The New York Times ran a story the other day on a recent study in the journal Pediatrics that “suggests that children may be safer when their grandparents are driving than when their parents are at the wheel.”  Both the article and the study are flawed.  The study is bad for statistical reasons I’ll get into in a minute, and perhaps it is better to say that the popular reading of the article makes too much of what the results actually show.  The New York Times story is flawed because there is no evidence that any thought was given to the possible merits of the study, merely summarizing without any attempt to do actual journalism.  This is all-too-often true of the coverage of health-related studies in the popular press.  As most people are unlikely to read the original study or critique its methods, reporting results without providing critical analysis runs the risk of giving people wrong, and potentially dangerous, advice.

So, what results are reported in the study?  The study finds that grandparents were the drivers in 9.5 percent of vehicle accidents involving children, but only 6.5 percent of the injuries.  Thus, children in crashes in which their grandparents were the drivers were less likely to be injured than children in crashes in which their parents were.  The result remains true even once you control for known risk factors for injuries such as use of proper restraints, the size of the vehicles involved and measures of severity of the crash.  In fact, it gets a bit stronger, so that children in grandparent-driven crashes are 50% as likely to be injured as children in parent-driven crashes.  The Times quotes one of the study’s authors as saying “But there’s something about the crashes of grandparents that we were unable to measure that was protective. It would be great to figure out what this is, because it could be protecting a lot of kids.”

OK.  So what’s the problem?  Well, the study fails to account for the fact that far more miles are driven by parents than by grandparents.  So, while it may be true that a child in an accident where a grandparent is the driver are less likely to be injured than a child in an accident where the parent is the driver, grandparents seem to have so many more accidents per mile driven that a child is far more likely to be injured in a mile driven by a grandparent than a parent.

Let’s do some back-of-the-envelope calculations.  Some facts take from the paper, which are not ideal, but the best I could find on short notice.  “Up to 33% of nonresidential drivers will make trips with children a few days per month, 14% a few days per week, and 5% almost every day. Of such nonresidential adult drivers, 42% were the child’s grandparents.”  A quick look at the original source suggests that 4% of grandparents report driving children “almost every day” and 14% report driving kids “a few days a week.” Now, I think it is reasonable to assume that a child drives with a parent every day (especially since the data in the study are limited to kids who are driven in cars and have accidents).  It is a bit of a leap, but if 4% of grandparents drive kids almost every day and we round up to account for more occasional grandparent drivers, then maybe the number of trips kids take where their parents drive is something like 20 times as large as the number of trips which grandparents drive (since 100% of parents drive their kids every day).  If the trips are of equal length, then that suggests 20 parent-driven miles for ever grandparent-driven mile.  My guess is that parents tend to make longer trips, so if anything it is more parent miles per grandparent mile, but lets go with 20:1.

Now, the study found 1143 accidents involving grandparent drivers and 10716 accidents involving parents.  But, to account for the fact that parents drive more often, you should weight these numbers, basically by multiplying the 1143 by 20 to get a number that corresponds to what would happen if grandparents drove as many miles as parents.  If we do that, we get 22860, meaning that a child is twice as likely to have an accident in a mile driven by a grandparent than in a mile driven by a parent.  Going on, the study found 113 injuries when grandparents were the drivers and 1189 injuries when parents drove.  Again multiplying the grandparent number by 20, you get 2260, meaning that children are also twice as likely to be injured in a mile driven by a grandparent than by a parent.

Given the data, in order to find that the risk of accident and injury to a child in a mile driven by a parent and grandparent were approximately the same, you’d need the child to be driven by a parent for no more than 10 times as many miles as by a grandparent.  This seems unlikely to me.

So, my reading of the data is almost exactly opposite those of the paper.  Now, to be fair, the paper usually states its conclusion as ‘if you are going to have an accident, it is better to have one with a grandparent behind the wheel.’  This is accurate, although I believe the authors are overstepping the data when they go on to suggest there is something protective about grandparent driving.  (In fact, the protective thing is that it doesn’t occur all that often!)  The more relevant question is ‘should I send my child to school with a parent driver or a grandparent driver?’  The study does not directly investigate this question (and the New York Times does not investigate anything in its write-up).  My suspicion and back of the envelope calculations suggest that the answer to this question is clearly in favor of the parents.

Note: the views expressed in this blog should not be interpreted as an indictment of any particular grandparents, especially my son’s grandparents, who are welcome to drive him around whenever they like.

More options are bad?

Filed Under (Health Care) by Nolan Miller on Aug 31, 2011

One of the bedrock principles of standard economics is that choices are good.  The simple version of the argument goes like this.  If I offer you a choice between an apple and a banana, increasing the options so that you can now choose an apple, a banana, or an orange must make you better off.  Since in the second case you can choose anything you would have chosen in the first (i.e., apple or banana), but you can now also choose an orange if you prefer it, it must be that the adding the option to choose an orange makes you better off.  Or so the simple argument goes.

While this argument has a certain intuitive appeal, recent evidence of poor decision making when faced with multiple options suggest that choices, while good in theory, may lead to poor decisions and thus be bad in practice.  One such study (written by J. Michael McWilliams, Christopher Afendulis, Thomas McGuire and Bruce Landon) just appeared in the online edition of the health policy journal Health Affairs.  The authors of the study consider seniors’ decisions about whether to enroll in Medicare Advantage, the HMO-like system that runs alongside traditional Medicare.  For seniors in the U.S., the default decision is to participate in “traditional Medicare,” the plan where seniors go to whatever doctors they like and the government pays the bills.  But, they also have the option to choose to enroll in a Medicare Advantage plans.  In exchange for accepting some limits on which providers they can see (or financial consequences for choosing out-of-network providers), Medicare Advantage plans often provide additional benefits, such as prescription drug coverage, vision or dental benefits, or else reduce their patients’ out-of-pocket costs of care.  These plans differ in their networks and in the portfolio of benefits they offer and may or may not appeal to any particular senior.

The standard “choices are good” argument would seem to apply here.  The more Medicare Advantage plans are available to a particular senior, the greater the chance that she will prefer one to traditional Medicare.  So, the likelihood of enrolling in Medicare Advantage should increase as the number of participating plans increases.  The Health Affairs study finds that this is, in fact the case, but only up to a point.  Increasing the number of plans available to a person tended to increase enrollment in Medicare Advantage, but only if there were fewer than around fifteen plans available.  When there were between fifteen and thirty plans available, additional options did not affect enrollment, and when there were more than thirty plans available, increasing the number of options available actually decreased enrollment in Medicare Advantage.  This tendency for additional options to reduce enrollment was particularly pronounced for participants with decreased cognitive abilities, consistent with the contention that when the choices facing a person become too complex, they tend to make worse decisions.

Lest you think that “choices are bad” only applies to the elderly, another such example comes from a 1995 study by Donald Redelmeier and Eldar Shafir that appeared in the Journal of the American Medical Association.  

In the study, a group of family physicians were presented with two different scenarios:

Scenario 1:  The patient is a 67-year-old farmer with chronic right hip pain. The diagnosis is osteoarthritis. You have tried several nonsteroidal anti-inflammatory agents (e.g., aspirin, naproxen, and ketoprofen) and have stopped them because of either adverse effects or lack of efficacy. You decide to refer him to an orthopedic consultant for consideration for hip replacement surgery. The patient agrees to this plan. Before sending him away, however, you check the drug formulary and find that there is one nonsteroidal medication that this patient has not tried (ibuprofen). What do you do?

The second scenario was the same as scenario 1, except the underlined phrase was replaced with “two nonsteroidal medications that this patient has not tried (ibuprofen and prixicam).”

Now, if more options are good, what we should have seen was that the doctors should be more likely to pull back the referral and try another drug in the second case than in the first.  After all, if you would pull the referral and try ibuprofen, then you should certainly pull the referral if you can try ibuprofen or prixicam.  However, the doctors behaved quite differently.  While 53% of physicians choose to refer the patient under scenario 1, 72% choose to refer the patient under scenario 2.  (The study reports similar results for other decision making scenarios.)  It seems that the doctors, faced with the additional task of thinking through whether to treat the patient with ibuprofen or prixicam after pulling the referral, simply decided to avoid the issue by continuing to refer the patient.  Just as in the case of Medicare Advantage plan choice discussed above, when faced with a difficult or complicated choice, decision makers responded by avoiding the effort of figuring out the right answer and simply going with the default option.

Studies such as these are disturbing on many levels, not the least of which because they shake our confidence in the basic principle that options are good.  If increasing a person’s available options is not good, then we need to think hard about which options we should offer them and which we should suppress.  Decisions like this, which involve making judgments about the kind of information others would find useful are value-laden and inherently difficult.  In light of this, the above studies suggest that the most likely response will be to stop offering people choices altogether.  Wait, that can’t be good either.

Behind the Gotcha! Moment, Romney had a point about corporations being people

Filed Under (U.S. Fiscal Policy) by Nolan Miller on Aug 18, 2011

Last week Mitt Romney lost focus on his primary campaign strategy of keeping his mouth shut and actually said something, providing the cable news networks with an excellent “gotcha” moment.  The phrase that paid, which Romney spoke in response to an audience member’s statement that we should pay for entitlement programs by taxing corporations, not people,  was:

Corporations are people, my friend.

This phrase, seemingly pro-business and dripping with condescension, drew immediate criticism from the Democrats, who called it a “shocking admission” of “misplaced priorities.”

Now, let’s leave aside the existential question of whether corporations are people or not and focus on Romney’s main point, which has been conveniently left out in many cases.  He continued to say “Everything corporations earn ultimately goes to people.  Where do you think it goes?”

Now, this is a point that I often make in class.  Curiously, however, when I make it I start by saying that corporations are NOT people.  That is, they don’t eat.  When money goes into a corporation, it isn’t like the corporation uses the money to buy fancy cars and big screen tv’s for its own enjoyment.  Money that goes into a firm goes to pay its bills, and what’s left over is split between its employees and its owners.  In the case of a publicly traded corporation, the owners are the people who own stock in the company. 

In this light, the logical fallacy underlying the belief that corporations can be taxed without harming anyone becomes clear.  If you take money from the corporation and give it to the government, this is not without consequences.  That money is coming out of someone’s pocket.  Sometimes that money may be coming out of the company’s top executives’ bonuses, but other times the pocket in question belongs to a middle-class worker who has his or her retirement money invested in the stock market.

Now, I don’t mean this as an argument for or against raising corporate taxes.  Rather, I simply want to point out that raising corporate taxes is a form of redistribution from the owners of the firms (and the firms’ customers if the higher taxes cause them to raise prices) to the recipients of government services, and these owners may be the very same “hard working middle class Americans” whose welfare we are raising taxes to protect.  This may or may not be desirable.  But, corporate tax revenue is not “free money.”  Despite the joy of a good Gotcha Moment, Romney was right on this point.

 

Raise your hand if you’d favor a balanced budget that spent 18% of GDP. Not so fast, GOP hopefuls!

Filed Under (U.S. Fiscal Policy) by Nolan Miller on Aug 12, 2011

Last night’s GOP debate featured some high political theater.  One of the highlights was when the moderator asked the eight candidates to raise their hands if they would reject a deficit deal that included $1 in tax increases for every $10 in spending cuts.  Every one of the contenders raised their hands.

Now, I don’t want to be political here, but I don’t think it is political to say that the candidates could not possibly have been thinking when they supported this proposition.  (The one exception is Ron Paul, who is a principled Libertarian and supports the elimination of the income tax entirely.)  Let’s think about what it would mean.  Currently, the U.S. federal government spends about 24% of GDP each year and takes in about 15% of GDP in taxes.  So, a 10-to-1 ratio of spending cuts to revenue increases, if scaled appropriately, could lead to a balanced budget that spends around 16% of GDP.

Now, the current revenue number is somewhat lower than the historical average, which has run around 18% of GDP.  This is partially due to the recession and partially due to the Bush tax cuts.  If the economy recovers and the Bush tax cuts are extended, CBO expects receipts to grow to about 21 percent of GDP by 2020 (with part of this increase being driven by new taxes aimed at paying for the Patient Protection and Affordable Care Act).  Of this increase, expiration of tax provisions are expected to contribute about 1.8% of GDP.  About 0.5% of GDP comes from expiration of the Bush tax cuts for households making more than $250,000 per year, which President Obama opposes. 

So, let’s do a quick, back-of-the-envelope calculation using numbers from the Office of Management and Budget.  (See tables 1.1 and 1.2).  Between 2011 and 2016, OMB estimates that total tax receipts will be about $18.54 trillion and total outlays will be about $23.95 trillion, for a total deficit of $5.41 trillion.  Suppose we were to close the gap using a 10-to-1 ratio of spending cuts to tax increases.  This would give us a balanced budget that spends $19.03 trillion.  Total GDP over this period is expected to be $104.02 trillion, which implies that federal government spending would be 18.3 percent of GDP over that period.  Ballpark computations (which I haven’t done fully) suggest that about the same conclusion comes from using a 10 year window.

The balanced budget amendment proposals that the Republicans have proposed tend to cap federal spending at about 18% of GDP unless there is an extraordinary override vote.  Many of the candidates have voiced their support for these proposals.

Now, the calculations I’ve done may not be quite right, but I think the point is clear.  A 10-to-1 ratio of cost reductions to revenue increases gets us to exactly where Republicans say they want us to be: a balanced budget that spends around 18 percent of GDP.  At the very least, a thinking candidate should have thought that the numbers were close enough to the ballpark that the proposal would require more scrutiny.

So, this leaves us with two possibilities.  Either the candidates were making a stand, saying that while they were willing to spend 18 percent of GDP, 18.3 percent was just too much, or else they just weren’t thinking and dutifully raised their hands in response to what they thought people wanted to hear.  If the former, I can respect that.  If, as I suspect, support for the proposition that a 10-to-1 ratio of spending cuts to revenue increases arose from a failure to consider the proposal and a desire to pander to the party’s base, the candidates are going to need to step it up.  (I suspect that the same set of hands would have gone up if the ratio had been 20-to-1 as well.)  The issues facing the country are too difficult and important to entrust to someone who is not willing to think about them.

Cut, cap and (you-do-the-) balancing

Filed Under (U.S. Fiscal Policy) by Nolan Miller on Jul 21, 2011

I was inspired by this feature on the Washington Post’s web site, which invites readers to try decide, in the event that the U.S. does not successfully raise the debt ceiling by August 2, which payments we should make and which we shouldn’t.

As I wrote last week, much of the discussion surrounding whether or not to raise the debt ceiling has focused on “shrinking government,” with Democrats favoring the federal government spending upwards of 24% of GDP each year and Republicans favoring spending less than 18%, with some favoring spending as little as 14%.  This week, Republicans in the House have even gone so far as to propose a Balanced Budget Amendment for the U.S. Constitution that would cap spending at 18% of GDP.

To see what that would be like, I’ve prepared this spreadsheet, with numbers taken from the Congressional Budget Office’s most recent budget analysis.  The numbers I have here are pretty close to adding up with what’s in the CBO analysis.  So, here’s the game:

1. Do your homework.  You can read about the spending categories in the CBO’s report and learn about topics like the difference between mandatory and discretionary spending (hint: not all mandatory spending is mandatory and not all discretionary spending is discretionary!).   Chapter 3 focuses on spending.

2.  Download the spreadsheet here.

3.  Make American Government work!  The yellow boxes are yours to play with, while the green boxes are numbers calculated to help you.  Start by choosing the percent of GDP that you think we should be spending (E5).  Once you do this, J15 – J17 will show how much money you have available to spend, how much you’ve spent so far, and how much is remaining to spend.  Then, in column F, choose how much we should spend on each of the categories listed.  I’ve started you out by filling in numbers for programs such as Social Security, Medicare, Medicaid and Defense spending in order to illustrate that it will be pretty hard to make the numbers work if you want to reduce spending to 18 percent of GDP and do not cut these programs. But, you’re in charge.  Do what you want.

Now, here are a few things to keep in mind.  First, this ignores the tax side of things.  The taxes that must be imposed in order to support a BALANCED-BUDGET government that is 24 percent of GDP are much more costly than those that must be imposed to support one that is 14 percent of GDP.  So, keep in mind as you cut that every dollar you cut means a dollar more (actually more than a dollar, since raising money through taxes is costly and distorts the economy in other ways) in somebody’s pocket.  Second, this ignores the feedback between the size of government and productivity.  So, if a smaller government leads to lower interest and tax rates, this might lead to higher growth, and if the base GDP number gets bigger it makes it easier to solve the spending problem.  Third, this is a static picture, but based on current projections the problem is supposed to get worse over time.  For example, CBO projects that total spending will rise to 27.6 – 35.2 percent of GDP by 2035 under its best-guess extension of current law (p. 7).  So, if you think the problem is difficult to solve today, just wait and try and do it in 25 years.

Debt Ceiling — shut up, then put up.

Filed Under (U.S. Fiscal Policy) by Nolan Miller on Jul 14, 2011

OK.  Here’s my deal on the debt ceiling fiasco.  As I and many others have pointed out before, behind all of the political posturing about tax increases, the budget deficit and the national debt are two very different visions of what the correct role of the U.S. government is.  Republicans favor smaller government, perhaps one with spending as small as 14 – 17 percent of GDP, while Democrats favor larger government, with government spending running in the range of 22 – 24 percent of GDP according to President Obama’s budget proposals from this spring, and possibly even larger since these proposals were already being influenced by Republican pressure.

Currently, the federal government spends about 24 percent of GDP each year.  From this starting point, the two parties’ positions on deficit reduction and the debt ceiling become clear, as does the fact that they’re really not about deficit reduction or the debt ceiling at all.  Republicans want to shrink the size of government.  Phrasing this in terms of fiscal responsibility, it means that the deficit gap should be closed by decreasing spending.  Democrats want to maintain or increase the size of government.  Phrasing this in terms of fiscal responsibility, it means that the deficit gap should be closed by increasing revenue.

Now, while this disagreement between Republicans and Democrats is fine in the long run, it makes much less sense in the short run, especially in light of the serious economic crisis we continue to endure.  For the next year or two, spending decisions should be driven by the short term concern of keeping the fragile recovery afloat.  And, by far the biggest risk to the recovery is the fallout from a failure to increase the debt ceiling before the August 2 deadline.  Almost everybody seems to agree on this, except for about 536 people who happen to live in the nation’s capital.

So, here’s my two-part plan on the debt ceiling.  Part 1: shut up.  Pass an increase in the debt ceiling that takes us well beyond the 2012 elections.  Both sides need to quit risking the economy in order to score political points.  Part 2: put up.  Since the disagreement between the two parties is really about their competing visions for government, let’s see them.  Give me a ten year financial plan for the government.  Make it detailed — more detailed than the 10 year plans put out by Representative Paul Ryan and President Obama.  Tell us what you’re going to cut and whose taxes you’re going to raise.  (Please don’t tell us you’re going to eliminate waste, fraud and abuse, because this cliche has a 200+ year record of failure.)  Let us see what these competing visions of the future are.  Get it all together for the 2012 election, and then we’ll vote on it.  If you think you can save the economy, do it by coming up with a plan for saving the economy.  At this point, the two sides only seem able to agree on plans for wrecking it.