Reflections of a Conservative, Lefty, Right Wing, Do-Nothing, Liberal, Moderate, Tea-Partying Privatizer

Filed Under (Health Care, Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Nov 29, 2010

In American politics, individuals who advocate a move in the direction of more limited government, greater reliance on market force, and who emphasize the role of individual choice are often labeled as conservatives, neo-cons, right-wingers, privatizers, or, in the last election cycle, tea partiers. Those who advocate a greater government role, restrictions on individual choice, and more regulation are labeled as liberals, progressives, left-wingers, and socialists.

Lately, however, I have been thinking about how meaningless some of these phrases can be when describing specific policies reforms relative to the status quo. The reason is that U.S. economic policy as a whole lacks ideological consistency. This reflects, in part, the fact that our existing set of laws and regulations are often creatures of the time period in which they were passed.

As an example, I want to focus on a broad issue on which I have spent much of my professional life as a researcher and policy adviser. Namely, how we as a nation choose to handle risk. In particular, how we allocate risk – and insurance for risks – across the public and private sectors.

If you think about it, the allocation of risk is one of the primary roles of government in the modern era. Indeed, I once heard the U.S. government described as “a very large insurance company with an army.” This is not a bad description. The U.S. government runs the world’s largest life- annuity and disability programs (Social Security), some of the largest health insurance programs (e.g., Medicare, Medicaid, the VA system), a pension default insurance program (the PBGC), a deposit insurance program (the FDIC), an unemployment insurance program, a crop insurance program, a terrorism risk insurance program, and many more.

There is tremendous scope for reasonable and intelligent debate about the appropriate role of government when it comes to intervening in private insurance markets. I do not pretend to have the only “correct” view – how could I, when some of the economists I most respect in this world have come to different conclusions than I have?

But I do believe that I have developed a world-view about what constitutes a sensible and appropriate division of responsibility between the public and private markets that is informed by economic theory, empirical evidence, a dose of experience in how the government operates, and my own ideological predisposition towards individual freedom over government control. The world view that I have developed is one that believes that when it comes to the allocation of risk, we should find the least intrusive role possible for the government that is consistent with providing citizens with adequate opportunities for insuring against risks when doing so enhances societal well-being.

Yes, that is a mouthful. So let me briefly explain. I first note, however, that you need not agree with this world-view to agree with the main point of this blog. But allow me to – very briefly – explain my rationale. Basically, for nearly any economic policy, I go through the following thought process:

1. Can the private market achieve an efficient outcome without government intervention? Here, I define efficiency is the usual economist way of “1st best” outcome that would be generated by Adam Smith’s ideal of a perfectly competitive market without market failures. If the answer is “yes” – as I feel is typically the case with most markets for goods and services, then my belief is that the government should stay out of the way and let markets work their magic.

2. If the answer to question 1 is “no” because of the existence of a market failure (such as adverse selection or moral hazard in insurance markets, the existence of externalities, etc.), then I ask whether the government is capable of over-coming the market failure. Importantly, the answer is often “no.” In many cases, the government faces the same problem as private markets. For example, if there is moral hazard in insurance markets (e.g., if people behave in inefficiently more risky ways when they are insured), then there is very little the government can do about it. The answer is sometimes also “no” because of “government failure,” that is, a political process that leads to even good ideas being poorly implemented due to policy being influenced by special interests or policies being poorly implemented by an inefficient bureaucracy. Whatever the reason, if the answer to this question is “no,” then I will again favor the private market solution, even with its flaws.

3. In the relatively small subset of cases where the private market does not work, where the government has the ability to overcome the market failure, and where the government solution is likely to be designed and implemented in a sensible manner, then I am entirely willing to back such a policy. Even then, however, I will favor the most limited form of government intervention necessary to overcome the market failure. Thus, for example, I have no problem mandating that drivers carry collision insurance because a government mandate can overcome the adverse selection problem that might cripple a purely voluntary market.

Because my approach starts with a belief in the power of free markets and a healthy dose of skepticism about the political process and the skills of bureaucracies, my view is definitely “right-of-center.” But it is clearly not an unabashed “free markets all the time” view because it does recognize a need for limited government intervention in some cases. You may not agree with this view – but it is an ideologically and economically coherent and internally-consistent approach to economic policy.

But now, let us return to the how my views would be labeled by the political process in America today. In practice, application of my world-view to policy means that I often favor having the government encourage insurance through automatic enrollment or even a mandate (in order to overcome adverse selection), but then allowing competitive private market to actually provide the insurance.

But the U.S. is all over the map when it comes to how we treat insurance programs. Consider two dimensions of the problem:
1. Is insurance mandatory or voluntary?
2. Is insurance provided by the government or the private sector?

There are 4 possible combinations of answers, and we have programs in each. Here are a few examples:

Voluntary/Private – dental insurance, 401(k) plans
Voluntary/government – long-term care under the new CLASS Act
Mandatory/private – automobile insurance
Mandatory/government – Social Security, Medicare, PBGC, FDIC

My view is that we ought to have lots of programs in the mandatory/private, when in fact this is one of the least used approaches. What is interesting, however, is how advocating movement towards mandatory/private is viewed relative to the status quo. Over the years I have publicly advocated the use of personal accounts as a supplement or partial replacement for Social Security, and I would be perfectly happy to make them mandatory (or at least the default option). I have also publicly advocated replacing the PBGC with mandatory private pension insurance. I’d also like to see our public sector defined benefit plans reformed so that they have a defined contribution component. In all of these cases, I am advocating a move from mandatory/public to mandatory/private. As a result, I have been labeled a “conservative” or “neocon,” a “right-winger” and a “privatizer.”

In recent years I have also advocated that we consider making annuities the default distribution option from 401(k) plans, and in a blog in October I suggested that we considering mandating that people buy long-term care insurance in order to eliminate dependence on the inefficient Medicaid program. In these cases, where I am trying to move from voluntary/private to mandatory/private, some people labeled me a “lefty” and “liberal.”

Now, let’s take my view about automobile insurance. In essence, I think we have a reasonable approach – namely, that we mandate coverage but allow private insurance providers to provide it. This has not been a major policy issue in recent years. So I can be fairly characterized as having a “do nothing” or “status quo” approach to this policy issue.

At the other extreme, I cannot help but point out that the recent CLASS Act is precisely the opposite of what I would design. It is voluntary, so fails to overcome the main problem in the market but is provided by the government, despite the fact that the private market is fully capable of providing it! Here I just get labeled as a critic.

So, where does this leave me? Am I a right-wing, small government, neo-con intent on privatizing major government programs? Or am I a left-wing advocated who wants to take away individual choice? Or am I a defender of the status quo? Or am I just a critic of government policies?

The answer to all of these questions is “yes.” But this does not mean that I am a flip-flopper or ideologically inconsistent. To the contrary, it means that I am applying an ideologically consistent world-view to a wildly inconsistent set of existing public policies.

At the end of the day, I believe that much of our political rhetoric has become vacuous, school-yard name-calling that does little to illuminate our policy discussions. I find it frustrating – even sad – that we so often mindlessly label and name-call instead of engaging in well-reasoned, analytical discussions of important policy issues.

Let’s Eliminate Waste, Fraud, and Abuse

Filed Under (Environmental Policy, Finance, Health Care, Other Topics, Retirement Policy, U.S. Fiscal Policy) by Don Fullerton on Nov 5, 2010

For the U.S. Federal Government, estimated receipts for the fiscal year 2010 are $2.381 trillion.  President Obama’s budget for 2010 adds up to $3.55 trillion; a difference in spending of $1.17 trillion.  That annual deficit is 49.2% of receipts!  Now that’s scary.  We’ve got to do something.  What we hear of course, is that we need to cut waste, fraud, and abuse.  No doubt about it; nobody in their right mind LIKES waste, fraud, and abuse.

So I went to find out how much of U.S. Federal government spending is on waste, fraud, and abuse.  For that purpose, of course, I turn to the best source for information that is accurate, unbiased, and objective.  I mean Wikipedia, of course.   On the Wikipedia entry for “2010 United States federal budget”, I see a breakdown for $2.184 trillion worth of “Mandatory Spending”:

  • $677.95 billion – Social Security
  • $571 billion – Other mandatory programs
  • $453 billion – Medicare
  • $290 billion – Medicaid
  • $164 billion – Interest on National Debt
  • $11 billion – Potential disaster costs

That $2.184 trillion of mandatory spending is 61.5% of the total $3.55 trillion of spending!   That MUST be spent, by law.  We can’t just renege on promised social security benefits or interest payments on the national debt.   And if it’s mandatory, it can’t include any waste, fraud and abuse.  So let’s keep looking for where to cut that waste, fraud, and abuse.  Here are some of the top categories for the remaining $1.368 trillion of spending, called “discretionary spending.”

  • $663.7 billion – Department of Defense (including Overseas Contingency Operations)
  • $78.7 billion – Department of Health and Human Services
  • $72.5 billion – Department of Transportation
  • $52.5 billion – Department of Veterans Affairs
  • $51.7 billion – Department of State and Other International Programs
  • $47.5 billion – Department of Housing and Urban Development
  • $46.7 billion – Department of Education
  • $42.7 billion – Department of Homeland Security
  • $26.3 billion – Department of Energy
  • $26.0 billion – Department of Agriculture
  • $23.9 billion – Department of Justice
  • $18.7 billion – National Aeronautics and Space Administration
  • $13.8 billion – Department of Commerce
  • $13.3 billion – Department of Labor
  • $13.3 billion – Department of the Treasury
  • $12.0 billion – Department of the Interior
  • $10.5 billion – Environmental Protection Agency

The biggest item ($663.7 billion) is defense spending, and we certainly can’t cut that during a war.  And that is 48.5% of all discretionary spending.  All of the rest of discretionary spending adds up to $704 billion, which is only 60.2% of the total $1.17 trillion of deficit.  In other words, even if we completely eliminated ALL discretionary spending other than defense, we’d still be stuck with 40% of the current deficit ($466 billion, or half a trillion dollars per year).  And that would mean zero spending on health and human services, zero on transportation, zero on veterans affairs, etc.

Still, however, it seems like we ought to be able to eliminate SOME of that spending, at least the spending on waste, fraud, and abuse.   So let’s look for that category.  Hmmm.  As I look down that entire list, I don’t SEE a category for waste, fraud, and abuse!

Okay, I’ll stop being sarcastic, but this does have a point.  Some very careful analysts might in fact be able to find some waste, fraud and abuse.  But that is much easier said than done, and it will be a tiny fraction of the deficit.  Any plan to get serious about cutting federal spending must make serious cuts in programs that are important to people, like welfare and transportation.  To eliminate the deficit will require changes in entitlements like Social Security and Medicare.

Moreover, we can’t substantially cut the deficit with only cuts in spending.  The categories listed above just cannot be cut enough to dent the deficit.  To eliminate the deficit, the only alternative is a combination of spending cuts and tax increases.  The new Congressional leaders do not want to increase taxes, of course, and I’m not saying they must.  Maybe we won’t close the deficit.  But just don’t tell me you’ll eliminate the federal deficit by cutting waste, fraud, and abuse.

Long-Term Care is a Long-Term Problem

Filed Under (Health Care) by Jeffrey Brown on Oct 6, 2010

Yesterday, I gave a talk at the Dutch Ministry of Health in the Hague (the political center of the Netherlands).  I was asked to make a presentation about the U.S. long-term care insurance system.  The problem is, we have no “system” to speak of.  Rather, we have a confusing patchwork of public and private programs that together do – at best – a modest job of protecting individuals from the financial risks of long-term care.

Long-term care is a classic case of a risk that people ought to insure – it is highly uncertain whether you will need it, but if you do, there is a chance of it consuming enormous sums of money.  A typical nursing home can cost you north of $6,000 per month, and having skilled RN care in the home can easily cost $30 or more per hour.  These numbers can quickly exhaust the limited financial wealth of a majority of American households.

And yet, most people in the U.S. do not insure against this risk.  In aggregate, people pay about 1/3 of all long-term care costs out of their own pocket, whereas only about 4% of expenses is paid by private insurance.  Who covers the rest?   Taxpayers – through Medicaid, and to a smaller extent through Medicare.

But Medicaid is pretty lousy insurance because it requires that you impoverish yourself before you qualify.  Normally, we think of buying insurance so that a big financial shock does not ruin our future consumption possibilities – for example, if your house burns down (say, for example, you failed to pay the fire department your annual fee – see Nolan’s latest post!), you get enough money to rebuild so that you do not have to cut back on your other expenditures.  With Medicaid, however, it helps you out only after you have spent virtually all your other money paying for care.

So why don’t people buy private insurance?  There are many plausible reasons, but one of them – as shown in my work with Amy Finkelstein – is because Medicaid’s means-testing and secondary payer status means that it is in your interest *not* to buy insurance.  Why?  Because most of what you buy ends up duplicating what you could have gotten for “free” from Medicaid.  And because many policies available in the private market fail to cover a large share of you possible expenditures, you may end up on Medicaid anyway.

This highlights a fundamental problem – and one that, I learned yesterday, is shared by the Netherlands and Germany (both countries about which others presented).  Namely, once you decide that you are going to not let people die on the streets for lack of funds to pay for long-term care (and thus provide a government program to help), you cannot help but mess up the private market.

This leaves a dilemma.  If the private market cannot function properly because of the government means-tested program, and if you are not willing to get rid of the means-tested program (which would almost certainly leave some people in need of care left without it), then the net result is that people will have significant exposure to uninsured risks. Of course, one solution is to drop means-testing altogether, and simply cover all long-term care under the universal Medicare program.  But I confess that I really dislike the notion that just because we allow one form of government intervention (e.g., Medicaid), we must then provide even more government intervention n (e.g., covering all long-term care under Medicare) just because the market can no longer work!  Not to mention that an expansion of our entitlement programs is the last thing we need given our long-term fiscal outlook.

Or do we just accept the status quo?  Let Medicaid continue to help those who need it, but at the cost of crowding out potentially better private coverage and thus leaving many people exposed to the risk of impoverishment.  It is a hard choice.  Different countries have taken very different paths – and none of them are happy with it.  The Netherlands covers all the care, but as a result they are facing large and growing government expenditures and are asking whether this is sustainable.

So, what are we to do?  There is only one solution I can think of that a) relies on private markets rather than a taxpayer –financed government program, and b) ensures that everyone gets the coverage against financially-catastrophic long-term care expenditures.  And that is to have the government mandate that everyone have coverage, but leave it up to the private market to provide it.  Then, take the money we are currently using to pay for long-term care through Medicare and Medicaid, and use part of it to subsidize the premiums for those with low-incomes.

The problem, of course, is that an “individual mandate” to purchase long-term care insurance would be politically unpopular in the U.S. (even then-candidate Obama was against an individual mandate for regular health insurance during the campaign).  It goes against our nation’s free market preference (which I am usually a huge advocate of!)  But in this case, the irony is that a government mandate would probably result in less government control of long-term care, at least compared to the current system under which the government provides $3 out of every $5 spent.

Care About the Economy? Ignore the Goldman Sachs Testimony, and Watch the Fiscal Responsibility Commission Instead

Filed Under (U.S. Fiscal Policy) by Jeffrey Brown on Apr 28, 2010

While the Goldman Sachs testimony yesterday made all the political headlines yesterday, there was a second event occurring simultaneously that is much more important for our long-term economic security.  You see, despite all the rhetoric about financial regulatory reform, the Goldman Sachs hearings are really all about the past. 

The bigger story is about our future.  President Obama formally kicked-off of the “National Commission on Fiscal Responsibility.”

This Commission has the most difficult and important jobs in Washington – to figure out how to restore U.S. fiscal policy to something akin to a sustainable course.  It won’t be easy.  After 50+ years of total government spending comprising about 1/5 of the U.S. economy, the three entitlement programs – Medicare, Medicaid and Social Security – are projected – all by themselves – to exceed this share of the economy in the lifetime our today’s schoolchildren.  Throw in continued expenditures on all other functions of government – national defense, homeland security, environmental protection, education, the court system, and more – government spending is projected to consume an ever larger share of our economy.  This, in turn, has the potential to raise interest rates, crowd-out private investment, and thus reduce our rate of economic growth.

The President was careful not to take anything off the table yesterday.  That is important because this is not going to be an easy problem to solve.  At the end of the day, there are only two solutions to our fiscal problem. 

Solution 1: Raise more revenue.  In political terms, this means raising taxes.  I doubt that the Republican members of the Commission will be fond of this.

Solution 2: Cut spending.  In political terms, this means reducing the growth rate and/or level of benefits from “sacred cow” programs with vocal constituencies – such as seniors.  Democrats proved in 2005 that they are unwilling to cut benefits.  And many Republican members of the House sought to “solve” the problem through free lunch gimmickry, arguing that personal accounts (which I support, albeit for different reasons) would generate high enough returns that no benefit cuts would be needed. 

Where does that leave the Commission?  I see it most likely pursuing one of three possible outcomes.

Outcome 1:  The D’s and R’s on the Commission are unable to find enough common ground, and thus the Commission issues a final report that offers a series of options, each with proponents and dissenters.  In other words, partisanship.

Outcome 2: The Commission agrees they need to have at least some options that most members agree to.  And, caving to political pressure, they throw intellectual honesty out the window, and use a combination of both time-tested and brand new gimmicks to make it seem like the problem can be fixed without serious revenue increases or spending cuts.

Outcome 3:  The Commission takes a brave political stand by pointing out the extraordinarily difficult fiscal challenges ahead of us, proposes politically earth-shattering reforms, and then disbands and watches its proposals wither and die in the backrooms of Congressional committees.

Given the composition of the committee (see list here), I am optimistic that option 2 will be discarded.  But I think 1 and 3 are equally likely.

If there is hope for real reform coming out of this Commission, it will be because the Commission actually includes many sitting members of Congress who control the key committees.  In this important sense, this Commission has more in common with the 1983 Greenspan Commission, which led to politically difficult Social Security reforms being passed by Congress, than with the 2001 President’s Commission to Strengthen Social Security, which had no members of Congress and which saw its recommendations soundly ignored.

I hope my skepticism is mis-placed.  I sincerely hope this Commission comes up with good options, and that those in power listen.  If this happens, the long-term implications for “good” are far greater than 99% of all other economic news …

The Future of Fiscal Responsibility

Filed Under (Health Care, Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Feb 23, 2010

On February 18, the President Obama signed an Executive Order establishing the “National Commission on Fiscal Responsibility and Reform.”  The Commission will consist of 18 members.  Of these, 6 will be appointed by President Obama (with no more than 4 of the 6 being Democrats).  The remaining 18 will be divided up “3 each” among Democratic and Republican House members and Democratic and Republican Senators. 

The stated mission of this Commission is to identify “policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run.”

The mission is a critical one.  As I have noted in other posts (see, for example, my post from 2/2/10 on the 2011 budget or my post on 1/14/10 about why deficits matter), the long-term fiscal outlook is dire.   While the short-term deficits are being driven by a combination of recession-induced revenue declines, aggressive spending policies targeted at averting an even worse credit crunch and/or recession (e.g., TARP, stimulus, etc), as well as high levels of spending on Iraq and Afghanistan, the most serious long-term fiscal problems arise as a result of the runaway growth of entitlement programs.  Social Security, Medicare, and Medicaid are growing faster than the economy as a result of an aging population, rising health care costs, and the important interaction of these two factors. 

Commissions have a long history in the U.S., some of them successful in terms of leading to real changes (e.g., the Greenspan Commission in 1983) and some of them not (e.g., the President’s Commission to Strengthen Social Security in 2001 on whose staff I served.)  One of the features of this new commission is that it will be dominated by sitting members of Congress.  IF (1) these members are ones with real power (e.g., chairs and ranking minority members of the key committees like Senate Finance and House Ways and Means) and IF (2) these members can somehow move beyond ideological bickering and election-year politics and come to some meaningful compromises, THEN such a Commission could have an extraordinarily meaningful and positive impact on our fiscal future.  If, however, they simply resort to their political safe zones – with Republicans calling for balancing budgets solely through spending cuts and Democrats calling for balancing budgets solely through tax increases – then I would not expect much to come out of it.   

The political outlook is not promising, however.  Recall that only a month or so ago – in January 2010 – the Senate failed to garner the 60 votes needed to pass the “Bipartisan Task Force for Responsible Fiscal Action Act of 2010.”  In a blog on this same subject (click here to see it), Stephen Huth notes that “even before members have been appointed, both liberals and conservatives are dooming the work …”

The economic consequences are real.  As the Financial Times reported in January, the credit rating agency Moody’s announced that the U.S. could be at risk of losing its tripple A credit rating in the future unless it took steps to reduce its long-term deficits.  While Treasury Secretary Geithner says the U.S. will “never lose” its top rating, the very fact that the Treasury Secretary has to engage in such a conversation is an indication of just how serious are the risks posed by long-term deficits.  As noted by CNBC, “even if a downgrade in US credit is not imminent, the underlying conditions that raised such fears are worrying investors about what the future holds.” And even if our credit rating is not at risk, the long-run tax burden required to finance projected levels of spending are so enormous that I am afraid we will risk something far more important – our potential for sustained economic growth.

In short, I am in the “glass half empty” camp when it comes to my political assessment of the Commission’s likely impact.  I hope they prove me wrong …

Why Deficits Matter

Filed Under (U.S. Fiscal Policy, Uncategorized) by Jeffrey Brown on Jan 14, 2010

 

I happened to spot a USA Today in the coffee shop where I was working today (think of it as practice for my upcoming furlough days) and noticed a headline in the “Money” section entitled “How do we dig out from under $12 trillion in debt?”  It reminds readers of the very salient fact that our national debt-to-GDP ratio (now at 70.4 percent of GDP) is the highest it has been since the post WWII period.  Importantly, this figure substantially under-states the sad state of the U.S. fiscal position because it ignores the massive unfunded obligations facing our “big three” entitlement programs – Medicare, Medicaid and Social Security. 

While this is not good news, I was pleased to see one of the nation’s widely read newspapers addressing the issue.  And I thought it was worth a brief post about why deficits matter. 

There is some public confusion around this issue, not least because neither party seems to do much about it.  Whatever you like or dislike about the Bush Administration (disclosure: I worked for President Bush in 2001-02, participated in the Social Security reform tour with him and 2005, and received a Presidential appointment to the Social Security Advisory Board in 2006), it is near impossible to make a credible case that his Administration took deficit or debt reduction seriously. 

 Thus far, the Obama Administration has an even worse record of fiscal discipline.  Yes, yes, I know – the midst of a deep recession is not the best time to cut federal spending (or increase taxes) in an attempt to close the fiscal gap.  But despite the significant lip service that the Obama Administration gives to deficit reduction, there is so far scant little evidence that they are serious about reducing it even after the economy improves.  Most of their calls for increasing taxes are accompanied by new ideas for growing the size of government, such as paying for health care reform. 

 Leaving politics aside, do deficits matter?  V.P. Cheney famously quipped that they do not.  But most economists agree that they do.  The standard textbook analysis is that deficits reduce national saving and drive up long-term interest rates, thus reducing private investment and thus sacrificing long-term economic growth. 

 There is plenty of empirical evidence to support this.  Indeed, President Obama’s own budget director Peter Orszag, a distinguished economist and fiscal policy expert (another disclosure: Peter is a good friend and co-author of mine, despite our policy disagreements) has an influential paper on this topic.  The full paper (with Bill Gale) appeared in the Brookings Papers on Economic Activity, but a more reader-friendly summary is available from their piece in the Economist’s Voice. 

 Keep in mind that this article was written in 2004, back when annual deficits were projected to run 3.5 percent of GDP.  In contrast, current deficits are running about double that (although, admittedly, no one expects the current level of deficit spending to persist once the economy improves and we stop spending like drunken sailors in an attempt to stem the decline). 

 Here is what Gale and Orszag said then: 

 “Under reasonable projections, the unified budget deficits over the next decade will average 3.5 percent of GDP. Compared to a balanced budget, the unified budget deficits will reduce annual national income a decade hence by 1 to 2 percent (or roughly $1,500 to $3,000 per household per year, on average), and raise average long-term interest rates over the next decade by 80 to 120 basis points. Looking out beyond the next decade, the budget outlook grows steadily worse. Over the next 75 years, if the tax cuts are made permanent, this nation’s fiscal gap amounts to about 7 percent of GDP. The main drivers of this long-term fiscal gap are, in order, the spending growth associated with Medicare and Medicaid, the revenue losses from the 2001 and 2003 tax cuts, and increases in Social Security costs. The nation has never before experienced such large long-term fiscal imbalances. They will gradually impair economic performance and living standards, and carry with them the risk of a severe fiscal crisis.”

 I am heartened that OMB Director Orszag understands the serious long-term consequences of our nation’s fiscal imbalance.  Of course, Peter and I will likely disagree on how to fix the problem (he will want to rely primarily on taxes, whereas I would prefer to first go after spending).  But future generations had better hope that our elected officials find a way to compromise, do some of both, and get this nation back on a sustainable fiscal path.   

Should a Proposal “Pay for Itself” (and How do We Know if it Does)?

Filed Under (U.S. Fiscal Policy) by Don Fullerton on Sep 18, 2009

A member of Congress who wants to spend additional money often has to say what tax will be raised to pay for it.  Somebody else who wants a particular tax cut for their favorite lobbyist may have to say what other tax will be raised.  As a general principle, this kind of “budget neutrality” is often a good idea.  In all likelihood, the Tax Reform Act of 1986 only succeeded because it was revenue neutral.  It broadened the tax base and lowered tax rates, to fix the tax system without changing the amount collected.

But how is revenue neutrality calculated?  Politicians on both sides of the aisle call upon the non-partisan Congressional Budget Office (CBO) as the arbiter of budget balance.  If important policy choices must pass the CBO’s litmus test, then we need to understand what test is being administered.  According to its website, the “CBO’s [cost estimate] statement must also include an assessment of what funding is authorized in the bill to cover the costs of the mandates and, for intergovernmental mandates, an estimate of the appropriations needed to fund such authorizations for up to 10 years after the mandate is effective” (http://www.cbo.gov/CEBackground.shtml).  This CBO test has a few major problems that could limit the benefits from a policy, or even prevent enactment of a good policy.

First of all, not every act of Congress must be revenue neutral.  But policymakers may want the restriction of revenue neutrality, in order to “prove” they are fiscally responsible.  Recently, President Obama in his health care policy speech to a joint session of Congress promised that he “will not sign a plan that adds one dime to our deficits — either now or in the future.”  Thus, one general problem is: who decides which projects must be revenue neutral?

Second, of course, a project may generate revenue or cost savings after ten years.  President Obama’s health care reform has initial start up costs, but it may “bend” the long-run cost curve for federal expenditures on Medicare and Medicaid, so that cost savings accrue and accumulate over more than ten years.  In general, the CBO’s ten-year balance sheet could say that a policy adds to the debt over ten years, even though it may save taxpayer dollars in the long-run.  On Wednesday, September 16, 2009, the CBO released its official cost estimate for the Senate Finance Committee’s draft health care bill, stating that it would have a “net reduction in federal budget deficits of $49 billion over the 2010–2019 period” (http://cboblog.cbo.gov/?p=354).  However, an additional, unofficial estimate by the CBO concluded that the “the added revenues and cost savings are projected to grow more rapidly than the cost of the coverage expansion”, meaning that over a longer time horizon that the bill further reduces the deficits.

To be clear, the federal debt is a real concern.  Running massive deficits that pile up year after year is unsustainable and irresponsible.  But a strict CBO ten-year cost estimate test may not be the best way to evaluate a potential policy change.

A third problem is that any such test must be somewhat arbitrary, regarding what is counted as “revenue”.  Does it just count actual dollars flowing into government coffers?  What about features of a policy that reduce future outflows?  Some pieces of additional spending in proposed health care reforms are intended to improve future heath and thus to avoid the need for some future medical expenses.  The CBO would count current “preventive care” spending as a cost, but it may not count the fact that this current spending could reduce the need for Medicare and Medicaid to pay for some future medical procedures.

Fourth, and most importantly, even if NOT revenue-neutral, SOME policies are still valuable, important, and worthwhile.  A project may have generalized benefit to everybody in society that exceeds the actual social cost, meaning that it passes a benefit-cost test, even though it requires government spending and is not “revenue neutral”.

Any revenue-neutrality test is a way for policymakers to “tie themselves to the mast” and prevent them from pork spending of the most egregious sort.  Maybe that’s good and worthwhile.  But it may also mean we can’t have some other worthwhile policies either.