The Constant Idiocy of US Deficit Reduction

Matt Yglesias has a very important piece up today. Everyone should read it, and keep it in mind both when you listen to the Obama and Romney campaigns talk about the deficit, as well as when you hear about people complimenting the Ryan plan, or Simpson-Bowles, or whatever.

I've often said - and this isn't original analysis on my part - that we don't have one budget deficit, we have several. They are:

- A short term budget deficit related to the Great Recession. When the economy is shit all sorts of automatic stabilizers (unemployment, AFDC, &c) kick in while tax revenue declines. As a result the deficit increases. You can also lump TARP and the various stimulus programs in here, but as they've mostly run their course at this point they're not really a part of the deficit.
- A deficit created by Bush-era policies that created a revenue/expenditure imbalance: tax cuts, Medicare Part D, &c. You can lump the Iraq and Afghanistan wars in here as well; though the former is basically done with and the latter is winding down.
- A long-term deficit created by the retiring of the baby boomers causing a one-time increase in Social Security and Medicare outlays, as more beneficiaries are added to this program.
- A long-term deficit created by Medicare cost expansion as a function of overall healthcare cost growth in the US.

Discussions about the deficit tend to focus overwhelmingly on the final two, and almost totally ignore the first one. Democrats like to talk about the second, but Republicans refuse to acknowledge it exists The thing is, it's the first two that Congress can reasonably deal with. Today Congress could improve our long-term fiscal picture by passing stimulative policies that create a short-term deficit in the interests of boosting long-term growth. Congress could also work to address the imbalances created by the previous GOP administration and Congress.

What politicians really like to do is talk about the latter two. And they do it in a totally asinine way: rather than come up with actual ways of containing Medicare cost growth, they just tell CBO to make an assumption. Assume that Medicare costs grow at GDP + 0.5% for example. CBO has to do this because they have to do what they're told, and as a result you get plans that seem to reduce the deficit.

Here's the thing: Congress can make no law binding future Congresses. There is literally no possible way for the Congress of today to mandate what the level of Medicare spending will be in 2040. That's up to the Congress and President of 2040. So even if Congress passes a law saying Thou Shalt Not Grow Medicare Faster Than GDP, short of an actual Constitutional amendment that law is totally, completely useless.

That's not to say that you can't do long-term deficit reduction today. It's just that such reduction is really difficult and it's politically poisonous. Take Social Security, for example: SS faces a medium-term increase in outlays as the baby boomers retire. There are various ways we could address this, suggestions range from raising payroll taxes (perhaps by removing tax cap on high incomes) to reducing benefits to raising the retirement age. The problem is that these are all changes that have various constituencies aligned against them, so they don't happen. Notably what won't work: passing a law declaring that SS outlays between now and 2040 will go up by only some percentage. That's just a waste of time.

Medicare is an even more difficult problem, because its problems are linked to the problems of our health care industry, and you all remember what happened last time politicians tinkered with that system.

So what's my point? When you're evaluating any discussion about the deficit, you should pay attention to the specifics. Anything that boils down to a mandate on a price level or rate should be totally ignored. Once you've done that, see what's actually left and then judge that on the merits.

I am reminded of... Was it South Carolina that wanted to legislate the rate of sea level rise?

North Carolina, and that was due to an insurance thing. They don't actually believe their powers can halt the sea.

tl;dr
</joke>

Sadly most people aren't interested in thinking past soundbites. Good article though, thanks.

How's this: you're in the wrong subforum.

It was kind of a joke. But as my intent was clearly missed I'll update my reply. Thanks.

Oh, and regarding the political economy of deficit reduction: the only way you do it is with massive bipartisan support. We're talking like 400+ ayes in the House and 90+ in the Senate. The policies that are going to be necessary to reduce the deficit - tax increase (on everyone, not just the wealthy), major changes to the US health care system, spending cuts, &c - are going to be politically toxic. The only way they get done is if both parties own them, such that neither party can use them as an electoral cudgel.

Democrats seem to get this; it's why you keep seeing them try for a "grand bargain" type proposal. They only get it so far of course; most so-called grand bargains are fairly shit. But at least they're dealing with reality. Unfortunately Republicans are (as usual) living in a fantasy land where we can fix the budget deficit by lowering taxes and offsetting the revenue losses by cutting funding for NPR.

Why should the bolded part be the case, besides political expediency? Or is that all you mean?

Another thought regarding deficit 3: one way we could offset the increased Medicare and Social Security outlays caused by the retirement of my parents is to allow more foreigners to immigrate to the United States. The third deficit is mostly a function of shifting age demographics (more old people relative to young people), but there are all sorts of young people all over the world who would be happy to come here and pay for our parents' retirement.

Not clear what you mean?

The reason we will end up raising taxes on everyone is that there just isn't enough money to be soaked from the rich. There's some - quite a bit - but it's probably not enough.

Really, though? I mean, there's a hell of a lot being left on the table right now. Assuming the ideal tax increases for this purpose could be passed, what do you think they'd look like?

It's hard to say because the word "ideal" is so subjective. Ultimately we need to raise enough revenue to pay for what we spend (recall: the actual tax rate is basically equivalent to government outlays; it's just a question of whether or not we pay for those outlays now or later) and I really don't think we can get all of that money by soaking the rich without running into some gnarly distortionary effects.

If I was dictartor for life I'd probably nuke the income tax entirely, replace it with some form (or forms) of consumption tax and a carbon tax. That'd be a less progressive tax system overall (sidenote: the liberal focus on maximal tax-code progressivity is sometimes frustrating), but I'd pair that with a fairly radical expansion of the social safety net such that the total distributive effects would be more progressive than the current system.

Of course that's politically impossible; we're left with what we have. So I guess my ideal system would be an overall tax increase coupled with adding several more brackets to capture a greater share of truly large incomes. I have no idea what the "ideal" rates are, but given the level of spending that we (as a country) seem to have settled on, they're higher than they are now.

Our public sector is actually quite large--something like 42% of GDP--larger, in fact, than most European countries (and not just the Eastern ones). From the spending perspective, our system is inherently going to be less efficient because ours is less centralized so you get duplication of efforts and/or conflicting agendas between the municipal, state and federal levels. The size of the whole thing is sufficiently large that we really need to also be thinking of ways to reduce the level of inefficiency.

Part of the problem with trying to raise more tax revenue is that the system is already pretty arcane and the rich are so very flexible because their income comes from a variety of sources. It's much easier to soak the middle class, since they are much less able to reshape their income to avoid taxes.

I'm not sure where you got the 42% number, that's too high. OECD numbers as of 2006 has the US at 36%, which is lower than every other European OECD member, who range from 38% to 54%. The financial crisis in the US increased it a few points, but didn't fundamnetally change the ordering.

Well, you have to consider that there are several different things you could mean by relative sizes. As for the source itself, I verified it when I first heard it from a labor economist in early 2011, but I've forgotten exactly what it is. I'll find it for you, but since punching "public sector size" or any similar phrase into Google currently returns a few hundred thousand partisan screeds, it make take me a few days to track it down.

They believe that reducing the burden of supporting the government will increase private sector activity such that more jobs will be created in the private sector than are lost in the public sector. Broadly speaking, the idea that reducing the government-related costs of doing business will spur private sector growth is at least somewhat plausible, but they are unable to articulate exactly how this process would occur or how they can be sure that the net impact on the number of jobs will be positive. They're not too much bothered by the uncertainties; it's an article of faith to them.

The exact number depends on calculation, I've seen it vary a few points in every direction, but the US always comes out on the bottom. Taxes as percentage of GDP is a comparable ordering.

Moving back to this thread, since the fiscal cliff seems to have been (temporarily) averted.

Kevin Drum once again highlights how stupid Washington is about the deficit. For the tl;dr crowd:
- Spending isn't the problem; we're projected to spend about as much as we always have (around 22% GDP)
- Taxes are the problem; irresponsible Republican policies have blown a hole in tax receipts.
- The real long-term problem is that our country is aging (more specifically the ratio of retirees to workers is increasing), and that old people are expensive.

Naturally you won't hear about any of this in our country's discussion on the subject. There's now broad bipartisan consensus that nobody should really pay meaningfully higher taxes, despite the obvious need for them.

This one comes up alot in the national discussion. But then you get people who scream and yell that Social Security/Medicare doesn't need reform; basically, a strawman to avoid the issue. Even if SocSec/Medicare don't need reform, we still need to think about the best way to handle this known, upcoming, long-term obligation in light of total government debt and economic reality. Sadly the screaming/yelling seems to drown out reasonable discussion about it even though reminders and comparisons to other countries (e.g. Japan's aging population) are constantly brought up.

One definitely observes that phenomenon. I think it's largely due to the fundamentally dishonest way in which those on the right approach the topic of deficit reduction. Observe the political two-step:

- We have a very large deficit today (left out: this deficit is largely the result of conservative policies)
- Therefore we must cut SS and Medicare (left out: neither today contributes meaningfully to the deficit today)

So yeah, to a degree liberals are rather defensive about these programs. Can you blame us? Obviously an honest discussion about the debt would include an acknowledgement of the degree to which SS faces a shortfall (modest) and the best ways to address it. Likewise, an honest discussion would include an acknowledgement of the long-term Medicare apocalypse and what causes it (healthcare cost inflation). An even more honest conversation would acknowledge that this country faces shifting demographics, and it's likely that we're going to have to raise taxes modestly above their historical average in order to adjust. An even more honest discussion would acknowledge that the SS and Medicare shortfalls occur on time horizons wherein economic conditions (including the country's financial condition) are going to be overwhelmingly dominated by forces outside of Congress's control and that trying to account for these programs on thirty or eighty year time horizon's is a somewhat of a fool's errand. Conservatives are simply incapable of having this honest discussion. So yeah, when they suggest we account for the deficit they created by screwing over the olds, the liberal response is fuck off. Can you really blame us?

How does medicare not contribute to the deficit - it's like 19% of the federal budget? Or it's funded via specific taxes and thus can be left out of the deficit equation?

Bingo. Medicare has a dedicated funding mechanism (so does SS). It doesn't come out of general revenue.

I agree with everything you said here. Every bit.

Can I blame us? Not for being defensive, no. But I can blame us for why "[t]he real long-term problem is that our country is aging (more specifically the ratio of retirees to workers is increasing), and that old people are expensive" is not as often in our country's discussion as it should be, your original point with which I also agree. Addressing the true problem of soaring health care costs gets to the latter half of that statement of yours, but not the former half/parenthetical. Both are important, even though one is more immediately so. I can blame us for ignoring that.

I guess it kind of goes to conversational context. The reason you don't hear that acknowledged in what I'll call typical political conversation is that the other side is fundamentally dishonest and is trying to destroy SS and Medicare; why give them any kind of a wedge? Yes it's politics trumping policy but that's par for the course.

Amongst liberal wonks you definitely do see that sort of thing being acknowledged and discussed, though there's legitimate questions about whether or not we should address it now. These programs are unstable on a multi decade time horizon, trying to fix them now may be foolish because a) on that time horizon the economy and our politics will be dominated by exogenous events and b) there's decades in between in which future Congresses can just cock it all up again.

I've always wondered how it's even acceptable to cut SS and Medicare when it comes out of my check every week. How is this even a topic of discussion in Congress without discussing that we can't take money from people's checks while not paying it back out? Honest question because this comes up more than I like and I don't quite understand how it's up for grabs.

Modern fiscal conservatism is, essentially, reneging on government debts for tax breaks. Because no one outside of a small subsection of the public understands the budget at a level deeper than vague checkbook analogies, the national conversation hinges on who can dress up the most attractive short-term incentive with the scariest scenario. Medicare and SS just get rolled into it as a Real Talk moment from conservatives even though they are terrified of alienating their aging base, so they need to dump the actual cut on Democrats. The strategy there is long-term attrition against the basic government infrastructure they've rebranded as an "entitlement", as opposed to, say, corporate welfare which is merely giving back to corporations what was stolen from them.

Just stare into the abyss for a while, and it will all make sense.

Hanaan: Simple: Social Security and Medicare aren't savings programs, or really insurance programs (OK, well, Medicare sort of is). They're straight up inter-generational transfers. The money coming out of your paycheck pays for today's retirees. When you retire, your benefits will come from current workers (e.g., your children).

At this point, we should break the two programs up because they face different challenges. Over the next few decades, Social Security finds itself in a situation where it pays out more in benefits than it takes in, because the proportion of retirees to workers increases relative to what it was in the 20th century. Potentially exacerbating this is the trend toward labor's share of income declining. Note that payroll taxes apply only to wages, if Americans in aggregate receive less wages and more capital gains then the country collects less in the way of payroll taxes. The problem ends up being that in a couple of decades the program is running a deficit, which it obviously can't do. At that point, you've got a couple of options:
1) Make up the shortfall from the general revenue fund. In this case, SS's deficit just adds to the general fund deficit.
2) Cut benefits to bring them in line with revenue.
3) Increase revenue to maintain benefits.

It needs to be emphasized that this is a one-time adjustment; barring the development of serious anti-senescance technology and/or another baby boom, the proportion of retirees to workers settles into a new equilibrium. It also needs to be noted that this is a relatively modest adjustment; we're not talking drastic cuts or tax increases. Seeing as how I'm a liberal, I prefer option 3 myself. But you can make arguments for 2, specifically chain-indexing SS benefits (which, while a cut, is at least a defensible cut). You can also means-test the benefits, which would mean that rich people get less, but means-testing is generally viewed as a gateway toward dismantling the program (by creating a bloc of old people who don't benefit from SS you now have the basics of a constituency to help you repeal the program entirely) so as long as we have crazy Republicans in this country, that's a nonstarter.

Medicare has the same underlying population dynamic problem as Social Security, with the added wrinkle that it's also subject to healthcare cost inflation. On an 80 year time horizon Medicare ends up devouring the entire federal budget. That sounds bad, except that Medicare's cost growth is just a reflection of underlying healthcare cost growth; on an 80-year time horizon healthcare in general eats most of US GDP. People like to talk about cuts to Medicare (raising the retirement age, voucherizing it) but that doesn't actually cut costs, it just shifts them. Fixing Medicare will require fixing the US healthcare system. We tweaked the healthcare system back in 2009-2010 and that turned into political armageddon; nobody's going to have an appetite for further healthcare reform for at least another 15 years.

tl;dr: as long as we have the modern Republican party, we can't have nice thing.

I want to post that to Facebook. Let me know if I should do it anonymously or if I can tag you on it.

jeffd

edit: clarification
So how is Congress able to borrow from SS/Medicaid if what you say is true? Wasn't that part of the reasoning for even fixing the system, because congress had been borrowing it against future generations? The intergenerational bit still doesn't explain why talk of eliminating entitlements is an option. It assumes that the money I pay today can't/shouldn't go to my grandmother -- yet the money is clearly paid. Sure, it could be less, but how is elimination an option?

It just sounds like voodoo budgeting where the money is coming out of our checks each week is a gamble, not a guarantee. I'm pretty sure it's supposed to be a guarantee or else why are we doing this? The people could be enjoying those extra dollars today and using them as they see fit for their own retirement if the benefit is not guaranteed to be there.

There is currently little proof that wages will keep up with us (it's been declining relative to cost for decades) or employment for that matter (gainful). I guess I don't see us digging out of this whole without some dramatic change and congress is NOT up to it. It doesn't look good at all. I also stopped believing the unemployment numbers in 2011; they aren't trustworthy. My guess is 2013 will be a far worse year than 2012 was, but I hope I'm wrong.

Started to reply, but then I saw: "I also stopped believing the unemployment numbers in 2011; they aren't trustworthy."

Backing away slowly. Slooooooowly. No threatening moves. No eye contact.

Medicare may be in better shape than people think. The rapid growth in the projections is apparently mostly the one-time rise in the old people population.

This is an amusing sidenote: the US government does not practice balance sheet accounting the same way every other entity in the economy does (assets minus liabilities). Basically it only acknowledges its liabilities (the debt). Which is kind of amusing, because - by one measure - its assets are worth nearly 120 trillion dollars. Yes, trillion with a "T".

That's just Oil and Natural Gas assets. Not counting other minerals or tangible assets (it owns 86% of the land in Nevada for example).

Karl Smith has some smartypants stuff on understanding the deficit and debt.

TL;DR: it's not the size of the debt that matters, it's the real burden of carrying that debt. The overall debt size and even debt/GDP ratio are real variables; he produces the following chart to demonstrate that our debt isn't currently a problem:

The chart represents (deep breath) federal interest outlays as a fraction of GDP divided by the GDP deflator. Basically it shows the real cost of servicing our debt.

Hah, those late-1990s interest rates were still killer.

I believe this is not quite right. Medicare Part A is funded by payroll deductions, but parts B and D both draw directly from the general fund (as well as premiums).

More importantly though, this suggestion that medicare and social security don't contribute to the deficit is both true in a technical sense and very misleading. The fact is that SS & Medicare payments could be stopped tomorrow and the payroll taxes redirected to the general fund for savings of $1.3 trillion a year, or around $15 trillion over ten years. We can sit down with the books and draw pencil lines between general fund spending, entitlement spending and various forms of taxation, but ultimately the money is coming and being spent by the same entities.

The lines between them aren't even that dark. As SS begins to pull from the Trust Fund the general fund will be reduced by that same amount. So until the $2.7 trillion notional amount is used up, growing SS spending directly reduces money available for other Federal spending.

Both SS and Medicare should be discussed as if they do add to the deficit, because in all but a very technical sense, they do.

But that one time rise is going to last thirty years, right? I think that's a very reasonable worry.

I will say, though, that I personally ignore long-horizon medicare forecasts. Forecasting medical trend over decades is silly business.

This is a really, really important point, and I'm glad someone stated it in this thread - thanks jeffd.

I think the best answer is that you don't pay SS and Medicare taxes to save money for your old age, you pay them to support the elderly and disabled.

I'd like to throw in another thought, too. The fact that SS and Medicare are transfer programs is somehow not commonly known (it should be). However, that's really the only reasonable way to run them. To fund SS alone would require the government to set aside tremendous amounts of capital. The last SS trustees report I read estimated the closed block funding requirements for SS at $20 trillion, and that's almost certainly too low. Add in medicare and it could double. It's not even reasonable to make those programs funded programs, and they knew this when they created them.