Monday, October 01, 2007

Whose Entitlement Mentality?

David Brooks in his column last Friday in the New York Times, wrote a column entitled The Entitlements People. I am going to respond to some of his statements (and the general underlying presumptions of his argument). Let's start with an alarmist statement:

The U.S. government has $43 trillion in unfunded liabilities, or $350,000 for every taxpayer. Standard & Poor’s projects that in 2012, the U.S. will lose its AAA bond rating.

The current Gross Domestic Product of the U.S. is about $13 trillion. How these unfunded liabilities are supposed to equal over three times the entire annual U.S. economy is beyond me. Total tax revenues in 2006 equaled $2.4 trillion. The unfunded liabilities are supposed to equal almost 20 times annual tax revenues? Somehow that doesn't compute, either.

In a web post by a group called The Social Security Network entitled The "Unfunded Liabilities" Ruse who was responding to a USA Today article claiming that the U.S. Government would have a $53 trillion unfunded liability in the next four years in October 2004:

All of the grotesquely huge unfunded liability numbers spouted by scare mongers depend on forecasts that go out many decades, often hundreds of years. Such forecasts routinely go beyond the point where we could have any firm knowledge of what to expect. Of course, it is technically very easy to trace the implications of assumptions about future productivity, birth and immigration rates, labor force participation levels, and various costs over the next 20, 50, or even 1,000 years. These assumptions have implications for the age structure of the population, the rate of economic growth, and the cost of various government programs. Plugging those assumptions into a spreadsheet can tell us precisely how much Social Security or Medicare will cost us, extrapolated to eternity, if we like.

The problem is that over such long time horizons, small differences in those assumptions compound to huge variations in forecasts. If something (say health care costs) is growing faster than something else (say incomes) and we assume that this continues indefinitely, then eventually, what is growing fast will swamp what is growing slowly. That's arithmetic, not policy analysis.

Here it is in 2007 and now that number has shrunk to $43 trillion in Brook's column. Another assumption is that taxes will not be raised and/or inflation will not cause revenues to increase to meet those obligations. Again, from The "Unfunded Liabilities" Ruse post linked above:

The notion of "unfunded liabilities" in certain programs is based on the arbitrary assumption that certain designated revenue sources should pay for certain classes of government expenditures. The story that Social Security and Medicare should be paid for out of payroll taxes and their trust funds is not a recent creation of critics of those systems. It has been around for decades. But why? Revenues and expenditures are "fungible," meaning that a dollar is a dollar is a dollar. In fact, today's Social Security surplus flows right into the pot with other revenues, while a significant portion of Medicare costs already are paid for out of general revenue. The real question is not "will the designated revenues be enough to pay for the designated programs" but "will we have enough income to afford to keep the promises we have made?"

There is no question that the nation's gross domestic product will be sufficient to meet all of our Social Security promises forever, leaving lots of income for increasing the prosperity of the young. In general, the outlook for economic growth is good. Our average income per person in 100 years is likely to be much, much higher than it is today (more than four times as high). Social Security benefits are predicted to rise from about 4.5 percent of our GDP to about 6.6 percent over the next century. Even though such long predictions are very uncertain, this one should leave us sanguine: if incomes in 100 years are only twice their present level, and incomes of the old rise from 4.5 to 6.6 percent of income, that still leaves us with $1.96 for every dollar we have today, after Social Security obligations are taken care of. We can continue to keep our modest Social Security promises, and young families still will be much better off than families are today.

I agree with the conclusion The "Unfunded Liabilities" Ruse makes when they say:

Imagine if in 1950, someone had calculated the costs of educating the baby boomers in public institutions through their college years. What an immense, unmanageable burden! And nothing-not a penny-had been set aside by 1950 to cover the costs of public universities in the 1960s and 1970s! Using the logic of unfunded liabilities that has fueled alarmist media stories, public universities should have been closed; education should have been left to the private sector.

Yet nobody ever claimed in the 1950s and 1960s that the education of the Baby Boomers was an excessive burden our society, or that our public institutions could not afford to accept the challenge. When we needed more schools, we built them. Why should the Boomers' retirement be unmanageable? We need to strengthen social insurance for old people, and we will be able to afford it.

I hate to beat a dead horse, but I still think that many Americans would take advantage of Social Security as a full pension if they understood how unsecure their current pensions are.

I also want to focus on something else Brooks wrote:

Democrats vow to pay for their grand spending plans by raising taxes on the rich, even though each one percent increase in the top tax rate only produces $6 billion in revenue.
It's nice how he limits the question only to the top tax rate of income taxes. As I have pointed out before, the rich often don't pay income taxes. As Warren Buffett has tried to point out, people in his class almost always pay far lower capital gains taxes (which makes up most of their incomes). I'm curious how much an increase in the capital gains rate to, say, 30% (i.e. doubling the rate) would have on revenues. Tax revenues from capital gains were roughly $80 billion in 2005. Even if we assume that raising the rate would have some adverse effect on tax revenues, I think that $120 billion in revenue per year would not be out of the question. That would be an increase of $40 billion per year.

I think one of the problems is that even as inflation has caused incomes to rise, the payroll tax has not extended beyond $120,000 and taxes on the investor (wealthy) class is too low (even Warren Buffett agrees with this). Instead, it appears that Congress is content to sock it to the middle class through inflation's effect on the Alternative Minimum Tax (AMT).

Another major problem is that we are not paying for the government we know we need. The fact that tax revenues don't pay for the government that our elected representatives allocated ought to be a clue that tax revenues are lacking somewhere. Deficit spending is only supposed to take place during war or economic distress according to Keynesian theory. The debt is then supposed to be paid back when the economy rebounds or when the war is over. But we seem to be in a perpetual cycle of government deficit and ever-increasing government debt obligations.

The fact is that all government is nothing more than a very large service-based industry. Whatever services we deem necessary need to be paid for. With a $9 trillion national debt, we are obviously not paying for the services that we are utilizing.

I guess we all just feel entitled.


P M Prescott said...

Didn't FDR say it best, "All we have to fear is fear itself."?

Charles Hugh Smith said...

Excellent posts this week. As with any "family" budget, you have to look at the expense side too. We can't keep borrowing $200 B a year or even $400B with no consequences. What will be cut? How about interest on the debt, which is $200B and rising?