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George H. Blackford, Ph.D.

 Economist at Large

 Email: george(at)rwEconomics.com

 

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Social Security, Healthcare, and Taxes*

George H. Blackford © 2014

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The deficit in the federal budget was 9% of GDP in 2010, and on December 1 of that year we were told by Erskine Bowles and Alan Simpson, co-chairs of the President’s National Commission on Fiscal Responsibility and Reform, that there was a $5.4 trillion unfunded mandate in the Social Security system that must be dealt with. 

The last time we were told something like this was back in 1983 when the federal deficit was 6.0% of GDP in the aftermath of the 1981-1982 recession, following the 1981 Reagan tax cuts, and at the beginning of Reagan's anti Soviet defense buildup.  At that time, the Social Security trust funds were dwindling, and Social Security was in danger of running out of money.  In the midst of that fiscal mess, President Reagan established the Greenspan Commission to reform Social Security. 

The Greenspan Commission

In accordance with the recommendations of the Greenspan Commission, Congress agreed to

  1. Increase the payroll taxes paid by self employed individuals.

  2. Increase the retirement age from 65 to 67 by 2022.

  3. Accelerate previously scheduled payroll tax increases.

  4. Require that 50% of the Social Security benefits received by higher income beneficiaries be taxed and paid into the Social Security trust fund.

  5. Expand Social Security coverage to nonprofit and newly hired federal employees.    

Congress also made a number of additional changes that, when combined with previously scheduled payroll tax and income cap increases, not only dealt with the trust fund problem, but changed Social Security from a pay-as-you-go system in which the money received by current beneficiaries is paid by current workers, to a partial-advanced-funding system in which the current workers prepaid a portion of their own retirement, Medicare, disability, and death benefits as they also paid for the benefits of the current beneficiaries.  (SSA)  As a result, Social Security has had an annual surplus since 1984—a surplus that increased the Social Security Old-Age Survivors and Disability Insurance (OASDI) trust fund to $2.6 trillion by 2011 with an additional $0.3 trillion in the Medicare and supplementary medical insurance trust funds as well. 

Investing the Social Security Trust Fund

This $2.9 trillion represents the prepayment of the current working generations for their own retirement, medical, disability, and death benefits—payments they made into these trust funds while they fully supported (paid for) the retirement, medical, disability, and death benefits of the generations that went before.  And what happened to this $2.9 trillion?  It was placed in the safest investment on Earth: United States government bonds backed by the full faith and credit of the United States of America.  Why?  Not only because this is the safest investment on Earth, but because there was no acceptable alternative way to invest these funds. 

If the Social Security Administration were to invest in non-government securities, it would involve the federal government in the private securities markets in a massive way.  The potential for corruption with so much money involved was daunting, so much so that virtually no one thought this was a good idea.  At the same time, the idea that these funds be divided into private accounts and invested in private securities by private individuals was also deemed unacceptable.  This would make them vulnerable to the vagaries of the private-securities markets, and, as such, would defeat the central purpose of the Social Security System. 

Social Security was created to provide a system of government guaranteed social insurance that is not dependent on the private-securities markets.  It was the lack of such a system following the financial disaster in 1929 that inspired the Social Security System in the first place.  What's more, the idea that the trust funds should have been invested in private securities was put to the test in the 2000s.  It is only because these funds were invested in government bonds that they survived the stock market crash of the early 2000s and the financial crisis of 2008.   

The Baby Boomer Problem

The baby boomer retirement problem is explained in The 2011 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds.  A concise statement of this problem can be found in the Trustees' message to the public in the summary of this report:

Social Security expenditures exceeded the program’s non-interest income in 2010 for the first time since 1983. . . . This deficit is expected to shrink to about $20 billion for years 2012-2014 as the economy strengthens. After 2014, cash deficits are expected to grow rapidly as the number of beneficiaries continues to grow at a substantially faster rate than the number of covered workers. Through 2022 . . . redemptions will be less than interest earnings, [and] trust fund balances will continue to grow. After 2022, trust fund assets will be redeemed in amounts that exceed interest earnings until trust fund reserves are exhausted in 2036 . . . .  Thereafter, tax income would be sufficient to pay only about three-quarters of scheduled benefits through 2085.  (SSA)

The Trustees further explain in this message that

Program costs equaled roughly 4.2 percent of GDP in 2007, and are projected to increase gradually to 6.2 percent of GDP in 2035 and then decline to about 6.0 percent of GDP by 2050 and remain at about that level. (SSA)

This is what all of the fuss is about:

  1. If we do nothing, the current payroll tax structure and trust fund is expected to carry the system into 2036 at which point the trust fund will be exhausted and payroll taxes will cover only 75% of the promised benefits.  At that point either taxes will have to be raised or benefits cut to make up the difference.

  2. The annual costs of Social Security benefits were 4.2% of GDP in 2007 and are expected to increase to 6.2% in 2035, then decline to 6.0% by 2050 and thereafter.  This means that in order to maintain benefits, the proportion of GDP devoted to Social Security benefits must increase by 2.0% of GDP (6.2-4.2=2.0) between 2007 and 2035 and decrease thereafter by 0.2% of GDP between 2035 and 2050 for a net increase of 1.8% of GDP from 2007 through 2050. 

Where's the crisis?  According to the Trustee’s report, the Social Security trust fund is expected to continue to increase until 2022, and Social Security is fully funded until 2036.  Social Security benefits must increase by 2% of GDP by 2035, which would not seem like much of a problem since the United Sates is one of the wealthiest countries on Earth.  Increasing Social Security benefits by 2% of GDP between now and 2035 should not be a major problem. 

What's more, the trustees assume in their report that over the next 75 years productivity, as measured by output produced per hour of labor, will increase in the United States at an annual rate of 1.7%.  This is the average rate of productivity growth for the past forty years, and if productivity continues to grow at this rate it means, through the magic of compounding, our economy will be 50% (1.017 multiplied by itself 25 times = 1.52) more productive in 2035 than it was in 2010.  Even if productivity only grows by the worst case scenario considered in the trustees’ report, 1.3% a year, we will still be almost 40% (1.013 multiplied by itself 25 times = 1.38) more productive in 2035.  Why should we believe that an increase of Social Security benefits equal to 2% of GDP between now and 2035 is going to be a crushing burden on society in a world in which the labor force that produces that GDP will be able to produce 40% to 50% more per hour of work than we do today?   (Baker)     

It's time to step back, take a deep breath, and remember what we are talking about here.  We are talking about increasing the share of GDP that is devoted to the payment of Social Security benefits from 4.2% today to 6.2% by 2035, then a decline in this share to 6.0% by 2050.  This is a net increase of only 2.0% of GDP over the next twenty-five years.  At the same time, productivity is supposed to increase 40% to 50% by 2035.  This is the economic problem posed by the baby boomers' retirement, a problem that most certainly must be dealt with, but it is not a problem that portends a budget crisis that will require drastic changes in the Social Security System to solve.  

Figure 1, which plots federal expenditures as a percent of GDP from 1965 through 2012, should help to put this problem in perspective. 

 

Source: Source: Office of Management and Budget.  (1.2)

As is indicated in this figure, the average of federal expenditure as a percent of GDP during the 1980s (22.2%) was 2 percentage points above the average in the 2000s (20.3%).  In other words, an increase in Social Security benefits equal to 2% of GDP by 2035 would be the equivalent of taking us back to where we were in the 1980s in terms of the federal budget.  This would hardly require a dramatic change in the American way of life, especially since productivity today is 40% to 50% greater than it was in the 1980s and is expected to be 40% to 50% greater in 2035 than it is today.  What’s the big deal about the baby boomers increasing Social Security payments by 2% of GDP between 2010 and 2035 in a world in which output, and, hence, real income per worker is expected to be 40% to 50% greater than it is today? 

Legacy of the Greenspan Commission

It is essential to recognize, however, that even though the existence of a $2.6 trillion trust fund goes a long way toward solving the funding problem the baby boomers present to the Social Security Administration, it adds nothing toward solving the fiscal problem faced by the federal government.  The reason is that the Greenspan Commission’s partial-advanced-funding scheme does not change the fiscal situation of the government when it comes time for the baby boomers to retire. 

Back in the 1980s, the Reagan Tax Cuts led to huge deficits in the federal budget that were not brought under control until the 1990s.  One of the mechanisms that helped to bring these deficits under control was the increase payroll taxes paid by working people as the Social Security System was converted from a pay-as-you-go system to a partial-advanced-funding system.  As was noted above, since the mid 1980s Social Security has had an annual surplus, a surplus that increased the Social Security OASDI trust fund by $2.6 trillion.  These funds were, in turn, lent to the federal government to help finance its general expenditures, to the effect that by 2001 the money borrowed from the Social Security System’s trust funds in that year alone amounted to 8.75% of the federal budget

The problem is, as the baby boomers began to retire in the early 2000s, the amount of cash available to be borrowed from the Social Security System began to dwindle, and in 2010 there was no cash left to borrow even though the Social Security System still had a surplus in that year.  The reason is that even though there was a surplus in the budget for Social Security in that year, the amount of cash the system took in from payroll taxes was less than the amount of cash it paid out in benefits and costs.  This situation is explained in the passage from the Trustee's Report quoted above:

Social Security expenditures exceeded the program’s non-interest income in 2010 for the first time since 1983. . . .Through 2022 . . . redemptions will be less than interest earnings, [and the] trust fund balances will continue to grow.  After 2022, trust fund assets will be redeemed in amounts that exceed interest earnings. . .  (TRSUM

This means that in 2010 the government could no longer simply credit the interest it owed the Social Security System to its account and borrow its surplus cash since there was no surplus cash left to borrow.  There was a cash deficit in the Social Security systems accounts, and the federal government was forced to pay a portion of the interest it owed the system in cash in order to fund this cash deficit.

As a result, since 2010 the federal government has been forced to pay a portion of its interest obligation to the Social Security System in cash in order for the Social Security System to pay its benefits and administrative costs in cash.  At the same time, the amount of money the federal government owes the Social Security trust funds each year continues to grow because the amount of cash the federal government has been forced to pay into the Social Security System each year has been less than the amount of interest that accrues each year on the debt the federal government owes to the system.  The difference must be credited to the Social Security System's trust fund which, in turn, increases the trust fund. 

This situation is expected to continue through 2022 when the Social Security System's cash deficit is expected to equal the amount of interest the government owes the system in that year. At that point the Social Security trust fund is expected to peak, and from then on the trust fund is expected to fall as the federal government is forced to redeem the government bonds in the Social Security trust fund (as well as pay the interest that accrues each year on its remaining debt to the Social Security trust fund) in cash in order for the Social Security System to meet its obligation to pay its administrative costs and benefit payments to the baby boomers in cash.

There are only two ways the federal government can come up with the cash needed to pay the interest on its debt to the Social Security System and to begin paying back the principal it borrowed from working people:  It can either raise taxes or borrow the needed funds. If it doesn’t raise taxes, it will have to borrow, and it can’t borrow without increasing the national debt. The only alternative is for the federal government to default on its obligations to the baby boomers by reducing their Social Security benefits.

Thus, when it comes to making up the difference between payroll tax receipts taken in and benefits paid out it makes no difference whether there is a trust fund or not.  In either case, the government must either borrow or tax to make up this difference.  As a result, the trust fund has no effect on the fiscal situation facing the government when the benefits owed the baby boomers come due.[1]

But if prepaying a portion of their Social Security benefits did not contribute to a solution to the government's fiscal problem when the baby boom generation retires, just what did the Greenspan Commission accomplished?  What it accomplished was an increase in the taxes paid by working people to support the general expenditures of the government.  That increase yielded the government $2.9 trillion from working people since 1983 that it would not have received if the Social Security System had stayed on a pay-as-you-go basis.  That's what prepaying a portion of the Social Security benefits accomplished, and that's all it accomplished from the perspective of the fiscal soundness of the government.

This is where the real crisis in Social Security lies, and this is not an economic crisis.  We are still talking about increasing Social Security benefits by only 2% of GDP by 2035 in a situation where increases in productivity is expected to increase output per worker by 40% or 50%.  It is a moral and political crisis, however, because our society has to decide how it is going to come up with the funds necessary to make this adjustment or if it is going to not come up with these funds and renege on its promise to the baby boomers. ()

The Moment of Truth Report

The bipartisan Moment of Truth report written by Alan Simpson and Erskine Bowles is the end product of the President’s National Commission on Fiscal Responsibility and Reform.  While this report was formally rejected by the Commission, it puts forth a set of recommendations to deal with our federal deficit and debt problems in a comprehensive way, recommendations that have gained a significant amount of political support.  Of particular interest in this report are the recommendations regarding Social Security, Medicare, and revisions of the tax code. 

Social Security

Concerning Social Security, the Simpson-Bowles recommendations are summarized in Figure 2

Source: Moment of Truth Report.

These recommendations contain five key elements:

  1. Gradually phase in progressive changes to the benefit formula while increasing the minimum benefit and adding a longevity benefit. (29%)

  2. Index retirement age and earliest eligibility age to increase with longevity. (18%)

  3. Use a chained CPI rather than the standard CPI to adjust benefits for changes in the cost of living. (26%)

  4. Gradually increase the income cap to cover 90% of wage income. (35%)

  5.  Add newly hired state and local government employees to the program after 2020. (8%)

The percentage in parentheses following each item indicates its contribution toward eliminating the expected shortfall in Social Security funding over the next seventy-five years. 

The first element in this list combines the first, second, and forth items in Figure 2 where the savings are supposed to be achieved by making the benefit payout system more progressive—that is, by lowering the benefits paid to high income recipients while, at the same time, increasing the benefits paid to low income recipients.  The suggestion that these savings are coming from making the system more progressive is rather disingenuous, however, in that the savings come from a net cut in benefits, not from the fact that the resulting payout scheme is more progressive.  If the increase in benefits paid to low wage earners were equal to the decrease in benefits paid to higher wage earners there would be no savings from this adjustment in progressivity. 

The second item obviously achieves the savings, without any pretext, through a straightforward across the board cut in benefits by increasing the retirement age.  The third also achieves the savings by cutting benefits by way of a controversial change in the way the Social Security cost of living adjustment is calculated.  (WSJ SGS)  The last two achieve their savings by increasing the payroll tax base. 

Thus, when we do the math, we find that these recommendations solve Social Security’s future revenue problem by cutting benefits to cover 73% of the expected shortfall and by expanding the tax base to cover an additional 43% of the shortfall.  (Presumably, the redundant 16% of savings is there to maintain the Social Security trust fund that will be lent to the government.)  According to Simpson and Bowles, if we accept their recommendations Social Security will be on a sound financial footing for the next 75 years. 

It is worth noting, however, that if these recommendations are implemented they will have the effect of converting Social Security from an insurance program in which the benefits provide some protection against a catastrophic loss into a kind of non-means-tested welfare program for the elderly in which there are hardly any benefits at all.  The extent to which this is so is indicated in Figure 3 which shows the expected payout under the current law and how the payout structure would change under the Simpson-Bowles recommendations.

Source: www.StrengthenSocialSecurity.org, Benefits Chart.

Under this scheme benefits would fall by 47% for "'Maximum' Earners($106,800)", 39% for "'High' Earners ($68,934)",  27% for "'Medium' Earners ($43,084)" and even "'Low Earners' ($19,388)" would see a decrease.

Even worse, the Simpson-Bowles scheme proposes to fund this program through the payroll tax.  The payroll tax is one of the most regressive taxes there is.  It is levied only on earned income (income received from wages and salaries) with no deductions and only minor exemptions, and the total amount of earned income taxed is capped where the cap in 2011 was $106,800.  It is not levied on unearned income (income received in the form of interest, dividends, capital gains, rent, and corporate profits) or on earned income above the $106,800 cap.  As a result, virtually all of the income of low income families is subject to the Social Security tax since virtually all of their income comes from wages and salaries below the cap, while virtually none of the income of the wealthy is subject to this tax since virtually all of their income is either above the cap on earned income or comes from unearned income. 

The payroll tax is hardly an equitable way to finance a welfare type program.  The burden of financing this sort of program should fall heaviest on those who can afford to pay, not on the backs of the working poor as is the case when the payroll tax is used.  It makes sense to use a payroll tax to finance an insurance program.  It does not make sense to use a payroll tax to finance a welfare-type program.

Healthcare

Our multiple-payer, third-party, fee-for-service payment healthcare system whereby healthcare providers decide with patients what services to provide and how much to charge while insurance companies or the government picks up the tab virtually guarantees continually increasing costs. There is a powerful incentive to over prescribe in this system and little incentive to deliver quality healthcare in a cost effective manner since the decisions as to what to charge and how much to prescribe are made primarily by providers. 

To make matters worse, rising healthcare costs virtually guarantee that a continually increasing share of the healthcare costs will be passed on to the government as the higher costs force people, especially those with poor health, out of the private healthcare system.  This is so because as people are forced out of the system society must decide the extent to which the government should pick up the tab for those who can no longer afford the cost of private healthcare.  To the extent the government picks up the tab, it reinforces the process of third-party payment irrespective of cost that leads to the increasing costs that forces people out of the private healthcare system in the first place.  To the extent the government does not pick up the tab, people who could otherwise be saved are left to die or to suffer with maladies that could otherwise be cured.  This choice begs the question: How many poor people who cannot afford to pay for the cost of healthcare should be allowed to suffer or die—in the wealthiest country on Earth—in order to lower the costs for those who can afford to pay? 

There is no optimal answer to this question that is in any sense humane, and our attempt to find one over the past 75 years while at the same time attempting to hang on to our archaic multiple-payer, third-party, fee-for-service payment system has caused the American healthcare system to become the least efficient among the advanced countries of the world.  We rank 51th in terms of life expectancy, 51th in terms of infant mortality, 24th in terms of the availability of doctors, 25th in terms of mother’s health, 37th in terms of the overall performance of our healthcare system, and at the same time, we spend more for healthcare per person and as a percent of GDP than any other country in the world. (OECD OECD Charts NYT IOM JAMA1 JAMA2 STC WHO)

Over the past thirty years healthcare expenditures as a percent of GDP have increased at the rate of 2.2% per year.  At this rate, expenditures as percent of GDP will double every 32 years.  Obviously something is going to give before this can occurred.  The only question is what: the government’s budget, employer sponsored health insurance, or both? 

The Patient Protection and Affordable Care Act has attempted to address this rising healthcare cost problem, but while there are a number of cost saving provisions in this bill, the Affordable Care Act hangs on to the fee-for-service, multi-third-party-payer model.  There is no single-payer mechanism or public-option plan provided for in this act to provide a direct mechanism by which costs can be controlled.  In addition, the 85% payout restriction on insurance companies that is part of this bill means that once insurance companies reach this limit they will only be able to increase their profits in the aggregate if healthcare costs increase, thereby, increasing what insurance companies can make from their 15% cut.  This does not exactly provide an incentive for insurance companies or providers to hold down costs, and if healthcare costs continue to grow the way they have in the past, the cost of Medicare and Medicaid, which together make up the largest single component of our social insurance system today, will eventually become unbearable. 

In dealing with healthcare, the main thrust of the Simpson’s-Bowles recommendations is to reduce healthcare costs by forcing healthcare recipients, both public and private, to pay a larger proportion of the cost.  But, as was noted above, this plan can only reduce costs to the extent it forces those who cannot afford the added costs out of the healthcare system with all of the implications that has for the health of our population; to the extent the government picks up the tab for those who cannot afford the added cost there is no saving.  This plan is just more of the same kind of thing we have been doing for the past 65 years, and there is no reason to think the results will be different: rising healthcare costs with a larger and larger portion of the tab being picked up by the government.

Reforming the Tax Code

What is particularly disturbing about the Simpson-Bowles bipartisan plan for deficit reduction, however, is that while they recommend massive cuts in Social Security and Medicare benefits, at the same time they recommend the top marginal income tax rate paid by corporations and the wealthy be cut from 35% to 28%, that the marginal income tax rate paid by middle-income earners be set at 22%, and that the lowest income tax rate paid by the not so wealthy be increased from 10% to 12%

It these changes are passed into law, the combined 14.2% [2] employee/employer payroll tax rate plus the income tax rate in the lowest income bracket will equal 26.3%—less than two percentage points below the maximum marginal rate corporations and multibillionaires will pay.  Those in lower end of the middle tax bracket will face a combined marginal rate of 36.2%—8.2 percentage points above the marginal rate multibillionaires and corporations will pay.  Even though Simpson and Bowles also recommend treating dividends and capital gains as ordinary income and recommend a few other changes that will make the tax code somewhat more progressive, there is something very wrong here.  

There was a surplus in the federal budget equal to 2.4% of GDP in 2000 before the massive 2001-2003 Bush tax cuts, before the invasion of Iraq, and before those who ran our financial institutions devastated our economy.  The fiscal problems we face today are clearly the result of the Bush cut taxes combined with the increases in defense expenditures squandered in Iraq and the devastating recession brought on by the fraudulent, reckless, and irresponsible behavior of those in charge of our financial institutions.  Social Security and Medicare had nothing to do with this mess.

And yet—in the name of fiscal responsibility—Alan Simpson and Erskine Bowles, acting as co-chairs of the National Commission on Fiscal Responsibility and Reform, released their Moment of Truth report in which they propose we 1) cut Medicare benefits and increase the private cost of healthcare dramatically, 2) convert Social Security into a welfare-type program paid for with payroll taxes in order to avoid paying an increase in benefits equal to 2% of GDP, and, at the same time, 3) give additional tax cuts to those at the top of the income distribution, many of whom made fortunes out of the Iraq war and through financing the housing bubble that devastated the economy of the entire world.  And to add insult to injury, we are also supposed to increase the taxes paid by those in the lowest income tax bracket.  This not only defies common sense, it defies common decency.  

An Alternative Approach

The Moment of Truth report released by the co-chairs of the  National Commission on Fiscal Responsibility and Reform does not deal with the deficit problem in a substantive way.  There is no discussion as to how the optimum level or quality healthcare can be provided to the population in the most cost effective manner in their report.  No discussion as to how Social Security and Medicare can be maintained as viable insurance programs.  No discussion as to how the optimum level of essential government services can be made available in their most cost effective manner. 

This report concentrates only on cutting government services and lowering tax rates paid by the ultra wealthy.  As a result, it simply ignores obvious solutions to our Social Security, healthcare, and fiscal problems—solutions that do not entail emasculating Social Security and Medicare.

Social Security

There are many ways to deal with the expected shortfall in Social Security revenues needed to finance the benefits promised to the baby boomers that would not involve drastic changes in the Social Security program.  One would be to

  1. Increase the payroll cap to apply to 90% of covered earnings as Congress intended back in 1977 or, perhaps, to an even higher percentage.

  2. Convert the federal estate tax to a dedicated Social Security tax that is credited automatically to the Social Security trust fund.

  3. Expand the program to cover newly hired state and local workers.   

  4. Implement modest changes in payroll taxes and Social Security benefits, if needed, after the above changes have been made and, perhaps, extend the payroll tax to include unearned income and/or remove the income cap altogether. 

Approaching the expected Social Security deficit problem in this way would not require the draconian cuts in benefits put forth in the Moment of Truth Report nor would it require draconian payroll tax increases. 

Healthcare

It is the rising cost of healthcare that poses the most serious fiscal problem faced by the federal government, and, as has been noted above, every advanced country in the world that has better health statistics and lower healthcare costs than we do has abandoned the cost ineffective multiple-third-party payment system for a single-payer universal healthcare system that provides government subsidized healthcare for all—paid for through taxes—where costs are controlled through government negotiated prices. They pay higher taxes than we do, but their higher taxes are more than offset by the savings in insurance premiums and lower healthcare costs—not to mention the fact that they are healthier than we are, and they live longer than we do.  (OECD OECD Charts NYT IOM JAMA1 JAMA2)

The simplest, most efficient, and most cost effective way to provide a comparable system for the United States would be to extend the Medicare program to the entire population.  This program works, and the institutions necessary to run it are already in place.  It would take very little effort to retool Medicare to meet the needs of the entire population compared to the massive effort it is going to take to implement the Patient Protection and Affordable Care Act.        

Reforming the Tax Code

By 2000, increases in the Social Security trust fund was adding over $150 billion a year in cash flow and deferred interest payments to the government’s general fund, and it continued to do so for the next eight years.  From 1996 through 2008, the federal government relied on the increase in the OASDI trust fund to finance over 6% of its outlays and, as was noted above, this reached a peak in 2001when the money borrowed from the Social Security System’s trust funds in that year alone amounted to 8.75% of the federal budget

Now that the baby boomers are starting to retire, this source of revenue is coming to an end.  While some of the interest the government owes the Social Security System each year can still be simply added to the System's trust funds, cash receipts from payroll taxes have fallen below the cash benefits and administrative costs the Social Security System must pay out.  As a result, the government must either borrow the difference or it must increase non-payroll taxes in order to pay that portion of the interest it owes the Social Security System each year in cash to meet this cash shortfall—if that’s what our government chooses to do.  It also has the option of reneging on its agreement with the baby boomers by reducing their benefits or increasing the payroll taxes paid by their children and grandchildren. 

Even though there are a number of simple fixes that will solve the Social Security baby boomer retirement problem, and it would be fairly easy to fix our healthcare system, none of these fixes will work if the federal government is not made fiscally sound.  These fixes can only work if we come up with the funds needed to make  them work while, at the same time, coming up with the funds needed to provide the other government services the American people demand.

What this means is that, if we are to preserve Social Security, Medicare, and provide for all of the other government services that are demanded by the American people, we must raise taxes. (Fieldhouse Diamond Sides)

Reregulating the Financial System

It will, of course, also be necessary to reregulate our financial system if we are to keep our financial institutions from creating the kinds of economic disasters that unregulated financial institutions have created throughout history. At the very lease we must

  1. reenact the Glass-Steagall Act to eliminate the kinds conflicts of interests inherent in conglomerate mega-bank financial institutions,

  2. break up those financial institutions that are "too big to fail," and

  3. provide for direct regulation of hedge funds, over-the-counter derivatives, and the market for repurchase agreements with the power to set margin requirements for repurchase agreement loans and capital requirements for Credit Default Swaps.

These are the minimum actions required to keep those in charge of our financial institutions from creating in the future the kind of economic catastrophes they have created in the past when unrestrained by government regulation—the kind of economic catastrophe we are in the midst of today.

Simply passing laws, however, is not enough. Government regulation begins with the law, but it ends with the regulators. It was the belief in free-market ideology that was the primary cause of the financial crisis we face today, not the absence of legislation. The Home Ownership and Equity Protection Act (HOEPA) passed 1994 gave the Federal Reserve the absolute authority to regulate the mortgage market. Enforcing the laws against predatory lending practices, enforcing strict underwriting standards for mortgage loans, and setting maximum loan to value ratios on mortgages would have prevented the housing bubble that came into being in the 2000s. The Federal Reserve had the absolute authority to do all of these things under HOEPA during the housing bubble, but the ideological faith in free markets to regulate themselves on the part of regulators, the administrations, and the Congress kept the Fed from doing so. (Bair)

In addition, the regulators could have petitioned the government to bring Money Market Mutual Funds, Cash Management Accounts, and repurchase agreements under the purview of depository regulators during the Reagan administration and to extend the regulatory authority of the Security and Exchange Commission and Commodity Futures Trading Commission to regulate hedge funds and the markets for Credit Default Swaps during the Clinton administration, but, again, ideology stood in the way.

Until the terribly misguided view of reality embodied in the failed nineteenth-century ideology of free-market capitalism is replaced in the minds regulators, administrations, Congress, and the body politic by a pragmatic view of financial regulation that recognizes the need for the government to rein in and control the speculative and fraudulent urges of the financial sector there is little hope of our being able to survive the current crisis with our basic social institutions intact or to avoid similar economic catastrophes in the future.

Reviving the Economy

Today we are faced with the same kind of situation we faced in the 1930s: Given the state of mass-production technology, the distribution of income is incapable of providing the domestic mass markets needed to achieve full employment in the absence of a speculative bubble.  If we do not come to grips with this problem our domestic markets for mass-produced goods will continue to erode; we will be plagued with boom and bust cycles of economic instability, and it will be impossible to maintain the standard of living of the vast majority of our population as our economic resources are transferred out of those industries that produce for domestic mass markets and into those industries that produce for the privileged few. (King)

Not only will it be impossible to maintain the standard of living of the vast majority of our population if the concentration of income is not reduced, those at the top of the income distribution will eventually find they are getting a larger piece of an ever decreasing pie. It is domestic mass markets that make mass production possible, and it is mass productionmade possible by our domestic mass marketsthat made the United States the economic powerhouse of the world. The erosion of our domestic mass markets erodes the very foundation on which our economic system rests, and to the extent that foundation is undermined, our ability to produce is undermined as well. (Ostry)

The only way a country can take advantage of mass-production technologies in the absence of an income distribution that provides a domestic mass market capable of purchasing output produced without increasing debt relative to income is by producing for export and running a current account surplus.  Unfortunately, continually running a current account surplus leads to increasing the debts of foreigners relative to their incomes, especially when those debts are accumulated through the process of financing consumption or the production of capital goods in the midst of speculative bubbles that do not increase productivity.  Increasing domestic debt relative to income, or the debts of foreigners relative to their incomes is not sustainable in the long run.  The transfer burden from debtor to creditor must eventually overwhelm the system, and must eventually lead to a financial crisis that causes the system to collapse. 

In the final analysis, it was the rising debts in the importing countries relative to their incomes that led to the current crisis.  The only way to avoid this kind of crisis is through producing for domestic markets without a continually increasing debt relative to income. This, in turn, requires a distribution of income capable of supporting the domestic mass markets needed to purchase the domestic output that can be produced.

Given the extent to which non-federal debt has increased relative to income over the past twenty-five years it should be obvious that we are not going to be able to solve the economic problems we face today without a major intervention on the part of the federal government. Simply raising taxes is not going to solve our deficit/debt problem or return our economy to full employment. It was the massive government expenditures during World War II that finally brought us out of the Great Depression, and it was the fall in concentration of income during and following the war that made it possible for our mass production industries to survive. There is no reason to believe we will be able to survive the current crisis with our basic social institutions intact and without a fall in the standard of living of the vast majority of the population in the absence of a similar effort on the part of the federal government today and without a similar reduction in the concentration of income.

The government has already had to step in to the tune of $700 billion in TARP funds and trillions of dollars of guarantees in order to bail out the financial institutions that brought the current crisis down upon us, but this is only placing a band aid on the economic wound we suffered as this bailout transferred wealth and income from taxpayers to the bankers who caused the problem in the first place.  It is the mortgagors that should have been bailed out, not the bankers who created the problems we face today. (Bair) The fiscal resources of the federal government should be used to increase taxes and government expenditures to mitigate the effects of the current recession and rebuild the public infrastructure we have allowed to deteriorate over the past thirty years. They should not be squandered on lower taxes for corporations and the higher income brackets or on bailing out those who created the financial house of cards that has fallen down upon us.

Mobilizing our fiscal recourses by increasing taxes and government expenditures to provide relief to those whose mortgages are underwater and waging a war on our deteriorating public infrastructure certainly makes more sense than waiting for—or manufacturing—a real war to justify the mobilization of these resources.  If we do not approach our non-federal debt and unemployment problems by increasing taxes and government expenditures in a way that makes it possible to deleverage the system while improving our public infrastructure our economic situation can only get worse as our financial system struggles to survive. Our unemployment problem will persist, and eventually the productivity of our economic resources will begin to fall as our economic resources are transferred out of those industries that produce for domestic mass markets.  Our transportation, water and waste treatment facilities, education, power distribution, communication, regulatory, legal, and other governmental systems will continue to deteriorate, and it will be impossible to maintain the standard of living of the vast majority of our population.

These things should be obvious, and, yet, our political leaders (at home and those in Europe as well) are in the process of negotiating how best to cut government expenditures and “entitlement” programs—the very expenditures that kept our economy from spiraling in to the abyss it spiraled into in the 1930s and the very programs that allowed us to avoid the wretched squalor and misery we experienced during that dismal period of our history—and, at the same time, they are negotiating how best to lower taxes on the upper income groups even further.

At the center of these negations is the Moment of Truth Report written by Alan Simpson and Erskine Bowles—the end product of the President’s National Commission on Fiscal Responsibility and Reform.  As we saw above, the primary recommendations of this report are to

  1. Convert Social Security from an insurance program in which the vast majority of the participants benefit, into a non-means-tested welfare program for the elderly, funded by a regressive payroll tax, in which only the poorest of the poor benefit.

  2. Reduce healthcare costs by forcing healthcare recipients, both public and private, to pay a larger proportion of the cost directly thereby forcing those who cannot afford the added costs out of the healthcare system—the ultimate death panel solution to the healthcare cost problem whereby those who can’t afford the added costs are simply allowed to suffer and die.

  3. Cut the maximum marginal tax rate paid by corporations and multibillionaires from 35% to 28%, set the middle tax bracket at 22%, and increase the tax rate paid by the lowest income earners from 10% to 12% thereby creating a situation in which the combined 14.2% employee/employer payroll tax rate plus the income tax rate in the lowest income bracket will equal 26.2%—less than two percentage point below the 28% marginal rate corporations and multibillionaires will pay. Those toward the lower end of the middle bracket will face a combined marginal rate of 36.2%—8.2 percentage points above the marginal rate multibillionaires and corporations will pay.

At the same time, the Dodd-Frank Wall Street Reform and Consumer Protection Act has added restrictions on the Federal Reserve’s ability to act in an emergency situation, (Bair) and the fundamental provisions of this bill do not go near far enough to eliminate the conflicts of interest in our financial system or to reign in the behavior of our financial institutions. In addition, those provisions of this bill that do hold some promise to moderated the fraud and deception that has pervaded our financial system over the past thirty years, the Consumer Financial Protection Bureau for example, are under attack on ideological grounds by a large segment of the politically powerful.

The ultimate question is whether we are going to deal with our problems by increasing taxes and thereby enhance the government’s ability to solve them, or are we going to follow the mantra of the free-market ideologues and undermine the government’s ability to deal with these problems by cutting taxes and government expenditures, dismantling our social-insurance programs, turning Federal Reserve policy over to Congress and, thereby, cut the threads that have so far saved us from the fate of the 1930s.

Lower taxes, less government, and deregulation caused the economic problems we have today, and more of the same is not going to solve these problems. If we are to solve these problems we must strengthen government, not weaken it; we must increase taxes, not lower them, and we must increase government expenditures as we rebuild the regulatory systems that were dismantled since the 1970s and rebuild the public infrastructure that has been allowed to deteriorate over the past forty years.

If we do not do these things and, instead, continue to follow the failed ideological mantra of lower taxes, less government, and deregulation we are most certainly going to end up right back where we started in the 1930s.  And if the political leaders throughout the world continue to follow this failed ideological mantra and refuse to come to grips with the root causes of the worldwide economic catastrophe we face today, we are likely to end up where we ended up in the 1940s.

Endnotes

 * This Paper was previously Chapter 17 in Where Did All the Money Go?

[1]  It should be noted that privatizing individual Social Security accounts also does nothing to solve the baby boomer retirement problem.  Even if the Social Security system were made up entirely of individualized accounts that contained the government bonds now in the trust fund these bonds would still have to be redeemed by the government when the owners of these accounts began withdrawing retirement funds, or some non-Social-Security-account buyer would have to be found who is willing to purchase these government bonds. 

The situation would be even worse, not for the government but for the Social Security account holders, if the private accounts contained private securities.  Aside from the vagaries of the private securities markets, the flow of funds into the private securities markets as the baby boomers built up their accounts would have undoubtedly been a boon to these markets.  It is just as undoubtable that the flow of funds out of these markets as the baby boomers retired would be a serious drag on these markets.  The baby boomers would be buying as they drove prices up and selling as they drove prices down, not exactly a formula for getting rich.  Such a scheme would, perhaps, serve the older baby boomers well, but certainly not the younger baby boomers. 

[2] The combined rate is 14.2% rather than 15.3% since in combining the rates paid by the employer and employee we must include the portion of the payroll tax paid by the employer as part of the employee's income.

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