Tuesday, October 29, 2013

The Menu of Pain

The first step in solving a problem is acknowledging it exists. The growing fiscal gap is a problem that needs to be acknowledged.

The U.S. fiscal gap is 222 trillion dollars and growing.

How can we close it? For me,  Laurence Kotlikoff is the go-to economist on fiscal issues in the United States.  Kotlikoff's menu of pain contains a lot of sobering options of either renegotiating our promises or paying for them.

  • Closing the fiscal gap through tax increases alone would require an immediate and permanent 64 percent increase in ALL federal taxes.

  • Closing the fiscal gap through spending cuts alone would require an immediate and permanent 35 percent cut in ALL federal outlays (including welfare and payments on interest and principle of existing debt). 

These numbers get worse every year the problem is not addressed. 

Solving the problem requires first that people acknowledge the severity of the problem -- that our promises far exceed our ability to deliver on them. A little extra growth won't close the gap. Modest immigration reform and a small increase in the birthrate won't do it. Cutting all federal discretionary spending including defense to $0 won't do it. Even a 100% tax and enslavement of the richest 1% wouldn't be enough to close the fiscal gap. 

Why is it so hard to acknowledge the severity of the problem? I think a lot of it comes from a misunderstanding of how most welfare programs work (they're complicated, and change over time). Many people, especially current seniors, have this impression that they have paid into a system all their lives and are getting a fair return on their investment and benefits based on what they paid into it. 

The reality is that most large welfare programs are pay-as-you-go which rely on an ever-increasing pool of workers paying into them -- and that pool of workers is not getting big enough fast enough. There is no personal bank account with your name on it accumulating market interest and protecting your principle. Current and past seniors have gotten a fantastic deal, getting much more out in benefits than they paid in:
According to the [Urban Institute]'s data, a two-earner couple receiving an average wage — $44,600 per spouse in 2012 dollars — and turning 65 in 2010 would have paid $722,000 into Social Security and Medicare and can be expected to take out $966,000 in benefits. So, this couple will be paid about one-third more in benefits than they paid in taxes.
If a similar couple had retired in 1980, they would have gotten back almost three times what they put in. And if they had retired in 1960, they would have gotten back more than eight times what they paid in. The bigger discrepancies common decades ago can be traced in part to the fact that some of these individuals’ working lives came before Social Security taxes were collected beginning in 1937.
Some types of families did much better than average. A couple with only one spouse working (and receiving the same average wage) would have paid in $361,000 if they turned 65 in 2010, but can expect to get back $854,000 — more than double what they paid in. In 1980, this same 65-year-old couple would have received five times more than what they paid in, while in 1960, such a couple would have ended up with 14 times what they put in.
Such findings suggest that, even allowing for inflation and investment gains, many seniors will receive much more in benefits than what they paid in.

This is why public benefits programs (which are actually at their heart, just transfers) are so popular. It's also why Detroit's pensions have collapsed so spectacularly and why Social Security is going to "run out of money." 

I think as people realize how the programs actually work and the strain on workers of having to pay for unreasonable promises grows, people will be willing to talk about ways of making transfer programs work by funding a responsibly-sized pot (or a personal account) before taking from it. 

Friday, October 18, 2013

Echoes

It's not over. The game continues to the next round.
McConnell was pushing hard to include language to give federal agencies more flexibility to implement the sequester, something Reid was objecting to Wednesday morning, sources say. Democrats argued that provision would make it harder to eliminate the sequester in the future and it was not included in the final package.  

Wednesday, October 9, 2013

The Shutdown Makes Sense (Both Parties are to Blame)

I feel ashamed to admit I am enjoying the spectacle in Washington more than just a little bit. It's entertaining and scary all at the same time. And all of the maneuverings of the last couple of weeks make a surprising amount of sense.

Reality Squished Into a Non-Cooperative Game

Suppose Republicans' preferred funding initiatives are a subset of the Democrats' preferred funding initiatives. (Crudely, Republicans' prefer "less" government spending; Democrats "more".) Further suppose the Republicans always get to propose funding initiatives (they control the House and propose the "budget") and Democrats then get to accept or reject each proposal (they control the Senate and the Presidency). If the proposal is accepted, it becomes law. If it's rejected, the institutionally binding "no decision" option is exercised.

Status Quo

Suppose the institutionally binding "no decision" option is current funding levels. Current funding levels are greater than the Republicans' preferred position and lower than the Democrats' preferred position.  If Republicans propose any budget that funds the government at lower levels than the current levels, Democrats simply reject the proposal. Republicans are not willing to negotiate with Democrats because there is nothing to negotiate over. Any negotiation would lead to funding new programs or existing programs and agencies at levels higher than current levels moving the Republicans FURTHER from their preferred budget. Why bother?

The upside is that there is stability in reverting to the status quo -- the government is always funded. But this doesn't address the real question: Should all of government continue to be funded unquestioned and all increases in spending automatically guaranteed?

Notice that if the "no decision" result is current levels of funding, Democrats don't have to be a majority to block reductions in government spending. They only need to control one of the House (to control the proposing), the Presidency (to veto), or 40 votes in the Senate (to filibuster).

The Shutdown Gives Leverage to Republicans

Suppose the institutionally binding "no decision" result is a low level of government funding (the "shutdown"). Now the tables are turned. The shutdown is further away from the Democrats' preferred position than the current funding "no decision" result, so Republicans can propose lower levels of funding than they would have been able to if "no decision" resulted in current funding levels. In fact, if the shutdown is less funding than the Republicans' preferred position, at first glance it looks like Republicans have a strategy to win 100% of what they want!

If Democrats vote truthfully on every budget proposal, Republicans can pass "one at a time" measures to fund their preferred policy positions at the levels they desire. Since Republicans' preferred policy positions are a subset of the Democrats', every Republican proposal is preferred by Democrats to the shutdown and the Democrats should agree to the Republican budget.

Republicans get their most preferred budget and there is no shutdown!

The Shutdown Gives Leverage to Democrats

But hold on! If the shutdown funding level is lower than the Republicans' preferred position, Democrats have leverage, too! They don't have to vote truthfully on every budget proposal. They can issue a threat to Republicans: propose a budget with at least enough funding such that you (Republicans) are indifferent between that budget and shutdown. We (Democrats) will reject all other proposals.

Now Republicans are in a pickle. Democrats, by threatening to vote against proposals they actually like, are able to extract more of what they want.

This seems to match what's going on. Democrats have issued a threat to reject all proposals that don't fund the government at least at the sequester levels and Republicans seem to be waffling on whether it's better to fund the government "cleanly" at those levels or persist with the shutdown.

The Point:
Both parties are at fault for the shutdown because they both can use the shutdown to extract more from the other side.

Additional Wrinkles

But is the Democrats' threat credible? If the Republicans pass their preferred budget, would the Democrats actually reject it in favor of a shutdown? Here's where my simple model starts to fall apart. What's really going on is more dynamic; it's a repeated game or a war of attrition where there isn't a defined "last period." In those situations, yes, Democrats can credibly issue these threats and rationally follow through (for a time, anyway).

Also, the costs to the shutdown may be asymmetric. This is especially likely when the Democrats have some control over the shutdown. By making the shutdown more painful and more painful only for Republicans, they are able to extract more. In this case, the budget that makes Republicans indifferent between it and the shutdown is even closer to the Democrats' preferred budget.

"We've been told to make life as difficult for people as we can. It's disgusting."

Asymmetric costs also help explain why Republicans are able to maintain the shutdown in the face of higher disapproval ratings than Democrats. The shutdown is more costly to them than Democrats in terms of future chances at re-election, but the lower funding levels probably hurt Democrats a lot more (it's further from their ideal) even with partial Democratic control over the shutdown's enforcement.

So, as "strange" or "irrational" as the shutdown may seem; it's not. It's the result of two parties with very different visions for America who have been unable to talk seriously and cooperatively with each other.

(10/10/2013: Edited for clarity.)