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Posts Tagged ‘Entitlements’

President Biden pushed through $1.9 trillion of new spending earlier this year, but that so-called stimulus plan was mostly for one-time giveaways. As I warn in this recent discussion on Denver’s KHOW, we should be much more worried about his proposals to permanently expand the welfare state.

When I first got to Washington, I would be upset that politicians wanted to add billions of dollars to the burden of government.

Well, those were the good ol’ days. Biden is proposing to divert trillions of dollars from the private sector to expand the welfare state.

Even worse, he wants to make more Americans dependent on the federal government.

Maybe that’s a smart way of buying votes, but it will erode societal capital.

John Cogan and Daniel Heil of the Hoover Institution warned about the consequences of this dependency agenda in a column for the Wall Street Journal.

The federal government’s system of entitlements is the largest money-shuffling machine in human history, and President Biden intends to make it a lot bigger. His American Families Plan—which he recently attempted to tie to a bipartisan infrastructure deal—proposes to extend the reach of federal entitlements to 21 million additional Americans, the largest expansion since Lyndon B. Johnson’s Great Society. …more than half of working-age households would be on the entitlement rolls if the plan were enacted in its current form. …57% of all married-couple children would receive federal entitlement benefits, and more than 80% of single-parent households would be on the entitlement rolls.

Many of the handouts would go to people with middle-class incomes.

And higher.

…The American Families Plan proposes several new entitlement programs. One promises students the government will pick up the entire cost of community-college tuition; another promises families earning 1.5 times their state’s median income that Washington will cover all daycare expenses above 7% of family income for children under 5; still another promises workers up to 12 weeks of federally financed wage subsidies to take time off to care for newborns or sick family members. …Two-parent households with two preschool-age children and incomes up to $130,000 would qualify for federal cash assistance for daycare. Single parents with two preschoolers and incomes up to $113,000 would qualify. And some families with incomes over $200,000 would be eligible for health-insurance subsidies. Other parts of the plan, such as paid leave and free community college, have no income limits at all.

The Wall Street Journal opined on this issue last month. Here are the key passages from their editorial.

The entitlements are by far the biggest long-term economic threat from the Biden agenda. …entitlements that spend automatically based on eligibility are nearly impossible to repeal, or even reform, and they represent a huge tax-and-spend wedge far into the future. …We’d highlight two points. First is the dishonesty about costs. Entitlements always start small but then soar. The Biden Families Plan is even more dishonest than usual. For example, it pretends the child tax credit ends in 2025, so its cost is $449 billion over the 10-year budget window that is used for reconciliation bills that require only 51 votes to pass the Senate. But a future Congress will never repeal the credit. …Second, these programs aren’t intended as a “safety net” for the poor or those temporarily down on their luck. They are explicitly designed to make the middle class dependent on government handouts.

The editorial explicitly warns that the United States will economically suffer if politicians copy Europe’s counterproductive redistributionism.

…on present trend the U.S. is falling into the same entitlement trap as Western Europe. Entitlement spending requires higher taxes, which grab 40% or more of GDP. Economic growth declines as more money flows to transfer payments instead of investment. The entitlement state becomes too large to afford but also too politically entrenched to reform. …Only a decade ago the Tea Party fought ObamaCare. Now most Beltway conservatives worry more about Big Tech than they do Big Government. If the Biden Families Plan passes, these conservatives will find themselves spending the rest of their careers as tax collectors for the entitlement state.

Amen. I’m baffled when folks on the left argue that we should “catch up” with Europe.

Are they not aware that American living standards are far higher? Do they not understand that low-income people in the United States often have more income than middle-class people on the other side of the Atlantic Ocean?

P.S. As I mentioned in the interview, the 21st century has been bad news for fiscal policy, with two big-government Republicans and two big-government Democrats.

For what it’s worth, the $3,000-per-child handouts are Biden’s most damaging idea. In one fell swoop, he would create a trillion-dollar entitlement program and repeal the successful Clinton-Gingrich welfare reform.

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As a libertarian, I don’t care if couples have zero children or 10 children.

But as an economist, I’m horrified that big changes in demographics are going to lead to fiscal crises thanks to poorly designed entitlement programs.

Simply stated, modest-sized welfare states are sustainable if more and more new taxpayers enter the system to finance benefits for a burgeoning population of old people.

But that’s not happening any more. In most nations, traditional population pyramids are becoming population cylinders because of falling birthrates and increasing longevity.

That’s the bad news.

The good news is that there is growing awareness the demographic changes are happening. Indeed, Damien Cave, Emma Bubola and have a big article on population decline in the New York Times.

All over the world, countries are confronting population stagnation and a fertility bust, a dizzying reversal unmatched in recorded history that will make first-birthday parties a rarer sight than funerals, and empty homes a common eyesore. Maternity wards are already shutting down in Italy. Ghost cities are appearing in northeastern China. Universities in South Korea can’t find enough students, and in Germany, hundreds of thousands of properties have been razed, with the land turned into parks. …Demographers now predict that by the latter half of the century or possibly earlier, the global population will enter a sustained decline for the first time. …The strain of longer lives and low fertility, leading to fewer workers and more retirees, threatens to upend how societies are organized — around the notion that a surplus of young people will drive economies and help pay for the old. …The change may take decades, but once it starts, decline (just like growth) spirals exponentially. With fewer births, fewer girls grow up to have children, and if they have smaller families than their parents did — which is happening in dozens of countries — the drop starts to look like a rock thrown off a cliff. …according to projections by an international team of scientists published last year in The Lancet, 183 countries and territories — out of 195 — will have fertility rates below replacement level by 2100.

Plenty of interesting data, though remarkably little focus on the fiscal implications. Sort of like writing about 1943 France with almost no reference to World War II.

In any event, the article takes a closer look at the challenges in certain nations., including South Korea.

To goose the birthrate, the government has handed out baby bonuses. It increased child allowances and medical subsidies for fertility treatments and pregnancy. Health officials have showered newborns with gifts of beef, baby clothes and toys. The government is also building kindergartens and day care centers by the hundreds. In Seoul, every bus and subway car has pink seats reserved for pregnant women. But this month, Deputy Prime Minister Hong Nam-ki admitted that the government — which has spent more than $178 billion over the past 15 years encouraging women to have more babies — was not making enough progress.

I was struck by the statement from the Deputy Prime Minister that his nation “was not making enough progress”?

That’s a strange way of describing catastrophic decline in birthrates, as noted in the article.

South Korea’s fertility rate dropped to a record low of 0.92 in 2019 — less than one child per woman, the lowest rate in the developed world. Every month for the past 59 months, the total number of babies born in the country has dropped to a record depth.

Maybe, just maybe, government handouts are not the way to boost birthrates.

I’ll conclude by noting that the real problem is tax-and-transfer entitlement programs, not low birth rates.

Both Singapore and Hong Kong have extremely low birth rates, for instance, but they aren’t facing a huge fiscal crisis because they have very small welfare states and workers are obliged to save for their own retirement.

Other Asian jurisdictions, however, made the mistake of copying Western nations, meaning entitlement programs that become mathematically impossible when populations pyramids become population cylinders (or even upside-down pyramids!).

In addition to South Korea, Japan also faces a major challenge.

And the situation is very grim in Europe, even though birth rates haven’t fallen to the same degree (though the numbers is some Eastern European nations are staggeringly bad).

P.S. The United States isn’t far behind.

P.P.S. We know the answer to this crisis, but far too many politicians are focused on trying to make matters worse rather than better.

P.P.P.S. You can read my two-part series on this topic here and here.

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There are many compelling economic arguments against entitlement programs.

Since I’m a libertarian, I also have moral concerns about tax-and-transfer programs.

Today, though, let’s address the big problem of entitlements and demographics, especially with regards to social insurance programs that transfer money from young people to old people (most notably Social Security and Medicare).

But I’ll start by acknowledging that demographics doesn’t have to be a problem. When nations first created such programs, they generally had “population pyramids” featuring a few old people, lots of working-age people (i.e., taxpayers), and then an even greater number of children (future workers and taxpayers).

As illustrated by this image, entitlement programs can be sustainable with that type of demographic profile.

But there’s been a big shift in demographics in developed nations.

Simply stated, we’re living longer and having fewer kids. In some sense, population pyramids are becoming population cylinders.

And this creates major challenges for entitlement programs because instead of there being many workers supporting just a few retirees, you wind up with “old-age dependency ratios” that require very onerous tax burdens (or very high levels of government borrowing).

I’ve already written how this is a big problem for the United States.

Indeed, I periodically cite long-run forecasts from the Congressional Budget Office to warn about the worrisome fiscal implications.

And I’ve also noted that Japan is in serious trouble.

Today, let’s look at some recent data to show that Europe is another part of the world where this problem is acute.

The European Commission published its 2021 Ageing Report late last year and there are three visuals that deserve attention.

First, here’s a look at the European Union’s population cylinder (or maybe an upside-down pyramid).

And here’s a table that compares the number of old people with the working-age population in 2019, 2045, and 2070.

At the bottom of the table, I’ve circled in red the averages for the eurozone (nations using the single currency) and the entire European Union. From the perspective of fiscal policy, these are horrific numbers.

But there are numbers that are even worse.

Our final visual is a table showing the economic dependency ratio, which the European Commission defines as “… the ratio between the total inactive population and employment. It gives a measure of the average number of individuals that each employed person ‘supports’ economically.”

Once again, I’ve circled the averages at the bottom of the table.

The bottom line is that most European nations already have a stifling fiscal burden, yet it’s all but certain that there will be even higher taxes and more government spending in the near future.

Which means more economic stagnation for Europe (and those of us in America face that possibility as well).

At the risk of stating the obvious, there is a solution to both Europe’s woes and America’s woes. Simply stated, there needs to be genuine entitlement reform.

That means “pre-funding,” which is the jargon for mandatory private savings, presumably augmented by some form of safety net.

Singapore is probably the world’s leading example for mandatory savings, while AustraliaDenmarkChileSwitzerlandHong KongNetherlandsFaroe Islands, and Sweden are a few of the many other jurisdictions that have fully or partially shifted to systems based on real savings.

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A few days ago, I shared some slides from a presentation to an e-symposium organized by Trends Research in Abu Dhabi.

Here’s a video of my presentation, which includes 16 visuals to drive home the point that the world is facing a demographic/entitlement crisis.

Today, I want to share five more visuals to underscore the severity and magnitude of this catastrophe.

But before we look at the charts, I’ll start by saying this isn’t a fast-developing problem. It’s taken several decades to get where we are now and most nations probably have several decades before an actual crisis materializes.

Though what’s already happened in Greece (and what’s presumably about to happen in Italy) should underscore the seriousness of this issue.

This issue is global, as illustrated by this chart showing the staggering shift that will happen to the world’s population. Simply stated, there are going to be lots and lots of old people, but no concomitant increase in the number of children.

It’s not just that there’s not a corresponding increase in the number of children.

The real story is that birthrates are plummeting.

The data for Europe is particularly sobering.

Here’s a look at some other nations that face big fertility declines.

By the way, there’s absolutely nothing wrong with families deciding they want fewer children.

But it does create a big fiscal problem because governments have tax-and-transfer entitlement programs that were created when everyone thought there would always be ever-larger generations.

But that’s not happening now, which explains why the world is going from eight workers per retiree to four workers per retiree.

That’s the global data. For many developed regions, such as Europe, the situation is far more challenging.

And the United States isn’t far behind.

I’ll close by observing that there’s actually a very simple solution to this problem. We need genuine entitlement reform.

Sadly, that definitely didn’t happen in the past four years in the United States. And it also won’t be happening in the next four years.

P.S. Hong Kong and Singapore have very low birth rates and very long lifespans, but those jurisdictions are in reasonably good shape because they didn’t make the mistake of imposing western-style welfare states.

P.P.S. Some have argued that the demographic problem can be solved by having government-created incentives for fertility. At the risk of understatement, I’m skeptical of that approach.

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I’ve written many times about demographic change and the implications for public policy – both in the United States and around the world.

Simply stated, it will be increasingly difficult to maintain tax-and-transfer entitlement programs in societies where people are having fewer children and people are living longer.

I’m raising this issue because I spoke on this topic earlier today at an e-symposium organized by Trends Research in Abu Dhabi, UAE. Here’s a slide with my main message.

Why is it bad news from an economic perspective?

As I noted in the next slide, tax-and-transfer entitlement programs for the elderly (most notably Social Security and Medicare in the United States) become harder to finance when there are lots of beneficiaries and too few taxpayers to support them.

So what’s going to happen in various nations when the irresistible force of more beneficiaries meets the immovable object of fewer taxpayers?

In my presentation, I pointed out that there are only three potential solutions.

I explained that higher tax burdens and higher debt levels would not be economically prudent.

The right approach is genuine entitlement reform, but I freely admitted that this “pre-funding” model probably won’t happen.

Here’s the relevant slide.

By the way, Singapore is the role model for pre-funding, but many other nations have adopted that approach for retirement income (such as IsraelDenmarkSwitzerlandHong KongNetherlandsFaroe Islands, and Sweden).

Unfortunately, most nations are heading for a demographic iceberg (including the U.S.) but I fear few of them will enact the reforms that are needed to avert a bad outcome.

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Back in 2015, just five years ago, it seemed like entitlement reform might happen.

Republicans in the House and Senate voted for budgets based on much-needed changes to Medicare and Medicaid. That was only a symbolic step with Obama in the White House, to be sure, but the presumption was that actual reform would be possible if Republicans controlled both the White House and Congress after the 2016 election.

The good news is that the GOP did wind up in control of Washington.

The bad news is that Donald Trump was in the White House.

Given his unfortunate views on government spending, that killed entitlement reform for the past four years.

And now Biden will be in the White House, and he wants to expand those programs, so that presumably kills reform for the next four years.

But does that change the fact that the programs should be reformed?

In a column for National Review, Fred Bauer asserts that Republicans should give up on trying to control big government.

Republicans…risk being lured toward a pivot back to 2010s-style austerity politics during the Biden administration, with a renewed focus on the federal deficit and entitlement reform. …Trying to push party-line entitlement reform has backfired on the GOP again and again in the recent past. George W. Bush’s 2005 Social Security–privatization proposal kneecapped his second term from the start. In 2012, Republicans got bogged down defending their position on Medicare reform… retreating to austerity politics could cost Republicans a chance to promote other kinds of reforms that would strengthen workers and families: fixing the medical marketplace (by reducing cartelization, revising medical licensing, etc.), passing a 21st-century infrastructure program, trying to secure a strategic industrial base, enacting smarter regulation of Big Tech that addresses market concerns and serves the public welfare, offering Americans family tax credits, and so on.

Also writing for National Review, Yuval Levin of the American Enterprise Institute explains that we have no choice but to grapple with entitlements.

The Republican Party has styled itself the party of fiscal restraint for the better part of a century… But there hasn’t been much action, or much willingness to expend political capital or make some painful deals to achieve a meaningful change in the trajectory of the government’s finances. …the willful blindness of the Trump era…means the underlying fiscal problems have grown worse… the costs of fiscal irresponsibility have more to do with constraints on future growth… Fiscal reform will need to involve changes to these programs.

Levin even suggests that entitlement reform is so important that it might be worth ceding ground in other areas.

Repub­licans should be willing to make bargains that involve leaving discretionary spending untouched, or even on a path of modest growth, if that allows for some reforms of entitlements. They should also be willing to contemplate tax increases and reforms that move the burden of federal revenue upward on the income scale, provided such changes do not unduly undermine growth.

My two cents is that Levin is right and Bauer is wrong.

To be sure, I don’t agree with everything Levin wrote (it’s theoretically possible to make a tax increase acceptable, for instance, but that won’t happen in the real world). But at least he recognizes the long-run spending outlook is so dour that entitlement reform is absolutely necessary.

Bauer, by contrast, argues that we should throw in the towel because reform is politically difficult.

I think he misreads the evidence.

Regarding Social Security, Bush got elected twice while supporting personal accounts, but the issue never went anywhere in his second term in large part because the White House never proposed a plan. Moreover, the public continued to be supportive of the idea of personal accounts, even after Bush left office.

Likewise, I think Bauer is wrong on Medicare and Medicaid. Republicans easily maintained control of the House in 2012, 2014 and 2016, notwithstanding Democratic attacks that they wanted to “push granny off a cliff.” And they still control the Senate after years of similar attacks.

But even if Bauer was right about the politics, he’s wrong about policy.

America will become another Greece if we don’t reform entitlements. That will be bad for the nation. It will be bad for our economy. It will be bad for our children and grandchildren. It will be bad for the fabric of our society.

The bottom line is that entitlement reform is the patriotic thing to do.

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Back in 2017, I compared the welfare state vision of “positive rights” with the classical liberal vision of “negative rights.”

To elaborate, here’s a video from Learn Liberty that compares these visions.

For what it’s worth, I don’t like the terms “positive rights” and “negative rights” for the simple reason that an uninformed person understandably might conclude that “positive” is good and “negative” is bad.

Needless to say, I don’t think it’s good for people to think they have a right to other people’s money.

That’s why I prefer Professor Skoble’s use of the terms “liberties” and “entitlements,” which we also find in this slide from Professor Imran Ahmad Sajid of the University of Pakistan.

As you might expect, there are plenty of politicians who try to buy votes with an agenda of “positive rights.” Bernie Sanders, for instance, constantly argued that people have a “right” to all sorts of goodies.

But he wasn’t the first to make the case for unlimited entitlements.

Franklin Roosevelt was one of America’s worst presidents, in part because his policies deepened and lengthened the Great Depression. But also because he pushed the idea that people have the right to get all sorts of taxpayer-financed handouts.

Let’s see what some other people have to say about this topic.

In his National Review column, Kevin Williamson looks at the logical fallacy of positive rights.

Positive rights run into some pretty obvious problems if you think about them for a minute, which is why so much of our political discourse is dedicated to moralistic thundering specifically designed to prevent such thinking. Consider, in the American context, the notion that health care is a right. Declaring a right in a scarce good such as health care is intellectually void, because moral declarations about rights do not change material facts. If you have five children and three apples and then declare that every child has a right to an apple of his own, then you have five children and three apples and some meaningless posturing — i.e., nothing in reality has changed, and you have added only rhetoric instead of adding apples. In the United States, we have so many doctors, so many hospitals and clinics, so many MRI machines, etc. This imposes real constraints on the provision of health care. If my doctor works 40 hours a week, does my right to health care mean that a judge can order him to work extra hours to accommodate my rights? For free? If I have a right to health care, how can a clinic or a physician charge me for exercising my right? If doctors and hospitals have rights of their own — for example, property rights in their labor and facilities — how is it that my rights supersede those rights?

And here’s what he says about “negative rights.”

A negative right is a right to not be constrained. The right to free speech, for example, implies only non-interference. The right to freedom of the press doesn’t mean the government has to give you a press. The good of negative freedom is, in the economic sense, not rivalrous — your exercise of free speech doesn’t leave less freedom of speech out there for others to enjoy

And Larry Reed opines on the issue for the Foundation for Economic Education.

America is a nation founded on the notion of rights. …Despite the centrality of rights in American history, it’s readily apparent today that Americans are of widely different views on what a right is, how many we have, where rights come from, or why we have any in the first place. …if you need something, does that mean you have a right to it? If I require a kidney, do I have a right to one of yours? Is a right something that can or should be granted or denied by majority vote?

He helpfully provides a list of negative rights (a.k.a., liberties).

And he argues that positive rights (a.k.a., entitlements) are not real rights.

The bottom line, he explains, is that so-called positive rights impose obligations on other people.

Indeed, they can only be provided by coercion.

The first list comprises what are often called both “natural rights” and “negative rights”—natural because they derive from our essential nature as unique, sensate individuals and negative because they don’t impose obligations on others beyond a commitment to not violate them. The items in the second are called “positive rights” because others must give them to you or be coerced into doing so if they decline. …while I believe neither you nor I have a right to any of those disparate things in the second list, I hasten to add that we certainly have the right to seek them, to create them, to receive them as gifts from willing benefactors, or to trade for them. We just don’t have a right to compel anyone to give them to us or pay for them.

There’s not much I can add to this issue, given the wisdom contained in the video and in the articles by Williamson and Reed.

So I’ll close with the should-be-obvious point that a system based on entitlements only works if there are enough people pulling the wagon to support all the people riding in the wagon.

But that kind of society contains the seeds of its own downfall (think Greece or Venezuela) because it subsidizes dependency and penalizes production.

Which means, as Margaret Thatcher warned us, that positive rights can’t be provided when politicians run out of other people’s money.

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Compared to most of the world, Japan is a rich country. But it’s important to understand that Japan became rich when the burden of government was very small and there was no welfare state.

Indeed, as recently as 1970, Japan’s fiscal policy was rated by Economic Freedom of the World as being better than what exists today in Hong Kong.

Unfortunately, the country has since moved in the wrong direction. Back in 2016, I shared the “most depressing chart about Japan” because it showed that the overall tax burden doubled in just 45 years.

As you might expect, that rising tax burden was accompanied by a rising burden of government spending (fueled in part by enactment of a value-added tax).

And that has not been a good combination for the Japanese economy, as Douglas Carr explains in an article for National Review.

From 1993 to 2019, the U.S. averaged 2.6 percent growth, …far ahead of Japan’s meager 0.9 percent. …What happened? Big government happened… Japanese government spending was just 17.5 percent of the country’s GDP in 1960 but has grown, as illustrated below, to 38.8 percent of GDP today. …the island nation’s growth never recovered. The theory that government spending boosts long-term growth has failed… What government spending does is crowd out investment.

Amen. Japan has become a parody of Keynesian spending.

Here’s a chart from Mr. Carr’s article, which could be entitled “the other most depressing chart about Japan.”

As you can see, the burden of government spending began to climb about 1970 and is now represents a bigger drag on their economy than what we’re enduring in the United States.

Unfortunately, the United States is soon going to follow Japan in that wrong direction according to fiscal projections from the Congressional Budget Office.

Carr warns that bigger government in America won’t work any better than big government in Japan.

Rather than a problem confined to the other side of the world, Japan’s death spiral is a pointed warning to the U.S. The U.S. and Japanese economies are on the same trajectory; Japan is simply further along the big-government, low-growth path. …The United States is at risk of entering a Japanese death spiral.

Here’s another chart from the article showing the inverse relationship between government spending and economic growth.

Moreover, the U.S. numbers may be even worse because of coronavirus-related spending and whatever new handouts that might be created after the election.

The negative relationship of government spending with growth and investment holds with adjustments for cyclical influences such as using ten-year averages or the Congressional Budget Office’s estimates of cyclically adjusted U.S. government spending. CBO data highlight how close the U.S. is to a Japanese-style death spiral. …Of course, CBO’s recent forecast was prepared before the coronavirus shock and does not incorporate spending by a new Democratic government, so this dismal outlook is likely to worsen.

So what’s the solution? Can the United States avoid a Greek-style future?

The author explains how America can be saved.

Boosting growth means restraining government. Restraining government means reengineering entitlements… Economically, it shouldn’t be too difficult to do better. We have an insolvent, low-return government-retirement program along with an insolvent retiree-health program — part of a Rube Goldberg health-care system.

He’s right. To avoid stagnation and decline, we desperately need spending restraint and genuine entitlement reform in the United States.

Sadly, Trump is on the wrong side on that issue and Biden wants to add fuel to the fire by making the programs even bigger.

P.S. Here’s another depressing chart about Japan.

P.P.S. Unsurprisingly, the OECD and IMF have been cheerleading for Japan’s fiscal decline.

P.P.P.S. Japan’s government may win the prize for the strangest regulation and the prize for the most useless government giveaway.

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Before our depressing discussion today about the fiscal impact of entitlement programs (Social Security, Medicare, Medicaid, EITC, Food Stamps, welfare, and Obamacare, etc), here’s a video of how it all began.

I think this is a great introduction to the issue, particularly since you learn how “public choice” (i.e., politicians engaging in self-serving behavior) played a key role in the development of today’s welfare state.

But if you don’t have the time to watch a long video, here are four key things to understand.

  1. Entitlements (budget geeks sometimes use the term “mandatory spending”) are programs that automatically give people money if they meet certain requirements (such as reaching a certain age or having income below a certain level).
  2. Since these programs automatically give people money, they are not part of the annual appropriations process (the “discretionary spending” parts of the budget that are determined on a yearly basis).
  3. Some entitlement programs are “means tested” and designed to funnel money to low-income individuals. This type of spending is sometimes referred to as “unearned benefits.”
  4. Some entitlement programs are “social insurance” since people pay specific tax in exchange for specific benefits. This type of spending is sometimes referred to as “earned benefits” (though in many cases recipient receive much more than they paid).

By the way, there’s one additional thing to understand.

Indeed, it may be the most important thing to understand if you care about America’s fiscal and economic future.

5.  Entitlement programs are a slow-motion fiscal train wreck.

Let’s look at a new study authored by James Capretta of the America Enterprise Institute. He also has some sobering observations on the history of entitlement programs.

The growing expense of entitlement programs has occurred steadily for more than a half century and is reflected in the shifting distribution of federal spending activity. …by the early 1960s, two-thirds of all spending continued to require approval by the House and Senate appropriations committees each year, and less than a third was spent on entitlement programs. … By 2019, nearly two-thirds of all spending in the budget was for entitlement programs, and less than a third went to annually appropriated accounts.

If you prefer this information visually, here are a couple of pie charts from the study.

While there are dozens of entitlement programs, the big three are Social Security, Medicare, and Medicaid.

The largest entitlement programs are Social Security, Medicare, and Medicaid. Together, they now make up nearly half of all federal spending. Their combined growth over the past half century is the primary source of intensifying fiscal pressure. …In 2019, combined federal spending on them was 9.8 percent of GDP, up from 3.7 percent in 1970. CBO expects them to cost 17.2 percent of GDP in 2050, which is almost equal to the average annual revenue collected by the federal government from 1970 to 2019.

And here’s how they’ve been consuming ever-larger shares of America’s economic output.

What’s driving this ever-increasing fiscal burden?

In part, it’s because we have more and more old people and they are living longer.

So what does all this mean?

Capretta points out that uncontrolled entitlement spending may lead to a debt crisis.

I don’t disagree, but I think that’s a secondary concern. The real problem is that government spending will become an ever-larger economic burden. And that will hinder growth whether it’s financed by borrowing or taxes.

Speaking of taxes, here’s the chart from the study that deserves our close attention. It shows the relationship between demographics, benefit generosity, and tax burdens.

Here’s how Capretta describes the relationship.

…for each of the stipulated replacement rates (25, 50, and 75 percent), the tax rate necessary to keep the program solvent rises with increases in the aged dependency ratio. This explains why social insurance taxes in many aging societies have been increased to high levels in recent decades.

I’ve taken the liberty of augmenting the chart to show how these factors interact (though the order of #1 and #2 doesn’t matter).

The bottom line is that the United States is on track to become a high-tax, European-style welfare state if fiscal policy is left on autopilot.

In other words, unless there’s genuine entitlement reform, future Americans will be condemned to lower living standards.

P.S. Here’s some more history. In a column for the American Institute for Economic Research, Richard Ebeling looked at British history to explain how the private sector played a role in social insurance before being displaced by government.

Throughout the 19th century, a primary means for the provision of what today we call the “social safety nets” was by the private sector outside of government. The British Friendly Societies were mutual assistance associations that emerged to provide death benefits for the wives and children of the breadwinner who had passed away. But they soon offered a wide array of other mutual insurance services, including health care coverage, retirement pension programs, unemployment insurance, savings clubs to purchase a family house, and a variety of others. …by the end of the 19th century around two-thirds to three-quarters of the entire British population was covered by one or more of their programs and insurances. The research also discovered that a large majority of the subscribers were in the lower income brackets of the time… What stands out is that these were all private and voluntary associations and exchanges, in which the government paid little or no role.

On a related note, here’s an excellent short video on the English “poor laws” from the 1800s.

P.P.S. In addition to the fiscal burden of entitlement programs, there’s also a major problem in the way these programs discourage work.

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Despite the fact that Social Security is an ever-increasing fiscal burden with a 75-year cash-flow deficit of nearly $45 trillion, many politicians in Washington have been trying to buy votes with proposals to expand the program (Barack Obama, Hillary Clinton, Bernie Sanders, Elizabeth Warren, etc).

A new working paper from the European Central Bank gives us some insights on what will happen if they succeed.

Authored by Daniel Baksa, Zsuzsa Munkacsi, and Carolin Nerlich, the study look at the long-run impact of related policies in Europe, using Germany and Slovakia as examples.

Here’s their description of the study.

In view of the adverse macroeconomic and fiscal implications of ageing, many European countries have implemented significant pension reforms… More recently, however, the reform progress has stalled, and despite an unchanged demographic outlook, several European countries reversed, or plan to do so, parts of their previously adopted pension reforms. In this paper we offer a framework that allows us to evaluate the macroeconomic and fiscal costs of pension reform reversals. …By using a general equilibrium model with overlapping generations we can account for feedback effects between changes in pension parameters, pension expenditures and macroeconomic variables. …The model is calibrated for Germany and Slovakia.

Before sharing their findings, here’s a look at how demographics are a ticking time bomb for Europe.

The yellow dots are the 2016 numbers for the old-age dependency ratio (the number of people over 65 compared to the 15-64 working-age population) and the red dots show how that ratio will deteriorate by 2070 (the numbers for the United States are similarly grim).

These bad numbers mean that Europe’s economic outlook will worsen over time.

…population ageing has adverse macroeconomic and fiscal implications. …the results show an increase in the public debt-to-GDP ratio by around 100 percentage points until 2070, compared to the initial period, for both Germany and Slovakia. Moreover, real GDP per capita is projected to decline by almost 14% in Germany and 9% in Slovakia, compared to the initial period.

But it’s possible for the numbers to get better or worse, depending on changes to public policy.

…similar to other studies we find evidence that pension reforms help to contain the adverse implications of ageing… In particular, increases in the retirement age appear to help to alleviate ageing pressures most. …we find strong evidence for the presumption that reversals of pension reforms are potentially very costly. In fact, reform reversals would not only result in higher aggregate pension expenditure and public debt-to-GDP ratios, but would in most cases also exacerbate the adverse macroeconomic impact of ageing.

Unfortunately, public policy is now trending in the wrong direction. Here’s what’s been happening in Germany and Slovakia.

Germany recently decided to cap the decline in the benefit ratio and the increase in the contribution rate until 2025 at certain levels, and is considering whether to extend this cap even until 2040. Slovakia decided to break the automatic link between changes in life expectancy and retirement age, by capping the retirement age at 64 years. …in the reversal scenario for Germany we freeze the benefit ratio at its current level of 48% and assume that the contribution rate would not exceed the threshold of 20% until 2040. With this reform reversal scenario we assume that the agreed freeze of the benefits ratio and contribution rate until 2025 will be ex-tended until 2040. In Slovakia, we assume the retirement age to stop increasing from the year 2045 onwards.

And what do they find when countries backtrack on reform?

Here’s what they estimated in Germany.

For Germany, we find that the reform reversal would imply sizeable costs (see Table 6, column “reform reversal”). Specifically, by 2070, the increase in the public debt-to-GDP ratio can be expected to be ceteris paribus almost 60 percentage points higher than under the baseline scenario, as a result of higher pension expenditures, adverse feedback effects and lower contribution rates.

For those interested, here’s Table 6, which I’ve augmented by highlighting in red the most relevant changes. Yes, the debt increases compared to the baseline, but I think it’s equally important (if not more important) to see how young people are hurt and how the burden of government spending goes up.

Now let’s see what the authors found for Slovakia.

…we quantify the fiscal costs of the reform reversal in Slovakia by comparing the debt impact under the reform reversal scenario with that under the baseline scenario. Our results show that such a reform reversal would be very costly. In fact, the increase in the public debt-to-GDP ratio would be more than 50 percentage points higher than the estimated increase of around 100 percentage points of GDP under the baseline scenario (see Table 7).

Here’s Table 7, and again I have highlighted in red the increase in debt as well as the data showing additional harm to young people and a much bigger increase in the burden of government spending.

So what do these findings mean for the United States?

Let’s explain using a homemade infographic. I’ve put four options for Social Security on a spectrum. Here’s what they mean.

  • “Expand Social Security” means more taxes and spending in pay-as-you-go systems that are already costly and out of balance.
  • The “Status Quo” is a typical pay-as-you-go-system (where the United States is now and where Germany and Slovakia were before their reforms).
  • Conventional Reform” means trying to stabilize a pay-as-you-go system by demanding that workers pay more while promising to give them less (what Germany and Slovakia did).
  • The most market-friendly position is “Personal Retirement Accounts,” which transforms creaky pay-as-you-go systems into real individual savings.

Here’s the infographic, including arrows to indicate that some options mean more government and others mean more prosperity.

What Germany and Slovakia did was move from “Status Quo” to “Conventional Reform.” But now they’re backtracking on those reforms and shifting back to the old version of the “Status Quo.”

In other words, a move in the direction of “More Government” and the European Central Bank’s study shows such a step will have negative consequences.

In the United States, by contrast, some folks on the left want America to move from “Status Quo” to “Expand Social Security.”

Like Germany and Slovakia, we’d be moving in the wrong direction. But the damage for the U.S. presumably would be worse because we didn’t first take a step in the right direction.

P.S. If you want to learn more about the best option, Australia, Denmark, Chile, Switzerland, Hong Kong, Netherlands, Faroe Islands, and Sweden are a few of the many jurisdictions that have fully or partially shifted to systems based on real savings.

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When I put forth the “The Case for Social Security Personal Accounts” in early 2011, I pointed out that the program’s long-run fiscal shortfall was more than $27 trillion.

We should be so lucky to have that problem today.

The Social Security Administration just released the annual report on the program’s finances, so I went to to Table VI.G9 of the “Supplemental Single-Year Tables” to peruse the yearly projections for future revenue and spending (which are adjusted for inflation so we have a more accurate method for comparisons).

The bad news is that an ever-increasing amount of our income is going to be grabbed by payroll taxes. The worse news is that Social Security’s spending burden will climb at an even-faster rate (historical data to the left of the red line, future projections to the right of the red line).

For those who focus on the less-important issue of red ink, the gap between revenue and spending over the next 75 years is projected to reach $44.7 trillion.

The gap in this year’s report is not directly comparable to the number I cited in 2011, but there’s no question the program’s finances are heading in the wrong direction.

This is partly because Social Security – as a “pay-as-you-go” program – is very vulnerable to demographic changes.

Like other types of Ponzi Schemes, it can work so long as there are always more and more new people entering the system.

But America’s demographic profile is changing. We’re living longer and having fewer kids.

In a column for the Foundation for Economic Education, Daniel Kowalski has a summary of how the program works and why it has a grim future.

Social Security recipients are not paid with the money that the government deducted directly from them and their past employers. Instead that money was used to pay the benefits for past retirees, while current retired recipients are getting their money through Americans who are currently working and contributing to the system. …the first recipients of the Social Security program took out far more than they put in with the difference being made up by the fact that active workers then greatly outnumbered beneficiaries. In 1940 this was not an issue as there were 159 workers supporting one beneficiary. …By 1960, 15 years after President Roosevelt’s death, that ratio was reduced to 5 workers for every beneficiary. In 1980, the ratio dropped to just above three and in 2010 it dropped below that. …there is one thing that Millennials and Generation Z can do to prepare themselves for that day. Start saving and planning for retirement now and make a plan that does not count on a government-issued Social Security check.

He’s right, and his column doesn’t even address the other problem for young people, which is the fact that they get a rotten deal from the program, paying in record amounts of money in exchange for hollow promises of a meager monthly benefit.

By the way, the numbers in the two charts above are based on the Social Security Administration’s “intermediate” assumptions.

I’ve never had any reason to question the reasonableness of those numbers. But in a world with coronavirus, which is causing crippling short-run economic damage and could cause significant long-run harm, it may be more prudent to look at SSA’s “high-cost” assumptions.

The bottom line is that the program’s long-run shortfall could be more than $20 trillion higher.

And remember, these numbers are in 2020 dollars. In other words, adjusted for inflation.

So how do we solve this mess? How do we avoid a grim fiscal future?

Shifting to a system of personal retirement accounts would be the most prudent approach. Yes, there would be an enormous transition cost since we would need to pay benefits to current retirees and many older workers, but that transition cost would be less than the $44.7 trillion unfunded liability (or even more!) of the current system.

I’ve written many times about the benefits of personal accounts for the United States, but I find most people are more interested in real-world evidence. Here are just a few of the several dozen nations that either fully or partially utilize private savings instead of political promises.

P.S. Some folks in Washington want to exacerbate Social Security’s fiscal burden by expanding the program.

P.P.S. I hate to add to the bad news, but the long-run finances for Medicare and Medicaid are an even-bigger problem.

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Back in 2008, the soon-to-be Chief of Staff for President Obama infamously stated that, “You never want a serious crisis to go to waste.”

Sure enough, the Obama Administration – elected in the aftermath of the financial crisis – quickly rammed through a so-called stimulus, followed by Obamacare and Dodd-Frank.

Now it’s happening again. Politicians are trying to exploit the coronavirus by pushing a proposal to expand government by enacting paid sick leave.

Veronique de Rugy and Don Boudreaux of George Mason University’s Mercatus Center explain the downsides of such a new mandate in National Review.

It’s one thing to support temporary provision of sick leave paid for by the government when we face a public-health crisis. …But it would be deeply misguided to use COVID-19 as an excuse for a permanent policy change. …If Congress rushes through a universal paid-leave plan, …many employers will reduce their privately supplied coverage in response. Such crowding-out is what has already happened in states where paid-family-leave programs were adopted, with many companies…now requiring employees to first tap all the available taxpayer-provided benefits, which in turn has produced larger-than-expected budgetary costs for state governments. …Obliging companies to permanently provide paid sick leave to workers who don’t currently have it would impose eventual reductions on their take-home pay. The provision of such benefits isn’t costless. We can be sure that in the long run — after the coronavirus fades from the headlines — mandated paid leave would inflict a pricey and permanent toll on workers who would prefer to receive more of their compensation as take-home pay and less as paid leave. …This negative effect would exist even if leave benefits were paid for through the government and financed with a payroll tax split between employers and employees, as they would be in the Family and Medical Insurance Leave (FAMILY) Act also proposed by DeLauro and Murray… Unfortunately, the requirement that part of the tax be paid by employers is a legalistic formality: Economics dictates that the cost of this part of the tax, too, will over time fall on workers in the form of lower wages. …coronavirus is a serious problem… We must not further enfeeble American workers by using it as an excuse to enact permanent government mandates and entitlements that risk unleashing unintended negative consequences.

Here are some excerpts from a Wall Street Journal column on the same topic from Aaron Yelowitz and Michael Saltsman.

Democrats in Congress have a cure for the coronavirus crisis: a nationwide paid sick-leave mandate. …Ms. Murray and Ms. DeLauro began advocating such a policy in 2004 and have clearly internalized Rahm Emanuel’s immortal political advice that “you never want a serious crisis to go to waste.” …San Francisco was the first locality to require paid sick leave, starting in 2007. The law brought modest benefits and significant costs. A 2011 study by the Institute for Women’s Policy Research found nearly 30% of the lowest-wage earners reported layoffs or reduced hours… Connecticut’s sick-leave policy was the focus of a 2016 study…, which found a “sizeable decrease in labor demand” as a consequence of the mandate. …The coronavirus’s domestic arrival in these two states complicates Ms. Murray’s promise that a paid-leave mandate could “prevent” its spread. …Why didn’t paid-leave regimes in California and Washington prevent the spread of the disease, as Ms. Murray imagines? According to Johns Hopkins researchers, it takes five days on average for coronavirus symptoms to present. …The relative benefits and consequences of paid sick leave must be considered carefully. Using a pandemic to justify its swift enactment would result in ineffective policy that may hurt the workers it’s meant to help.

The bottom line, as I’ve explained before, is that employers don’t create jobs out of a sense of charity.

They hire workers because of an expectation that the revenue generated by those people will exceed the cost of employing them.

So when politicians enact laws to create new goodies, there will be “unintended consequences” that are bad for workers.

They’ll get less take-home pay, either because of higher taxes or higher costs (a point inadvertently acknowledged by a columnist for the New York Times).

Sadly, I don’t expect economic arguments to have much impact on vote-seeking politicians. Especially when they can exploit a crisis.

Which is a sad pattern in American history, as documented by Robert Higgs in his classic book, Crisis and Leviathan.

It’s what they did during the Great Depression. It’s what they did after 9-11. It’s what they did after the financial crisis. It’s what they’re doing today.

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The race for the Democratic nomination is very depressing. All the candidates – even supposed moderates such as Biden and Buttigieg – are openly advocating a much bigger burden of government.

I’m hoping some of their proposals are simply election-year pandering, that they really don’t believe in statism, and that they would be reasonable if they got to the White House.

We got a good bit of economic liberalization under Bill Clinton, for instance, even though he didn’t campaign as any sort of libertarian.

Some people speculate that Michael Bloomberg, the former New York City mayor, might be this year’s closet moderate. A few people have even sent me this CNN article as proof of his underlying rationality.

…when he was mayor of New York City, Bloomberg twice compared Social Security to a “Ponzi scheme” and repeatedly said cuts to that program as well as Medicare and Medicaid had to be part of any serious solution to reducing the federal deficit. …if there’s ever a Ponzi scheme, people say Madoff was the biggest? Wrong. Social Security is, far and away,” Bloomberg said in a January 2009 appearance… “We are giving monies out with the next guy’s money coming in and at the end of — when the music stops — it’s just not gonna be enough chairs for everybody,” Bloomberg said. …Bloomberg’s past comments are at odds with the mainstream positions within the Democratic Party. …During other radio appearances, Bloomberg called for passing Simpson-Bowles, the deficit cutting plan named after former Wyoming Republican Sen. Alan Simpson and former Clinton White House chief of staff Erskine Bowles.

I have mixed feelings after reading that article.

The good news is that Bloomberg at one point was semi-rational about entitlements.

  • He understood Social Security is a Ponzi scheme, meaning that the system is only made possible by having new people enter the scheme to finance promises made to people who joined earlier.
  • He recognized that some sort of corrective action was needed on entitlements because of enormous unfunded promises, driven by demographic change and poorly designed programs.

The bad news is that Bloomberg never supported the right policies that would address both Social Security’s gigantic fiscal shortfall and the fact that the program is a really bad deal for younger workers. Instead, he supported plans such as Simpson-Bowles that would merely make people pay more to get less.

The worst news is that Bloomberg has abandoned his semi-rational view and is now urging higher taxes and program expansions. He’s presumably not as bad as some of the other candidates, but that’s damning with faint praise.

Here’s a simple way of thinking about Social Security. First, are people actually connected to reality? Do they understand math and demographics? If yes, they’re on the rational (left) side of this 2×2 matrix.

But even if people are rational and recognize there’s a problem, do they support the right type of reform (top half), which is personal retirement accounts?

As you can see, Bloomberg used to be in the bottom-left quadrant, which is bad but rational. Now he’s in the bottom-right quadrant, which is bad and irrational.

A politician who is good and rational will be in top-left quadrant.

P.S. Social Security technically isn’t a Ponzi scheme. That’s because people have the freedom to reject a con artist peddling a pyramid scam. With Social Security, by contrast, participants are legally required to be part of the scheme.

P.P.S. The logical assumption is that the top-right quadrant is empty other than a question mark. After all, any politicians who supports good policy presumably would also recognize there’s a problem. That being said, Trump could be the exception. He doesn’t think we have an entitlement problem, so he obviously belongs on the right side of the matrix. But if he decided to support individual accounts (Trump is very inconsistent on policy, but that does mean he is good on some issues), he could replace the question mark.

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When the Congressional Budget Office released its Budget and Economic Outlook yesterday, almost everyone in Washington foolishly fixated on the estimate of $1 trillion-plus annual deficits.

What’s far more important – and much more worrisome – is that the burden of government spending is projected to relentlessly increase, violating the Golden Rule of fiscal policy.

More specifically, the federal budget currently is consuming 21 percent of gross domestic product, but will consume 23.4 percent of economic output in 2030 if fiscal policy is left on autopilot.

Here is a chart, based on CBO’s new data, that shows why we should be very concerned.

By the way, last year’s long-run forecast from CBO shows the problem will get even worse in the following decades, especially if there isn’t genuine entitlement reform.

We’re in trouble today because government has been growing too fast, and we’ll be in bigger trouble in the future for the same reason.

But the situation is not hopeless. The problem can be fixed with some long-overdue and much-needed spending restraint.

We don’t even need to cut spending, though that would be very desirable.

As this next chart illustrates, our budgetary problems can be solved if there’s some sort of spending cap.

The grey line shows the current projection for federal spending and the orange line shows how much tax revenue Washington expects to collect (assuming the Trump tax cut is made permanent). There’s a big gap between those two lines (the $1 trillion-plus deficits everyone else is worried about).

My contribution to the discussion is to show we can have a budget surplus by 2028 if spending only grows by 1 percent annually and we can balance the budget by 2030 if spending grows by 1.7 percent per year.

Needless to say, I’m not fixated on balancing the budget and eliminating red ink.

The real goal is to change budgetary trend lines with a spending cap so that the fiscal burden of government begins to shrink as a share of the nation’s economy.

The bottom line is that modest spending restraint (government growing at 1.7 percent annually, nearly as fast as projected inflation) would slowly but surely achieve that goal by gradually reversing the big-government policies of Bush, Obama, and Trump.

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Every year, the Social Security Administration issues a “Trustees Report” that summarizes the program’s financing. So every year (see 2018, 2017, 2016, 2015, etc) I cut through all the verbiage and focus the numbers that really matter.

First, here’s the data from Table VI.G9 showing annual spending and annual revenue, and the numbers are adjusted for inflation. Everything to the left of the vertical red line is historical data. Everything to the right is an estimate based on “intermediate” economic and demographic projections.

The bad news is that there’s a never-ending increase in the program’s fiscal burden.

The only good news is that country presumably will be much richer in the future, so we’ll have more income to pay all those taxes and finance all that spending.

That being said, the fiscal burden is projected to increase faster than our income, so the economic burden of Social Security will increase over time.

But there’s also a wild card to consider. Simply stated, we have more data from Table VI.G9 that shows the program has a giant, ever-expanding deficit.

Here are the grim numbers (though not quite as grim as last year when the cumulative shortfall was $43.7 trillion). Once again, everything to the left of the line is historical data and everything to the right is a projection.

The obvious takeaway is that the program is bankrupt.

Indeed, a private pension fund with these numbers would have been shut down a long time ago. And its executives would be in prison for running a Ponzi Scheme.

Politicians won’t put themselves in prison, of course, but they eventually will be forced to address Social Security’s huge shortfall. If nothing else, the so-called Trust Fund (which isn’t a real Trust Fund since it is filled with IOUs) runs out of money in 2035.

The interesting question is what sort of “solution” they choose when the crisis occurs.

Sadly, many politicians are gravitating to a plan to impose ever-higher taxes to prop up the system.

A far better approach is personal retirement accounts. I’ve written favorably about the Australian system, the Chilean system, the Hong Kong system, the Swiss system, the Dutch system, the Swedish system. Heck, I even like the system in the Faroe Islands.

The bottom line is that there’s been a worldwide revolution in favor of private savings and the United States is falling behind.

P.S. If you have some statist friends and family who get confused by numbers, here’s a set of cartoons that shows the need for Social Security reform.

P.P.S. As I explain in this video, reform does not mean reducing benefits for current retirees, or even older workers.

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When I write about Social Security, I normally focus on the program’s huge fiscal imbalance ($44 trillion and climbing).

But it’s not just a fiscal crisis. Social Security is also an increasingly bad deal for workers. Especially minorities with lower average lifespans. When compared to what they would get from a private retirement system, people are paying in too much and getting out too little.

There’s also another major problem with the program.

Academic experts have quantified how older workers are lured out of the labor force when they get money from the government. And since economic output is a function of the quality and quantity of labor and capital, this means we’re sacrificing wealth and reducing prosperity.

Here are some excerpts from a study by Professors Daniel Fetter and Lee Lockwood.

Many of the most important government programs, including Social Security and Medicare, transfer resources to older people… Standard economic theory predicts that such programs reduce late-life labor supply and that the implicit taxation reduces the ex-post value of the programs to recipients. Understanding the size and nature of such effects on labor supply and welfare is an increasingly important issue, as demographic trends have increased both the potential labor supply of the elderly and its aggregate importance, while simultaneously increasing the need for reforms to government old-age support programs. …We address these questions by investigating Old Age Assistance (OAA), a means-tested program introduced in the 1930s alongside Social Security that later became the Supplemental Security Income (SSI) program.

Here are charts illustrating how people are retiring earlier in part because of government payments.

And here are some calculations from the study.

Our estimates indicate that OAA significantly reduced labor force participation among older individuals. The basic patterns that we explore in the data are evident in Figure 2, which plots male labor force participation by age, separately for states with above- and belowmedian OAA payments per person 65 and older. Up to age 65, the age pattern of labor force participation was extremely similar in states with larger and smaller OAA programs. At age 65, however, there was a sharp divergence in labor force participation between states with larger OAA programs relative to those with smaller programs, and this divergence continued at older ages. Our regression results, which isolate variation in OAA program size due to state policy differences, imply that OAA can explain more than half of the large 1930–40 drop in labor force participation of men aged 65–74. …Our results suggest that Social Security had the potential to drive at least half—and likely more—of the mid-century decline in late-life labor supply for men. …Taken as a whole, our results suggest that government old-age support programs can have large effects on labor supply, through both their transfer and taxation components.

This chart captures how old-age payments in various states were associated with varying degrees of labor force participation.

By the way, I’m not sharing this information because it’s bad for people to retire at some point.

I’m merely establishing that there’s academic support for the common-sense observation that people are more likely to leave the labor force when there’s an alternative source of income (though it’s worth noting that there should be a sensible and sustainable system for providing that retirement income).

Moreover, people are likely to stop working when government systems give them money before age 65.

Three academics, Andres Erosa, Luisa Fuster, and Gueorgui Kambourov, have a study quantifying this problem in European nations.

There are substantial differences in labor supply and in the design of tax and transfer programs across countries. The cross-country differences in labor supply increase dramatically late in the life cycle…while differences in employment rates among eight European countries are in the order of 15 percentage points for the 50-54 age group, they increase to 35 percentage points for the 55-59 age group and to more than 50 percentage points for the 60-64 age group. In this paper we quantitatively assess the role of social security, disability insurance, and taxation for understanding differences in labor supply late in the life cycle (age 50+) across European countries and the United States. … The social security, disability insurance, and taxation systems in the United States and European countries in the study are modelled in great detail.

Here’s a sampling of their results.

The main findings are that the model accounts fairly well for how labor supply decreases late in the life cycle for most countries. The model matches remarkably well the large decline in the aggregate labor supply after age 50 in Spain, Italy, and the Netherlands. The results support the view that government policies can go a long way towards accounting for the low labor supply late in the life cycle for these European countries relative to the United States, with social security rules accounting for the bulk of these effects… relative to the United States, the hours worked by men aged 60-64 is…49% in the Netherlands, 66% in Spain, 44% in Italy, and 29% in France. …government policies can go a long way towards accounting for labor supply differences across countries. Social security rules account for the bulk of cross country differences in labor supply late in the life cycle (with its contribution varying from 50% to 100%), but other policies also matter. In accounting for the low labor supply relative to the US at ages 60 to 64, taxes matter importantly in the Netherlands (6%), Italy (6%), and France (5%); disability insurance policies are important for the Netherlands (7%) and Spain (10%).

And here’s one of their charts comparing hours worked at various ages in Switzerland, Spain, France, and the United States.

The good news is that we don’t push people out of the labor force as much as the French and the Spanish.

The bad news is that we’re not as good as Switzerland (probably in part because the Swiss have a retirement system based on private saving, so they have the ideal combination of good work incentives and comfortable retirement).

But it shouldn’t matter whether other countries have good systems or bad systems. What does matter is that America’s demographic profile is changing. We’re living longer and having fewer children and our system of entitlements is a mess.

We should be reforming these programs, both for fiscal reasons and economic reasons.

P.S. It’s not just Social Security. Other programs also lure people out of the job market and into government dependency, with Obamacare being an especially harmful example.

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The world is in the middle of a dramatic demographic transition caused by increasing lifespans and falling birthrates.

One consequence of this change is that traditional tax-and-transfer, pay-as-you-go retirement schemes (such as Social Security in the United States) are basically bankrupt.

The problem is so acute that even the normally statist bureaucrats at the Organization for Economic Cooperation and Development are expressing considerable sympathy for reforms that would allow much greater reliance on private savings (shifting to what is known as “funded” systems).

Countries should introduce funded arrangements gradually… Policymakers should carefully assess the transition as it may put an additional, short-term, strain on public finances… Tax rules should be straightforward, stable and consistent across all retirement savings plans. …Countries with an “EET” tax regime should maintain the deferred taxation structure… Funded, private pensions may be expected to support broader economic growth and accelerate the development of local capital markets by creating a pool of pension savings that must be invested. The role of funded, private pensions in economic development is likely to become more important still as countries place a higher priority on the objective of labour force participation. Funded pensions increase the incentive to work and save and by encouraging older workers to stay in the labour market they can help to address concerns about the sustainability and adequacy of public PAYG pensions in the face of demographic changes.

Here’s a chart from the OECD report. It shows that many developed nations already have fully or partly privatized systems.

By the way, I corrected a glaring mistake. The OECD chart shows Australia as blue. I changed it to white since they have a fully private Social Security system Down Under.

The report highlights some of the secondary economic benefits of private systems.

Funded pensions offer a number of advantages compared to PAYG pensions. They provide stronger incentives to participate in the labor market and to save for retirement. They create a pool of savings that can be put to productive use in the broader economy. Increasing national savings or reallocating savings to longer-term investment supports the development of financial markets. …More domestic savings reduces dependency on foreign savings to finance necessary investment. Higher investment may lead to higher productive capacity, increasing GDP, wages and employment, higher tax revenues and lower deficits.

Here’s the chart showing that countries with private retirement systems are among the world leaders in pension assets.

The report highlights some of the specific nations and how they benefited.

Over the long term, transition costs may be at least partially offset by additional positive economic effects associated with introducing private pensions rather than relying solely on public provision. …poverty rates have declined in Australia, the Netherlands and Switzerland since mandatory funded pensions were introduced. The initial transformation of Poland’s public PAYG system into a multi-pillar DC approach helped to encourage Warsaw’s development as a financial centre. …the introduction of funded DC pensions in Chile encouraged the growth of financial markets and provided a source of domestic financing.

For those seeking additional information on national reforms, I’ve written about the following jurisdictions.

At some point, I also need to write about the Singaporean system, which is one of the reasons that nation is so successful.

P.S. Needless to say, it would be nice if the United States was added to this list at some point. Though I won’t be holding my breath for any progress while Trump is in the White House.

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During the 2016 presidential campaign, I was very critical of Donald Trump’s proposal to expand the entitlement state with a new program for paid parental leave, just as I was very critical of a similar proposal from Hillary Clinton.

Neither candidate offered much detail, but it was reckless and irresponsible for both of them to propose any sort of new tax-and-transfer scheme when the country already faces a long-run crisis because of entitlement programs.

And that looming entitlement crisis explains why I also criticized a paid-leave proposal developed by AEI and the Urban Institute.

But not all parental leave proposals involve a net increase in the fiscal burden of government. Senator Marco Rubio and Congresswoman Ann Wagner have put forth a plan that would allow new parents to finance time off with newborns with money from Social Security, so long as they are willing to accept lower retirement benefits in the future.

The Wall Street Journal is skeptical of this kind of initiative.

Republicans should consider the consequences before signing up for a major expansion of the entitlement state. …Mr. Rubio…claims his benefit doesn’t expand government or create a new entitlement. But what is expanding government if not taking a benefit financed by private industry and administering it through a government program? Paid leave by definition entitles Americans to a de novo benefit… Mr. Rubio says leave will pay for itself by delaying retirement benefits… Does anyone believe those retirement benefits won’t be restored eventually, at least for the non-affluent? …The biggest illusion is that this proposal is a shrewd political move that will steal an issue from Democrats. In the real world they will see Mr. Rubio and raise. The National Partnership for Women & Families called the Rubio plan “reckless, irresponsible and ill-conceived” for making parents choose between kids and retirement. They want both. Once Social Security is open for family leave, Democrats will want to use it for college tuition, and why not a home downpayment?

Ramesh Ponnuru counters the WSJ, arguing in his Bloomberg column that the Rubio/Wagner plan merely creates budget-neutral flexibility.

Senator Marco Rubio of Florida and Representative Ann Wagner of Missouri…have introduced legislation to let parents finance leave by either delaying taking Social Security benefits when they retire or getting slightly reduced benefits. …The proposal doesn’t raise federal spending over the long run, but only moves benefits forward in time from a person’s retirement to her working years. …the proposal is better seen as a way of adding flexibility into an existing entitlement than of creating one. …Because Democrats will demand more generous leave policies, the Journal warns that the Rubio-Wagner proposal will backfire politically. But the bill is an attempt to satisfy a demand among voters for help with family leave. It’s not creating that demand. Republicans can choose whether to counter Democratic policies with nothing, or with an idea that gives families a new option at no net long-term cost to taxpayers. The political choice should be easy.

Ramesh makes several good points. There is a big difference between what Rubio and Wagner are proposing and the plans that involve new taxes and additional spending.

And he even cites the example of a provision in the Social Security system, involving early benefits for disabled widows, that hasn’t resulted in a net increase in the burden of government.

So what’s not to like about the plan?

Plenty. At least according to John Cogan of the Hoover Institution, who has a column warning that it is very unrealistic to hope that politicians won’t expand an entitlement program.

Mr. Rubio’s well-intentioned plan begins by promising a small, carefully targeted benefit and assuring us that it won’t add to the long-run public debt. But history demonstrates that is how costly entitlement programs begin. …New programs initially target benefits to a group of individuals deemed particularly worthy at the time. Eventually the excluded come forth to assert that they are no less worthy of aid and pressure lawmakers to relax eligibility rules. …The broadening of eligibility rules brings yet another group of claimants closer to the boundaries of eligibility, and the pressure to relax qualifying rules begins all over again. The process…repeats itself until the entitlement program reaches a point where its original noble goals are no longer recognizable. …Medicaid and food-stamp programs followed a similar path. These programs were originally limited to providing health and nutrition assistance, respectively, mainly to supplement welfare cash assistance. Both programs now extend aid to large segments of the population who are not on cash welfare and in some cases above the poverty line. Medicaid assists 25% of the nonelderly population. Food stamps pay a major part of the grocery bills for 14% of the nonelderly population. …For more than 200 years, no entitlement program has been immune from the expansionary pressures…and there is no earthly reason to think Mr. Rubio’s plan will prove the exception.

Here’s my two cents on the topic (the same points I made when addressing this issue earlier in the year).

  1. From a big-picture philosophical perspective, I don’t think the federal government should have any role in family life. Child care certainly is not one of the enumerated powers in Article 1, Section 8, of the Constitution. Proponents of intervention routinely argue that the United States is the only advanced nation without such a program, but I view that as a feature, not a bug. We’re also the only advanced nation without a value-added tax. Does that mean we should join other countries and commit fiscal suicide with that onerous levy?
  2. Another objection is that there is a very significant risk that a small program eventually become will become much larger. …once the principle is established that Uncle Sam is playing a role, what will stop future politicians from expanding the short-run goodies and eliminating the long-run savings? It’s worth remembering that the original income tax in 1913 had a top rate of 7 percent and it only applied to 1/2 of 1 percent of the population. How long did that last?
  3. Finally, I still haven’t given up on the fantasy of replacing the bankrupt tax-and-transfer Social Security system with a system of personal retirement accounts. Funded systems based on real savings work very well in jurisdictions such as AustraliaChileSwitzerlandHong Kong, and the Netherlands, but achieving this reform in the United States will be a huge challenge. And I fear that battle will become even harder if we turn Social Security into a piggy bank for other social goals. For what it’s worth, this is also why I oppose plans to integrate the payroll tax with the income tax.

My goal today is not to savage Sen. Rubio and Rep. Wagner for their proposal. For all intents and purposes, they are proposing to do the wrong thing in the best possible way.

If it’s a choice between their plan and some as-yet-undeveloped Trump-Pelosi tax and transfer scheme, the nation obviously will be better off with the Rubio-Wagner approach.

But hopefully we won’t be forced to choose between unpalatable and awful.

P.S. This debate reminds me of the tax reform debate in 2016. Only instead of doing the wrong thing in the best possible way, Senators Rand Paul and Ted Cruz had tax plans that did the right thing in the most risky way.

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The United States has a bankrupt Social Security system.

According to the most recent Trustees Report, the cash-flow deficit is approaching $44 trillion. And that’s after adjusting for inflation.

Even by DC standards of profligacy, that’s a big number.

Yet all that spending (and future red ink) doesn’t even provide a lavish retirement. Workers would enjoy a much more comfortable future if they had the freedom to shift payroll taxes to personal retirement accounts.

This is why I periodically point out that other nations are surpassing America by creating retirement systems based on private savings. Here are some examples of countries with “funded” systems (as compared to the “pay-as-you-go” regime in the United States).

Now it’s time to add Denmark to this list.

Here’s how the OECD describes the Danish system.

There is…a mandatory occupation pension scheme based on lump-sum contributions (ATP). In addition, compulsory occupational pension schemes negotiated as part of collective agreements or similar cover about 90% of the employed work force. …Pension rights with ATP and with occupational pension schemes are accrued on a what-you-pay-iswhat-you-get basis. The longer the working career, the higher the employment rate, the longer contribution record and the higher the contribution level, the greater the pension benefits. …ATP covers all wage earners and almost all recipients of social security benefits. ATP membership is voluntary for the self-employed. ATP covers almost the entire population and comes close to absolute universality. …The occupational pension schemes are fully funded defined-contribution schemes… Some 90% of the employed work force is covered… The coverage ratio has increased from some 35% in the mid-1980s to the current level… Contribution rates range between 12% and 18%.

A Danish academic described the system in a recent report.

As labour market pensions mature, they will challenge the people’s pension as the backbone The fully funded pensions provide the state with large income tax revenues from future pension payments which will also relieve the state quite a bit from future increases in pension expenditures. Alongside positive demographic prospects this makes the Danish system economically sustainable. … a main driver was the state’s interest in higher savings… Initially, savings was also the government motive for announcing in 1984 that it would welcome an extension of occupational pensions to the entire labour market. … Initially, contributions were low, but the social partners set a target of 9 per cent, later 12 per cent, which was reached by 2009. …it is formally a private system. Pensions are fully funded, and savings are secured in pensions funds. …It is also worth noting that the capital accumulated is huge. Adding together pensions in private insurance companies, banks, and labour market pension funds (some of which are organized as private pension insurance companies), the total amount by the end of 2015 was 4.083 bill.DKK, that is, 201 per cent of GDP.

Denmark’s government also is cutting back on the taxpayer-financed system.

… the state has also sought to reduce costs of ageing by raising the pension age. In the 2006 “Welfare Reform”, it was decided to index retirement age with life expectancy… Moreover, the voluntary early retirement scheme was reduced from 5 to 3 years and made so economically unattractive that it is de facto phased out. Pension age is gradually raised from 65 to 67 years in 2019-22, to 68 years in 2030, to 69 in 2035 and to 70 in 2040… These reforms are extremely radical: The earliest possible time of retirement increases from 60 years for those born in 1953 to 70 years for those born in 1970. But the challenge of ageing is basically solved.

Those “socialist” Danes obviously are more to the right than many American politicians.

The Social Security Administration has noticed that Denmark is responding to demographic change.

The Danish government recently implemented two policy changes that will delay the transition from work to retirement for many of its residents. On December 29, 2015, the statutory retirement age increased from age 67 to 68 for younger Danish residents. Three days later, on January 1, 2016, a reform went into effect that prohibits the long-standing practice of including mandatory retirement ages in employment contracts.

And here’s some additional analysis from the OECD.

…pension reforms are expected to compensate the impact of ageing on the labour force… To maintain its sustainability…, major reforms have been legislated, including the indexation of retirement age to life expectancy gains from 2030 onwards. …a person entering the labour market at 20 in 2014 will reach the legal retirement age at 73.5. This would make the Danish pension age the highest among OECD countries. …As private pension schemes introduced in the 1990s mature, public spending on pension is projected to decline from around 10% of GDP in 2013 to 7% towards 2060.

Wow. Government spending on pensions will decline even though the population is getting older. Too bad that’s not what’s happening in America.

Last but not least, here are some excerpts from some Danish research.

Denmark has also developed a funded, private pension system, which is based on mandatory, occupational pension (OP) schemes… The projected development of the occupational schemes will have a substantial effect on the Danish economy’s ability to cope with the demographic changes. …the risks of generational conflicts seem smaller in Denmark than in many other countries. …Overall, the Danish OP schemes are thus widely regarded as highly successful: they have contributed substantially to restoring fiscal sustainability, helped averting chronic imbalances on the current account and reduced poverty among the elderly.

This table is remarkable, showing the very high levels of pension assets in Denmark.

To be sure, the Danish system is not a libertarian fantasy. Government still provides a substantial chunk of retirement income, and that will still be true when the private portion of the system is fully mature. And even if the private system provided 99 percent of retirement income, it’s based on compulsion, so “libertarian” is probably not the right description.

But it is safe to say that Denmark’s system is far more market-oriented (and sustainable) than America’s tax-and-transfer Social Security system.

So the next time I hear Bernie Sanders say that the United States should be more like Denmark. I’ll be (selectively) cheering.

P.S. The good news isn’t limited to pension reform. Having reached (and probably surpassed) the revenue-maximizing point on the Laffer Curve, Denmark is taking some modest steps to restrain the burden of government spending. Combined with very laissez-faire policies on other policies such as trade and regulation, this helps to explain why Denmark is actually one of the 20-most capitalist nations in the world.

August 8 addendum: Here’s a chart from a report by the European Commission showing that private pension income is growing while government-provided retirement benefits are falling (both measured as a share of GDP).

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I wrote yesterday about the continuing success of Switzerland’s spending cap.

Before voters changed the Swiss constitution, overall expenditures were growing by an average of 4.6 percent annually. Ever since the “debt brake” took effect, though, government spending has increased by an average of just 2.1 percent.

For all intents and purposes, Switzerland is getting good results because it is now complying with fiscal policy’s Golden Rule.

Unfortunately, the same cannot be said for the United States. The Congressional Budget Office just released its new long-run forecast of the federal budget.

The most worrisome factoid in the report is that the overall burden of federal spending is going to expand significantly over the next three decades, jumping from 20.6 percent of the economy this year to 29.3 percent of economic output in 2048.

And why will the federal budget consume an ever-larger share of economic output? The chart tells you everything you need to know. Our fiscal situation is deteriorating because government is growing faster than the private sector.

Actually, the chart doesn’t tell you everything you need to know. It doesn’t tell us, for instances, that tax increases simply make a bad situation worse since politicians then have an excuse to avoid much-need reforms.

And the chart also doesn’t reveal that entitlement programs are the main cause of ever-expanding government.

But the chart does a great job of showing that our fundamental problem is growth of government. Which presumably makes it obvious that the only logical solution is a spending cap.

The good news is that there already is a spending cap in Washington.

But the bad news is that it only applies to “appropriations,” which are a small share of the overall federal budget.

And the worse news is that politicians voted to bust that spending cap in 2013, 2015, and earlier this year.

The bottom line is that we know spending restraint works, but the challenge is figuring out a system that actually ties the hands of politicians. Switzerland and Hong Kong solved that problem by making their spending caps part of their national constitutions.

Sadly, there’s little immediate hope of that kind of reform in the United States.

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Writing a column every day can sometimes be a challenge, in part because of logistics (I have to travel a lot, which can make things complicated), but also because I want to make sure I’m sharing interesting and relevant information.

My task, however, is very easy on certain days. When Economic Freedom of the World is published in the autumn, I know that will be my topic (as it was in 2017, 2016, 2015, etc). My only challenge is to figure out how to keep the column to a manageable size since there’s always so much fascinating data.

Likewise, I know that I have a very easy column about this time of year (2017, 2016, 2015, etc) since that’s when the Social Security Administration releases the annual Trustees Report.

It’s an easy column to write, but it’s also depressing since my main goal is to explain that the program already consumes an enormous pile of money and that it will become an every bigger burden in the future.

Here are the 1970-2095 budgetary outlays from the latest report, adjusted for inflation. As you can see, the forecast shows a huge increase in spending.

The good news, as least relatively speaking, is that we’ll also have inflation-adjusted growth between now and 2095, so the numbers aren’t quite as horrifying as they appear. That being said, Social Security inexorably will consume a larger share of the private economy over time.

Now let’s examine a second issue. Most news reports incorrectly focus on the year the Social Security Trust Fund runs out of money.

But since that “Trust Fund” is filled with nothing but IOUs, I think that’s an utterly pointless piece of data. So every year I show the cumulative $43.7 trillion cash-flow deficit in the system. Using inflation-adjusted dollars, of course.

Assuming we don’t reform the program, think of these numbers as a reflection of a built-in future tax hike.

You won’t be surprised to learn, by the way, that politicians such as Barack Obama and Hillary Clinton already have identified their preferred tax hikes to fill this gap.

Let’s wrap up.

Veronique de Rugy of Mercatus accurately summarizes both the problem and the solution.

The single largest government program in the United States will soon have an annual budget of $1 trillion a year. …The program is Social Security, and our national pastime seems to be turning a blind eye to its dysfunctions. …Since 2010, it has been running a cash-flow deficit—meaning that the Social Security payroll taxes the government collects aren’t enough to cover the benefits it’s obliged to pay out. …

Veronique punctures the myth that there’s a “Trust Fund” that can be used to magically pay benefits.

Prior to 2010, the program collected more in payroll taxes than was needed to pay the benefits due at the time. The leftovers were “invested” into Treasury bonds through the so-called Old Age Trust Fund, which is now being drawn down. …In fact, the Treasury bonds are nothing but IOUs. …Treasury…doesn’t have the money: It has already spent it on wars, roads, education, domestic spying, and much more. So when Social Security shows up with its IOUs, Treasury has to borrow to pay the bonds back. …Did you catch that? Past generations of workers paid extra payroll taxes to bulk up the Social Security system. But the government spent that additional revenue on non-retirement activities, so now your children and grandchildren will also have to pay more in taxes to reimburse the program.

So what’s the solution?

Veronique explains we need to reform the system by allowing personal retirement accounts. She was even kind enough to quote me cheerleading for the Australian system.

Congress should shift away from Social Security into a “funded” system based on real savings, much as Australia and others have done. The libertarian economist Daniel J. Mitchell notes that, starting in the ’80s and ’90s, that country has required workers to put 9.5 percent of their income into a personal retirement account. As a safety net—but not as a default—Australians with limited savings are guaranteed a basic pension. That program has generated big increases in wealth. Meanwhile, Social Security has generated big deficits and discouraged private saving. Who would you have emulate the other?

Though I’m ecumenical. I also have written favorably about the Chilean system, the Hong Kong system, the Swiss system, the Dutch system, the Swedish system. Heck, I even like the system in the Faroe Islands.

The bottom line is that there’s been a worldwide revolution in favor of private savings and the United States is falling behind.

P.S. If you have some statist friends and family who get confused by numbers, here’s a set of cartoons that shows the need for Social Security reform.

P.P.S. As I explain in this video, reform does not mean reducing benefits for current retirees, or even older workers.

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According to research from the Bank for International Settlements, the long-term fiscal outlook for the United Kingdom is very grim. The data generated by the International Monetary Fund and the Organization for Economic Cooperation and Development isn’t quite as dour, but those bureaucracies also show very significant long-run fiscal challenges.

The problem in the U.K. is the same as the problem in the United States. And France. And Germany. And Japan. Simply stated, the welfare state is becoming an ever-larger burden in large part because the elderly population is expanding in developed nations compared to the number of potential taxpayers.

The good news, as noted in this BBC story, is that some folks in the United Kingdom realize this is bad news for young people.

Lord Willetts…said the contract between young and old had “broken down”. Without action, young people would become “increasingly angry”.

The bad news is that these folks apparently think you solve the problem of young-to-old redistribution by adding a layer of old-to-young redistribution.

I’m not joking.

A £10,000 payment should be given to the young and pensioners taxed more, a new report into inter-generational fairness in the UK suggests. The research and policy organisation, the Resolution Foundation, says these radical moves are needed to better fund the NHS and maintain social cohesion. …The foundation’s Intergenerational Commission report calls for an NHS “levy” of £2.3bn paid for by increased national insurance contributions by those over the age of 65. It says that all young people should receive a £10,000 windfall at the age of 25 to help pay for a deposit on a home, start a business or improve their education or skills.

To be fair, proponents of this idea are correct about young people getting a bad deal from the current system. And they are right about older people getting more from government than they pay to government.

“There’s no avoiding the pressures for more spending on healthcare and social care, the question is how we meet those pressures,” he replied. “Extra borrowing is unfair on the younger generation. “Extra taxes on the working population – when especially younger workers have not really seen any increase in their pay – will be very unfair. “It so happens that the older people who will benefit most from extra spending on health care have got some resources, so at low rates, it’s reasonable to expect them to contribute.

But I fundamentally disagree with their conclusion that bigger government is the answer.

“It is better than any of the alternatives.”

For what it’s worth, what’s happening in the U.K. is an example of Mitchell’s Law. Young people are getting a bad deal because of programs created by government.

But rather than proposing to unwind the programs that caused the problem, the folks at the Resolution Foundation have decided that creating additional programs financed by additional taxes is the way to go.

By the way, you won’t be surprised to learn that the group also has other bad ideas.

The report calls for the scrapping of the council tax system, replacing it with a new property tax which would raise more money from wealthier homeowners. The proceeds would be used to halve stamp duty for first-time buyers.

Let’s close by looking at some interesting data about the attitudes of the young.

…a poll undertaken for the Intergenerational Commission also suggested people were more pessimistic in Britain about the chances of the next generation having “better lives” than the one before it – compared with almost any other country.

Here’s the chart showing data for the U.K. and several other nations.

Congratulations to France for having the most pessimistic young people (maybe this is why so many of them would move to the U.S. if they had the chance).

And I think the South Koreans are too glum and the Chinese are too optimistic. The Italians also are too upbeat. But otherwise these numbers generally make sense.

P.S. I was very pessimistic about the U.K. in 2012, but had a more upbeat assessment last summer. Now the pendulum has now swung back in the other direction.

P.P.S. If the Brits screw up Brexit, I’ll be even more downbeat about the nation’s outlook.

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Five former Democratic appointees to the Council of Economic Advisers have a column in today’s Washington Post asserting that we should not blame entitlements for America’s future fiscal problems.

The good news is that they at least recognize that there’s a future problem.

The bad news is that their analysis is sloppy, inaccurate, and deceptive.

They start with an observation about red ink that is generally true, though I think the link between government borrowing and interest rates is rather weak (at least until a government – like Greece – gets to the point where investors no longer trust its ability to repay).

The federal budget deficit is on track to exceed $1 trillion next year and get worse over time. Eventually, ever-rising debt and deficits will cause interest rates to rise. …the growing debt will take an increasing toll.

But the authors don’t want us to blame entitlements for ever-rising levels of red ink.

It is dishonest to single out entitlements for blame.

That’s a remarkable claim since the Congressional Budget Office (which is not a small government-oriented bureaucracy, to put it mildly) unambiguously shows that rising levels of so-called mandatory spending are driving our long-run fiscal problems.

CBO’s own charts make this abundantly clear (click on the image to see the original column with the full-size chart).

So how do the authors get around this problem?

First, they try to confuse the issue by myopically focusing on the short run.

The primary reason the deficit in coming years will now be higher than had been expected is the reduction in tax revenue from last year’s tax cuts, not an increase in spending.

Okay, fair enough. There will be a short-run tax cut because of the recent tax legislation. But the column is supposed to be about the future debt crisis. And that’s a medium-term and long-term issue.

Well, it turns out that they have to focus on the short run because their arguments become very weak – or completely false – when we look at the overall fiscal situation.

For instance, they make an inaccurate observation about the recent tax reform legislation.

…the tax cuts passed last year actually added an amount to America’s long-run fiscal challenge that is roughly the same size as the preexisting shortfalls in Social Security and Medicare.

That’s wrong. The legislation actually increases the long-run tax burden.

And that’s in addition to the long-understood reality that the tax burden already is scheduled to gradually increase, even measured as a share of economic output.

Once again, the CBO has a chart with the relevant data. Note especially the steady rise in the burden of the income tax (once again, feel free to click on the image to see the original column with the full-size chart).

The authors do pay lip service to the notion that there should be some spending restraint.

There is some room for…spending reductions in these programs, but not to an extent large enough to solve the long-run debt problem.

But even that admission is deceptive.

We don’t actually need spending reductions. We simply need to slow down the growth of government. Indeed, our long-run debt problem would be solved if imposed some sort of Swiss-style or Hong Kong-style spending cap so that the budget couldn’t grow faster than 3 percent yearly.

In any event, they wrap up their column by unveiling their main agenda. They want higher taxes.

Additional revenue is critical…responding to the looming fiscal challenge required a balanced approach that combined increased revenue with reduced spending. Two bipartisan commissions, Simpson-Bowles and Domenici-Rivlin, proposed such approaches that called for tax reform to raise revenue as a percent of GDP…set tax policy to realize adequate revenue.

As I already noted, the tax burden already is going to climb as a share of GDP. But the authors want an increase on top of the built-in increase.

And it’s very revealing that they cite Simpson-Bowles, which is basically a left-wing proposal of higher taxes combined with the wrong type of entitlement reform. To be fair, the Domenici-Rivlin plan  has the right kind of entitlement reform, but that proposal is nonetheless bad news since it contains a value-added tax.

The bottom line if that the five Democratic CEA appointees who put together the column (I’m wondering why Austan Goolsbee didn’t add his name) do not make a compelling case for higher taxes.

Unless, of course, the goal is to enable a bigger burden of government.

Which is the message of this very appropriate cartoon.

Needless to say, this belongs in my “Government in Cartoons” collection.

P.S. Entitlement spending is not only to blame for our future spending problems. It’s also the cause of our current spending problems.

P.P.S. In a perverse way, I actually like the column we discussed today. Five top economists on the left put their heads together and tried to figure out the most compelling argument for higher taxes. Yet what they produced is shoddy and deceptive. In other words, they didn’t make a strong argument because they don’t have a strong argument. Reminds me of Robert Rubin’s anemic argument last year against the GOP tax plan.

P.P.P.S. Four former presidents offer good advice on the topic of taxation.

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Given Social Security’s enormous long-run financial problems, the program eventually will need reform.

But what should be done? Some folks on the left, such as Barack Obama and Hillary Clinton, support huge tax increases to prop up the program. Such an approach would have a very negative impact on the economy and, because of built-in demographic changes, would merely delay the program’s bankruptcy.

Others want a combination of tax increases and benefit cuts. This pay-more-get-less approach is somewhat more rational, but it means that today’s workers would get a really bad deal from Social Security.

This is why I frequently point out that personal retirement accounts (i.e., a “funded” system based on real savings) are the best long-run solution. And to help the crowd in Washington understand why this is the best approach, I explain that dozens of nations already have adopted this type of reform. And I’ve written about the good results in some of these jurisdictions.

Now it’s time to add Sweden to the list.

I actually first wrote about the Swedish reform almost 20 years ago, in a study for the Heritage Foundation co-authored with an expert from Sweden. Here’s some of what we said about the nation’s partial privatization.

Swedish policymakers decided that both individual workers and the overall economy would benefit if the old-age system were partially privatized. …Workers can invest 2.5 percentage points of the 18.5 percent of their income that they must set aside for retirement. …the larger part-16 percent of payroll-goes to the government portion of the program. …What makes the government pay-as-you-go portion of the pension program unique, however, is the formula used for calculating an individual’s future retirement benefits. Each worker’s 16 percent payroll tax is credited to an individual account, although the accounts are notional. …the government uses the money in these notional accounts to calculate an annuity (annual retirement benefit) for the worker. …the longer a worker stays in the workforce, the larger the annuity received. This reform is expected to discourage workers from retiring early… There are many benefits to Sweden’s new system, including greater incentives to work, increased national savings, a flexible retirement age, lower taxes and less government spending.

While that study holds up very well, let’s look at more recent research so we can see how the Swedish system has performed.

I’m a big fan of the fully privatized portion of the Swedish system (the “premium pension”) funded by the 2.5 percent of payroll that goes to personal accounts.

But let’s first highlight the very good reform of the government’s portion of the retirement system. It’s still a tax-and-transfer scheme, but there are “notional” accounts, which means that benefits for retirees are now tied to how much they work and how much they pay into the system.

A new study for the American Enterprise Institute, authored by James Capretta, explains the benefits of this approach.

Sweden enacted a reform of its public pension system that combines a defined-contribution approach with a traditional pay-as-you-go financing structure. The new system includes better work incentives and is more transparent to participants. It is also permanently solvent due to provisions that automatically adjust payouts based on shifting demographic and economic factors. …A primary objective…in Sweden was to build a new system that would be solvent permanently within a fixed overall contribution rate. …pension benefits are calculated based on notional accounts, which are credited with 16.0 percent of workers’ creditable wages. …The pensions workers get in retirement are tied directly to the amount of contributions they make to the system. …This design improved incentives for work… To keep the system in balance, this rate of return is subject to adjustment, to correct for shifts in demographic and economic factors that affect what rate of return can be paid within the fixed budget constraint of a 16.0 percent contribution rate.

The final part of the above excerpts is key. The system automatically adjusts, thus presumably averting the danger of future tax hikes.

Now let’s look at some background on the privatized portion of the new system. Here’s a good explanation in a working paper from the Center for Fiscal Studies at Sweden’s Uppsala University.

The Premium Pension was created mainly for three purposes. Firstly, funded individual accounts were believed to increase overall savings in Sweden. …Secondly, the policy makers wanted to allow participants to take account of the higher return in the capital markets as well as to tailor part of their pension to their risk preferences. Finally, an FDC scheme is inherently immune against financial instability, as an individual’s pension benefit is directly financed by her past accumulated contributions. The first investment selections in the Premium Pension plan took place in the fall of 2000, which is known as the “Big Bang” in Sweden’s financial sector. …any fund company licensed to do business in Sweden is allowed to participate in the system, but must first sign a contract with the Swedish Pensions Agency that specifies reporting requirements and the fee structure. Benefits in the Premium Pension Plan are paid out annually and can be withdrawn from age 61.

And here’s a chart from the Swedish Pension Agency’s annual report showing that pension assets are growing rapidly (right axis), in part because “premium pension has provided a 6.7 percent average value increase in people’s pensions per year since its launch.” Moreover, administrative costs (left axis) are continuously falling. Both trends are very good news for workers.

Let’s close by citing another passage from Capretta’s AEI study.

He looks at Sweden’s long-run fiscal outlook to other major European economies.

According to European Union projections, Sweden’s total public pension obligations will equal 7.5 percent of GDP in 2060, which is a substantial reduction from the…8.9 percent of GDP it spent in 2013. …In 2060, EU countries are expected to spend 11.2 percent of GDP on pensions. Germany’s public pension spending is projected to increase…to 12.7 percent of GDP in 2060. …The EU forecast shows France’s pension obligations will be 12.1 percent of GDP in 2060 and Italy’s will be 13.8 percent of GDP.

I think 8.9 percent of GDP is still far too high, but it’s better than diverting 11 percent, 12 percent, or 13 percent of economic output to pensions.

And the fiscal burden of Sweden’s system could fall even more if lawmakers allowed workers to shift a greater share of their payroll taxes to personal accounts.

But any journey begins with a first step. Sweden moved in the right direction. The United States could learn from that successful experience.

P.S. Pension reform is just the tip of the iceberg. As I wrote two years ago, Sweden has implemented a wide range of pro-market reforms over the past few decades, including some very impressive spending restraint in the 1990s. If you’re interested in more information about these changes, check out Lotta Moberg’s video and Johan Norberg’s video.

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Back in 2015, I wrote some columns about policy differences with folks who normally would be considered allies.

  • In Part I, I defended the flat tax, which had been criticized by Reihan Salam
  • In Part II, I explained why I thought a comprehensive fiscal package from the American Enterprise Institute was too timid.
  • In Part III, I disagreed with Jerry Taylor’s argument for a carbon tax.

Now it’s time for another friendly spat.

A handful of right-of-center groups and individuals have decided to embrace a new entitlement for paid parental leave.

Such as the Independent Women’s Forum.

…the United States is the only industrialized nation that does not mandate or subsidize at least some form of paid parental leave. …there is a way for the federal government to provide paid parental leave to every worker in the United States at no additional cost: offer new parents the opportunity to collect early Social Security benefits after the arrival of their child in exchange for their agreeing to defer the collection of their Social Security retirement benefits. …New parents deserve this choice.

Along with the American Enterprise Institute (cooperating with the left-leaning Urban Institute).

…public interest in creating a federal paid family leave policy has grown. …we came up with a compromise proposal… Its key elements are benefits available to both mothers and fathers, a wage-replacement rate of 70 percent up to a cap of $600 per week for eight weeks, and job protection for those who take leave. It would be financed in part by a payroll tax on employees and in part by savings in other parts of the budget. …we felt an obligation…this was better than doing nothing when the US is the only developed nation without a national paid leave policy.

And Ramesh Ponnuru of National Review.

The more I’ve followed the debate, the more I’ve supported the idea. …there are certain similarities between the personal-account and paid-leave ideas that ought to reduce conservative skepticism of the latter. …there’s a mental block that’s keeping the paid-leave objectors from seeing how much these debates have in common.

Kristin Shapiro of IWF and Andrew Biggs of AEI elaborated on a version of this idea in a column for the Wall Street Journal.

The U.S. is the only industrialized nation without a law guaranteeing workers paid parental leave. The idea has broad public support, but how to pay for it? One idea is to mandate that employers fund it, but economists find employers offset the cost by reducing wages for female employees. …Our proposal is simple: Offer new parents the opportunity to collect early Social Security benefits for a period—say, 12 weeks—after the arrival of their child. To offset the cost, parents would agree to delay collecting Social Security retirement benefits… We estimate that to make the Social Security program financially whole, a parent who claimed 12 weeks of benefits would need to delay claiming retirement benefits by only around six weeks. …This idea should be considered as Congress turns to entitlement reform. It’s a fiscally responsible opportunity to help parents and children.

All of this sounds nice, but there are several reasons why I’m very skeptical.

But let’s first distinguish between a very bad idea and a somewhat bad idea. The AEI-Urban scheme for a payroll-tax-funded paid leave program is the very bad idea. The United States already has a baked-in-the-cake entitlement crisis, so the last thing we need is the creation of another tax-and-transfer program.

So I’ll focus instead on the IWF-designed plan to enable parents to get payments from Social Security when they have a new child.

I have three objections.

  1. From a big-picture philosophical perspective, I don’t think the federal government should have any role in family life. Child care certainly is not one of the enumerated powers in Article 1, Section 8, of the Constitution. Proponents of intervention routinely argue that the United States is the only advanced nation without such a program, but I view that as a feature, not a bug. We’re also the only advanced nation without a value-added tax. Does that mean we should join other countries and commit fiscal suicide with that onerous levy?
  2. Another objection is that there is a very significant risk that a small program eventually become will become much larger. I haven’t crunched the numbers, but I assume the plan proposed by Shapiro and Biggs is neutral. In other words, the short-run spending for parental leave is offset by future reductions in retirement benefits. But once the principle is established that Uncle Sam is playing a role, what will stop future politicians from expanding the short-run goodies and eliminating the long-run savings? It’s worth remembering that the original income tax in 1913 had a top rate of 7 percent and it only applied to 1/2 of 1 percent of the population. How long did that last?
  3. Finally, I still haven’t given up on the fantasy of replacing the bankrupt tax-and-transfer Social Security system with a system of personal retirement accounts. Funded systems based on real savings work very well in jurisdictions such as Australia, Chile, Switzerland, Hong Kong, and the Netherlands, but achieving this reform in the United States will be a huge challenge. And I fear that battle will become even harder if we turn Social Security into a piggy bank for other social goals. For what it’s worth, this is also why I oppose plans to integrate the payroll tax with the income tax.

Now let’s see what others have to say about a new entitlement for parental leave.

Veronique de Rugy of Mercatus explains for National Review why Ramesh’s support for a new federal entitlement is the wrong approach.

…we don’t currently have a national parental-leave entitlement. Yes, the plan he’s talking about isn’t as bad as what Hillary would propose, but it still assumes that the federal government should be playing a role in this. Let’s not pretend otherwise. It relies on the government-run Social Security system, and it increases spending for a good while. That’s regress, not progress. And we also need to be realistic. Once the door has been opened, the Left will radically expand the scheme in ways that none of us like. And, to be honest, I can already hear future conservatives demanding that the program be expanded because parents who have to retire a few months later because they use paid leaves pay “a retirement penalty” compared to non-parents. …my point of reference for judging this plan is economic freedom and smaller government involvement. If you prefer more pro-family benefits even at the risk of growing the government, then we won’t agree.

Writing for Reason, Shikha Dalmia also is a skeptic.

…this is a flawed proposal that’ll do more harm than good, including to its intended beneficiaries. …The scheme will incentivize more workers to take off and for longer periods of time. This will be especially disruptive for small businesses and start-ups that operate on a shoestring budget and can’t spread the responsibilities of the absent workers across a large workforce. They will inevitably shy away from hiring young women of childbearing age. This will diminish these women’s job options. …Furthermore, it isn’t like Social Security has a ton of spare cash lying around to dole out to people other than retirees. The program used to generate surpluses when its worker-to-retiree ratio was high. But this ratio has dropped from 42 workers to one retiree in 1945 to less than four workers per retiree now. And even though payroll taxes have gone up from 2 percent at the program’s inception to 12.6 percent now, the system is still taking in less money than it is paying out in benefits, because of all the retiring baby boomers. …It is also beyond naïve to think that once the government is allowed to dip into Social Security to pay for family leave at childbirth, it’ll simply stop there. Why shouldn’t families taking care of old and sick parents get a similar deal? Liberals are already floating proposals to use Social Security for student loan forgiveness. The possibilities are endless.

The Wall Street Journal opined against the idea last month.

…some in the ostensible party of limited government think this is the perfect time to add a new entitlement for paid family leave. …this would shift the burden of providing the benefit from the private economy to government. Academic evidence shows that family leave keeps employees in their jobs and can make them happier or more productive, which is one reason many companies pay for it. But why pay when the government offers 12 weeks? …This “crowd out” effect is a hallmark of all entitlements… Also strap yourselves in for the politics. Social Security started as a 2% payroll tax to support the elderly poor, but the tax is now 12.4% and the program is still severely under-funded.

The WSJ shares my concerns about a small program morphing into a huge entitlement.

No politician is going to deny leave to a pregnant 22-year-old merely because she hasn’t paid much into Social Security. Watch the social right demand a comparable cash benefit for stay-at-home moms, and also dads, or caring for an elderly dependent. And wait until you meet the focus group known as Congressional Democrats, who are already dismissing the proposal as unfair for forcing women to choose between children and retirement. Democrats will quickly wipe out the deferral period so everyone is entitled to leave now and get the same retirement benefits later. And once Republicans open Social Security for family leave, the door will open for other social goals. Why not college tuition? …every entitlement since Revolutionary War pensions has skied down this slope of inexorable expansion. Disability started as limited insurance but now sends checks to roughly nine million people. Medicaid was intended to cover the vulnerable and disabled but today dozens of states cover childless working-age adults above the poverty line.

If you want more information, I had two columns last year (here and here) explaining why federally mandated parental leave is a bad idea.

To put the issue in context, we should be asking whether it makes sense for the government to make employees more expensive to employers. And since this proponents will probably sell this new entitlement as being good for new mothers, it’s worth pointing out that even a columnist for the New York Times admitted that women actually get hurt by such policies.

Remember, if someone says the answer is more government, they’ve asked a very silly question.

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Writing about federal spending last week, I shared five charts illustrating how the process works and what’s causing America’s fiscal problems.

Most important, I showed that the ever-increasing burden of federal spending is almost entirely the result of domestic spending increasing much faster than what would be needed to keep pace with inflation.

And when I further sliced and diced the numbers, I showed that outlays for entitlements (programs such as Social SecurityMedicareMedicaid, and Obamacare) were the real problem.

Let’s elaborate.

John Cogan, writing for the Wall Street Journal, summarizes our current predicament.

Since the end of World War II, federal tax revenue has grown 15% faster than national income—while federal spending has grown 50% faster. …all—yes, all—of the increase in federal spending relative to GDP over the past seven decades is attributable to entitlement spending. Since the late 1940s, entitlement claims on the nation’s output of goods and services have risen from less than 4% to 14%. …If you’re seeking the reason for the federal government’s chronic budget deficits and crushing national debt, look no further than entitlement programs. …entitlement spending accounts for nearly two-thirds of federal spending. …What about the future? Social Security and Medicare expenditures are accelerating now that baby boomers have begun to collect their government-financed retirement and health-care benefits. If left unchecked, these programs will push government spending to levels never seen during peacetime. Financing this spending will require either record levels of taxation or debt.

Here’s a chart from his column. Only instead of looking at inflation-adjusted growth of past spending, he looks at what will happen to future entitlement spending, measured as a share of economic output.

And he concludes with a very dismal point.

…restraint is not possible without presidential leadership. Unfortunately, President Trump has failed to step up.

I largely agree. Trump has nominally endorsed some reforms, but the White House hasn’t expended the slightest bit of effort to fix any of the entitlement programs.

Now let’s see what another expert has to say on the topic. Brian Riedl of the Manhattan Institute paints a rather gloomy picture in an article for National Review.

…the $82 trillion avalanche of Social Security and Medicare deficits that will come over the next three decades elicits a collective shrug. Future historians — and taxpayers — are unlikely to forgive our casual indifference to what has been called “the most predictable economic crisis in history.” …Between 2008 and 2030, 74 million Americans born between 1946 and 1964 — or 10,000 per day — will retire into Social Security and Medicare. And despite trust-fund accounting games, all spending will be financed by current taxpayers. That was all right in 1960, when five workers supported each retiree. The ratio has since fallen below three-to-one today, on its way to two-to-one by the 2030s. …These demographic challenges are worsened by rising health-care costs and repeated benefit expansions from Congress. Today’s typical retiring couple has paid $140,000 into Medicare and will receive $420,000 in benefits (in net present value)… Most Social Security recipients also come out ahead. In other words, seniors are not merely getting back what they paid in. …the spending avalanche has already begun. Since 2008 — when the first Baby Boomers qualified for early retirement — Social Security and Medicare have accounted for 72 percent of all inflation-adjusted federal-spending growth (with other health entitlements responsible for the rest). …

Brian speculates on what will happen if politicians kick the can down the road.

…something has to give. Will it be responsible policy changes now, or a Greek-style crisis of debt and taxes later? …Restructuring cannot wait. Every year of delay sees 4 million more Baby Boomers retire and get locked into benefits that will be difficult to alter… Unless Washington reins in Social Security and Medicare, no tax cuts can be sustained over the long run. Ultimately, the math always wins. …Frédéric Bastiat long ago observed that “government is the great fiction through which everybody endeavors to live at the expense of everybody else.” Reality will soon fall like an anvil on Generation X and Millennials, as they find themselves on the wrong side of the largest intergenerational wealth transfer in world history.

Not exactly a cause for optimism!

Last but not least, Charles Hughes writes on the looming entitlement crisis for E21.

Medicare and Social Security already account for roughly two-fifths of all federal outlays, and they will account for a growing share of the federal budget over the coming decade. …Entitlement spending growth is a major reason that budget deficits are projected to surge over the next decade. …The unsustainable nature of these programs face mean that some reforms will have to be implemented: the only questions are when and what kind of changes will be made. The longer these reforms are put off, the inevitable changes will by necessity be larger and more abrupt. …Without real reform, the important task of placing entitlement programs back on a sustainable trajectory will be left for later generations—at which point the country will be farther down this unsustainable path.

By the way, it’s not just libertarians and conservatives who recognize there is a problem.

There have been several proposals from centrists and bipartisan groups to address the problem, such as the Simpson-Bowles plan, the Debt Reduction Task Force, and Obama’s Fiscal Commission.

For what it’s worth, I’m not a big fan of these initiatives since they include big tax increases. And oftentimes, they even propose the wrong kind of entitlement reform.

Heck, even folks on the left recognize there’s a problem. Paul Krugman correctly notes that America is facing a massive demographic shift that will lead to much higher levels of spending. And he admits that entitlement spending is driving the budget further into the red. That’s a welcome acknowledgement of reality.

Sadly, he concludes that we should somehow fix this spending problem with tax hikes.

That hasn’t worked for Europe, though, so it’s silly to think that same tax-and-spend approach will work for the United States.

I’ll close by also offering some friendly criticism of conservatives and libertarians. If you read what Cogan, Riedl, and Hughes wrote, they all stated that entitlement programs were a problem in part because they would produce rising levels of red ink.

It’s certainly true that deficits and debt will increase in the absence of genuine entitlement reform, but what irks me about this rhetoric is that a focus on red ink might lead some people to conclude that rising levels of entitlements somehow wouldn’t be a problem if matched by big tax hikes.

Wrong. Tax-financed spending diverts resources from the private economy, just as debt-financed spending diverts resources from the private economy.

In other words, the real problem is spending, not how it’s financed.

I’m almost tempted to give all of them the Bob Dole Award.

P.S. For more on America’s built-in entitlement crisis, click here, here, here, and here.

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I write constantly (some would say incessantly and annoyingly) about entitlement spending. And I occasionally write about discretionary spending.

It’s time to address the budget in a comprehensive fashion. Let’s look at five charts to put everything in context and to show how we got into our current mess.

Our first chart (based on Table 8.2 from the Office of Management and Budget’s Historical Tables) shows what has happened to major spending categories from 1962 to 2017. And all the data is in inflation-adjusted dollars (2009 benchmark) to accurately gauge how and why the burden of federal spending has grown.

This next chart shows the actual percentage increases in the major spending categories during this time period. The two big takeaways are that 1) the defense budget is not the cause of our long-run fiscal problems (though that doesn’t mean it should be exempt from cuts), and 2) entitlement expenditures have exploded.

And if you look at the data I shared from the Congressional Budget Office’s long-run forecast, you would see that these same trends will prevail for the next three decades.

In other words, our fiscal problems start with entitlements and end with entitlements.

If you want to look at the problem with a broader lens, this next chart shows that the problem is domestic spending (i.e., the combination of entitlement and domestic discretionary outlays).

If you’re pressed for time, you can stop reading now. You have the key information already.

But if you want to get a bit wonky, here are two other charts that help explain the intricacies of how budgets work (or don’t work!) in Washington.

The first thing to realize is that there are two budget processes in Washington. There are entitlement programs, which basically operate on autopilot. For all intents and purposes, the President and Congress could go on vacation for the next three years and programs such as Social Security, Medicare, Medicaid, and Obamacare would mechanically continue. But there is also “discretionary” spending for the Pentagon and various domestic programs, all of which is determined through an annual “appropriations” process. Whenever you read about a government shutdown, it’s because politicians can’t agree on the level of funding for the discretionary part of the budget.

Now let’s get to my favorite part, which is figuring out how to limit the size of the federal leviathan.

This last chart shows that net interest spending is genuinely untouchable (unless one wants a Greek-style or Argentine-style default). The rest of the budget, however, can be addressed. Entitlements can be changed through “reconciliation”, which is a legislative process designed to minimize procedural roadblocks (in general, tax bills also use reconciliation legislation). And discretionary programs can be changed via annual appropriations legislation.

I should add that net interest may not be directly touchable, but interest payments can be reduced by controlling spending and thus reducing red ink.

Another thing to understand is that the budget caps (yes, the ones that were weakened in 2013, 2015, and earlier this year) only apply to discretionary spending.

And the most important thing to realize is that the only solution to our budget mess is genuine entitlement reform. Which is why we need constitutional (and comprehensive) limits on total outlays. Politicians will only do what’s right if every other option is off the table.

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At some point in the next 10 years, there will be a huge fight in the United States over fiscal policy. This battle is inevitable because politicians are violating the Golden Rule of fiscal policy by allowing government spending to grow faster than the private sector (exacerbated by the recent budget deal), leading to ever-larger budget deficits.

I’m more sanguine about red ink than most people. After all, deficits and debt are merely symptoms. The real problem is excessive government spending.

But when peacetime, non-recessionary deficits climb above $1 trillion, the political pressure to adopt some sort of “austerity” package will become enormous. What’s critical to understand, however, is that not all forms of austerity are created equal.

The crowd in Washington reflexively will assert that higher taxes are necessary and desirable. People like me will respond by explaining that the real problem is entitlements and that we need structural reform of programs such as Medicaid and Medicare. Moreover, I will point out that higher taxes most likely will simply trigger and enable additional spending. And I will warn that tax increases will undermine economic performance.

Regarding that last point, three professors, led by Alberto Alesina at Harvard, have unveiled some new research looking at the economic impact of expenditure-based austerity compared to tax-based austerity.

…we started from detailed information on the consolidations implemented by 16 OECD countries between 1978 and 2014. …we group measures in just two broad categories: spending, g, and taxes, t. …We distinguish fiscal plans between those that are expenditure based (EB) and those that are tax based (TB)… Measuring the macroeconomic impact of a plan requires modelling the relationship between plans and macroeconomic variables.

Here are their econometric results.

There is a large and statistically significant difference between the effects on output of EB and TB austerity. EB fiscal consolidations have, on average, been associated with a very small downturn in output growth: a spending based plan worth one percent of GDP implies a loss of about half of a percentage point relative to the average GDP growth of the country, which lasts less than two year. Moreover, if an EB austerity plan is launched when the economy is not in a recession, the output costs are zero on average. …On the other hand TB plans are associated with large and long lasting recessions. A TB plan worth one per cent of GDP is followed, on average, by a two percent fall in GDP relative to its pre-austerity path. This large recessionary effect lasts several years.

Here’s a chart from the study showing that economic performance drops farther and farther to the extent taxes are part of an austerity package.

In addition to the core results, the authors explain why tax-based austerity packages are bad for capital…

…investment growth responds very differently following the introduction of the two types of austerity plans. It responds positively to EB plans and negatively to TB plans. …in their sample of OECD countries, business confidence increases immediately at the start of an EB consolidation plan, much more so that at the beginning of a TB plan.

…and why tax-based austerity packages are bad for labor.

…clearly tax hikes and spending cuts – beyond other effects – have different effects on labor supply. …EB plans are the least recessionary the longer lived is the reduction in government spending. Symmetrically, TB plans are more recessionary the longer lasting is the increase in the tax burden and thus in distortions.

Since capital and labor are the two factors of production, the obvious and inevitable conclusion is that the economy does worse when taxes are higher.

The study also make a critical point about the futility of tax increases when the burden of government spending is rising faster than the private sector. Simply stated, that’s a recipe for ever-increasing taxes, sort of like a dog chasing its tail.

…a TB plan which does not address the automatic growth of entitlements and other spending programs which grow over time if much less like likely to produce a long lasting effect on the budget. If the automatic increase of spending is not addressed, taxes will have to be continually increased to cover the increase in outlays.

That’s why spending restraint is the only way to successfully address red ink.

It doesn’t even require dramatic spending cuts, even though that would be desirable. All that’s needed is some modest fiscal restraint so that spending grows slower than the productive sector of the economy.

Nations that follow this approach for a multi-year period always get good results. But if you want examples of nations that have achieved good outcomes with tax increases, you’ll have to explore a parallel universe because there aren’t any on this planet.

P.S. I need to update the table because both the United States (between 2009-2014) and the United Kingdom (between 2010-2016) enjoyed dramatic improvements in fiscal outcomes in recent years because of spending restraint.

P.P.S. Politicians don’t like spending restraint, which is why most periods of good fiscal policy come to an end. To achieve good long-run outcomes, some sort of constitutional spending cap is probably necessary.

P.P.P.S. The study cited above builds upon research I cited in 2016.

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The United States and other western nations became rich during the 1800s thanks to a combination of rule of law and very small government.

Sadly, very few nations – most notably East Asian tiger economies – have become rich in the modern era. Yes, some other countries have grown, but they are not on a path to converge with rich nations.

Chile, however, may be an exception to that unfortunate pattern. It has enjoyed amazing levels of growth since a shift to free-market policies starting about 40 years ago. It is now the richest country in Latin America and if its “improbable success” continues, it will soon be comfortably part of what used to be called the first world.

The flagship reform in Chile was the creation of a funded retirement system based on personal accounts. Basically universal IRAs.

Writing for the Weekly Standard, Fred Barnes shared what he learned about the nation’s private retirement system.

The rags-to-riches Chile story lives on as a model of what a poor country can achieve if it spurns socialism and adopts free markets and democracy. Peru is now copying Chile. More may follow. …Chile was once a Third World country headed downhill economically after Salvador Allende was elected president in 1970…bent on creating a Marxist state. In 1973, the military led by General Augusto Pinochet staged a coup. …When he took over, Chile had one of the highest rates of poverty in South America. It was a basket case. Now it has the continent’s strongest economy. Without Pinochet’s having heeded the advice of economist Milton Friedman, imposed capitalism, and hired a team of free market economists, many trained at the University of Chicago, the rise to First World status wouldn’t have happened. One of the economists was José Piñera, brother of the new president and Harvard-educated. He created a stable, fully-funded pension program that has become a monument to the success of private markets. …Piñera released a study in January that found “72 percent of the capital accumulated in the personal retirement account of the average Chilean worker, after 36 years in the private pension system, comes from the return on the investments done with their contributions.” That’s a long way of saying the plan is a dazzling success.

Though there are opponents, mostly those inspired by the communist regime in Cuba and a Pope who thinks we should worship the state.

But obstacles remain. …Even with Fidel Castro gone, Cuba exports communism as aggressively as it once did sugar. …socialists have an ally in Pope Francis, who spent three days in Chile in mid-January. …there’s a disconnect between how people here feel about capitalism—as a concept anyway—and the economic success they are experiencing. Pinochet is partly to blame, I suspect. He’s a hard man to credit, given his bloody takeover.

Barnes’ final point is also important.

I’ve had many people tell me that personal accounts are bad because they were implemented during Pinochet’s reign. But that’s a silly argument, sort of like deciding to be against free trade because the dictatorial Chinese government opened up to the global economy.

As far as I’m concerned, tyrannical leaders are awful and should be condemned, but if they happen to grant citizens a slice of economic liberty, that’s a silver lining to an otherwise dark cloud.

Back to our main topic, Monica Showalter, in a column for the American Thinker, explained what makes Chile’s system a role model for the United States.

…the Chilean Model…shows some spectacular new results for ordinary citizens… the Chilean Model is working, big time.  Basically, you skip Social Security taxes for starters, which leaves you a lot more money to play around with.  You then put 10% of your income into a government-certified private pension account (and you have many choices among them)… This is mass-scale wealth creation, and it benefits workers most of all. …Chile has no pension crisis as most of the rest of the developed world does – no worries about a “trust fund” and no Social Security “cuts” to speak of.  This is why.  Thirty nations have adopted the same plan… the left hates this stuff.  It keeps workers out of the clutches of unions and un-dependent on government handouts.  Of course leftists want it gone.  They tried hard in Chile to turn workers against this pension idea.

And here’s a chart that was linked in her article showing how investment returns have played a big role in helping ordinary Chileans build nest eggs for their old age.

Let’s look at some additional research.

In a monograph published by the U.K.-based Institute of Economic Affairs, Kristian Niemietz takes an in-depth look at Chiles’s approach.

Taken together, the value of the assets accumulated by Chilean pension funds is equivalent to about two thirds of the country’s GDP (Figure 1). This places Chile in the same league as countries which have had private pensions for over a century, and miles ahead of countries with traditional Bismarckian systems… The poverty rate among the elderly is lower than that of the population as a whole – 3.9 per cent vs. 10.3 per cent, or 8.4 per cent vs. 14.4 per cent, depending on the poverty measure used… Chile’s 1981 pension reform has given rise to a number of positive economic spillover effects: the prefunded system has been an active ingredient in the accelerated economic development that the country has been experiencing since the mid-1980s. …It has increased employment, especially in the formal sector… It has boosted the development and sophistication of Chile’s capital markets, and thus raised Total Factor Productivity… Despite the current backlash against it, Chile’s pension system is a success story. The system has achieved consistently high rates of return. It offers excellent value for money and solid pensions for those who contribute regularly. … The official retirement age is not as important in Chile as it is in countries with state-run systems. By and large, in that system, people retire when they have accumulated enough savings, not when politicians think they should retire.

Here’s the chart Kristian mentioned in the text. By this important metric, Chile is firmly ensconced in the upper tier of developed countries.

Now let’s address some of the critics.

Under the previous leftist government, there were protests against the country’s famous private social security system and attempts to undermine the model. Indeed, I wrote about that battle back in 2014. And I also noted that even some academics agreed that it would be foolish to undermine a successful approach.

Let’s see what’s happened since then. The Economist reported about the complaints about a year ago.

…tens of thousands of Chileans in Santiago…protest against the country’s privatised pension system. Organisers—a mix of unions, pensioners’ associations and consumer-advocacy groups—say that… Pensions are too small…benefits have not measured up to people’s unrealistic expectations. The scheme’s founders told workers that if they contributed continuously throughout their careers they would receive a generous 70% of their final salaries upon retirement. …But most workers contributed far less. Women took time off to raise children (and retire earlier than men). Many Chileans spent time in informal jobs or unemployed. On average, they contribute for only 40% of their prime working years. …The system has generated high returns for pensioners, averaging 8.6% a year between 1981 and 2013. But…high fees have bitten a huge chunk out of those returns, reducing them to 3-5.4%.

Though the article also noted all the benefits of personal accounts.

Rather than saddle the government with an unaffordable pay-as-you-go system, in which today’s taxpayers support today’s pensioners even as the population ages, Chile created one in which workers save for their own retirement by paying 10% of their earnings into individual accounts. These are managed by private administrators (AFPs). …the system worked. Contributions to the AFPs flowed into capital markets, which boosted growth. Annual GDP growth from 1981 to 2001 was 0.5 percentage points higher than it would have been without the investment, according to one study. This helped lift millions of people out of poverty.

The last couple of sentences of the above passage are worth highlighting. As I’ve noted, even small differences in economic growth – if they are sustained for a long period – make a huge difference in terms of national prosperity. And 0.5 percent more growth every year is actually a big boost when looking at the impact of just one policy.

Last but not least, here’s Ian Vasquez’s response to the attacks on the Chilean system.

Critics in Chile assert that the average pension provided by the private pension fund companies is around $340 per month, which is not better than the public pension system. But as the Chile-based Liberty and Development institute (LyD) has shown, that is like comparing apples to oranges. To calculate the private system’s figures, all those affiliated with it are taken into account, even if they have only contributed to their accounts once in their lifetime. The corresponding figure for the public pension system, however, only takes into account the pensions of those who have contributed for a minimum of 10 to 15 years, something that leaves out half of the people affiliated with that system. In addition, pensions under the private system are obtained through contributions that amount to 10 percent of wages, while in the public system the contribution is 20 percent. Correcting for those distortions shows that the value of the pensions the AFPs provide is three times higher than that of the public system. …it’s true that many Chileans do not contribute regularly to their retirement accounts because too many work outside the formal sector and getting work is still too precarious for many, that is a problem that affects any pension system, whether public or private, and can only be solved with labor reforms. …Chile’s private pension system can certainly be improved, but the reality is that it has been extremely successful. …old-age pensions no longer represent a burden on the treasury. Pension savings have reached $168 billion, about 70 percent of GDP, which has stimulated high growth and domestic investment, and has put Chile on the verge of becoming a developed country—a remarkable achievement.

Amen. Chile’s system isn’t perfect, but it’s far better, by several orders of magnitude, than the debt-ridden, pay-as-you-go models that are wreaking havoc with the public finances of other countries.

And Chile is prospering in a way unimaginable in other Latin nations.

It would be very nice to have a similar system of personal retirement accounts in the United States. And here’s the cartoon version of the argument.

P.S. Chile also has nationwide school choice.

P.P.S. Bill Clinton supported good Social Security reform and was prepared to work with congressional Republicans (and some Democrats) on good legislation for personal accounts, but that effort was sidetracked by the partisan impeachment fight. A genuine tragedy.

P.P.P.S. I’ve written before about overseas bathroom adventures and I now have another episode to add to the mix from my recent trip to India. I like modern facilities, including ones that have energy-saving features. But building engineers should realize that motion-activated lights may not make sense in bathrooms. At least not when people may be locked in stalls with no good options when the lights go out. Enough said.

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I wrote yesterday about “the world’s demographic problem,” citing a new study about the fiscal implications of aging populations. The report was produced by the Organization for Economic Cooperation and Development, which is not my favorite international bureaucracy when they make policy recommendations, but I’ll be the first to admit that the bureaucrats produce some useful statistics and interesting reports.

To be succinct, the basic message of the study is that developed nations (the U.S., Europe, Asia, etc) face a demographic nightmare of increased longevity and falling birthrates.

It’s good that people are living longer, of course, and there’s nothing wrong with people choosing to have fewer kids. But since most governments maintain tax-and-transfer entitlement programs, the OECD report basically warns that those demographic changes have some very grim fiscal implications. In other words, the world’s demographic shift is actually a policy problem.

That’s the bad news.

The good news is that there’s a policy solution.

The aforementioned OECD study (which can be accessed here) is a survey of how retirement income is provided in key nations. So in addition to grim information about fiscally unstable government-run retirement systems we looked at yesterday, the report also has data about the nations that rely – at least to some degree – on private savings.

Let’s start with this helpful flowchart in the report. It illustrates that there are three approaches for the provision of retirement income. The first tier is government-run programs such as the U.S. Social Security system and the third tier is voluntary savings such as IRAs and 401(k)s in America.

For today’s discussion, let’s focus on the second tier. These are the systems that are “funded” with mandatory savings.

And I highlighted (in green) the two private options. In a “defined contribution” system, retirement income is determined by how much is saved and how well it is invested. Workers accumulate a big nest egg and then choose how to spend the money when retired. In a “defined benefit” system, workers are promised a pre-determined level of retirement income and the managers of their pension funds are expected to ensure that enough money will be available.

Yes, public options based on real savings do exist. And they presumably are better than the pay-as-you-go, tax-and-transfer schemes found in the first tier. But it’s also the case that these systems (such as pension funds for state and local bureaucrats) generally don’t work very well.

So now let’s look at another table from the OECD report. It shows nations that have some degree of mandatory private retirement savings, either defined contribution (highlighted in red) or defined benefit (highlighted in yellow). As you can see, there actually are a lot of “privatized” systems.

I’ve actually written about many of these systems, especially the ones in Australia and Chile.

And I have very recent columns on the Dutch and Swiss systems.

A common theme in these columns is that government-run systems are very risky because workers are at the mercy of politicians, who are great at making extravagant promises. But huge unfunded liabilities show that they’re not very good at delivering on those promises.

Nations with funded systems, by contrast, accumulate private savings. That’s not only good for workers, but it’s very beneficial for national economies.

This table from the OECD report shows that Americans and Canadians have managed to save a lot of money, but all of the other nations with pension assets of more than 100 percent of GDP have mandatory funded systems.

When I talk about how the United States would benefit by moving to a private retirement system, people sometimes say it sounds too good to be true.

That’s obviously not the case since other nations have very successful private systems. But there is a catch, as I acknowledged in 2015.

…a big challenge for real Social Security reform is the “transition cost” of financing promised benefits to current retirees and older workers when younger workers are allowed to shift their payroll taxes to personal accounts. Dealing with this challenge presumably means more borrowing over the next few decades.

The appropriate analogy is that shifting to private retirement accounts for younger workers (while protecting current retirees and older workers) would be like refinancing a mortgage. The short-run costs might be higher, but that temporary burden is overwhelmed by the long-run savings. That’s a good deal, at least if the goal is fiscal stability and secure retirement.

Or we can stay with the current approach and become another Greece.

P.S. Social Security reform is especially beneficial for blacks and other minorities.

P.P.S. There is some risk with personal retirement accounts. But I’m not talking about the implications of a falling stock market crash (even a horrible crash would be offset by decades of compounding earnings). Instead, I’m referring to the possibility that future politicians might simply confiscate the money.

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