Category Archive: Debt/Spending

  1. Suffering is Venezuela’s new normal.

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    Venezuela is an unfolding story of the chaos resulting from government intervention in economic affairs. President Maduro faces a political crisis, and violent protests pose real threats to his desperate attempts to retain power. The economy is collapsing in front of our eyes, but the real tragedy is not the macro indicators that we read about daily: soaring inflation rates, increasing unemployment numbers, nonexistent consumer goods, and crashing oil prices. The real tragedy is that the innocent citizens of Venezuela suffer and that suffering is the new normal.

    The Maduro administration continues to believe that it can use policy to assuage the angst of the citizens who cry out against him and the policy wreckage under which they suffer. In a last-ditch effort to “help” people, Maduro raised the Venezuelan minimum wage by 60% and offered free apartments to those who are displaced. This is the 15th minimum wage hike enacted by Maduro since he took office in 2013, and while the increase sounds nice on paper, the new wage amounts to just under $50 per month — hardly a windfall.

    Not only is this paltry income insufficient for surviving, let alone thriving, it occurs against the backdrop of out-of-control inflation that the IMF predicts to soar above 1600% this year. Every hour of every day, the bolivar is worth less and less, stealing from citizens their ability to buy basic goods and services and forcing them into the black-market economy.

    There is no magic policy wand

    F.A. Hayek understood the nature of market activity. It is the organic process of exchange among individuals guided by prices, profits, and losses in the context of the institutions of property rights. As such, economies cannot be directly controlled by experts, technocrats, or dictators.

    The economy is not a jigsaw puzzle that we are trying to solve. The economy is a dynamic process of discovering new ways of doing things in the context of institutions that facilitate exchange. When this process is allowed to function, income and wealth grow — across all people and places. There is no policy that can act as a magic wand to override or “fix” what we deem insufficient.

    Moreover, as Hayek highlighted, for governments that use policy to increasingly control the economy, totalitarianism is a likely result. The more control government officials extend over what are normally individual economic affairs, the more economic chaos results. That chaos breeds more control, which breeds more chaos. This is the current state of affairs in which Venezuelan citizens find themselves.

    Totalitarian authority is a feature, not a bug, of increasing efforts to control economic affairs — precisely because economic affairs are ordered by ordinary people pursing their interests. As the necessary conditions for productive market exchange — prices, property rights, and the rule of law — erode, suffering is exacerbated and the economic breakdown continues to spiral out of control.

    Totalitarian governments suppress value creation

    Economic activity is about individual exchange within the context of institutional arrangements. That exchange can be productive when individuals are allowed to use profit and loss to guide their use of scarce resources. In a market economy, the result is that we grow richer.

    Markets are positive sum. For me to make a profit, I must give you something that you need or want, and there is pressure to deliver at ever-lower prices and ever-higher levels of quality. Growing rich does not come from arbitrary wage increases set by governments; it comes from being rewarded for creating value.

    Venezuelans suffer today because it is increasingly difficult to create value for oneself or others in a totalitarian regime that tries to control economic life. Trading partners are limited, needed goods and services are nowhere, and there are no strong incentives to be creative and entrepreneurial because there is no just reward. People are forced into black-market activity and barter economies.

    Mandating wage raises will do nothing to restore the necessary institutions of value creation and entrepreneurship. Rather, these mandates restrict the possibilities for legal exchange, thus forcing more people out of work and condemning Venezuelans to further poverty and suffering.

    Markets work best when governments retreat

    The best way to restore productive institutions of trade, value creation, discovery, and entrepreneurship is to retract the government’s scope and size and allow markets to work. In the words of F.A. Hayek:

    It is often said that political freedom is meaningless without economic freedom. This is true enough, but in a sense almost opposite from that in which the phrase is used by our planners. The economic freedom which is the prerequisite of any other freedom cannot be freedom from economic care which the socialists promise us and which can be obtained only by relieving the individual at the same time of the necessity and of the power of choice; it must be the freedom of our economic activity which, with the right of choice, inevitably also carries the rise and the responsibility of that right.

    People must be free to choose and to make themselves rich through value creation within the market process. This economic freedom will make them rich in a way that no coercive government policy, no matter how good it sounds, can.

     

  2. A Case Against Public Education

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    Prof. Bryan Caplan argues that public funding for education doesn’t make sense. Watch the full interview on the Rubin Report

    Caplan claims that educational degrees communicate a signal of worth rather than delivering valuable skills or information. Second, he argues that public education does not lead to a knowledgeable citizenry, since surveys show high school and college graduates are poorly informed on basic civics and history.

  3. The health care shell game: Why not leave health care policy to the states?

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    Recent arguments against cutting federal health care spending — and letting states handle insurance regulation — reveal just how unaffordable the Affordable Care Act (Obamacare) is.

    Law professor and Incidental Economist contributor Nicholas Bagley, reconstructing the arguments of the moderate Republican Tuesday Group, says that “it’s fine to give the states more authority to oversee their insurance markets,” but the states “don’t have the fiscal capacity to finance massive coverage expansions on their own.”

    They’re required to balance their budgets every year, so any commitment to covering the uninsured will throttle their budgets when the next downturn comes.…

    The states thus need federal money; it’s the lifeblood of health reform. And the real cleavage among Republicans is over how much money the federal government is willing to shell out. The Freedom Caucus wants to repeal the ACA’s taxes on industry and the wealthy, financing them with savage cuts to Medicaid and slightly less savage cuts to individual-market subsidies. The Tuesday Group likes the tax relief, but worries about the coverage losses associated with all the cuts.

    State Budget Requirements

    The case against letting the states fund Medicaid expansion on their own is that they have to run balanced budgets. But wait, I thought the Affordable Care Act actually reduced the deficit! That was, after all, the assertion of the Congressional Budget Office and the Joint Committee on Taxation in 2013.

    So if federal ACA spending were cut or even zeroed out, why couldn’t states that like the legislation simply reinstate the same taxes and spending that the federal government currently uses under the law? If the net budgetary impact of the health care law really is zero, there is no inconsistency with state balanced-budget requirements.

    What’s more, most states don’t have strong constitutional requirements that they actually run balanced budgets at the end of the fiscal year. More often, they just have statutory requirements that balanced budgets must be enacted — or even merely proposed — at the beginning of the fiscal year. Most states run balanced budgets because they want to, not because they are required to by law.

    Federal and State Spending Constraints

    Having the federal government pay states to run programs is just a complicated shell game — the states aren’t really winning if the federal government pays for the programs, because the federal government ultimately gets that money from taxpayers living in the states.

    Now, perhaps Bagley’s response would be something like this: The ACA generally reduces the deficit, but there might be some years when its taxes bring in less than expected, and states would be tempted to cut spending in those years. The federal government doesn’t face the same constraint.

    To this possible response, there are two counterarguments.

    First, the federal government faces a stricter constraint than the states in one crucial respect: its total debt burden is much larger. Federal debt is already greater than 100% of GDP, leading to higher interest costs and crowding out private investment. Expanding the debt even further would only exacerbate these serious problems.

    State and local debt is much lower, at about 16% of GDP. State and local governments are much more fiscally responsible than the federal government, and that’s precisely what gives them room to spend if there’s a good reason for it.

    Second, states have a ready mechanism to deal with economic downturns and sudden revenue shortfalls: rainy day funds. States accumulate surpluses in good years and then use the saved funds to smooth out spending in bad years. Spending out of a rainy day fund violates no balanced-budget rules.

    Desire vs. Ability

    In short, state balanced-budget rules provide no good reason why states couldn’t fund health care spending on their own. Perhaps ACA supporters truly worry that states wouldn’t want to fund massive health-care programs, because states want to keep taxes low. (Even Vermont realized that it didn’t really want single-payer health care when it recognized the price tag.)

    But isn’t this demand for hiding the costs of the ACA almost tantamount to admitting that the ACA isn’t good policy?

  4. US Economic History 3 — National Banks’ Rise and Fall

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    Does a national bank make the US economy more stable or more chaotic? Video created with the Bill of Rights Institute to help students ace their exams.

    This is the third video in a series of nine with Professor Brian Domitrovic, which aim to be a resource for students studying for US History exams and to provide a survey of different (and sometimes opposing) viewpoints on key episodes in U.S. economic history. How do you think we did?

  5. Don’t raise Uncle Sam’s credit limit

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    Once again, the United States government is rapidly approaching a fiscal debt ceiling. After March 16, 2017, Uncle Sam is not legally allowed to borrow any more money to cover its budget deficits, unless Congress votes to raise the debt limit like it has every time in the past.

    Uncle Sam’s debt has been growing at a frightening rate over the last several decades. It took almost two hundred years, from around 1790, when the government of the United States was established, to 1980 for the federal government to accumulate $1 trillion of debt through deficit spending.

    In the twenty-year period, 1980 to 2000, that national debt grew to $5 trillion. Then during the eight years of George W. Bush’s Republican Administration from 2001 to 2009, the debt doubled to around $10 trillion. And over the eight years of Barack Obama’s Democratic Administration, the national debt doubled, once more, to just short of $20 trillion.

    The Taxpayer Cost of the National Debt

    United States Gross Domestic Product – the market value of all final goods and services produced during a year –is estimated to have been about $18.6 trillion in 2016. That means if the American people were to devote last year’s entire national income to paying off the federal government’s accumulated debt, it would still fall short by nearly $1.5 trillion dollars!

    With an estimated population of around 325 million people at the end of 2016, the per capita financial burden of the national debt comes to around $61,550 per person in the United States. About half of the U.S. population submits and pays some amount of tax to the federal government. This means that the per capita burden of the national debt for those submitting and paying federal taxes is almost $123,500 per taxpayer.

    Of course, in reality, many pay no or little net taxes to the federal government, while others pay far more. But this number at least gives a sense of what it would cost each of us, on average, if we were to try to pay off the national debt in one lump payment.

    The Debt Limit and Short-Term Fiscal Tricks

    The Congressional Budget Office (CBO) recently issued a report on “Federal Debt and the Statutory Limit, March 2017.” The report reminds us that Congress passed the Bipartisan Budget Act of 2015 that temporarily lifted any limit on how much the federal government could borrow and add to the national debt until March 15, 2017, which is, now, just around the corner.

    After that date, whatever has been added to the national debt up to that time becomes the new legal debt ceiling, which will be at or very close to that $20 trillion mark. Anything beyond this amount will require Congressional approval with a new, higher ceiling on government borrowing.

    The CBO also points out that, as with earlier administrations that have reached that lawful limit without an immediate Congressional approval of a higher number, the Secretary of the Treasury has a variety of short-run smoke-and-mirror tricks to keep spending by playing games with several internal government financial accounts. In other words, the Treasury Department can “juggle the books,” adding to the net debt through ledger book subterfuge and then make good on what has been manipulated out of the higher debt ceiling passed by Congress.

    The Congressional Budget Office suggests that the available leeway to get away with this could allow the federal government to keep spending beyond taxes collected for several months before a real hard limit would be reached, after which there would no more room for such financial games unless the Congress increases the debt limit.

    Uncle Sam’s Future Red Ink Has No End

    Government and its spending are out of control. In its January 2017 long-run “Budget and Economic Outlook” report covering the next ten years, the CBO estimates that continuing, and indeed, rising annual budget deficits between 2017 and 2027 will likely bring the federal government’s overall debt to at least a total of $30 trillion, or a 50 percent increase in the national debt in ten years or less. Those $1 trillion-a-year deficits experienced in the early years of Obama’s presidency, the CBO projects, will be back starting in 2023 and thereafter.

    This, of course, presumes that the estimates for government revenues and expenditures made by the CBO for the next decade turn out to be correct. But if anything has a relatively high degree of certainty, it is that government ends up spending more than originally projected and planned. So the deficits and debt estimates can easily turn out to be on the low side by the time we reach 2027.

    Uncle Sam’s budgetary excesses are being fed, more than by anything else, by the “entitlement” programs, especially Social Security and Medicare spending. According to the Office of Management and Budget, in the current federal budget for fiscal year 2017 (that runs from October 1, 2016 to September 30, 2017), Social Security and related programs will consume 36 percent of federal expenditures; Medicare and other health programs will eat up an additional 28 percent; and net interest on the federal debt will absorb 7 percent.

    These two general redistributive categories make up over two-thirds of all federal government spending. And when net interest on the national debt is added, this comes to over 70 percent of all federal expenditures. The Social Security Administration spending in the current fiscal year will be around $908 billion, while expenditures by the Department of Health and Human Resources will come in at over $1 trillion.

    Classical liberals and libertarians may well consider that the United States government spends too much on defense and its military interventions in various parts of the world, spending that many friends of freedom may view as unnecessary and misplaced, but the Defense Department’s planned $516 billion spending in the current fiscal year, nonetheless, makes up only approximately 15 percent of overall federal budget. A lot of wasted money, no doubt, but right now it is not defense spending, per se, that is driving this growth in the size and scope of government.

    Yet, the new Trump Administration, like virtually all other administrations before it, has insisted that Social Security and Medicare and related expenditures remain sacrosanct – untouchable by any budget cutter’s pen. Plus, the Republican majority leadership in Congress, already unwilling to repeal ObamaCare without putting in its place the GOP’s “moderate-conservative” variation on the national health insurance theme, clearly has no intention of challenging two of the core programs of the American welfare state. (See my article, “For Healthcare the Best Government Plan is No Plan.”)

    If the President and the Treasury keep asking for increases in the national debt limit, and if Congress, in turn, after handwringing and gnashing of teeth about fiscal irresponsibility, continues to raise that debt limit there will clearly be no end to deficit spending.

    A Frozen Debt Limit Means a Balanced Budget

    But there is a simple and straightforward way to bring the fiscal hemorrhaging to an end. Don’t raise the debt limit. In one legislative act, in this case, a non-action, the federal government will have to operate within the confines of a balanced budget.

    With no increase in the debt limit, the Federal government will be legally restrained to spend only what it takes in in taxes and other revenue sources. This, in itself, makes the case for not increasing the debt limit very appealing.

    Of course, this would mean that the government could not cover a part of those expenditures that it has contracted or legislatively committed itself to in previous years. This is what normally generates most of the outcry about needing to raise the debt limit.

    The Congressional Budget Office estimates that in the federal government’s fiscal year, 2017, Uncle Sam will spend a total of nearly $3.96 trillion and collect in taxes about $3.4 trillion, leaving a budget deficit in the neighborhood of $560 billion.

    To stay within the current statutory budget limit during this fiscal year, all that the federal government would need to do is to cut spending across the board by about 14 percent. Given the mismanagement and waste that virtually everyone admits goes in every bureau, agency, and department run by the federal government, a 14 percent “trimming” does not threaten (some might say, unfortunately) any of that “cutting to the bone” that the budget busters among both Democrats and Republicans constantly warn about.

    Either You Spend Your Money or Government Does

    But we should also realize that if the government is prevented from any more borrowing, it would become crystal clear that the government does not possess an unlimited financial horn-of-plenty from which to satisfy every conceivable ideological and special interest demand for which an appeal is made to Washington.

    If any of these demands for government spending above what can be covered by current government revenues were to be satisfied, it would then compel politicians and bureaucrats to tell the American public that which they avoid admitting like the plague: there is an inescapable trade-off between the people spending their own money and government taxing it away and spending it instead.

    In other words, no longer could there be the illusion of a “free lunch,” in which the federal government makes it seem that something can be had for nothing, or at less than its real full cost. Every additional dollar of higher government spending above what is currently collected in taxes would require one less dollar left in the hands of private citizens who had produced and earned it because that extra dollar of government spending would require an extra dollar of taxes taken out of the taxpayer’s pocket. (See my article, “Why Government Deficits and Debt Do Matter.”)

    This would require the citizens and the taxpayers of the United States to ask themselves exactly what it is they want the government to spend money on, and for which they will have to make the hard choice to have less money in their own pockets to pay for it.

    In other words, the American people would be reminded that there is a thing called “scarcity,” that the resources and financial means to obtain all that we would like to have is limited and insufficient relative to our wants and demands for things.

    Balancing the Budget Means Accepting Trade-Offs

    We each make such trade-offs and hard choices in our own personal, daily lives. Out of our take-home pay we decide whether we are willing to sacrifice going on that desirable but more expensive vacation so to put more money in our savings account to have the means to repair the roof on our home or to have more money put aside to pay for our child’s education when they are ready to go off to college.

    Or if we put that new flat-screen television on our credit card, we know it may mean planning to go out to dinner less frequently for a while, since our monthly payment will be higher while we are paying it off, including more interest on that borrowed money.

    A balanced budget for the government means having to prioritize what it can afford to spend, and on what – just like you and me.

    Would the burden of cuts have to fall on “discretionary” government spending – including defense – if “entitlements” remain off the table? Yes, but that in itself would impose hard thinking on the American people as to whether they are willing to face the fact that it is the entitlement programs like Social Security, Medicare, and whatever may replace ObamaCare that are sucking up the greatest amount of what the government takes in as taxes now and will be even more so in the future.

    Deciding on the Role of Government in Society

    The American citizenry would be forced to look at themselves in the mirror, and ask whether they are willing to pay the higher taxes to cover these rising entitlement costs, or whether they are finally going to accept the fact that real entitlement reform must be undertaken – including ending government responsibility and involvement in people’s retirement and health care costs altogether through full privatization and real free market alternatives. (See my article, “There is No Social Security Santa Claus,” on the coming fall of Social Security under current legislation, and a market-based policy for its full repeal.)

    These are tough choices, given the increasingly embedded psychology of paternalistic government dependency, and the politics of trying to live at other people’s tax expense for things we want the government to do for us.

    But either we face this reality and reevaluate the role of government in society or we go on “busting the budget” with continuing deficit spending, growing the national debt, and inviting potential financial ruin for ourselves and our posterity.

    The inescapable choice is ours.

  6. Entitlements driving Washington to trillion-dollar deficits

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    The Congressional Budget Office (CBO) recently released the “The Budget and Economic Outlook: 2017 to 2027.” This annual report provides the federal government’s most comprehensive analysis of the current state of federal spending, taxes, and debt. It also provides a framework within which to analyze the President’s budget proposal and upcoming Congressional legislation.  The news is not good.

    CBO projects that tax revenues over the next decade – 18.1 percent of the gross domestic product (GDP) – will exceed all other ten-year periods in American history outside of the 1990s. Yet spending will surge to 23.4 percent of GDP in a decade, resulting in a 2027 deficit of $1.4 trillion.

    A decade from now, rising entitlement spending and interest on the national debt will consume 99 percent of tax revenues – forcing virtually the entire discretionary spending budget to be financed on the nation’s credit card.

    Over the next decade, the national debt is projected to rise from $20 trillion to $30 trillion, and reach 107 percent of GDP for the first time since World War II.

    Between 2009 and 2015, the deficit declined due to sequestration cuts, a modest economic recovery, and tax hikes. The deficit began increasing again last year, and – driven by entitlements and net interest costs – is projected to reach $1 trillion by 2023.

    Washington will spend $31,154 per household this year. Federal spending is projected to jump another $5,800 per household over the next decade (adjusted for inflation).

    Social Security, health entitlements, and net interest costs are responsible for $2.1 trillion of the $2.6 trillion growth in projected federal spending over the next decade. These items comprise 57 percent of current spending, yet will account for 82 percent of all new spending over the next decade.

    Net interest costs – $241 billion in 2016 – are projected to reach $768 billion by 2027. And even that assumes interest rates remain far below historic norms. Rising interest rates would push budget deficits over $2 trillion within a decade.

    Individual income tax revenues are projected to reach 9.7 percent of GDP in 2027 – the highest level in American history outside of bubble-inflated 2000.

    The budget deficit predictably fell from its 2009 peak because the recession ended, taxes were increased, discretionary spending was capped, and low interest rates limited the net interest costs on new debt. However, over the next decade, sharply rising Social Security and heath care spending, higher interest rates on the national debt, and sluggish economic growth are projected to bring back trillion-dollar deficits. Lawmakers will face difficult decisions to rein in this spending and debt, and to ensure economic prosperity.

    For full report click here

    Brian Riedl is a senior fellow at the Manhattan Institute. Follow him on twitter @Brian_Riedl.

    This piece was originally published at Economics21.

  7. Healthcare will never be affordable without action on prices

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    Republican reformers have repeatedly promised affordable healthcare for all Americans — doubly affordable, in fact. They promise sufficient subsidies to put premiums and out-of-pocket costs within reach of low- and middle-income consumers. At the same time, they promise that the plan will be affordable to the federal budget, even given the constraints their most conservative members would like to impose on federal spending.

    Unfortunately, the American Health Care Act (AHCA) now before Congress will make healthcare affordable in the budgetary sense only, by making it less affordable in the individual sense. According to analysis by the Congressional Budget Office, the AHCA will reduce the budget deficit by $337 billion over a ten-year period, but only at the expense of reducing the number of insured by 14 million in the near term and by 24 million after the full effects of the bill come into force. As the CBO points out, even many people who retain coverage will find it more expensive because the ACHA tax credits will be less than the subsidies available through exchanges under the current Affordable Care Act (ACA). For others, the only option that will become more “affordable” is that of going without insurance, due to the ACHA’s elimination of the ACA’s individual mandate.

    Under the ACHA or ACA, one uncomfortable fact remains unavoidable: There is no way to make healthcare affordable for either the budget or individuals without strong action to control prices for drugs, medical devices, hospitals, and doctors’ fees that are higher than in any other country. The current draft of the ACHA does nothing to deal with that critical problem.

    The Elephant In The Room

    Princeton economist Uwe Reinhardt calls high healthcare prices the “elephant in the room.” Yes, he says, there is waste at every level of the U.S. healthcare system. Yes, U.S. doctors and hospitals probably do overuse some procedures (C-sections) and tests (MRIs). Still, Reinhardt argues that by and large, it is the high price of care, not an excessive amount of care, that makes our healthcare so much more costly than that of any other advanced country. We don’t have more hospital beds per capita, or more doctors, or more births. We just pay more for each unit of service.

    Reinhardt cites data from the International Federation of Healthcare Plans to back up his claim. For example, in 2012, the average cost of an appendectomy in the United States was $13,851, compared to $5,467 in Australia, the country with the next highest price. For a normal delivery, the U.S. price was $9,775 compared to $6,846 in Australia. The range of prices charged within the United States was even more astonishing than the average. At the twenty-fifth price percentile, an appendectomy in the United States cost $8,156 — higher than Australia’s average. At the ninety-fifth percentile, the U.S. price was an astounding $29,426. A normal delivery in the United States raged from $7,282 to $16,653.

    What causes high prices and what can we do about them? Here is a list of some of the most common ideas. (Warning: Each of the following paragraphs would have to be expanded to its own long post — or even to a doctoral dissertation — for a complete treatment.)

    Lack of Transparency

    A lack of transparency helps keep prices high by discouraging consumers from shopping around for the best deal, even when their problem is not so acute that they have no time to shop. As Reinhardt puts it, “Fees in the private [healthcare] sector have been jealously guarded trade secrets among insurers and providers of health care.”

    Some reformers hope to encourage consumers to be smart comparison shoppers by imposing higher deductibles and copays and softening the blow with health savings accounts, which consumers can draw on to pay their out-of-pocket costs. However, those devices are useless if consumers cannot get price information in the first place.

    Some insurers are trying to combat the lack of transparency by providing comparative price information, but what they give is not always easy to understand, and many patients do not look at it. A 2015 poll by the Kaiser Family Foundation found that only 6 percent of patients had seen price information on hospitals and doctors, and only 2 to 3 percent had made use of it.

    There are plenty of ideas around to make price information more accessible and easier to use. For example, Jeffrey Kullgren, writing for the New England Journal of Medicine Catalyst, recommends bundling price quotes to show the sum of all fees that a consumer would face for a procedure, rather than separate fees for use of facilities, doctors’ services, supplies, and medications. He also recommends that providers have dedicated staff to provide price information to patients and explain what it means. Providers should also be willing to tell patients what services might not benefit them. For example, a $100 blood test might be essential for one patient but provide no useful information to another.

    Structural Incentives

    Even when price information is available to consumers, the structure of their insurance plan may not encourage them to use it. For example, if a plan covers whatever the provider charges, once a deductible has been satisfied, the consumer has no incentive to look for the best value for major procedures. In another article, Reinhardt  recommends “reference pricing,” a scheme under which an insurer pays only the price charged by a low-price provider in the area, leaving consumers to pay the balance if they choose a higher cost provider.

    Narrow network policies are a step in that direction of reference pricing, but they can meet resistance when patients have established relations with certain doctors and hospitals. Also, some consumers, to their sorrow, find that narrow networks can fail, leaving them with surprise bills from radiologists or anesthesiologists who are not network members, even though the hospitals where they work are.

    Individual consumers are not always the ones to blame for a failure to respond to incentives. Reinhardt notes that employers are also notoriously bad shoppers for low priced care. One reason may be that they think they can pass higher healthcare costs along to workers through lower wages — a hypothesis that many labor economists agree with.

    At a minimum, it is fair to say that a well-structured healthcare system should include some checkpoint in the chain between provider and patient where some party has an incentive to ask whether the product or procedure in question has a medical value that is commensurate with its cost. There is room for discussion as to who this should be or what standards should apply. The problem with the current U.S. system is that often no one at all has an incentive to address this question.

    Fragmentation

    Insurance coverage in the United States is highly fragmented. In the private insurance market, there are many carriers. Small carriers, especially, have weak bargaining power compared to large hospital groups and drug companies. On the government side, coverage is divided among Medicaid, Medicare, and VA systems that have differing authority to negotiate for low prices — and sometimes none at all.

    In the private sector, insurers could be given the power to negotiate jointly with providers in their area. Government providers could also have a way to negotiate jointly for advantageous prices.

    The ultimate in bargaining power would be to have a single payer for all healthcare services. The bargaining power inherent in single-payer systems is one of the main reasons other advanced countries have lower healthcare costs and still manage to produce superior quality of care compared with the United States, where doctors remain in individual practices and hospitals are privately owned.

    Drug Prices

    The issue of pricing has nowhere received more attention than in the case of drug prices. Some observers think the advent of a million dollar pill is not far off. A recent commentary by Scott Alexander provides a good summary of the complexity of the issues involved.

    The central problem is that of balancing the high costs of research and testing against the relatively low costs of producing drugs, once they are in use. The current regime handles this by giving drug companies temporary monopoly rights through patents. During the patent period, producers can charge whatever prices they deem appropriate. After patents expire, competition from manufacturers of generics usually brings the price down toward production costs.

    This regime can have good outcomes or bad. The new generation of drugs to fight hepatitis C, which are very expensive but also very effective, appear to represent the good end of the spectrum. Research that, at vast expense, only fiddles with a molecule or two to produce a drug that prolongs a patent with no added medical benefit is the bad end.

    Price discrimination also contributes to high U.S. drug prices. A 2015 report from Bloomberg found that the prices of seven out of eight common medications cost less abroad than in the United States, even after taking into account the discounts negotiated behind closed doors with some insurers. The cholesterol lowering pill Crestor cost five times more in the United States than in the next-most-expensive country at list price, and more than twice as much even after discounts. The leukemia drug Gleevec cost four times more in the United States, and no discount was available.

    Economists do not universally condemn price discrimination. No one objects when theaters or theme parks charge reduced prices for children. Airlines use price discrimination to keep their airplanes filled — a practice that lowers average prices in the long run and increases the number of fights passengers can choose from. However, there are ways to keep price discrimination from getting out of control without undermining its usefulness in markets where fixed costs are high.

    High barriers to resale across markets are one factor that facilitates price discrimination. For that reason, many reformers suggest allowing consumers to purchase drugs online from retailers in Canada, Mexico, and other countries where prices are lower. Since the United States is the high-price consumer in most cases, moves to reduce price discrimination would probably lower prices here. However, the net gains would be less than suggested by the current cross-border price differential, since curbing price discrimination would probably raise drug prices abroad at the same time it lowered them in the United States.

    Mergers, Monopolies, and Entry Barrier

    Numerous studies (this one, for example) have found that mergers among hospitals tend to raise prices in the affected areas. Mergers between hospitals and physician groups can have a similar effect. During the Obama administration, the Federal Trade Commission began to push back against the wave of mergers. It is not yet clear whether such actions will continue under the Trump administration.

    Entry barriers are another factor that contributes to a lack of competition and higher prices. A recent study from the Mercatus Center notes that thirty-six states do not allow the entry of new hospitals without a certificate of need issued by a government agency. The ostensible purpose is to improve the quality of care by preventing excessive competition. The Mercatus study casts doubt on that claim, showing that by some measures, the quality of medical service is actually lower in states with certificate of need laws.

    Economists have also long argued that limits on admission to medical schools help to keep doctors’ salaries higher than in other equally wealthy countries. Observers on both the left and the right of the political spectrum complain that the American Medical Association acts as a cartel in resisting the expansion of medical schools even as the number of applicants rises.

    Administrative Costs

    The fragmented nature of U.S. healthcare produces higher administrative costs than other countries. Those costs ultimately work their way into the prices of hospital care, physician services, drugs, and every other area of care. A study from the Commonwealth Fund found that in 2014, administrative costs accounted for 25 percent of all hospital expenses—higher than any of eight other countries studied, and double the level of Canada. An earlier study from the Office of Technology Assessment found similar results for total administrative costs in the healthcare system.

    Single payer systems are inherently more efficient in terms of administrative costs. International experience shows that many savings can be realized within a unitary administrative framework without requiring that hospitals be owned and operated by the government or that all physicians become government employees.

    No Simple Answer But a Need for Action

    It should be clear from these examples that there is no single explanation for high U.S. healthcare prices, and no simple solution. Action is needed, but it needs to come across many fronts at once — against mergers, entry barriers, drug prices, lack of transparency, administrative fragmentation, and other problems. If each of these areas could eliminate a single percentage point of the gap between U.S. prices and those that prevail in our high-income peers, we could save billions of dollars a year.

    If the current draft of the AHCA is not revised to address the problem of excessive healthcare prices, it is likely to do little to improve affordability. Any savings it brings can come only from reducing the quantity or quality of care provided, not by reducing costs per unit of service.

    Paul Ryan, the most vocal backer of the bill, insists that this is only the first step. We have to understand, he says, that the AHCA is tailored to meet the arcane requirements of the Congressional reconciliation process, which limits changes to matters directly affecting taxes and spending. He promises a second wave of reforms to address cost controls and issues of efficiency.

    There is a huge danger in this approach, however: Every dollar saved in healthcare costs means a dollar less of revenue for some healthcare provider. Any proposals to cut drug prices, increase competition among hospitals, or squeeze out administrative costs in the insurance industry will face tooth-and-nail opposition from an army of lobbyists.

    The AHCA, if passed in its current form, will satisfy the potent symbolism of repealing Obamacare. Any Republican Senator or Congressman who votes against it will have broken an explicit campaign promise and will face a primary fight in the next election. But once a repeal bill passes — any bill — the political heat will be off. The motivation to tighten the screws on big pharma or the insurance industry, against the will of the lobbyists, will evaporate.

    At the same time, Democrats will dig in their heels against anything that might make the AHCA work better. At least a few Democratic votes will be needed for any further reforms that can’t squeeze through the eye of the reconciliation needle. But where is the political motivation to cooperate? Many Democrats may well prefer to see a half-baked GOP reform collapse in a death spiral, (as I predicted in an earlier post that it will do), and hope to pick up the pieces after the 2020 elections.

    In short, the two-part approach is unworkable. Sen. Tom Cotton was right when he tweeted to his colleagues in the House to “Pause, start over. Get it right.”

    This piece was originally published at the Niskanen Center.

  8. Entitlement reform key to fixing America’s fiscal future

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    In his first address to Congress, President Trump lamented that “the past Administration has put on more new debt than nearly all other Presidents combined.” With federal debt approaching $20 trillion, he is right to be concerned about the rapid accumulation in recent years.

    However, the president did not  mention of Medicare and Social Security, two of the largest and fastest-growing federal programs, and he has previously stated that he sees no reason to reduce spending on these programs. Treasury Secretary Mnuchin reiterated last week, “We are not touching [entitlements] now, so don’t expect to see that as part of this budget.”

    Without substantive reform, it will be exceedingly difficult to address the country’s long-term fiscal problems, and it will only get harder if needed changes are delayed.

    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. Medicare, Social Security, and net interest payments on the debt will account for roughly 55 percent of federal outlays by 2027, an increase over their already significant share of 45 percent last year.

    Source: Congressional Budget Office, “10-Year Budget Projections, January 2017,” Tables 1-2 and 1-3.

    Entitlement spending growth is a major reason that budget deficits are projected to surge over the next decade. Although forecasting ten years in advance is notoriously difficult, the deficit is estimated to exceed $1.4 trillion by 2027 and accelerate further after that, with trillions added to the debt as a result. By 2045, debt held by the public will almost double, to 145 percent of GDP according to the Congressional Budget Office. It is practically inconceivable that politicians would not step in before this happened.  However, if left unaddressed. debt at these levels would severely hamper economic growth, reduce living standards, and put increasing amounts of pressure on net interest payments and other areas of the federal budget.

    Source: Congressional Budget Office, “Long Term Budget Projections, January 2017,” Supplemental Table 1. Annual Data Underlying Key Projections in CBO’s Extended Baseline.

    Efforts to root out waste, fraud, and abuse, or to increase government’s efficiency are certainly worth pursuing, but proposals that eschew any kind of entitlement reform will leave the main drivers of debt in the long-term untouched.

    Similarly, reducing regulatory barriers, improving the tax code, and generally developing a policy framework that allows the economy grow more rapidly are good ideas. To some extent, this could attenuate structural fiscal issues, but even higher rates of growth cannot make them go away.  According to one recent estimate, productivity growth would need to be twice projected levels just to stabilize the debt at slightly lower levels as a percent of GDP. Doubling productivity growth rates would be an impressive accomplishment, but there is a limit to how much it can help the country get out of its debt problem.

    This is why entitlement reform is key. 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.

    For example, the Social Security Trustees estimate that an immediate and permanent benefit reduction of 16 percent for all beneficiaries would be enough to make the program solvent for the full 75-year projection. If nothing is done until the trust fund becomes insolvent in 2034, an immediate 21 percent reduction in benefits would be necessary.

    Phasing in a gradual increase in the retirement age indexed to increases with longevity, or using the chained CPI for cost of living adjustments are measures that could go some way to making the program sustainable without sudden, significant benefits or tax increases. Kicking the can down the road will only increase the magnitude of eventual disruption, when changes will have to be concentrated in fewer years and the burden will fall on fewer people.

    Part of the political difficulty stems from the public. People are wary of reforms that could affect their benefits, and they lack understanding regarding which programs are the drivers of the country’s debt. In a recent poll, 46 percent of respondents said they thought foreign aid, which accounts for roughly one percent of the federal budget, contributes “a great deal” to the national debt, a higher proportion than for any of the other programs polled. It is laudable to take a hard look at spending at all agencies and to excise inefficient or wasteful spending, this alone will not be enough to improve the overall fiscal picture.

    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.

    Charles Hughes is a policy analyst at the Manhattan Institute. Follow him on twitter @CharlesHHughes.

    This piece was originally published at Economics21.

  9. The black hole of Pentagon finance

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    The Pentagon suppressed a 2015 study exposing $125 billion—yes, billion—in administrative waste over a five year period in order to protect its own budget from being slashed. The Washington Post revealed the suppressed report earlier this month.

    The numbers in the report are staggering:

    • 23% of the Pentagon’s $580 billion budget ($134 billion) is spent on overhead and core business operations like accounting, HR, and property management.
    • The Pentagon employs over 1 million people in its back-office bureaucracy.
    • The average administrative job at the Pentagon costs taxpayers more than $200,000.

    But none of this should come as a surprise given how government bureaucracies operate. The political arrangement of the military-industrial complex is very different from the way competitive markets work, which has important consequences. In competitive markets, profit and loss provide continual feedback as to whether companies are using their resources effectively or not. The result is that resources tend to be used where they create the most value.

    But for government (in this case the Department of Defense), profit and loss are determined not by the market, but by a political actor’s ability to navigate politics. Decisions about where resources will go are made by bureaucrats, not consumers and entrepreneurs. This means there is no way to ensure that resources in the defense industry are being used where they are valued most highly. Success is determined by the size of the agency’s budget. This incentivizes bureaucratic bloat and administrative secrecy.

    After all, it’s taxpayer money, so there is little accountability for wasteful spending. The result is that the Department of Defense overspends and under-delivers.

    Impossible to Audit

    Given the incentives at work, it shouldn’t be surprising that this report is not the most recent instance of waste and mismanagement.  Consider that since 1997, the Government Accountability Office has been legally required to audit the financial statements of federal agencies. Despite this requirement, it has been unable to audit the Department of Defense because the DOD has been unable to provide accurate and credible financial documents.

    This fundamental lack of basic accounting processes and controls means that the Pentagon is unable to keep track of its financial resources and expenditures in any kind of meaningful way. But this wouldn’t change the underlying problems anyway. The sheer size and complexity of the military bureaucracy coupled with overly lofty foreign-policy goals means thorough oversight and accountability are virtually impossible.

    The only real solution would be to drastically reduce the size and scope of the military and related government agencies, which would remove many of the incentives for the DOD to overspend and to obfuscate its spending. This reduction, in turn, requires adopting a restrained foreign policy minimizing the use of military abroad and the significant resources necessary to fund such international adventures.

  10. Fiscal and economic implications of higher interest rates

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    As the Mercatus Center’s Scott Sumner often says, one ought never to reason from a price change. Interest rates, like other prices, can change for all sorts of reasons; the implications of the change generally depend on the particular reason for such a change.

    Consequently, there’s no simple answer to the question, “If the interest rate on bellwether bonds, such as a 30-year Treasury bond, increases by 200 basis points, will the average US citizen (or the US Treasury, or both), be better off or worse off?” The most correct answer is “It depends.”

    Any nominal interest rate reflects two predominant influences: the state of economic productivity and the expected future rate of inflation. Of these influences, the inflation rate is far more variable. Most of the decline in nominal interest rates since the 1980s reflects a corresponding decline in inflation.

    Lately, however, both productivity and inflation have been subdued. Inflation has been hovering around 1 percent, while annual total factor productivity growth has been bouncing between 0 percent and 0.6 percent. In light of such figures, today’s remarkably low T-bill yield of just under 2.34 percent is hardly surprising. Still, it’s disturbing to realize that this value reflects market makers’ opinion that current low rates of inflation and productivity growth are likely to persist for some time.

    To say that long-term Treasury bill rates mainly reflect the course of economic productivity and inflation doesn’t mean that those rates don’t themselves depend on monetary policy. Monetary policy is, of course, an important determinant of the inflation rate and of the public’s inflation expectations. In the long run, a looser monetary policy stance means higher inflation and therefore higher nominal interest rates, ceteris paribus. In the short run, however, looser policy can, and often does, lower both nominal and real interest rates. Its ability to do so—especially its ability to lower long-run rates—will be limited to the extent that it results in relatively rapid, upward adjustment in inflation expectations.

    In any event, monetary easing alone can’t reduce rates for long, though it may appear to do so when it happens to coincide with a decline in either productivity growth or inflation expectations. It follows that, despite popular opinions to the contrary, easy money hasn’t had much—if anything at all—to do with the low rates that have prevailed since 2009. Had monetary policy really been easy all this time, spending growth and inflation would not have remained so subdued.

    The more complicated truth is that, although the Fed has added trillions to the monetary base, the demand for both cash reserves and other relatively safe assets has also grown proportionately. That growth is in part a result of other Fed policies, including the decision to reward banks for holding reserves; the adoption and enforcement of Basel III’s Liquidity Coverage Ratio; and the more stringent regulation, if not outright prevention, of many once-conventional (and mostly prudent) kinds of bank lending. These and other measures have served to “shunt” available bank funds into a relatively limited set of markets, contributing to the “easiness” of money in those markets, while making it scarce elsewhere. Bubbles, perhaps; but no suds.

    Having considered why rates are so low to begin with, it’s evident that they might rise in the near future owing to either an increase in the expected rate of inflation or an increase in the growth rate of productivity. Rates might increase by 200 basis points because the expected inflation rate increases by 200 basis points, with no change in the productivity growth rate; because the rate of productivity growth increases by 200 basis points, with no change in the expected rate of inflation; or because the two rates change by other values that sum to 200 basis points.

    Some of those possibilities are of course less likely than others. For several decades now the growth rate of total factor productivity has seldom been as high or higher than 2 percent, or 200 basis points, and more recent experience suggests that it’s likely to remain well below that level for some time.

    Notice that none of these possibilities depend on the Fed’s tightening its policy stance. On the contrary, whatever the more immediate interest rate effects might be, such tightening would almost certainly lead to reduced levels of both actual and expected inflation. Though the effects of Fed tightening on productivity are less predictable, those are also more likely to be negative than positive.

    To come finally to the question that forms the topic of this colloquium, it should be clear by now that the general economic implications of an increase in long-term interest rates will depend on the underlying cause of the increase. An increase based on more rapid productivity growth should be a cause of celebration, for the simple reason that such productivity growth is desirable in itself. Higher interest rates will mean higher costs of borrowing, but those costs will be higher because there are more opportunities to use funds productively and because people can afford to bear the higher rates.

    A substantial increase in rates based mainly or entirely on higher inflation is, in contrast, likely to do more harm than good. Even those experts who favor a rate of inflation close to 2 percent doubt that still higher rates are desirable. Because it tends to distort relative prices, inflation at such rates is likely to undermine both productivity and overall economic prosperity.

    To the extent that it hasn’t been fully anticipated (and it is clear that markets today are not anticipating any substantial rise in inflation), a higher rate of inflation will also tend to reward debtors at the expense of creditors. In particular, it will reduce the government’s real debt burden at the expense of those who own non-indexed Treasury securities. The government might, therefore, benefit from an inflation-based increase in long-term interest rates, even though such an increase would make things worse for the average Joe.

    This piece was originally published at the Mercatus Center.

  11. A political economist explains the best way to shrink the government in 9 charts

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    Let’s say that you’re a policymaker interested in reducing the size of government. Strategically, is it easier to cut government regulation or roll back the welfare state (thereby reducing government spending)?

    The Niskanen Center’s Will Wilkinson recently wrote a piece relating to this question that’s gotten a lot of attention: “What If We Can’t Make Government Smaller?” His argument rests on an inference from what’s known as Wagner’s Law, or the law of increasing state spending. This law suggests that as per-capita GDP rises in a country, so does the government share of GDP.

    If this empirical regularity reflects a kind of law of politics, it suggests that it’s impossible to cut government spending as the economy continues to become more prosperous.

    Wilkinson argues we should instead focus on deregulation and leave the welfare state alone.

    Note: Whether one believes that the welfare state is just or efficient is a totally separate question from the one that Wilkinson’s piece raises. You could think that the welfare state is unjust and inefficient yet be persuaded by Wilkinson’s argument that shrinking it is just too difficult in the near future. Or you could support the welfare state yet not be persuaded that it’s invulnerable to political attacks. In fact, there’s an ongoing debate in political science on just this question. The general consensus seems to be that welfare states have remained stable in size, but that economic risks have become more privatized.

    Questioning Wilkinson’s Conclusions About Reducing the Size of Government

    I want to take a closer look at the data on this question of whether welfare state or regulatory state retrenchment is politically easier.

    First, we need to make a distinction between welfare state transfers and the overall economic footprint of government. “Government consumption” measures what the government spends on wages and benefits and goods for its own use.

    We see no Wagner’s Law in government consumption (Figure 1, data from Penn World Table 9.0).

    reducing the size of government

    Figure 1: U.S. Government Consumption/GDP Over Time

    In fact, in periods of economic prosperity, like the 1980s and 1990s, government consumption has fallen as a share of the economy. In times of economic stagnation, like the 2000s, government consumption has risen. Of course, it could be that government consumption significantly harms economic growth. Still, these data show little evidence for the view that it’s impossible to cut government consumption.

    So what has risen over time? Welfare state transfers. Between 1985 and 2012, Medicare and Medicaid spending nearly tripled as a share of GDP and are projected to rise further. Social Security spending has also risen, more than quadrupling as a share of GDP between the mid-1950s and early 1980s before leveling off somewhat. Most of these increases are driven by the aging of the population and cost disease in the health care sector, not public demand for new programs.

    What about regulation? Figure 2 shows how the number of pages in the federal register, which includes administrative rules, proposed rules, public notices, and presidential orders, has changed over time.

    Figure 3 does the same for the number of pages in the federal administrative code.

    Figure 4 shows how the inflation-adjusted budgetary cost of enforcing federal regulation has changed over time.

    Finally, Figure 5 shows the number of economically significant final regulations by year for different presidential administrations.

    reducing the size of government

    Figure 2

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    Figure 3

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    Figure 4

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    Figure 5

    However you measure them, the number of regulations octupled between 1963 and 2013. Over that same period, real GDP less than quintupled. The inflation-adjusted budgetary cost of enforcing regulation has also increased by a factor of about 10 over the last 55 years. Every recent presidential administration has added more regulation, but the Reagan administrations are an outlier in their lighter regulatory touch. There’s certainly an indication that George W. Bush was a more avid regulator than Bill Clinton, and Barack Obama yet more avid than Bush.

    By any measure, then, the federal regulatory burden has skyrocketed, even as a percentage of the economy. It’s difficult-to-impossible to believe that the state and local regulatory burden has fallen enough to compensate for this rise.

    These data certainly don’t suggest that cutting federal regulation will be easier than trimming the welfare state.

    Whether a Providing a Social Safety Net Makes It Easy to Reduce the Size of Government

    A final point to consider is whether cutting the welfare state would make it harder to cut regulation. Perhaps a social safety net makes voters more amenable to free markets.

    The best way to examine this idea is to look at how changes in free markets correlate with changes in size of government.

    I’ve looked at five-year changes in government consumption share of GDP and in economic freedom, excluding size of government and international trade (which is often controlled by international agreements, not domestic politics) for all western European countries and the Anglo-American democracies of North America and Oceania since 1990. (For 2010–2014 the change examined is just four years.)

    Figure 6 shows a scatter plot of the two variables for all these countries.

    Figure 7 limits the scatter plot to larger countries.

    Figure 8 lags government consumption change by five years.

    Figure 9 does the same for just the larger countries.

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    Figure 6: Government Consumption Change and Economic Freedom Change

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    Figure 7: Government Consumption Change and Economic Freedom Change, Larger Countries

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    Figure 8: Lagged Government Consumption Change and Economic Freedom Change

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    Figure 9: Lagged Government Consumption Change and Economic Freedom Change, Larger Countries

    None of these figures suggest a strong, linear relationship between cutting government and either increasing or decreasing other elements of economic freedom, either contemporaneously or with a five-year lag. Now, this is pretty crude evidence and not definitive on the question, but it definitely casts doubt on the claim that bigger government leads to freer markets.

    Conclusion

    Governments do have a tendency to grow. However, the U.S. has cut government consumption significantly in the past and could do so again. The drivers of welfare spending are the aging of the population and rising health care costs, not political support for new programs.

    And finally, there really is no evidence that cutting federal regulation is going to be easier than cutting spending.