fiscal policy

Bloomberg: Some Health Care For All, but Not Too Much

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This article originally appeared in Bloomberg

Tyler Cowen caught a lot of flak recently for saying something that is clearly correct. A lot of the flak has come from people who have misunderstood the implications of what he wrote.

Here’s the relevant passage:

Trying to equalize health care consumption hurts the poor, since most feasible policies to do this take away cash from the poor, either directly or through the operation of tax incidence.  We need to accept the principle that sometimes poor people will die just because they are poor.…  We shouldn’t screw up our health care institutions by being determined to fight inegalitarian principles for one very select set of factors which determine health care outcomes.

Cowen is right. As both inequality and health-care costs rise, it becomes more difficult to equalize health-care consumption through transfer payments. The size of the transfers eventually becomes untenable. They also become wasteful: You end up providing hugely expensive health-care transfers to people with low incomes who would be better off with cash, housing or something else. Even if it meant they wouldn’t live as long, at least the quality of their lives would be higher.

I think a lot of liberals have taken umbrage because they read Cowen as implying that government programs designed to get health care to poor people aren’t worth the cost. But that does not follow. Cowen is simply saying that we should apply the cost-benefit analysis more rigorously, and that our guarantees of health care are not unconditional.

For example, let’s imagine that there are two diseases, Ailment A and Ailment B, both of which are equally common and both of which shorten life spans. There is a treatment available for each, each of which extends life by an average of one year. But the treatment for Ailment A costs $1,000, and the treatment for Ailment B costs $100,000.

Providing treatment for Ailment A to those who cannot afford it should be a clear public-policy priority. Treating Ailment B is a much less compelling government purpose, and we might leave people to finance such treatment on their own. Thus poor people who lack privately purchased insurance and get Ailment B would die sooner simply because they are poor.

Maybe that sounds cruel to you. Maybe you think Ailment B should be covered at taxpayer expense. So let’s imagine that treating Ailment B costs $1 million, or $10 million, or that the treatment only extends life by only a month, or a week. There has to come a point where treatment is so cost-ineffective that financing it is a bad use of taxpayer dollars — even though those with the means to get treatment might choose to buy it. The question for policy makers is this: Where should that line be drawn?

In deciding, it’s important to remember why we have transfer payments in the first place. There is declining marginal utility of money: A person who makes $10,000 gets more value out of an extra dollar than a person who makes $100,000 does. So, transferring wealth from rich people to poor people makes the public better off in the aggregate.

But high tax rates and generous benefit programs both discourage people from working and producing. Public policy needs to strike a balance between transferring wealth and encouraging the creation of wealth — and therefore leaves some people much wealthier than others.

So, the transfer budget has to be limited, and policymakers have to decide how to allocate it. It’s not obvious that “fully equalized health care access” should be anywhere near the top of the priority list.

That calculus is already implicit in any government health-care program. No program simply cuts a check for anything a patient or physician wants. But politicians don’t like to talk about that, because Americans react badly to the idea that health benefits should be subject to cost-benefit analysis. In recent years, they have been egged on by Republican politicians who insist that attempts to increase cost control in Medicare amount to “death panels.”

In practice, the political barriers to getting government-funded health programs to deny treatments are much higher than they should be, which is a big reason the U.S. spends so much money on health care. This wasn’t a reason to leave tens of millions of Americans without insurance. Still, expanded coverage will make the lack of cost control even more fiscally pressing than it had been.

Unfortunately, the cost of health-care entitlements will swallow the federal budget if we don’t get more comfortable with the idea of cost-benefit analysis. In time, we will need to set stricter limits on what sort of treatments taxpayers are expected to finance. In other words, we’re going to have to get more specific on when exactly we will let people die simply because they are poor.

Of course, this is not consistent with the idea that there is a “right to health care.” A right to what health care? Well, “basic” health care, is usually the reply. Or, if you prefer, “sufficient.” So what does “basic” or “sufficient” mean? That this is a question subject to political debate and cost-benefit analysis is your clue that we’re dealing not with a right but with a strategic question of how to best improve public welfare, in which health care is only one of many goods available.

Instead of “Health Care for All,” maybe the slogan should be “Some Health Care for All, but not Too Much.” It’s not sexy, but unlike the policy status quo or the health-policy agendas of both parties, it’s something we can afford for decades to come.

The New York Times: A Power Vacuum Is Killing the Euro Zone

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This article originally appeared in The New York Times

As problems mount in the euro zone, it’s increasingly evident that we’ve been witnessing an institutional failure of monumental proportions.

What is to be done about Greece? Simply keeping it in the euro zone won’t help much, even if it’s possible.  The continuing crisis has sapped confidence in banks not only in Greece, but also in Spain, Italy, Portugal and Ireland, though to varying degrees.  Unless there are explicit guarantees to these banks soon, the market will likely take a further turn for the worse.

An absence of guarantees could prompt a broader chain reaction of capital flight and bank collapses across several countries.

The basic problem is that many people won’t keep their euros in a Greek bank, and perhaps not in a Spanish bank, either, when those euros can be moved to Germany or some other haven.

Yet German citizens do not appear ready to guarantee Spanish banks or, by extension, the whole credit system of Spain and the other periphery nations. Guarantees of that scope are probably impossible and may also require constitutional changes in some nations.

We thus face the danger that the euro, the world’s No. 2 reserve currency, could implode.  Such an event wouldn’t be just another depreciation or collapse of a currency peg; instead, it would mean that one of the world’s major economic units doesn’t work as currently constituted.

We are realizing just how much international economic order depends on the role of a dominant country — sometimes known as a hegemon — that sets clear rules and accepts some responsibility for the consequences.  For historical reasons, Germany isn’t up to playing the role formerly held by Britain and, to some extent, still held today by the United States.  (But when it comes to the euro zone, the United States is on the sidelines.)

There appears to be a power vacuum, and the implications are alarming. We may be entering a new world where international cooperative arrangements, in environmental areas as well as finance, are commonly recognized as impossible.  If the core European nations cannot coordinate effectively, what can we expect in dealings with China, Russia and other countries that have less of a common background and understanding?

In the euro zone, we are seeing two refusals to cooperate: Germany won’t renew financial pledges to Greece without Greek compliance on previous agreements, and Greece doesn’t want Germany to control its national budget.  Both seem reasonable positions, and maybe they are, but reasonable positions can apparently destroy an international agreement rather easily.

Is there a way out?  To seek a binge of pro-growth government spending, in the hope of stimulating economies, is to assume what already stands in doubt. The crisis has reached a head partly because the market already lacks trust in the periphery governments to invest money for sustainable economic growth.

There is also talk of forming a true fiscal union, but that seems to be doubling down on a bad idea.  If the euro zone cannot summon enough cooperation now, how is any union requiring tighter cooperation supposed to work?  How would national budgets be set and approved?  A credit collapse remains a real possibility.

Is it too late for monetary policy to make a difference?  The other euro-zone nations might allow Greece to leave, while guaranteeing payments for food and fuel, both of which Greece imports, for a reasonable period.  Higher price inflation might then depreciate the euro, limit the need for difficult downward wage adjustments, and help Spain and Italy improve their competitiveness.  The inflation could come through central bank bond purchases from the troubled nations, thus easing their debt problems.  That may be the only useful option still on the table.

But that’s also not easy.  First, economically healthier nations may be reluctant to accept the inflation, which would represent a rather direct, continuing redistribution of wealth to the troubled debtor countries.

The second problem is that some of the banking systems in the periphery nations may be too broken for monetary policy to take hold.  Imagine the European Central Bank trying to infuse new money and credit into Spain, while bank deposits move quickly to Germany, Switzerland and other safer places.  Again, why would anyone want to keep money in the bank of a fiscally troubled nation?  That loss of confidence will not be easily repaired.

Since December, the European Central Bank has lent more than a trillion euros to euro-zone banks, but that has bought no more than a few months of peace.  It isn’t clear how much more can be done.  It probably is about time to judge the euro zone as a failed idea — and rarely is it wise to double down on failed ideas.

What is most disturbing is that the euro-zone nations are democratic, protective of basic liberties, and have advanced intellectual and research communities. The final lesson of this debacle is that smart nations with noble motives can make very big mistakes.  And that should concern us all.

Tyler Cowen on NPR: Credit Downgrade Should Serve as a Wake-Up Call

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Just before Standard and Poor’s downgraded U.S. debt, economist Tyler Cowen warned it would be a distraction to slam the ratings agency. Many analysts and economists doubt S&P, but Cowen argues in his blog “Marginal Revolution” that there are some real lessons to learn. He discusses them with Steve Inskeep.

Listen: Tyler Cowen Discusses the U.S. Credit Downgrade

It’s Time to Face the Fiscal Illusion

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This article was originally published in The New York TImes

Fiscal policy debates often focus on technocratic questions about how much money the government should spend and when, yet the actual course of events depends not on the experts but on politics. The more that our government runs up unfunded obligations and debt, the more we are setting a trap for ourselves.

James M. Buchanan, a Nobel laureate in economics — and my former colleague and now professor emeritus at George Mason University — argued that deficit spending would evolve into a permanent disconnect between spending and revenue, precisely because it brings short-term gains. We end up institutionalizing irresponsibility in the federal government, the largest and most central institution in our society. As we fail to make progress on entitlement reform with each passing year, Professor Buchanan’s essentially moral critique of deficit spending looks more prophetic.

We are fooling ourselves most of all. United States government debt in public hands is now more than $9 trillion, but most people still don’t realize what it will take to pay that off.

Here’s an example: Say that you have $20,000 in Treasury bills. You probably believe that you own $20,000 in wealth. This will encourage you to spend and come up with ambitious plans. Yet someone — quite possibly you — will be taxed in the future to pay off the government debt. The $20,000 may be needed in order to do that.

The illusion is this: A government bond represents both a current asset and a future liability, yet for most people, those future tax payments feel less concrete and less real than the dollars they’re holding in a money market account.

The field of behavioral economics analyzes imperfections in market decision-making, but the biggest practical problems often involve our inaccurate perceptions of what the public sector is up to and how much it will affect us.

In this case, the sorry truth is that our savings aren’t worth as much as many of us think, and a rude awakening is coming. One way or another, some of our savings will be taxed away to make good on governmental commitments, like future Medicare benefits, which we currently are framing as personal free lunches.

Keynesian economics talks of the “fiscal illusion” created by government debt: the issuance of such debt can stimulate the economy in the short run by encouraging a false perception of wealth and thus bolstering consumer spending. But, eventually, the books must balance. There is then a fiscal crunch, a sudden retrenchment of plans and great rancor over budgets, as we have been seeing lately at both the federal and the state level.

The famous Keynesian rejoinder, “In the long run we are all dead,” is less comforting when that long run comes into sight. Short-run planning is a hard carousel to stop, especially when there are frequent election cycles, but the federal government must act soon. Limiting Medicare and Social Security spending involves re-indexing benefits, adjusting eligibility ages, shifting the growth rates of costs and making other changes that have their full fiscal impact only over the longer run.

Yet we are postponing even these actions. Experts’ recommendations might lead us toward a fiscal smooth landing, but at this point the fiscal illusion — and not the advice of experts — is in control. So Professor Buchanan’s argument is ringing true.

The technocratic Keynesian recommendation was to run deficits in bad times and surpluses in good times. But except for one stretch during the Clinton administration, this notion has been broken since the early 1980s. In the United States, at least, Keynesian economics has failed to find the necessary political institutions to enact and sustain a wise version of the theory.

Now that fiscal constraints are starting to bite, many politicians are afraid to reform or even to discuss changes in the largest problem areas: Medicare and Medicaid. Yes, some laudable cost controls on Medicare are embedded in the new health care law, but they’re not enough. Most likely, we will end up making other spending cuts that won’t solve our fiscal problems — and in areas that could instead benefit from Keynesian employment stimulus. These kinds of knee-jerk, poorly reasoned decisions are what happens when fiscal illusion reigns.

Fiscal austerity may sometimes sound like a dogmatic religion, but fixed principles often help us do the right thing, especially when temptation beckons. Professor Buchanan argued that the real choice was between a religion of budget balance and a rule of illusion. Seeking an optimal technocratic path is not on the menu.

So, given this mess, what should be done?

As Matthew Yglesias from the Center for American Progress has proposed, President Obama could pledge to veto any budget that increases the projected medium-term deficit, relative to the status quo. He should include in that veto threat any deficit increases that arise from annual budgetary gimmicks like patches to the alternative minimum tax or the “doc fix” adjustment of Medicare reimbursement rates.

Such an announcement would not fix health care costs, but it would force us to recognize them, and would move us away from purely short-term planning. It would force the government to consider both spending cuts and tax increases.

In any case, the rigor of the numbers will soon sweep away the fiscal illusion. The only question is whether we will end the charade on our own terms or continue to play the fool.

What Germany Knows About Debt

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This article was originally published in The New York Times

In many countries, including the United States, there are calls for the government to spend more to jump-start the economy, and to avoid the temptation to cut back as debts mount.

Germany, however, has decided to cast its lot with fiscal prudence. It has managed rising growth and falling unemployment, while putting together a plan for a nearly balanced budget within six years. On fiscal policy and economic recovery, Americans could learn something from the German example.

Twentieth-century history may help explain German behavior today. After all, the Germans lost two World Wars, experienced the Weimar hyperinflation and saw their country divided and partly ruined by Communism. What an American considers as bad economic times, a German might see as relative prosperity. That perspective helps support a greater concern with long-run fiscal caution, because it is not assumed that a brighter future will pay all the bills.

Even if this pessimism proves wrong more often than not, it is like buying earthquake or fire insurance: sometimes it comes in handy. You can’t judge the policy by asking whether your house catches on fire every single year.

Keynesians have criticized fiscal caution at this point in the economic cycle, arguing that fiscal stimulus will give economies more, not less, protection against adverse events. But is that argument valid?

Certainly, in Germany, the recent history of fiscal stimulus wasn’t entirely positive. After reunification in 1990, the German government borrowed and spent huge amounts of money to finance reconstruction and to bring East German living standards up to West German levels. Millions of new consumers were added to the economy.

These policies did unify the country politically but were not overwhelmingly successful economically. An initial surge was followed by years of disappointing results for output and employment. Germany’s taxes remain high, and overall West German living standards failed to rise at the same rate as those of most other wealthy countries.

Persuading former East Germans to spend more as consumers turned out to be less important than making sure that they had the skills to mesh with the economic expansion of the country. It is no surprise that many Germans are now skeptical about debt-financed government spending or excessive reliance on domestic consumers.

In recent times, Germany has shown signs of regaining a pre-eminent economic position. Policy makers have returned to long-run planning, and during the last decade have liberalized their labor markets, introduced greater wage flexibility and recently passed a constitutional amendment for a nearly balanced budget by 2016, meaning that the structural deficit should not exceed 0.35 percent of gross domestic product.

Amid the sluggish economies of much of Europe, Germany has booming exports and is nearing full capacity utilization. And many of its workers are postponing vacations to produce, and earn, more. The unemployment rate in Germany is 7.5 percent — below that of the United States — and falling.

Far from embracing this social democratic model, American Keynesians have criticized it for relying too heavily on exports and not enough on spending and debt. Yet it is not just the decline in the euro’s value that supports the German resurgence.

Most of the other euro-zone economies are not having comparable success because they did not make the appropriate investments and reforms. Moreover, the euro is still stronger than its average value since 2001, which suggests that the recent German success is not attributable only to a falling currency.

In any case, the Germans are exporting much quality machinery and engineering (not just glitzy autos), which can help other nations recover. It is an odd state of affairs when the relatively productive nations are asked to change successful policies because of an economic downturn.

The German government is also making credible long-term commitments to reduce its debt. Germany’s ratio of debt to G.D.P. has been hovering in the unhealthy range of more than 70 percent, and the country has one of the lowest birth rates in the developed world, which raises the question of how to pay for future pensions.

Yet many investors consider German bonds a haven, in part because the government has a reputation for addressing fiscal issues promptly and responsibly. It is working to cut government spending, although not in crucial long-term areas of research and education.

Germany is likely to continue having a higher relative level of government spending than the United States. But the German civil service has a stronger hand in writing legislation — a role that limits the sort of waste and short-term thinking that Congress injects into American law. It is also well understood in German political discourse that tax cuts need to be paid for.

The German economy is far from perfect. In addition to high taxes and a low birth rate, there are potential solvency problems in German banks, and these institutions lack transparency. Furthermore, poorer countries may need a looser monetary policy from theEuropean Central Bank than Germany wishes to support.

Nonetheless, it’s a common German attitude that adding debt, whether private or public, will not solve those problems. In fact, debt can provide the illusion of relief and thus postpone their resolution. Increased spending is a quick fix for what are very often more fundamental difficulties.

The point is not that Americans can or should copy Germany. But are German policy makers so wrong in their long-term orientation? We can lecture, or we can listen. The choice is ours.

Can’t Cut Spending? Look Around the Globe

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This article was originally published in The New York TImes

America’s long-run fiscal outlook is bleak, mostly because of an aging population and rising health care costs. To close the gap between expenditures and revenue, we’ll likely see a combination of revenue increases and spending cuts. And we’ll need to focus especially on reducing spending, largely because that taxes on the wealthy can be raised only so high.

Consider the tax burden on high earners once the Bush administration’s tax cuts expire next year. Add up the federal, state, city and sales taxes for a lawyer in New York City who earns $300,000 a year. Depending on the circumstances, this individual could be facing marginal tax rates in the range of 60 percent. Higher income tax rates would discourage hard work and encourage tax avoidance, thereby defeating the purpose of the tax increases.

The most potent way to add revenue is to impose a value-added tax. As its name indicates, a V.A.T. takes some percentage of the value added at each stage of production. V.A.T.’s raise money so readily and so invisibly that they often climb to a range of 15 to 20 percent; politicians like the revenue, and voters don’t always notice the burden.

A move toward a V.A.T., however, also brings price inflation, a big increase in the tax-collecting bureaucracy and the emergence of favored sectors with exemptions or lower rates. Though we may well end up with a V.A.T., it isn’t obviously the best option.

Burdening citizens with much higher taxes would fundamentally change what this country is about. Our founders envisioned a government that would provide public goods but not guarantee everyone’s well-being against every possible obstacle. Immigrants would be offered a franchise to come here and make good if they could — while bearing considerable risk themselves. To this day, this openness has elevated many millions in health, prosperity and liberty — and enabled many newcomers to innovate and offer new goods and services, or scientific ideas, to the world.

Higher levels of government spending and taxation would also soak up resources that might otherwise foster innovation and new businesses. And sentiment would most likely turn ever stronger against those immigrants who consume public services and make the deficit higher in the short run. Current residents might feel more secure in a larger welfare state, but over time the loss of commerce and innovation takes a toll.

The macroeconomic evidence also suggests the wisdom of emphasizing spending cuts. In a recent paper, Alberto Alesina and Silvia Ardagna, economics professors at Harvard, found that in developed countries, spending cuts were the key to successful fiscal adjustments — and were generally better for the economy than tax increases. Their conclusion was based on data since 1970 from the Organization for Economic Cooperation and Development.

The received wisdom in the United States is that deep spending cuts are politically impossible. But a number of economically advanced countries, including Sweden, Finland, Canada and, most recently, Ireland, have cut their government budgets when needed.

Most relevant, perhaps, is Canada, which cut federal government spending by about 20 percent from 1992 to 1997. The Liberal Party, headed by Jean Chrétien as prime minister and Paul Martin as finance minister, led most of this shift. Prompted by the financial debacle in Mexico, Canadian leaders had the courage and the foresight to make those spending cuts before a fiscal crisis was upon them. In his book “In the Long Run We’re All Dead: The Canadian Turn to Fiscal Restraint,” Timothy Lewis describes Canada’s move from fiscal irresponsibility to a balanced budget — a history that helps explain why the country has managed the current global recession relatively well.

To be sure, the spending cuts meant fewer government services, most of all for health care, and big cuts in agricultural subsidies. But Canada remained a highly humane society, and American liberals continue to cite it as a beacon of progressive values.

Counterintuitively, the relatively strong Canadian trust in government may have paved the way for government spending cuts, a pattern that also appears in Scandinavia. Citizens were told by their government leadership that such cuts were necessary and, to some extent, they trusted the messenger.

It’s less obvious that the United States can head down the same path, partly because many Americans are so cynical about policy makers. In many ways, this cynicism may be justified, but it is not always helpful, as it lowers trust and impedes useful social bargains.

Forces like the Tea Party movement argue for fiscal conservatism, though it isn’t obvious that they are creating the conditions for success. Over the last year, we have been treated to the spectacle of conservatives defending Medicare against proposed cuts, in large part to curry favor with voters and mobilize sentiment against the Democratic health care plan.

Right now there is plenty of concern about debt and deficits, but little consensus on which expenditures should be cut or reined in. Sooner or later, we’ll have to reconsider virtually every segment of the federal budget.

The issue of fiscal responsibility isn’t going away. So the question is now this: How deeply will we dig ourselves in before we create a more mature and more forward-looking political culture?