Diogenes of NY

Why Most Government Antipoverty Programs Aren't Effective

In Part 1 Diogenes discussed in economic terms what it means to be poor in America and reviewed federal programs for those in need. After 50 years of effort and spending at a rate of about $600 billion/year, more Americans are poor than when the programs began. An old adage states that “insanity is repeating the same mistakes and expecting different results.” Here we will look at a policy alternative to current approaches.

The primary reason for the failure of governmental poverty programs is an “agency problem.” The antipoverty bureaucracy has itself often become an impediment to those who would try to climb out of poverty because of disincentives for working. We have agencies that try to insure that those receiving aid it use it for “correct” purposes (milk, not beer).  Such attempts always fail because nobody spends somebody else’s money as carefully as their own. And then there is the cost of the agency. For example, the food stamps program (SNAP) has program costs of about 12%.

Add in waste and poor management, and today America cumulatively spends more on poverty programs than it would cost to raise the income of every American above the poverty level. Even assuming NO income for the 46.2 million Americans in poverty, and multiplying by the $11,170 per capita that is the level below which per capita poverty is defined, would cost about $514 billion. The costs would be considerably less if we gave this aid on a household income basis.

The only enduring cure for poverty is increasing production of goods and services which result in greater demand for labor, because ultimately jobs are needed to pull people out of poverty no matter how good government antipoverty programs are. In other words, free markets are the ultimate antipoverty programs.

What We Should Do

Diogenes believes that America should implement a Guaranteed Minimum Income (GMI). Also known as a Negative Income Tax (NIT), a GMI would provide baseline support to which all would be entitled. Diogenes would define this as the federally defined household income poverty level of $23,050 for a family of four, plus $1. Adjustments up or down would be made for additional children and for each state’s cost of living.  The GMI would be implemented through the tax code utilizing IRS infrastructure.

The GMI is not a new idea. Milton Friedman advocated for a NIT in the early 1960s. Legislation was first proposed during the Nixon administration, and had support from both liberals and conservatives along with a long list of recipients of Nobel Prizes in Economics and other economists, but ultimately did not pass Congress.

Almost all other antipoverty programs should be phased out in order to pay for the GMI. The GMI would be far more efficient than welfare, food stamps, subsidized housing, unemployment benefits, and the 47 different federal job training programs. The GMI should be progressively phased out at a rate of 50% reduction of benefits per dollar of income, so as to incentivize Americans to find any sort of work at any wage.

The GMI would also necessitate a repeal of minimum wage laws, as all workers would already be guaranteed a base income just above the poverty level. Any work income would incrementally reduce government assistance even as the workers’ household income rose to median levels. Reducing the costs of unskilled labor would encourage business to hire more workers, providing crucial entry level jobs that are priced away with existing minimum wage laws.

At first blush, the move to a GMI might appear to be a radical shift away from the status quo. However, the GMI would be a dramatic expansion of perhaps the single most efficacious federal antipoverty program, the Earned Income Tax Credit (EITC). Congress first implemented the EITC in 1975 to offset the burden of social security taxes for the working poor, in order to provide greater incentive to work. When the EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit. According to the IRS, the total cost of the EITC was $61 billion in 2011, and program costs were less than 1%. It helped move 6.6 million Americans, half of them children, out of poverty. In 2013, the maximum credit to a married couple filing jointly with three children is $6,044. The credit phases out as income increases to about the national median income level.

Why This Hasn’t Been Done Before

Diogenes proposes to dramatically expand the single best program we have and replace lots of programs that do not work. The incremental cost would be nothing because the change would redirect current antipoverty funding. And if the program succeeds, it’s cost would decline. So who would disagree? For starters, the entire federal antipoverty bureaucracy who would lose their jobs. Unlike the private sector, government is rarely reorganized when the results yield fewer jobs.

Historically, government antipoverty programs have seemed reluctant to give cash aid to the poor. For example, food stamps have value restricted to consumable products excluding alcohol, as if aid recipients didn’t know how to spend what funds they have. The moral legitimization of the welfare system requires that recipients use aid to support lifestyles that comport in some rough sense with the idea of a good life held by taxpayers who provide the funds. In the minds of many, it’s one thing to provide a safety net, and another to support those who just don’t want to work. The counter argument is that by keeping a GMI at a less than “comfortable” level for able bodied Americans, incentives to work would dramatically increase.

Others might argue that there are other problems with a GMI:

• The incentive to work is reduced, however marginally, by providing any level of guaranteed income.
• If government lowers the minimum guaranteed level below an absolute safety net, we don’t fulfill our societal imperative to provide for all who are unable, for whatever reason, to provide for themselves.
• By having only a gradual phaseout of support as income grows, we invariably will pay (some) benefits to those above the poverty level.
• Whatever the initial level of a GMI, politicians will continue to raise the amount until it eventually bankrupts us. Just look at Social Security, welfare and the Income Tax for examples.

The rebuttal to these arguments is that living at the no work GMI base level is pretty tough in America. No one would want that kind of life if they could reasonably easily augment it. Raising lower than median incomes to the median level (about $51,000 for a family of four), would be an excellent use of American resources. Because of income inequality, this measure is far below the mean income, and we are already spending at the cost of a GMI with far less effective programs. A limit to future spending largesse could be enshrined in the legislation by defining the base income to $1 over the poverty level and by pegging the phaseout of the GMI to an upper limit just below the median income.

A GMI would not be a perfect program, but the perfect is not to be found. It would be a significant improvement over current antipoverty programs and would not cost taxpayers a dime. Isn’t that something virtually everyone wants?

What does it mean to be poor in America?

There are many ways of defining poverty. For most of recorded history, man’s basic needs were food, clothing and shelter. In recent generations, we have included access to clean water, sanitation, health care and education. Poverty can also mean a relative lack of material goods or money, so that in every “free society” (where inequality in income to some extent reflects inequality in ability and effort)  some portion of the population will be considered poor.

We can also define poverty in overtly economic terms. The federal poverty threshold is $11,722 in annual income for an individual, and $23,497 for a family of four, which is about 44% of mean income for an individual and 30% of the mean for a family of four. The economic definition of poverty has changed over time, but real wage growth in the 1960s caused the poverty rate to fall from about 20% in the 1950s to around 15% of our citizens today.

A hundred years ago, having enough food to eat meant that you weren’t poor in most places. In most wealthy countries, death by starvation is already very rare. Poor Americans today are not likely to be starving, though malnutrition remains a scourge. Many live in households that have a refrigerator, a washing machine, a high definition TV with cable , an XBox and a cellular phone. In fact, the electronic gadgets used by our poor are not substantially different than those employed by the wealthiest Americans. Overall, the quantities and qualities of what ordinary Americans consume are closer to that of rich Americans than they were in decades past despite growing income disparities between the wealthy and the poor.

The inflation-adjusted hourly wage hasn’t changed much in 50 years. Still, it is unlikely that an average American, even one living in poverty, would trade his wages and benefits in 2013—along with access to the most affordable food, appliances, clothing and cars in history, plus today’s cornucopia of modern electronic goods—for the same real wages but with much lower benefits in the 1950s or 1970s, along with those era’s higher prices, more limited selection, and inferior products.

Is it better to be poor here than elsewhere?

Poverty tends to be defined in the relative sense. The poorest 5-10% of a population would probably be considered poor in any society, but to the extent that “fairness” in a society is defined as less disparity between rich and poor, a higher percent of US citizens would be considered poor than in most other developed countries. The OECD, a rich-country club, provides comparative figures for a poverty line of 40% of median household income after tax and transfer. On that basis America’s rate is 11%, well above the OECD average of 6%.

Another way to define poverty is in an absolute sense rather than a relative one. The World Bank estimates that “extreme absolute poverty” is living on somewhere between $1-2/day/person depending on where one lives. Few Americans are this unfortunate, but something like 20% of the world’s population are subject to these conditions, so most poor Americans could be considered “not poor” in most of the world.

Are federal anti-poverty programs working?

Federal programs to reduce poverty in America trace their origins to FDR and the New Deal in the 1930s, though what most Americans would identify as specific anti-poverty programs were begun in 1964 with LBJ’s Economic Opportunity Act which came to be known as the “war on poverty”. Today, there are more than 120 different federal anti-poverty programs. The major ones are Medicaid, unemployment insurance, food stamps and welfare, ans our government spends about as much on these programs as it does on defense. And yet, almost 50 years later, and despite about $13 trillion dollars spent, the rate of poverty and the total number of Americans living in poverty has not been significantly reduced.

“…the federal government spent more than $591 billion in 2009 on means-tested or anti-poverty programs, and will undoubtedly spend even more this year. That amounts to $14,849 for every poor man, woman and child in America. Given that the poverty line is just $10,830 (in 2009), we could have mailed every poor person in America a check big enough to lift them out of poverty – and still saved money.”  M.D.Tanner, NY Times, 9/16/2010

In general, the liberal left’s approach to social policy is to shield people from the American economy, while conservatives’ approach must be to enable them to enjoy its benefits—to enable people to move up rather than to make them more secure in poverty. Some call for a wholesale rethinking of antipoverty programs.

“The bottom 20% in America are not stuck because their welfare support is insufficient. It is because these cultural institutions are not helping them lead the lives they deserve. Volumes of research have shown that Great Society welfare policies—such as public housing and aid to families with dependent children—fueled family dissolution, community fragmentation, generational joblessness and government dependency. Many … welfare and redistribution policies are encouraging a return to these conditions.” Arthur Brooks, WSJ, 10/8/12

Some might argue that one of the causes of persistently large numbers of Americans living in poverty is that economic mobility constantly moves some of our citizens out of poverty even as others descend into poverty from the middle class. This notion of being able to move from rags to riches in a generation is a fundamental plank of the American Dream. Unfortunately, Americans’ perceptions about their likelihood of changing position in the income distribution may be exaggerated. Those within the three middle quintiles (the middle class) will, statistically, experience some economic mobility. But according to a study by the Pew Economic Mobility Project, 43 percent of children whose parents were born in the bottom quintile remained at the bottom when they became adults. In contrast, 40 percent of children born to parents at the top quintile were also at the top as adults. The study compared inter-generational mobility rates between 1984 to 1994 and 1994 to 2004. In addition, contrary to public perceptions, social mobility in the US is less than in Europe.

What to do?

As a nation, it is dangerous to our social fabric to have created a semi-permanent underclass living in poverty. Spending more on poverty programs does not appear realistic now, especially in fiscally austere times. We need to make sure the programs we do have create incentives to replace handouts with wages, even as we strive to close the opportunity gap through better education for all. The best solutions are complex and to be found through a mix of policies including education reforms and revamping the tax code.

Most Americans, regardless of their political leanings, desire a strong safety net for all citizens. Americans living in poverty do not have comfortable or easy lives, and taking advantage of available programs is incredibly time consuming, even as it is dispiriting. Permanent solutions are to be found not in more funding or more programs, but from economic growth that fuels demand for more employees at higher real wages.

What is the Fed?

The Federal Reserve Bank System is a unique hybrid public-private bank network whose 12 district members are owned by local banks and regulated by a 7-person Board of Governors, each of whom are appointed for one 14-year term by the White House. It was created in 1913 and amended in 1935 primarily to use monetary policy to deal with cyclical bank panics. Congress established three key objectives for monetary policy in the Federal Reserve Act:

• maximum employment

• price stability

• moderate long-term interest rates

The private banks give input to the government officials about their economic situation and these government officials use this input in Federal Reserve Board policy decisions.

How does the Fed employ monetary policy?

Monetary policy should ideally be used in conjunction with fiscal policy as a means to achieve desired national economic objectives. In America monetary and fiscal policies mostly are independent of each other. Congress and our President have led America to the brink of a “fiscal cliff”, and no comprehensive fiscal policy reform seems likely in the near term. This state of affairs has thrust the Federal Reserve Board, and its Chairman Ben Bernanke, to the forefront as the savior/enabler of today’s American macro economic policy.

The primary tools of the Federal Reserve Board are:

• to set bank reserve requirements

• to set the discount rate for interest paid by the Fed on bank reserves

• to conduct Open Market Operations that seek to influence the Fed Funds rate (that is paid by banks to each other for short term borrowings) via open purchases and sales of US Treasury and federal agency securities

Minutes of the regular meetings of the Fed’s Open Market Committee (FOMC) are widely published by the media in order to inform business and banking leaders about probable Fed actions. The Fed has said it doesn’t expect to touch short-term rates until it sees the unemployment rate fall to 6.5% or lower, as long as inflation forecasts remain near its 2% target. That would mean, according to the Fed’s economic projections, that it would keep short-term rates near zero into 2015.

” In case there was any doubt about its resolve, the Fed statement also issued a new implicit annual inflation target: 2.5%. The official target is still 2%. But the Open Market Committee stated that it will keep interest rates near zero, and by implication keep buying bonds, as long as the jobless rate stays above 6.5% and inflation stays no more than a half-percentage point above the Committee’s 2-percent longer-run goal…That is a 2.5% inflation target by any other name, and it’s striking to see a central bank in the post-Paul Volcker era say overtly that it wants more inflation.”  WSJ, 12/12/12 “The Fed’s Contradiction”

Many economists think we have to inflate our way out of the debt crisis. Inflation remains quiescent, but central banks that ask for more inflation likely get it. The Fed is now buying about 70% of new long-term Treasury debt, and when you add “QE3” debt purchases, it appears to be well on its way to monetizing not only the deficit, but also a large chunk of the accumulated federal debt.

Why do the Fed’s policies matter?

Fed policy continues to punish thrift and reward irresponsible debtors. A 2.5% inflation rate and interest rates on deposits near zero compounded diminishes the real value of saving by 1/2 over only 28 years even absent any income or taxes. This is a tax on our middle class. Benefits for those receiving government benefits will be indexed to a CPI. The rich can make investments in hedge funds, private equity and other vehicles that can earn better than inflation adjusted returns after taxes. It is those who have long worked and saved who will pay these penalties.

By keeping interest rates ultra low, central banks including the Federal Reserve may have likely created a ticking time-bomb for investors in the bond market. The risk is that the many retail (middle class) investors who sought safety in bonds don’t fully understand the losses they will face if there is a sustained economic recovery and yields start to rise.

The Fed’s near-zero interest rate policy will continue to disguise the real cost of government borrowing. One reason the Obama Administration can keep running trillion-dollar deficits is because it can borrow the money at bargain rates courtesy of the Fed. Each 1% increase in rates on a $16 trillion federal debt is $160 billion per year, and those increases must begin sooner or later.

For the past four years the Fed has maintained expansionary and unconventional policies and we are told there is still no end in sight. Mr. Bernanke famously failed to predict the 2008 monetary crisis, and then was slow to react (although he did so effectively). Now we are supposed to believe he will know when to pull the ripcord on growing his balance sheet. The Fed and Mr. Bernanke may well be geniuses and get it all just right this time, but Diogenes is not optimistic that this will happen.

Hostess Brands, makers of Twinkies, Wonder Bread and many other relatively “junkie” foods, filed Chapter 7 bankruptcy liquidation papers recently. The company had revenues of nearly $3 billion, and was bought and sold by private equity funds twice in the last 10 years. After loading the company up with debt, Hostess twice filed for Chapter 11 bankruptcy in order to restructure. Six different management teams in the last eight years, each presumably more highly compensated than its predecessor, failed to change the company’s product offerings to respond to the market’s demand for healthier products.

The liquidation was triggered by a nationwide strike by the 5,600 employees who were members of the Bakery, Confectionery, Tobacco Workers and Grain Millers Union (BCTWG). 92% of that union’s employees rejected a new collective-bargaining proposal in September. The company’s offer included an 8% wage cut in the first year, a 17% increase in employee health-care costs and changes to workers’ pension plans that could have reduced payouts. Hostess long had said it couldn’t survive without cutting labor costs, even as it enraged workers by increasing top executives’ pay by 60% earlier this year. In a move reminiscent of Russian Roulette, the bakers union workers essentially pulled the trigger for all of the company’s workers…and lost.

Teamsters, which with 6800 employee members was the company’s largest union, narrowly voted to accept the company’s proposed deal. Teamster President Jimmy Hoffa said his team “switched gears” from trying to preserve all 18,000 Hostess jobs, a prospect he viewed as “off the table,” and instead was trying to drum up buyers for “bits and pieces” of the business.  Average pay for union workers was $16 an hour for the bakers and $20 an hour for the Teamsters. Frank Hurt, President of the BCTWG, called the company’s proposed 8% wage cuts “draconian” even as his members received 100% wage cuts from loss of their jobs. For this inspired leadership, he is paid about $250,000/year.

Hostess Chief Executive Gregory Rayburn had a different vision of how the bankruptcy auction process would play out. “Nobody wants to have anything to do with these old plants or these unions or these contracts,” Mr. Rayburn said. The company had hunted for buyers for the last several years as it tried to avoid a second trip into bankruptcy, but no buyer came forward. Potential buyers have made clear that their interest partly is because a liquidated Hostess would be free of its collective-bargaining agreements. A buyer might yet pick up a few of Hostess’s plants. Alternatively, the union(s) can now buy the assets in bankruptcy and reconstitute the company as a workers paradise without management sucking out all the benefits.

The mismatch between federal government revenues (taxes) and spending has resulted in $1 trillion+ deficits for the last four years. Left unaddressed, the US could become another Greece in the next 10 or 12 years; unable to sustain existing benefits and services for its citizens. Democrats favor balancing the equation by increasing taxes while Republicans have opposed most tax increases and demand spending reductions. This has led to an impasse and multiple calls for reform of the US Tax Code, which has become 73,000+ pages long and has not seen major revisions since 1986. The Simpson Bowles Commission and other would be reformers advocate a simplified structure with 3 tax brackets and a great reduction in deductions.

In order to see where such changes would need to come from, Diogenes examined the major deductions and credits taken by US taxpayers to discover which are the most unfair, or unjust. Below is a chart showing the magnitude of each of these “tax expenditures”.

Employer Paid Health Insurance

The largest single deduction, that taken for employer provided insurance plans, should be the first deduction to be eliminated. The amounts companies (or government) spend on these plans should become ordinary income for everyone. All Americans should be given a deduction of up to about $10,000 for direct health insurance spending. While this would cost revenue, there is no public policy benefit to forcing the 30% of Americans who are self employed or self insured to pay for their health insurance with after tax dollars.

Municipal Bond Interest & State and Local Income Taxes

Not shown on the chart are an estimated $120 billion in interest payments on about $3 trillion in municipal bonds, which are generally not subject to federal taxes. Many wealthy citizens avoid tax on substantial portions of their income with these deductions. The Alternative Minimum Tax (AMT) was originally enacted to force these few to pay their “fair share”, but because of the “Fiscal Cliff“, the number of Americans subject to the AMT absent Congressional action before January will rise from about 4 million to over 25 million.

This deduction should also be eliminated. There is simply no justification to reduce federal revenues to provide support for the local and state projects that these bonds finance. Similarly, the $54 billion in deductions for state and local income taxes should not be deductible from federal taxes. Why do all taxpayers have to subsidize the profligate states (California, Illinois, Massachusetts)? We could broaden the tax base and lower marginal tax rates. The real effect of this deduction is subsidize the high-tax-rate states at the expense of all other taxpayers. People deserve the governments they get. Those who don’t like the policies in Illinois and don’t live there don’t deserve to be forced to pay for a part of the results.

Mortgage Interest Deduction

“Subsidizing housing finance is especially problematic, as home building clearly over expanded in the early 2000s and needed to contract. If public policy subsidized a good into excess supply, further subsidies aren’t the cure. The Fed has merely delayed adjustment in the housing and financial sectors by continuing to direct credit to them.” (Gerald O’Driscoll, WSJ 8/31)

The mortgage interest deduction is also socially unjust, as it disadvantages minorities and the poor. Only 43% of minorities and 65% of whites are able to take advantage of it. Furthermore, it has failed to achieve it’s public policy purchase of increasing home ownership. The rate of home ownership in the US trails many other countries which provide no tax advantages to home owners. By subsidizing housing finance, the US government has also absorbed about $160 billion in losses at Fannie Mae and Freddie Mac (so far).

Deduction of Charitable Contributions

Americans have a long history of being among the most charitable people on Earth. But why does government need to support this generosity with over $50 billion in tax deductions? Wouldn’t we still give? And if I am an atheist, why do I need to taxably support contributions to your church?

How Do We Decide Which Deduction and Credits To Eliminate?

We have just identified over $325 billion in tax deductions that should be immediately eliminated in the tax code. However, one can only imagine the howls of protest from lobbying groups whose determined efforts have resulted in these distortions to an equitable tax code.

The AMT and various code reform attempts including Simpson Bowles suggested that deductions be phased out as income increases. However, this again results in continuing complexity within the tax code. A reform proposed last week by Republican Presidential candidate Mitt Romney is to enact tax simplification by limiting any taxpayer’s total deductions to an amount that would result in revenue neutrality after enactment of across the board rate cuts. He has suggested that the number would be between $17,000 and $50,000. The genius of this proposal is that it would protect the deductions of the middle class. It would limit benefits to high income earners even as it cuts their rates to spur investment activities.

The approach is also appealing because it would make more income subject to taxation—which boosts revenue—while reducing opposition from taxpayers who want to preserve specific deductions. One benefit for politicians is that capping deductions wouldn’t produce the same intense opposition they would get if they tried to eliminate just a few specific deductions. And Congress could continue to sell their fiscal favors to special interests secure in the knowledge that they wouldn’t be hurting the country (much).

What is the Fiscal Cliff and Why is it Important?

“Fiscal Cliff” is a term coined by Federal Reserve Chairman Ben Bernanke to describe the confluence of tax hikes and spending cuts set to begin in January 2013.  The non-partisan Congressional Budget Office (CBO) has projected that as a result of these changes in fiscal policy, over $600 billion will be taken out of the US economy in 2013, of which approximately 60% are tax increases and 40% expenditure reductions.  Over a third of all the changes are tax increases that arise from repeal of the 2001 “Bush Tax Cuts” and an increase (from about 4 million to over 30 million) in the number of taxpayers subject to the Alternative Minimum Tax (AMT), which phases out tax deductions and regular code benefits as income increases. Unlike regular tax rates, AMT rates are not regularly adjusted for inflation. The chart below shows the relative impact of the expiring provisions and changes.

Source: CBO

Other key parts of the pending policy changes are the expiration of Payroll Tax cut, the end of extended federal unemployment benefits, and the first of the across the board “sequestrations” which limit all federal expenditures, including defense, without respect to the relative importance of programs. Taken together, if Congress does not act to prevent these changes, the US economy will have about 5% lower total GDP next year as compared to a continuation of current policies. The expected growth in 2013 in GDP without the pending changes is 1.7% according to the CBO. Unabated, the policy changes would push the US economy into a significant recession with as much as a 3% contraction in 1Q’13 and would be accompanied by a large increase in unemployment.

How Did we Get Here?

The US economy has run record budget deficits of over $1 trillion for each of the past 4 years. As in Europe, constantly rising deficits threaten to eventually overwhelm any government’s ability to repay their debts and are not sustainable. Congress has been unable to forge a bipartisan consensus for achieving stability. Taxes and the role of government lie at the heart of the debate. Generally speaking, Republicans favor spending cuts as a primary means to achieve deficit reduction. Most have publicly pledged to oppose all tax hikes, suggesting that growth through tax cuts will increase revenue. Democrats typically believe tax increases should be part of any bargain to reduce long-term entitlement spending, and have generally supported greater reductions in defense spending.

The Fiscal Cliff is in many ways the culmination of a series of increasingly contentious fiscal showdowns between the two parties over the last few years. A fight to raise the debt ceiling in August 2011 (so the government could continue to pay its bills) resulted in the Budget Control Act (BCA). The BCA required a bipartisan “supercommittee” to identify $1.2 trillion in targeted budget savings over ten years by November 2011 or trigger automatic spending cuts for both defense and non-defense spending in fiscal 2013, a result so onerous to both sides that it was believed to incent agreement. The supercommittee was unable to reach a consensus. The balance of the policy changes in the Fiscal Cliff essentially occurred as an accident of timing, unplanned and unintended, a result of lack of agreement and disagreements.

What’s Going to Happen Now?

The US economy is in the middle of a political game of “chicken”. Almost no one expects any significant attempt to deal with the Fiscal Cliff before the November general election. This uncertainty is widely expected to shave 0.5% from GDP growth in the second half of 2012, as successful businesses postpone capital purchases and hiring additional employees until after some clarity appears.

If action to alter the policy changes does take place, most think it will occur during the Lame Duck session of Congress to begin in late November. Many alternatives could occur as Congress addresses each of the fiscal changes individually. The theory is that by delaying some of the near-term contraction in favor of longer-run deficit reduction, we could get the best of both worlds: no recession in the near term and no debt crisis in the long-term.

It is likely that the largest single change, the Bush era tax cuts, will be allowed to expire. Democrats were reluctant to extend them in 2010, and aren’t anxious to do so again, as they achieve the party’s goal of raising taxes on those who pay taxes rather than broadening the tax base. Republicans perversely want the Bush cuts to expire so that any changes to rates enacted after January can later be claimed to be tax cuts from a higher rate.

The Lame Duck session will probably extend the “temporary” Payroll Tax Cuts,  and an AMT “patch” will likely be passed to keep millions of middle income taxpayers from being subjected to the AMT’s higher rates. The fate of the balance of the Fiscal Cliff policy changes are subject to the general election results. If Mr. Romney wins the presidential race, the Lame Duck session will likely pass legislation to postpone most or all of the changes for about six months to allow the new administration to deal with the issues. If Mr. Obama is re-elected, it is likely that most of the changes will be allowed to take effect. A mild recession will almost certainly ensue, but many believe that taking this tough medicine could set the stage for a more enduring recovery.

How Do We Fix the Problem?

The worst possible outcome from the Fiscal Cliff would be if Congress merely postpones all the 2013 policy changes. The trouble with kicking the can down the road is that you eventually encounter it again. Allowing current law to take effect (walking off the cliff) might pressure legislators enough to enact a comprehensive plan to replace much of the policy changes with a combination of tax reform, entitlement reform, and spending reductions which could phase in gradually and thoughtfully to put the debt on a clear downward path. (see On Leadership). Lower tax rates coupled with the phaseout of the many special interest deductions and credits could unleash GDP growth that would allow the US to grow its way out of deficits and reduce persistently high unemployment.

Harvard College was established in 1636. For the next 200 years Harvard, six other members of what became the Ivy League and a few religious schools were the only colleges in America. Attendance at these schools was almost exclusively a rich man’s privilege. The first government funded public universities were established after passage of the Morrill Land-Grant Colleges Act of 1862, which aimed to make higher education more easily accessible to the citizenry of the country. Unlike the Ivy League schools, which provided a broad liberal arts and religious education, the land grant schools redefined higher education to have more practical applications. They were designed to be agricultural and industrial colleges.

Roughly 80% of American college students now attend public colleges and universities. These schools have a long tradition of  being essentially free and open to all. Despite that tradition, today public school students, or their families, typically pay about $10,000/year in fees, and room and board are not included. Many private schools now cost more than $40,000/year.  College costs increased 439% over the 25 year period from 1982-2007, compared to inflation of 106%, and outpacing even healthcare cost increases of 251%.

The reasons for the rise in higher education costs are many, but the primary one is the lack of productivity growth. Unlike the industrial and agriculture sectors, higher education is essentially unchanged from its 19th century conception. It is labor intensive and not subject to the demands for ever increasing efficiencies which after inflation have reduced the costs of manufactured and distributed goods such as electronics, clothing and food.

Higher education cost increases have been largely made feasible by government Pell Grants and the federal takeover of education lending. These now allow any citizen not convicted of major crimes to obtain funding without any assessment as to ability to repay this debt, much as no documentation loans fueled the sub-prime credit crisis, so essentially, we already have a higher education entitlement.The Department of Education spends about $30 billion/year for various higher education programs, grants and aid, and has now largely pushed private lenders out of the $1 trillion student loan market.

Even with this public support, 82% of college students now take out college loans to pay for a higher education that is far from perfect (see my post Grading Higher Education). If having more of our population attain a college education is the best way for America to increase our collective wealth and economic vitality, why do we saddle our young adult college students with debts that are the modern equivalent of indentured servitude, or an excess mortgage? Public universities should revert to their traditional function of providing good practical educations at very low cost.

The established model of education is under pressure given its accelerating costs, its reliance on public funding and institutional resistance to recognize new education-delivery techniques through technological advancements. At the same time, making education more accessible would be a giant step towards addressing income inequality and social inequity, because education level attainment is the best long term predictor of economic success. So how do we pay for low fee public education for more of our young adults?

Merely imposing more cost containment features will not be sufficient to significantly lower the costs of higher education. We need to reinvent what a college degree means in this century. Americans will need to adapt to new social and economic realities. Online classes have already become part of an extended curriculum for many students. In an iTunes version of public education, relevant learning experiences will originate from the large building down the street, from a music studio in Lincoln Center or a lecture hall at Oxford. Critical thinking skills will still need to be developed by working in close interaction with educators who can correct papers and offer individual advice, but online lectures for most courses will permanently reduce the demand for bricks and mortar. Likewise, expensive library systems in a digital age are essentially unnecessary. Relatively new online ventures such as Coursera and Udacity already have over a million students taking free college classes from well known professors including many from elite schools.

In order to provide the incentives for public schools to control their costs, funding should be capitated for each student and paid directly to the schools much as we fund public primary and secondary schools. Taking only the existing expenditures on higher education at the federal level, this would equate to about $1500/student. State and local funding of public schools added another $85 billion, or $4300/student. Numbers vary every year, but public spending on higher education from all levels of government on the 20 million or so students is roughly $5800/student/year. So we aren’t talking about a lot more in costs; it’s a rethinking of how to spend that money in a vastly more efficient way.

If we are to re-imagine higher education as a low cost publicly funded “privilege” and entitlement as much as a primary and secondary education, we should then question why we should also continue to fund private higher education? Private universities should should be granted the standard student capitation rate much as charter schools are funded, or vouchers are provided for private schools in some districts. Beyond that, let private schools fund their own students.

If you get accepted at Harvard, then it should be up to Harvard to provide grants or loans that make it possible for you to attend. After graduation, you would owe Harvard or its bank, not a federal agency. Such debts could be discharged in bankruptcy, so real credit decisions would need to be made by loan officers, perhaps making it harder to fund art history majors, but easier to provide funds for engineering students. If Harvard declines to provide adequate funding, then you don’t go there. There would be some bright but poor (or middle-class) students who can’t go to Harvard. Instead they’ll have to go to UCLA or Rutgers. Why is this a tragedy? It might even end up as an improvement as state universities find themselves able to enroll more of the very best students, and private universities redesign their cost structures to adjust to a different funding model.

American government spending is remarkably consistent; it goes up every year. In an economy that mostly grows, but sometimes contracts, why is this so?

Mr. Obama and most Democrats are of the Keynesian persuasion, and think all government expenditures are positive for the economy. They believe that prosperity flows from government, which is why their policies promote more government. Republicans are supposed to be the party for limited government, but the historical record does not support this theory. The chart below shows that over the last 30 years, government spending has grown consistently regardless of which party has been in control of Congress or the White House.

Government programs that never die become political jobs programs. Look no further than the Post Office, which runs up multi billion dollar deficits every year. But try to cut the locations or unprofitable services, which are provided competitively by the private sector, and every congressman objects to any resulting job cuts in his district.  The same applies for hundreds of domestic and foreign military bases that are no longer needed. Reining in this spending is antithetical to elected officials because by doing so Washington would lose its powers to direct spending to political clients.

A 2011 report from the GAO identified 81 areas with unnecessary duplication in government spending. “Congress is wasting hundreds of billions of dollars every year because it has created duplicative and fragmented programs, many of which are producing little or no value for taxpayers,” said Sen. Tom Coburn (R., Okla.), who pushed for the report. “Even worse, Congress has done almost nothing to address problem areas GAO has already identified,” he added. At his behest, the GAO updated their report for 2012. Mr. Coburn estimated the first report identified between $100 billion and $200 billion a year in duplicative spending, although the GAO didn’t put a specific figure on the spending overlap in either report.

Waste and duplication are not the only causes of the persistent growth in public expenditures. Government spending is (mostly) incremental, or base plus budgeting. Essentially, percentages are added on to whatever last year’s spending was. Efficacy reviews are rare and toothless; they can not cut anything. Compare this practice to the private sector which (mostly) utilizes zero based budgeting while typically requiring annual productivity increases also known as cost reductions.

Omnibus spending bills are beyond the reach of most individual members of Congress, other than to insert added spending items. Last December, the House voted on a 1,200-page bill containing more than $1 trillion in spending but members had only 15 hours to review it! Is it any wonder that congressional approval ratings are down to under 15%?

Presidents without a line item veto cannot much effect change either. Presidents from both parties have strongly endorsed the LIV as a method to control spending. The first law passed in 1996 granting President Clinton these powers by a Republican Congress, was struck down by the Supreme Court as an abdication of congressional authority over power of the purse. A new law proposed by Rep. Paul Ryan (R-WS) and  Rep. Chris Van Hollen (D-MD), gets around the prior ruling by requiring Congress to take an up-or-down vote without amendments on any cuts sought by the White House. Although the Ryan-Hollen Bill was passed the House with broad bipartisan support, a similar Senate version proposed by Sen. Claire McCaskill (D-MS), has failed to find any sponsors and Majority Leader Harry Reid (D-NV), who has opposed the LIV in the past, is unlikely to schedule it for a vote.

Let’s for a moment contrast government with the private sector. According to the American Bankruptcy Institute (reported in the Kansas City Business Journal on August 25, 2009), “more than 30,000 businesses filed for bankruptcy protection in the first half of 2009, up 64 percent from the nearly 18,500 in the same period last year”.  This means that even during a good year, over 35,000 American private businesses go under. Of course, sometimes they fail due to bad luck and market conditions. Not all bankruptcies are caused by incompetence, and not all incompetence leads to bankruptcy. What all this bankruptcy and failure means is that the private economy is in perpetual turmoil, with ongoing “creative destruction” winnowing out excesses. Some jobs are lost even as others are being created. There are no guarantees of economic survival. There is no such organic mechanism for self correction in government. Without the feedback loop of a profit incentive, failed government programs can continue forever.

So what should we do? If we are serious about cutting expenses, multiple changes must be implemented. Here are four that might do the job.

1. The President must be given the Line Item Veto by Congress.

2. The GAO Report on Duplicative Spending should be used as the basis for a bi-partisan Congressional Committee to recommend $100 billion in budget cuts for 2013. The Committee’s recommendations should be sent directly to the floor of both houses for a straight up or down vote. The same process should be repeated every two years.

3. The head of every government agency and department should be required to annually present a plan to increase efficiency/productivity by say at least 3% per year, and their funding should be reduced accordingly.

4. All federal programs should have sunset provisions. A shorter duration would be better, but perhaps ten years terms for all programs’ lives would be enough to allow for the continual reassessment of the need for and efficacy of federal spending programs.

These policy changes might not be sufficient to permanently change the trajectory of federal spending, but they would go a long way towards reforming a system that cannot be sustained. More importantly, these proposals would force our elected officials to focus on increasing the value of existing programs instead of only adding new ones.

Effective leadership is using one’s influence to enlist others in support of achieving a specific goal. In America’s two party democracy, our leaders are rarely able to craft legislation that is purely to their liking. The give and take that is the sausage of Congress usually forces our presidents to make concessions in order to pass new laws that move our country in a positive direction. This process normally provides effective checks and balances on the party in power. It is only when one party has large majorities in both houses of Congress and control of the White House that uncompromising legislation such as the Affordable Care Act (Obama Care) is passed without input from the minority.

One of the most urgent problems facing America’s economic health is the unsustainable mismatch between revenue (taxes) and expenditures. Republicans generally want to cut expenditures while keeping tax rates constant while Democrats generally want to raise taxes (only on the rich of course) while keeping expenditures at their historically high rates. One need only look at Greece, Italy or Portugal to see where the current course is taking our country.

In 2010, President Obama heeded calls from Congress and created the National Commission on Fiscal Responsibility and Reform (often called the Simpson-Bowles Commission from the names of co-chairs Alan Simpson and Erskine Bowles) to come up with a bipartisan plan to deal with the pending crisis. He appointed 18 members to the group: 12 were serving members of Congress, of which there were 6 Democrats and 6 Republicans. The 2 co-chairs were politicians not in office, one Democrat and one Republican. There were 2 CEOs, one Democrat and one Republican. The remaining two members were Alice Rivlin (Brookings Institution; former director CBO and OMB and Fed vice chair), and Andy Stern (former president of Service Employees International Union), both Democrats. Of course, the executive director of the commission was also a Democrat. So out of a total of 18 members, 10 were Democrats and 8 were Republicans. Theoretically, as a bipartisan group, the commission would give both sides the political cover to make difficult compromises and still achieve the common goal of fiscal reform. Because Democrats outnumbered the Republicans and controlled the agenda, the president’s party would still drive the conclusions.

Simpson-Bowles came up with over $4 trillion in recommendations for deficit reduction. For every dollar of new taxes, $3 of spending cuts were to be made over time. Cuts were to come not only from discretionary spending but from “sacred cow” entitlement programs such as Social Security. Higher revenues were to come from increases in gasoline taxes and reductions in tax deductions such as home mortgage interest. The debt commission offered a blueprint for turning the corner on the federal debt, breaking its peak and having it constitute a declining share of GDP over time.

The members of the Commission voted in favor of its conclusions by 11-7. Democrats were 6-4, and Republicans were 5-3. The conclusions were widely criticized by both right and left, although many others from both sides thought it was clearly a move in the right direction. President Obama could have sent the Commission’s report for almost certain, bipartisan approval from both houses of Congress. Instead, he chose not only not to send it up as his proposed budget; he failed to propose any budget! Why Obama would appoint the debt commission and then largely ignore its recommendations is a political mystery and one of history’s great missed opportunities. But he did, and he has not offered an alternative approach to turning the corner on the national debt.

Even Andy Stern, the labor leader who voted against the Commission report — a decision he says he regrets, because while he had reservations about the 67-page proposal, he now says he would have liked to have seen Congress take it up. Co-chair Erskine Bowles has noted his surprise at Obama’s stiff-arm, telling a Wall Street Journal forum in November that the report “exceeded every single one of the goals that he had given us” before the commission started its work.

Mitt Romney effectively secured the Republican nomination for president last week with sweeping victories in five more primary states as Newt Gingrich and Rick Santorum dropped out of the race. Current polls indicate that the general election race is currently very close, with Mr. Obama slightly ahead. Now that Mr. Romney no longer has to pander to extreme fiscal conservatives in his party to win the nomination, he is more free to win over the roughly 1/3 of American independents who will decide the election.

As Diogenes, I would hope for better, less compromising fiscal reform than the recommendations of the Simpson-Bowles Commission. As an ordinary citizen, I want to see action taken sooner, rather than later, to head off an impending fiscal catastrophe. It may be that the Republicans will sweep the November elections and be able to dictate alternative plans that eliminate new tax revenues. But it is my hope that Mr. Romney will propose that Congress again take up the Commission’s conclusions. Such a move would show far more leadership than his currently “safe” economic proposals.  Although Mr. Romney might win the election anyway, such a bold move would clearly show that he is prepared to govern.

Two stories in the news in recent weeks prompted me to rethink what is required to “fix” health care in America. By fix, I mean providing all Americans with medical services at an affordable and sustainable price. Last week’s oral arguments before the Supreme Court indicate that President Obama’s Affordable Care Act will likely be struck down as an unconstitutional encroachment by the federal government on the power of the states. The second story that caused me to reconsider was the White House decision to require all health insurers to provide birth control services even if it was contrary to their own strongly held religious convictions. In my opinion, this ruling infringes on the separation of church and state and would present another basis upon which to challenge Obama-care in court.

I have written before on health care reform solutions (7 Practical Solutions on Health Care , How Medical Insurers Encourage Doctors to be Dishonest). While I still stand behind the sentiments posted therein, I believe that a more sweeping market based solution to ever rising costs and entitlement benefits will be required to get this problem under control. New ideas are required because our health care system is broken and unsustainable, and neither partial reforms or awful, comprehensive 2700 page+ laws like Obama-care will get the job done. Unlike elected officials, Diogenes is free to ruminate creatively on practical solutions unbounded by partisan political or parochial concerns. Here’s what we need to do.

1. Create price discovery in health care. There is no other sector of our economy (healthcare is 18% of GDP and rising) where most consumers make use of a product whose cost they do not even need to know because its being paid for by somebody else. Diogenes proposes that service providers post prices for their most common services and have their patients/customers be aware of those prices before treatment commences. Price shopping should be encouraged.

2. Service providers should be required to charge their patients/customers similar prices much as other sectors of the economy operate. When we go into a store to buy something, we typically do not expect to haggle over the price. It’s the same for everyone, with some exceptions. A store could be having a sale on overstocked items or perhaps business is slow and some products are offered at lower prices as promotional loss leaders to drive more volume. But in health care, a service provider typically asks patients/customers what their insurance is before quoting a price. A customer with Oxford Health Insurance might be billed $100, a Medicaid patient might be billed $80, and a patient without health insurance might be billed $400. The uninsured patient will typically be asked to pay at the Point of Service at the higher rate while insurance companies and Medicaid/Medicare typically pay at the reduced rates in two or three months. Does this strike anyone as remotely fair?

3. Stop the practice of insurers questioning the billing of service providers except on an exceptions basis. In the era before “managed” health care, insurance companies paid the bills submitted to them without the pretense that every bill needed to be questioned for possible malpractice or mispractice. State licensed or certified providers were assumed to know what they were doing and their bills were questioned only when they were seen to be egregiously or obviously incorrect. Clerical insurance support staffs were not required by service providers, and physicians did not typically have to spend time daily arguing with clerks at insurers. Conversely, insurers did not have armies of clerks whose sole job is to question every bill. Neither insurers nor service providers had to recoup the costs for those dueling clerks in the form of higher prices.

4. Structure health insurance like other types of insurance. Insure against unexpected events, not routine expenses. Other than coverage for annual physicals (which have been repeatedly shown to have strong value for limiting and preventing more costly subsequent care for neglected ills and injuries) health care  insurance should cover major medical expenses and have deductibles equal to a couple of month’s insurance premiums in order to give policy holders a stake in cost containment. Your auto insurance does not cover oil changes or wear and tear on your tires. And health insurance shouldn’t have to cover a Georgetown student’s routine use of birth control pills. Auto policy holders have a deductible amount in the case of an accident, and then have a reasonable expectation of being reimbursed in full for repairs in excess of the deductible up to a fixed limit. With health insurance, a policy holder typically has a deductible amount and then “out of network” providers are reimbursed at a “Usual & Customary”  maximum rate that is typically below what any provider actually charges. This bait and switch practice should be illegal, as is it certainly unfair.

5. Take employers out of the health care business. There can be no reasonable justification for having employers pay for health insurance. It inhibits jobs mobility and is an unwelcome intrusion into our private medical lives. How can it be considered socially fair to require the self employed to shop for their health care with after tax dollars when those who are employed in companies offering health insurance as a benefit get preferential tax treatment? Employers should increase monetary compensation to their employees and let them shop for their own health care insurance, just like they shop for their other insurances. Since the policy goal is to have universal coverage, offer tax credits up to an average policy cost amount, not just deductions, for Americans to buy their own insurance. That way every rational citizen with taxable income would be insured! Those without income or low income could be given vouchers for premium support and encouraged to comparison shop for a plan. (Of course, this change would need to be made in conjunction with changes to rates in the tax code!)

“Managed health care” is not transparent or fair, can often be seen to be arbitrary, and has on numerous occasions been subject to fraud by insurers. Americans are smart. They know how to price shop and determine fair prices, if only they are given the opportunity to do so. Higher deductibles will reduce the cost of insurance because individuals will have more “skin in the game.” Americans spend more per capita than any other nation on earth, and yet we have poorer than expected outcomes. It’s time to change our approach to providing health care. Allowing the free market to work will result in bending the cost curve of health care down and provide more Americans will proper coverage.