Tuesday, April 05, 2011

Is it possible to have thoughtful conversation about America's future between Conservatives and Liberals?

I don't read Conservative periodicals as a matter of practice. But I do read the NY Times Op-Ed regularly and thus read most of their columnists regularly. Ross Douthat is certainly Conservative, and typically thoughtful in his analysis. I don't always agree with him, but I do appreciate getting the point of view. He's actually much easier to read than some of the Times other columnists. Nicholas Kristof, in particular, is sometimes hard to swallow, though I thought his pieces from Egypt were good. I do read Paul Krugman quite regularly. While I agree with him a fair amount - maybe 80% of the time - I know he practices that standard debating practice - don't admit touché to the opposition....ever. The goal is to win the argument, not produce a consensus based on the better points of the two sides. But if he changed his tune, would he be met halfway or instead be trampled on by Conservatives who are sure in the rightness of their own held position? I'm afraid it's the latter.

So I don't expect to see anything like a meeting of the minds in the near future. But it is clear that there will be a significant speech by Congressman Paul Ryan on Thursday and I think it would do well for Liberals to listen to it attentively, see if they can agree with the issues that he defines, and then if there is a disagreement on the proposed solutions (surely there will be) at least the rest of us can compare the various arguments. I am afraid however, that there won't even be some agreement on the issues. So here I'm going to outline the issues as I understand them along with my own proposed solutions, which probably neither side will like.

Before doing that let me say that I followed the links in Douthat's column today and read both the Yuval Levin essay Beyond the Welfare State, which on first reading I thought was quite interesting (I did have some second thoughts that I will get to below) and the CPAC speech by Mitch Daniels. Douthat bemoans the fact that Daniels doesn't appear to be running for President. I've seen David Brooks express a similar view in regard to Daniels. Both Douthat and Brooks want a candidate with gravitas. Daniels is their man and if not him then Tom Pawlenty. Much of the rest of the potential Republican field lacks their depth.

It is unmistakable reading this stuff that the big issue of concern is long term and cascading deficits, with an accelerating ratio of National Debt to GDP. That is the fear. They want to take steps now to ward off the problem. I'm quite confident we'll hear about that issue from Paul Ryan on Thursday. I wish the argument could be made in a balanced and dispassionate way, because I believe the fear is shared by many Americans and what part of it is grounded would be good to pinpoint as would the part that is hype. Unfortunately, it seems that the Conservatives are over cooking this. Let me illustrate the concern.

This graph
is from the Levin essay. It says the source is the Congressional Budget Office. It occurred to me after reading the piece to search for the source so I looked on the CBO Web site. I found this PDF which has a similar graph on page 5, only the time horizon is briefer, both in going backward in time and in going forward in time. Levin's piece does the extrapolation of the growth of debt to GDP ratio over a much longer period. Why? Why not instead simply reproduce the graph in the CBO document? Of course the explicit answer for that presentation decision is not spelled out. So let me offer my conjecture.

If the economy didn't have other structural issues, the recent history in the growth of this ratio could be completely explained as a short term phenomenon - when the economy shrinks due to recession and the government attempts counter cyclical fiscal policy that expands the debt. The graph shows that. It is exactly what you'd expect. When the economy grows out of recession and the temporary stimulus is ended, the ratio comes back down. But there are structural issues and nobody disagrees on them. In Levin's essay he claims the structural issues and the current large deficit are all part of one big problem. If you read Krugman, he says they are two different problems. Krugman is not all that explicit now about how to deal with the structural issues. He doesn't want to muck up the recovery near term with achieving budget balance long term. But those structural issues are on people's minds so that's what I want to advance here, though again my proffered solutions will probably be disliked by both sides. And in some cases (health care is the big one) I don't have a solution because I don't believe there is one.

There are two biggie structural issues - one is that the U.S. is the World's policeman. We know neither how to reconcile our domestic politics to this fact nor do we know how to finance the activity. The other is that the society is aging. This one has gotten lot's of press, but still hasn't produced great solutions. It's on this one where I believe Paul Ryan's proposals should have the most interest for us. There is a third issue that is in the background that haunts Republicans. They are clearly pro capitalism inasmuch as they are pro capitalists. But capitalism can be cruel and can exclude people. So there needs to be compassion that addresses the displacement and lack of access. Some of that can be done by charitable organizations and other non-profits. But government should play some role. What role should that be?

More on each of these below. I do want to pose the question here, after reading Levin the first time it occurred to me immediately, what is the difference between Levin's delineation of the issues now and George W. Bush's delineation of the issues back in 2000? In philosophy, and the essay was mostly a political philosophy document, they seemed quite similar to me, though the large debt issue wasn't present when Bush was running for President. If the views are different otherwise, I'd appreciate learning in which ways they are different. The related question is that we had six year starting in January 2001 where the Republicans controlled the White House and both houses of Congress. During those six years, we had the infamous Bush Tax Cuts and a bunch of deregulation, both of the de jure and the de facto forms. Did those reforms release the engine of economic growth from the burden of excessive regulation? If not, why not? Further, if not, why should things be different this time around? One way that Liberals should want to listen to Conservatives is on the evidence they use to support their beliefs. But I could launch an entire polemic on that, probably not a good thing to do here. I will do a bit of that near the end of this piece.

So, without further ado, here are my suggestions on the core issues based as a response to the framing of them in Levin's piece.

On Foreign Entanglements

The basic idea is simple. If we are in a war abroad, institute a temporary tax to pay for it. The tax would kick in after so and so days of operations abroad at or above such and such spending levels on a per daily basis. We're talking about another Iraq or Afghanistan (so now maybe Libya) not about a brief peace keeping operation. What the thresholds should be for so and so and such and such, really I have no idea. I'm simply articulating a principle. If we go to war as a nation, all Americans should bear some of the cost, if not in sweat and blood then in dollars. Wars that are deemed necessary should not put the economy in a deficit cycle like the one we are seeing now. Trigger happy folks in Washington shouldn't be allowed to wage war without facing the consequences in the ballot box, if not for the dislike of foreign wars then from the temporary tax increase. They need to have skin in the game, not simply to have bluster.

I doubt Democrats or Republicans could agree to this, because it takes away a good deal of discretion from whoever is governing, and because it says tax increases are possible when the situation warrants it. But if we are to have government by rules, to me this should be the first one we adopt.

On the Aging of Society and Social Security

Levin argues that the Great Society is a broken concept. I will write below about health care, where he may very well be right, but I think it is more complicated than that. And I think he is wrong in other respects. It is not that the concept behind Social Security is wrong but rather that some of the rules of the game need to be changed because of the changing demographics. When field goal kickers all went soccer style and ended up being able to do kickoffs longer than before, football moved the yard line from where the teams kick. This seemed weird initially and in my own head I will always remember the 40 yard line, but the change didn't dramatically alter the game. Why not think that way about the aging issue and Social Security, especially as the first step?

A core problem with doing so, as I understand it, is that life expectancy varies significantly with income, which serves as a proxy for the type of work people do. For blue collar work, life expectancy hasn't gone up that much. For white collar work, it has gone up dramatically. My solution to this is to start differentiating the retirement age for Social Security by the nature of work people do and in particular for white collar workers, up the age dramatically, in phases, based on what we know about life expectancy. At the moment, it is my sense that for white collar workers the retirement age should be somewhere in the 70 to 75 range. I have one data point on this, not a full study. My dad retired in 1982 at the age of 69. He passed away when he was 86. It seemed to me he retired more or less at the right time and that as a society we should aim for between 15 and 20 years of retired life, on average. We don't discuss how long expected retirement should be. We need to do that. My numbers may be off, but I believe the general idea is correct. Figure out the expected length of retirement and the life expectancy and back out the retirement age for Social Security from that.

Now an aside here since I *retired* from the U of I when I was 55. I did what I did because it made sense given the current incentives and circumstances where the University needed to downsize. However I didn't stop working. I'm simply working under contract now. I believe my own real retirement age will be in the ball park of the time period that I'm suggesting above. If the general suggestion were to happen, it means the society will have to figure out how to profitably employ very senior white collar workers. This is a big deal issue that nobody is talking about much. First things first, however, and that issue is down the road.

If you do push back the white collar retirement date, you change the ratio of people paying into the system to those who are receiving benefits, restoring the fiscal health of the system. It is a political loser to do this for blue collar workers too and, truthfully, it is unfair to them because on average they won't live as long. Levin wants to mean test benefits. Instead of that, push the retirement date back for those whom we expect to live longer.

On Income Tax Reform

I'm quite sympathetic to a flat tax proposal. I can do my Illinois State taxes without the need of TurboTax. I definitely couldn't do the Federal return that way at present. But moreover, tax incentives are a bad idea. They create distortions in markets. Those may make sense at one point in time but persist well past their usefulness. The mortgage interest deduction is a case in point.

However, in contrast to Levin's argument and Governor Daniels view as well, my view is to tax all income at the same rate, capital income as well as labor income, and to have no deductions whatsoever, not for charitable contributions, not for retirement savings, not for any other purpose at all.

Levin claims in his piece that Liberals who are enamored with the Great Society didn't understand its unintended consequences. I believe that Conservatives don't understand the unintended consequences in their proposal. So here are a few to consider.

First, there is the question of whether the system as a whole is deemed fair or if it seems rigged. Capital income is received more narrowly than labor income. If the former is tax exempt and the latter is not, that is favoritism for the few. This might be warranted by a rising tide lifts all boats argument. I wonder if anyone still believes that. I certainly do not. If many people see the system as rigged, we'll never achieve the vibrant capitalism that Levin wants.

Second, there is the question of whether income inequality is distorting prices of services in such a way as to put them out of reach for ordinary Americans. College education is one example. Health care is another. If the rich can get a tax break by donating for a new university building, creating a cycle of non-price competition in physical plant across universities, or by giving an endowment for a faculty chair that bids up the price of such faculty and not just the recipient of the chair but also others at different universities who are of comparable quality, this in turns puts the pressure on to raise tuition and creates a driver for the hyperinflation we're seeing there. You can't stop the rich from giving, but you sure don't need to give them a tax break for doing so. In the small the gifts the rich provide look like they solve problems. But in the large, they are creating or reinforcing bigger ones.

Third, there is the question of whether the tax system is stable or if having some exemptions will invite other exemptions in the future. If you haven't designed the system perfectly up front (there is no reason to believe you will do that) it will encourage tinkering and that can escalate to ultimately have all sorts of exemptions. Better to have none. That purity can help keep the system simple.

On Health Care

In my view the problem is very hard. Most people want to ignore the underlying issues and then propose a solution blithely. The core question is whether health insurance should be priced by experience rating of the individual or if it should be priced by experience rating averaging over all society. The first solution is called a separating equilibrium. It is what insurers do as a matter of course, separating risks and pricing insurance accordingly. (With driving, for example, we want society to price auto insurance by experience so good drivers get lower premiums. That is in society's interest.) The second is to pool risks across society and then price by the average risk, which in health care might be justified by a Rawls Veil of Ignorance argument - unlike with reckless driving, none of us choose to be sick. The problem with the separating equilibrium solution is that some health care can be extremely expensive (high end surgeries or long term care). The health care costs can then bankrupt those who require lots of care. (Or, alternatively, the person/the person's family can preserve net worth by shunning treatment.) The problem with the pooled solution, if the purchase of care is not coerced (coercion here would mean government mandates that are financed out of tax dollars) is Akerlof's Market for Lemons. The good risks will opt out and the insurance will be very expensive. This is the worst of both possible worlds. So to me the two real options to consider are a separating solution perhaps with some subsidy or a coerced pooled solution. Both of these have some serious issues with them. So I view the choice as between the lesser of evils, though it is almost never discussed this way.

My sense of how we want to handle the solution to the potential bankruptcy (shunning of treatment) issue is that we want to have a two-part scheme. The first part is a pooled solution for basic coverage that includes all best practice preventative care and those surgeries or procedures doctors and hospitals must perform irrespective of the patient's ability to pay for them simply as a result of the ethics required by the Hippocratic Oath. All other health care should be deemed elective and priced by experience rating. In principle one might be able to see how this breaks out between the pooled core and the separating elective pieces. In practice however, I believe this would be extraordinarily difficult, to the point where such a solution might be impossible to implement. And even if it were to be implemented, it still doesn't fully solve the bankruptcy problem for people who are likely to consume a lot more health care than the average, were they to have the elective coverage.

There is a related issue that people look at this from the perspective of whether the Federal budget deficit is out of wack or not. But putting the government's fiscal house in order isn't the same as solving the underlying issue. Really, it is simply kicking the can down the road, making private citizens bear the potential bankruptcy due to large health care costs. I don't see any solution to this problem whatsoever, unless you believe that having the person that requires expensive treatment walk in front of a moving bus makes for a solution.

Based on the pre-release information about Paul Ryan's speech, where the issue of whether he is proposing "vouchers" is what the commentators gravitated to, he favors some government subsidy but then consumers must decide on coverage levels and premiums to pay. The high risk in the crowd might find no policy affordable in that case. I don't want to jump the gun on this before listening to what he has to say, but that is my sense of it now.

One last point here. The severity of the bankruptcy/shunning treatment issue correlates with the age of the patient. It is comparatively rare in young adults, more common with senior citizens. We might want a solution that is age dependent since the current system clearly is. Medicare was originated so senior citizens wouldn't shun treatment if it were made available/affordable to them. It's a nice aspiration, I suppose one we all have for Medicare, but it might not be affordable for society as a whole. Among those alternatives that are affordable, which is the most humane is hard to figure. A good critique of a solution doesn't offer an alternative that is not itself affordable.

Vibrant Capitalism and Social Insurance

Having been so immersed in the cause of online technology to advance teaching and learning, I have strong and vibrant memories of the late 1990s, when the economy was going gang busters and many people were using the expression "paradigm shift" in considering "the new" macroeconomics. We need something of the order of importance of the Internet, but something else, something new, to create a rebirth of the intensity we saw then. Of course, looking backward at that time much of the growth was fueled by entirely unrealistic expectations and an optimism that anything you'd throw at the wall would stick. That bubble burst. But the burst of the dot.com bubble doesn't mean that the Internet didn't create a fundamental change in our lives. It did. It is also almost surely correct that the causes for this fundamental change weren't planned. They happened mainly by serendipity, a side benefit of Defense Department Research. This is perhaps frightening. We want to ensure the future by making the right investments now. That probably is doable for ancillary infrastructure investments. For the core driver of the next wave of growth, however, it probably is not possible because we don't know what that driver will be.

Since that boom we've had two recessions, one bad, the other much worse. The growth coming out of the first one was fueled by a different bubble. Credit was too cheap. Housing values inflated. We're paying for that dearly now, even as the economy seems to be emerging from its slumber. The experience makes one ask what is meant by a vibrant capitalism and what we should expect from it should we be able to produce it.

I don't think it means we will eliminate the business cycle. I also don't think it means we'll fully solve the issue of vast capital mobility in an international context creating pressure on wages to equalize internationally and hence meaning more and more Americans facing direct competition for their jobs from China, India, Latin America, and elsewhere. I hope it does mean that we'll see thinking about the economy over time and perhaps becoming happy with growth not quite so intense as the late 1990s if that growth is more balanced and rational so as to avoid such deep troughs in the aftermath. And I hope it means that while people will have high aspirations for their own personal economic growth and the well being of their offspring, it nonetheless means a development of modest expectations with regard to their own lifetime budget constraint and learning to live within that, instead of having a good fraction of the population living beyond their means, as we seem to have now. Capitalism has demand as well as supply. Both need to be healthy.

I also hope it means a restoration of the American Dream - anyone can lift themselves up by their own bootstraps through their own enterprise - based on real opportunities. For that there are multiple desiderata. Labor force participation rates need to be high. Unemployment needs to be low. Education needs to be attainable financially, as does health care, not just in booms but over time. We are not there yet. And it may be that as we improve in some dimensions we make things worse in others.

One is tempted purely as an intellectual matter to ask Conservatives the following. Suppose we do it your way for 10 years, 15 years, or even 20. Government spending is dramatically reduced, government regulation is slashed. But suppose you are errant in considering what the capitalism so engendered will produce. Suppose it does poorly in many ways, primarily because too many of the capitalists are myopic and go for short run gains only and that creates long run pain. What then? Do you switch your views or still cling to them?

Under Reagan and Bush 1 we had divided government. Under Bush 2 we didn't for the first six years. My feeling is those six years were enough to send us over a steep cliff. If we luck out and find the next killer app for the economy as a whole, this movie won't replay itself in the near future and the economy will roar forward. If we don't luck out however and the Conservatives get their way, we'll see a lot of gimmicks masked as new growth initiatives and a potential repeat of the Bush 2 first year six years. That is frightening to contemplate.

The one Compassionate Conservatism idea that I associate with Bush 2 is No Child Left Behind. I view it as a disaster - narrowing the curriculum and overemphasizing testing. It may have been motivated by high ideals rather than the meanness that critics (Jonathon Kozol, for example) attribute to it. But it clearly had major conceptual flaws. Bush 2 also had the Medicare prescription drug benefit. To me this was less about compassion than it was about making an appeal to a significant voting block, senior citizens. But even if Bush 2 gets credit for being warm and fuzzy here in an apolitical way, it is exactly the type of program that Conservatives now seem to want to cut, because of the high cost of the program. How can you have Social Insurance without having Government spending? (In Daniels speech, he was for limited government but the limits were determined by the revenues collected, first and foremost. Using that logic and then keeping total government spending down as Conservatives want, it stands to reason that social insurance will be quite limited and individuals will therefore bear much of the social risk.) Levin seems to expect that Social Risk will itself be small because Capitalism is vibrant. Is that expectation grounded in reality or simply wishful thinking?

Wrap Up

We need an ongoing discussion between Conservatives and Liberals about the core economic issues America faces. We need each side to own up to legitimate criticisms of proposed solutions. Serious as though some commentators might be, it seems to me that there nonetheless is a tendency to find solutions by finding a new form of the free lunch. Milton Friedman taught there is no free lunch. If there is anything we can agree on, I hope it is that.

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