Monday, November 28, 2011

A view from the ten percent but not the one percent

I liked Bill Keller's column today, a snip of which is below.  There is a sort of Gresham's Law for economists in the Internet era.  The bad drives out the good.  It's definitely true and an important point.

Yet paying attention only to the good economists is not enough.  There are questions about the economic morass that economists normally don't dwell on too much.  One is about fairness.  Another is about obligation.  Should we take Thoreau as a model?   When we consult our consciences they may suggest that is the right path.  But truthfully, if I can use myself as a case in point, I don't want to live in the woods and I don't think I'm capable of that. 

Even with that admission, however, there's probably a lot more my family can do without, some of which we pay for directly out of our pockets.  So I, for one, wouldn't mind if the Bush tax cuts expire for people in my tax bracket.  Our marginal rate is 28%.  If it were the year 2000 regarding tax brackets for everyone, but our income was as it is in 2011, our marginal rate would be 36%.  We would need to adjust to that, but we  could.  (I did a quick calculation of the difference in tax owed under this scenario assuming an AGI of $180,000.  I don't know what our AGI is, but I'm guessing we're in that ballpark.  In that calculation the taxes increase by almost $7,000.) 

I had thought that if there were enough like-minded people at around the same level of income that making that known would shame those at higher income levels to also be willing to contribute that much more.  I still wish that to be true.  It is why there is this Facebook group, For a More Compassionate and Saner America.  But that group didn't grow like weeds, as I originally hoped.  Occupy Wall Street has been infinitely better at capturing people's attention and raising the issues of unfairness and income inequality in our society.

So in this post I would like to show solidarity with that movement.  And beyond that I'd like to suggest resolution of the big economic issues, as they make sense to me, where the economic issues are tied to the ethical issues, the increase in the income tax for people who can afford it an example of what I have in mind.  

Debt Forgiveness

The Right is captivated by the magnitude of the National Debt and the fear that it will bury us, or bury our children, or bury our children's children.  There is some basis for that fear, but not in the way it is depicted by the Right.  However, there is another problem that has been well aired over the last several months, which we in the ten percent can do something about more immediately. This regards privately held debt, particularly with respect to housing and in student loans.  Some fraction of the principal needs to be absorbed by the taxpayer, as long as the loan satisfies certain criteria.  The economist Ken Rogoff has recommended a general inflation to address the problem  (inflation reduces the value of the debt in real terms), because he doesn't believe a more direct solution is politically feasible.  We should go for that direct solution and recognize that those who can fund it will shoulder a good chunk of the burden.

In the case of housing, the criteria should include: fraction that the house is under water, number of periods that the mortgage has been delinquent, past and current income of the debtor.  The most troubled loans, those nearest to foreclosure, should be targeted first, provided the occupants do have a decent source of income.  The aim of the program is that after forgiveness and a refinancing of the mortgage to current low rates, the occupants should be able to stay in the home and make future payments.  It makes no sense to forgive debt only to then have subsequent default, as I wrote here

In many cases the income requirement won't be met.  What then? There has been a fair amount of discussion that many of these current borrowers should in the future become renters and leave the issue of paying off the mortgage to the landlord.  I would like to see the arithmetic on this regarding how the likely rents compare to current mortgage payments.  And I would like to know: what will keep the rents modest over time?  So I have my doubts that a move to a rental model alone solves the problem.  Maybe it does, but I'd like to see the analysis.  At the link I provided there is an analysis from the perspective of investors who purchase underwater mortgages and convert those units to rental properties. We need an analysis from the perspective of the current occupants.

I should point out here that this is why a jobs program is so important.  The jobs issue and the housing debt issue are tied at the hip.  It's why I can't understand not attempting a latter day version of  the WPA.  In turn, there seems to be some consensus for a Federal Investment Bank, which would oversee and provide financing for such projects.   Sure, making private sector jobs would be a good thing.  But, clearly, that's not happening fast enough.  Let's make public sector jobs in the meantime, as many as we can, and keep doing so till until the economy recovers. 

It also needs to be admitted, up front, that a debt forgiveness program will not preclude foreclosures entirely.  That shouldn't be the aim of such a program.  Rather the aim should be twofold.  First, the goal is to keep as many current occupants in their home as is possible.  Second, troubled assets on bank balance sheets need to be resolved.  In some cases the resolution will be by some forgiveness financed by taxpayers and new smaller loans replacing the trouble loans that should be healthy.  In other cases there will be foreclosure and mortgage holders will have to write down the value of those assets.  Clearing up the bank balance sheets should loosen credit for small business and those seeking mortgages in the future.  The tightness of the credit market for such borrowers has been a major impediment to economic growth. 

Turning to students loans, for those covering tuition and fees at accredited not-for-profit institutions, a partial forgiveness program is in order.  The program should be targeted at students of modest income and, if below age 26, those whose parents are also of modest income. This would be a near term solution to the hyperinflation in tuition issue that as a result means high quality education is no longer accessible by students of modest means.  It would serve as a prelude to a longer term solution, that needs to keep costs in check while keeping quality of education high, at least for qualified students of modest income.  As health care reform was the target of the first Obama administration, higher education reform surely will be the target of future administrations. There is not a quick and dirty solution to this.  Elsewhere I suggested that a salary cap system might be in order.  But nobody else seems to be talking about that so it is not in the offing.

Loans should not be forgiven at all for people who could have self-financed their education but took the loans simply because payments could be deferred till after graduation.  So the means testing on such a program is important.

A different but related issue regards predatory practices of some for-profit higher education institutions that admit unqualified students who are eligible for federally sponsored student loans and grants.  There is a piece in Wednesday's Chronicle of Higher Education on the issue.  That piece refers to this GAO report.  Even if the students are the victims of these predatory practices, having their hopes raised only to eventually drop out or get a diploma mill degree that has no value on the job market, loan forgiveness is not the right solution here.  That would be like pouring fuel on a fire.  Better to go after these institutions hard, force them to pay heavy fines and/or rebate tuition they have already received. The predation needs to come to an end.  As much as we might feel sympathy for the victims, our remedies should not prolong the problem.

Entitlement Reform

There are two distinct issues at root that need to be addressed.  The first is the increase in life expectancy, especially for those who've done white collar work.  This means that current beneficiaries receive their benefits over a longer period of time than beneficiaries 70 years ago.  The system needs to be recalibrated as a consequence.  The second is that there is confusion on whether the primary purpose of these programs is as insurance against low income when people retire or if it is meant as a payback for contributions made while working, irrespective of the person's income.  There is a third concern that is more of an accounting matter, but I raise it here because it has influenced discussion of the programs in the political arena.  The issue is whether each program must balance receipts and expenditures or if balance needs to happen only overall, i.e., a balanced federal budget but where individual programs may run surplus or be in deficit.

Social Security and Medicare are actually quite different on these fronts.  Social Security is near to in balance and does act like an income insurance program.  Depending on when the individual retires, there is an income limit where if income exceeds the limit social security benefits are reduced on a fractional basis for each additional dollar earned.  This is precisely how an income insurance program should work.

There are three possible controls to adjust in the recalibration process on Social Security.  (I'm assuming no adjustments are made to benefits.)  First is the tax rate; second is the maximum income subject to taxation; and third is the retirement age.  Because of the income insurance aspect of Social Security, if you work sufficiently while above the retirement age, you will receive no Social Security benefit. For this reason I favor leaving the retirement age as is, with the following caveat.  The applicable income limit currently applies to wage income.  Dividends and capital gains are not included in the calculation.  They should be.

The Social Security tax is a flat tax - up to the limit.  The rate applies to employees and then again to employers.  Self-employed individuals pay both the employee and employer shares.   Raising the rates would put a hardship on lower income earners.  That is a bad idea.

A better adjustment, in my view, would be to raise the income limit rather substantially.  If high income earners do live longer, they should contribute more.  This type of adjustment would do that.  It also is in accord with the idea that those who can afford it do pay more in taxes to help out those who are less well to do.  So this is also a matter of fairness.

Medicare is a different animal, in large part because while working most people get their health insurance through their employer.  Not discussed very often, but something that is frightening about Republican proposals on Medicare reform, particularly the Ryan proposal, is that both employer provided health care and Medicare as it is currently constituted is not experience rated according to the health history of the insured.  Premiums that are collected from employers as well as the employee contribution are tied only to the average health risk of all those insured.  Likewise, this is true for Medicare.  Contributions depend on income, but not on health history.

A private market, however, will price health insurance based on perceived risk, and the individual's health history clearly matters for this.  This makes health insurance unaffordable for those who've been in bad health.  It is why single payer, something we should have but don't, is preferred. One of the unfortunate aspects about the political rhetoric in the time immediately before the Affordable Care Act was enacted, is this Market for Lemons aspect of health insurance was not brought to light.  Alas, we won't have single payer and in what I write in the next few paragraphs, I assume single payer is not possible to address the issues.

Medicare is much more out of balance than Social Security.  With Medicare, the hyperinflation of health care costs exacerbates the issues created by longer life expectancy.  So much of the solution will rest on controlling health care expenditure, particularly near end of life.  It will also be about controlling income of health care service providers.  Both of those issues have been discussed elsewhere, so I won't repeat that discussion here.  Instead I will discuss something that hasn't gotten any attention but should.  The revenues needed to support Medicare are inadequate.  Those revenues need to be enhanced.

Unlike Social Security, there is no income limit on the Medicare component of FICA.  But the Medicare tax rate is less than one quarter of the Social Security tax rate.  Either Medicare rates must go up or additional taxes must be raised for Medicare from a different source.  The question is how to do this without over burdening people with modest incomes. 

I favor two different ideas to address the the revenue shortfall issue.  First, working people who do get employer provided health insurance, even if they make a direct contribution to that heath insurance, should be required to treat the employer contribution as income for tax purposes and pay income taxes on it that are returned to the Medicare trust fund. There are several reasons for this.  Employees may be less than fully aware even of their own contribution to health insurance because that is something that is withheld from their paycheck at first.  They never receive the income and don't explicitly write a check to cover their own contribution.  Employees have no obvious way of learning the magnitude of the employer contribution.  One clear way to do this would be to have that amount reported on W-2 forms.  Further, employees would become sensitized to the full cost of their health insurance, by paying income taxes on the employer contribution.  Then there is the fact that currently the Medicare tax is a flat tax, but this way the employer contribution would be taxed differently depending on the individual's marginal tax bracket.  This idea will raise eyebrows.  It may seem like a step back from the social contract.  But given the imbalance, it is necessary.

Second, historically there has been a separation between payroll taxes and income taxes, with only the former used to finance Medicare.  The first idea is beginning to eliminate that separation.  It is not sufficient in itself.  The second idea is to further use the income tax to help finance Medicare, perhaps raising marginal tax rates beyond the Clinton rates, if necessary.  In this way adequate revenue can be raised to pay for Medicare.  It also means, in particular, that senior citizens who generate sizable income will continue to pay for Medicare, well after they have "retired."  It may mean that we stop using the word "entitlement,"  which I believe has taken on a pernicious connotation, as if there is a right to health care without having to pay for it.  In our society as a whole, we have to own up to the fact that the benefits need to be paid for.

Means Testing

There are three points I'd like to make here.  First, the extended family needs to provide some self-insurance for family members.  An example, currently being discussed, is that many college grads who have been unable to find a job have gone back home to live with mom and dad.  As a partial explanation for why the economy is not growing faster, this is of course bad news.  The demand for housing, in particular, is less as a consequence.  But from a social insurance perspective, this is very good news.  When things are bad family members should take care of each other, if they can.  This means that when government benefits are means tested it is really income of the extended family that should be measured.  When one generation is well to do while another is not, the source of social insurance should be from within the extended family, not from the government.

Second, there needs to be self-insurance by individuals done over time.  The traditional vehicle for doing this is via personal savings.  The low saving rate in our society makes people particularly vulnerable to hard luck.   A higher saving rate should be encouraged.  One way to do this would be to instead of using current income only as a measure of means, use a 5-year moving average of income as a preferred measure, as I suggested here.  When incomes are rising, this means the person's taxes rise less quickly than income, so there is an ability to save the residual.  It also means, however, when incomes are falling the person is on the hook for obligations and can anticipate that, even as income falls.  This provides a motive for the precautionary savings.

Third, means testing may very well become a two-sided concept in the future, where if income inequality persists to the extent it does now, then those above a certain income threshold find themselves facing an imposed obligation that the rest of us don't face.  This obligation would be something like a charitable contribution, but with the difference that the giver doesn't get to specify the use.   Here I'm thinking in particular of funding public schools, where the property tax mechanism almost guarantees there won't be decent schools for all, so that too many low income students are denied a decent education.  This fact itself is eroding the notion we call the American Dream.  Why have this sort of means testing rather than make the income tax system more progressive?  The answer is that the current arrangement has tax collection severed from how tax revenues are spent, with Congress responsible for the latter.  There are very few of us who believe Congress has acted responsibility with respect to its spending authority.  And the current process is fraught with problems due to lobbying, so the rich get to manipulate how tax revenues are spent for their own benefit.  The proposed solution then is to carve out some areas of spending, public education is a very good place to start, and obligate those who are above the income threshold to help make the system better and more equal.


I would like to see more mainstream economists make their policy recommendation based on a mixture of economics orthodoxy and ethical considerations.  Whether left or right, I believe this would bring us closer to consensus on what we should be doing.  There is a tendency for economists to eschew the ethical issues - that's not their department.  The biggest lesson we can learn from Occupy Wall Street is that we must deal with the ethical issues squarely, as we look for economic solutions.

1 comment:

Lanny Arvan said...

Joe Nocera today talks about applications of ethics in perverse way. His column is entitled Germany Cuts Off Its Nose. Near the end of the piece he talks about a column he wrote on mortgage principal reduction, where he got a lot of push back from readers who argued that is wasn't right to bail out borrowers who bought houses too big for them to afford.

What I find interesting with this view is that it absolves those who could contribute to a bail out from personal responsibility. I wonder if in hindsight they'll feel regret for that.