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Thoughts from the Frontline

Back to the Basics

July 15, 2011

Choose your language

This week we are going to revisit some themes concerning the problems of the debt and the deficit. I am getting a number of questions, so while long-time readers may have read most of this in one letter or another, it is clearly time for a review, especially given the deficit/debt-ceiling debate. I will probably offend some cherished beliefs of most readers, but that is the nature of the times we live in. It is the time of the Endgame, where things are not as black and white as they have been in the past.

Let’s begin with a question that is representative of a lot of the questions I have been getting, from reader John:

“John, it appears that you're arguing that two contradictory things have the same effect: adding government spending doesn't help the economy, and reducing government spending hurts the economy. Which is it? At first, you say that adding government spending doesn't help, no new jobs are actually created, it fails the sharp pencil test,…

Discuss This

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Steve Herr

July 22, 2011, 9:07 a.m.

In regard to the deficit you state “And you can’t blame it on the wars.  That contributed but it is not even close to the lions share.”  Where is your evidence to support this statement?  Expanding “wars” to mean the entire military industrial complex here are some sobering facts.  Using you definition of GDP which subtracts (or adds) the deficit to arrive at a true GDP, in 2000 the GDP was 9.899 trillion plus a surplus of .23 trillion for a total of 10.129 trillion.  In 2010 GDP was 14.78 trillion minus a deficit of of 1.29 trillion for a total of 13.49 trillion.  DOD spending (which excludes things like NASA, nuclear weapons, state department, Homeland Security) was 295 billion or 2.91% of true GDP.  In 2010 DOD spending plus the cost of the war was 700 billion or 5.19% of GDP.  If we returned to spending the same ratio as 2000 we would save 300 billion a year, or over 3 trillion over 10 years.  This is equal to all the spending cuts currently being negotiated, and 1/3rd of the way to what you suggest is needed. Include the growth of the other budget items involved with security, and the legacy costs of the wars, such as the VA, and you can quickly can get to 4 trillion in savings.  What exactly do you mean by “lions share”?  I agree that in the long run health costs must be controlled, but isn’t also important to understand why we got to where we are now.  Integrate the increases in defense spending over the last decade and the increased costs are between 2 and 3 trillion depending on who you talk to.  Your analysis could help bring the facts to light.

Frank Rockwell

July 20, 2011, 5 p.m.

My 2-cents:  We (the USA) have too much debt.  We have more debt (current and future) than we can ever repay.  We will never repay the debt.  We are not Greece, a currency consumer.  We are a currency supplier.  We can and will inflate the debt away, big time.  The dollar will crash and burn.  Savers lose.  Debtors win.  Who is the biggest debtor of all?  The US government.  Hmmm!

David Blanchard

July 20, 2011, 10:33 a.m.

I am not a supporter of government messing with the economy.

What happens to the charts if you change GDP = C + I + G + net exports to GDP = (C + I + net exports ) - G ?

Tom Zimmerman

July 19, 2011, 11:28 a.m.

‘The polls say a large, bipartisan majority of people want to maintain Medicare and other health programs (perhaps reformed), and yet a large bipartisan majority does not want a tax increase. We canâ??t have it both ways, which means there is a major job of education to be done.’

Respectfully, I suggest this statement misses the side of the barn.  We can choose one or the other and still wind up with a weak, debt-overburdened second world economy.  The annual deficits must be brought to a halt now;  health care solutions can be longer term.  So here’s The Plan, Part I:

Assuming this year-to-date revenue increase carries through FY2012, we’ll have revenue next year of $2.36T.  Set spending at $2.86T.  That’s midway between the spending levels we had in FYs 2008 and 2009.

Set each department’s dollar and personnel budgets where they were at that time.  Any really, really necessary increases must be offset by reductions elsewhere.  Think of it as better-delayed-than-never pay-go.

Then:  Recall that the eight Clinton budgets averaged an annual spending increase of 3.6%.  Take this approach one better:  hold the spending at that nominal level until revenues catch up.  At this YTD rate of revenue growth (8.58%) we’ll be in balance three years out, 2015.  At that point, permit nominal spending growth at 2% per year.  Excess revenue must go first to un-printing the Fed’s QEs, then to retiring public debt.

The Plan, Part II:  Fix social security band medicare for the future.

Robert Irvin

July 18, 2011, 9:28 p.m.

If the article is correct in its discussion of multiplier effects, then the economic solution is to cut spending and also cut taxes. And just maybe, free markets up a bit. I have chosen to live in Costa Rica, which has its own pluses and minuses. However, a big economic plus is freedom from the tyranny of prescription drugs. For the most part, you can just go to a pharmacy and buy the drug you need. Antibiotics and such, not psychedelic. The reduction in the cost of medical care is astonishing. The “risk” is that one will be a fool, resulting in self-harm, but hey, in that case you go to the doctor first. You can also order your lab tests without a doctor, then take them with you, thus eliminating a duplication of medical costs. Just an example, but freedom of choice, that is, freedom from government telling you what you must do, could lower costs. Don’t believe me? Just do it. It works. And the average life expectancy in Costa Rica is slightly longer than in the U.S., at much lower expense. Perhaps breaking the European/liberal American paradigm would open us to some cost savings that would not require sacrifice, just common sense.

Stephen Wilson

July 18, 2011, 7:39 p.m.

You say, “If Obama says he wants $4 trillion in cuts, then let him give us details”, but you then propose far greater cuts with no details when you say, “Either we willingly cut the deficit by a far more significant amount than anyone is discussing, or we hit the wall at some point and become Greece. $4 trillion? No, letâ??s talk about 10 or 12”.

I took the CBO’s estimated revenues and outlays for the next 10 years (dated January) and cut outlays by an amount roughly the same percentage each year in order to trim the debt by $12 trillion by 10 years out. The percentage proved to be about 27% in cuts from the CBO’s projected outlays every year.

I do not think cuts that deep can be proposed off-handedly without dealing with specifics. So how would you go about your proposal? Everything must be on the table, of course. So, the military by 27%? Means testing and delayed eligibility to cut Social Security payout by 27%? If Medicare is to be cut 27%, how would that be done—annual caps no matter how sick, no costly treatments for modest life extension, etc.? Instead of Europe next week, it would be interesting to see you follow this up.

Jeff Little

July 18, 2011, 4:27 p.m.

Emil Assentato

“But I believe there is a growing school of thought that believes that an additional government job, which is the route this administration prefers to take, does not create any additional growth over the actual cost. This seems to be much different than the theory that a new job in the private sector has a multiplier affect, ...”

There is no difference between a public sector job and private sector job except in terms of efficiency, which I am using here to refer to the quality of the output (including is the right output being generated) and the cost of the inputs.  If you interpret efficiency broadly to include the work quality, then the aphorism “private companies are more efficient” is obviously spot on in some subsegments of the economy (Eg. hot dog stands) and completely specious in others (eg. we could subcontract 2nd grade education to Exon).

The multiplier effect is absolutely the same for public and private jobs.  Why not?  A dollar spent is a dollar spent!

By the way, it turns out my previous post was edited.  The link was removed, but the paragraph explaining the link was left in, so there was a floating paragraph that might have been confusing.  One more try.  If it doesn’t show up, then you can google “us historical tax rates graph” because I know you are dying to see it… :)

An article and graph concerning US tax rates over the last century:

http://www.ritholtz.com/blog/2011/04/us-tax-rates-1916-2010/

The link above lists the top tax rates for various time periods in US history.  Since it only lists the top bracket, it is probably more an indication of when taxes were most progressive than an indication of when they were highest.

You can see brackets of:
70%: 1918 - 1921
25%: 1922 - 1931
60%: 1932 - 1935
75% - 90%: 1936 - 1964
70%: 1965 - 1981
50%: 1981 - 1985
35%: 1986 - 1992
40%: 1992 - 2000
35%: 2001 - today

To create a quick description of these brackets, when the tax rate was less than 40%, the stock market and other real assets boomed.  When the tax rate was > 50% the economy showed solid growth.  The Clinton years showed a middle ground, when taxes were higher, but assets were able to bubble a bit anyway.

Jeff Little

July 18, 2011, 3:02 p.m.

Gary Given
“The generation that came home from WWII had it all.  They had social security, medicare, the GI Bill, pensions plans, a growing robust economy, a growing real estate market with ever rising valuationsâ?¦the US was a mighty power and they were immortal.  They had it allâ?¦they still want it all, and they taught their children (yes, us boomers) to have it all as well.”

The key question we need to determine is what is the difference between them and us.  They had a 90% top tax bracket, whereas we have a 35% top tax bracket and the Great depression started with a 20% top tax bracket, Strong Dollar, and major asset bubbles.  Clearly we need to have an economy more like the 40’s and 60’s.  The answer is probably more complicated then “big government”, but it is almost certainly not unadulterated supply side economics, either.

Joel Arney
Not to disagree with you directly, but I think one of the biggest problems with health care is you have no idea what you are buying when you buy insurance.  Plan A is 600 a month and plan B is 800 a month.  Which is a better deal?  Who knows?  The insurance companies consider their service prices and benefit levels a competitive advantage that they protect with the shroud of secrecy.  They are probably right to given the environment they are in.  I once called for a dental procedure, and could not get prices for services even when I had the codes unless I told them which doctor I was using, and then only for the services I was planning in the immediate future.

I am not sure what the solution is, but before talking about a voucher system, we would need standardized plans such that an HR person could make apples to apples comparisons between different companies and reward efficiency rather than marketing savvy with their purchasing dollars.  If an actual fair and open market based on consumers understanding what they are getting could be set up, then we could potentially move the idea of a voucher system from ‘right wing’ to ‘reasonable’.  Maybe your suggestion for prioritization could also be used to set up understandable standardized coverage levels and potentially move health care from a closed, inefficient market to a more efficient one.


Stephen Decruz
“6. Government grew because business could not be trusted to police themselves. “

1 - 5 are Excellent points, IMO.  Regarding #6, I prefer to think of it less in terms of irresponsibility and more in terms of “Tragedy of the commons”.  Think of the economy as a “local optimizer”.  It is the job of the private economy to work within the established rules to optimize reward.  It is the job of the public economy to make sure that the right behavior is being rewarded.  The classic example is public grazing land, but it works just as well for pollution, carbon credits, financial risk management, etc.  If you just rely on private parties to manage grazing, then Farmer A who grazes his fair share will always lose to Farmer B, who grazes based on whatever feels best to Farmer B, and meanwhile the land get’s destroyed.

A tongue in cheek way to define the political camps:
* Conservative - someone who believes there are perverse incentives in public economic activity.
* Liberal - someone who believes there are perverse incentives in private economic activity.
* Pragmatist - someone who believes that everyone is human and the strongest economies come from balance of power.

Craig Rodby

July 18, 2011, 6:29 a.m.

I have two comments.

First, if this analysis is right, then expense cuts hurt more, and have more immediate effects, than tax increases. The idea that “you can’t raise taxes in a recessions”, but at the same time saying we need to cut expenses, and this somehow won’t hurt the economy IN THE SAME WAY AS TAX INCREASES (only more immediate), is nonsense.

Second, in the United States, medical clinics are run like law firms. We will never fix our health care costs until we change, fundamentally, how resources are allocated here compared to the rest of the world.

For example, in a law firm, while the partner billing generates a lot of revenue and some profit, the REAL profit is made from the asscociates and the paralegals. becasue they can be billed at far higher rates than their costs. This excess profit accrues to the law firm and distributed to the partners.

The same is true, for the US, in our clinics. the excess profits from the ancillary care accrues to the clinics.

In the rest of the world, and in some closed panel HMOs in this country, the ownership is non-profit.

While the quality of care can be a significant issue in those countries, depending on their governance, the cost is far, far lower because the workers, including the doctors, are usually salaried, and the profit accrues to the non-profit owners, often the government

Tony Heppelmann

July 18, 2011, 6:05 a.m.

The US should look at medical care and senior care as an opportunity, not a burden.  A number of commentor’s wondered what we could have people do that was productive to put them back to work.  Medical care and senior care is probably the answer.  After all once we take care of food, shelter and clothing what else is more important.  There is no reason to have 15 to 20% of our work force sit on the sidelines and collect unemployment and welfare checks.

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