This essay suggests some policies that might be the basis for consensus on divisive political issues.It suggests an agenda for economic development based on making markets work more effectively for energy efficiency and for housing, on making the tax system more progressive so that we can eliminate or reduce many elements of welfare programs, reforming how we pay for health care so that it no longer is a tax on jobs, on improving education, and on getting the money out of politics.
The current economic crisis: why we need to act.
America’s problems are much more serious and persistent than the need to recover from the recession.
Let’s start with the observation that the American economy turned a corner—a bad one—abruptly in 1973. That was the year of the first oil price spike.
The trend of growth in median household income, which had been rising steadily till then, abruptly turned flat and stayed there, more or less, for almost 40 years.
High energy costs produced a set of imbalances in the American economy that have plagued us ever since:
• inflation
• trade deficits
• government deficits; and overall increases in debt
• low savings rate
• reductions in US competitiveness and loss of jobs
and also triggered, from time to time but particularly in the last decade:
• the mortgage crisis
• weak consumer spending
Why do I blame high energy costs—and our half-hearted response to them—for our continuing economic distress? For two overall reasons. First, economists from all parts of the political spectrum, from left to center to right, agree with these seven factors of economic imbalance and agree that they are important.
High energy costs are implicated in all of these imbalances, and are primary factors in the most important of them. The details are explained in my blogs and in my book Invisible Energy, and are summarized briefly below.
Second, some factor suddenly kicked in during the period after 1973 to stop income growth (meaning real per-household median income) in its tracks. Nothing else can be identified that changed suddenly and that had a plausible mechanism for causing this much trouble for this long.
And energy costs seem to be a big enough factor to explain much of the problem: they amounted to about 10% of GDP in 1973 and at other times when prices were cyclically high.
Invisible Energy also explains why some fairly small and non-controversial policy changes can make a big difference in reducing all of these drags on the economy and allowing it finally to grow. Better still, this growth will be accompanied by improvements in environmental quality, and with an impressive reduction in climate pollution.
But just as important, failure to do so will condemn any incipient recovery to being self-extinguishing. Oil prices are already hovering in the $100 a barrel range—quite high compared to 40-year averages. Further increases driven by increasing consumption could push oil back above $150 a barrel, and perhaps far above. Could a recovery continue in the face of $150 a barrel oil and $5 a gallon gasoline?
But if we can improve efficiency enough, we can lower both the amount of energy we use and the price we pay for it, driving oil prices down dramatically and leaving more money in the American economy and less in the hands of foreign energy producers.
Reforms to reduce energy costs and jump-start the economy.
1) Reform mortgage underwriting
The most important and simplest change that needs to be made is to reform the way mortgages are underwritten. Despite mortgage defaults being universally acknowledged to be the trigger for the recession, very little has been done to reform the process. It remains true that in financing a median priced home, the lender looks at the borrower’s income and evaluates his ability to pay a loan of $140,000 or less over 30 years while ignoring an even more urgent and predictable obligation over the same 30 years to pay $75,000 in utility costs and $350,000 in transportation costs (assuming the house is built in urban sprawl with no transit services, which is the case with most new construction over the past 20 years and more). It remains true that homes with higher transportation and utility costs are much, much more likely to default .
So either we are writing new toxic assets every day, or else the lenders have tightened up so much on conventional risk management methods that they will continue to crush housing construction for the foreseeable future. The very weak recovery of the housing market suggests that the second possibility is at least partially correct.
How will we ever get a recovery in housing? There seems to be no path forward without mortgage underwriting reform. Most housing produced over the past 40 years has been in suburban sprawl. That is where the defaults are concentrated—not surprisingly, since the costs of transportation exceed $350,000, which is unaffordable to many. Conventional wisdom says that it will take about three years to work off the inventory of distressed property, so no recovery is likely for three years.
But what then? If we look at the demographics of families who tend to live in sprawl—traditional families with children—we see that we already have enough housing stock to satisfy the demographics projected for the year 2030. Where we need housing, according to demographic projections, is in the more compact neighborhoods of suburbs and central cities and towns.
But compact, walkable, transit-served neighborhoods (where transportation costs are often half or less compared to sprawl) are more expensive than sprawl because of the laws of supply and demand: there hasn’t been much of this type of housing built in 40 years but the demographics are pushing the demand up. More construction will eventually bring prices down, but this is a vicious circle: if lenders won’t allow families to spend more on the house, even if this choice saves $200,000 in driving costs, there won’t be much new construction in these smarter locations. But absent this construction, the costs of housing there will actually go up, not down.
Therefore we see that the only places where the market demographics support the construction of new ownership housing, the current lending rules prevent it. The only places where lending rules support new construction are the places where the market doesn’t want it because it is unaffordable.
This reform should be attractive to both progressives and conservatives. Conservatives in particular should be happy to relax a regulation on who can qualify for a mortgage in a way that enhances economic liberty for families who would otherwise be disqualified from buying the house that they want.
2) The importance of energy efficiency in controlling inflation
One of the primary concerns of budget hawks is the if we create larger federal deficits now, we will trigger inflation later. To make this scenario even worse, fighting inflation will require higher interest rates that will further weaken the economy.
But energy efficiency policies are an effective way to lower inflation, and one that has not been employed seriously at the national level for most of the last 40 years. The connection is this: whenever America has had a serious problem with increasing inflation, it has been when energy prices were rising.
The most obvious examples were in 1973 and 1979, but rising energy prices also led to inflation several times in the interim. The most recent was in 2007, when high energy prices raised the inflation rate and then led to an increase in interest rates, that not only weakened the economy in general but also triggered the resets of adjustable rate mortgages that exacerbated the mortgage default crisis. This was the perfect storm: homeowners with high transportation costs were hit with mortgage interest rate increases just when gas prices doubled to $4 a gallon, affecting such families even more than most.
Energy efficiency policies reduce the demand for energy so for any given level of supply, the price goes down. We see from the past decades of experience that even small decreases in demand can lead to large decreases in price. So with new tools to control energy prices, we also have new tools to reduce overall inflation and keep interest rates lower.
With these new tools at our disposal to fight inflation, the deficit problem is not as serious. But efficiency policies also reduce the deficit.
3) The large role of energy efficiency in reducing government deficits
Energy efficiency policy will help with the deficit, in part because $600 billion a year of energy use and waste by the business sector is tax deductible. So if we can cut energy use by businesses in half, we can cut the deficit by about $100 billion a year, and the deficit reduction grows over time. This amounts to $1 trillion over ten years—about ¼ of the entire $4 trillion reduction goal.
So far, none of these suggestions of the source of the problem seems very debatable, nor are the solutions very controversial. Conservatives have supported market-based interventions that advance new technologies and to encourage efficient behavior. In fact, one of the two cosponsors of legislation I helped develop and pass to provide tax incentives for energy efficiency in buildings was Phil Crane, an Illinois Congressman who ran to the right of Ronald Reagan in the 1980 Presidential primaries. (The other was the progressive Democrat from Massachusetts Ed Markey.)
Solutions beyond energy efficiency
The second problem that seems hard to deny as a primary reason for stagnation after 1973 is the increase in economic inequality. One is drawn in that direction because even though energy is a large and highly leveraged part of the economy, amounting to almost 10% of GDP in times when prices are cyclically high, even energy-centric analysts such as myself find it hard to believe that energy alone is responsible for this being the first generation of Americans that is not as well off as its parents.
One is drawn to income divergence as another major source of the problem for two reasons. First is the timing of the response—taxes on high earners were cut in 1981, early in the period of stagnation, and the change persisted in weaker or stronger form thereafter. After the Fed’s intervention to fight inflation through raising interest rates in 1979-81 succeeded, and energy prices went down (assisted in large part by the first set of fuel economy standards for cars), we should have expected median incomes to start growing again. But they didn’t.
Second is the pattern of the problem: while growth in GDP and in AVERAGE per household income slowed only moderately, growth in MEDIAN income came to just about a dead halt. Some people were doing better, but it was mostly the top 10%, or even the top 1% or 1/1000 of a percent.
I will argue here that levels of income disparity as large as America has now are unjustified in terms of economic justice, in terms of their affects on growth, and in terms of the incentive structure that they provide. They also lead to political instability in the long run.
In terms of economic justice, the primary argument against the high marginal tax rates on the rich that would (and have done when they were employed) reduce disparities in income and wealth is that the wealthy earned their income by their hard work and it is not fair for the government to take it away from them. (There is also an argument that high taxes on high earners reduces economic growth, but I showed in Part 1 that this argument is factually wrong.)
The first deficiency of this argument is the definition of the word “earned”. People with initiative and drive can “earn” a lot of money in America (and other advanced market economies) because they are part of an infrastructure based on rule of law, and based on mutual trust in the business world about what behaviors are acceptable and what are not. Smart, hard-working, and ambitious people can only become rich in a cultural and legal environment with an infrastructure that supports free enterprise and enforces rules of fair competition. When these legal and social infrastructures are not there, people can be just as entrepreneurial, just as educated, just as hard-working, but they cannot succeed to the same extent .
Developed countries—those with a strong rule of law--offer far more opportunity for hard-working individuals to become rich through their own efforts, while poor countries are characterized by there being very little chance for people to improve their fortunes by their own efforts The rich gain a lot more from a well-organized society than the poor, because they can only become rich and keep their property in such an environment . In other words, rich people become rich through a combination of their own efforts and the support that the cultural infrastructure provides for allowing such efforts to work. So it is only fair that the portion of income provided by this infrastructure be paid for by the beneficiaries, who are disproportionally the rich.
This is why the multi-billionaires are created in the United States, and in Europe, and in Japan, but not in Nigeria, Paraguay, Pakistan, or Haiti. As much as Americans love the myth of the self-made man, the only way you can make yourself into something important that you did not come into by family or connections is by rule of law. So no matter how much you deserve your economic success relative to your high school classmates, you owe a lot of it to the American system of law when you look at your success relative to a Tunisian.
If your success is in part due to the infrastructure, then the folks who pay for the infrastructure deserve a cut. And since the more income you earn, the more you have depended on that infrastructure, it makes sense from a pure economic efficiency point of view to pay a higher percentage of your income in taxes. As Oliver Wendell Holmes expressed, “Taxes are what we pay for civilized society.”
And of course, if you inherited the source of your income, you owe it entirely to the infrastructure that assures it legally is yours: clearly you didn’t work for it and clearly the law COULD HAVE assigned it to anyone. Recall that until recent eras British law assured inheritances only to the first born son; daughters and younger sons got nothing. Of course it could have been otherwise. The point is that inheritance is not a law of nature, but a law of governments. If you benefit from it, then it is only reasonable that the government that let you have any of it at all should get a share .
Progressive income taxes also make sense from the point of view of making the population happier. Recent research has confirmed the following common-sense observation: that wealth makes people happier only up to a point. That point turns out to be about the median income for a wealthy country. Income beyond this point is subject to greatly diminishing returns in terms of collective happiness; and all the more so because a part of the benefits incurred by high income are the ability to have more than your peers. Thus beyond the point of roughly median income, a main benefit of your getting more is the ability to be ahead of the Joneses, winning in the rat race. If the government taxed even 90% of the income, those better off would still win the race and no one would really be noticeably worse off.
This is easy to understand, because beyond some point, and one can argue about whether it is $100,000 a year or $1 million or $5 million, an individual can satisfy all of his real needs. The reason people spend more is largely on positional goods: items intended more to increase ones social status than on satisfying any serious need or want. This observation becomes obvious when you look at incomes in the $100 million area: consumption is at this point mostly on luxury goods whose only value is to surpass the goods acquired by your peers.
Or maybe the motivation is not the income at all: maybe it is the motivation to win, or to accomplish something for which you will be remembered. Very successful workers such as Bill Gates and Warren Buffet consistently say that their motivation was not to make more money but to be the best at something they enjoy doing, or do bring the world the benefits of their accomplishments and vision. What motivates people like this is that they love the work and love succeeding at it.
The consequence of this observation is that raising marginal tax rates on very high incomes does not reduce work effort at all. As long as the $100 million a year earner can one-up the $90 million earner in possessions, the incentive to keep working remains. Thus highly progressive taxation raises lots of revenue without impacting significantly (if at all) either the well-being or the work incentive of the taxpayer.
Progressive taxation also makes sense from the viewpoint of preserving (more properly restoring) what made America special economically: the ability of a child to work hard and raise his socio-economic status. As incomes have become more unequal in the past 40 years, Americans are less likely to be able to better their position compared to that of their parents than Europeans.
Finally, I believe there is moral value in relatively equal incomes. Louis Brandeis, a Supreme Court Justice, said, “We may have democracy, or we may have wealth concentrated in the hands of a few, but we can’t have both.”
Those of us with a religious inclination will note that all the world’s major religions downplay the importance of personal consumption, if not outright discourage it, and emphasize the importance of caring for the poor and the sick.
The Bible, for example, says:
Beware that you do not forget the LORD your God by not keeping His commandments, His judgments, and His statutes which I command you today, 12 lest—when you have eaten and are full, and have built beautiful houses and dwell in them; 13 and when your herds and your flocks multiply, and your silver and your gold are multiplied, and all that you have is multiplied; 14 when your heart is lifted up, and you forget the LORD your God who brought you out of the land of Egypt, from the house of bondage; 15 who led you through that great and terrible wilderness, in which were fiery serpents and scorpions and thirsty land where there was no water; who brought water for you out of the flinty rock; 16 who fed you in the wilderness with manna, which your fathers did not know, that He might humble you and that He might test you, to do you good in the end— 17 then you say in your heart, ‘My power and the might of my hand have gained me this wealth.’
18 “And you shall remember the LORD your God, for it is He who gives you power to get wealth, that He may establish His covenant which He swore to your fathers, as it is this day. 19 Then it shall be, if you by any means forget the LORD your God, and follow other gods, and serve them and worship them, I testify against you this day that you shall surely perish. 20 As the nations which the LORD destroys before you, so you shall perish, because you would not be obedient to the voice of the LORD your God. (Deuteronomy 8:11-20, New King James Version translation, emphasis added)
To put this in more conventional terms, this passage, which is quoted at length so the reader can see that the context supports the following interpretation, says that rich people do not have a moral right to their wealth because they earned it through God’s gifts to them more than to their own exertions. And the consequence is that the reader should be obedient to God’s commandments.
These commandments are expressed in great detail in the Bible, and they include taking care of the poor and the weak. The Bible also includes commandments that are explicitly aimed at redistributing income and wealth from the rich to the poor and at preventing the accumulation of family fortunes: requirements for remitting debts regularly (every seven and fifty years), rules to assure that the distribution of land stays democratic and does not become concentrated in fewer and fewer hands, and paying for public infrastructure.
Also it seems to me that eras and countries where income disparities are relatively small are more patriotic and cohesive than those where they are larger.
The “right” has criticized this idea by claiming that America should provide equal opportunity, not equal outcomes. But this claim is a parody of Democratic proposals and is not even valid for the more ambitious proposal that follows, in which marginal tax rates on the most successful are much higher than they are today. In all cases, those who make more keep more after taxes, and a difference of, say, 100 to 1 pre-tax incomes between two families today would still result in a difference of over 30 to 1. A difference between, for example, an income of $50,000 a year and $1.5 million is hardly equal outcomes.
Research demonstrates that more equal societies have far lower levels of social problems, such as teen pregnancies, homicides, and mental illnesses, and have longer life expectancies. These observations should be particularly interesting to conservatives, since reductions in teen pregnancies and crime are high on their priority list of problems to solve, and because other solutions don’t have a track record of success.
So relatively rich people in more equal societies are better off overall than they would be if they were taxed at a lower rate. Richard Wilkinson summarized his research, which found “the U.S. can be twice as rich as Greece, Portugal, or Israel—the poorer of the rich, developed countries we look at—and the problems are no better even though Americans are able to buy twice as much of everything as the poorer developed societies.” These problems affect everyone, including the rich.
So another irony: failures of civil society expressed in increasing income disparity lead to further economic losses of common goals and to civil infighting rather than working together. Certainly we have seen this trend in the United States over the past 40 years.
Opponents of more progressive taxation for the rich have argued that small business entrepreneurs will be subject to this tax, and since most new jobs are created by small business, higher income taxes will reduce job growth. But this thread of argument gets it backwards. Even if we assume that small business itself creates jobs, rather than saying that the economy as a whole creates jobs, raising taxes INCREASES the propensity of relatively wealthy small business owners to work harder and expand their businesses.
Why? Because even at a 90% tax rate, a rate higher than anyone is proposing, the small business owner still makes more with a larger business than he does with a smaller one. But more importantly, I personally know several small businessmen who retired before they were 50. They did so because they already had made all the money they needed. So under the current system, they no longer are “creating jobs”. But with higher marginal tax rates, it would have taken them longer to reach their retirement goals, and they would have continued to work.
As a side note, one cannot reconcile the idea that small business CREATES jobs with the idea of the Invisible Hand of the free market. Adam Smith noted that if we allow each business to pursue its own profitability, the invisible hand directs the result to be something that is best for everyone. It is then business’ obligation only to make money. Thus business does not create jobs because it wants to, it only creates jobs as an unintended consequence of maximizing profit. Profit is maximized by exactly the same decisions with a high income tax rate as with a low one. This is why economists theorize that taxing profits is the best way to tax business. (Of course, this oversimplifies Smith’s argument.)
Thus, if we want to create more jobs, it does not matter how heavily we tax entrepreneurs, it only matters how fast and how well we make the economy grow. And the evidence of the past century in the U.S. shows that higher taxes on high earners help the economy grow.
The problem of health care.
A third problem has been driving our competitive decline in America—an issue that is related deeply if indirectly with the health care debate. That is NOT the issue of who gets health care, but of who pays for it.
Most everywhere in the developed world, health care is provided by government insurance programs, funded as any other government program would be, by general taxation as well as payments by the insured. But in America, through tradition rather than only by law, it is assumed that the employer is responsible for providing health care for his or her employees.
We now reverse all the traditional words used in the political debate between left and right: big companies are the nannies in this (the existing) nanny state; the employer is responsible for his or her employees’ health (why not housing, too, and transportation [actually the case sometimes where there are company cars provided for personal use], why not food and vacations and education?). This begins to sound like the Soviet Union or the state-owned part of the Chinese economy, where the employer does provide housing, entertainment, etc.
The point is that the tradition of employee-provided health care benefits is a regulation—not a formal legal one but a pragmatic one—that kills jobs very successfully by raising the cost of US labor relative to our competitors.
So if a US worker makes $60,000 a year, his US employer is taxed almost $6,000 for pensions and medical care; plus he is compelled by tradition to pay health care insurance costs for the whole family that on average exceed $10,000 . So the $60,000 employee costs his company $76,000 or more , and jobs migrate to Europe or Japan or China where this isn’t the case.
The parties that would have benefited the most from single payer national health care as an option in the U.S. were and are the biggest corporate employers, the very ones who were at the heart of the opposition to such a program.
The left has helped inflict these job-killing traditions on business through its apparent belief that it is business’ responsibility to take care of the personal needs of its staff. They have been abetted by the big business community lobbies that insist on retaining a system that reduces US competitiveness.
A Path Forward
I will build this discussion around conservative values both because I think these are being violated by those who claim to support them but also because they form a consistently articulated logical basis for starting out, as opposed to the more diffuse set of principles coming from the left.
It begins pragmatically with a will to create jobs and get out of the recession. Everybody favors more jobs, so this is not an issue dividing people. The problem is that no one really understands job creation very much, so all sides press their own agendas and claim with little or no evidence, or even despite evidence to the contrary, that their agenda alone will create jobs.
The right answer starts with a little humility. We ought to be able to look skeptically and open-mindedly at claims of growth and job creation and act in ways that can be supported with evidence and analysis. The following suggestions are thus just a first cut at deriving policies that can honor conservative principles of assuring responsibility by getting the incentives right and support patriotic values of promoting America’s economy and our moral interests and values, consistent with our Constitution and other founding documents.
It also supports progressive values of valuing diversity and promoting greater (but not complete) economic equality and protecting personal freedom and privacy. And it promotes environmental protection, a value that should be resonant with both sides but somehow has become identified as a progressive value. (Actually there are a few reasons why it could have been identified as a liberal value, since some of the environmentalist rhetoric is anti-corporate and anti-growth. But the actual policies enhance growth and profitability and are based on science and on the principle of responsibility.)
A consensus policy suite would start with trying to get us onto a path of economic recovery. I will begin with policies that should be the easiest to get across-the-board buy-in.
I assert here that an energy efficiency policy suite will without any doubt address most of the fundamental causes of our economic distress without compromising any of them.
Energy efficiency policies can greatly reduce the potential for future inflation, where the biggest causative factor is spikes in energy prices that efficiency will avert; they can eliminate the energy portion of the trade deficit, which is about one third, they can eliminate about a third of the risk of home mortgage lending, the defaults from which are still a major burden on the economy, and they can increase government tax revenue without increasing taxes.
Perhaps more importantly, they can create new local jobs directly through retrofitting homes, workplaces, and declining neighborhoods, and indirectly by saving money for consumers and businesses that can be spent on other things that people enjoy more than paying their utility and gas bills, creating new jobs.
The effect on inflation is particularly important, because the only real tool we have for fighting inflation besides energy efficiency is raising interest rates. A big risk confronting any nascent economic recovery is energy prices. For the past two years, every apparent uptick in the stock market has been accompanied by an uptick in oil prices.
If the economy ever starts a serious recovery, it is reasonable to expect a parallel increase in oil prices.
Efficiency also reduces the federal deficit. Some $600 billion a year is spent on energy by business and all of it is tax deductible. If we cut business energy use in half, then some $300 billion is no longer there to deduct and the deficit is cut by $100 billion a year. Efficiency in government use of energy could cut tens of billions more.
More broadly, I think we could achieve widespread consensus on a policy that starts with the conservative virtue of responsibility and starts to reward people and corporations for acting responsibly and to punish those that don’t. This does not mean abandoning the virtue of mercy—America is the land of the second chance and that is part of our success—but we should not let people or companies mess up and ask others to clean up the mess for them. This is a strong argument for tougher regulations on the environment, on product safety, on worker health and safety, on protection from fraud, etc. It is also an argument for financial incentives and disincentives to backstop the regulations and to encourage people to go beyond them. Progressives often underplay the importance of voluntary programs backed by real carrots.
I think we can find consensus for a policy that makes the tax system more progressive by increasing taxes on the wealthy. Progressives will support this policy based on their ideas of fairness but conservatives should also be able to support it because the evidence supports the thesis that an increase in taxes on the higher income population will create jobs, and that a policy plan that reduces government borrowing over the long term will do the same. They should also support it as a bulwark against a future threat of Communist ideas in America, a threat that could only occur if people start seeing free markets as the cause of great economic disparities.
Conservatives also ought to favor a directly more progressive tax system because it is better than our current system of what I call “basket-case socialism”.
There has been a long-standing political consensus in the US that certain social services and economic assurances be provided to the poorer segment of the population, or to everyone. These include pension benefits to retired workers, medical care for the elderly, public education, price reductions to youth and to the elderly, scholarships to college for low and moderate income students, and numerous other departures from what a completely free market would offer.
But these benefits typically are means-tested: they are only available if the recipient’s income is below a threshold. This provides the perverse incentive to TRY to keep your income below that threshold. The result is a system that charges the highest marginal income tax rate to the poorest households, reducing incentives to work. I call it “basket-case socialism”, because in order to qualify your family for benefits, you have to prove that you are a basket case, and you must be sure to remain one.
A further distortion to the market is that many benefits come in the form of subsidies to one sort of activity rather than another. Examples are subsidized housing and food stamps. Economic theory is clear that people would be better off if you just gave them money, and conservatives who like that theory would seem to be inclined to support this change. In fact, anecdotal evidence suggests that rather than creating gratitude for the reduced-cost items recipients of these benefits are getting, it produces resentments: occupants of subsidized housing don’t seem to like it and the restrictions on the use of food stamps also create negative attitudes.
Means-testing in the tax system, with phaseout of benefits as incomes rise above thresholds, results in upper middle income people being taxed at higher rates than the rich. This is the unintended consequence of the standoff between left and right where the left insists on the importance of a tax preference to the poor and middle class, and achieves political acceptance by cutting the costs of the program by phasing out the benefit with income.
But if a family is in the phaseout income range, they pay effectively 2-4% higher taxes on their additional income than the ultra-rich. Rather than phasing out tax breaks “for greater fairness, so as not to pay upper middle class people who don’t need the break so much”, it would make more sense to just increase actual stated tax rates by a few percentage points so they don’t phase out for the ultra-rich.
This is just one of dozens of examples where important benefits are conferred if you can show yourself to be enough of a basket case to merit special treatment. One particularly gruesome example is when one of my friends overheard their hospital roommate talking to his physician about how to recover from an accident where he had cut off his thumb off. The surgeon had recovered the thumb and could replace it but the operation would cost over $100,000.
The man was uninsured. So they informed him that if he had no assets, he could declare bankruptcy and the operation would go ahead. But if he owned a home and a car, the hospital would take them away to pay for the operation. The reward for being responsible and saving your money is that you would lose everything, whereas if you had been a spendthrift or lazy and had no possessions to seize, you would get the treatment for free. I turned out that the man owned his house and a car. He faced the choice of losing everything he had saved or losing his thumb.
THIS IS A TRUE STORY. I don’t know how it came out.
The same thing, on a much less offensive level, occurs for college scholarships. When our older child entered college, we asked about financial aid. The office told use to fill out a form; the result of which was the remarkable conclusion that we would have qualified for aid if we had our actual incomes but no assets; but that since we had been saving for retirement, we no longer qualified. The best strategy would have been to take luxury vacations every year and drive two Mercedes.
Where we are now combines the worst of socialism and capitalism: it reduces the incentive to work for the near-poor, and provides benefits that the consumers value less than their cost. And people evidently don’t like it, recalling the success of President Clinton’s comment that the system should reward people that work hard and follow the rules.
One set of people who especially don’t like it are those with low but reliable incomes in the range of $9.00 an hour. Low-paid workers particularly resent basket-case socialism, as well they should: it raises the economic status of people just below them—people they see every day—who appear to be working less hard. People who work hard for their pay OUGHT TO be angry at programs that reward those who don’t work as hard.
Unfortunately, this resentment is cynically cultivated by the leadership of the “Right” who figure that if we distract low paid workers by the clear unfairness of a system that rewards the poor relative to their own families, they will fail to see how much more money is taken by the rich.
A fair system would reward hard work by creating a large distinction in economic outcomes between those at the lower end of the spectrum who work for their money and those who don’t. It would eliminate many welfare programs that target specific needs and that have income or other limits that encourage people to show how helpless they are.
Instead of providing services that the lower income recipients might not really want or appreciate, it would make sense to simply rebate the income assistance in cash. This is more or less what Social Security does, and is what the State of Alaska has been doing for decades. If we provide for basic, low economic level human needs in cash, then we can start taxing any additional income at a modest rate, creating a stronger incentive to work. The tax rate would then rise steadily with income.
The idea of providing a minimalist guaranteed income to citizens is not a new or leftist idea: Thomas Jefferson proposed it over 200 years ago, arguing that full freedom requires that each citizen receive a (modest) estate when he comes into majority, enough to keep him fed and clothed his whole life if he spent it wisely.
I believe this proposal would achieve some consensus when it is coupled with the termination of most varieties of welfare, because it creates greater fairness at the lower end of the income spectrum while compressing the outcomes at the higher end, where they make less (or no) difference in personal happiness or pride of accomplishment.
Conservatives may be skeptical about embracing an idea that appears to support laziness at the low end of the income spectrum. After all, if you can just sit on your porch and drink beer all day without working, why should anyone else work. Why should we reward the lazy and shiftless poor?
The first answer to this question is to note that we do already.
The second is to remember that higher tax rates on the successful cause the economy to grow and provide more opportunities to work.
The third answer is to look more closely at why people end up poor. I can see three reasons:
1. Poor people are poor because they had bad luck. In this case it is fair and compassionate to help them with money.
2. Poor people are poor because of health problems that prevent them from working, or from working effectively. This is another reason for compassion rather than tough love: if you can’t work, more incentives to do so will fail.
3. Poor people are poor because they are lazy and irresponsible. Suppose this is the case for poor person A. Would YOU hire him? Some people are not only lazy but actually disruptive in the workplace. And they may encourage poor work habits among their peers. America would be better off if these people were paid not to work.
We also ought to be able to find consensus on a policy that substitutes taxes on pollution for taxes on employers for their payrolls, because this reform will also increase jobs and competitiveness. If these are not enough, Social Security and Medicare could be funded out of general revenues, rather than taxing work effort and the provision of jobs by business, which is the way we do it now. If we tax jobs, we will have less of them, and foreign experience shows that reduced taxes on employment leads to more hours of work.
Living within our means is something progressives need to learn to value. But this will not happen if frugality is a code word that means reducing economic equality or cutting services for the poor and middle class. More broadly, a program that calls for “shared sacrifice” or austerity is not something I think either party should want to embrace. Economic policies should promote growth and abundance, not sacrifice and austerity. If individuals want to choose austerity for themselves, that might be a good thing, but no one should want government to impose it on us, no matter how liberal or conservative their politics.
Living within our means as a nation requires that we embark on an honest discussion of what level of services we want to pay for, and then raise the revenue needed to actually pay for it. For 30 years, “conservatives” have used balanced budgets as a code word for cuts in Social Security and Medicare that they would not advocate in so many words. Only recently have they begun to propose this out loud. Their continuing failure to make any significant cuts when they have held power seems to show that serious cuts are not politically feasible, or are not justified, or both. Thus the conversation has to START with revenue enhancements that balance current levels of spending. It has to start there because of the likelihood that higher taxes will promote growth and get the nation out of the current vicious circle of austerity leading to low spending leading to low growth. Once we have a plan that balances revenues and expenditures, we can discuss where cuts in both services and taxes can be made.
It also has to start there because the only explanation for 40 years of stagnation that I can think of, besides energy waste, is tax cuts on the wealthy that were not balanced by spending cuts. If we want to overcome the poor performance of past policies, we can’t use them as the starting point.
It is interesting to note in this regard how much the burden of these entitlements in the future has been overstated. I noted in Part 1 that the report of the Trustees of the Social Security trust fund stated that their models show the system going broke in 2033. But going broke does not mean what the “Right” suggests: the report showed that it merely means that after 2033 benefits would have to be cut by 23%. I can’t see this as a crisis, especially given how little one ought to trust 25-year economic forecasts.
It should be noted that some of the cuts in spending over the past two years were actually time bombs for MORE government spending: cuts in home weatherization funds commit the government to a stream of continuing waste in paying for low income energy bills that could have been less; cutting the high speed rail spending program commits the nation to spending what is likely to be more than twice as much for highways and airports as we would have spent on railroads. It goes without saying that such “cuts” should be avoided.
There is one other policy choice that most clearly supports economic development—improving education. California based much of its success over the past century on constructing the world’s leading system of higher education. This has led directly to the state’s dominance in high technology and innovation. Yet now we are trying to undo these gains. Education spending is under pressure at the state and local levels, from kindergarten all the way through graduate schools, and little is being done to address that issue at the national or state level. A major commitment to education would produce jobs (or retain them) in the short run and attract the world’s most creative talent here in the long run.
Health care provision remains a crisis that will drag down America’s economy as it grows from some 17% of GDP inexorably until some unaffordable level is reached and a crisis ensues. Health care fundamentally is not a market, for the reasons discussed in Annex A: the way it is provided violates over a dozen of the conditions that have to occur for markets to work. Since markets in health care fail, competition cannot in principle bring down prices. Without the possibility of transitioning to a single-payer system, we will continue to “tax” job creation and make American labor less and less competitive globally.
But the Left is in error when it insists, without explanation, that the employer is responsible for his staff’s health care expenses. The employer was an easy target in union/management disputes, so we can see how they got there, but it is hard to find a rationale for why the employer has such as obligation, as opposed to the obligation falling on society more broadly.
We have models all over the world, and are beginning to have some in US states, of how to transition incrementally to a single payer system. We have found that not a single health care system anywhere in the world costs as much as the US private-insurance-based system, even though single payer systems in all other wealthy countries deliver much better outcomes. And we have found that if one state tries to implement a single-payer system on its own, it can cut health care costs for the period 2015-24 by about 25% with no change in the quality of care and with an increase in jobs.
Both parties need to emerge from their bed of mothballs and get beyond the politics of the past. Progressives need to realize that the world is not a struggle between “working people” and employers. Many employers are small business people with modest incomes, and many of America’s richest people earned their wealth as workers. They need to recognize that positive behaviors such as hard work and honesty and self-discipline should be rewarded and the reverse behaviors punished. They need to look more closely at the details of how to craft policies whose results can be measured and that can be shown to really work.
Another reform that both left and right ought to support is to get the money out of politics.
This is a common theme that I have found to resonate with all parts of the political spectrum. Conservatives and Progressives may have different motivations for doing this, but most everyone I have talked to or read agrees that big contributions corrupt a democratic system. They result in the awarding of special favors to contributors, either in the form of fat government contracts or in terms of preferential access to elected officials.
I have seen first-hand the problem of access. For several years, I spend nearly 15% of my work time lobbying for efficiency tax incentives. In all that time, I think I got no more than 4 hours of face-to-face meetings with the actual elected officials. All the rest of my time was spend with their staff. In many cases working with staff was sufficient, but when it wasn’t I was at a real disadvantage compared to interests that made campaign contributions.
America needs to put some serious effort into reforming the system of campaign finance so that legislators can spend their time legislating rather than spending the lion’s share of it on fund-raising.
This is not the place to get into the details of how this reform might be done. But here is one simple idea that may serve as a starting point. Occasionally I have done paid work for organizations where I am a Board member. In such cases the law requires that I recuse myself from any Board discussion related to my work contract. This is just common sense.
What if we required the same of legislators? Suppose Congress decided that a Member would have to recuse themselves from any decision that affected the business interest of a campaign contributor?
Of course, the details of implementing such a system would be important and difficult, and perhaps this is not even the right approach. But we need to develop a dramatically different system of financing campaigns to avoid wasting government money and to renew democracy.
Conclusions
Conservatives need to realize that Communism is not ever going to be a threat unless the fruits of current “conservative” policies cause a crisis that makes this nonexistent risk become real. They need to look at the economic data on taxes, spending, and regulation, and see that fundamental conservative principles do not support tax cuts or blanket deregulation, either economically or morally. They need to reclaim the moral high ground on limiting debt to make it the highest priority option, not one subordinate to military spending or low taxes—otherwise no one else will be the advocate of balanced budgets.
These ideas could constitute the beginnings of a policy suite that honors conservative values and achieves progressive goals of greater equality. At the very least, it could be the beginning of a discussion that is based on the facts, and that follows America’s earliest Constitutional traditions of arguing issues on the merits, acting in ways that are self-consistent, and being willing to compromise for the good of the nation.
ANNEX A
Why Health Care is not a Market, and thus market forces will not lead to efficiencies The health care debated has been framed at the national level as a decision between reliance on market forces and socialist or big-government “solutions”. This misstates the problem in a fundamental way. This article will show why the current private-sector-based health care system violates over a dozen of the unquestioned economic assumptions that must be satisfied for true competitive markets to exist. These violations are so severe that market forces are and will continue to be unable to contain costs or to produce anything remotely resembling a Pareto-optimal solution. Instead, with health care costs inexorably rising, they will undercut the competitiveness of the rest of the American economy.
It then shows why a single-payer system makes more sense from the perspective of economic theory and has the ability to control costs without reducing the quality of care. Finally, it shows how the current system of financing health care, in which employers are primarily responsible for providing the costs, undercuts job grow and reduces American competitiveness.
1. Assumptions of micro-economics that are invalid
a. Irrational decisionmakers
i. Consumers are unable to make rational decisions
1. Emotionally involved self and family precludes hard choices being made analytically
2. Mental illnesses or physical weaknesses may preclude rational choices of any sort
ii. Consumers do not act in their self-interest
1. Aversion to healthy practices leads to expensive remedial treatments instead of cheap prophylactics
2. Consumers and even doctors rely on simple heuristics when dealing with probablitistic outcomes that are inconsistent with proper statistical reasoning. (This issue was researched by Daniel Kahneman and is described in this book Thinking, Fast and Slow. Many of the examples he cites are from health care decisions that he shows were made irrationally not only by patients but by doctors, including those with statistical expertise.)
iii. Providers are often unable to make rational decisions because of the multiple and overlapping rules and standard procedures and the risk of litigation.
b. Asymmetric (at best) information; and transactions costs of trying to get enough (not to mention interfering with professional expertise)
i. This applies to choice of doctor, choice of treatment method, choice of insurance provider, choice of hospital, choice of drugs…
ii. Pricing can act as a signal of quality: cutting prices may not lead to competitive advantage. People want to go the “best” doctor or hospital. This encourages high pricing in situations where economic theory says that lower pricing is preferred (see John Kay Culture and Prosperity for an explanation of how this works in the office rental market.)
c. Often no choice of direct provider, especially in high-cost circumstances (if you are unconscious, you will just be treated with no choices).
d. Usually little or no choice of insurer: you take what your employer offers.
i. Uncompetitive markets in any event: individual insurance is unavailable or exorbitant compared to group. Competition requires that the same price is available to everyone for the same product.
ii. People with pre-existing conditions have an even less economically defensible set of choices. In this case there can be no market because the product in question—health care insurance with a given list of providers, covered services, and co-pays does not exist because the product is actually dependent on who the customer is and thus cannot be traded. This would be like a store that charged blue-eyed people double.
e. Competitive markets work for known goods, but treatments are seldom known goods, as each individual case may be different, even for the same person at different times.
i. Insurance policies are also not known goods, in that every provider offers its own individual policy with its own unique set of in-system providers
ii. Pricing, by tradition, is essentially cost-plus (time-and-materials, for each patient), which provides practitioners with a perverse incentive (“The current fee-for-service (FFS) promotes over provision of health care services.”); a competitive system for known goods (services, actually) would have providers bidding on the full package of services needed to keep the patient healthy.
f. Some services—especially the most expensive ones—will be given away for free to anyone who cannot afford to pay.
i. This distorts pricing significantly as hospitals “bury” the uncompensated costs by overpricing other services. So prices have little relation to marginal costs. If prices do not correctly communicate cost information, then markets cannot work.
ii. It also creates moral hazard, in that young healthy people will fail to buy health insurance because they have little risk and no assets to lose if they require expensive treatment; and most importantly , they know that they will be treated for life-threatening conditions regardless.
iii. More broadly, prices do not allow consumer choice because they are bundled: consumers cannot select which individual products or services they are billed for.
g. Markets are based on the assumption of unlimited material wants. But health care isn’t a want: most people would prefer to have as little of it as possible. At best, most people will accept the care they need, and may prefer higher quality of care if they know what that means but prefer less rather than more, as long as it works.
h. Markets assume one person’s consumption does not affect others. This is evidently untrue for contagious diseases, or for public health issues. It is also untrue for insurance markets, where the moral hazard described in f.ii implies that if healthy people don’t pay for insurance sicker people will pay more, and subsidize the uninsured lower-risk customers when they do need treatment. If everyone bought insurance, the rates would be a lot lower; thus others’ behavior does affect you.
i. Markets assume person A’s utility is not affected by person B. But information on the quality of health care is largely based on word-of-mouth, which means that B’s preferences DO affect A’s perceived utility.
j. Consumers cannot always choose the treatments they want: some choices (e.g., assisted suicide, use of unapproved drugs, treatments that the doctor thinks are ineffective, etc.) are not available; other service choices (such as treatment by Doctor A) may not be available (e.g., if you get sick during the 128 hours a week when he isn’t on shift) or may be non-covered and thus unaffordably expensive.
k. Professionals often work in health care because they are motivated by altruism, rather than money.
l. There are immense principal/agent disconnects in health care: hospitals may have different interests than the professionals they employ, and insurance companies have little interests in common with the end use consumer. Very little of the sector involves direct payments from consumers to doctors. Even less involves direct payment from consumers to nurses or paraprofessionals.
m. The health care system involves long-term relationships of trust. Markets require that buyer and sellers maximize their benefits with each transaction, but doctors and patients may want to retain the same partner for the long term. This precludes or mutes competition. In everyday terms, people who have a doctor tend to stay with one; people without a doctor tend to not seek medical care; or eventually wind up in the Emergency Room .
n. Barriers to entry and exit: pre-existing conditions make it hard for a consumers to enter into health insurance; a barrier to exit is that it is hard to opt out of health care: the system will treat you, and at great expense, anyway.
These powerful failures of the health care system to satisfy the prerequisite conditions of a market mean that reliance on market forces to achieve optimal results can never work.
Specifically, the market forces that could restrain escalation in costs cannot work. Neither hospitals, nor health care professionals, nor insurance companies, nor end use consumers have any significant economic reasons to cut costs. Hospitals don’t care because with more expenses, they may be able to claim better outcomes, and insurance will pay the freight in any case. Insurance companies make most of their money by getting their competitors to pay for sunk costs, and can pass on any cost increases to the employers that pay for insurance.
Insurance companies have little incentive to cut costs because if all of them increase their costs at the same rate, the system is stable. Employers in principle can change providers, but this change comes at a cost in employee retention and may not be worth it, especially if such a change forces employees to change doctors, hospitals, etc., frequently. And since so little information is available on the quality of care that a plan offers, price can be used as a surrogate for good ratings, prompting companies to be less concerned about their rates.
2. Adverse Economic Effects of the Current System
a. It is a de-facto jobs tax
b. It produces inferior outcomes to other nations’ systems but costs twice as much
c. It allows health care costs to escalate without control
d. It creates a self-sustaining infrastructure, making changes progressively more disruptive. This problem embraces lobbying by incumbent interests as well as generating future instability
i. A disaster scenario: an epidemic causes costs to double in one year. No one is capable of paying them: insurance companies would go bankrupt. The government finds it harder to step in because of the difficulty of deciding who is too big to fail.
3. Benefits of a single payer system
a. Medicare is less expensive than private systems and well accepted by consumers.
b. If some consumers are always going to be treated for free, or for deep discounts, it is better to rationalize the system so that everyone is treated equally. This cannot be done when each provider and insurance company is out for itself.
i. Example: the story of the man who faced the choice of losing his thumb or losing his house.
c. Systems with competing providers spend too much on administrative costs. A study performed for the State of Vermont found that the reduction in administrative costs from the state’s adopting a single-payer system would be about 25% even while providing more people with insurance at the same level of coverage that currently-covered consumers had. Paul Krugman has pointed out that the most effective way to increase profits for a competing insurance company is to get someone else to pay for the most expensive claims. This means that the profits are made by litigating over who pays sunk costs. But from a societal point of view, it is never worth worrying about sunk costs: it is only worth worrying about future costs.