Negotiating the Budget
Although House Speaker Kevin McCarthy promised his caucus that he would not agree to an increase in the debt ceiling without obtaining substantial cuts in federal spending, he’s now committed not to allow the U.S. government to default on its outstanding indebtedness. Having seemingly set the debt ceiling issue aside, the President and Speaker McCarthy now have to work on reaching an agreement on the federal budget. To that end, President Biden has promised to release his budget proposal on March 9th and has asked Speaker McCarthy to do likewise. This is intended to enable a budget to be hammered out well in advance of the government’s exhausting its ability to avoid a default which is currently on track to occur in the middle of this summer.
Admittedly, House Republicans are not wrong in again raising the issue of the nation’s large fiscal deficits. Last week the Congressional Budget Office predicted that the nation’s outstanding indebtedness will grow by $19 trillion over the remainder of this decade and that the average annual federal deficit will exceed $2 trillion between 2024 and 2033. That’s a frightening prospect when you consider that the nation’s gross domestic product (or GDP) will only grow at approximately half that amount, leaving the nation even more vulnerable in the event of an economic adversity such as might be caused a prolonged military conflict, a weather related disaster or another pandemic. Michael Peterson, CEO of the Peter G. Peterson Foundation, a nonpartisan organization, has characterized our rising debt level as “an intergenerational justice issue and a moral issue.” Unfortunately, confronting our fiscal deficits will require our government to make some hard budgetary choices, something it seems to have little appetite for doing.
At the heart of this problem is the fact that the nation’s two principal political parties have very different approaches to managing the nation’s economy. The Republicans operate under the belief that those who manage business enterprises are best able to direct our economy. They are reinforced in that belief by the fact that business enterprises tend to be far more efficient than governmental agencies. (See, ”The Role of Government” for an explanation.) They, therefore, assert that the nation’s economy will perform better by funneling its economic resources to businesses and those who control those businesses and let them decide how to best employ those resources. This governing philosophy was succinctly summarized by Charles Wilson, the CEO of General Motors, in a Senate hearing over his confirmation as President Eisenhower’s nominee for Secretary of Defense. During that hearing, Wilson is reported to have explained, “What’s good for General Motors is good for America.”
In stark contrast, the Democrats believe that economic growth can be best achieved by empowering all Americans to maximize their individual productivity. To do this, the nation’s resources must be directed toward the well-being of its citizens and the creation of infrastructure and new technologies. In short, Democrats don’t accept the proposition that business leaders will subordinate their own prosperity as well as the prosperity of their shareholders to that of the nation. As explained below, this difference in governing philosophies lies at the heart of the current runaway growth in our nation’s level of indebtedness.
Virtually all of the nation’s $31.4 trillion indebtedness has been accumulated since 1980. This has been the result of high levels of spending coupled with relatively low levels of taxation. This process was initiated when Ronald Reagan became president and embraced “supply-side economics,” an economic theory propounded by Arthur Laffer. Laffer postulated that if you cut income tax rates (corporate and/or individual), more monies will become available for businesses to expand their operations. That, in turn, will accelerate economic growth while generating at least as much tax revenue as was being collected prior to the reduction in tax rates.
If this sounds crazy, you’re not mistaken. George H.W. Bush, who challenged Reagan for the Republican nomination in 1980, denounced Laffer’s theory as “Voodoo Economics.” It has now been tried three times at the federal level (during the administrations of Ronald Reagan, George W. Bush and Donald Trump) and each time it failed to increase economic growth and resulted in significantly higher annual fiscal deficits. This prompted Paul Krugman, a Nobel laureate in economics, to characterize supply-side economics as a “Zombie” because even though it has been disproven multiple times it keeps being resurrected.
The periodic reintroduction of supply-side economics occurs because Republican politicians continue to promote it. They do this for the simple reason that it tends to concentrate the nation’s wealth in the hands of the wealthy, the principal contributors to their political campaigns (see, “The Myth of Republican Economic Managerial Superiority”). Taken together, the tax cuts promoted by Republican administrations have reduced the highest individual federal income tax rate from 70% in 1980 to its current rate of 37% and the highest corporate federal income tax rate from 48% in 1980 to the current rate of 21%. It’s therefore no coincidence that the large increase that has taken place in the nation’s level of indebtedness over the past 40+ years has coincided with the Republican tax cuts.
The problems with the federal Income Tax Code, however, run much deeper than reductions in the rates of federal taxes. The tax code has not been subjected to a major re-examination since 1986 and is now filled with a plethora of loopholes that skew how the burden of funding the federal government is allocated among its citizens. For example, there’s no justification for capital gains to be taxed at lower rates than income derived from one’s labors. The fact that businesses regularly engage in stock buy-backs indicates that there is no shortage of capital for those businesses to invest. Nor is there any reason why the cost basis of capital assets should be stepped up upon one’s death? This is just another way to allow the wealthy to avoid paying taxes on a major source of their wealth.
Similarly, it doesn’t make any sense to allow building owners to depreciate the costs of their buildings when the market value of those buildings is actually increasing. Also, is there any justification for allowing money managers to have the income they earn for their management services to be taxed at capital gains rates (20%) and not as ordinary income (37%). These and countless other provisions of the tax code are the handiwork of corporate lobbyists (rather than members of the Congress or their staffs) who all-too-often are the authors of tax code revisions.
On the spending side, almost 50% of the nation’s annual expenditures come from two programs (Social Security and Medicare), both of which were adopted during Democratic administrations. Social Security was enacted in 1935 (during the height of the Great Depression) as a part of President Franklin Roosevelt’s New Deal. At that time the highest individual income tax bracket was 63% and the corporate income tax rate was 13.75%. Medicare was adopted in 1965 as a part of President Johnson’s Great Society when the maximum federal individual income tax rate was 70% and the highest corporate income tax rate was 48%. Because of the relatively high level of taxes prevailing when these programs were enacted neither of them led to significant increases in federal deficits before 1981.
Over the past four decades a distinct pattern has developed. When Republicans are in control of the federal government they push to cut taxes and government regulations; and when Democrats are in control of the federal government they expand social welfare programs. While each political party has sought to roll back the legislative achievements of the other, in practice such undertakings have at best only been marginally successful. Even though Democrats have passed small tax increases to help fund their new social welfare programs, they have not been able to pass wholesale tax increases that would significantly reduce budget deficits. This is largely because many Democratic legislators, like their Republican counterparts, are reticent to offend their own principal donors.
Similarly, while Republicans officials have had some success in chipping away certain aspects of the social welfare programs enacted by Democratic administrations, they have been unsuccessful in repealing those programs. For example, George W. Bush unsuccessfully sought to privatize Social Security and Donald Trump was unsuccessful in his effort to repeal the Affordable Care Act. This is because once social welfare programs are in place, they become very popular with voters of all political persuasions. In short, every effort to tame rising federal deficits (whether its raising taxes or cutting expenses) has largely failed. Stated another way, in the struggle between politics and fiscal sanity, politics has consistently prevailed.
Although the fiscal peril that lies ahead has increased, it doesn’t currently appear to be sufficiently threatening to change the prevailing political dynamics of the budgetary process. This was made clear during President Biden’s recent State of the Union address. When the President asserted that some Republicans want to repeal Social Security and Medicare, Republicans were quick to disclaim any such intentions. Even former President Trump strongly advised against doing so. Conversely, even though President Biden stated that he wants to increase taxes on those whose annual income exceeds $400,000, he did not indicate any intention of rolling back the Trump tax cuts, much less those passed during the administrations of George W. Bush or Ronald Reagan.
This leaves a number of discretionary items in the federal budget which might be cut in an effort to reduce the annual deficits. By far the two largest items are the defense budget which currently stands at $817 billion and Medicaid which currently stands at $561 billion. Here the problem is that Republicans don’t want to cut defense spending and the Democrats are afraid of the political repercussions if they try to do so. The reverse is true with respect to Medicaid; the Democrats don’t want to cut the Medicaid budget and the Republicans are afraid of the political repercussion if they do so. This essentially eliminates these items from being the source of meaningful spending cuts. All other discretionary budget items are so small that their total elimination would have only a small impact on reducing the nation’s annual deficits.
Of course, the problem runs much deeper than simply trying to put the nation on a path to cutting its annual budgetary deficits. At best, this would only open the possibility that the nation’s aggregate level of indebtedness might be reduced to a smaller and more manageable percentage of its annual GDP which currently stands at 136%. It would not address the fact that both the Social Security and Medicare programs are currently under-funded and will have to be curtailed if they are not reformed. The latest figures published by the Congressional Budget Office indicate that the trust fund supporting the Medicare program will be depleted in the next few years and that the trust fund supporting the Social Security program will become exhausted in about ten years. Both of these programs which are vital to the nation’s economic health are being imperiled by demographic changes and require immediate remedial action.
According to the Urban Institute and the Brookings Institution, the ratio of workers supporting each retiree was about 5 to 1 back in 1960. By the end of this decade it will fall to just over 2 to 1. Stated another way, people who live until age 90, a fast-growing group, will spend one-third of their adult life collecting Social Security and Medicare benefits. As a result, today’s typical retiring couple will receive Medicare benefits three times as large as their lifetime contributions to the system. They also will come out ahead (adjusted into present value) on their contributions to Social Security.
These statistics have prompted Senator Ron Johnson to characterize Social Security as a “Ponzi scheme” which he contends should be rescinded. To refresh your recollection, he’s the senator who advocated that Americans should use Ivermectin (an anti-parasitic drug developed for treating livestock) to prevent the Covid virus. While he has made a number of other silly pronouncements, he is not wrong in asserting that Social Security is a “Ponzi scheme.” That’s because in a very real sense it is. Each year a 12.4% tax is imposed on the wages of all American workers and those monies are used to pay retirement benefits to individuals who have retired. Of course, this practice also fits the definitions of an insurance policy and an annuity agreement, neither of which characterizations carry the pejorative connotations of a “Ponzi scheme.”
The danger that the Old-Age and Survivors Insurance Trust Fund (aka the Social Security trust fund) will soon run out of money is not a new problem. It has been addressed several times in the past by increasing the percentage of annual wage contributions and by increasing the maximum amount of wages on which that percentage is assessed. The problems facing the Social Security program have also been addressed by increasing the age that an individual becomes eligible to receive Social Security benefits. A combination of these modifications to the program would seem appropriate, particularly the possibility of raising the amount of earnings subject to the Social Security assessment. This would shift most of the additional funding obligation upon those most able to assume that burden.
It has been suggested on many occasions that the Social Security program be privatized so that each wage earner could place his or her annual contribution to the Social Security trust fund into an individual account and invest those monies as he or she desires. This would presumably permit the invested monies to earn a greater return and thereby increase the program’s longevity. This suggestion, however, has been repeatedly rejected as most wage earners lack the fiscal sophistication to make wise investment decisions or to even select a competent money manager. It also opens the possibility that many might have no savings in their individual trust funds when they retire thereby defeating the purpose of the program.
The most immediate issue confronting Medicare is the solvency of its Hospital Insurance Trust Fund, which funds Medicare Part A (hospital care) benefits. Unlike other parts of Medicare, the trust fund is financed mainly through a FICA tax of 2.9 percent, split between employers and workers; Parts B (outpatient care) and D (prescription medications) are financed through a combination of general government revenues and enrollee premiums. The problems associated with the Hospital Insurance Trust Fund can be addressed in a manner similar to the Social Security trust fund.
Reforming Part B and D of the Medicare Program is a much more complex issue because there are many more ways to enhance their viability. Like Social Security, the Medicare program is threatened by the fact that the American population is growing older. In 1965 when the Medicare program was enacted the average life expectancy of an American was 70.11 years. Today, the average life expectancy of Americans is 79.11 years. While it can be argued that this increase is because Americans are now healthier, it is difficult to argue that almost tripling the number of years of medical coverage does not add to the costs of the program.
Perhaps a bigger problem for the Medicare program is the rising costs of medical services. There are a number of factors underlying this problem. First, medical science has advanced so more maladies are now able to be treated. This alone accounts for much of the increases in medical costs. In addition, many of the advancements in medical science are in the area of diagnostic equipment. This equipment tends to be quite expensive and doctors fear malpractice claims if they don’t make every effort to ascertain the exact nature of their patient’s afflictions. Thus, they tend to prescribe a number of costly tests before making a diagnosis and commencing remedial actions. These changes in medical practice present a particular problem for Medicare, as well as other medical insurers, as they are loath to question doctors as to what tests and procedures are necessary and appropriate in any given case. This leaves medical practitioners, who profit from the scope of their services, free to exhaust the full range of medications and treatments at their disposal.
A significant part of medical costs today are drug costs. Today, simply bringing a new drug to market takes approximately seven years and can cost as much as $100 million. That’s because the drug approval process is so rigorous. To make such an undertaking cost effective pharmaceutical companies are granted limited patent protection for their new products before they have to face price competition from generic drug manufacturers. This puts pressure on them to realize as much profit on each new drug as they can while they still enjoy patent protection (generally about 13 years). Accordingly, they advertise heavily on television to build the breath of their market and raise the price of their drugs every few months. The result is that drug prices in America are frequently many times higher than the same drugs cost in other countries.
In a very real sense, the U.S. subsidizes the costs of developing pharmaceutical products that will benefit all nations and drug development costs seem to increase each year. While there is a high level of public outrage over the high costs of drugs in this country, the pharmaceutical companies have largely been successful through extensive lobbying efforts in keeping Congress from taking action to reduce drug prices. This explains why since the effective date of Medicare Part D on January 1, 2006 the Medicare program has been prohibited from using its considerable bargaining power to negotiate drug prices. It was only this past year that a step (albeit a small one) was taken in that direction with the passage of the Inflation Reduction Act.
As noted at the outset, President Biden has promised to release his 2023 budget proposal on March 9th and has requested that Speaker McCarthy release the budget that the House Republicans would like to adopt. This is an invitation to a childish game wherein each side seeks to score political points by arguing that the other party is trying to skew the federal budget in a manner which the public will find distasteful. Proceeding in this manner is not likely to achieve a satisfactory result and will only serve to further postpone dealing with the serious fiscal problems currently facing the nation.
It doesn’t take a genius to figure out what should be done in the forthcoming budget negotiations. President Biden and House Speaker McCarthy should first tentatively agree to suspend the debt ceiling for a year as all but a few members of the House Freedom Caucus seem to understand that defaulting on the nation’s outstanding indebtedness is not an option. They should next agree on how to breathe extended life into the Social Security program. Congress has previously done this on several occasions so this should not be difficult to achieve. Lastly, they should then develop specific goals for restructuring Medicare and the federal tax code and appoint two small bipartisan committees (each not to exceed 12 members) of House and Senate conferees to make recommendations for implementing the agreed-upon goals negotiated by President Biden and Speaker McCarthy. While there is no guarantee that plans for restructuring these two critical programs can be reached, proceeding in this fashion at least has a chance of removing the debate from the political arena where nothing is likely to be accomplished.