Schumerism

Here's a brief essay expanding on a post I made at The Agenda:


The typical discussion of the middle class begins with a tale of statistical woe. We are often told, for instance, that median household disposable income has remained virtually flat from in the last several decades. Strictly speaking, this is true. Such examples of middle class compression form the basis for narratives of how the American dream is being crushed and requires an active countervailing force to resist that pressure.

Chuck Schumer has done more than virtually any politician in voicing that narrative. Yet his success comes in equal measure from voicing tales of doom, as well as cannily recognizing the ways in which middle America has changed in order to offer up government solutions to satisfy people's new needs. To the extent that we confront a larger government, it is because Americans have increasingly bought an ideology — “Schumerism” — that sells government spending as the solution to the problems of an increasingly affluent middle class.

This rising wealth stems from the continuous productivity advances of the last several decades, which have yielded enormous improvements in the typical American quality of life. One telling statistic comes from the CBO, which estimates that a typical family of four received in 2010 an overall pre-tax compensation of $94,900. In some sense, the vast majority of Americans are millionaires — not of course in terms of their immediate access to assets, but rather in the raw earnings potential a typical family can expect over a lifetime. This reflects a degree of prosperity unimaginable in 1958, when John Kenneth Galbraith already considered the pattern of private wealth to constitute unbelievable affluence. Families with two-earners or more education than average can expect to earn even more.

Thus, in comparisons with generations past, Americans find themselves with a lower need for government than ever before. If the goal is simply to ensure a basic absolute level of income, the insurance and welfare aspects of government are less necessary than they ever have been.

That simple economic logic has had drastic implications for both political parties. Democrats in particular have been forced to adapt to new economic realities. Their core constituencies have simply evaporated as the working class has graduating in income; College education has increasingly become the norm; and union membership has plummeted. If the voting patterns based on education and income had remained fixed from, say, the 1970s -- Democrats would simply be politically annihilated. In order to remain electorally viable, Democrats have been forced to appeal to the demands of an increasingly wealthy and educated public.

This appeal has rested on a potent and incisive understanding of the demands of wealthier households. As an Atlantic profile of Chuck Schumer explained:

 “A lot of times, what Democrats say are the struggles of the middle class are not really the struggles of the middle class,” says Jim Kessler, a longtime Schumer adviser and a vice president of Third Way, a centrist Washington think tank. “They’re the struggles of people who are actually poor. So when people in the middle class hear you talking about these things and calling them middle-class problems, they actually think you’re talking about someone else’s problems.” 

For Chuck Schumer and other politicians from both parties, this represents potential crisis as well as an opportunity. Conceivably, the rising affluence of the middle class could result in a lower dependence in government. But if politicians could target the new demands of increasingly wealthy households, government could expand to fit new niches. The result has been a government increasingly tasked with handling the pressures of new middle class life.

A full reckoning of these programs begins with the tax code and the various deductions that enable off-balance sheet subsidies to favored consumption categories. The Treasury estimates that all income tax expenditures will reach $1.2 trillion in fiscal year 2011. The largest of these categories include the exclusion for employer-sponsored health insurance and the mortgage interest deduction - both of which subsidize middle class consumption of healthcare and housing.

The universal nature of Medicare and Social Security constitute the two other pillars of government spending. Regardless of the essential merits of these programs, their universal status guarantees millions in subsidies to Americans capable of financing their own retirement and future health expenses.

In the pivotal areas of government focus — housing, healthcare, and education — the genius of Schumerism lies in government's ability to sell itself as a solution to problems created by its other various branches. For instance, as the Economist Ed Glaeser has emphasized, high housing costs faced by residents of the coasts areas owe in large part to onerous restrictions on construction and rent control. Yet instead of supporting free market attempts to cut down on such regulation, such housing policies generate additional pressure to regulate housing prices or generate additional housing finance to make home purchases more affordable.

The same is true in education. Education costs have spiraled in part due to increasing demands for educational amenities. For instance, the student-teacher ratio has plummeted from 22.3 to 15.6 in the last forty years, while educational facilities are better than ever. The stranglehold that public provision and unions place on the structure of K-12 education has ensured steady inflation in education costs. Yet politicians have successfully sold parents on the idea that the real problems with education lie in insufficient funding for their local schools -- to be financed through additional rounds of government funding.

In healthcare, the imposition of government mandated fee-for-service has been directly responsible for spiraling growth in this sector. Amy Finklestein, an Economist at MIT, for instance has roughly estimated that roughly half of the increase in real per capita health spending from 1950 to 1990 may be accounted for by the spread of insurance - in particular government mandated insurance. Medicare has enshrined a low-deductible fee-for-service model that is popular with voters, but has proven destructive to pocketbooks. The healthcare deduction provides additional incentives for labor compensation to be drawn in the form of health insurance.

Yet the resulting high costs of healthcare become arguments for why additional subsidies and regulations are required. The latest iteration of this vicious cycle is PPACA -- another system of subsidized insurance coverage (again, for increasingly wealthy Americans) who cannot afford insurance in government-fixed markets.

The final mechanism of creeping demands for government support comes through taxes. It is true that taxes, as a share of GDP, have remained relatively constant; and that marginal tax rates are relatively low by historical standards. But if the tax burden has remained constant in the face of rising GDP -- that implies a government growing at the rate of income. Even as we have become richer and better capable of weathering the storms of economic insecurity, the government has steadily found new programs to satisfy new demands created by more income.

The cost of these programs has taken a heavy toll on the middle class's balance sheets. In The Two Income Trap, Elizabeth Warren and Amelia Tyagi painted a dire picture of middle class evolution by presenting the balance sheet of one family in the 1970s and another in the 2000s. The two families, the authors argue, end up with a similar discretionary income - a sign of the middle class’s stagnation. Yet as Todd Zywicki has pointed out, a key factor behind this seeming stagnation is the fact that a typical family in this situation can expect to see their tax liability grow by 140%.

The result has been a middle class pressure cooker. If families don’t feel as rich as the $94,000 they receive in compensation, it’s because households have felt their post-tax compensation suffer due to a variety of cost pressures — coming either directly from the government (in the form of higher taxes) or indirectly in the form of greater regulations and higher costs in fields like housing and healthcare. Yet rather then offering fundamental reforms to alleviate those cost pressures, politicians like Chuck Schumer have instead offered individualized government programs as the solution. The benefits of those programs are clear and immediate to struggling households; the long-run costs are less visible but serve to escalate the long-run cost pressures and create demand for future entitlement and public spending.

Another form of relief has come from extending lines of credit. Wall Street and big government have common interests in many fields, a relationship personified by Chuck Schumer’s excellent finance contacts. Wall Street is happy to purchase government debt and extend credit to consumers. As Raghuram Rajan argued in Fault Lines, increases in credit serve as another palliative to the fundamental stresses in the middle class balance sheet — stresses induced in no small part by the government. Fannie and Freddie, too, drastically expanded their operations starting in the late 90s. Today, the federal government backs over 58% of the mortgage market, including virtually all new mortgage originations. This flow of credit enables the sort of housing consumption that the new middle class demands, but cannot afford due to cost pressures elsewhere.

Collectively, in essence, we have decided to delegate the task of household consumption. Instead of purchasing goods ourselves, we have the government spend and regulate consumption for us. Such a decision might have made some sense if the government were an effective arbiter of spending. Unfortunately, it is not -- too many government programs are badly functional and breed the very cost pressures that they were designed to counter.

It is easy to see how the broad coverage of such government entitlement and spending programs might generate instant political appeal. But the demands to ensure universal access to such programs have another source -- the belief among many liberals that programs meant for the poor will be poorly funded. The argument goes that even if universal access and broad spending may benefit individuals who strictly speaking could afford services on their own; such buy-in is essential to ensure the continued stream of services to the truly needy. The richer, in this reading, cannot truly empathize with the poor unless they receive the same services -- so it's essential to ensure that the rich continue to consume Medicare and send their children to public schools.

The logic behind this sentiment is questionable. Medicaid, for instance, has seen steady rises in public funding over the decades, even if recessions leave state governments temporarily stressed and reluctant to expand that program. It's not at all clear that buy-in from relatively prosperous sections of society is necessary to ensure the continued success of public programs. Many European countries for instance combine greater spending on the poor in relative terms with more expansive spending in general — while America directs a greater proportion of government spending to the rich.

But more fundamentally, ongoing fiscal challenges will heighten the challenge of large-scale spending on both the middle class as well as the poor. Rather than serving as the guarantee that the poor will receive sufficient spending of their own, middle class entitlement programs increasingly compete with those programs for funding. And the political life that they have taken on ensures continual sources of funding, while programs for the poor are increasingly on the cutting block.

In an age of austerity, we can no longer afford an expansive welfare state — at least without corresponding increases in taxation that even Democrats have been reluctant to endorse. Yet the pressures of an aging population and rising healthcare costs will result in enduring budgetary costs. The only solution is to trash Schumerism, and accept that increasingly affluent Americans must pay their own way.

The Texas Non-Bubble

Mike Konczal serves up some interesting graphs on the Texas economy. One important element he flags relates to jobs and the debt burden. Texas managed to go through the past decade with no housing bubble, and a limited increase in housing-related debt. This served the state a great deal in avoiding foreclosure and a subsequent “balance sheet” recession driven by households aiming for deleverage. Mike offers this commentary on how Texas did that:

Fisher states that a free regulatory environment is causing this growth, but the rather strong regulations on the mortgage market and growth in the housing stock are more likely the factors in preventing the build-up of housing debt that in turn isn’t holding back the economy. There are strong regulations on the housing market, especially in terms of housing equity loans that in turn make it harder to bid up values.

Well, why did Texas avoid a bubble? Mike flags consumer regulation. But I’d also point to lax local zoning and land use regulations.

The chief restriction on home equity loans in Texas is that they cannot exceed 80% of the market value of the home — essentially requiring all borrowers to have some sort of equity. Cash out refinances were restricted in the same manner. Requiring that homeowners place a sufficient amount as a downpayment, and restricting people from using equity gains as collateral to acquire new debt, substantially reduced speculation and cash outs.

But it’s something of an open question as to how much this reduced price fluctuation. Certainly, requiring sizable downpayments lowered the plausible group of buyers in a given property. However, the restriction on refinancing was probably a factor reducing leverage more than increasing price. Ie, it prevented existing homeowners from doubling down on home prices by acquiring more debt. Certainly, the option to extract future equity may have enticed buyers in other states. But limiting future equity extraction may or may not have been a small factor in actually inducing higher prices.

By contrast, there are good theoretical reasons to focus on housing restrictions. Paul Krugman argued all the way back in 2005 that house price appreciation seemed to be much higher in areas where geographic and zoning restrictions lowered the available supply of housing. Since then, Ed Glaeser and co-authors have written a paper arguing that price increases in housing were driven most strongly in areas where housing supply was relatively fixed.

This makes a lot of sense from a demand-supply framework. Where supply is flexible; builders respond to greater demand for housing by building more houses, so prices remain flat. Where supply is inflexible, increases in housing demand largely translate into increases in prices, not increases in the number of houses built. Even if the increase in housing demand comes from speculators who place little money down and expect to extract future equity from their houses; as long as builders can keep building this increase in demand will not translate into an increase in prices. You need both an increase in demand, as well as inflexible supply to generate an increase in housing prices.

The national data backs this idea up well enough, but there are two big stumbling blocks: basically Las Vegas and Phoenix. The housing market in these areas saw huge price increases, but the thinking is that land policy should have been fairly flexible here. If you look at both markets specifically though, the real problem may also have been inflexible housing supply:

In Nevada, something like 85% of all land is federally owned, including a lot of the land in the neighborhood of Las Vegas, and overseen by the Bureau of Land Management. A local journalist at the Nevada News & Views, Mike Chamberlain, has repeatedly emphasized the role of government ownership of land in building up the bubble. A federal law in 1998 split land sale proceeds with local governments, which gave local authorities strong incentives to try to bid up land sales. As this Economist article mentioned, other local housing participants in 2005 thought the government was far too stingy in releasing land at a suitable pace. At the very least, there are good reasons to think that not all of the land outside Las Vegas was free for development.

Phoenix is also wrongly classified as freely developable state. Rather, beginning in 1998, the state opted for a “growth management” policy limiting land use. Similar to Las Vegas, land outside of Phoenix land was held by the government, which limited sales to maximize revenues. This link from Demographia (honestly not sure how I ran across this, so perhaps take with a grain of salt) argues in Maricopa county, home to Phoenix, agricultural land was selling for a fraction of development land. The problem wasn’t a land shortage per se, so much as a segmented real estate market in which agricultural land was not easily convertible into housing. Wendell Cox at New Geography argues:

Building is largely impossible on the "abundance of land" surrounding Las Vegas and Phoenix. Las Vegas and Phoenix have virtual urban growth boundaries, formed by encircling federal and state lands. These are fairly tight boundaries, especially in view of the huge growth these areas have experienced. There are programs to auction off some of this land to developers and the price escalation during the bubble in the two metropolitan areas shows how a scarcity of land from government ownership produces the same higher prices as an urban growth boundary...

In Las Vegas, house prices escalated approximately 85% relative to incomes between 2002 and 2006. Coincidentally, over the same period, federal government land auctions prices for urban fringe land rose from a modest $50,000 per acre in 2001-2, to $229,000 in 2003-4 and $284,000 at the peak of the housing bubble (2005-6). Similarly, Phoenix house prices rose nearly as much as Las Vegas, while the rate of increase per acre in Phoenix land auctions rose nearly as much as in Las Vegas.

Somewhat conspiatorially, a similar situation prevailed in Spain. An Economist article has noted that building on vacant land required local governments to extend town limits, and entitled them to 10% of development land (which town governments then sold for revenue). I find it suspicious that three of the biggest housing bubble markets in the world in the last decade were characterized by these sorts of crony capitalist land ownership rules. It’s easy to imagine how governments could limit the sales in these auctions to artificially constrain supply and encourage price inflation.

I think all of this is at least circumstantial evidence to think that local zoning and housing policy may have played a role in preventing a housing bubble in Texas. There are other factors at play too — Texas has high property taxes, further limiting speculation, and it tends to draw its migrants from states in the Midwest, which also saw low property price appreciation. By contrast, Nevada and Arizona saw a lot of migrants from California (cashing in on previous house appreciation), while Florida had a lot of migrants from pricey New York.

Still, there’s no reason we can’t follow both the consumer regulation and the lax zoning. Texas’ housing policy involves “regulations,” but ought be relatively palatable for regulation-distrusting libertarians and others to swallow. There aren’t strict mandates on what or where to build, but simply sensible rules requiring that homeowners keep sufficient collateral in their homes. This seems reasonable enough. Not to get too into the politics of this, but the chief opposition to collateral requirements tends to come from progressive community activists worried that downpayments punish wealth-poor families.

Meanwhile, the loose regulations on housing seem to do a great deal of good in preventing price bubbles from building up as well. Those, too, seem reasonable. There’s no reason not to adopt both sets of policies throughout the nation. That would lower rents, limit speculation, and likely lower house price volatility. It’s too bad Rick Perry isn’t running on that platform.

Data Revisions and the Guns and Butter Model

Karl Smith has a request:

Has anyone run the guns a butter model on the last election with the new disposal income data? Supposedly the Dems lost an extra 20 seats in the House or so above what could be explained structurally. However, now that we know the structure of the economy was worse than the frontline data does that estimate still hold?

I haven’t run the numbers but I am guessing what looked to be policy backlash will vanish in the structural void with new estimates.

I decided to check this out. First, I went with Douglas Hibbs site, the original source of the "Guns and Butter" model. He had predicted that the Dems would win 211 seats, roughly an overestimate of 20 seats (relative to Democrat actual wins of 193). However, this estimate came with caveats:

In fact there is uncertainty about income growth during last quarter - the 2010q2. The personal income data for q2 posted by the Commerce Department's Bureau of Economic Analysis on 30 August 2010 are second estimates and they are subject to potentially large revisions later.

Of course, this is exactly what happened.

I decided to download his data and update the consumption statistics. I took the latest disposable per capita income, which have been revised going back to 2008Q1. I couldn't get the CPI data to match exactly, but this page seems to do well enough to deflate the numbers.

At this point, I decided to run the full model with the 2010 election as an additional data point. This is the relevant point to use in evaluating all of the data to use for future modeling; but it may overstate the fit exactly for 2010 slightly. Here's what I have:

The new prediction for 2010 is 202.5 seats. This overstates Dem gains about about 10 seats, but does cut the overstatement.

I wondered how much adding 2010 did on its own, so next I threw out the 2010 data, and fit the 2010 election based on previous election data, but current economic data: now, I get a Democrat prediction of 206 seats. Roughly, a fourth of the Democrat "underperformance" can be accounted for by economic conditions that were worse than thought at the time.

I'm not sold on this model -- with so few elections to go through, it seems likely that many elections will be "anomalies" ex ante and then rationalized ex post through the model (you can sort of see that here -- throwing in the new data lowers the rate of misfit for 2010). Plus there are the various structural reasons to mistrust any model like this - Andrew Gelman offers some comments here, and then there is the Lucas Critique.

But if you're looking for ways in which worse economic data should change your priors, here's one of them -- the Democrats faced a worse economic climate in 2010 than commonly realized, and their performance is more understandable as a result.

Are Democrats or Republicans better for the Economy?

Larry Bartels has frequently argued that Democrat Presidents are better for the economy. Here's the takeaway graph:

Just observing a correlation between the partisan identity of a President and some economic outcome isn't the most convincing argument in the world. Jim Manzi and James Campbell present reasons to be skeptical that this is a causal relationship. Among the reasons to be skeptical are that the state of the economy drives political results (ie, reverse causation); and that it's difficult to imagine the exact mechanism driving this result. Presidents can't wave their arms and force a given result -- Congress passes laws. Yet you don't see this same relationship if you graph Congressional partisan identity against economic outcomes.

I've long thought that a better way to think about this would be to do an event study on the stock market before/after an election, using past polling data as a way to get a

sense of what the market was "expecting" before the final electoral outcome. Justin Wolfers and co-authors have a new paper arguing in favor of this strategy (with prediction markets instead of polls), which uses this question as a motivating example:

First, we show that in the 2004 U.S. Presidential election, candidate convergence did not occur, as predicted by Downs (1957) and many other models. Specifically, the stock market rose 2% in value on news of a Bush victory (over Kerry). Secondly, we show this difference of 2% between Republicans and Democrats has been remarkably consistent over time, appearing in an analysis of all elections between 1880 and 2004. This suggests that whatever the changes in party structure and policy issues over that period, Republicans have consistently been the party of capital, and Democrats the party of labor. Finally, we show that the stock market declined in response to the news of a Democratic victory in the Senate (and House) in 2006, suggesting that,contrary to conventional wisdom, markets do not prefer divided control of the legislature and executive to unified control of both branches. [emphasis added]

Aside from representing a more statistically sound way of figuring this question out, this result has the advantage of consistency. The Republican-Democrat difference does vary from election to election, but is at least typically in one direction. There is also consistency between the Congressional and Presidential outcomes here. Here's a sample graph:

To be sure, the exact mechanisms behind this result remain opaque. A differing partisan propensity to levy capital gains taxes could be enough. Nor do better stock markets settle the question of which party is uniformly "better" for the economy -- even if Republicans are better for company profits, they may also institute other policies that alter the income distribution. The authors suggest that this makes Democrats "the party of labor;" but it is at least possible that higher stock prices reflect a greater earnings potential for the economy, which could filter down to all workers.

But what is clear is that this approach is a million times better than interpreting a correlation for causation. It's also better than just looking at how the stock market behaved before/after an election, as this takes into account the prior expectation that a given President was going to be elected. With the growing reach of InTrade, this method could probably be used for all sorts of things--the impact of PPACA on health company profits, etc. The only caveat I have is that what the authors call "the predicted probablility from InTrade" probably can't be interpreted as easily as they suggest.

Discretionary Spending Freezes

The discussion about Obama's spending freeze has been fairly negative. The freeze excludes defense spending and entitlements--the bulk of the budget--and comes into effect even as the economy will still be hurting.

Still, it's worth pointing out that this idea would have been great to have about nine years ago. The graph to the left shows how non-defense discretionary spending--so excluding Homeland Defense, Veterans Affairs, and war spending--grew by 60 percent between 2000 and 2008. Despite Bush's reputation as a ruthless slash-and-burn conservative, (discretionary, non-defense) government spending exploded under his watch. The states, too, went on a binge--Mitch Daniels estimates that state spending rose by 6 percent annually in the past decade.

Both of these trends are unsustainable. It's not clear what exactly state and federal governments are doing that require their spending to rise faster than people's earnings.

So all else considered, I can't say this sort of cap is a bad idea. It would be even nicer still if we treated defense and entitlements as "real" spending too, but one can't have everything.

Schumer-Hatch on Jobs

Surprisingly, Chuck Shumer (and Hatch!) are showing more initiative than the White House in creating jobs:

Here’s the idea: Starting immediately after enactment, any private-sector employer that hires a worker who had been unemployed for at least 60 days will not have to pay its 6.2 percent Social Security payroll tax on that employee for the duration of 2010. The Social Security trust fund will then be made whole with spending cuts elsewhere in the budget between now and 2015. That’s it. Simple to understand, and easy to explain.

The beauty of this proposal goes beyond its simplicity. Unlike a jobs tax credit of a specific dollar amount, this credit is “front-loaded” in that it provides an incentive for businesses to hire workers earlier in the year — because the tax benefit will be greater. A $60,000 worker hired on Feb. 1 will save a business about $3,400 in taxes, while that same worker hired on May 1 will save it about $2,500.

While this would have been more welcome a couple of years ago, this is welcome now.

There's a strain of thought out there that Republicans are being needlessly partisan in refusing to endorse any major Democrat initiative. Setting aside the issue of whether the Senate should operate on a supermajority or not, Hatch's support on this suggests that Republican votes are available for conservative legislation.

When Numbers Fail

I'm about as pro-numbers as you can get, but even I have to draw the line when and where math fails to solve problems. Healthcare is good example. A lot of the rhetoric coming from White House economists--Orzsag in particular--emphasizes how various methods of technocratic control like comparative effectiveness research can dramatically cut costs without any impact on care. The idea is that government scientists trained in fancy new behavioral methods can figure out "what works" and what doesn't. American healthcare is so expensive because we do too much of the stuff that doesn't work, relative to Europe.

My suspicion is that instead of clear walls between things which "work" and don't, things are more complicated and difficult for the government to figure out. There's a great piece in the New York Review of Books which details how comparative effectiveness studies don't have a great history, partly due to biases of the investigators themselves:

With other experts, I performed a "meta-analysis," i.e., a study bringing together data from multiple clinical trials. We concluded that erythropoietin significantly improved the health of cancer patients and we recommended it to them as their default option. But our analysis and guidelines were wrong. The benefits ultimately were shown to be minor and the risks of treatment sometimes severe, including stroke and heart attack.^[4]

After this failure, I came to realize that I had suffered from a "Pygmalion complex." I had fallen in love with my own work and analytical skills. In behavioral economics, this is called "overconfidence bias," by which we overestimate our ability to analyze information, make accurate estimates, and project outcomes. Experts become intoxicated with their past success and fail to be sufficiently self-critical.

It closes with:

The care of patients is complex, and choices about treatments involve difficult tradeoffs. That the uncertainties can be erased by mandates from experts is a misconceived panacea, a "focusing illusion."

Well worth reading. The departures from a perfect world of rational economic agents are real; but they don't have unambiguous lessons for the optimal balance between markets and government.

The Real Winner Today was Romney

Virginia, New Jersey, and now Massachusetts. Romney's been a key reason Republicans won all three of these. I'd say he's odds on favorite to win the Republican nomination in 2012; and the Presidency depending almost entirely on how the economy does.

Wages and Bernanke

Here's what Becker has to say about job creation:

Keynes and many earlier economists emphasized that unemployment rises during recessions because nominal wage rates tend to be inflexible in the downward direction. The natural way that markets usually eliminate insufficient demand for a good or service, such as labor, is for the price of this good or service to fall. A fall in price stimulates demand and reduces supply until they are brought back to rough equality. Downward inflexible wages prevents that from happening quickly when there is insufficient demand for workers.

Here's Mark Thoma, hitting back:

There's a more sophisticated story below, and I may be oversimplifying too much, but basically when things are bad -- when firms cannot sell all that they are (or could be) producing -- a cut in the wage does not generate any new employment, it simply reduces income. Why hire more people when you aren't selling anywhere near to existing capacity (in the story below, even if interest rates did fall as a result of the wage cut, I don't think it would generate much investment due to the excess capacity that firms have)? In fact, the reduction in income from the fall in wages makes it even harder to sell the goods that are (or could be) produced, and that will cause firms to lay off even more workers, which lowers income even more, and a downward spiral ensues.

The point is that in a severe recession, a cut in the wage rate may not generate any new employment, instead it simply lowers income and demand, and that makes things even worse.

The mixed effect here centers around the fact that what we call a wage refers to two separate things. One is the wage paid by the employer. This is the price of employment; and Becker is correct to point out that the higher this price, fewer people will be employed. During recessions, companies are willing to pay much less for labor; but wages are fixed. So they lay off workers. If we could get this wage to go down in bad times, companies would be willing to hold on to employees and we wouldn't have ten percent unemployment.

However, there is also the wage received by employees. Lowering this wage reduces the purchasing power people have, so they cut consumption and prices fall. Brad DeLong and Lawrence Summers have a good paper estimating that effect.

Under normal situations, the two wages are the same, and it's not obvious what employment effect a wage decrease or increase will have (though some evidence suggests that raising wages didn't work in the Great Depression).

But there's a way around this--create a gap between what employers pay and what employees receive. This way, employers could cut their wages to employees during bad times, so employment would stay high. But employees would receive the same amount, so you maintain price stability.

One way of doing so is through a permanent payroll tax cut. Employers are now more likely to hire at the margin; and employees will spend and save more.

But the best way of creating this gap is through a direct wage subsidy. This allows employers to slash the wages they pay out; while keeping the wages employees receive fixed by having the government make up the difference. Labor market interventions like these are the dominant way Europe is responding to the recession (they have rather small stimulus projects); and they're keeping employment losses lower than America.

Obviously, this involves a fiscal cost. But the government is already taking on a huge fiscal burden through automatic stabilizers and a stimulus comprised of bad tax cuts and spending. These projects are much less effective than a direct wage subsidy in cost-effectively creating jobs and cutting unemployment.

Still, none of this is the best way to target unemployment--the best way would be to use monetary policy to generate inflation expectations to lower real interest rates below zero. This can be difficult when interest rates are already zero, but a number of scholars--among them Bernanke and Krugman--have advocated such policies in the past for countries like Japan. Yet Bernanke now rules out this policy out for the United States:

• D. Brad Delong, University of California at Berkeley and blogger: Why haven’t you adopted a 3% per year inflation target?

[Bernake] The public’s understanding of the Federal Reserve’s commitment to price stability helps to anchor inflation expectations and enhances the effectiveness of monetary policy, thereby contributing to stability in both prices and economic activity. Indeed, the longer-run inflation expectations of households and businesses have remained very stable over recent years. The Federal Reserve has not followed the suggestion of some that it pursue a monetary policy strategy aimed at pushing up longer-run inflation expectations. In theory, such an approach could reduce real interest rates and so stimulate spending and output. However, that theoretical argument ignores the risk that such a policy could cause the public to lose confidence in the central bank’s willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy going forward. The anchoring of inflation expectations is a hard-won success that has been achieved over the course of three decades, and this stability cannot be taken for granted. Therefore, the Federal Reserve’s policy actions as well as its communications have been aimed at keeping inflation expectations firmly anchored.

This is a little puzzling. The Fed's mandate is to balance inflation and unemployment; yet inflation is at zero percent and unemployment is at ten. Yet Bernanke is fine with this balance, and will not do anything to reduce unemployment further--even though his academic work, which got him his job, emphasized exactly those policies.

So one way or another, all the ways to create jobs--fiscal stimulus, monetary policy, labor market intervention--are off the table. I would find this even more discouraging if I were unemployed.

Daniels on Running

Strongest wording we've heard yet from Mitch Daniels:

But in Indiana we think about the next generation. We think about the future. We want this state to be better for our kids than it was for us. We don’t resign ourselves for a second to the idea of any decline. Any step back. And that’s the job that we have taken on as a party. That you have made possible. That you’re making possible by your attendence tonight. I cannot thank you enough for that.

I just want to tell you that we’re not going to default on the burden that falls on the party of hope. I read this great line. It’s been on my mind since I read it. In the book Lee’s Lieutenants, the classic study of Civil War generals under Robert E. Lee, there’s a great line. It’s about Gen. Beauregard, whose best battles were his first ones. Bull Run. Early days of the war. Then he gets cautious. Then he gets timid. Then he’s always looking at the newspapers to see how it’s all playing. Freman, the author, says, “A soldier is on the wane from the moment he begins to think more of reputation than opportunity.” A soldier is on the wane from the moment he begins to think more of reputation than opportunity. He meant if you start thinking more about yourself than the people you’re there to serve, the cause you’re there to serve, if you start worrying more about how it’ll look, how it’ll play, than about what’s the next challenge? What’s the next hill? What’s the next battle? What am I going to do for the benefit of the cause I’m a part of? Then you’re not the soldier you used to be. You’re not the soldier you ought to be.

We have to be soldiers who think always of opportunity, not of reputation. Who think always of the future and tomorrow. Not of things we already did. Not of preserving gains and any credit that might have come from it. I promise you tonight, on behalf of everybody who’s part of our team. On behalf of the Republican Senate majority that is and the Republican House majority that will be, we will think of opportunity, not reputation. We will think of tomorrow, not yesterday. We will think of yes, not no; hope, not memory. And we will create in this state a model of a party and a state that all of America looks to for greatness.

Thank you for your support and for being here tonight.

I am now ~70% confident that he will run in 2012. Yet he's still very cheaply priced on Intrade.

The Chimera of Chimerica and Obama's Foreign Policy

Really, I've just been looking for an excuse to put up that title. But check out Acorn, my co-blogger at INI:

It is one thing to argue that the US-China bilateral relationship is one which is most important to the world, but quite another to call it “G-2″ suggesting it would engage, in some form, in the task of global governance... an important reason why the US-China relationship is seen as important is because it is a problem. It is important to the rest of us in the same way as Pakistan is for international security. So just like how you wouldn’t entrust Pakistan with the job of ensuring international security, you wouldn’t entrust the United States and China with the task of global governance.

Unfortunately, this G-2 mindset... is influencing the Obama administration’s foreign policy. “US-China consultations regarding India and Pakistan,” the former argued, “can perhaps lead to more effective even if informal mediation, for a conflict between the two would be a regional calamity.” Sure enough, the joint statement at the end of President Obama’s summit with President Hu Jintao included a words that said that “the two sides welcomed efforts conducive to peace, stability and development in South Asia.” Clearly, there is an attempt by the two countries to get China involved in India’s relations with Pakistan, as well as in Afghanistan.

On Taiwan, you have a statement that goes:

The two countries reiterated that the fundamental principle of respect for each other's sovereignty and territorial integrity is at the core of the three U.S.-China joint communiqués which guide U.S.-China relations. Neither side supports any attempts by any force to undermine this principle. The two sides agreed that respecting each other's core interests is extremely important to ensure steady progress in U.S.-China relations.

This is just one joint statement. But it seems to reflect a durable assessment among the Obama team that the G-2 relationship is of primary importance due to China's role in global imbalances, Treasury holdings, climate change, and regional/security issues. These items are apparently of such importance to the Administration that they are willing to sacrifice relations with India, Taiwan, and other local powers--as well as the human rights agenda--even for little substance in return.

My own impression is that an "allies-first" approach of deepening ties to local democracies is more in line with American values, ensures the spread of democracy and human rights as sources of stability for the entire region, and grants greatest bargaining power with respect to China. I suspect that China's domestic constraints are greater than America's in some sense, and little cooperation will be forthcoming. But I'm no foreign policy expert, and the China-first strategy may well work out.

But whether or not this works out for China and America; certainly it's India (and Taiwan) that has room to be concerned. While Bush and Clinton saw the potential for a serious potential partnership with India; the new Administration seems largely intent on viewing India as either an adjunct to Af-Pak (Holbrooke) or a bargaining chip to be wagered to further the crucial China policy. Surely Obama is aware that China and India are going through one of the worst patches of bipartisan relations since the 1962 war--and a failure to consider that is a sign that India has little strategic significance to America beyond Thomas Friedman-ish platitudes of "largest democracy, peaceful Muslims, etc. etc." One can't really fault America for this. It's a failure of Manmohan Singh's foreign policy to think beyond America and consider strategic partnerships with democracies and China-skeptic powers around Asia. The Pakistan-China geopolitical nexus represents an existential threat to India's survival and economic progress, and the US has demonstrated where they stand on that, push come to shove.

I was initially impressed by Obama's foreign policy. There were seeming turnarounds in relations with rogue states like Iran, Cuba, and North Korea; and you heard great things about his team and their professionalism. You have a President who can seemingly get out of any bad scrape through a well-delivered speech.

But whether it's the lack of Asian trade policy, the reversal of the stance against settlements in Israel, or the now-ambiguous Af-Pak strategy; I think it's fair to say things look murkier. Obviously it's a little soon to pass judgments, nor do I think that Glenn Beck-style rants hold. Most Administrations have a crappy first year and this seems to be going better than most.

Still, I think it's fair to say that the more overblown hype is gone. Here is Andrew Sullivan almost two years ago:

Consider this hypothetical. It’s November 2008. A young Pakistani Muslim is watching television and sees that this man—Barack Hussein Obama—is the new face of America. In one simple image, America’s soft power has been ratcheted up not a notch, but a logarithm [sic]. A brown-skinned man whose father was an African, who grew up in Indonesia and Hawaii, who attended a majority-Muslim school as a boy, is now the alleged enemy. If you wanted the crudest but most effective weapon against the demonization of America that fuels Islamist ideology, Obama’s face gets close. It proves them wrong about what America is in ways no words can.

Yet a recent poll finds that far more Pakistanis rate the US as a threat than India or the Taliban. Having a lower impression in Pakistan than India is quite an accomplishment, and suggests that American policy--for instance the drone strikes so beloved among the doves in the Administration--rather than the identity of the American President drives resentment and blowback. Obama's star power has moved the US in global polls (with the telling exception of Pakistan), but it remains to be seen how much of that increase is durable, and to what degree that assists America in achieving foreign policy goals or cubing terrorism.

Weird Days

I spend far, far too much time following the news cycle of the day. It's toxic and unrewarding, yet I'm addicted to the information fix.

Anyway, it's a little bizarre to see liberals pulling all sorts of sexist stunts with Sarah Palin--she deserves to shown as a sex object, she's obviously stupid and superficial, etc. etc.--while conservatives throw out all sorts of feminist arguments. These positions would be exactly reversed if Hillary Clinton or someone was on stand instead of her.

I actually used to like arguments and the like. You hash things out, and get somewhere. Since then, I've kept seeing how ideas are more like the rationalizations and weapons people use to defend their gut reactions to things for which they feel an emotional affinity. All politics is identity politics, one way or another.

A good way to get over this is to follow politics in some other country, or listen to foreign commentary on the US. When there's less of a sense of who you're supposed to be rooting for, you can get a clearer picture. Or just accept the inevitable and become a partisan hack. Or better yet, turn off the TV.

Capretta on Obamacare

Here he is:

For months, the president and his team argued that stepped-up investments in health information technology, comparative effectiveness research, and prevention and wellness programs could “bend the cost-curve,” thus making an expansion of coverage affordable for taxpayers. But the Congressional Budget Office, along with a chorus of independent skeptics, said those steps would never be up to the task of reliable cost control without more fundamental changes in the financial incentives facing consumers and providers of services.

Unfazed, the administration argued that it had other ways to control costs waiting in the wings. The conversation turned to “delivery system reform,” with the administration and its allies in Congress suggesting that new ways of paying health-care providers in Medicare could spur a wholesale shift in how doctors and hospitals cared for patients. As White House Budget Director Peter Orszag put it, “Medicare and Medicaid are big enough to change the way medicine is practiced.” The implication was that the new team was working on ways to painlessly root out wasteful spending by compensating providers for their services differently than they are paid today.

But no such proposals were ever forthcoming (except for relatively minor adjustments related to payments for hospitals with high readmission rates, and some baby steps toward more “bundling” of payments for a full episode of care). What the White House did eventually propose was a commission that would have the authority to change the way Medicare pays for services without further approval by Congress. So instead of offering a serious plan to “bend the cost-curve,” the administration offered a commission that would come up with a serious plan to “bend the cost-curve.” Quite predictably, many in Congress have not been so keen on this idea, as it would hand off to an unelected commission the power to rewrite Medicare’s provider-payment regulations. The administration’s commission idea is not in the House-passed bill.

Not to worry! The administration has another favorite cost-cutting tool. The idea is to tax so-called “Cadillac” health insurance plans, thus forcing both the insurers and the plan enrollees to find ways to economize to avoid the tax. But there’s a little problem with this idea too. President Obama was against it before he was for it. Recall that Republican presidential candidate John McCain proposed to convert today’s preferential tax treatment of employer-paid insurance premiums into a refundable credit. In October 2008, the Obama-Biden campaign excoriated this idea in scores of ads because it would tax health benefits “for the first time ever.” Now, the president wants to do just that — but, again not surprisingly, the populist revolt he stoked against it in 2008 was still smoldering when he endorsed it in 2009. It turns out that taxing high-cost insurance plans will actually hit many middle-class households, especially those with union members enrolled in collectively-bargained plans. House Democrats wouldn’t go near the idea, and reports indicate that the version of the high-cost insurance tax in the Senate Finance Committee bill is getting watered down by the day. If some version of it survives at all, it is highly unlikely to pinch enough to generate meaningful cost control.

Reviewing this legislative landscape, it’s suddenly dawning on all concerned that the bills moving in Congress won’t come close to “bending the curve” after all. That’s the thrust of a piece today in the New York Times, as well as one from last week in the Washington Post. Of course, even as House members and Senators shy away from tough decisions, they are not nearly as reticent about extending new health entitlement commitments. Thus, it is now abundantly clear that if anything is produced by this legislative process, it will be a bill that piles more unaffordable entitlement commitments on top of the unreformed ones already on the books.

The complete spinelessness of Congress is now a fairly entrenched trend. Going back to Social Security reform; the Medicare prescription drug plan; etc.--it's very hard to write sweeping legislative changes these days. Every President going back to at least Reagan came to Washington and at the very least was forced to substantially roll back their agenda. Past Presidents may have left a broader impact in other countries, through their foreign policy, than domestically through their legislative agenda. Obama's majorities, his legislative background, and legislative staff may make a difference. But it seems very unlikely that any of their major bills--on healthcare, climate, or what have you--will be seen as very worthwhile on the merits.

And then you have Jonathan Gruber's logic, in which health care reform is a Pascal's wager; and increased coverage will make cost-cutting possible. This is a little like saying "Sure, eat another cheescake; there will be far greater pressure for you to diet once you're heavier, so there's no way you can get morbidly obese." Aside from the on-face absurdity, this does not match the experience of state governments testing variants of reforms under consideration, nor of any other countries as far as I can tell. Yet the idea that Congress will spontaneously grow a conscience before health costs engulf the economy is the best hope any of us have.

Going Dutch

All industrialized countries other than the US offer universal health care, but they do in different ways. England has an entirely government-run system. But several countries manage to cover everyone with a more market-oriented system. Here's what the Dutch have to say:

Between meetings, Mr. Klink sat down with The New York Times. The Dutch are in the midst of a significant health overhaul to inject greater competition into the nation’s insurance and hospital markets, but Mr. Klink also offered some pointed observations of the health system in the United States.

His first official visit to the United States as health minister came in 2007, and he came with the usual European preconceptions that this country had a wide open and fiercely competitive health insurance market with a myriad choices.

“And what struck me,” he said, “is actually the lack of competition you have.”

Mr. Klink pointed out that nearly 40 percent of the nation’s population gets care fromMedicare, Medicaid and Veterans Affairs, all of which have significant restrictions on the choices available to patients. “We don’t have these kind of public insurance groups in our country,” he said.

And even among those in the United States who get insurance from their work, he went on, “it’s the employer who is making the choices of the health plans from which you can choose.”

The Swiss have a similar system. Singapore has one that's even more free market--people have health savings accounts to pay for most routine care--and they also spend the least out of any industrialized country on Healthcare as a percent of GDP. What's common across all three is that subsidies are targeted through means-tested vouchers, rather than with a public plan, Medicaid, or Medicare.

Yet somehow we get caught in a debate where one side yells at the other for throwing people at the mercy of markets; and the other refuses to tinker with the system. Ensuring Universal Coverage should be the premise of the health care debate, and there are a range of options both to the left and the right on how to get there. Yelling at John Mackey for expanding health coverage and cutting costs isn't going to help; there are issues here beyond the purely moral.

Mitch Daniels for President

As some of you know, I've been a big fan of Mitch Daniels, Governor of Indiana, and think he would make a great Republican Presidential candidate in 2012. The big issue with his campaign, though, has always been that he's been very reticent about running, citing family issues. These can be serious, as we found out with Colin Powell. Still, you don't make it as a two-term Governor without a little bit of political ambition.

He's been playing this very smartly too. He came out against the stimulus, but in a more principled and soft-spoken way than Perry and Sanford and the rest. He's been against the Health Bill, but again on very general grounds. He's been making his media appearances and WSJ op-eds. He already has a compelling story and record; this helps prepare some of the groundwork, much as Romney did his time appealing to evangelicals. But doing so in an off-key manner allows you to come in a little later, with far fewer negatives and with more of a post-partisan Obama feel. Jindal should be taking notes.

Anyway, now you're starting to read stuff like this:

Still, despite the dominance of the big three likely presidentials, some in the GOP are hoping for a new conservative face, particularly one being pushed by the activists who attended spring antitax tea parties and flooded summer town halls to demand a halt to government expansion. And for them, insiders say, that could be Daniels, the fiscal conservative and rare Republican governor to win re-election in a state President Obama won in 2008. We hear he's serious about considering a 2012 entry, so much so that he's consulting with some of those who once sat in the White House, like former Vice President Dan Quayle, also a Hoosier.

I suppose I should highlight why this is a good idea: Daniels has turned Indiana around; attracting jobs, balancing the budget, and reforming government. He has good ideas on transportation, healthcare, and education. This is exactly the sort of working-class agenda that can appeal to dying rust-belt states. Even if you're not a Republican, you know they have to win at some point, so it's better to have the party be functional. Nominating a no-nonsense technocrat would go a long way towards erasing the stains of fiscal irresponsibility and incompetence after Bush, and frankly would be exactly what the country needs after several rounds of bipartisan binge spending.

And no; Sarah Palin will not win the nomination. Zero chance.

Not So Deep Thoughts

Two people coming out as highly effective politically in the last year are Rahm Emanuel and Nancy Pelosi. Under Pelosi, the House has passed a sweeping stimulus package; a cap-and-trade program; and now a Health Care Bill. Emanuel's more behind the scenes, but by all accounts he's the most powerful Chief of Staff in recent memory; with sweeping authority on foreign policy, healthcare, finance reform, and the economic recovery.

Interestingly, people tend to say the same thing about why each is so successful: both are very active in pulling their levers of power and driving forward at a frantic pace. Pelosi has moved to vote on bills where others would have held back, while Emanuel has been very active in pressing his agenda as much as possible.

There's another school of thought that says you should husband your power, as a failed attempt to demonstrate what you have weakens your authority. Pelosi and Emanuel would suggest that your power actually comes from your constant exercise of it.

Obviously, this is going on in the backdrop of a very popular President, a solid Democrat majority in the House, etc. etc. But it makes you wonder about WTF Reid is doing; what are the consequences of legislation at all costs; and whether this is a useful template going forward.

WNC Politics

I'd just like to point out that Heath Shuler, House Representative of NC 11, Western North Carolina, has voted against the health care bill. This follows his voting against several stimulus provisions. He is also against abortion, in favor of gun control, and against illegal immigration. And yes, he is a Democrat.

I imagine this is bad news for the 20% of his non-elderly adult constituents who are uninsured. But the broader picture here is that Democrats are finding it difficult to pass their agenda not (just) because of Republican intransigence, but because of loud opposition from Democrats representing conservative bits of the country. Rahm Emanuel's strategy of running culturally conservative moderates in red districts paid off huge electoral dividends, but these marginal legislators are much less favorable to a progressive agenda.

It also looks like Hendersonville's hotshot mayor, Greg Newman, is planning on running for this seat in 2010, the first of what looks to be a wave of local Republicans hoping to cash in on the coming 2010 Republican bonanza. This is, of course, another great reason for Shuler to vote against the Health care bill, lest Newman and company scare all the old people into thinking that their Medicare is going away.

Man, politics really is local. It's great reading the comments to some local story on a totally non-consequential issue, and seeing people get completely riled up about it.

Jobs, Jobs, Jobs

After the latest set of elections, everyone is really harping on the "jobs jobs jobs" agenda. With unemployment crossing ten percent, this is an eminently reasonable approach to take.

Yet both Republicans and Democrats haven't a clue about how to actually generate jobs. Meanwhile, Europe's managed to keep the rise in unemployment fairly low, and some countries are actually recovering. And they've done so without a stimulus. Here's what The Economist has to say:

The United States has put in place a hefty fiscal stimulus, but relatively little of that money has gone into labour-market policies—schemes to slow firing, boost hiring or support the jobless. Although America has extended its (meagre) unemployment benefits, and is likely to do so again, Congress’s main response to persistently high joblessness has been a host of ill-targeted new stimulus proposals. The extension of a homeowner’s tax credit is imminent and a $250 payment to old people is being discussed.

Europe’s policymakers, in contrast, appear to have a more coherent strategy: one which uses government money to subsidise a shortened work week, cuts labour costs and, in a few cases, offers tax subsidies to support new jobs. The OECD says 22 out of 29 of its member countries have extended support for workers on furlough, and 16 have cut payroll taxes and other social contributions. The countries doing these sorts of things are disproportionately in continental Europe.

And The Economist's resident blogger:

As the piece notes, one wants to be careful putting in place policies that will lead to ossification of the current structure of the work force, particularly given the structural shifts underway in the American economy. But America's oblique approach to stimulus has meant fewer jobs saved per stimulus dollar. What's more, the fact that stimulus policies have not directly targeted unemployment (for the most part) has probably led to a waning of public confidence in the very idea of stimulus, thereby making it difficult to follow up the spring economic package with a booster shot. Tying stimulus more directly to hiring subsidies and payroll tax cuts would ensure a steady constituency for additional action. Washington should take note.

In fairness, I suppose I should say that the Republicans have been far more favorable to this type of European strategy--which is, after all, in many cases being implemented by the local right-of-center party. And, of course, parts of Europe still have plenty of structural problems generating chronic unemployment. As the graph shows, the type of unemployment now seen as catastrophically bad is more or less routine in Continental Europe.

The general point is that wage inflexibility is really bad. The reason why you see rising unemployment during recessions is that companies want to compensate workers less during bad times. But people don't tend to like wage cuts. So you see mass layoffs. The way to tackle this is not through massive spending somewhere else, but by altering the incentives of employers to hire and fire; by cutting payroll taxes, giving out credits for job creation, or ideally allowing employers to cut wages and have the government make up the difference.

But I'm optimistic about this. Given the huge importance of job creation to politician survival--I think it's fair to say that the Democrats will win or lose in 2010 and 2012 based almost solely on the strength of the labor market--you'd expect them to take seriously ideas which have a proven track record of generating jobs very cost-effectively. And you'd expect the crack economic team advising the White House to be aware of these types of policies and their performance internationally.

And if it doesn't happen--well I guess I'll be there to write an angry blog post in response. It would really be very short-sighted and horrible for the US not to follow suit with useful policies to generate jobs.

Bruce Bartlett Review

Bruce Bartlett is one of the original architects of Reagan's Supply-Side Revolution. Recently, he's come out with a new book defending that movement, while arguing for higher taxes today in the form of a VAT, or consumption tax.

I don't buy it. I don't think adding extra consumption taxes would further either conservative or liberal goals.

Start with the conservatives. Bruce makes all of the conventional arguments against the Bush tax cuts: they didn't magically boost the economy, etc. etc. From the point of view of a bipartisan, maximize GDP perspective, these are fair points. In many ways, he repeats claims made by Jonathan Chait a few years back, when he denounced the extreme views of supply-siders as crackpot economics. What both miss is that the tax-cutting agenda is not driven purely by a motivation to boost "the economy." Transferring income away from the government towards people doesn't show up in GDP, but has an enormous impact on family welfare and the role of government in a free society.

To a substantial extent, the supply-siders are driven by the genuine desire of ordinary Americans to keep more of their hard-earned money. The rationalizations supply-siders offer for that goal are often dubious. But refuting those claims doesn't answer the broader question of how much government do we want, and what level of taxation would we like. This is very much a political and ideological question; yet Bartlett largely sidesteps that issue in favor of a broadly technocratic lens.

His diagnosis is that government is set to rise due to an entitlement crisis; that current economic problems are now ones of deflation and deficient demand; and that the only contribution of supply-side analysis is to pave the transition towards a larger government as smoothly as possible. His champions the VAT as a relatively efficient way to raise revenue.

Look, it would be one thing if we needed more taxpayer dollars to pay for some sort of Whiggish program of internal improvements, and a VAT was the only way to pay for that. But that's not the case. The long-term drivers of government spending are the entitlement programs--health care and social security--along with defense. Who benefits from these programs?

Social Security is distributed to everyone over 65--a population that has spent a lifetime earning and accumulating assets, and is rather well-off in aggregate. Medicare similarly benefits all the elderly, regardless of wealth, while its reimbursement program is riddled with fraud, and is a major driver of overtreatment and rising medical costs (Contributing 40 percent of the recent rise in medical costs by one estimate). Defense spending post-War on Terror is also insane. The US spends somewhere around $700 billion a year on defense; not only is this substantially more than any other country, it's also about twice what was spent during the 90s. Once Afghanistan and Iraq wind down, military spending could easily be cut in half with no discernible loss in welfare to the ordinary household.

This is to say: The drivers of higher government spending are basically wasteful and unnecessary spending, much of it consisting of transfers to the wealthy. This doesn't strike me as a cause worth funding through burdening the poor and working classes--who would be disproportionately hit by a tax on consumption.

There's an alternative here: slashing payroll taxes for poor workers and instituting flexible wages. Two of the biggest economic problems today are that wages are stagnant for many low-skill workers and unemployment looks to be persistently high. Both of these can be controlled by policy. By cutting regressive taxes on the poor, we can make wages rise as fast as we like--while attacking the real and growing disincentives for work. Bartlett is right to suggest that this may not have much of an impact as a "stimulus" or on economic aggregates. But this is to mistake GDP for human welfare. Families struggling to pay bills benefit tremendously with more after-tax income. It's precisely for this reason that many liberals worry so much about wages, even though the share of labor compensation doesn't have an impact on GDP.

We can cure unemployment as well. Singapore and France, along with other European countries, have implemented Edmund Phelps' policy of flexible wages. The idea is to allow employers to cut back on compensation during downturns, and have the government make up the difference. This allows labor markets to clear while keeping unemployment low. It's hard to think of any government spending that would further family welfare as much as keeping wage growth as high as we like, and unemployment as low as we want. Indeed, it's hard to think of many proposals that do so much to advance liberal goals. But fundamentally, this agenda relies on lowering the tax base and making it more progressive. Bartlett's VAT would move America in the opposite direction on both counts, while doing little to help struggling households.

I'll agree with Bartlett that Republican orthodoxy is sniffling the debate on many of these issues. Treating any defense cuts as tantamount to treason, and any cuts in Medicare as out of bounds entirely, doesn't do much to advance the debate on how to deal with a looming entitlement crisis. Republicans have done little during their time in office to tackle the long-term fiscal situation, and have placed too much emphasis on income tax cuts rather than dealing with chronic economic insecurity. But higher taxes on the poor won't help either.

That's the tradeoff we face. We can continue spending on wasteful and unnecessary transfers and spending, much of it going towards the rich, and balancing the cost on the already-burdened working and middle classes. Or we can solve the central economic problems of the day by addressing ballooning spending front-on. But that will require both more committed conservatives than Bartlett, and more devoted liberals than those in office.

The McCain Health Plan, Again

I noticed about a year ago that McCain actually had a decent health plan. It called for taxing premiums for insurance to pay for coverage for those without. The idea is that the tax-exclusion privileges wage compensation that comes in the form of health benefits, encouraging a general rise in healthcare costs. At the same time, the fact that this benefit only applies to employer-provided insurance contributes to a world in which millions of people without employer-coverage can't get health insurance. I noticed how prominent Obama economists had in fact called for exactly such a plan to reign in out-of-control healthcare spending while expanding coverage.

Obama was very opposed to the idea at the time. He denounced it as a new tax, and spent millions on ads convincing people it was a bad idea. The wonkish liberal blogosphere joined in attacking the plan. Here is Matt Yglesias:

One issue that hasn’t gotten nearly the widespread attention it deserves is that in the context of John McCain’s overall policy for steep tax cuts for high-income Americans he’s also proposing a very significant tax increase on the broad group of people who receive health insurance through their employers

As a result of that kind of fear-mongering, Democrats have found it very hard to impose any kind of tax on health care plans in current bills. The bills they plan cement the link between employment and health insurance and do little to tackle the fundamental drivers of escalating health costs. Well, here's Yglesias now:

by artificially subsidizing health care consumption by the relatively prosperous, [the tax exclusion] drives prices up for everyone, including the not-so-prosperous. And because it’s a tax-side subsidy, the subsidy does little-to-nothing for the poor.So scrapping or curbing the subsidy makes sense in general. And it especially makes sense as a way of raising money to finance progressive policy like ensuring that health care is affordable for the poor and the lower-middle class.

You can argue about whether McCain's plan for redistributing the revenue from the tax--in the form of a refundable tax credit--was the best way to expand coverage. A lot of the criticism there said something like "poor people don't pay taxes, so they won't benefit." But a refundable tax credit will effectively act as a subsidy for people who don't pay much in taxes. In fact, Wikipedia tells me that some conservatives and libertarians oppose such credits exactly for this reason.

But instead of having a debate about the particulars, we effectively shelved one of the best tools for health reform off the table about a year ago. In a world in which the financial crisis hit a few months later--say the Bush team decided to save Lehman--McCain would probably have been elected President. It's intriguing to imagine if McCain could have teamed up with Wyden-Bennett to produce a bipartisan health plan by now. One suspects not, but everyone is entitled to their own counterfactuals.