Month: December 2012

Chaining seniors to poverty

Posted on by j.giglio

The latest deficit-cutting proposal in the fiscal cliff negotiations has seniors up in arms. President Barack Obama and House Speaker John Boehner have agreed to a new measure of inflation that would reduce annual cost-of-living adjustments, or COLAs, for Social Security and other government programs.

The new measure is called the chained consumer price index (CPI). If adopted, it would have far­ reaching effects because annual adjustments to many government programs are based on year-to-year changes in consumer prices.

The change is another assault on the once sacrosanct middle-class safety net. According to the Congressional Budget Office, Social Security payments would be $108 billion less over 10 years with chained CPl.

When certain products become more expensive, consumers switch to cheaper ones. Chained CPI attempts to account for that by looking at purchasing changes over time and linking, or chaining, the data together. For example, if beef prices rise faster than chicken prices, consumers will substitute chicken for beef.

So chained CPI takes spending changes into account, not just the price of goods. Nearly every conversation about using chained CPI is based on the notion that market exchanges are always voluntary, the products equivalent and that the elderly use the same goods as other Americans. They ignore how much more seniors spend on health care, the cost of which is increasing at an alarming rate.

Under chained CPI, annual increases in Social Security payments, government pensions and veterans’ benefits would, on average, be reduced by about 0.3 percentage points annually. For example, next year’s 1.7 percent COLA would be about 1.4 percent.

Changes to ·Social Security are politically delicate because the program touches so many people. Nearly 56 million people -one out of every six Americans -receive Social Security benefits. The program accounts for about 20 percent of the Federal government’s $3.7 trillion in spending.

The average annual retiree benefit is $14,800. Those with lower wages get less and those who had higher wages get more; even Warren Buffett gets a Social Security check.

It is estimated that nearly half of Americans 65 or older would be below the poverty line if not for Social Security; a quarter of the elderly get at least 90 percent of their income from the program. Given their standard of living, many retirees are already making onerous trade-offs.

For a long time, there was more money coming into the Social Security Trust Fund then going out. The surplus was turned over to the Treasury, which promptly spent it.

Still, the Trust Fund is sound until 2036. So why is Social Security even part of the fiscal cliff negotiation? It is not driving the deficit. The gap going forward between revenue and expenditures for Social Security does create problems over the long run, but they are manageable.

If we really want to protect Social Security, remove the $106,800 income cap that results in less than 86 percent of wages being subject to the payroll tax. Economists estimate that taxing incomes over $106,800 would entirely eliminate the projected Social Security shortfall over the next 75 years.

Other common-sense reforms include reducing or eliminating benefits for the wealthy and raising the retirement age to reflect longer life expectancy.

Still better, subject investment gains to the payroll tax. Hedge fund managers’ earnings are taxed at the capital gains tax rate of 15 percent instead of being treated as ordinary income taxable at 35 percent.

All these reforms could be phased in over 20 years. Finally, we have to make Social Security a real trust fund, insulating it from Washington politicians who raid it and use the money for other programs.

These are the adjustments politicians should be considering, not technical tweaks in the cost-of-living formula that are not widely understood and are easily manipulated.

We face trillion-dollar annual deficits and total debt of more than $16 trillion. But the Washington political class is talking about $2.4 trillion in new revenue and spending cuts over 10 years.

Clearly there is much to be done, but we shouldn’t do anything to Social Security right now. That should work because the folks in Washington are awesome at doing nothing.

originally published: December 29, 2012

The Federal Reserve and paper money

Posted on by j.giglio

A couple of weeks ago, the Federal Reserve announced that it will continue printing money to keep interest rates near zero until the headline unemployment rate drops below 6.5 percent, provided inflation does not rise above 2.5 percent. The Fed expects to continue this policy until the end of 2015.

The Fed is focusing on job creation by putting its foot on the monetary accelerator to spur consumer spending and housing purchases. Last month’s jobless rate was 7.7 percent, down from previous levels but still high by historical standards. Even though the recession officially ended in December 2009, unemployment has not been below 6.5 percent since September 2008.

The headline unemployment rate to which the Fed has attached itself actually declines as more people abandon hope of finding a job. The unemployment rate dropped to 7.7 percent in November because about 351,000 people left the workforce. lf the same percentage of adults were in the workforce as four years ago, the headline unemployment rate would be 11.1 percent.

To further accelerate hiring, the Federal Reserve also announced that it would continue its monthly buying binge of $85 billion in long-term Treasury bonds and mortgage-backed securities. To do this, you have to print a whole lot of money.

The Fed’s objective is to push long-term interest rates even lower. It’s not easy, considering that the 10-year Treasury bond is trading at 1.8 percent – less than inflation, which has averaged 2.3 percent over the last four years. Years after moving interest rates to near zero in December of 2008, the Fed is still redistributing income from savers and to borrowers.

The Fed’s catechism is that this will reduce already-low mortgage interest rates, which will help spur a housing recovery, which will lead the economy out of its doldrums. So much for claiming the government doesn’t pick winners and losers in the economy.

Sure, the housing market is on a slow road to recovery. But tight credit is standing in the way of a more robust housing recovery. Too many potential homebuyers cannot access interest rates that are at near­ historic lows. Potential buyers need pristine credit to get a mortgage because banks are afraid of owning the loan again if a borrower defaults.

If the federal government were serious about fixing the housing market, it would arrange massive refinancing at today’ s low interest rates for those who owe more on their homes than the structure is worth. That would give millions of homeowners more spending cash to lift the economy. We did, after all, spend more than 700 billion taxpayer dollars to bail out the banks without nailing any hides on the shed door.

The Fed’s near-zero interest policy also masks the real cost of financing trillion-dollar annual deficits that have become the norm. Low interest rates are an incentive for the federal government to continue borrowing at record levels. If the Federal Reserve were serious about getting the Obama administration and Congress to address the debt and enact fiscal policies to stimulate the economy, it would not keep enabling them with cheap money.

The flood of money from all over the world has helped push down the interest rate the U.S. Treasury pays to 50-year lows. But this ability to borrow enormous sums at incredibly low interest rates cannot and will not last forever, even if no one can say exactly when the day of reckoning will arrive.

Even the mighty U.S. government cannot assume it will always be able to cheaply borrow whatever it needs. Future Americans sending an unprecedented chunk of their incomes overseas to pay down debt means spending much more on our past than on our future. We should invest in education, R&D, infrastructure and addressing the job-skills deficit, not in robbing future generations of the opportunities we enjoyed.

originally published: December 27, 2012

America’s debt is the real fiscal cliff

Posted on by j.giglio

Escaping wall-to-wall fiscal cliff headlines is a full-time job. The media constantly tells us we cannot sleep until we solve the crisis, which, of course, puts people to sleep.

If we go over the fiscal cliff, we lose $600 billion in spending we can’t afford and we increase taxes that should have been raised a long time ago. One reason the situation has come to this is that politicians don’t like to talk about taxes, except to use them the way a matador uses a red cape.

The fiscal cliff, while serious, is a short-term problem. The real cliff is America’s addiction to debt. The average American household’s share of the national debt is now about $137,000. This is an epic, generational tale, while the fiscal cliff is a short story.

In fiscal 2012, the federal government spent about $3.5 trillion, or about 23 percent of gross domestic product. It collected revenues of about $2.4 trillion, or 16 percent of GDP. The resulting $1.1 trillion shortfall marked the fourth year in a row the deficit exceeded $1 trillion.

The federal government borrowed about 30 cents of every dollar it spent. As the late U.S. Sen. Everett Dirksen said, “A billion here, a billion there, and pretty soon you’re talking about real money.” Today, substitute trillion.

By the end of fiscal 2012, total government debt was more than $16 trillion and growing feverishly. Our GDP, the value of goods and services produced in the United States each year, is about $15.7 trillion. The ratio of debt to GDP is a measure of our production and ability to service the debt.

The federal debt as a percentage of GDP is at the highest level since the end of World War II. It has increased from 35 percent in the 1990s to over 100 percent, which means our debt is now bigger than the entire economy.

To make matters worse, it is estimated that our total unfunded liabilities are north of $60 trillion. Medicare and Social Security alone make up 75 percent of these liabilities. In the near future Medicare, Medicaid, Social Security, and interest payments will consume all available revenue.

Needless to say, this kind of debt results in some scary interest payments. Despite the lowest interest rates in 200 years, America will spend around $220 billion on net interest on its debt in 2012, money that can’t be spent on other priorities.

If the debt problem is not addressed, annual interest payments are expected to top $1 trillion by 2020. Each point interest rates go up increases the payments by at least $150 billion per year.

If interest rates return to their historic average of about 6 percent, interest on the national debt will likely be the largest line item in the federal budget by 2020. It would slow economic growth, reduce our standard of living, displace other government priorities, require future generations to pay for current government spending and reduce our ability to respond to future crises.

In the long run, a growing federal debt is like driving with the emergency brake on, slowing an economy that already can’t get out of first gear. We will take on the economic profile of a third world country: a few rich folks at the top, scarcely any middle class and a vast peasantry.

With all their posturing, Washington political leaders have spent 90 percent of their time talking about less than 10percent of the real problem: the mounting level of debt. With all the talk about taxes on both sides, the new revenue would only address 5 percent of the problem.

We need comprehensive spending and tax reforms that are crafted to encourage economic growth. To do otherwise is sheer masochism. After all, our economy is what keeps America strong.

We must also keep in mind that leaders don’t lead without the consent of the governed. It may be, as Shakespeare’s Cassius said, that the fault lies not in the stars but in ourselves.

originally published: December 15, 2012

The American Dream is now a nightmare

Posted on by j.giglio

With national unemployment still stubbornly high four years after the start of the economic crisis, the time has come to ask whether the American Dream of opportunity and increasing prosperity is now out of reach for the average worker. Economists and academics haven’t reached consensus about the underlying causes of long-term sluggish job creation, but technological change and globalization are leading candidates.

There are still 12.1 million unemployed Americans; 23 million when you add those who are working fewer hours than they’d like or are too discouraged to look for work. Include these workers and the unemployment rate remains stuck at 14.7 percent as we continue to slog through the slowest economic recovery since World War II.

Perhaps worst of all, 4.8 million have been unemployed for six months or more; over half of them have been out of work for more than a year. These people suffer not only financial hardship, but also psychic trauma.

Adding insult to injury, about 2 million long-term unemployed Americans will lose their federal benefits at the end of the year if we go over the impending “fiscal cliff.” The $600 billion package of mandatory spending cuts and tax increases that will take effect at year’s end if no deal is reached to avert it eliminates federal benefits. These benefits provide 14 weeks of additional support beyond state unemployment benefits of26 weeks and up to 33 weeks beyond that in states with especially high unemployment.

Genuine understanding of persistent unemployment is more than a numbers game. The unemployed suffer from depression, anxiety and poor self-esteem, as well as the strains financial problems place on family relations. Those with jobs worry that they could be let go at any moment.

The technological revolution has created employment opportunities for many high-skill workers. But at the same time, those who perform more routine activities have been increasingly displaced. This is one reason why there are more than three million job openings in America even as we continue to suffer through high unemployment. And as the cost of technology decreases, firms have an incentive to substitute capital equipment for labor.

Globalization has also created opportunities for some workers but displaced others. Middle-skill jobs are especially subject to this type of labor competition. Inexpensive overseas labor is a temptation many firms cannot resist.

Ironically, some firms that moved production overseas are now bringing it back to America because advanced technology is making it cheaper to produce locally. The result is rising manufacturing output without a corresponding increase in the middle-skill jobs that are the foundation of the middle class.

Taken together, globalization and the technology revolution have wiped out many middle-class jobs and replaced them with positions that demand skilled human capital. The result is increasing pay for higher-skilled workers and decreasing pay for those in the middle. As the labor market becomes more polarized, income inequality rises.

These changes may represent a tectonic shift in the nature of employment in America. As Washington resumes its conversations about how to avoid the fiscal cliff and deal with pressing economic and fiscal challenges, officials may want to give some thought as to how to train Americans for the 21st century.

If we do nothing, we might as well discard Labor Day as a national holiday. If the labor market becomes even further polarized into low- and high-income jobs, we might as well do the same to the American Dream.

originally published: December 11, 2012