Thursday, December 20, 2012

Social Security on the Chopping Block

The White and Congress are presently engaged in heated Fiscal Cliff negotiations. With the national debt exceeding $16 trillion and the CBO projecting continued deficits for the next decade, even Social Security has entered the budget-cutting discussions.

However, Social Security is financed by an independent payroll tax, which solely funds the program. For 75 years, Social Security collected more funds than it paid out. By the end of 2011, that surplus had reached $2.7 trillion. Those surplus funds were used to buy special bonds from the U.S. Treasury, creating the so-called Social Security Trust Fund. This fund is expected to keep Social Security fully solvent until 2033.

Even after that time, payroll taxes are projected to cover approximately 75% of program obligations.

Under current law, the securities in the fund represent a legal obligation the government must honor when the program's revenues are no longer sufficient to fully fund benefit payments.

According to the Social Security Trustees, who oversee the program and report on its financial condition, program costs are expected to exceed non-interest income from 2011 onward. However, due to interest (earned at a 4.4% rate in 2011) the program will run an overall surplus that adds to the fund through the end of 2021.

The problem is that, over many years, the government used the monies slated for the Trust Fund to instead finance its annual budgets. In other words, the $2.7 trillion Trust Fund was transferred to the general fund, which pays the government's everyday operating expenses each year. And it's all gone.

In order to repay retirees the money that was already collected from them, the government will have to redirect money from it's future budgets, or general fund, back to retirees. This is why Social Security is suddenly on the chopping block in current budget negotiations.

Though Social Security is independently funded and does not contribute to the government's annual budget deficits, there are some reasons for concern.

According to the Social Security Administration (SSA), just over 1 in 4 of today’s 20 year-olds will become disabled before reaching age 67. That will be a heavy burden for the system to bear. It may also force a reexamination of the definition of "disabled" and result in stricter rules for qualifying.

The SSA also notes the following:

• In 1940, the life expectancy of a 65-year-old was almost 14 years; today it's almost 20 years.

• By 2033, there will be almost twice as many older Americans as today -- from 43.4 million today to 75.7 million.

• There are currently 2.8 workers for each Social Security beneficiary. By 2033, there will be 2.1 workers for each beneficiary.

Given longer life expectancies, the coming tidal wave of retirees, and the diminishing number of workers per retiree, it's clear that some changes may be needed by 2033, when the Trust Fund (aka, the money the government collected and spent on other things) is finally exhausted.

In the meantime, the government owes it to its citizens to return the surplus money that's been collected from them, and it is legally obligated to do so. That money will have to come out of other government programs, such as military spending. Regardless, it will surely have to come from elsewhere in the budget.

It should also be noted that the Social Security retirement age is already 67 for those who were born in 1960 and after. That's something that needs to be considered in any negotiations.

One way or another, the government needs to repay the citizens the money it has already collected from them. And it should not attempt to tax them again in order to repay them.

Monday, December 10, 2012

Despite Headlines, Jobs Problem Continues to Confound U.S.

The government reported that 146,000 nonfarm payroll jobs were created in November. Though the creation of jobs is always welcome news, it must be viewed in the proper perspective.

Over the past year, employment has risen by an average of 157,000 per month in a country with 134 million jobs. That’s an increase of about 0.1% a month.

While the unemployment rate also fell sharply to 7.7%, it was due to a decline in the labor force, not to any improvement in the labor market.

The labor force fell by 350,000 in November and the labor force participation rate (the percentage of people employed and those who are unemployed but seeking a job) fell to 63.6% from 63.8% in October.

For perspective, the labor force participation rate was 67.3 in January 2000. Yet, when the recession began in December of 2007, the participation rate had fallen to 66 percent.

This means that in less than 13 years, the percentage of Americans participating in the labor force has dropped from 67.3% to 63.6%, a rather striking decline.

Clearly the long term trends are not good. The unfortunate reality is that discouraged people continue giving up their search for work.

Additionally, the average duration of unemployment was at 40 weeks in November, near historic highs.

The official unemployment figure doesn't include those who have lost their unemployment benefits. Nor does it count those who only have part-time jobs but want full-time work.

None of that is encouraging.

It takes about 125,000 new jobs per month just to keep up with population growth. Though the economy is currently achieving that, we need 250,000 new jobs per month for a year to truly drop the unemployment rate by a little more than 1%. Yet, in order for that to happen, the economy needs to grow north of 3% per year.

However, U.S. gross domestic product increased at an annual rate of 1.3% in the second quarter and by 2.0% in the first quarter. That does not bode well for job creation.

Unfortunately, at this rate, it will take years to create jobs for everyone who wants one.

At the pace of job creation over the past two years, the U.S. would not return to pre-Great Recession employment levels until after 2025, according to the “jobs gap” calculator from The Hamilton Project.

The Great Recession—which officially lasted from December 2007 to June 2009—resulted in massive job losses that the economy is still trying to recover. In 2008 and 2009, the U.S. labor market lost 8.4 million jobs, or 6.1% of all payroll employment. This was the most dramatic employment contraction (by far) of any recession since the Great Depression. By comparison, in the deep recession that began in 1981, job loss was 3.1%, or only about half as severe.

The economy has since recovered four million of those lost jobs, meaning we are only half way to recovery. Yet, that doesn't even begin to address the monthly increase of new entrants into the labor market, which creates a continual need for even more jobs.

Despite the slow but steady state of job creation, here’s the underlying problem: the recovered jobs on average pay a lot less than did the jobs that were lost. Low-wage jobs like retail and food service workers have made up 58 percent of the subsequent job growth. With less income, Americans have less to spend and spending is what expands economies.

Wages in the retail industry remain low compared to other sectors, with the average full-time sales worker making just $21,000 per year, according to the Bureau of Labor Statistics.

Peter Edelman, a law professor at Georgetown University, says the proliferation of low-wage jobs is the single biggest cause of persistent poverty.

"The first thing needed if we're to get people out of poverty is more jobs that pay decent wages," he argued in a July New York Times op-ed. "We've been drowning in a flood of low-wage jobs for the last 40 years… Half the jobs in the nation pay less than $34,000 a year, according to the Economic Policy Institute. A quarter pay below the poverty line for a family of four, less than $23,000 annually."

And wages in the bottom half "have been stuck since 1973, increasing just 7 percent," Edelman noted.

Jeff Faux, a progressive economist who founded the Economic Policy Institute in 1986, argues that by the mid-2020s, even with the most optimistic assumptions about economic growth, current trends indicate that the average American's wages will drop about 20 percent. One big factor is that more and more good jobs will go overseas, leaving even America's best and brightest no alternative but to enter the service industry.

America's dual problems of high unemployment and low-wage jobs will continue to have negative consequences for our consumption-based economy, which is 70% reliant on consumer spending.

Obviously, there is less consumption when fewer people are working and when so many of those with jobs are earning so comparatively little. Ultimately, there is less disposable income being directed back into the economy. It also results in lower tax receipts at both the state and federal levels.

If unemployment remains stubbornly high, wages will also remain stagnant. That will create a negative feedback loop of both lower consumer spending and lower economic output.

As of now, we're still a long way from recovery, and a full recovery is anything but assured.

Japan's bubble economy burst in the late 1980s and, nearly a quarter-century later, it has yet to recover.

That's a horrible precedent for the U.S.

Sunday, December 02, 2012

Fiscal Cliff an Opportunity to Correct Fiscal Imbalances

A point that I've repeatedly made on this site is that the U.S. government has both a spending problem and a revenue problem.

In the last fiscal year, the government collected 15.5 percent of GDP in revenue and spent 22.4 percent. That's a considerable problem and it cannot continue.

Due to high unemployment plus lower incomes and wages, tax revenues have plunged from their historical average of !8 percent of GDP. As a share of GDP, income tax revenues are at their lowest level since 1951, when Harry S. Truman was president.

To offset this lack of private demand, the government increased expenditures to fill the void and undergird the economy. Yet, that has grown the government to excessive proportions, which is not good for the long term health of the economy.

A 1998 Congressional Joint Economic Committee study concluded the optimal size of government to maximize economic growth was about 18% of gross domestic product. The government is now spending well above that.

Washington's profligate ways go back many years.

Over the forty years ending in 2008, federal revenues averaged about 18.3 percent of our economy, while spending averaged over 20.6 percent, resulting in an average deficit of about 2.4 percent. Since 1970, the Federal Government has run deficits for all but four years (1998–2001).

All those deficits have added up to a national debt that now exceeds $16 trillion, and counting. Medicare and defense spending are the biggest drivers of the government’s continual deficits and massive debt.

The U.S. dedicates 18% of GDP to healthcare — the greatest share of any nation in the world and about twice as much as other industrialized nations.

By the end of the Congressional Budget Office’s 10-year budget forecasting period in 2022, Medicare outlays will be more than $1 trillion a year. For the entire ten-year period, 2013-2022, Medicare will cost taxpayers $7.7 trillion.

However, American workers pay a Medicare tax (separate from the income and FICA taxes) that funds the hospital insurance system, which provides medical benefits to eligible individuals upon reaching age 65. That tax may be raised, or benefits lowered, to counter shortfalls. The same is not true with military spending.

Pentagon spending accounts for over 50 percent of all discretionary spending in the federal budget, and overall security spending constitutes two-thirds of the discretionary budget, according to the CBO. Military spending has tripled since 1997. Simply put, the Defense budget is bloated and wasteful.

According to estimates by Nobel Prize-winner Joseph Stiglitz and Professor Linda Bilmes of the Harvard Kennedy School, when all the costs are counted, the Iraq invasion and the Afghan war will each cost US taxpayers $3 trillion dollars. Both were unfunded. In other words, the two wars doubled the U.S. public debt.

When all defense-associated spending is added up — including the Defense Department, Overseas Contingency Operations, the Department of Veterans Affairs and the Department of Homeland Security — all of the mandatory and discretionary programs amount to a whopping $877.9 billion annually, according to the Office of Management and Budget.

And this doesn't even include the money dedicated to the Department of Energy to maintain the nation's nuclear weapons arsenal.

Based on the Government Accountability Office’s latest long-range alternative budget simulation, by the end of this decade our interest payments will become the largest single expenditure in the federal budget. By 2040, all of our federal tax revenues will add up to cover only our two biggest expenses: interest on our debt plus Medicare and Medicaid. Everything else — Social Security, defense, education, road building, you name it — will fail to be funded.

Washington has finally accepted that it has a significant problem that can no longer be ignored and passed on to the next group of legislators. Negotiations are underway to avoid the fiscal cliff. Congress will also have to negotiate another raise of the debt limit. Furthermore, Congress hasn't even passed the fiscal 2013 budget, which was submitted by the White House back on February 13th.

It's worth noting that the fiscal year began on October 1st and runs through next September. So, the government has been operating for more than two months (one-sixth of the year) without a formalized budget.

One of the big sticking points in negotiations to avoid the fiscal cliff is President Obama's insistence that income tax rates go up for the wealthiest Americans. Most congressional Republicans are against that idea.

House Speaker John Boehner claims that raising taxes on the top 2 percent of income earners would be unfair because half of those taxpayers are small business owners who pay their taxes through their personal income tax filing each year.

The Speaker made that assertion again this week. Yet, Boehner has been repeatedly corrected on this by fact-checkers. In fact, the Speaker's office says that he misspoke when he made that claim this week, although it's a misstatement he's made more than once.

Last year, some analysts at the Treasury Department took a closer look at what constitutes a small business, and they defined them as those making up to $10 million.

They excluded all those that were making over $10 million. At the other end, they threw out people who might have a big salary from a day job and then a little small business on the side.

When they narrowed the definition that way, what they found was about one in five taxpayers in those top two brackets is a small business owner. And of all the income in those brackets that would be taxed at a higher rate, only about 7 percent comes from small businesses.

Republicans say that raising tax rates on the highest earners would result in a loss of jobs.

However, when the Congressional Budget Office looked at what the affect of raising those taxes would be on jobs, they found it'd really be pretty tiny — about 200,000 jobs over the course of a decade. That's about as many jobs as the economy has been adding in one or two months.

Additionally, a recent report by the non-partisan Congressional Research Service (CRS) found no correlation between top tax rates and economic growth, a central tenet of conservative economic theory. Specifically, the report found that there is no evidence that tax cuts for millionaires and billionaires leads to improved economic growth. The CRS analysis compared tax policy with GDP patterns over the last 65 years.

The report was first released in September, but was removed from public circulation shortly thereafter because Senate Republicans objected to the findings.

Republicans say any new revenue should be raised by curbing tax breaks.

Given that 45 percent of U.S. households do not pay income tax (either because they don’t earn enough or through credits and deductions) and 3% of taxpayers contribute around 52% of total tax revenues, a major overhaul of the U.S. taxation system is in order. In fact, eliminating tax breaks may ultimately be a better, fairer way to raise more revenue.

The problem is that anti-tax crusaders like lobbyist Grover Norquist, and his Republican adherents in Congress, have insisted that any tax reform which reduces or eliminates write-offs, deductions and exemptions must be revenue-neutral. If that's the case, then what's the point? This cannot be an exercise in futility amounting to nothing more than simply rearranging the deck chairs.

Simply increasing tax rates on the wealthiest Americans would not raise enough revenue to address the nation's fiscal crisis. Additional measures are needed.

If the Bush tax cuts were allowed to expire on couples whose income is over $250,000 and singles over $200,000, it could raise close to $1 trillion over 10 years, according to Tax Policy Center data. Allowing the Bush tax cuts to expire on income over $500,000 ($400,000 for singles) could raise at least $315 billion over a decade. And if the Bush tax cuts were allowed to expire on income over $1,000,000, at least $242 billion could be raised.

As you can see, squeezing additional revenues from only the very wealthiest Americans results in increasingly diminishing returns.

To truly get at the revenue problem, all of the numerous tax loopholes must be closed and deductions eliminated. Lobbyists have spent the past couple of decades getting favored status for their varied interests and layering the tax code with assorted breaks, deductions, write-offs and loopholes.

After all, what's the point of tax brackets if the effective rate people are paying is less than that written into law?

Republican Senator Bob Corker of Tennessee has circulated a proposal to cut the deficit by $4.5 trillion over 10 years. Corker would address entitlements by gradually increasing the age for Medicare and Social Security eligibility and would lower cost of living increases for Social Security.

As for taxes, Corker would not raise rates, but would cap itemized deductions at $50,000. The senator says there are $1.2 trillion in loopholes and deductions in the tax code at present. His hope is to "simplify the code."

Corker says his proposal, "keeps rates where they are but generates revenues from wealthy citizens by closing loopholes."

And he believes that such an idea would popular, telling NPR, "I would say that most Americans would like to see the tax code get rid of all the loopholes that exist there."

He's probably right. What most Americans surely want is fairness. They'd like to know that some taxpayers aren't granted the privilege of special breaks the rest of us aren't privy to. The highest-income households enjoy more than 40% of the benefits of all tax breaks taken every year, according to the Tax Policy Center.

However it is arrived at, the government needs to increase revenue and reduce spending.

Some economists and analysts advance the notion that a country can indefinitely run deficits without endangering its economic survival as long as those deficits remain below its rate of economic growth.

However, the U.S. has a debt that exceeds $16 trillion and is still growing. Though it will be impossible to ever fully repay that debt due to the nature of money itself, it is important to begin continually chipping away at the debt rather than adding to it. Otherwise, the bond market will eventually turn on the U.S., sending interest rates soaring.

The trouble for the U.S. is that we are in a sustained pattern of about 2% economic growth and it is difficult to foresee that changing over the next few years. Any sudden internal or external shocks (economic crisis in Europe or Japan, for example) could easily tip the U.S. into recession.

That's the concern with the fiscal cliff. According to the Congressional Budget Office, the looming combination of tax increases (the end of the payroll tax holiday and the Bush tax cuts) and legislated budget cuts will lead to a recession, shrinking the economy by 1.3% in the first half of 2013.

The upside is that the CBO also says the economy will then expand 2.3% in the second half. There's some pain upfront, but there's some relief in the end.

Congress and the nation are faced with a moment of truth. Though this combination of hikes and cuts will be painful, it is needed nonetheless. Congress needs to swallow this bitter medicine and take a leap off the fiscal cliff.

Yes, it will result in a recession next year, but the long term benefits will make it worthwhile. Congress has avoided these difficult decisions for far too long and to avoid them any further will result in an even worse predicament down the road.

The time for easy choices or good alternatives has long since passed.