The United States crises

The United States, though being the wealthiest, most influential and most powerful country in the world, for all its strengths, has its weaknesses as well. Being an economist, I want to discuss three points in particular that I’m worried about concerning the U.S’s future and status as a superpower. In this article, I argue that if the U.S government keeps on maintaining the same policies as the last 20 years, it will gradually wane and may even go bankrupt.

1) Medicare, Social security, and healthcare expenditure: Right now, it is projected that over 77 million baby boomers will retire within the next 2 decades. This will have a dramatic affect on the cost of Medicare and Social security. The congressional budget office predicts that if we maintain the same level of health care benefits, health care costs will soar to about 40% of government spending in 2020 and gradually cause the U.S debt level to be 100% of its GDP, if we extend it to 2085, the projection is that debt will reach 600% (!) of U.S GDP. That is truly a scary number. It is directly a result of a pay-as-you go system, where seniors retire and push the costs of their retirement to future generations. To close the fiscal gap, the solution is to cut medicare benefits by 2/3s (a scary thought), double income taxes (another scary thought) or cut government spending by 134% (not feasible nor possible). Another solution is to privatize social security and medicare entirely, or to raise retirement age to around 70. Either way, something has to be done in the near future.

2) Taxes: Despite Americans thinking that they pay too much tax, actually from an economists point of view, they don’t pay enough. The optimal amount of marginal tax rate in the highest bracket is determined to be about 40-50% (where marginal revenue is equal to marginal benefit). Right now, with the Bush tax cuts, they are about 35%. When you compare taxes in the U.S to that of Canada or Europe, Americans actually pay much less tax. Another thing is that the U.S has no VAT (value added tax) at the federal level. Some states have no income tax, no sales tax, or both. The US provides farm and gas subsidies that are much higher than other developed countries (which is same thing as not getting enough tax). All these low taxes have the effect of not producing enough revenue for the government. As a result, we run into the same problems as in 1), how can the federal government or state government pay for retirement and healthcare benefits without having enough tax revenue. At current levels, clearly it’s unsustainable, and its clear that eventually taxes will have to be raised.

3) Pensions: State governments are in crisis right now, not only is the country in a recession, but they have to pay large amounts of pension benefits to many people, part of this is due to a loophole where the highest salaried government job determines what pension you get. As a result, people can ‘double dip’ and earn six figures while also receiving six figure pensions. Clearly this is unsustainable, and the reason why many states are on the brink of defaulting. California for example, has already had to slash its budget on many expenditures such as education, raise tuition levels, etc, and it’s still in a big hole. Again, mostly because of unsustainable pension payouts. New Jersey is predicted to be the first state to default, according to its expenditures, in the next decade, pension payouts will constitute 100% of the state expenditure (!).

All of these points raise truly terrifying prospects for the future generation of Americans. The situation in the U.S is bleaker than that of many other developing countries, because of the way Americans have been living on a life of low taxes, a pay as you go health care system, and broken pension costs. Eventually these issues will have to be dealt with, if politics prevent any of these solutions that I mentioned, then the U.S will be on its way to bankruptcy, and having unimaginable debt levels. Truly, something will have to give eventually, it’s only a matter of time. Let us hope that politicians will (eventually) put country ahead of politics, and aim to reform the broken pension, health care, and tax systems.

Edit: Now that it’s certain that current tax rates will continue (actually lower because of the 2% reduction in payroll taxes), the projected deficit with current spending levels and tax rates is projected to be $55 trillion by the time that a person my age will retire (around 2050).

L.J. Kotlikoff, 2006, “Is the United States bankrupt?” Federal Reserve Bank of St. Louis Review, 235-250.
Alan Auerbach, “Deja vu all over again: On the dismal prospects for the federal budget”, NTJ 2010.


Political views

Related to my previous post on equality, given the light of the recent elections in Toronto, and the hostility towards the newly elected conservative leaning mayor, I feel I am somewhat a minority as a moderate.

Canada historically has been fairly liberal compared to the United States, their country was formed by a group of government officials at a table, Confederacy, establishing the beginnings. In contrast, the US was established through a war of freedom and independence. Naturally, it is not surprising that Americans tend to be more conservative and right leaning in their views towards freedom and equality. Canada is contrasted as a capitalist-socialist country. I use the term socialist as the definition of socialism is an ideology that the government should provide utilities, social welfare, and own enterprises that compete on the market. This is all true for Canada, especially the last one (ie. Petro Canada, LCBO, etc). So for me to say that liberals are socialist, that’s because they generally are.

At my college, the University of Toronto, being an academic university in a left leaning city, it is not surprising that the majority of my colleagues are liberal. And why not, college students have the most to gain from liberal policies. Most don’t work and don’t pay any taxes, and are progressive, wanting to help everyone.

I used to be a liberal as well. But gradually, the impact of my internship and economics and exposure to American politics have left me to be a political moderate, or in Canada, a ‘conservative’. The reasons are fairly simple to me, but may not be to many of my colleagues. Younger people tend to be more progressive. Yes, liberal policies sound good on the outside. It sounds good to be able to help everyone, to make everyone more equal, to support progressive causes, to have the government supply services, improve roads + transportation + public goods + healthcare, to have the rich give to the poor. That all sounds good right? The Democratic party is so forward thinking to take care of everyone and support equality.

Then I looked a bit deeper into things. The more power you give to government, the more authority they will have over you, and the less freedom you have. The more you try to make everyone equal, the more it tends towards communism. The more you let government supply, the less you let business and private enterprise supply. And private businesses tend to be more efficient than government. Remember the government doesn’t have to make profit and because of this, they have no incentive to serve the people whereas businesses do in order to gain revenue. And of course, higher taxes to pay for these new services and expansion of government. Remember that when you tax high income individuals, you are taxing the economically most productive workers in the economy, and taking their hard earned money away to give to poor people who presumably have more incentive to be lazy and unproductive because of this redistribution of wealth. I would rather have private enterprise supply those services, and have the government do less, cut spending, cut taxes, and keep the inequality gap the way it is. It may sound like I’m being bigoted and selfish, but when I think of the idyllic time of the 1950s, a great prosperous time, it was mostly conservative policies and atmosphere that worked the way it should.

And so, the new mayor Rob Ford takes office, and I hope that Toronto should become more conservative if he enacts his policies, as I know politicians often lie and deceive. Most of my colleagues are disgusted at his election, as they should be as liberals, but as for me, I don’t have a problem with it, I just want to implore more people to realize the long term implications of their ‘progressive’ views, what it entails and that Mr Ford fulfills his promises.

To further expand on what I’ve said before about the role of government in society, there’s always a tradeoff in the role of government. I personally believe that the government should only provide services that the majority of people would want. For example, defense, healthcare, and education are common public goods that the government provides because most people want them. At the same time, people also have the choice of going with a private good instead (except in the case of defense). Medicare competes with private health insurance, though it only benefits a segment of people (people over 65). Private universities provide a higher quality education at a higher cost than public universities.

On the other hand, too little government means that inequality and corruption will abound. A good example is the United States during the late 1800s – early 1900s, where people like J.P Morgan and John Rockefeller amassed huge sums of wealth, while poor people were literally dirt poor. You think today’s inequality is bad? Back when there was no social security and safety net, the top 1% earned about a million times more than the average worker. J.P Morgan was so powerful that his wealth and influence could actually be measured as a percentage of the US GDP, he had a sizable influence during President Roosevelt’s administration, and he single handedly saved the US financial system from collapse during the Panic of 1907. In this era, huge monopolies such as US Steel and Standard Oil existed, basically causing widespread corruption in all levels of the government and private enterprise. In the absence of government intervention, this kind of corruption and inequity will be tremendous. This is what pure capitalism with no government intervention would have looked like. What we see in the USA right now is reformed capitalism, or capitalism with post-FDR social reforms in place, to mitigate this kind of greed and inequality (though it still exists).

The main thing is that if you want the government to provide you a service, then the majority must agree, the service must also be provided to everyone, and the cost comes from taxpayer’s pockets. On the other hand, if the majority disagrees, and if that service is one that benefits you more than others, then it is efficient to have a private company provide you that service. Consider the example of getting your driveway paved. Suppose the government raises taxes in order to provide a service to everyone of getting their driveway paved whenever they want. Clearly, some people are better off than others because some people have bigger driveways, get their driveways dirtier more often, etc. In other words, it’s not efficient for the government to provide this service. It’s better off to do it yourself or to hire a private company to do it for you, at your own extra cost.

Ted Sorenson once said that “The difference between Republicans and Democrats have always been that the former cares more about property, and the latter cares more about people”. I would extend that to say that the difference between liberals and conservatives is that liberals believe more in social welfare at the cost of higher taxes, and conservatives believe more in individual responsibilities at their own personal cost.

Politics School/Work

Thoughts today after lecture (big vs small government)

For the first time in college, I disagreed not with the professor, but with what he was teaching. The class I was in is called Public Economics, and it was about what role the government should have in the free market. Naturally, this topic is subject to political bias and the part I disagreed with was what was referred to as the ‘Second fundamental welfare theorem’ which essentially stated that the government should redistribute wealth in lump sum payments between individuals in order to make the market more efficient.

I disagree with this on several levels. Firstly, that the professor mentioned Pareto efficiency had several problems, one of which was that it introduced inequality. I argued that one of the consequences of capitalism was that it produced inequality, but it wasn’t necessarily a bad thing, and here they are treating it as something which must be fixed. I also argued that redistribution of wealth was socialism; the government should not tax one group (ie. the wealthy) to benefit another group (the poor) for the sake of equality. I argued that the principles of capitalism is that there exists a social hierarchy where one group could be better off than the other. This makes the economy more competitive. The power of the free market will hold true, mostly. The Panics of 1873, 1893, 1907, the Great Depression, and the current recession being examples of where government intervention was needed to prevent total economic collapse, so I believe a minimal amount of regulation is needed (the Fed Reserve was created after the 1907 panic). Some regulation is needed, but not too much so that it doesn’t interfere with private enterprise.

The professor’s response was that socialism wasn’t necessarily bad, but I think that this is a point of ideological contention. Liberals would agree, but me as a conservative would disagree with government taking such a big role in society. Health care is another issue, that I think should be left to private enterprise. One reason is that businesses are able to use money more effectively than government. If the goal of every business is to make profit, then the quality of private services should always equal or exceed that of the government, which doesn’t make profit, therefore has no incentive to provide good quality. Second, it gives individuals choice. If I want health care then I will pay for it, even if the premiums are higher, so what I am getting better quality. And if someone who is poor can’t afford health care then so be it, that’s the nature of survival of the fittest. If I don’t want health care, then I don’t pay for it, and I’m not taxed to provide health care to others (which is what the single payer system does). To me, health care is a privilege, not a right.

Here is the fundamental difference between the US and Canada; the US promotes little intervention by the government in the free market, they have a food stamp system for low income earners; Canada has the welfare system. The US’s ideology is to cut taxes for people, but especially the high income earners, in the belief that they will use that tax money saved to invest more and hire more workers, which is trickle down economics. Canada’s ideology is to tax the rich and middle class more such that public goods such as healthcare and subsidies could be provided to the lower class.

I do not agree that society should somehow be more equal; that is on the path to communism, and eliminates the competitiveness of the economy. When everybody is equal, no one has incentive to move up, and therefore productiveness and competitiveness fall. This is why I believe Canadian workers and the Canadian economy is both less productive and less competitive than the American economy. In Canada, because of this huge social safety net, one has less incentive to do better, whereas in America, people have the desire to achieve and aim higher because everyone is out for themselves.

In short, though I disagree with the professor and the material he teaches, I can’t drop this course, so I will have to do my best to push aside any political commentary I may have. I do question the ‘fundamental’ theorem though, because being a theorem, it assumes that it’s always right, and there are lots of economists in the US, along with me, that would disagree with that assumption.