Spending problems:

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  The nation's debt problems are well known and extensively written about. However, Andrew L. Yarrow, in "Forgive Us Our Debts: The Intergenerational Dangers of Fiscal Irresponsibility," brings it all together with this timely reminder and summation of the problems involved.
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Most disturbing, however, is the total lack of budget discipline amongst the legislators in Congress and in many states.

Keynesian economics undermined budgetary discipline and provided intellectual justifications for ever greater reliance on debts and ever greater tolerance for the assumption of future obligations that are clearly beyond the nation's financial capacity.

"Interest payments, expanding by 20 percent per year, are the fastest-growing part of our budget."

The worst deficit thus is the leadership deficit.

  Surging entitlement expenses and the ongoing retirement of the baby boomer generation already constitute overwhelming financial problems. Most disturbing, however, is the total lack of budget discipline amongst the legislators in Congress and in many states.
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  Until the post WW-II advent of Keynesian economic policies, national debts were kept small and repaid rapidly, Yarrow points out. However, Keynesian economics undermined budgetary discipline and provided intellectual justifications for ever greater reliance on debts and ever greater tolerance for the assumption of future obligations that are clearly beyond the nation's financial capacity. By election day 2008, the U.S. had surged past $10 trillion in debts and had well more than $50 trillion in explicit and implicit unfunded liabilities. (The U.S. is now $12 trillion in debt.)
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  The U.S. now owes more than the nation's total net worth. State and local government liabilities add more than another $2 trillion (and are by now much higher). These figures are increasing at a rate similar to the growth of Bernie Madoff's Ponzi scheme. The debt more than doubled in just the first six years of the new decade, thanks to the Bush (II) administration and his three  Republican Congresses. The $2 trillion in consumer debt and $10 trillion in personal debt equaled 130% of private disposable income as of 2007. The ratio of national debt to national income surged even faster as a result of the Credit Crunch. It had passed 66% in the middle of the decade and is now well on its way to 100%.
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  "In the 2008 fiscal year, the U.S. government [was] projected to pay $261 billion in taxpayer dollars in interest payments - half of that to foreigners." This figure will surge past the half trillion dollar mark shortly. It is projected to consume half of government revenues by 2030 and all of them by 2040. We no long just "owe it to ourselves."  "In fact, interest payments, expanding by 20 percent per year, are the fastest-growing part of our budget."
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  Yarrow provides a plethora of statistics on the problem, of which these are just the highlights. Another (not unrelated) problem is the nation's huge trade and international payments deficits. While acknowledging these problems, most politicians are busy making matters worse by enacting additional spending schemes and future commitments. The worst deficit thus is the leadership deficit.
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The bipartisan political consensus is to ignore the problem and let the next generation deal with it.

  Yet this trend has been progressing for decades already without observably limiting economic growth. In the meantime, the bipartisan political consensus is to ignore the problem and let the next generation deal with it. Unfortunately (as with the Madoff Ponzi scheme and the Credit Crunch bubbles), these kinds of problems multiply rapidly over time. At some time they will mean a loss of wealth, reduced standards of living and reduced national status and power. The timing is uncertain, but the outcome is not. (In fact, the Great Inflation of the 1970s and the depression of 1980-1982 were direct results of these spending and monetary inflation policies as practiced in the 1950s and 1960s.)
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Most Americans want more services from government but don't want higher taxes. This is clearly not a basis for sustainable national policy.

  Federal revenues declined from 20% of GDP in 2000 to approximately 16% in 2006 because of tax cuts. However, spending picked up to about 22% - of a considerably larger GDP.

  Herein lies the real problem. In nominal terms, revenues rose sharply with the advent of the tax cuts because the economy expanded much faster - exactly as the tax cutters promised. It is a mark of just how fast a Republican Congress increased spending that spending grew even faster than that. The problem is clearly not insufficient revenues. The problem clearly is completely undisciplined spending increases. It is clear that without discipline on the spending side, no amount of tax increases and revenue growth can match the spending proclivities of Congress.

  State and local taxes and expenditures add over 60% to these figures. The Bush (II) administration with three Republican Congresses and one Democratic Congress boosted federal spending by 60% - making him the biggest spender since Lyndon Johnson.

  Unfortunately, there is no major fiscally conservative political party any longer. The Republicans proved themselves to be nothing but an organization of unprincipled political hacks. With effective leadership from Ronald Reagan and Newt Gingerich, they were able to restrain the government's domestic spending proclivities during the 1980s and 1990s, but today they are in desperate need of adult supervision.

  The entitlement programs and defense account for most of the increase, but certainly not all. (Despite two wars, the spending increase attributable to defense was a minor fraction of this total.) Under-funded pension systems are a looming threat at all levels of government. However, we can't just blame our legislative representatives. This is a democracy, after all, and the American people are getting the government that they deserve. Most Americans want more services from government but don't want higher taxes. This is clearly not a basis for sustainable national policy.
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  All of this is leading to a budget train wreck, Yarrow explains at some length. He explains some of the smoke and mirrors of the Congressional budgeting process, and continues at some length into the increasingly dysfunctional and onerous tax system. None of this is new, of course, but it does have to be repeatedly stated and emphasized. It is not a pretty picture.

  "The Byzantine federal tax code is about 17,000 pages long, with four times as many words as the Bible and a mind-boggling fourteen thousand tax-law changes in just the past twenty years -- more than even the most knowledgeable accountant or tax lawyer could digest." (The figures on the tax regulations are far, far worse.)

Debts, entitlements and unfunded liabilities:

  Yarrow then turns his attention to Medicare, Medicaid and Social Security - the big three entitlements.
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  He goes at mind-numbing length into the numbers. Fraud and inefficiency absorb hundreds of billions of dollars. (All of this might be changed drastically - for the worse - by the health care bill.)

  "While the best of American medicine is the world's best, and while U.S. medical research remains at the forefront of innovation, it is hard to imagine a more miserably designed health care system for a rich country if one had entrusted it to the Three Stooges; even to call it a 'system' dignifies a crazy-quilt of policies, players, and incentives."

  Of course! What else could you expect? This is the system Congress has been working on for six decades, already. Unfortunately, we did not entrust the system to the Three Stooges. We have entrusted it even further to Congress, which has outdone anything the Three Stooges - or Rube Goldberg - could have imagined.

    "While these [Congressionally enacted] programs have had many beneficial effects, aside from the fiscal tidal wave they may bring, they are also problematic in that the ways in which revenues are collected and benefits are paid are regressive, helping the middle class and well-to-do more than the needy, and benefiting generations born in the first two thirds of the twentieth century much more than Americans born in the past few decades."

Medicare unfunded liability was $38 trillion in 2007.

  Social Security at least presents solvable problems. The rising health care costs of the health care entitlements, on the other hand, seem unstoppable. Moreover, retiring baby boomers and lengthening life spans dictate explosive growth in entitlement expenses in the next two decades.

  Economics 101: If you massively increase demand without increasing supply, prices will rise sharply.

   The budgetary history of the U.S. is sketched by Yarrow. Until 1960, debts were generally confined to periods of war and depression. The advent of Keynesian policies and entitlement expansion changed that.
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  The inaccuracy of the government's "projections" is notorious. (See, Kotlikoff & Burns, "The Coming Generational Storm," at segment on "Generational accounting.") Medicare Part D prescription drug coverage originally projected as costing $400 billion is now projected as costing over $800 billion through 2017, Even this projection is undoubtedly still significantly low. The long term costs run to $8 or $9 trillion.

  Medicare was projected to cost only $9 billion by 1990, but actually cost about $90 billion - only half the difference being accounted for by inflation. See, Gratzer, "The Cure," at segment on "Medicare."

  Health care paperwork costs over $400 billion per year. Medicare unfunded liability was $38 trillion in 2007. Medicare and Medicaid were expected to cost about $620 billion in 2008 with Medicaid costs to states adding about $160 billion  - all projected to double in a decade.
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The result is that more than 60% of federal spending is for entitlements and interest on the federal debt. Congress thus fails to fulfill its responsibilities under the Constitution for control over its budget.

  Although existing entitlements are already clearly insolvent and unsustainable, Congress insanely repeatedly expands them. The public loves these gifts from the public treasury but rejects the taxes needed to pay for them. Much of the intellectual community equally insanely applauds them. The cost of these three entitlements was 8.5% of GDP in 2006 (and is now much higher).
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  Even before the Credit Crunch, the total federal debt was $10 trillion, not even counting the far more massive unfunded obligations. About 40% of this debt is "intragovernmental" - sums pilfered from federal trust funds like the Social Security trust fund.
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  The result is that more than 60% of federal spending is for entitlements and interest on the federal debt. Congress thus fails to fulfill its responsibilities under the Constitution for control over its budget. The rest of the federal budget process is "an often stumbling, bumbling, politically motivated, fiscally dishonest, and procedurally dysfunctional ritual that is the antithesis of good management in almost every way."

  Well, what do you expect? As FUTURECASTS has long stressed, government management is INHERENTLY inept, and government generally exhibits a NEGATIVE learning curve. Each reform effort adds additional layers of stupidity onto its spending schemes. This is being increasingly confirmed by the health care "reforms." Fannie Mae and Freddy Mac - now losing hundreds of billions of dollars - are currently the poster children for government mismanagement. See, Government Futurecast, Part II, "Government Management."

  Yarrow describes this appropriations process.

  "The sheer bizarreness of this process allows many earmarks to be slipped in by particular members without most of their colleagues realizing what has been added to these massive documents. Needless to say, while many poorly paid congressional staffers are tasked to track the budget, there is nary a member of Congress who reads appropriations acts from cover to cover. To make matters even more absurd, these measures are often passed under duress, with little debate, in the wee hours of the morning, on simple yes-or-no votes. Finally, as an example of our nation's profligacy, the president increasingly has requested and Congress increasingly has passed supplemental spending bills that ostensibly are for national emergencies, such as the war in Iraq or Hurricane Katrina, but typically include a huge amount of additional unrelated pork-barrel spending."

All of the $1.7 trillion in the Social Security trust fund has actually been spent on other government programs.

By September, 2007, foreign holdings totaled $2.2 trillion - over 45% - of this debt.

  The government has been plundering its trust funds. There are more than 200 of them, and they now hold little besides IOUs. Social Security, Medicare and Civil Service Retirement funds account for the majority of the $3.7 trillion as of 2006. All of the $1.7 trillion in the Social Security trust fund has actually been spent on other government programs.
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  The government floats a wide variety of IOUs in the public markets. Of the $5 trillion in public debt owed in early 2008, $500 billion was held by state and local governments, $300 billion by pension funds, almost $600 billion by domestic financial institutions, about $75 billion by domestic individuals. By September, 2007, foreign holdings totaled $2.2 trillion - over 45% - of this debt.
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  These debts seriously threaten the nation's international interests. China, run by an autocratic Communist party, and theocratic Saudi Arabia are primary creditors. Ultimately, foreign nations may opt for pounds, euros and even gold as safe reserve alternatives to the dollar. If this tendency accelerates, the U.S. would have to defend the dollar with higher interest rates, imposing a substantial constraint on its economy. (Of course, all major paper currencies are subject to similar problems, so gold - although volatile - will on balance continue to rise over time.)
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  Unfunded obligations, variously estimated at $50 trillion, dwarfs even the vast debts. Of course we can (and have been) simply printing money to cover shortfalls, but significant levels of price inflation are not something the American electorate would or should tolerate for any extended period.

  Price inflation above de minimus levels comes with its own list of noxious economic consequences. See, "Understanding Inflation."

 Economic theories that purport to show that deficits don't matter or are even beneficial are briefly reviewed and disposed of by Yarrow. He correctly notes that the famous Reagan tax cuts were increasingly offset by Reagan tax increases after 1982, and that the increasing prosperity of the Clinton years came after the 1993 tax increases, substantial cuts in defense spending, and the budget restraint of a fiscally conservative Republican Congress during his last six years.
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Federal Reserve monetary manipulations can hold back such interest rate increases for awhile - at the risk of even higher rates of price inflation and even higher interest rates later.

  A timely reminder of all the noxious impacts of heavy debt loads is provided by the author. No! We do not just owe it to ourselves. Increasingly, we owe it to foreign creditors, and even domestic debts undermine economic stability and growth prospects. The extra burdens of federal debt ripple down to state and local governments, many of which also have extreme budget problems, debt loads and massive unfunded liabilities for pension and health care plans.
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  Heavy debt loads lead to higher interest rates which slow economic growth or initiate recessions. Alternatively, they can be paid down by inflation which ultimately leads to even higher interest rates, stagflation and worse recessions. Federal Reserve monetary manipulations can hold back such interest rate increases for awhile - at the risk of even higher rates of price inflation and even higher interest rates later.

  "Beyond reduced national savings, increased interest rates, reduced investment, and perhaps inflation and reduced economic growth, sustained deficits and debts have other less than salutary effects. Economically and morally, they unjustly transfer the burden of paying for current consumption onto future generations."

  Eventually, tax burdens must rise substantially - and not just on the "wealthy." Eventually, entitlement benefits must drop - substantially.
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  Yarrow also speculates on the impacts of home mortgages, auto loans and other consumer debt. Unsurprisingly in this age of chronic price inflation, Americans have chosen to reduce their savings rates - often to negligible amounts - leaving many increasingly dependent on government benefits. Moreover, the paralysis of the federal government as it confronts these problems adds to public cynicism about their government.
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Warren Buffett, for the first time in his storied career, recently began investing in securities denominated in foreign currencies. 

  The prospects if nothing is done are reviewed by Yarrow. With additional health care entitlements adding to the normal yearly cost increases, health care and social security entitlements will eat up 18% of GDP by 2040 - about what the entire federal budget consumed as of 2006. Interest payments will cost another 18%. The $10 trillion (now already $12 trillion) in federal debt will increase to three times the size of the national economy. There will be little money for infrastructure, research, the environment, education or even defense. Payroll taxes would rise to about 30%, but this figure depends on income growth rates which themselves are threatened by those debts. The approximately $50 trillion in unfunded liabilities would balloon stratospherically.

  Clearly, this will not happen. In economics, if the line goes off the chart, the line will not go off the chart. The electorate will not allow this to go on that long, but the exact nature of the political response is always uncertain.

  Yarrow continues with a long list of similar horribles. He speculates at some length on the economic, political, military, diplomatic and social consequences. As the U.S. weakens, its adversaries will strengthen and be emboldened (as in the 1970s). And this assumes that decline will be gradual rather than catastrophic - an assumption clearly not inevitably correct. America's AAA credit rating may be gone by 2012 and reduced to junk bond levels by 2020. Warren Buffett, for the first time in his storied career, recently began investing in securities denominated in foreign currencies. The U.S. could be forced to respond with sharply higher interest rates - a disaster for an economy heavily encumbered with debts.
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Gerrymandering:

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  Every year that we dawdle adds an astounding $1 trillion to the cost of reform. However, Congress remains paralyzed by its short-term concerns, bitter partisanship, and various rationalizations for a lack of concern.
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  Yarrow accurately fingers the gerrymandering of House districts as the real culprit. Gerrymandering has become so precise that over 90% of House seats are generally safe for one party or the other. Voters don't choose their representatives, representatives choose their voters. This makes the primaries the predominant selection process, and primaries are frequently dominated by each party's ideological core.

  "Consequently, candidates play to their activist bases, so that conservative Republicans and liberal Democrats have been much more likely to win safe seats than have more moderate, compromise-inclined members of either party. In addition, safe seats and the recent power of incumbency lead to a tyranny of the majority, which discourages citizens opposing the incumbent from voting."

  Every Congressman wants to be able to boast about "bringing home the bacon" for his district, but none want the blame for raising taxes to pay for those appropriations. Legislators are not sent to Washington to say "No!" to their constituents. The American people look very favorably on those legislators providing increased benefits from Washington. Thus, there is no longer a fiscally conservative party in Washington. Both parties vie with each other to provide additional benefits for voters.
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  Influence in Washington becomes more important as government has grown bigger and more complex. A wide array of interest groups have descended on Washington to influence government decisions, taxation and appropriations. Of course, over time, they largely succeed. Increasing sums are spent for campaigns. This increases the influence of monied interests.
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  There has been little clamor for fiscal responsibility from public, business or interest groups during this first decade of the 21st century. Politicians react to popular pressure, and there has been little for this cause so far. Nor has there been political leadership sufficient to generate public support. Nor have legislators been held accountable for budget-busting expenditures. (The results in the special election for the senatorial seat in Massachusetts may indicate a welcome change in public concern.)
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  The public is well aware of the problems. These problems are no secret. However, action has been delayed so long that all suitable actions will be painful - the more effective the action, the deeper and wider the pain.

  To paraphrase one European monetary official, every responsible official knows what should be done. What they haven't figured out is how to get reelected if they do it. That was the political genius of Ronald Reagan and Margaret Thatcher.

A menu of possible reform measures:

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  The general way forward is not obscure. The U.S. must reform its entitlements and cut wasteful spending. (Hasn't Washington already pledged to cut "waste, fraud and abuse" at least every other year since WW-II?) It must also raise new - but not onerous - revenues.
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  Yarrow does not offer any prescription for success. Instead, he offers a list of plausible suggested actions. Some he clearly favors, but he includes many for which he does not express either support or opposition.

• Political reform:  He begins accurately by targeting the gerrymandering that empowers extremist Congressional candidates at the expense of centrist candidates.

  "If politicians truly were elected to further the common good, rather than posturing for hard-core supporters or cash-dispensing lobbies, they might hammer out agreements that represent give and take, and at least move the nation forward. Moreover, as many polls suggest, the American people agree on a broader array of issues than their elected representatives do."

  State legislators must be pressured to surrender redistricting authority to independent, bipartisan commissions. This is done in Iowa (and now in California, but just for state legislative electoral districts). Other electoral reforms on the list include campaign finance reforms and term limits.
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  There have been several efforts to form centrist coalitions across party lines. These efforts have had some modest success. However, this movement has a long way to go to achieve real success. Indeed, just reducing the partisan attacks would be a big improvement.

• The budget process:  Yarrow favors "PAYGO" as an essential disciplinary process. Tax cuts and spending increases must be offset by tax increases and/or spending cuts. This actually proved quite effective in the 1990s, until it was allowed to expire by a profligate Republican Congress in 2002. Other approaches are generally riddled with loopholes.

  "Rules should have teeth, with specific triggers and defaults built into the budgeting process, so that if revenues and spending do not match, taxes are automatically raised and/or spending is automatically cut."

  There is no way to prevent Congress from undermining any such disciplinary process.

  The list of budget suggestions includes:  A balanced budget amendment; requirements that future funding increases be paid for to avoid unfunded obligations; spending and tax growth restricted to inflation and population growth or to GDP growth; the abolition of the smoke and mirrors accounting gimmicks, many of which would be criminal in the private sector; the protection of trust funds from plunder; unfunded liabilities funded immediately on an actuarial basis; and evaluation of current spending and taxation expressly for their longer-term impacts.

  Needless to say, Washington finds all such disciplinary suggestions very distasteful. Our gallant legislators value the economists who provide Keynesian and other excuses for rejecting effective disciplinary measures. They hire mathematical economists to peer into invalid macroeconomic models to produce the phony "projections" that low-ball program expenses and provide an appearance of rational planning to impress the credulous.

  Other budget suggestions include: Disclosure of the intended beneficiaries and both the lobbyists and legislators who support tax and spending measures; "sunset" requirements that force periodic reevaluation of all programs, spending and tax provisions; longer term budgeting; a requirement that the President submit a balanced budget; disclosure of all budget increases and decreases.

  Clearly, many of these suggestions are impractical as a matter of Constitutional law or nebulous definition or because of the limits of legislative procedures.

  The line item veto has been declared unconstitutional by the Supreme Court, but Yarrow suggests that some method might be provided that would enable the President to force Congressional reconsideration of particular expenditures so he would not be presented with huge omnibus spending bills on a take-it-or-leave-it basis. (A line item veto would considerably increase the political power of the presidency.)
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  Performance-based budgeting procedures might also be devised.

  "Performance-based budgeting is already the law in countries such as Canada, the Netherlands, Australia, and New Zealand: such provisions make it possible to ax needless programs and reprioritize what government does and how it does it. The 1993 Government Performance Responsibility Act - GPRA - and OMB's rarely used Program Assessment Rating Tool - PART - offer means of gauging the effectiveness of government programs. Additional funds should be provided for more comprehensive performance evaluation, and when programs are found to be ineffective, consequences should ensue -- perhaps a provision to 'shape up or ship out' of government."

  Congress will surely welcome with open arms requests for appropriations for the performance review of their pet programs.

•   Ending the "entitlement" aspects of entitlements:  The suggestion that the "entitlement" aspects of entitlements be removed would unfortunately not be received well in Washington.

  Today this suggestion is an anathema. However, it is something that Congress will be forced into - kicking and screaming all the way - in one way or another - by the immutable laws of economics - sometime before the second half of the 21st century. Obviously, the sooner it happens the better, but it will be put off until the budgetary wolf is at the door.

  The concept of major entitlements is economic insanity - similar to socialism or government industrial policy - and is supported by the same ideological groups. These concepts constitute intentional ignorance of basic economics.

Social Security:

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• Social Security reform: Reforming Social Security is the easiest of the entitlement reform tasks. Nevertheless, it has proven beyond the meager capabilities of Congress for over a decade. "Only" a few trillion dollars is involved and the fixes are obvious.

  With life expectancy currently in excess of 18 years at ages 62 and 66, it is imperative to raise the age of qualification for social security benefits. Voluntary delay of retirement could be encouraged by reducing or eliminating the social security payroll tax for those over 66, but mandatory age increases for qualification are undoubtedly needed.
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  About 75% of senior citizens already draw benefits by age 62. The current age for full benefits is 66 and is scheduled to rise to 67 in 2027 - constituting an obviously inadequate response to the problem. Yarrow suggests that 70, phased in fairly quickly, is a clearly reasonable requirement. The retirement age could be indexed to rising life expectancy. Such changes would themselves solve about half the problem.
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  The formula governing years of work required to qualify for full benefits could also be increased along with changes in the related formula that governs average indexed monthly earnings. These changes could cover most of Social Security's long-run financial problems.
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  Further suggestions include: freezing benefit increases for a few years, or indexing them to price inflation instead of wage inflation - at least for the "wealthy." However, the author points out that benefits for those over 80 and for widows and widowers are considered to be already too small, and does not seem concerned that this would enlarge the problem. (There is no end to the good ways in which to expand government benefits.)
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  The suggestion that private personal retirement accounts be substituted for some or all of social security is discussed by the author. Australia, Chile and Singapore have such a system. Yarrow favors private personal retirement accounts but warns that they must be properly structured. As he points out, there are many devils in the details.
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  Suggested methods for raising additional revenues include: drawing state and local government employees into the system and increasing taxes on the benefits of wealthier recipients. Revenues from estate taxes could be dedicated to funding retiree benefits on the theory that estates are enhanced by such benefits. An alternative is to simply reduce the benefits paid to wealthier recipients.
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  One sixth of aggregate national earnings are above the current social security salary cap and escape the payroll tax. Raising this threshold significantly or even abolishing it seems appropriate to Yarrow.

  Why not just abandon the pretence of social security as a pension program and reorganize it as the middle class welfare program that it has always been?

  Further, the author asserts that a payroll tax increase of up to 2% may be needed.

Defense:

• National defense: The need for a strong defense and adequate support for those serving in the military is accepted by Yarrow without indulging in any debate about current military engagements.

  However, he grieves the "waste, fraud and abuse" involved in defense contracting. Tens of billion are involved. It is always an easy call to attack waste, fraud and abuse.

  Lets emphasize this yet again! Government management, as FUTURECASTS has explained from its earliest issues, is INHERENTLY inept. Government has no ability to defend the public fisc. Waste, fraud and abuse must be constantly fought as best as possible, of course, but it is ignorance of the highest order to believe government can ever make substantial headway against it. Indeed, the bigger and more complicated government activities become, the more vulnerable to waste, fraud and abuse government becomes. Yarrow recognizes that this financial bleeding is a part of the price that must be accepted for any substantial government activity.

Domestic discretionary spending:

• Discretionary programs: There are about 1000 different domestic programs that are considered discretionary. They, too, involve waste, fraud and abuse. Improvements in budgeting procedures would help here, especially effectiveness reviews and sunset provisions and specific spending caps.

Tax breaks and subsidies for corporations:

• Industrial policy: "Corporate welfare" is targeted by Yarrow. He specifically mentions agricultural subsidies for wealthy agribusinesses. There are big bucks involved in these programs.

  Other corporate welfare targets are the Small Business Administration, the Export-Import Bank, the Overseas Private Investment Corp., the Advanced Technology Program, the FreedomCAR Partnership, and the Maritime Administration. Subsidies for Amtrak and flood insurance are also questioned, as are the billions for Pension Benefit Guarantee Corp. insurance for bankrupt defined benefit pension plans. Of course, earmarks provide a particularly attractive - and growing  - target for cutbacks, as do the pork-laden transportation bills.

  On the other hand, dividend payments should be recognized as an expense of raising and maintaining the equity capital on which the stability of the corporate economy depends. It is policy insanity of the highest order to discourage equity capital while encouraging debt capital by allowing deductions for interest costs.

Privatization:

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• Privatization: The pros and cons of privatization proposals are considered by Yarrow. Federal grants to private entities at $400 billion per year deserve closer scrutiny. Grants for state programs total more than $400 billion and similarly deserve review. However, many worthy objectives are fulfilled by these grants programs, so pruning would have to be careful.

Healthcare:

• The healthcare entitlements: Which brings us to healthcare  - the 800 pound gorilla in the picture.

  The current system is inefficient, inequitable and subject to annual cost increases well in excess of those of inflation plus population growth. The burden on individuals, families, and public and private entities is becoming unbearable. The federal government pays nearly half the $2 trillion annual health care bill. State governments and other third party payers pick up much of the rest of the tab.
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  The problem is vast, complex and contentious. However, it must somehow be resolved. The current system, although delivering excellent care to most, is clearly financially dysfunctional. It threatens the financial viability of the nation.
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  Universal access to basic health care and the containment of costs are the basic objectives.

  Unfortunately, these two objectives are actually irreconcilable. Basic economics 101 tells us that a substantial increase in demand without any increase in supply MUST result in uncontrollable increases in prices. Administered alternatives to market pricing can never work, especially for so complex and vital an economic sector. See, Administered Prices and Health Care.

  A "single-payer" system with the federal government as the single payer would eliminate much of the vast administrative costs that have accumulated under the current system.

  "Under a single payer system -- a political loser for the past sixty years in the United States -- the government would pay for everyone's health care, using a public entity such as Britain's National Health Service to compensate doctors, hospitals, pharmacists, and other health care providers for their services. Single payer systems implicitly ration care -- a subject to which we will return -- as budgeted health care dollars are finite, leading to health care wonk jokes about not getting sick in Canada in December when the money has run out. Some left-leaning Democrats and labor unions continue to advocate for a single-payer system, and many states have introduced legislation to create single-payer systems, but -- while more surprising political changes have been known to occur -- a national single-payer system is not likely to be in the cards."

  Supporters ardently advocate the "public option" as a means of reaching their single payer goal. Competition with private insurers would be anything but "fair." The pubic "option" would enjoy taxpayer benefits while private insurance companies are loaded down with taxes, mandates, regulations and liability risks. They would clearly no longer be insurers, but would be thus changed into harried administrators of the government program. Ultimately, like a similar experiment with Fannie Mae and Freddy Mac in the mortgage market, the public "option" would become the only option - undoubtedly with the same disastrous results.
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  Indeed, some supporters of the public option advocate such tactics as a means of driving the entire for-profit health care system out of business. See, Richmond & Fein, "The Health Care Mess," at segments on "Medicare for all" and "A mere expansion of the FEHB program." They apparently missed the collapse of socialism during the 20th century.

  Basic universal insurance with some degree of government support supplemented by a variety of options seems to be the way forward. Potential options include: "Managed competition" among insurers; greater co-pays and deductibles; price and practice controls; enhancement of public health campaigns; medical malpractice reform; rationing; and, greater application of information technology.

  Yarrow mentions that powerful constituencies are arrayed against many of the above options, but neglects to mention that some -- like price controls -- are impossible as a matter of economics, and others, like practice controls, are impractical in such a rapidly advancing industry. Nor does he mention allowing people to purchase health insurance from insurers across state lines, like auto insurance, to create a national market. Questions of degree can be as contentious as the questions of adoption.

  Of course, tax increases are always under consideration. Tinkering with the tax deduction for health care and health care insurance is also always under consideration. Piecemeal changes, like a commission to review health care budgets and practice and government-negotiated prescription prices have already been tried. Raising the age a few years for qualification for Medicare would save small sums, and of course there are the ever popular but always illusive savings from attacking waste, fraud and abuse, which currently absorb hundreds of billions of dollars.

  The government bureaucracy is a soft marshmallow with no capacity for protecting itself from waste, fraud and abuse. So let's say it again and even more emphatically: government management is INHERENTLY inept. Moreover, with any activity of this complexity, government exhibits a negative learning curve. See, Government Futurecast at Part II, "Government management." Each round of health care reform has made the system more complex, inefficient, costly and unsustainable.

  Broader health care system approaches include: Shifting from government payments for health care to universal subsidized insurance premiums; mandatory health insurance; shifting from employer-based insurance to insurance that is individual and portable. All of these approaches actually have significant support but also generate opposition. "Every reform has at least one entrenched interest opposed to it, and many reforms are not the sort that Americans happily would embrace."

  "As under the Federal Employees Health Benefit Program  - FEHB - which provides insurance for nine million civilian federal workers and their families, or the military TRICARE system, government would pay for most, but not all, of the cost of health insurance, yet offer potential beneficiaries a choice among several plans. For higher-cost plans, which provide more extensive coverage, individuals would have to foot more of the bill, while lower-cost  plans, such health-maintenance organizations - HMOs - or 'consumer-driven' plans, would be less expensive to the individual."

  Health savings accounts, high deductible catastrophic coverage plans, managed plans, fee-for-service plans, and HMOs are the choices available under the FEHB. Means testing for subsidies can be applied broadly to any reforms.
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Administered approaches to market mechanisms such as rationing and best practices determinations and guidance all involve vast complications and conundrums only dimly perceived at present, but health care provision without limits is unsustainable.

  Suggestions for Medicaid reform include shifting costs and responsibilities to the states with federal grants and/or assistance for insurance premiums. Managed care and cuts in payment rates are also under consideration. (The number of facilities willing to take Medicaid patients keeps declining and others limit the number of patients they will accept.)
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  Egalitarians want to go further, reducing all health care to a lowest common denominator system or otherwise taxing higher-end insurance and providers. However, a two-tier system based on wealth is likely to remain a characteristic of the nation's health care system. (Even now, many people travel abroad as "health care tourists" to get the care they want at better prices.)
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  Administered approaches to market mechanisms such as rationing and best practices determinations and guidance are discussed by Yarrow. They all involve vast complications and conundrums only dimly perceived at present, but health care provision without limits is unsustainable. Yarrow also notes the extent to which the U.S. market subsidizes medical research for the rest of the world. The vast costs of malpractice insurance and defensive medicine practices are significant factors in health care cost inflation.
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  Market influences, such as they are, can be enhanced by "evidence-based-medicine" practices and disclosure of outcomes, all made possible by appropriate information technology. (See Porter & Teisberg,  "Redefining Health Care.")
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  Testing these suggestions at the state level has much to recommend it. For example, the $2,450 average cost per policy expected under the Massachusetts plan quickly doubled. Six states were scheduled to initiate premium support demonstration projects based on the FEHB. 

  Federal health care reform would disrupt all these efforts. The federal government would make its mistakes from sea to shining sea.

  The current third party payer system dictates rapidly increasing costs and prices. Higher co-pays and deductibles might help bring some market pricing pressures to bear. Currently, only about 1/8th of health care costs are out-of-pocket. There currently is no real restraint on the extent of testing or medical procedures or medical consulting consumed.

  There really is no adequate administered alternative to the market pricing mechanisms of even grossly imperfect markets as long as there is at least some measure of competition in the market. See, "Administered Prices and Health Care."

Taxes:

  Raising the federal government's tax take from the historic approximately 18.5% of GDP to about 22% is considered doable by Yarrow without damage to the economy.
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  Just letting the Bush (II) tax reductions lapse would bring in over $100 billion.

  It's amazing how little of the debt problem would be dealt with by eliminating these tax breaks. The problem has clearly been too much spending, not too little taxation.

  The myriad loopholes, exclusions and credits should each be considered for closing. The author particularly mentions the farm subsidies, almost all of which goes to wealthy agribusinesses rather than to family farmers. He also mentions the $225 billion exclusion for employee-based health care. Individuals benefit from a variety of deductions and credits with which Congress attempts to micromanage the economy and engage in social engineering. Some could be eliminated, others capped so they don't disproportionately benefit the wealthy. There is more than a few hundred billion dollars in play here.
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  Sales - consumption based - taxes are the most efficient methods of taxation. They encourage savings and bear more heavily on the wealthy who spend more. Basic goods could be exempted to reduce their burden on the poor, and many other variations are possible.
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  Taxes targeted towards funding specific generally desired programs are a favorite method for getting around public resistance to higher taxes. In effect, the politicians hold hostage the electorates favorite programs - like schools or prisons or roads - to force them to accept higher taxes.

  The same propaganda ploy is used by state legislatures to gain acceptance of bond issues. Money is fungible. With minor exceptions, a budget is just one pile of revenues and one pile of expenditures. Money added at one point of the pile increases the whole pile, and any expenditure increases the total of expenditures.

  User fees are another source of revenues that receive wide support. Carbon taxes and higher energy taxes are favored by environmentalist. "Sin" taxes could be expanded to include "junk" foods, and another crack at "luxury" taxes could be tried. Restoration of estate or inheritance taxes and increased efforts to collect the taxes already on the books could all bring in hefty sums.

  How convenient for the politicians! Almost every problem can be solved by imposing a tax.

  Tax simplification has widespread support. The atrocious tax code is an easy target for improvement and there is no shortage of brilliant ideas for how taxation can be made more palatable.
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  However, the author finds reasons for additional expenditures even in a book about the drastic need to cut the budget deficit. He notes that expansion of the earned income tax credit has broad support.
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  The annual revision of the alternative minimum tax is one change sure to be implemented. The tax was designed to make sure the wealthy pay taxes but without revision suddenly expands due to inflation and bracket creep to include 40 million ordinary taxpayers - a large proportion of whom vote. Unfortunately, in the smoke and mirrors budget accounting in Washington, this revision increases deficits by as much as $1 trillion by 2015.
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Conclusion:

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  Bigger government is inevitable and desirable, according to Yarrow, so everybody should just relax and accept the higher taxes that are needed to fund it. Reform choices must be based on what is fiscally effective and politically possible - and they must begin soon.
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For all that it is doing wrong, there is no doubt that the U.S. government bestows vast benefits on the nation and even makes possible in a wide variety of ways the capitalist economy that provides the resources. However, growth of entitlement spending to over half the federal budget is a vast failure of government.

  The budget, with its spending and revenue provisions, defines much of the nation's priorities and culture, and the role of its government. The huge and growing deficit demonstrates a callous disregard for our children and for the future of the nation.
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  For all that it is doing wrong, there is no doubt that the U.S. government bestows vast benefits on the nation and even makes possible in a wide variety of ways the capitalist economy that provides the resources. (See, Government futurecast, Part I, "Economic virtues of the U.S. political system.") However, growth of entitlement spending to over half the federal budget is a vast failure of government. It is crowding out other programs that are desirable, productive or even necessary. Is also threatens the economic growth that makes all other things possible and without which nothing is possible.
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  Ultimately, Americans must abandon the culture of "entitlement." They will do this voluntarily in an orderly manner or suffer from increasingly vicious market processes that will force this upon them.

  The task seems daunting. However, the productivity and resilience of the American economy and its people are such that nothing more is required than some sanity in Washington.