Semi-Daily Journal

Just a point here. Perhaps this new awakening to the potential upstream difficulties that can result from the growing structural deficit (Paul Krugman - to his credit - has been flagging this problem in his NYT column)may help people in the US to appreciate the pretty dire situation in Europe on this score. The ECB has no easy and clear policy option since, amongst its other difficulties, relaxing the three per cent deficit limit imposed by the stability and growth pact would mean long term deficit problems spiraling out of control in a number of key countries. Between a rock and an extremely hard place I think is the appropriate expression.

The prospect of national bankrupcy US side in less than a generation will only be rivalled by a much more rapid bankruptcy in some key EU states (Germany, Italy, Spain....), if in doubt just look at the population numbers and the pension liabilities.

And, if I'm right, these obligations could come online at a moment when a change in the economic worth of some key players is pretty much on the cards (India and China up, EU and US down) - in relative terms of course. This means that such incurred liabilities could become even more onerous as the ravages of time and deflation do their work.

Looked at in this light - aging and global repositioning - the 'mystery' of deflation no longers seems such a mystery. Yet whilst national bankruptcy is a terrible thing, universal bankruptcy (paraphrasing and plagiarising both Brad and Keynes) can serve the interests of noone.

I think it's time we started to look for a plan B, and tried collectively to do something to avoid this unpleasant outcome.

What I find intriguing is that this is exactly the pattern of the Reagan tax cuts, lo those many years ago, as described in David Stockman's book --- we have the ideologically driven purists like Stockman himself who had the idea that services would have to shrink with revenues coming up against politicians unwilling to actually
make the cuts (or even really recognize their necessity; he says Reagan's only response to being confronted with the numbers was Rumsfeldian demands for more innovative thinking). And then there are the senior White House staff more concerned with having a policy they could sell than with whether the policy was sound in the first place.

I blogged about this a bit more than a year ago here:

http://thelookingglass.blogspot.com/2002_01_13_thelookingglass_archive.html#8651082

but the bottom line seems the same to me now as it did then: We are ignoring history, and condemning ourselves to repeat it.

Or it could be as simple as Republicans are happy so long as taxes are cut for the rich. The economy cratering and the government going bankrupt doesn't concern them.

I'm not an economist, so I have a bit of a different take on this. I think that the deficit might restrain spending at the point when interest rates were driven up by the federal government's increase in demand for borrowing, making each marginal bit of spending that much more expensive and making the housing market and a lot of other markets out of whack. This would create a need to curtail spending. But that's not necessarily the point. A political uproar over deficits and the resultant need to constrain spending can happend outside of any real economic impact of the deficit. You can have a political uproar without there being a real economic basis for one anyway. Either way, the result would be a new era of Gramm-Rudmanesque cuts and caps perhaps even the vaunted balanced budget amendment (remember that? Its disappearance from policy discourse is a sign of how far into an alternate reality the GOP has come). As a result, someone will be able to claim the title of "deficit hawk" and defender of limited government. This scenario totally ignores the idea that rather than cut spending we might raise taxes. It has a quality to it that seems almost akin to bulimia. We binge (deficit) and then we purge (spending cuts). And just like bulimia isn't about weight control, this isn't about government being too big or too small. It seems to me that the people talking this way and believing it mostly don't know if government grows more over a long term in the absence of or the presence of deficits. Its symbolic and pychological. The pleasure, such as it is, is in the process.

>>if in doubt just look at the population numbers and the pension liabilities<<

... as I find myself repeating, a lone voice in the wilderness, this problem disappears with a five year shift in the retirement age ...

The only theory that seems to fit all data (besides economic incompetence on a scale not even Josh Marshall will contemplate) is the idea that they are counting on a future Democrat to play the Clinton role and spend capital to fix the books. The GOP gets all the fun and games of deficit spending, and the Democrats play the patriot and fix the mess.

Next year, when growth in discretionary spending is scheduled to fall to 4% from 13%, in reaction to this year's deficit. And let's look at some more numbers...

>> If (as Mickey Kaus and others maintain) running a large federal deficit is good because it restrains spending, how come spending growth is not restrained now? <<

Well, as an obvious first thing, the legislative budget process operates with a lag. If revenues unexpectedly boom or bust in a given year, Congress can't react until the next year's budget.

And as an obvious second thing, formula spending on entitlements and such is set years in advance. So let's separate that out and look at growth in Congress's discretionary non-military spending.

Hypothesis: Discretionary spending will accelerate when politicians have a surplus to spend but be constrained when they do not -- with a one year lag to account for the legislative response to fiscal developments.

Data:

fiscal position
1990-1997: deficit
1998-2001: surplus
2002-forever: deficit

discretionary spending growth
1990-1998: 4.4% average (only 1.6% real over inflation)
1999: 5.2%
2000: 7.9%
2001: 8.9%
2002: 12.7%
2003: 4.5%

http://www.whitehouse.gov/omb/budget/fy2003/pdf/hist.pdf

The hypothesis is not refuted.

And quoting a conversation with former CBO director Rudy Penner on this very web site, 3/22/02:
~~~
"Brad praises how well and honest the budgetary process worked in the early and mid-1990s, and ... the Budget Enforcement Act [BEA] and its Pay-As-You-Go restrictions [PAYGO] that made any piece of legislation that increased the deficit out-of-order...

"Brad: ... So what happened at the beginning of 1998 to change things so completely? That's still not clear to me...

"Rudy: I believe it was the surplus. PAYGO was originally designed to stop tax and entitlement policy from increasing the deficit. (Really, to preserve the gains from the 1990 budget agreement.) After 1997, it had the effect of preventing any reduction of the surplus and that didn't make much sense...."
~~
What?? Preventing the reduction of a surplus doesn't "make much sense" to Congress?

Well, a CBO director would know if anybody would.

But Jim, that analysis completely neglects expectations. The 2002 deficit could be seen coming in 2001, so why didn't it have an effect? Are you really using a current-period myopic model, and if so, why not use one with respect to deficits and interest rates?

Surely deficits have a lot in common with stock market bubbles or credit card debt -- short term feedback is weak and the benefits of incurring one are obvious at the start and that will continue to be the case on a marginal basis. It is just that at some point you become vulnerable and find that you are taking all your medecine in one go. So to hope that they start self correcting before something very bad starts to happen is probably naive, especially if, as seems to be the case there is no "golden rule" to set limits this side of the precipice. Have I missed something or has there been no explanation of why the deficit exists and when it might go away or stop growing? Given that when will it be expedient for someone to make it go away or stop growing? When President Bush starts posting comments here?

Its nice to see that Jim Glass and others on the conservative aisle have modified the "starving government" theory from one espoused a few months ago to focus on discretionary non-military spending and to add a one year lag to the process (both of which I think strengthen the previously tenuous theory).

I am still bothered by a few items that I hope someone on that side of the aisle can clarify for me.

1. If the goal is to cut domestic non-military discretionary spending why not be upfront about it and announce what you want to cut. Isn't that part of what being a conservative is all about: a desire to cut wasteful spending? So why not cut the wasteful things now instead of waiting for some sort of impending crisis to take all discretionary spending down?

2. When deficits become too large, won't the government just resort to raising taxes? Certainly Bush I and Clinton give us historical reason to think this would be the case. If so, isn't what Bush is doing simply getting cheap political gain by cutting taxes now when he knows some other poor sap (like Jeb!) will just be forced to raise those same taxes later?

3. Isn't starving domestic non-military discretionary spending macroeconomically pointless if you don't put that money to good use in tackling the entitlement programs? Otherwise you would starve one part of government to zero and the other part will just keep on growing.

I think what Greenspan said yesterday adds to what Jim was espousing with regard to the need of restoring some type of spending discipline through PAYGO. In the end, though, I think the history of U.S. fiscal policy is not about spending being driven by the availability of budget surpluses to spend. It can't be, simply because the periods of surplus have been so infrequent compared to the period of spending increases.

The history is that governments that don't worry about deficits increase deficits and governments that worry about deficits take steps to reduce them.

So if Bush is seriously concerned about rising deficits, he will cut spending. But right now he is not. If he was serious about cutting spending he would be able to articulate something beyond school lunches that he wants to cut. He can make all the speeches he wants about he wants to cut spending and how the democrats want to increase spending but his actions speak louder than words.

Right now, Bush is very serious about cutting taxes and is partially serious about fixing entitlement programs but doesn't want to give up tax cuts to pay for the costs of fixing them. He is not too interested in cutting spending, whether it be defense, education, health or other non-discretionary domestic stuff. The stuff about how deficits are all some kind of master plan to cut the things that conservatives love to see cut is just empty rhetoric.

>> ... as I find myself repeating, a lone voice in the wilderness, this problem disappears with a five year shift in the retirement age ... <<

Although *other* problems appear for politicians with a five-year delay in the retirement age. ;-)

But you're right -- and the entitlement financing problem similary disappears easily by means testing "the rich" and upper middle class out of receiving retirement transfers from those who are considerably poorer than themselves. Or one could easily do both -- a little less of both retirement deferment and means testing.

The economics of all this is simple, it's only the politics that is hard.

I've gotta say I'm somewhat confused by all the "class warriors" who are so outraged at the thought that the rich might get some kind of tax break today -- yet who are so wedded to the principle that taxes must go up by 10% of GDP in the future so the rich can collect full retirement and medical benefits by direct transfer from those poorer than them tomorrow. I mean, financing Warren Buffett's Social Security and Medicare benefits with taxes withheld from the paychecks of his Dairy Queen workers' doesn't seem very "progressive" to me.

"The rich" and upper middle class already have trillions of dollars of assets in retirement accounts alone -- not to mention their beach homes and all. And by 2030, or 2050, or whenever it is supposed the US will be threatened with "bankruptcy" by the cost of future entitlements piling up upon current debt, they will have *more* trillions of dollars.

So I'll make this wager: Long, long, before the U.S. is threatened with bankruptcy -- probably sometime after these programs go on general revenue, around 2016 -- politics will cause the rich to be means tested out of them and be invited to pay for more of their own retirements. Once these programs go beyond their dedicated funding to general revenue, mighty political alliances will form to point out the "justice" of having them do so. And really, what could be fairer? Will the class warriors of the future object?

Why the "progressives" of today don't even consider this possibility, and its policy implications for today, is beyond me. ISTM they can only defeat their own intentions by failing to do so.

By the way for a truly insightful reading of the budget, you should read not DeLong or Krugman or Greenspan but that noted brainiac George Will

http://www.washingtonpost.com/wp-dyn/articles/A59703-2003Feb11.html

I think it would be cheaper not to have to check whether everyone worth over a billion dollars is entitled to medicare even at one postage stamp ahead.

Means testing would only be important if successfully carried out it would exclude quite a large section of the population.

Obviously getting rid of estate tax will make things worse though. Did Bill Gates Jr write these tax reforms himself?

The real outrage is that we continue this charade of having a social scurity trust fund and a regressive payroll tax.

We should immediately start finding social security out of general revenue, pay for it with the current progressive income tax system that is a couple of percentage points higher at every tax bracket and cap the maximum payout at the current level commensurate with the lifetime earnings of someone making the social security wage base.

The entire system will be much fairer and everyone will have a real stake in getting the costs of the system under control: higher taxes all around otherwise.

Though I have no wish to begina political fight, I do wonder if many conservatives really hope that deficits will cause us to significantly alter our Social Security and Medicare promises. Do they really believe that we would be better off, were Social Security and Medicare undone?

Then, again, every environment protection program I care about appears under attack in the Administration budget. What are conservatives about?

Achilles you are right. If there is one thing I have learned from conservatives of late, it is that by thinking and acting boldly, you can move the debate in a desired direction. Changing to a consumption based revenue system was considered extreme not long ago, and yet the conservatives have made it a possibility.

Progressives need to fight back in kind. End the regressive payroll tax, adjust income taxes accordingly, means test the entitlements, and push back the retirement age a few years for younger workers only.

Conservatives want tax cuts for the rich and will say anything to get them. When there was a surplus, the reason for cuts was to reduce the surplus (According to supply-side economics shouldn't that have increased the surplus?). When there was a recession the reason for cuts was to stimulate the economy. Now that there is a recession and huge deficits, the reason is to starve spending. These people have the intellectual honesty of the Enron accountants.

I don't think we can blame "these [Bush] tax reforms" on the Gates family. They seem definately to be in the other camp, ie. rich as they are, they're still willing to pay back into the system that helped them get that way in the first place. The Gates are hoping, I imagine, their re-investment is not too little too late before the golden goose gets cooked.

As others have suggested before, I agree that some other rich folk, the Republican Party's first constituency, is indeed willing to use Bush's runinous economic policies to grab real property and power on the ride down with the expectation they'll be able to switch to a fiscally disciplined Democrat before it's too late for a ride back up.

I suspect about now they're feeling quite surprised at how out-of-control and destructive their wrecking ball has become. The last time they miscalculated and drove the economy this far south it took 25 years for the DJIA to regain lost ground. Scooping up foreclosed properties and other bargains can't be worth a whole lost generation even for the hardest tycoon heart.

Ok. I don't really believe they're that concerted in thought and deed, but it's close.

I expect a Democrat to win back the Whitehouse in 2004 not because voters reclaim democracy but because Bush's benefactors will have decided they've lost enough on this particular gamble.

>Why the "progressives" of today don't even consider this possibility

Umm, because as you rightly pointed out for everything else, the politics are hard. In fact, impossible so why even go there. Look at how gently your party, in control of everything the eye can see, is prodding at things like affirmative action and SS, and now try to imagine a downtrodden progressive's sober reflection over handing the screaming heads another sound-bite.

I can add even more focus to Dsquared's future-vision:

A lot of hand-wringing is going on over medical costs- we had a big graph in the blogosphere recently showing it to be (for sure, of course, because there are nobody dead-on as economists for predicating the future) like 2 million % of GDP in 2030. But the same economists seem to take for granted that leaps in technology will solve any (although they won't admit that there really are any) growth-based environmental problems.

Well, I don't think it's a bad assumption that medical technology will also make said leaps. And I state now, for the record, if it's a choice between driving a Bentley and suffering the indignities of a 65 year old body, or driving a beater and having my vigor restored even to the level of my current not-so-impressive (ask my wife) 40 year old body, I'm all over the used car lots.

And if, in 2025, medical technology can make 65-year olds feel like 40-year olds, why couldn't they work another 10 years?

Actually, my ideal world (since I am a workaholic) would be a Euro-American mix: work 9 months a year but do it until you are like 85 years old. They say youth is wasted on the young, but when I was young the old bastards who said that turned around and only gave me 2 weeks of vacation a year.

Achilles writes: "The real outrage is that we continue this charade of having a social scurity trust fund and a regressive payroll tax...
We should immediately start finding social security out of general revenue..."

Which raises the question: why would it be so hard to renounce the concept of the trust fund? I mean it as an honest question.

Think about what it means for a woman or man of 65, to have 24,000 dollars a year from Social Security and Medicare support. Perhaps, you have saved 100,000 or 200,000 or 300,000 dollars in retirement funds. Think about how important the Social Security and Medicare backing really are in securing the rest of your life. These programs are of enormous consequence.= for so very many people.

JT,

I think it is because we have so throughly perpetuated the fraud that our social security money is sitting around in the form of bonds in a vault somewhere waiting for us to retire. I say we should end the charade now, I hope the man George Will calls a bold and visionary thinker unburdened by the shackles of the past leads the way.

I don't mean to lay the blame for the tax at the Gates family. Mr Gates Senior has indeed spoken against abolishing the estate tax but his son benefits from dividend and estate tax relief almost enough to make it a macro consideration. If Bill Jr doesn't give away most of his estate as he has said he would, his children will benefit from the tax cuts by billions of dollars.

As much as I sympathize with the proposal to abolish the payroll tax and adjust income taxes accordingly, this would make the tax system way too progressive in terms of incidence for the people in power, and this was the case even before the 2000 elections. They only way it would pass congress and the white house would be if Bush and company do a worse job with the coming war than Tsar Nicholas II or Kaiser Wilhelm did with theirs.

I think it best that the Dems propose something that is hard-hitting but is not radical enough to outrage every gray suit in the country. Reinstating the estate tax is definitely a good starting point. Repealing the 2001 tax cuts will only be possible if some unforeseen event drastically discredits the Bush adm. and hands congress back to the Democrats. So the general fiscal package that could get the Dems. back in power (at least sometime before 2009 when the deficits will really start to bite)and do something to restore fiscal responsibility would look something like this:

1. Either reinstate the estate tax or adjust income tax rates to compensate for the loss of revenue.

2. Pass the dividend tax cut if necessary, but again adjust income taxes to compensate.

3. At least partially scale back the massive boondoggle that is the Missile Defense Shield program. It is ridiculous too claim that NASA spending should be scaled back while this white elephant continues to disgrace the budget.

4. Prohibit the use of the SS trust fund to prop up non-SS federal spending.

5. As for the stimulus needed to get the economy out of the current recession/deflation, start by guaranteeing unemployment insurance benefits as long as the economy is growing by less than 1% and offer larger tax rebates--definitely more than Bush has provided--to the lower income half of the population.

I grant that these measures are insufficient to prevent a fiscal crisis a decade or so down the line, but it's time we take a page out of K. Rove's book and started using policy proposals for political goals rather than for purely economic considerations. However, again I must warn that I am no fiscal expert. Comments?

Lets play, Name That Economist:

>> It's true that in 2016, according to (pessimistic) projections, benefit payments will start to exceed payroll tax receipts. By then, however, the Social Security system will have accumulated a multitrillion-dollar "trust fund." Just as a private pension fund uses earnings on its assets to pay benefits, the Social Security system can use earnings from this trust fund to pay benefits. And that trust fund will extend the life of the system for decades, perhaps indefinitely. <<

"The hypothesis is not refuted."

Let's call it the Friedman hypothesis: that deficits tend to decrease spending. That is, surpluses should be correlated with spending (deficits inversely correlated with spending).

I loaded the % of GDP data on 1962-2001 from the tables of section 8 into Excel, and ran some correlations. I deleted the TQ, because I'm too lazy to fix up the correlation numbers correctly.

First, between surpluses and the various categories.

Total -.89
Discretionary -.16
Defense -.08
Nondefense -.32
International -.03
Domestic -.33
Mandatory -.42

Defense looks about like what you'd expect: it doesn't respond at all. International spending is surprising; I think this is just because the number is so small. Everything else is *way* surprising: a negative correlation means that when deficits go up (surpluses go down), spending tends to go *up*. Or maybe it's the other way? Still, this is completely the opposite of the Friedman hypothesis.

Next, with a one year time lag:

Total -.76
Discretionary -.04
Defense 0.00 (!)
Nondefense -.16
International .11
Domestic -.19
Mandatory -.44

About the same, although the correlations are even worse for Friedman.

Next, the same analysis, comparing interest outlays to the spending categories.

Total .62
Discretionary -.68
Defense -.59
Nondefense -.42
International -.64
Domestic -.25
Mandatory .87

Total spending going up when interest payments go up makes sense. The rest of it is bizarre: why would interest payment exhibit a strong correlation with mandatory outlays, while everything else has a negative correlation? Why on earth does defense spending have a stronger negative correlation with interest outlays than domestic spending?

Same dealie, one year lag:

Total .51
Discretionary -.73
Defense -.62
Nondefense -.55
International -.69
Domestic -.40
Mandatory .85

About the same, and that pesky "defense spending responds more strongly to interest payments going up than domestic spending" thing is still there.

"Why the "progressives" of today don't even consider this possibility, and its policy implications for today, is beyond me. ISTM they can only defeat their own intentions by failing to do so."

Progressives don't talk about means-testing social security because they're terrified that it'd make it a "welfare program" like AFDC, with all of relevant political exposure to elimination by conservatives. They're probably not right; people would still have to work for it. They're hyper-cautious after getting absolutely destroyed on AFDC, though, rightly or wrongly.

Ah, good old Patrick, leaving out the following paragraphs where Paul discusses the trust fund, and its implicit funding sources, at length.

"But the commission declares that these accumulated assets aren't "real," and don't count as resources available to pay future benefits. Why? Because they are invested in government bonds ? perfectly good assets when they are accumulated by private pension funds but worthless, says the commission, when accumulated by a government agency.

Does this make any sense? There is a school of thought that says that Social Security shouldn't have a separate budget, that Social Security receipts should be regarded simply as part of general revenue, and outlays as part of general expenditure. But in that case it's hard to see why we should get worked up about 2016: who cares if the payroll tax, which is only one of many taxes, collects less money than the government spends on retirement benefits, which are only one of many government expenses? Social Security benefits can be paid out of the general budget ? a transfer of revenue that is clearly justified if payroll tax receipts have meanwhile been used to pay off the national debt, releasing large sums that would otherwise have been consumed by interest payments.

Alternatively, you could say that for political reasons it's important that Social Security have its own separate account. But in that case, we should count government bonds in the trust fund as real assets, just as we would if Social Security were a private pension fund. (Here's a proposal: let's launder the trust fund by putting it in private banks, which then buy government bonds. Will that make the assets "real"?)"

Whoops, looks like my conclusions on the Friedman thing got left off.

The Freidman hypothesis, that deficits restrain spending, specifically, non-mandatory non-defense spending, does not match the evidence.

A fallback hypothesis, that *interest payments* constrain spending, matches the evidence pretty well. There's the bizarre results with defense and mandatory spending, though.

Patrick, I await your furious spinning on how deficits are a useless measurement, and Friedman was wrong in details but right and spirit, and we should only use interest payments.

Oh, forgot to mention: since year-to-year changes in the annual deficit have little effect on the total deficit, interest payments are barely affected by short-run changes in the deficit. However, changes in the interest rate, which has nothing to do with the matter under discussion (deficits constraint spending), have extremely strong affects on interest payments. Since interest rates are mostly the result of inflation and long-run growth expectations, they probably aren't a good correlator.

Why does Jim Glass think it's appropriate to leave military spending out of his computations?: "So let's separate that out and look at growth in Congress's discretionary non-military spending."

Well, I think it's appropriate; military spending, theoretically, should be determined by the nation's level of defensive needs. Though I guess if you think discretionary spending isn't determined by what voters want (an implicit corollary to the Freidman theory), then logically defense spending shouldn't be either.....

Delete that "Or maybe it's the other way?" line I put in there; I meant to point out that maybe spending increases are increasing deficits, and spending cuts causing deficit cuts (as opposed to the other way around, and the opposite correlation, of the Freidman theory), but screwed up the phrasing.

>> Ah, good old Patrick, leaving out the following paragraphs where Paul discusses the trust fund, and its implicit funding sources, at length.... <<

Thoughtless Patrick also left out the paragraph where the same economist used the descriptive "Ponzi game" when discussing the same.

"In practice [Social Security] has turned out to be strongly redistributionist, but only because of its Ponzi game aspect, in which each generation takes more out than it put in. Well, the Ponzi game will soon be over, thanks to changing demographics, so that the typical recipient henceforth will get only about as much as he or she put in (and today's young may well get less than they put in)."
http://bostonreview.mit.edu/BR21.6/krugmann.html

Ponzi games always end poorly redistribution-wise for the last players in. And that comment in parens "today's young may well get less than they put in" says a lot about the future of this program. There's no "may" about it. The SSA's actuaries detail how wide groups of the working young will get negative returns from SS, while their overall return will be on the order of 1% - 2% -- and that's assuming somehow the 25% funding gap is closed with a magic wand without lowering the return still more.

Remember, SS gained its great political popularity due to its paying *high* returns to *everyone* (it's not hard to be popular that way!) in a world where there were no widespread private retirement programs. It's heading into a world where it will pay low returns -- negative to a great many -- and where everyone will have private retirement options available that pay more than SS does on the 12% of wages they have to put into it. It's not so hard to imagine what may happen to the political popularity of SS in that world.

See -- it's even *worse* than just having Dairy Queen workers finance Warren Buffett's Social Security. Today's young Dairy Queen workers must get a negative lifetime return from Social Security so that Warren Buffett will get a *high* return. When today's younger workers realize that in some numbers, about 15 years from now...

And the 25% funding gap only makes things worse. It can be closed easily enough either by (1) increasing payroll taxes or reducing benefits (delaying retirement age) -- but that obviously just reduces returns to the young still further, or (2) means testing, preserving current low scheduled returns for some but cutting others right out -- turning SS into a rich pay for poor welfare program. Nobody young then will ever know what the future means testing limit will be, so they won't be able to rely on SS, so they'll ask who needs it? Or one may expect the politicians try to avoid both these by (3) pouring general revenue into SS, but I'll bet my IRA that leads to means testing and benefits being cut -- as FDR warned 68 years ago when he rejected all general revenue for SS.

The irony is that the "progressives" trying to preserve SS from all change are pushing it into a cul de sac where only these three options exist, any one of which will kill SS "as we know it." They should be thinking about this now, 15 years in advance, while there's still time to save the basic structure of SS permanently with something like the Moynihan or Feldstein plans. I mean, if Sweden can add private savings to their SS to assure a positive return from it for all, how come Democrats can't? Sweden is too right-wing for them?

BTW isn't it odd to see the same economist call SS's financing both a "Ponzi game" and sound "for decades, perhaps indefinitely"? Figure that one out. ;-)

>> Why does Jim Glass think it's appropriate to leave military spending out of his computations? <<

Like Jason said, it's obviously determined by other things. And one can see its 60-year downward trend with the naked eyeball. Like Greenspan just said, it's now at its lowest level as a % of GDP since before WWII, which gets us back to the 1930s. So it's hardly among the leading contenders as a cause of perpetual deficits.

>>About the same, and that pesky "defense spending responds more strongly to interest payments going up than domestic spending" thing is still there.<<

Defense spending has been generally going down since WWII. Debt has been accumulating since WWII so interest cost has been generally rising.

Two different processes happening over the same time is all, I'd think. Correlation is not causation.

"BTW isn't it odd to see the same economist call SS's financing both a "Ponzi game" and sound "for decades, perhaps indefinitely"? Figure that one out. ;-)"

That's laid out pretty clearly by Krugman in the paragraph you quote. I am surprised you didn't get it since you seem like a sharp guy.

The Ponzi game aspect is the "taking out more than you put in" dimension of social security. That can end without social security collapsing, i.e. each generation gets what they put in, each generation gets less than what they put in etc. So the Ponzi game can end but social security can still be around for years afterwards, no inconsistency there.

I am curious though Jim, would you support a plan that abandons the payroll tax and funds a benefit-capped social security program out of a progressive income tax? You seem awfully concerned about how regressive the payroll tax is, I am curious about whether you think that the progressive income tax is the way to fund social scurity.

Jason--
I also had the thought about spending increases causing deficit increases, or at least being a contributing factor. Can we run a correlation between revenue increases/decreases and spending? That should provide a nice test for the hypothesis that, when you get less money in, you spend less.

"Can we run a correlation between revenue increases/decreases and spending? That should provide a nice test for the hypothesis that, when you get less money in, you spend less."

Countercyclical fiscal policy will pretty much foul up that test because occasionally the government may launch a spending increase right as or soon after the economy weakens revenues fall, screwing up the link.

"Do they really believe that we would be better off, were Social Security and Medicare undone?"

We'd unquestionably be better off if those programs had never been passed. 15% of one's income is a hell of a lot of money no matter how you slice it, and it's small consolation that you might get it back eventually, if you live long enough.

Unfortunately, there's a hell of a lot of people that have been forced to pay into this system for quite a number of years, and they would be rightfully pissed off if we turned around and told them they'd have nothing to show for it.

It appears that we're either going to (a) run a deficit on Social Security or (b) screw a bunch of people that were forced to pay large amounts of money into it for decades. But the magnitude of those deficits matter. If we start reducing FICA collections right now, then the level of future benefits that could reasonably be called fair would also decrease. A gradual increase in the retirement age seems most appropriate as a simple mechanism for allowing people whose lifetime payin was only reduced by a small amount (since they enjoyed lesser FICA for a shorter time) will get more total benefits than those whose lifetime payin was reduced by a larger amount.

Repeat as necessary until the whole thing is phased out.

Better yet, turn the pharmas loose, let them reap the profits they deserve, let them introduce new drugs and profit from them without playing years of Mother May I, and in general make sure they have every incentive and freedom to advance the medical state of the art. Eventually, they'll come up with a cure for aging, and retirement will be a moot point.

"They should be thinking about this now, 15 years in advance, while there's still time to save the basic structure of SS permanently with something like the Moynihan or Feldstein plans."

Screw saving the basic structure. What we need is a way to get rid of it without screwing the poor saps that were forced to pay large amounts of money into it for decades.

>>... as I find myself repeating, a lone voice in the wilderness, this problem disappears with a five year shift in the retirement age ...>Because the baby boomers have not yet started to retire in force and accordingly the ratio of retirees to workers is still relatively low, we are in the midst of a demographic lull. But short of an outsized acceleration of productivity to well beyond the average pace of the past seven years or a major expansion of immigration, the aging of the population now in train will end this state of relative budget tranquility in about a decade's time. It would be wise to address this significant pending adjustment sooner rather than later.>And if, in 2025, medical technology can make 65-year olds feel like 40-year olds, why couldn't they work another 10 years?>Ponzi games always end poorly redistribution-wise for the last players in.<<

Very relevant point this on Ponzi games Jim. What no-one seems to be picking up on at the moment is the problematic situation of that most important Ponzi process of all: the property values game. It's no secret that US and UK consumption is been currently driven by equity withdrawals from housing, and that indebtedness levels are only not skyrocketing because house and land prices are rising far more rapidly than either the CPI or income. It's also the case that the most important single financial asset most people have is their home. Now long term the present dynamic is not sustainable. So at some point we will see a structural break. In the best of cases the changing age structure will merely produce problems as more people try to trade down their asset (eg try to live in a smaller house and raise some capital) than want to trade up. However, countries like Germany, Spain, Italy, South Korea........ are facing an absolute decline in population, coupled with a dramatic increase in the over 75's. However you look at it, this means that they will, in principle, need less houses. Now unless there is something very basic I have failed to understand the increase in supply and the reduction in demand should produce....a fall in price. In fact in Japan propety and land prices seem to be stuck somewhere back in the 1983/84 zone, and bank lending is falling as people become unwilling to get into debt for an asset of uncertain value.

So, I'm afraid the 'fix' will have to be something a lot bigger than an extra five years down at mill!

Something seems to have gone wrong with my last post so I posting again.

>>... as I find myself repeating, a lone voice in the wilderness, this problem disappears with a five year shift in the retirement age ...>Because the baby boomers have not yet started to retire in force and accordingly the ratio of retirees to workers is still relatively low, we are in the midst of a demographic lull. But short of an outsized acceleration of productivity to well beyond the average pace of the past seven years or a major expansion of immigration, the aging of the population now in train will end this state of relative budget tranquility in about a decade's time. It would be wise to address this significant pending adjustment sooner rather than later.<<

Couldn't put it better myself, and he's even caught on to the fact that immigration is going to be important. Of course raising the retirement age will help, but not by only a meagre five years. As I've pointed out before on this one, it's not uncommon for people in Japan to work to 75 (in fact they have about the same 'participation' rate at 75 as we Europeans have at 60) and they continue to be bogged down by deflation.

Two key points here: the realisable value stream for all those 70 year olds in a globalised labour market with rapidissimo technical change could be very low indeed (this could be worsened by reduced income from savings if the combined impact of aging and deflationary expectations generates a large, excess savings supply and hence low interest rates long term: the yield curve in Japan is currently flattening out over 30 years). Secondly, the impact on consumption patterns. The last 50 years have seen consumption driven by an ever younger age range as expections of strongly rising future incomes has encouraged people to bring forward consumption by borrowing. This pattern may well not survive the demographic regime change.

Now for the second part of the post!!

>>And if, in 2025, medical technology can make 65-year olds feel like 40-year olds, why couldn't they work another 10 years?>Ponzi games always end poorly redistribution-wise for the last players in.<<

Very relevant point this on Ponzi games Jim. What no-one seems to be picking up on at the moment is the problematic situation of that most important Ponzi process of all: the property values game. It's no secret that US and UK consumption is been currently driven by equity withdrawals from housing, and that indebtedness levels are only not skyrocketing because house and land prices are rising far more rapidly than either the CPI or income. It's also the case that the most important single financial asset most people have is their home. Now long term the present dynamic is not sustainable. So at some point we will see a structural break. In the best of cases the changing age structure will merely produce problems as more people try to trade down their asset (eg try to live in a smaller house and raise some capital) than want to trade up. However, countries like Germany, Spain, Italy, South Korea........ are facing an absolute decline in population, coupled with a dramatic increase in the over 75's. However you look at it, this means that they will, in principle, need less houses. Now unless there is something very basic I have failed to understand the increase in supply and the reduction in demand should produce....a fall in price. In fact in Japan propety and land prices seem to be stuck somewhere back in the 1983/84 zone, and bank lending is falling as people become unwilling to get into debt for an asset of uncertain value.

So, I'm afraid the 'fix' will have to be something a lot bigger than an extra five years down at mill!

It happened again goddam it!! (this must seem like a plug for James Gleick's 'What Just Happened).

Here's the botched part about medical technology (I hope it's a case of third time lucky).

>>And if, in 2025, medical technology can make 65-year olds feel like 40-year olds, why couldn't they work another 10 years?<<

This is all to the good, but it's forgetting the knock-on effect of all those extra years (after 75) such a medical pipedream would give you, you would need even more pension income for the added years later on. In this sense it's better to start from what we already know, if you are going to be 65 in 2025 you will still be working ten more years, even if your body doesn't feel any younger.

"Well, I think it's appropriate; military spending, theoretically, should be determined by the nation's level of defensive needs."

"Like Jason said, it's obviously determined by other things. And one can see its 60-year downward trend with the naked eyeball. Like Greenspan just said, it's now at its lowest level as a % of GDP since before WWII, which gets us back to the 1930s. So it's hardly among the leading contenders as a cause of perpetual deficits."

1. Military spending is a rather large fraction of all discretionary spending.
2. During the Reagan years, military spending increased at a faster pace than non-military discretionary spending. Ditto today. And deficits rose both then and now.
3. There's no reason that military spending should be a constant fraction of GDP. Yes, I know---we must pay soldiers, and the labor costs will be related to overall GDP. But for the nation's defense, more relevant variables are the amounts spent by other nations on their militaries. Why don't you compare *those* numbers between now and the 1930s?
4. You're assuming that the decision-making process for determining the level of military spending is somehow special, different from the process governing that of other discretionary spending, more insulated from political considerations, and so forth. That's peculiar. Care to share the reasoning behind that assumption?

Yeah, I don't actually think defense spending correlates with with deficits at all. Why would Friedman, however?

Jim, just because Social Security now gives a shitty return doesn't mean it can't go in a financially sound manner forever with little or changes. I've also got to wonder where the drop in the rate of return is coming from, as I blather on about here:

http://zebco.blogspot.com/2002_08_11_zebco_archive.html#80298411

and here:

http://zebco.blogspot.com/2002_08_18_zebco_archive.html#80495916

"I also had the thought about spending increases causing deficit increases, or at least being a contributing factor. Can we run a correlation between revenue increases/decreases and spending? That should provide a nice test for the hypothesis that, when you get less money in, you spend less."

Correlation between total revenue & the BEA categories:

Total -0.2
Discretionary -0.5
Defense -0.5
Nondefense -0.2
International -0.5
Domestic -0.1
Mandatory 0.3

It's consistent with the deficit numbers: decreases in revenue are correlated with increased spending. Hilariously, domestic spending is pretty much completely independent of revenue.

I tried re-running everything compared to just the on-budget deficit and on-budget revenue, but it didn't change significantly change anything.

All I can think of is that business cycle shifts drown out any noticable effect of deficits/revenue on spending; maybe someone wants to try the same analysis, except somehow adjust for the business cycle? I haven't the faintest idea how to do it.

It might be a good idea, because if deficits don't actually cut spending, which the data so far seems to show, then you're wrecking the government's finances for no good reason.

If anyone wants a go at the excel worksheet, it's located here:

http://www.hronk.com/Budget_Correlations.xls

Brad, whats up with the comment software stripping all urls?

As I claimed above, a good chunk of discretionary spending is military: the Center for Defense Information puts it at 51%:
"The Fiscal Year 2004 budget request includes $782 billion for discretionary spending (the money the President and Congress must decide and act to spend each year), $399 billion of which will go to the Pentagon. The 'National Defense' category of the federal budget for FY04 accounts for over half (51.0 percent) of all discretionary spending."

Some data I Google'd up regarding how our military spending compared to potential enemies a long time ago: (from http://www.rand.org/publications/MR/MR1112/MR1112.ch3.pdf)

"As Figure 3.2 illustrates, French, Russian, and U.S. real military expenditures peaked during World War I, while German and Japanese military expenditures reached their height during the buildup to World War II. *By 1939, Germany was spending more than twice as much on defense as the next biggest spender, Russia, while Japan had overtaken both France and the United States for third place.* As shown in Figure 3.3, on average, the French and Japanese devoted considerably more of their national output to a strong national defense than either Germany or the United States.4 For example, during the Russo-Japanese War of 1904–1905, almost 25 percent of Japanese output was invested in the military. *In 1938, Japanese military expenditures as a share of output topped 25 percent. In the United States, by way of contrast, less than 15 percent of output was devoted to defense even at the height of U.S. involvement in World War I.* And by 1929, U.S. military expenditures had fallen back to just 1.5 percent of output." [Emphasis added]

So far I gather the following ways a deficit might reduce spending:
1. Increased debt servicing substitutes for discretionary spending. Part of Jason's hypothesis
2. Government reduces spending because of general dislike of deficits and desire not to raise extra taxes. The Gordon Brown approach in theory.
3. Government reduces spending because of specific dislike of very large deficits and desire not to raise taxes. A possible mechanism for Jim's empirical claim. Is it also implicit in "dynamic scoring"?
4. Government reduces spending becuase it is nearly bankrupt and has no choice as a result of possible demographic timebomb explosion, war debts or extemely large deficit or rising interest rates. Roughly the "it's all a cunning plan" interpretation.

Only the last does not require the budget setter to care about the deficit more than spending plans. It seems the current government does not and to assume that spending will fall later assumes that they don't really mean it at the moment.

>but it's forgetting the knock-on effect of all those extra years

That's a fair cop, all I can say is from my observations is that I expect this technology to lead to a telescoping of the time between pumping iron and pumping daisies. That is, a given problem will result in either near-complete repair (and back to the mill with you!!) or much whispering about "making Pops comfortable" in his last days. YMMV. Certainly the days of people limping around for decades in arthritic agony will be gone.

Re another post: As far as unfairness to "the young".. by the very virtue of being born later they have received an awesome treasure, paid for by their elders, of continually extended life expectancy. So claiming that they are seeing reduced benefits by having to work longer is only plausible if everything to you is measurable by the almighty dollar, a position that will never fly with me.

SS/Med... - hell any retirement & health scheme for the majority the population- was never and could never be intended for people to spend 1/3 of their adult life drawing from it. This was the only subject that I have been lucky enough-to my complete disbelief- to see Rick Santorum make sense about.

The figure of five years refers only to France in the strictest sense and comes from "La Comedie des Fonds" by Jacques Nikonoff. Note that Japan has, famously, less immigration than the EU and thus a rather different demographic.

I am not sure what the hell Edward is going on about with the following paragraph:

>>It's no secret that US and UK consumption is been currently driven by equity withdrawals from housing, and that indebtedness levels are only not skyrocketing because house and land prices are rising far more rapidly than either the CPI or income. It's also the case that the most important single financial asset most people have is their home. <<

*ahem*

Houses aren't financial assets. They're tangible assets.
Indebtedness levels are not affected by land prices in general. *Net* indebtedness levels, net of housing wealth are, but these are not generally available series in the UK or US.
House prices are in general driven by affordability, which is mainly a function of interest rates (you can finance a much larger mortgage at 3.75% base than at 12% base). It is really quite difficult to make a rigorous argument to the effect that UK and US housing is a bubble.
House price booms do not have to end with busts if they are supported by genuine (rather than credit-driven or speculative) demand; Ireland has just had one deflate in an orderly fashion.
It is not a "well-known fact" that consumption has been driven by "equity withdrawal" from housing in the UK or US. There has been substantial equity withdrawal in the UK, but not enough to explain the growth in consumption. The effect on consumption is more easily explained by the cash-flow savings made by remortgaging a constant principal amount at lower interest rates; this is not a withdrawal of equity.

Replying to: "A political uproar over deficits and the resultant need to constrain spending can happend outside of any real economic impact of the deficit."

This is nothing compared to the political uproar that would result from the public figuring out that they're talking about cutting Social Security or Medicare or ANYTHING ELSE IN THE BUDGET. The public largely believes that the government spends its money somewhere else - somewhere that they don't really understand but doesn't affect THEM. This is why Republicans never actually explain WHAT spending cuts they are talking about!

The public won't stand for actual spending cuts of the size required to balance the budget. They will call for a return to a top rate of 90% AND a wealth tax before they will accept cuts in anything that affects THEM.

-" There's no reason that military spending should be a constant fraction of GDP "-

And it's not, it's been a declining fraction of GDP for 55 years.

Defense spending as % of US budget and GDP

1940: 18%, 2%
1945: 90%, 38%
1955: 62%, 11%
1965: 43%, 7%
1975: 26%, 6%
1985: 26%, 6%
1995: 18%, 4%
2001: 17%, 3%

With defense spending having fallen steadily to a percent of the budget now below what it was in isolationist, pre-WW2 USA, it really doesn't look like that's what is driving the deficit picture. The other, growing part of the budget seems to have rather more to do with it.

-"You're assuming that the decision-making process for determining the level of military spending is somehow special, different from the process governing that of other discretionary spending ... That's peculiar. Care to share the reasoning behind that assumption"-

Hmm ... What made military spending go from 2% of GDP in 1940 to 38% in 1945? The same processes that direct domestic discretionary spending? That's would be peculiar.

Moreover, being that as a % of GDP the military budget has fallen by more than 70% since 1955, while the nonmilitary budget is up to 240% of what it was then, it seems rather *self-evident* that different processes are driving their spending levels. Being that those spending levels have moved in opposite directions for half a century and all.

-"But for the nation's defense, more relevant variables are the amounts spent by other nations on their militaries. Why don't you compare *those* numbers between now and the 1930s?"-

If we were discussing the optimum level of military spending that might make sense -- but we're not. We're discussing the effects of deficits/surpluses on total spending. And with military spending declining steadily for 55 years come both deficits and surpluses, while the rest of the budget has increased steadily, that answers that as far as the military's part of the budget is concerned. It is anomalous.

-"I Google'd up regarding how our military spending compared to potential enemies a long time ago"-

Looks like an interesting link, thanks, though it kept timing out on me. (And I don't really see what comparing Japanese spending during the Russo-Japanese war of 1905 to US spending during the 1930s shows about anything at all.)

Remember though, you also have to consider how much your friends whom you must look out for spend on their militaries. E.g., when the Germans and French decide to bypass the UN to militarily impose regime change in Serbia, whose military do they call on? And would Asia really have been a safer, calmer place for the last 50 years if the Japanese had rearmed after WWII to be able to defend themselves, instead of having the US pull that duty all that time? Well, that's for another thread...

when the Germans and French decide to bypass the UN to militarily impose regime change in Serbia

Working on those talking points, I see. :D

"It is really quite difficult to make a rigorous argument to the effect that UK and US housing is a bubble."

Difficult it may be, but some good economists seem able to make it. Can I refer you to a recent speech by Mervyn King related to this topic and the associated one of debt deflation.

http://www.bankofengland.co.uk/speeches/speech181.pdf

In the UK and Spain the connection between the collapse of the stock market bubble (I presume you do accept that this was a bubble) and the subsequent circa 20% per annum rise in house values is surely more than a strange coincidence. In the US a rigorous case is certainly harder to establish, but I feel honoured to be in the company of people like Stephen Roach and Paul Krugman in my speculation here.

More than likely we'll be able to do a reality check on this within the next 18-24 months, so watch this space.

Meantime, can I recommend a classic of its kind: Homer Hoyt's 'One Hundred Years of Land Values in Chicago'. Failing that Kindelberger's 'Manias Panics and Crashes' is a good place to start.

"House prices are in general driven by affordability"

Affordability and demand. This is where the demographics come in, since with a population pyramid there is constant demand pressure from below. (In fact I'd go so far as to assert that the whole 70's/90's inflation thing was related to this, but I can't establish that 'rigourously' yet). Now the structure has changed and the relative value of real estate assets (I'm not going to get caught up in the debate about what asset class they belong to) is set to change as a consquence.

The point about Japan is fine, they don't have immigration period. But be careful about generalising from the French case, since demographically France and the UK are much better positioned than most EU countries due to substantial immigration over many years.

E Hugh: very interesting comments. When you write: "(In fact I'd go so far as to assert that the whole 70's/90's inflation thing was related to this, but I can't establish that 'rigourously' yet)." Are you referring to housing inflation or inflation as a whole?

"Are you referring to housing inflation or inflation as a whole?"

Inflation as a whole, the whole upward push has got something to do with the demography, but I'm not ready to go on record on this yet. At the moment I'd simply say it's a strong intuition. Of course I'm not being reductionist here, there are clearly other factors at work, but the demographic one has been largely ignored previously. You have to look at how the various cohort sizes move through the respective age groups.

On the US property question, I found this quote from Stephen Roach onsite here with Brad:

"The evidence in support of a housing bubble is compelling. The 27 percent increase in inflation-adjusted American house prices since 1997 represents the sharpest five-year increase since 1945. This surge is about three times the increase in real housing rents over this period. (The divergence of home prices and rents, which usually move in tandem, is one measure of the speculative element of the housing market.) As their property values rise, hard-pressed consumers have been quick to extract purchasing power from their homes, taking advantage of low interest rates to refinance their property and use the savings to buy cars, furniture, appliances and other luxury goods. Thus the ever-expanding property bubble has become central to the culture of excess that is now driving the United States economy."
http://www.j-bradford-delong.net/movable_type/archives/000901.html

At the time - Sept 2002 - Brad said he was less worried than Roach, but that he was moving in his direction. I wonder where he is at right now?

"Remember though, you also have to consider how much your friends whom you must look out for spend on their militaries."

Oh, U.S. taxpayers "must" look out for their "friends," "must" they? :-/

"I can not undertake to lay my finger on that portion of the Constitution that authorizes the U.S. Congress to spend taxpayers money defending people in other countries."---->Mark Bahner, echoing James Madison. ;-)

For every action there is an equal and opposite government program.