The Braine Trust

While the current jobs and economic agenda of the Administration remains largely focused on income inequality (e.g. minimum wage hikes, extension of unemployment benefits, further tax hikes on the “wealthy few”), a far bigger issue is largely being neglected-increasing the number of better paying jobs in the US. To be sure, there has been some progress on the overall job front associated with a lower unemployment rate and a decent new job number in February, the progress has been painstakingly slow and often illusory. Consider that the most important job statistic – the employment participation rate – recently fell to its lowest level in almost 35 years. After reaching peak levels of about 67% during 1998-2001, the labor force participation rate stabilized at above 66% between 2002-2008. However, since November 2008, the participation rate has hit the skids starting with the recession and continuing thru the recovery. As of October 2013 , labor force participation rate has hit a new low of 62.8% -the lowest level it has been since February 1978 and it has only rebounded slightly since then.

On top of this, many of the new jobs being added are in the lower-paying retail, accommodation and food services industries (about a third of the 2.2 million new jobs in 2013) and some of these aren’t even full-time jobs. In contrast, only 3.5% of all jobs added in 2013, were in the higher paying manufacturing industry. The overall median income picture reflects this problem as near zero growth in real (inflation adjusted) terms during the 2000-2008 has been replaced with outright declines during 2008-2013 such that median US income is now 8.7% lower in real terms in 2000.

The focus during the Obama years and also to some degree in the years prior to 2009, has been to use government subsidies and stimulus spending as the primary tool to increase job/economic growth in the US. This approach has had only mixed success and only temporary success at that. Subsidies of activities that are NOT economic today such as electric cars or solar power  inevitably lead to a lot of wasted dollars (e.g. Solyndra, Amonix and other companies that went belly up, never created jobs and never will pay back their subsidized loans, tax credits or outright grants) and only a few successes. Stimulus spending designed to increase near term demand and hence near term jobs is usually only temporary. Consider the “cash for clunkers” program which encouraged a number of new car sales in the near term (as customers flocked to dealers to get the government-funded $$$ credits for turning in their older vehicles) but not surprisingly hurt longer term sales because most were simply moving up the date in which they would buy a new car. Most importantly, by financing these and other increases in government spending during 2009-2013 with massive increases in federal debt, there will be a longer term price to pay. This includes increases in interest rates (which will likely soar in the next few years once the fed runs out of monetary firepower) and high inflation. These will hurt private capital spending and hence long-term economic and job growth.

This is NOT to say that ALL government stimulus spending is a bad idea or that near term economic/ job benefits aren’t important. Most economists would agree for example that some infrastructure spending which has traditionally been funded by the government (e.g. road repair and new roads and bridges where they are needed) can increase the efficiency of the economy and provide some needed near term construction jobs. The funding of basic research by the government is also important given the “public goods” problem that makes companies reluctant to fund research, other than applied research. However, the $800 billion+ (per year) stimulus package of 2009 that was rammed thru a then largely panicked Congress contained little of what I would call “efficient” stimulus spending. The result so far has been predictable, and we havent even felt the long-term consequences from our massive debt buildup and accompanying money printing yet!

So if not stimulus, what can be done to fix this problem? The answer is surprisingly simple. Though per usual, politically,  it may be very difficult to achieve even a few of these suggestions. Nonetheless, since I apparently love banging my head against the wall, let me give you my list of 5 major suggestions.

(1) Eviscerate the Current Federal Tax Code and replace it with the Fair Tax–I have blogged about this several times. I refer you to my blog on May 12, 2012 entitled “Should 5% appear to small….” and FairTax.org for more detailed information. The reasons for replacing our currently horrendous tax code with a simple and far more efficient consumption tax are many. However, when it comes to economic and job growth much of what I said almost 2 years ago still applies today:

“By eliminating the large amount of unproductive activity associated the current tax code, resources are freed up to produce more goods and services more efficiently across the economy. In addition, the elimination of subsidies and penalties in the current tax code, will help eliminate inefficient overinvestment (e.g. Real Estate!!!), eliminate overconsumption which is also inefficient, and encourage savings and investment which are badly needed in our debt-laden economy.  Net retail price increases in the first year of the tax should be relatively small because the 23% tax on prices will be mostly offset by the elimination in corporate and other business taxes (which are estimated by economists to account for about 20%+ of  retail prices today). The US will become the mecca for foreign investment and US companies will no longer produce as much offshore given the elimination of these embedded taxes on exports, and foreign imports will finally face the same effective tax burden as domestic production. This will mean many more jobs in the US and better paying jobs as well.”

I won’t belabor the economic analysis on the FairTax site or for that matter countless studies of how major tax reform is a huge plus for the economy. Suffice to say that tax substitution with the FairTax or something like it, is the single most important economic growth and job growth action that we can take as a nation. We are talking millions of new good paying jobs and trillions$ in economic benefits.

(2) Eliminate Unneccessary and Duplicative Regulation of Business and Commerce – To be sure, “some” regulation is very important. It helps ensure that new plant and equipment is being added and operated safely and with minimal environmental impact. It helps ensure that financial and tax reporting is fair and legitimate, and that market activities are transparent with broad market price discovery. However, the problem arises when we have regulation that becomes unnecessarily burdensome or duplicative. Examples of this abound ranging from the extraordinarily complex and burdensome requirements of Sarbanes-Oxley (enacted in reaction to Enron and WorldCom scandals of 2000-01) and of Dodd-Frank (enacted in reaction to the meltdown of the housing market and the banking industry in 2008). Building a power plant, a pipeline, a transmission line,  a factory or a new retail property or building can involve filing for and obtaining scores of permits (from federal, state and local authorities) , completing in most cases an Environmental Impact Study(EIS) and often lots of legal work to ensure compliance with all applicable regulations. In the environmental arena, some rules require costly additional equipment often for very small (and in some cases arguably zero) environmental benefits. All of this activity requires capital investment, and costs time and money, often lots of it, and means that costs and hence prices of products are higher. This hurts economic growth and translates into less new jobs.

Again, some regulation is necessary, but anyone who has experience dealing with the multitude of requirements and regulations from all levels of government (count me in this category) knows that we have gone WAY OVERBOARD when it comes to regulation in the US.

(3) Turn Public K-12 Education into a More Competitive Market– I often, not so jokingly, say when teaching classes on US electricity that Electricity Distribution is largely “19th Century Technology in a 21st Century World”.  Similarly, one might look at our current primary and secondary public school education system in the US and conclude that while a number developed nations have moved to better and more efficient  educational systems, we have remained as if nothing has changed in a century. Our math and science testing scores versus other countries are abysmal. We remain near the bottom of the list of developed countries based on tests of 12th graders in both Math and Science, behind even Russia! (For more info, google Pascal D. Forgione, Jr., Ph.D. U.S. Commissioner of Education Statistics who gave an excellent recent report on this). This is very problematic of course for the long-term US job markets, because the share of unskilled jobs continues to shrink, while the number of jobs that requires these same math, science (and reading) skills and at least a college education continues to grow.

Some would argue that this is because we don’t spend enough on public education, but the facts speak otherwise. In the US, we are now spending more per student on education than any other nation in the world. According to a 2013 OECD report which covered more than 40 developed countries, the United States spent $15,171 on each young person in the system — more than any other nation covered in the report. And it isn’t as if we havent tried to improve our educational performance by increasing our spending over time. Over the past 30 years, federal/state and local government education spending has grown at much faster than the rate of inflation with little improvement to show for it.  So clearly it is not a matter of  how much we spend but HOW we spend it.

The one area where we have had some success (though the experiment has been very limited by the dominance and resistance of the teacher’s unions) is thru charter and other school choice options for parents. Simply expanding these choices would represent a step in the right direction. However, a much more attractive option would be to move US K-12 education to market competition thru a voucher system. Parents would be given annual vouchers for school age kids equal to our current spending levels per student and then would be allowed to choose their school. Over time, this system would result in schools competing to get the best teachers, principals, facilities etc. Poor performing schools would have to improve or they would eventually go “out of business” while schools that perform well would grow further and likely add more teachers and facilities. Other countries have had a generally good experience with vouchers/ school choice systems such as Denmark, Sweden and the Netherlands.

I realize that not all of our educational problems will be solved by competition, but right now inner city schools are not doing their job with only rare exceptions. Shouldn’t parents of school age who are poor and live in the inner cities have access to better education for their kids? Of course, they should, but it will only happen sporadically and for precious few under our current system.

4. Immigration Reform – Many economists agree that a more open and reformed immigration policy would be a big boon to US economic growth. An analysis of  S. 744 (the immigration reform bill that passed the Senate) by the Bipartisan Policy Center shows significant increases in jobs (7 million more jobs by 2033) and economic growth. There are many important features of immigration reform when it comes to the labor markets, but two are most notable. First, there is an increase in legal immigrants and a reduction in illegal immigration (which has historically depressed wages for unskilled or less skilled workers). Second, reform gets rid of limits on professional/highly educated workers immigration (most of which are trained at US universities) which helps create more jobs. Most educated workers end up as professionals or entrepreneurs, often creating several jobs for Americans thru the businesses they create and/or the extra consumption they bring to the US.

To be sure, immigration reform is complicated and unfortunately very political. There would need to be compromises in how long and what would be required for current illegal immigrants to become citizens, and the degree to which we would protect our borders. Not surprisingly, those along our Southern borders with Mexico are most alarmed by immigration reform because they have seen a spike in crime related to the drug cartels.  I believe we should be able to work out these differences and more adequately secure our borders in future legislation. Clearly, there is a lot of upside for the US economy in doing so.

5. Increase Free Trade Agreements- In general, the evidence is strong that freer trade is a plus for the US economy and jobs. This will particularly true if free trade agreements are coupled with the Fair Tax  that levels the tax playing field and thereby encourages exports and discourages imports. The US currently has free trade agreements with 20 nations, mostly with countries in the Americas (i.e. Canada, Mexico, Chile, Colombia, Costa Rica, Dominican Republic. El Salvador, Guatemala, Honduras, Nicaragua, Panama, Peru) but only a few with developed economies (I.e. Australia, Israel, Korea and Singapore). Notably, the US has NO free trade agreements with Europe and most of Asia. Two significant trade partnerships are currently being worked on which is very encouraging. One is the Transatlantic Trade and Investment Partnership, between the US and EU with the first round of negotiations to take place in July. The other is the Trans-Pacific partnership which includes many of the nations that the US already has bilateral agreements with plus Japan, New Zealand, Malaysia and Vietnam. These negotiations are fairly far along as announced this past December.

The evidence regarding the advantages of free trade for the US economy and jobs is fairly compelling based on the well documented economic theory of comparative advantage . This allows the US to expand production in industries that it is a low-cost producer or better producer of good and services. And in so doing often lowers its costs and efficiency in producing these goods. Conversely, it allows companies to benefit from low cost imports which help increase US net disposable and lowers the cost of doing business. On a net basis, free trade has created more jobs in the US than have been lost. The bigger (and again more political) issue is that for certain industries (e.g. manufacturing and heavy industry) jobs have been lost and often these have been in unionized sectors (e.g. Steel making) where pay is higher. This is why it is important that further expansion of free trade agreements be accompanied by the Fair Tax reform which will give the US even greater competitive and comparative advantages in trade.

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There are other structural changes to the US economy that can help improve long-term jobs. In addition to education, we can look to make our health system MORE competitive which has helped lower prices and improve output and jobs in virtually every industry that deregulated over the past 30-40 years. This includes telecommunications, trucking, railroads, wholesale electric power, and natural gas production and pipelines among others (many of which I have studied in-depth during my career).

Will my top 5 suggestions ever happen? Hopefully, someday, though never in the current divided Congress. For now, I just hope that more and more people get a chance to work and have a good job and be “taking care of business and working overtime”!

With the State of the Union speech coming up on Monday and Martin Luther King’s birthday just past, I thought I would  “dream” a bit and imagine that President Obama would have his “Nixon goes to China” Presidential moment on Monday night:
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Good evening, member of Congress and the American people. I am going to give a very different State of the Union speech this year. Unlike most Presidential addresses, it will be completely non-political. I won’t talk much about the successes of this Administration or  Congress or our past individual or collective failures. Further, I won’t be talking about many policy areas such as foreign policy, immigration, energy, infrastructure to name a few, which though important won’t be the focus of this speech. Instead, I want to talk about what we need to do as a country that will be the best for the long run economic and financial health of the United States and all of its citizens. I and many others believe that the U.S. is at a financial precipice and if we don’t act soon, we risk an economic depression that may rival the 1930s in length and intensity and will harm our way of life for decades to come.

First, we need to understand that federal government spending, our annual deficits and our national debt  are still completely out of control. For the past three decades, we have continued to spend far more than we have collected in taxes and government revenues and this problem has been exacerbated since the economic recession of 2008. Although we have made a little progress in the past couple of years with the sequester and the recent budget deal for 2014, our government is still scheduled to spend $3.8 trillion in fiscal year 2014 which is  40% more than in fiscal year 2007  and more than twice what we spent ten years ago. And while we have made some progress on the deficit reducing it to $0.7 trillion in the most recent fiscal year from average levels  of $1.3 trillion per year (during fiscal years 2009-2012), even this level of deficit is still higher than it is EVER been prior to fiscal year 2008. As a result, our national debt totals more than $17 trillion almost twice what it was just 6 years ago, and more than 16 times higher than what it was in 1980. And as bad as our financial record has been historically and as economically dangerous as our debt levels are today, these are only expected to grow far worse as Social Security and Medicare and other mandatory spending as well as interest we must pay on our debt is expected to grow very rapidly in the future.

Second, our Federal Reserve Board has been engaging in an unprecedented monetary policy designed to accommodate our high deficit debt levels by printing large number of dollars and using them to buy back our debt. This has been done to keep interest rates very low in order to help the overall economy grow and recover from the 2008-09 economic recession. Further, the $8 trillion dollars of additional borrowing that we have done in just the past  5 years has made it increasingly difficult to sell our debt to our citizens and others around the world. As a consequence since 2009, we have more than QUADRUPLED the amount of US dollars in circulation from $0.8 trillion to more than $3.6 trillion today. But this massive amount of money printing does have major long-term costs , which will come in the form of very high inflation with very negative consequence for the US economy and the relative strength of the US dollar around the world. Though the Fed has recently reduced the rate of money creation and is expected to taper the rate of money supply growth in the future, we are still printing at an annual rate of $0.8-0.9 trillion per year which is dangerously high.

Third, we have a miserably complex and inefficient tax code which is costing the US economy trillions of dollars per year. Because of its complexity, an estimated $0.4 Trillion PER YEAR is spent on individual and corporate tax compliance or some 2-3% per year of the TOTAL US economy. This money is simply wasted as it doesn’t produce anything of long-term value for the US economy and consumers. Also, because of the complexity, our tax code is difficult to enforce resulting in a large underground economy of untaxed income which wastes $100s of billions in potential tax revenues. Finally and most importantly, the current tax code gives consumers and businesses incentives to borrow, consume beyond their means , AND at the same time provides DISINCENTIVES to save or invest. Our countries savings rate is among the lowest in the world, and even several years after the recovery our corporate investment levels are still very low. As all economists know, savings and investment are the key to long-term productivity and economic growth. This seriously compromises our long-term economic growth for decades to come.

The state of our US economic health and the federal government’s role in that health is NOT a matter of debate. We have borrowed way to much; we live well beyond our means; our dollar is increasingly at risk as  a valued currency and our tax system is extremely wasteful and compromises our long-term economic growth. The long-term consequences of all of these realities are not a matter of debate. We face serious economic problems in the future if we don’t change our ways including a dollar that will no longer be the world’s reserve currency, very high inflation and a long-lasting serious depression. I am very concerned for the future of my children. Unlike our parents who saved and invested in America, we are literally consuming and borrowing against our children’s future.

However, the good news is that there are solutions to our problems and it is NOT too late to try to implement them. But action is needed now and NOT later. Accordingly, I am proposing five specific policies which will go a long way to solving our problems and can and should be implemented beginning in 2014:

First, beginning with FY 2015, I am proposing a 5% per year cut in federal government spending for the next five fiscal years across all agencies in the Federal Government. The only exceptions to these cuts will be “mandatory” expenditures for Social Security, Medicaid, Medicare, food stamps, unemployment and disability insurance. As part of these cuts, I will immediately institute a freeze on all government salaries (except for non-officer enlisted military) and a freeze on hiring of any new government employees except where specific approval is authorized by Congress. In order to make achieving the cuts easier and more efficient, actions that privatize various departments, agencies, bureaus or divisions of the government or the use of user fees will be counted towards the achieving the budget targets.

Second, in order to curb growth in government pensions and Social Security, I am proposing instituting a CPI-1% inflation adjustment so that benefits will grow more slowly. Further, I will be raising the retirement age for full benefits in several steps to 70 years by 2020 and 72 years by 2025 and for partial benefits to 65 years of age from the current 62 years. Finally, I will fully fund the system thru the new tax system I will describing below.

Third, in order to help fund Medicare and control costs. I will propose a series of changes to the system to move it to greater long-term solvency. On the revenue side , I  am proposing a tax on all forms of sugar in all food  and drink products (and an elimination of all federal sugar subsidies) to help discourage the overconsumption of sugar and to help fund Medicare/Medicaid. Medical experts overwhelmingly agree that there is a close correlation between sugar consumption, high blood sugar, obesity, diabetes and other dangerous  health conditions.  A relatively small 1 cent per gram tax would raise approximately $80 billion per year. On the cost side,we need to make sure that Medicare is tiered so that basic coverage (akin to the “Bronze” plan in Obama Care) is available to all at no charge but that greater levels of benefits and coverages are only available thru additional payments by individuals. This not only would help reduce the net outlays of Medicare, but might help better police some of the fraud that Medicare has been subject to, because now individuals who are paying for higher levels of optional care are presumably incentivized to make sure they are getting what they pay for.

Fourth, I will be proposing a completely new tax system to replace our unfair and inefficient tax code. This new tax system would eliminate ALL current federal taxes in the US such as the social security payroll tax, the Medicare Tax, the federal income tax, the capital gains tax and estate tax. Replacing this will be the Fair Tax system. (See fairtax.org). This is the same as a single National Sales Tax rate on all goods and services in the US economy. It would be “revenue neutral” or in other words, would raise the same amount of revenues as the current tax system. In order to make sure this system is fair and progressive, it will include a tax “prebate” on all taxes paid up to the poverty level which means the working poor or unemployed will pay ZERO net federal taxes. This is in stark contrast to today where all workers pay federal payroll taxes and even working poor pay some federal income taxes.

The advantages of such a consumption tax based system are clear. We will be encouraging much-needed savings and investment, discouraging excessive borrowing, no longer subsidizing some industries, corporations and consumers at the expense of the country as a whole. We will also be leveling the playing field so that foreign companies will have the same tax burdens as US companies. Further, our tax code by its simplicity will no longer have special exemptions and deductions and will no longer require scores of wasted resources on tax accountants, tax lawyers or tax lobbyists. In fact, our tax code will be so simple that no tax forms will need to be filed, and there will be no withholding. Also, the IRS as we know it today will no longer be needed and can be substantially scaled back. Economists who have studied this system universally agree that such a system will increase economic growth, improve real wages and thereby increase tax revenues. In other words, it is tax reform that is good for virtually everyone in the US economy and will play a critical role in fixing our serious financial problems. We will phase the new system in over the next five years in order to give our citizens and companies time to adjust. 

Fifth, I will immediately instruct Congress to make it illegal for the Federal Reserve Bank to print any more dollars (through purchases of our treasury debt) beginning in 2015 and for three years thereafter. Further, I will be proposing a move back to a gold standard for the United States. This system will allow us to back our dollar with confidence and give confidence to our international trading partners in the full faith and credit of the United States.

These five broad steps will constitute broad legislation “The Federal Economic And Financial Reform Act of 2014” which I will ask Congress to pass in the next 90 days. I believe that this legislation is for the good of ALL Americans and as such should be non-controversial. This legislation should be simple and easy to understand and contains NO additional riders or exemptions or other special clauses. I will have the White House provide a first draft of this legislation for Congressional consideration in 2 weeks time.

I realize that some of these changes will be viewed as abrupt and even controversial by some. Further, there will likely be other measures to control Medicare and other federal health care spending that we will need to implement. However, I fully believe that we MUST act now to preserve the US economy, our way of life in the US and our children’s future.

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I admit I am just dreaming. And President Obama is about as likely as to give this speech as he is to start singing “Let me go crazy on you” on Monday night. But can you imagine the look on the faces of Democrats and Republicans in Congress if he were to give this speech? Now, that’s a State of the Union address I would really want to see.

One of my blog readers asked me to write about the government shutdown. What is evident upon only a little bit of thought is how irrelevant so far the government shut down and accompanying fight between Rs and Ds is to long-term U.S. fiscal and monetary policy. Yes, the fight is over defunding/ delaying Obama care (and/or eliminating the special exemptions for Congress and their staffs) and this fight is noble in the minds of many conservatives. And yes, Obama care remains generally unpopular with the public and has may flaws which will hurt full-time employment in a number of service industries. And the imposition of Obama care will cost us money as a society – every economic projection including those by the more optimistic CBO has demonstrated that.

But did anyone really believe that providing nearly universal and affordable health care would save us money as a country? ( I never bought into the cost savings claims when the bill was initially passed. “More” of something for more people never costs less!). This isn’t to pass judgement on the merits of providing more coverage. My own view and I suspect that of most Americans (both R and D’s) is that every civilized society needs to make sure ALL people can get at least basic health care coverage. And lets face it, that costs money.

More importantly, is this a threshold issue worth shutting down the government over? My view is this is a terrible mistake on the part of the Republican party in that it is an issue they can’t win on anyway and for which they will take most of the political blame. Most importantly, Obama care is NOT an important enough issue to warrant shutting down the government. However, having said that, most Americans (outside the Washington DC area) are finding that a government shutdown in the short-term ranges from having no impact to being annoying and inconveniencing (e.g. if they planned to visit a National Park). This is because all the essential functions of government (or at least those whose loss would be felt most acutely in the near term) either are not subject to the Congressional funding resolutions (eg. Social Security, Medicare/Medicaid, pensions, food stamps etc.) or have remained funded thru separate legislation (military pay and deployments, national security, etc.). Further, per usual, government employees will very likely get paid while on furlough. (This has happened the last 17 times the government was shutdown and legislation passed the House on Saturday and should eventually pass the Senate too). Of course, a longer government shutdown would have much more widespread impacts particularly on contractors/companies that do much of the government’s work or for necessary permitting and inspections for agricultural products or to commence new projects. However, as of now, nine days into the shutdown, for most people, this is not YET a big deal.

So my biggest frustration with the shutdown is that it is over the WRONG issue. We have a truly threshold fiscal issue in this country which is our enormous spending, debt and related monetary problems. We should start dealing with it NOW because the consequences will be much less painful than if we wait until later. Further, I believe the risk of high inflation, US default, stock market crash, and major economic depression is growing every day we continue adding to $17 trillion debt AND accommodating our debt by printing more than $1 trillion per year. So if it takes shutting the government down for an extended period to really deal with these issues in a very substantial way NOW, then I am completely for it. Of course, I would hope that Congress and the President would be mature enough to at least cut a deal to start this process in earnest. Then again, given what we have seen over the past few weeks, it’s hard to be optimistic.

Lastly, we have the emerging question of the debt ceiling being raised by mid to late October or risk the possibility of default. Here, there has been a lot of hyperbole about the possible effects of failing to do so and the stock markets have been reacting negatively the past few days. However, the President has been disingenuous in describing a failure to raise the debt ceiling in time as akin to US default on its debt and therefore an economic Armageddon. The reality is very different. Unless, the President WANTS to default on interest payments on the debt, he continues to have enough revenue to service the debt and pay a majority of the government bills, although he may have to continue to furlough employees and delay salary and other payments in order to make ends meet. This is obviously NOT a good outcome and will create economic problems of its own (particularly if it lasts awhile), but it is far better than debt payment default which could literally cost the US and the World economy trillions of dollars. The markets are jittery because they see this is a growing possibility, but the chances of this happening are still very remote and solely in the hands of the President if the debt ceiling is not raised by mid October. I believe wholeheartedly that the President and Democrats were more than willing to let the government shut down rather than negotiate away any part of the Affordable Care Act. However, I do NOT believe that the Administration would willingly default on debt payments if the debt ceiling is not raised when there are other less economically destructive options available. It would be both economic and political suicide.

Time will tell. I just really wish the petulant children would stop fighting and begin to solve the financial problems that plague our country NOW. And with that somber note, I promise to move on to non-political/ non-economic topics on my next blog post.

While the focus in Washington has been on the possible government shutdown, Syria, Obama Care, sequestration and the debt ceiling., the 800 lb. gorilla in the room is the exploding cost of government medical care in the US, particularly for Medicare and Medicaid, which Congress and the President have so far done nothing to address. Here the numbers are sobering:

–A decade ago, Medicare, Medicaid and other government medical expenditures such as federal disability stood at about a $0.4 trillion. Today, for FY 2013 they total some $1 trillion+ or more than doubling of these expenditures. While some of this reflected expansion of Medicaid benefits during 2008-2012 to deal with greater numbers of unemployed or working poor, most was due to increasing numbers of retirees and the rapid increases in the costs of medical care.

–By 2020, according to the CBO, government medical expenses are projected to grow rapidly to some $1.7 trillion or by almost 70% in 7 years. This $0.7 trillion in growth is driven largely by the number of baby boomers that will retire by 2020 as well as the growth in the government subsidies provided for Obama Care medical exchanges for lower-income workers.

–At the same time, other mandatory outlays, according to the CBO, most notably Social Security, is expected to increase to $1.3 trillion. Further interest on US debt (again according to the CBO) will increase to $0.7 trillion or about TRIPLE today’s levels.

–In total, this means that mandatory outlays (ie. medical, social security, food stamps, unemployment, interest on the debt etc.) will be more than $3.7 trillion and will account for almost 3/4 of the federal government’s expenditures of about $5.0 trillion. We will also have an $0.8 trillion dollar deficit and well over $20 trillion in outstanding debt, assuming anyone will be willing to buy our debt by then.

As alarming as these numbers are, they are actually pretty optimistic. As readers of this blog know, I have noted on a number of occasions that the CBO uses overly optimistic GDP growth estimates (which overstate government revenues) and optimistically low long-term interest rates which understate the government expenditures to pay interest on debt. Further, the CBO assumes that there will be virtually no growth in discretionary government expenditures between 2013-2020 which I find particularly hard to believe absent some major reforms. When you combine these factors, I believe deficits will soar after 2014 reaching $1 trillion again by 2015/16 and resulting in our outstanding debt exploding to over $25 trillion by 2020. In other words, we will see a HUGE financial meltdown/ economic depression in just the next few years unless we deal with our fiscal and monetary crisis SOON.

Can anything be done to deal with this impending financial cataclysm?

Actually, lots of things can be done BUT none of them are easy. However, reform of our Medicare and government medical services is perhaps one of the most important. However, in order to bring these costs under control we must take several steps.

First, we must STOP turning every discussion of Medicare, Medicaid, Obama Care (as well as Social Security) into a highly politicized, class warfare discussion of rich versus poor. For one, it immediately demonizes anyone who constructively proposes to reform a broken and soon to be bankrupt system. ( Consider the plight of Paul Ryan whose thoughtful ideas about reform introduced a couple of years ago got him vilified by the Democrats as one who cared little for the elderly and poor.). Likewise, the recent exhortations of liberal democrats such as Elizabeth Warren to INCREASE social security and medicare benefits in recent speeches to the AFL-CIO might be good for getting votes but not particularly helpful in solving our fiscal problems. Conversely, efforts to de-fund Obama Care by Ted Cruz and others in the Republican party merely have inflamed zealots on both sides of the aisle and aren’t very constructive. For better or worse, Congress passed Obama Care into law. We should figure how to improve it and make it more cost-effective with future legislation.

Second, we need to really educate the American populace how dire our financial position is. I’ll admit our government doesn’t help matters much by adopting a “keep filling the punch bowl” monetary policy which tells Americans “don’t worry be happy” while continuing to inflate our financial problems. However, unless we actually point out the consequences of NOT reforming Medicare, Medicaid etc. and NOT cutting some benefits in the stark terms of the potential financial collapse of the entire US government and a meltdown of the entire US economy, most people will simply say, “I have been paying Medicare taxes for 45 years, why should I accept ANY cut in MY benefits!”

Third, we need to reform our government medical insurance system so that the payments into the system reflects CONTROLLABLE health care risks. Unfortunately, here the Obama care system did us a disservice by setting a precedent in over-correcting for “pre-existing” health conditions. Under the current government-run health care exchanges, insurance companies are ONLY allowed to charge different premiums to smokers vs non-smokers. In the case of many pre-existing conditions (eg. already have cancer or another disease etc.), this seems more than fair to me that as a society we make sure that those unlucky citizens continue to get health care coverage at the same cost as the rest of us. However, I strongly disagree that someone with a controllable health care condition such as obesity (which is highly correlated to diabetes and many other illnesses) not pay more in insurance in line with their higher risks. I believe a system that actually made Medicare tax rates higher for those higher “controllable” risk candidates with a 1 to 2 year grace period for individuals to allow time to quit smoking or lose weight would be much fairer. (This could also be continued into retirement with greater co-payments for treatment of Medicare patients with such “controllable” conditions). Further, it might thru “tough love” end up lowering rates of smoking and obesity and improve many people’s health and lower US health care costs.

Fourth, we need to make sure that Medicare is tiered so that basic coverage (a la the Bronze plan in Obama Care) is available to all at no charge but that greater levels of benefits and coverages are only available thru additional payments by individuals. This not only would help reduce the net outlays of Medicare, but might help better police some of the fraud that Medicare has been subject to, because now individuals who are paying for higher levels of optional care are presumably incentivized to make sure they are getting what they pay for.

Fifth, I believe there should be a tax on sugar (and an elimination of all federal sugar subsidies) to help discourage sugar consumption and to help fund Medicare/Medicaid. I posted about this back in April 2012 so I won’t belabor it here. (See “No Sugar Tonight” for more details).

Finally, Medicare needs to be ‘means-tested” to a certain degree in order to help curb net outlays. This means we should recognize that wealthier individuals will  have to put some amount of dollars to their care (e.g. co-payments) while the less well off do not. This should be limited in scope, however. We must remember that many wealthy individuals may have already paid hundreds of thousands of dollars in medicare taxes over the working careers and several times as much as the average taxpayer (since unlike Social Security there is no wage limit for the Medicare tax).

Though I haven’t run the numbers, I believe with these changes and other reforms Medicare, Medicaid and other government medical expenditures could be made financially solvent again. Further, we would encourage better health and less “overconsumption” of health care which plagues these programs currently. If we add to this, other reforms that inject more competition in medical services markets we might just solve this problem without too much pain for the typical Medicare recipient. All that remains is having our politicians- both Democrats and Republicans- to have the political will to do this. As always, we can and should encourage them to do this thru our letters and emails. If we don’t we risk the end of these programs as we know them.

While the federal government’s debt, spending and money printing mania has received most of the attention in this blog, there is another serious problem — the large and growing municipal governments long-term debt . The recent news that Detroit will move forward in filing for bankruptcy in the next few days/weeks is a cautionary “canary in the coal mine”. To be sure, Detroit’s problems are unique in their severity having lost two-thirds of its population since the 1950s, operating at a $100 million per year deficit since 2008, with currently $19 billion in debt and an additional $3-5 billion in unfunded retiree pension and health liabilities. However, many other cities/towns are sure to follow in the next few years unless there are fairly drastic reforms in government pension and benefits for retirees.

Over the past several years, state and municipal debt and deficits have steadily grown with future pension liabilities becoming alarmingly large. Though the numbers are small in comparison to $17 trillion+ in federal debt and the prospect of $1 trillion per year deficits in the future, the ability to raise money to cover these shortfalls or to cut other expenditures is considerably smaller for states and particularly municipalities. Perhaps most importantly, cities and states do not have the power to print money that the federal government has been using to “monetize” the their debts.  For states and cities, the problem is real and now. Consider the following alarming facts and recent events in addition to those coming from Detroit:

• On July 18th, Moody’s downgraded the city of Chicago’s credit rating and says the future outlook is negative. Currently, the City of Chicago has $19 billion in unfunded pension liabilities. The problem is even more massive statewide with a total of nearly $100 billion in unfunded pension liabilities across Illinois.
• On July 17th, 80 of the 105 pension plans in Massachusetts received failing grades for their progress in covering billions of dollars in future pension obligations.
• In California, on June 13th, it was reported that pension changes from Moody’s, and separately the Governmental Accounting Standards Board, could result in Los Angeles, San Francisco, San Jose, Azusa and Inglewood joining fiscally troubled Stockton and San Bernardino, among others, as severe credit risks. It’s all largely due to soaring employee retirement costs, according to new analysis based on the methodology by Bob Williams and his team at State Budget Solution (SBS), a non-partisan organization that studies state budget crises. 

Total unfunded pension liabilities have literally exploded in the past few years and now exceed more than $4 trillion . While this doesn’t sound as menacing as the federal numbers consider that this represents only about a 41 percent funding based on “fair market valuation” (59 percent unfunded). Even “official” statistics using very optimistic rates of return for pension investments (on average about 7 percent per year) across the states still show significant underfunding -73 percent funded versus 27 percent unfunded. Not surprisingly, state and municipal bond debt has continued to grow now totalling more than $3 trillion or triple the levels a decade ago.

As dire as these numbers sound, consider how much worse they will be, if  the value of pension assets falls substantially due to a major selloff in the stock market and as interest rates continue to climb. With the market at very high valuations today, we could be facing pretty disastrous consequences for health and pension benefits for state and local government workers if this were to occur over the next couple of years.

What is clear is that state and local government leaders will have to push thru some painful reforms involving major reductions in future pension and health benefits and some additional taxes in order to remain solvent. However, past attempts to even cut benefits slightly or partially reduce collective bargaining rights for state and local unions on the part of Governor Walker in Wisconsin, led to strong opposition and an antagonistic and costly recall election. Thus, I find it highly unlikely that governors and mayors will do anything but fix only the most immediate of problems and let the longer term liability problems fester. I believe it is almost a certainty that many other cities and even some states will have to follow Detroit’s lead in just the next few years with Chapter 9 bankruptcy. Bankruptcy will likely mean be followed by pennies on the dollar settlements for pension and health care benefits along with unsecured bond holder payments, which will in turn destroy the municipal bond markets. Most importantly, the human toll of this all will be enormous.

Could it be avoided? Of course, but even in Detroit where the handwriting was clearly on the wall, the special city manager was unable to wring enough union and bondholder concessions to avoid Chapter 9. And even after the die was cast, the unions resorted to the Courts to block the bankruptcy filing. In other words, the unions are unlikely to concede much if past history is any judge.

How many other cities could be affected soon? In addition to Chicago and the California cities noted above, there are a number of cities that have a lower resident to employee ratio (and thus more unfavorable ratio) than Detroit’s current 60-1, which provides at least some indication of those that are in more serious trouble. Among larger cities, this includes Washington DC (25-1), New York (32-1), Baltimore (43-1), Denver (49-1), St. Louis (50-1), Philadelphia (51-1), Atlanta (51-1), New Orleans (52-1), Cincinnati (52-1) and Seattle (56-1).

It’s hard to predict when it all will happen BUT I am quite confident in saying that bankruptcy at multiple major cities WILL happen. Further, once we get a few additional bankruptcies, it will result in a major problem in raising money thru the municipal bond markets for virtually ALL cities, which will speed other bankruptcies.

What can any of us do? We can make our voices be heard and hope to convince our cities are dealing with these issues NOW rather than later. Otherwise, Chrissie Hynde and the Pretenders will be eerily prophetic.