Friday, May 23, 2014

Social Security and Budget Deficits: Michael Hiltzik v. Timothy Geithner and Andrew Biggs

In his new lengthy book, Stress Test, former Secretary of the Treasury Tim Geithner has a brief passage concerning a White House official (Dan Pfeiffer) suggesting he say that Social Security does not “contribute to the deficit” on the Sunday morning network talk shows. Geithner refused because, in his view, Social Security “wasn’t a main driver of our future deficits, but it did contribute.” While this is a brief passage in a book which focuses on financial crises and not Social Security, conservative commentators jumped all over this, some even saying that the White House encouraged Geithner to lie.
The debate over whether Social Security contributes to the deficit is uninteresting once one understands what is in fact going on, but it is representative of public policy advocates of various stripes taking advantage of a confusing subject in order to score political points rather than trying to clarify the issue while making a cogent argument.

The first thing to notice is that what Geithner writes is ambiguous and vague. For example, he does not clarify what deficit he or Pfeiffer are referring to. If it is the on-budget deficit, Pfeiffer is correct, since Social Security receipts, including interest payments from the Treasury, are higher than expenditures. It is nonetheless true, that if you net out intragovernment transfers, such as interest payments to government trust funds, as is done in the unified budget, Social Security then contributes to the deficit as measured in the unified budget in the sense that currently its expenditures are higher than its receipts with interest payments excluded.  
The ambiguity, though, is worse than that. Note that Geithner does not take a position on whether Social Security was currently contributing to the “deficit,” but rather that it would “contribute” to “future deficits.” This does not make much sense. If the discussion with Pfeiffer was taking place in 2011, as Fox News indicates it was, then Social Security was currently running a deficit if one did not include its interest payment receipts of $114.4 billion. If deficit refers to the on-budget deficit, then Social Security will deplete its funds in 2033 according to the latest report of the Social Security trustees. (The Disability Insurance fund will be depleted in 2016 according to the Report, but it seems to be a common assumption that Congress will solve this by transferring funds from the other Social Security trust funds.) However, under current law, this does not mean that Social Security would increase the on-budget deficit; rather, it means that benefits would be cut, perhaps by 25 percent. That, of course, is unlikely to happen, because the political costs to any Congress or Administration of letting that happen would be too great. Geithner does not say, though, that he is making a political forecast. In fact, in an attempt to minimize the minor political damage he apparently inadvertently inflicted on the Obama Administration, he indicated to Fox News that he is just speaking about math: “Asked, though, whether Social Security does contribute, he said: ‘To the long-term fiscal problem? Yeah, because, as is obvious, it's just a math thing.’” 

Michael Hiltzik, a liberal columnist for the Los Angeles Times, weighed in on the Social Security budget deficit with a column criticizing both Geithner and conservative commentators for not understanding that Social Security does not contribute to the budget deficit. Of course, he is talking about the on-budget deficit and does not mention the projections of the Social Security trustees that benefits will have to be cut in about 19 years absent any changes in the law.
Hiltzik’s column did not sit well with Andrew Biggs, who works at the American Enterprise Institute. He wrote a blog post on this, attacking what Hiltzik had written. While it is clear from a post he wrote in 2012 that Biggs understands the distinction between the on-budget and unified budget deficit, he does not explain that distinction in his attack on Hiltzik, though he does refer to places where he has written about it. He also seems to think that quoting Charles Blahous, a Republican who is currently one of the two public trustees for the Social Security trust funds, asserting that Hiltzik is “flat wrong” settles the matter. That is an assertion, not an explanation.

What Biggs does not recognize is that when Social Security was running a surplus, whether or not you included interest, there were some who argued that it should not be included in the budget deficit because it masked future liabilities. He does seem to indicate some sympathy to the view, though, that the Social Security surpluses were spent not saved.
Hiltzik subsequently responded to Biggs, arguing that it is legitimate to include interest when determining whether Social Security is contributing to the deficit. If you have had the patience to follow this, you can see why I think this whole debate is beside the point. The real issue going forward is what level of benefits do we want Social Security to pay and, if the current level of payroll taxes along with the accumulated trust fund assets built up in prior years are insufficient to finance the preferred benefit level, then what changes are made to finance the program.

It is mostly Republicans but also some Democrats who argue that we need to reform Social Security now because it will be harder and more painful if we delay. For example, Charles Blahous and Robert Reischauer, his Democratic colleague on the board of trustees for the Social Security Trust funds, jointly wrote in a message accompanying the release of 2013 Report:     
“Social Security’s long-term income shortfall is now larger than it has been at any point since before the landmark program reforms of 1983. The dates of projected depletion of each of its trust funds are unchanged from last year’s report. It is important to grasp that the amount of time remaining to enact a financing solution that is both reasonably balanced and politically plausible is far less than the amount of time projected before final depletion of Social Security’s combined trust funds. Toward that end, this year’s report contains new illustrations of the magnitudes of benefit changes required if lawmakers wish to preserve solvency without affecting current beneficiaries. Importantly, even if a Social Security solution were enacted today and effective immediately, it would require financing corrections that are substantially more severe than those enacted in the 1983 program amendments. Each passing year of legislative inaction reduces the likelihood that a solution can be found that is acceptable to lawmakers on both sides of the political aisle.”
Part of the reason for the hurry though is that most people do not believe that there will be a 25 percent cut in benefits come 2033 or so if no changes are made until then. James Kwak is persuasive in making the case why we should not plan on this happen. Therefore, if benefit cuts are part of what you advocate, you want to do this now before it becomes politically impossible.

It is interesting, though, that some Democrats have concluded that the best defense of Social Security is to go on the offense. Most prominent among this group is Elizabeth Warren, but there are others, who argue that Social Security should be expanded, not contracted.
Ultimately, all the accounting discussion is smoke which is an attempt to hide the real debate. Some liberals, as well as some conservatives, use arguments about accounting and current law to hide the real issues when they argue about this. As for issues that are on the table, they include removing the cap on payroll taxes, taxing more sources of income, and reducing benefits, at least marginally, for high income retirees. There are lots of other ideas out there, some better than others. One thing I would not be in favor of is increasing the payroll tax rates. The Greenspan Commission of the 1980s already succeeded in raising these rates too much, and as currently structured it is a regressive tax, even if Social Security as a whole is arguably not regressive.

There are, however, more pressing issues than Social Security reform, which can be handled one way or another. A more serious problem is the increasing share of the economy being devoted to the medical sector because of demographics and health care inflation. Whether or not the government is paying the costs through Medicare and Medicaid or private insurance companies are paying the costs with the premiums they collect, this is a burden on the economy that needs to be addressed. The Affordable Care Act did not do enough in this regard. This is, though, a more difficult problem than Social Security, and in the current political climate, there doesn’t seem to be much likelihood of addressing it in any meaningful way.

Monday, May 19, 2014

Comments: My Promised Land: The Triumph and Tragedy of Israel by Ari Shavit

Ari Shavit’s book, My Promised Land: The Triumph and Tragedy of Israel, should be read by anyone interested in Israel and its predicaments. While flawed, the book captures the Israeli situation and shows an author struggling to make sense of it both as a political and a personal matter. The author is a reporter, columnist, and member of the editorial board of the Israeli newspaper Haaretz, which is considered liberal or center left. (Nevertheless, Shavit, while unalterably opposed to Israeli settlement policy, is hawkish when it comes to Iran.)
In his book, Shavit does not minimize the country’s problems and contradictions and extensively quotes people with whom he disagrees. For example, both a West Bank settler and an Israeli Palestinian lawyer make their respective arguments in their own words in the pages of this book. Shavit seems to be engaging in a dialogue with himself about his country and what is moral or ethical. He is not successful in resolving many of these issues.

One of the admirable aspects of Israel is its willingness to tolerate books and movies that harshly criticize some of the country’s policies. For example, the 2008 animated Israeli movie, Waltz with Bashir, does not gloss over Israeli complicity in the 1982 massacres in Palestinian refugee camps (Sabra and Shatila) committed by Lebanese Christian militias. In addition, the 2012 Israeli documentary, The Gatekeepers, is a disturbing look at Shin Bet, Israel’s internal security force, made with the cooperation of six former heads of that organization. Ari Shavit’s book is in this tradition.
It may be, though, that works by Israelis obviously concerned about the moral underpinnings of policies are not viewed as being significant in changing Israeli politics or policies. After all, Ari Shavit decided to write this book in English. Apparently, there is a manuscript in Hebrew that will be published some day. For now, it appears that a main target audience for the book is the American Jewish community.

Not all in the American Jewish community are pleased with the book. While Tom Friedman is a fan as is Leon Wieseltier, the author’s recounting of the expulsion of Palestinians from Lydda during the 1948 war has received criticism from more conservative Jewish commentators. (I am not knowledgeable enough about Israeli history to have an opinion about what happened at Lydda.)
The book is in essence a series of magazine articles about different periods in Israeli and Palestinian history. In fact, some of the chapters originally began as articles, including the chapter on Lydda, which is based on the author’s New Yorker article on this subject. The resulting book is a bit surprising in what is highlighted. There is, for example, a great deal of detail about the Tel Aviv nightclub scene in 2000, and very little discussion of the 1982 Lebanon war. The author no doubt would justify the nightclub scene discussion as a way of portraying an aspect of current Israeli society, but the Lebanon invasion is an example of Israel’s deeper problems.

My main disappointment with the book, though, is the final chapter, where the author tries to explain why he is a proud Israeli and hopeful for his country. The problem is that it does not logically follow from the preceding chapters, which discuss Israel’s history and the burdens it presents. Moreover, in another chapter, Shavit recounts the arguments of an Israeli Palestinian lawyer, who does not believe in the two-state solution, but rather argues for one state, comprising both Palestinians and Jews. He says of this Israeli Palestinian: “I love Mohammed…He is as Israeli as any Israeli I know. He is one of the sharpest friends I have. We share a city, a state, a homeland. And yet there is a terrible schism between us.”
It is as if the author set the predicate for a logical argument but cannot move forward to a logical conclusion. One keeps reading, hoping for a resolution, but it is not forthcoming. Shavit does not find a logical way to his more or less hopeful conclusion. He writes: “The script writer went mad. The director went away. The producer went bankrupt. But we are still here, on this biblical set. And as the camera pans out and pulls up, it sees us converging on this shore and clinging to this shore and living on this shore. Come what may.” He implicitly admits he has to come to this conclusion. For him, there is no other choice, come what may.

This book is a fascinating and well-written account of an Israeli journalist struggling with his country’s history, burdens, and problems. It also provides the historical context that gave rise to the Zionist movement through its portrayals of individual lives. Most readers with some knowledge of the Middle East will find themselves agreeing with the author on some points and not others, but most will probably agree that his views should be taken seriously. While the author is unsuccessful in resolving the strands of his various insights, the book is well worth reading for its insights into a complex situation posing fiendishly difficult problems for Israel, the Middle East, and the world.

Monday, May 12, 2014

More on the Reagan Administration and Capital Gains Taxes – A Correction and More Detail

I generalized a bit too much in my previous post on Reagan and taxes about the Reagan Administration’s views on capital gains. Here is a correction and some more detail on this subject.
A tax lawyer who worked at Treasury in the mid-80s and was very involved in Treasury’s efforts to get tax reform enacted recently told me in reaction to my post that Treasury II (The President’s Tax Proposals to the Congress for Fairness, Simplicity, and Growth, May 1985) proposed a preferential rate for capital gains, which was later dropped for revenue reasons. As a consequence, I looked at both what Treasury I (Tax Reform for Fairness, Simplicity, and Economic Growth: The Treasury Department Report to the President, November 1984) and Treasury II said on this subject.

In fact, Treasury II did propose a top 17.5% long-term capital gains rate for individuals and non-corporate taxpayers. It reduced the exclusion rate for net long-term capital gains from 60% to 50% and the top propose rate was 35%. (See page 168 of Treasury II here.) The Administration though subsequently supported the legislation going through Congress that did away with capital gains preferences.
Treasury I did not propose an exclusion for capital gains but rather proposed indexing the basis of long-term holdings of capital asset to inflation. To avoid tax games, though, Treasury I also proposed eliminating the inflation compensation component of interest from both taxation and deductibility. This inflation indexation idea was dropped in the Treasury II proposal, which was developed when James Baker had replaced Don Regan as Treasury Secretary.

As for Treasury’s position on this, I remember listening to a speech by Charles McLure, who was Deputy Assistant Secretary for Tax Analysis from 1983 to1985. As I remember it, he argued that income does not come marked as to character and should all be taxed the same, whether the character was capital gains or ordinary income. It was this speech that I particularly remember on this subject.

Moreover, it should be noted that the Reagan Administration did find its way to supporting the elimination of the preferential treatment for capital gains. The elimination did not last long.   

Thursday, May 8, 2014

More on the Federal Reserve Paying Interest on Reserves

One of the most popular posts on this blog is one I wrote in August 2011, Why Does the Federal Reserve Pay Interest on Required and Excess Reserves?” The question in the title is really one for the Fed, since I found its explanations not entirely convincing. Recently, I came across a more recent explanation of the Fed’s interest rate payments on reserves policy at the Federal Reserve Bank of San Francisco’s website.
After reading this, though, one still has to ask what the point is of the Fed increasing its balance sheet and motivating banks not to lend out their excess reserves to other banks. The FRBSF post argues that this helps the Fed’s open market desk achieve its fed funds target by putting a floor on the fed funds rate. But the current target is 0 to 25 basis points, and zero is a floor. Moreover, if the reserves are just sitting at the Fed and earning interest of 25 basis points, that helps the banks a bit by allowing them to earn interest at no risk in excess of that available on Treasury bills but it is hard to see how it helps the economy.

When I was at Treasury, we were skeptical of allowing the Fed to pay interest on reserves. From a parochial standpoint, the payment of interest on reserves reduces the Fed’s payments to the Treasury out of its earning, resulting in increasing the amount Treasury has to borrow in the market (or providing a shortfall that ultimately is covered by increasing taxes).
In this regard, it is interesting to read that current Fed Chair Janet Yellen appears to be at least somewhat skeptical of a Fed staff paper discussing interest on reserves at the FOMC meeting in April 2008 (her discussion of this begins on page 177 of the minutes of that meeting). She analyzes the policy of not paying interest on reserves as a tax on banks that would need to be replaced by another tax.

Recently, though, Yellen has suggested that the Fed would raise the interest it pays on excess reserves when the economy strengthens and the inflation rate has increased to the Fed’s 2% target. (She does not seem to have said anything about interest on required reserves.)
While this so far has not been a huge deal, it is hard to avoid thinking that one of the reasons that the Fed pays interest on reserves is that it is something that banks want. It seems similar to regulatory capture, though I am sure Fed staff could reply vociferously against such a charge.

Monday, May 5, 2014

Capital Gains and Dividend Taxes: What Would Ronald Reagan Say?

Earlier this year, I was thinking about tax policy as I, like so many others, used software to prepare and file my federal tax return. This exercise reminded me of the significance of the reduction in the tax rates on most dividend income and long-term capital gains to 15 percent championed by and achieved during the Administration of President George W. Bush. Moreover, these rate changes were a radical break from the Tax Reform Act of 1986, which was enacted with the Reagan Administration’s enthusiastic support.
It is currently rarely mentioned by Republicans, many of whom consider President Reagan as their conservative hero, that the 1986 Tax Reform Act generally raised the maximum tax rate on long-term capital gains to 28 percent (in fact, the marginal tax rate on capital gains could be 33 percent for certain taxpayers whose taxable income fell in a phaseout zone of the 15 percent marginal tax rate on lower amounts of income). The Tax Reform Act resulted in the elimination of a separate Schedule D computation for determining the total amount of income tax owed, which has now come back, since the rate on capital gains and ordinary income were the same.

The differential tax rate between long-term capital gains returned during the Administration of George H. W. Bush as the top marginal rate on ordinary income, but not capital gains, was increased. The Schedule D computation of taxes for taxpayers with long-term capital gains returned for tax year 1991, when the top marginal rate on ordinary income was 31 percent. (Actually, the marginal rates were somewhat higher for certain taxpayers because of limits on deductions and a phaseout of personal exemptions based on adjusted gross income, which includes capital gains).
In subsequent years, the top marginal rate on ordinary income increased as did the differential between that rate and the top marginal rate on long-term capital gains. Thus, a central premise of the 1986 Tax Reform Act argued by Treasury officials in the Reagan Administration was undermined by policies advocated by both Republican and Democratic administrations. In brief, the Reagan Treasury argument was that income is income and should be taxed at the same rate. To do otherwise is not consistent with fairness and encourages stratagems which have no real economic purpose other than converting one type of income or loss into another type. For example, when there is a large difference between the tax rates applicable to ordinary income and long-term capital gains, this creates an incentive to attempt to devise strategies that effectively convert ordinary income into long-term capital gains and convert capital losses into ordinary losses.

The Bush tax cuts lowered the top marginal tax rate on long-term capital gains, and, significantly, qualified dividends, to 15 percent. For a taxpayer with a mix of ordinary income and long-term capital gain and qualified dividend income, there are effectively two calculations. The 15% is applied to the long-term capital gain and qualified dividend income and the normal tax rates are applied to the ordinary income. This means that a taxpayer who had significant long-term capital gain and dividend income and a modest amount of ordinary income would be taxed at a relatively low rate, since the modest amount of ordinary income is taxed by the same amount as another taxpayer who had no other income but this modest amount of ordinary income.
During the Obama Administration, very high income taxpayers have seen their tax rates on capital gains and ordinary income creep up because of the Affordable Care Act and other legislation. Nevertheless, investment income is still treated much more favorably than ordinary income under the tax code. Republicans will keep fighting to preserve that preference or increase it, even though it was the Reagan Administration that advocated its elimination

Note: A full analysis of tax changes requires consideration of the Alternative Minimum Tax. The AMT, though, does retain preferential rates for long-term capital gain and qualified dividend income.