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.

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.

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.   

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.

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.

Marijuana Businesses and Banks – The Federal Government’s Non-Reassurance Reassurance

Recent headlines would seem to indicate that the Treasury Department and the Justice Department had given the green light to financial institutions to provide financial services, such as checking accounts and credit card services, to marijuana businesses that are licensed and legal under state law. The articles themselves, though, tell a different story. The light isn’t exactly green. In fact, the Colorado Bankers Association issued a statement which said in part:

“The guidance issued today by the Department of Justice and the U.S. Treasury only reinforces and reiterates that banks can be prosecuted for providing accounts to marijuana related businesses.

“‘In fact, it is even stronger than original guidance issued by the Department of Justice and the Treasury,’ said Don Childears, president and CEO of the Colorado Bankers Association. ‘After a series of red lights, we expected this guidance to be a yellow one. This isn’t close to that. At best, this amounts to ‘serve these customers at your own risk’ and it emphasizes all of the risks. This light is red.’”

Now that twenty states and the District of Columbia have legalized marijuana for medical use, and two states, Colorado and Oregon, have gone further and legalized it for recreational use as well, there is a glaring conflict between federal and state laws. As it stands, states cannot preempt federal law, and marijuana remains illegal under federal law. In fact, the U.S. Supreme Court in a 2005 case (Raich v. Gonzales) decided that the federal Control Substances Act (“CSA”) applied to the legal use of marijuana under California law with marijuana that was grown and used in California and thus had not entered into interstate commerce. (This was a strange case since it involved an issue in which conservatives are more likely to favor a strong government stance against drugs such as marijuana but also raised federalism questions, in which conservatives are usually on the side arguing for limits to federal government power. The three dissenters were Chief Justice William Rehnquist and Justices Sandra Day O’Connor and Clarence Thomas. The opinion of the Court was written by Justice John Paul Stevens. Justice Antonin Scalia wrote a concurring opinion.)

This situation poses a dilemma for the Obama Administration. Obviously, a significant portion of the public does not agree with federal law’s treatment of marijuana, and the Administration has decided not to go after marijuana businesses which have been licensed by state government authorities if certain conditions are met. If these businesses, though, are not able to obtain banking services and can only receive and make payments in cash (including tax payments), this is likely to increase crime. Banks, though, are reluctant to provide services to entities that they know are breaking federal law for fear that they would be violating federal law.

On February 14, the Financial Crimes Enforcement Network (“FinCEN”), a bureau of the Treasury Department, issued guidance to financial institutions on what is expected of them when they do business with marijuana-related businesses. Banks have not been reassured by this guidance nor by a memorandum from Deputy Attorney James Cole to U.S. Attorneys (prosecutors) on “marijuana related financial crimes” the same day.

FinCEN administers the Bank Secrecy Act (“BSA”), a statute with a misleading name. The BSA does not protect customers by imposing secrecy requirements on banks but rather requires banks, among other things, to report suspicious activities of their customers to FinCEN. The secrecy is that the banks are prohibited from telling their customers that they have filed a report to FinCEN on their transactions. Some have, therefore, humorously called the BSA the “Bank Snitching Act.”

The Cole memorandum list eight areas of concern about state-licensed marijuana businesses. These are:

• Preventing the distribution of marijuana to minors;

• Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;

• Preventing the diversion of marijuana from states where it is legal under state law in some form to other states;

• Preventing state-authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity;

• Preventing violence and the use of firearms in the cultivation and distribution of marijuana;

• Preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use;

• Preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and

• Preventing marijuana possession or use on federal property.

The memorandum goes on to state that “if a financial institution or individual offers services to a marijuana-related business whose activities do not implicate any of the eight priority factors, prosecution for these offenses may not be appropriate.” It is hardly surprising that bankers do not find that statement totally reassuring.

As for FinCEN, financial institutions that have marijuana-related customers are required to file with FinCEN suspicious activity reports (“SARs”) periodically on these customers’ transactions. If a financial institution “reasonably believes, based on its customer due diligence,” that the transactions of a marijuana-related business customer do “not implicate one of the Cole Memo priorities or violate state law,” it “should file a ‘Marijuana Limited’ SAR. If the financial institution subsequently has reason to believe “in the course of conducting customer due diligence (including ongoing monitoring for red flags)” that its customer is engaged in activity “that potentially implicate one of the Cole Memo priorities or violate state law, the financial institution should file a ‘Marijuana Priority’ SAR.”

It is perhaps not as well-known and appreciated as it should be that two Treasury Department entities, FinCEN and the Office of Foreign Assets Control (“OFAC”), which administers and enforces international economic sanctions programs, impose substantial burdens on financial institutions to perform what are essentially law enforcement functions. There can be substantial ambiguity concerning the degree of effort financial institutions are required in order to comply with FinCEN and OFAC regulations. Consequently, it has happened that when banks become worried because of high-profile enforcement actions against particular institutions, they have flooded FinCEN with SARs.

At the time I worked for about a year and a half at OFAC in the middle of the last decade, the policy was to be reasonable and somewhat forgiving with financial institutions that had made mistakes and were apparently earnestly trying to take corrective measures to reduce the risk of future mistakes. Financial institutions have reason to take OFAC and FinCEN regulations seriously.

In the current situation, therefore, it is rather strange that FinCEN and the Justice Department are hinting that it may be all right for financial institutions to facilitate violations of a particular federal law, but then again it might not be. That is probably more ambiguity than is comfortable for most bankers.

Furthermore, as the Colorado Bankers Association points out, there is uncertainty how the various bank regulators, which have a good deal of independence from the Administration, will view institutions they regulate having marijuana-related business customers. Also, of course, a future Administration could reverse the current Administration’s marijuana policy.

This is why the banks would like legislation to be enacted to clarify the situation. Representative Ed Perlmutter (D, CO) has introduced legislation that would clarify that financial institutions can provide services to “legitimate” marijuana-related businesses without fear of prosecution or other federal action. The bill (H.R. 2652) has 27 co-sponsors, only two of whom are Republicans (Mike Coffman of Colorado and Dana Rohrabacher of California). As such, there would seem to be very little chance that it gets passed by this Congress.

As far as the Administration is concerned, it probably could do more than it has. For one thing, it apparently has the authority to reclassify marijuana from a Schedule I drug under the CSA, which is reserved for the most dangerous drugs such as heroin, to a lower schedule, or it may be able to remove it from the controlled substances list altogether. President Obama has stated that only Congress can reschedule marijuana, but this is disputed. Rescheduling would seem to make the medical use of marijuana not illegal under federal law.

Opponents of legalization of marijuana use for recreational use will likely point to the Single Convention on Narcotics, a 1961 international treaty to which the U.S. is a signatory. The International Narcotics Control Board criticized Uruguay’s decision to legalize marijuana as a violation of its treaty obligations, but it has no real enforcement power. The treaty, not surprisingly, is ambiguous, and it is a subject of disagreement whether it requires criminal penalties for possession of marijuana for non-medical, personal use. It also appears that UNESCO’s Commission on Narcotic Drugs could remove marijuana from coverage by the treaty.

Finally, the conflict between federal law on marijuana and those of twenty states and the District of Columbia (which is interesting, since the DC government’s authority to enact laws derives from federal law), is untenable and, one way or another, will have to be changed. Financial institutions are right to be uncomfortable. It will be interesting to see how many, if any, financial institutions take the legal risk of accepting marijuana businesses as customers.

Some Comments on the CBO Appendix – “Labor Market Effects of the Affordable Care Act: Updated Estimates”

On February 4, the Congressional Budget Office released a report, The Budget and Economic Outlook: 2014 to 2024. It immediately created a furor, not because of the main report or its general projections but because of an eleven page appendix (Appendix C, “Labor Market Effects of the Affordable Care Act: Updated Estimates”). The CBO was probably a bit taken aback by the reaction in political and policy analysis circles and in the news and opinion media. Evidently feeling it necessary to clarify what the CBO had said, the CBO’s Director, Doug Elmendorf, posted on the CBO’s website on February 10 a piece entitled “Frequently Asked Questions About CBO’s Estimates of the Labor Market Effects of the Affordable Care Act”, in order to clarify that they did not mean that 2.5 million people would “lose their jobs in 2024 because of the ACA” (Affordable Care Act).

The sentence critics of the ACA jumped on stated: “The reduction in CBO’s projections of hours worked [due to the ACA] represents a decline in the number of full time equivalent workers of about 2.0 million in 2017, rising to about 2.5 million in 2024.” Republican politicians immediately denounced the ACA as a job killer, and initially the media played along. When the media finally realized that the Republican characterization of the report was misleading at best, or just plain wrong, they subsequently wrote better articles. Nevertheless, some, most notably Chris Cillizza, a political reporter for the Washington Post, wrote a much ridiculed post for his Washington Post blog, “The Fix” (a reference to political junkies). Cillizza argued that it did not really matter what the facts were for a political analyst like himself; what is important is voters’ perceptions. He wrote: “My job is to assess not the rightness of each argument but to deal in the real world of campaign politics in which perception often (if not always) trumps reality. I deal in the world as voters believe it is, not as I (or anyone else) thinks it should be.”

David Weigel of Slate, responded to Cillizza by writing: “Now, if we're talking or reporting on what Republicans are saying at this moment, true: They're talking about the CBO report. What will we be reporting on a few months from now? What'll the attack be? We don't know.” Ezra Klein, Cillizza’s former colleague at the Post, wrote on his public Facebook page:

“I don't quite understand the model of politics underlying the backlash-to-the-backlash over the CBO report. The theory is that though the GOP's initial spin on the report was wrong it's meta-right because the lies will be used to power effective attack ads in the fall -- and in politics, what's true, and what voters can be tricked into believing is true, are two equally valid categories for inquiry…

“Obamacare is an unpopular law that suffered from a disastrous launch. Does anyone think the GOP would've been unable to find a way to write devastating attack copy about it if that CBO report hadn't come out? Of course not.

“The parties often don't have enough money to air the attacks ads they want to air. They often lack candidates with the credibility to make the attack ads stick. They're often lack the economic conditions that predispose the electorate to listen to them. They're typically chasing voters who lack any interest in watching another nasty political commercial.

“There are plenty of real scarcities in American politics that could really change elections if one party or the other solved them. But "things to say in an attack ad" just isn't one of those scarcities.”

In his blog post, Doug Elmendorf wrote:

“Q: Will 2.5 Million People Lose Their Jobs in 2024 Because of the ACA?

“A: No, we would not describe our estimates in that way...

“Because the longer-term reduction in work is expected to come almost entirely from a decline in the amount of labor that workers choose to supply in response to the changes in their incentives, we do not think it is accurate to say that the reduction stems from people ‘losing’ their jobs.

“Here’s a useful way to think about the choice of wording: When firms do not have enough business and decide to lay people off, the people who are laid off are generally worse off and are therefore unhappy about what is happening. As a result, other people express their sympathy to those people for having “lost their jobs” due to forces beyond their control. In contrast, when the labor market is strong and people decide on their own to retire, to leave work to take care of their families, or to cut back on their hours to pursue other interests, those people presumably think they are better off (or they would not be making the voluntary choices they are making). As a result, other people are generally happy for them and do not describe them as having ‘lost their jobs.’

“Thus, there is a critical difference between, on the one hand, people who leave a job for reasons beyond their control and, on the other hand, people who choose not to work or to work less. The wording that people use to describe those differing circumstances reflects the different reactions of the people involved. In our report, we indicated that ‘the estimated reduction [in employment] stems almost entirely from a net decline in the amount of labor that workers choose to supply,’ so we think the language of ‘losing a job’ does not fit…

“There is a broader question as to whether the society and the economy will be better off as a result of those choices being made available. Even though the individuals making decisions to work less presumably feel that they will be happier as a result of those decisions, total employment, investment, output, and tax revenue will be smaller. (Those effects are included in CBO’s budget and economic projections under current law.) To be sure, the health insurance system in place prior to the ACA generated its own distortions to people’s work decisions, but many of the decisions to work less under the ACA will be made possible by government-funded subsidies, the burden of which will be borne largely by other people. Moreover, people’s decisions about work are also affected by taxes and benefit programs apart from those related to health insurance. Hence, whether voluntary reductions in hours worked owing to the ACA are good or bad for the country as a whole is a matter of judgment.

“A tradeoff of this sort—although not necessarily of the same magnitude—is intrinsic in any effort to significantly increase health insurance coverage or to provide other types of benefits that are aimed at low-income people. As we wrote in the report: ‘Subsidies that help lower-income people purchase an expensive product like health insurance must be relatively large to encourage a significant proportion of eligible people to enroll. If those subsidies are phased out with rising income …, the phaseout effectively … discourage[es] work.’ Again, the best way to address that tradeoff is a matter of judgment.”

As it turns out, the hue and cry over what the CBO said about the ACA and jobs has died down. The media appears to have some remorse in the way they initially reported the story and Republican politicians who have mischaracterized the CBO report have been pilloried by liberal political websites. The story for the most part has disappeared, at least for now.

Still, there has been some more intelligent commentary from some critics of the ACA. The argument they make is that the ACA’s phase out of health care subsidies as lower income people earn more income acts like an implicit marginal tax and discourages work. (For example, see these blog posts from Charles Blahous and Keith Hennessey.) This is in fact the main reason the CBO cites for its estimate of the reduction in labor supply.

If one looks at the structure of the subsidies for health insurance bought on the exchanges, the phaseouts are poorly constructed. In some cases, an extra dollar of income would mean a loss of a subsidy of more than a dollar if one’s income is just below the cutoff level for the subsidy. However, in general, the amount of subsidy that an individual gives up with extra income appears to be in the neighborhood of 10 to 16 percent of the additional income. (One can play around with examples with this handy subsidy calculator at the Kaiser Family Foundation website.) The subsidies end at 400 percent of the Federal Poverty Level (“FPL”). Income is defined to be modified adjusted gross income. (For 2013, the FPL was $11,490 for a single adult and $23,550 for a family of four.)

It is not clear how the CBO estimated how much this would reduce the amount of labor supplied either by workers reducing the number of hours worked or dropping out of the labor market entirely. While significant, these implicit marginal tax rates by themselves are neither huge nor confiscatory. Also, it is worth remembering that one cannot live on health insurance subsidies alone. People who drop out of the labor force because of the reduction in subsidies as their income increases need to have other sources of income or wealth. 

If workers take a full time job that provides health insurance, they lose the subsidy. Whether or not that loss acts as an implicit marginal tax from the point of view of the individual worker depends on the particular facts. One would have to look at the change in the net cost of health insurance premiums and expected out of pocket costs to do a full analysis. To do this in the aggregate would seem to be a daunting task for economic forecasters.

Also, it should be noted that for states that have chosen to expand Medicaid, subsidies for health insurance begins at 138% of the FPL. Below that amount, people get coverage through Medicaid. While losing Medicaid can be viewed as a cost, it is hard to assign an implicit marginal tax rate for earning income that crosses the 138% line, because the private health insurance plans offered on the exchanges are likely to be much better than Medicaid. The number of doctors who accept Medicaid is quite limited and there can be severe frustrations, which differ among the states, in dealing with the Medicaid bureaucracy. (There can be frustrations in dealing with private insurance companies, but my impression is that these are probably not quite as bad as dealing with some state bureaucracies and their legal processes.)

In states that have chosen not to expand Medicaid, there will be people who will neither be eligible for exchange subsidies nor Medicaid. For these people, the law will provide an incentive to work at least enough, if they can, to get to the 138% of FPL in order to benefit from the subsidy. 

Finally, people who are covered by Medicare are not eligible for the subsidies provided for health insurance on the exchanges.

As many have pointed out in the discussion of the CB0 report, means testing a government benefit leads to an increase in implicit marginal taxes until the benefit is totally phased out. This is not new to the ACA. For example, welfare benefits, the earned income tax credit, and food stamps are all subject to means testing. What would be useful for policy analysis would be a comprehensive analysis of means-tested government programs, along with federal, state, and local income taxes, and what this might mean to particular classes of workers. Conservatives are of course right when they say that high marginal tax rates discourage additional work. Devising solutions to this issue is not simple.

However, focusing on the ACA in isolation and criticizing it for this does not do much to advance solutions. Some critics of the ACA would like to go back to the status quo ante, but that is not going to happen. Other critics would like to reduce health care coverage substantially for poor people by giving everybody the same fixed amount (a “refundable” tax credit) to buy private health insurance. That also is not going to happen.

As far as what the ACA does to economic growth, this is unclear. In the first instance, as the CBO admits, there is “substantial uncertainty” concerning its estimates of the effects of the ACA on labor market participation. Even taking the estimates as given, former Federal Reserve Vice Chairman Alan Blinder writes in the Wall Street Journal:

“…The CBO now estimates that the ACA will reduce labor supply by about 1.5% to 2% over a decade. That's small and, arguably, a good thing. Let's count it as antigrowth, though certainly not as a ‘job killer.’ But what about the potential savings in health-care costs from the ACA—which are clearly pro-growth?

“Remember, one of the principal objectives of health-care reform is to slow down cost increases, thereby reducing the burdens on both businesses and the federal budget. And health-care costs have indeed slowed dramatically. The following little tidbit is buried deep in the CBO report, and has gotten little attention: CBO ‘lowered their estimate of average premiums for insurance coverage through exchanges in 2014 by about 15 percent.’ Let me repeat that: 15% lower, just since last May. That's huge.”

As a final point, as long as we have substantial unemployment, that the ACA reduces labor market participation should not be a source of concern. Finally, I would note that many of those arguing that the ACA is fatally flawed because of its effects on labor market participation and economic growth also have been in favor of our current contractionary fiscal policy, which has served to slow the recovery and which monetary policy cannot totally counteract.