The Dark Cloud of Entitlements

The US does not at present have a deficit spending problem contrary to some public pronouncements by pandering politicians and doom-saying, tax-seeking, big government types. As a percentage of GDP our deficit spending is now quite low and continues to decrease given present tax rates, on-going GDP growth rates and the amazing increase in our nation's wealth.

We do, however, have a large dark cloud hanging over us, the amount of entitlement spending we are committed to in the future. Government accounting practice does not require the reporting of future commitments in dollars as does GAAP for corporate and business life.

President Bush touched this third rail of politics when he had the courage to embrace Social Security reform. Bush was hammered by, it seemed, every special interest group from big labour protecting future contributions to union pension funds to AARP protecting, I suppose, their future life and health insurance business. By the way, I recommend to my older friends to renounce, resign from or refuse to join AARP just for the group's massive PR campaign against Social Security reform. Recall also that the proposal was for a voluntary system to opt out of a portion of the required system and contribute some portion to an individually owned account. The opposition feared that so many people would choose to have a real self-owned account the over-all system would be hurt even though guaranteed by the US government. What a denial of the rights of the individual that the opposition to reform endorsed! And my thanks to President Bush for being willing to speak the truth no matter how unpopular and contentious he knew it would be. I hope at least some Republican running for higher office will show this courage on the privatization of Social Security during the campaign.

Robert Samuelson in this week's Newsweek discusses the fear and loathing of current politicians, especially those campaigning for the White House, to broach the issue and presents the scary projections in "When Silence Isn't Golden"; some excerpts:

If you haven't noticed, the major presidential candidates—Republican and Democratic—are dodging one of the thorniest problems they'd face if elected: the huge budget costs of aging baby boomers. In last week's CNN/YouTube debate, New
Mexico Gov. Bill Richardson cleverly deflected the issue. "The best solution," he said, "is a bipartisan effort to fix it." Brilliant. There's already a bipartisan consensus: do nothing....

The aging of America is not just a population change or, as a budget problem, an accounting exercise. It involves a profound transformation of the nature of government: commitments to the older population are slowly overwhelming other
public goals; the national government is becoming mainly an income-transfer mechanism from younger workers to older retirees.

Consider the outlook. From 2005 to 2030, the 65-and-over population will nearly double to 71 million; its share of the population will rise to 20 percent from 12 percent. Social Security, Medicare and Medicaid—programs that serve older people—already exceed 40 percent of the $2.7 trillion federal budget. By 2030, their share could hit 75 percent of the present budget, projects the Congressional Budget Office. The result: a political impasse.

The 2030 projections are daunting. To keep federal spending stable as a share of the economy would mean eliminating all defense spending and most other domestic programs (for research, homeland security, the environment, etc.). To balance the budget with existing programs at their present economic shares would require, depending on assumptions, tax increases of 30 percent to 50 percent—or budget deficits could quadruple. A final possibility: cut retirement benefits by increasing eligibility ages, being less generous to wealthier retirees or trimming all payments.

Little wonder politicians stay silent.

Frankly, Social Security is the easy one to fix by instituting voluntary private accounts for a portion of contributions, gradually raising the retirement age, and probably a slight increase in the tax to cover the unfunded liability and the problem would be solved.

Medicare and Medicaid are tougher due to the terribly fast rising cost of medical care and the demographics of the aging population. The problem is exacerbated by the trend to put more and people under the programs to provide more coverage to the uninsured.

I believe the US is well on its way toward the adoption of universal health coverage as I believe we should be doing. This is evident by both the campaign promises of all Democrat contenders for the White House and most Republicans striving to, at minimum, seek cover on the issue. To me, Obama's plan seems the least worrisome followed by Hillary's plan and worst, as usual, is the Edwards plan. It is also interesting to note that Gingrich is the most articulate on the R side of the aisle in discussing health care and that he and Sen. Clinton have worked jointly together on the health care care issue very recently. Also of note, although unnoticed, was President Bush's proposal to begin to achieve portability of health care by reforming the tax code to essentially move the burden and responsibility from the employer to the employee for the tax benefits and deductions. Also, in the Senate last week, Senators Richard Burr (R-NC) and Bob Corker (R-TN) with four co-sponsors introduced the "Every American Insured Act"; legislation which doesn't exactly do what the name suggests, but does move toward further portability with tax code changes including a refundable and advanceable flat tax credit for health care costs and coverage.

My point is that as we move toward universal coverage, which I support, we should not move toward a one-payer system, that being the US government. It seems to me the only way to retain quality and reduce the rate of cost increases is through competition coupled with some regulation of coverage. Some regulation does mean imposed rationing, unfortunately, but not to the weakness of service, the lack of innovation, and the over-bearing power of stringent rationing and control of a one-payer government controlled system.

As we move to universal coverage, the goal should be to control costs, provide coverage for all, avoid the weaknesses of a one-payer government system, and, if we get lucky, help to manage the all ready looming liabilities of Medicare and Medicaid. Social Security should be reformed to allow options for private accounts and the retirement age should be gradually and carefully raised.

The Folly of Luxury Taxes

Opinion Journal had a "fun" piece this week, originally from The American Spectator, written by David Hogberg, entitled "Emptying the Humidor" and sub-headed "Congressmen push a cigar tax, proving they've learned nothing from history." Here's some portions for you to smoke over:

Last week members of the Senate Finance Committee including chairman Max Baucus (D., Mont.), Jay Rockefeller (D., W.Va.), Chuck Grassley (R., Iowa), and Orrin Hatch (R., Utah) cut a deal to increase the funding for the State Children's Health Insurance Program to the tune of $35 billion over five years. To generate this money, the deal imposes a new luxury tax on cigars.

To understand why the luxury tax on cigars is a terrible idea, we need to revisit the history of the luxury tax of the early 1990s--a history that congressional members' severe amnesia is preventing them from remembering. Class-warfare thinking infected the luxury tax of 1990. Think of the multimillionaire whose wife was wearing a gold-and-diamond necklace and a fur coat. They were getting into their limousine to drive to their 100-foot yacht on which they would spend their weekend. How was it possibly fair that the rich spend so lavishly on such unnecessary items when Joe Six-Pack struggled just to put food on the table? Imposing a luxury tax on those items was a proper way to even things out, to make the rich pay their "fair share" to fund the government programs that helped Joe Six-Pack.

Unfortunately, Congress never bothered to consider that increasing the tax on these items, and thereby increasing the price of those items, might change the behavior of said rich people. (Indeed, many members of Congress stubbornly refuse ever to acknowledge that taxes ever affect behavior.) But said rich people had other ideas. If the price of jewelry, furs and yachts suddenly increased, then maybe purchasing a winter home in Florida seemed like a much better deal. Or maybe those rich people would take a shopping trip to other parts of the world, where the prices of jewelry, furs and yachts were now much more competitive thanks to the U.S. Congress.

And if members of Congress never considered that the luxury tax would discourage rich people from buying luxury items in the U.S., then they surely never considered that such an effect might not be so good for the Joe Six-Packs who worked in the industries producing luxury items. A Joint Economic Committee study later found that 330 jobs in the jewelry industry and 7,600 jobs in the yacht industry were lost thanks to the luxury tax. Perhaps the greatest irony was that in 1991 the federal government paid out over $7 million more in unemployment benefits to those workers than it collected in luxury tax revenues....

Fast forward to 2007. The current tax on cigars is a maximum 4.8 cents a cigar. The new proposed luxury tax on cigars is 53.13%, up to a maximum tax of $10 a cigar. Thus, if you like cigars worth $20, you'd be facing a staggering tax increase of 20,733%. By comparison, the luxury tax of 1990 was an increase of only 10%...

Of course, about as many people are going to shed tears for the person buying a $20 cigar as did for the rich person buying a yacht. But they might feel a lot of sympathy for the Joe Six-Packs who work in the cigar industry. Exact numbers about how many people work in the cigar industry today are hard to come by since the federal government stopped collecting data on cigar producers a few years ago. In 1999, the Census Bureau reported that 3,845 people worked in the cigar industry. Norm Sharp, president of the Cigar Association of America, guesstimates that the industry now employs between 7,500 and 10,000 workers, a plausible number given the growth in the industry in recent years. Whatever the number, what is clear is thousands of cigar employees face a fate similar to workers in the yacht and jewelry industries in 1990.

That is what Congress's severe case of historical amnesia yields--an astronomical tax increase leading to workers losing their jobs. But try to look at the bright side. If those cigar workers lose their jobs, the resulting decline in their incomes will mean that their kids will have no trouble qualifying for the State Children's Health Insurance Program.

I was with a glass and mirror company that was a supplier to a famous yacht manufacturer at the time of that tax on high-end goods and I saw first hand the effect of the luxury tax on workers who had no idea a "luxury tax" could hurt them.

Bottom line: All taxes have consequences and often the unintended consequences are the harshest.