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What's wrong with the Old New Deal?

It's really hard to overstate just how bad "The New New Deal," the cover story in the New Republic by Laurence Kotlikoff and Niall Ferguson is. It's extremely bad. As Kevin Drum noted, the writing is at the level of a high school essay -- although Ferguson is a fine historian and writer (The Cash Nexus and Empire are both worthy books) -- and the reasoning and economics are even worse -- although Kotlikoff is certainly a capable demographic economist, even if his long-term, generational approach to fiscal policy is controversial.

But the question of what the next stage of the U.S. social compact should look like is so important that it's worth trying to figure out what went wrong here.

After a long preface setting up an intergenerational doomsday scenario that would require doubling taxes or cutting Social Security and Medicare by two-thirds, the authors put forward three basic ideas, which seem only loosely related to the problem as they've described it:

1. Replace all taxes -- personal income tax, payroll tax, estate and gift taxes -- with a 33% retail sales tax. To make it more progressive -- or less blatantly regressive -- all households would get a rebate "based on the household's demographic composition, and equal to the sales taxes paid on average by households at the federal poverty line with the same demographics."

(To do a little of the simple math that the authors don't, what this means is that if the average family of three at the poverty line spends 100% of its income, the rebate for all families of three would be about $4,000. So a family of three earning $50,000 and consuming $40,000 would pay sales tax totaling $9200. ((40,000*.33)-4000) That same $50,000 family of three, with one earner and taking the standard deduction, would currently pay about $2400 in federal income tax and about $3500 in payroll tax, so they would be worse off, unless you count the employers' share of payroll tax, in which case they would break even.)

More importantly, the tax would not be 33%. As Bill Gale of the Brookings Institution has shown, such a tax would have to be somewhere between 40% and 45%, calculated in the same way as Kotlikoff and Ferguson ("tax-inclusive") in order to finance projected spending for the next ten years, never mind the long term.

And even that's assuming that all spending would be included. State sales taxes exclude housing costs, health care, and food, which together total half of personal consumption. If a federal sales tax actually became law, there would surely be pressure to exclude home mortgage interest. Having excluded interest, why not also exclude payments of principal, since that is not really consumption but savings. And what about education? After all, you're investing in your future. As soon as anything is excluded, the plan starts to become less "transparent and efficient," and the more that is excluded, the higher the rate goes. And anyway, what makes this system so much better for the future than, say, a balanced combination of income tax and smaller consumption tax? The authors don't say.

2. On Social Security, Ferguson and Kotlikoff propose to pay only currently accrued benefits, then close out the system and replace it with what they call personal retirement accounts into which workers would contribute 7.15% of their wages. (Oh, and that thing about eliminating the payroll tax? Never mind.) The accounts would be administered by the Social Security Administration, invested in an index fund, and everyone would receive the same rate of return, with a guarantee against negative returns. Near retirement, the accounts would be replaced with annuities.

So you have the worst of all worlds: none of the sense of ownership and flexibility that the Bush plan promised, but the forced annuitization that was one of the least appealing features. Again, how is this different in effect from simply investing a portion of the Trust Fund in equities, as Clinton proposed in 1998? It's different in only one sense: since apparently only half as much money is going into the system (the employers' share of payroll tax having been eliminated) a retiree would get only half as much retirement income as under Social Security, and probably less than that.

(I may be reading this wrong, since at the beginning the authors declare that one of their first principles is that "when they stop working, all Americans should be guaranteed a basic income of at least 40% of their pre-retirement earnings," something which could not be achieved with a 7.15% contribution alone. Perhaps some form of the employers' share of the payroll tax remains.)

3. The health care reform, on the surface, is a universal system of vouchers to purchase insurance, replacing Medicare and Medicaid and covering everyone else as well. But unlike other voucher-based plans, in this one, the size of the voucher would be individualized based on your own expected health expenditures over the coming year. "Thus, a 75-year-old with colon cancer would receive a very large voucher, say $150,000, while a healthy 30-year-old might receive a $3,500 voucher." The insurer would bear the risk of the difference between your personalized year-to-year voucher estimate and your actual expenses.

Can you even imagine the bureaucracy that would be required to determine what each individual's voucher should be, with the insurers and individuals all lobbying for them to be higher, and government trying to keep them lower? The question with any system of universal vouchers to purchase insurance will always be, why do we need insurance companies? In this case, that question is especially relevant. If the government is going to make a payment for an individual based on his or her expected health care costs in the coming year, why not just pay the actual costs?

The plan promises to "promote healthy competition in the insurance market," but that competition would take the form of a market for government error. That is, insurers would make money only when government overestimated an individual's cost. Companies would compete to insure individuals whose estimated cost was likely to be higher than their actual costs, and avoid those whose vouchers were lower. Imagine the bizarre incentives this would create, and the regulatory structures that would be necessary to manage it. At this point, the logic of a single-payer plan is unavoidable.

I'm tempted to exercise my policy wonkiness and go into more detail about how this health plan wouldn't work, but it gets tiresome. The more important question is why? Why did these two intelligent authors wind up with such a lousy package?

The common theme to these proposals, especially on retirement security and health, is that they insist on embracing the language and ideas of a laissez-faire, individualistic model, but adapting it to create a secure platform to protect against risk. Thus you have private retirement accounts that aren't really private accounts (since there's no ownership, no choice, and no risk). Or vouchers to purchase insurance that aren't really vouchers to purchase insurance (since to the extent that the government gets the estimates right, there's none of the risk-sharing involved in insurance).

And the price of these faux-individualistic policies is an enormous level of complexity that belies their original promise of "simplicity and efficiency."

The "New New Deal," then, isn't actually a thought-out policy response to the failings of the current safety net, it's a pose. The authors -- and they are not alone in this, I've done it myself -- like the sound of the idea that we need something new, individualistic, market-oriented, but they don't like it enough, so they proceed to build around it protections against all the individualism and market-orientation that they have created.

There may be other ways to construct such a hybrid that work much better. But at the end of the article, when Kotlikoff and Ferguson repeat something they said at the very beginning of the article -- "The old New Deal is all but dead. It and the Great Society programs of the 1960s are being inexorably killed by demographic changes...keeping them on life support is not an option" -- I'm suddenly unconvinced. At the beginning of the article I nodded along; at the end I was ready to defend the old programs. Because if this is the alternative, they look damn good.

Posted by Mark Schmitt on August 10, 2005 | Permalink


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fine post

Posted by: lightly | Aug 10, 2005 12:12:21 PM

As you well know the fundamental shift towards market thinking has led to a shift of risk from the top down. The crucial thing that is needed going forward, is some pressure in the opposite direction for programs that I would call universal -- programs that we as a rich society believe everyone should have, including security, education, health care and a guarantee of reasonable retirement. The universal nature of the programs makes them a bad fit for the purely market solutions (although market components are still crucial).
My theory is that as prodcutivity increases, we will expand the programs that we as a society consider universal -- think transportation.

Posted by: theCoach | Aug 10, 2005 12:25:41 PM

Mark, this is a *great* post--enormously helpful. Thanks.


Posted by: | Aug 10, 2005 12:26:07 PM

Lucid as always!

The final point you make: that much of the realignment going on in fiscal-social policy, has to do with issues of risk and its allocation or distribution, seems absolutely vital to me.

It's heartening, therefore, that "risk" is becoming (slowly) a common meme, because that suggests that at least for people who follow these debates, future proposals will not be able to blithely shift risk as the current round (key example: Bushes SocSec 'reform') have done.

Likewise, middle-class types more sensitized to the allocation of risk might make much more noise, or vote much more quickly with their feet, when employers try to shift risk too far or too rapidly onto their shoulders. This won't immediately help the situation of those who don't have many choices (those who work at Wal-Mart have little bargaining power about the company's systematic loading of risk onto them), but even there, greater awareness can't hurt.

Posted by: PQuincy | Aug 10, 2005 1:00:12 PM

Excellent job of pointing out the ultimate insincerity of Republican "market" solutions, Mark. Another great example of this is their celebrated use of tax policy to "create incentives" in the marketplace for private entrepreneurs to work their private sector magic.

"When do firms need special incentives to motivate them to invest in new ideas? The answer is NEVER. In modern market economies, COMPETITION provides firm managers with the most powerful motivation to continually invest that they will ever need: FEAR. They ultimately face both the fear of bankruptcy and the fear of LOST OPPORTUNITY. If your competition lowers its costs by investing in new equipment, or improves the appeal of its products by incorporating new innovations, then you’d better do the same or you will soon find yourself driven out of business. With only a few exceptions, additional government-provided financial incentives like tax cuts are nothing more than an unnecessary waste of tax dollars."

"Some marginal firms may have the desire to invest in their new ideas, but are nevertheless unable to obtain the funds they need because their investment plans seem too risky to banks, venture capitalists, and angel investors. One option for Congress in facing this would be to do NOTHING and simply allow the marketplace to reward firms-that-make-wise-investments with the market share of firms-that-do-not. The other option for lawmakers would be to help marginal firms obtain the funding they need for investments in the hope that they might then be competitive with better established firms. The only rational way to do this would be to provide these marginal firms with targeted investment tax credits or perhaps with guarantees on private loans."

"Risk takers do not need special additional incentives from the government to encourage them to take a chance on creating a viable business. True risk takers believe that their ideas will succeed in the market and have so much of their identities invested in them, they really don’t care if they receive any return at all on their invested time and money, sometimes for several years, as long as they have hope of eventual success. The only question for these individuals is IF they can get financing."

When Congressional Republicans say that the government should give special tax breaks to the oil industry to improve their incentive to do what they would do anyway, it is an outrageous and indefensible anti-market waste of taxpayer dollars.

Posted by: James Kroeger | Aug 12, 2005 8:28:00 AM

First of all, the New Deal was a realization of the notion--not well understood in this country, unfortunately--that taxes are the means through which the population funds government to take care of the needs of the population. We pay money in, we get services and benefits out; it's pretty simple when you think about it.

Second, we need to take note of the elephant in the living room, which is the half-trillion dollar defense budget that does nothing for the vast majority of the people of this nation. Cut that back to a reasonable level--probably twenty percent of what it is now--and we wouldn't be having this conversation because there would be plenty of discretionary income to be returned to the people in forms that benefit us.

Posted by: spaghetti happens | Aug 13, 2005 6:30:03 PM

Universal health care can be a great impact on health care system. It is unfortunate to hear so many lack health insurance. We really need to improve our health care system. Health insurance is a major aspect to many and we should help everyone get covered.

Posted by: California Health Insurance | Nov 18, 2005 5:30:13 PM

nice title. shout out to Huey Long and the others whose names we don't know who pressured FDR to make the New Deal a lot more progressive than it would have been. shout out to the socialists like Upton Sinclair for proposing and pushing Social Security type programs into the public discourse before the Democrats touched it.

Posted by: Phil | Nov 27, 2005 1:45:56 AM

hi All

from my studies of this field, my belief is that the best form of retirement savings accounts is that which operates for all workers in Singapore.

they have personal control of their own investments, and may withdraw to purchase a family home.

But otherwise their compulsory 20% savings are locked in until they retire

Posted by: Bernard Kelly | Dec 21, 2006 1:26:38 AM