We Take Care of Our Own

As Bruce Springsteen points out in his recent song, We Take Care of Our Own, American don't seem to have much tolerance for moral hazard when it comes to the social safety net.

I've been knockin' on the door that holds the throne 
I've been lookin' for the map that leads me home 
I've been stumblin' on good hearts turned to stone 
The road of good intentions has gone dry as bone 
We take care of our own 
We take care of our own 
Wherever this flag's flown 
We take care of our own 

Despite a long great recession, rising poverty and high unemployment, Americans persist in their belief that the poor are culpable for their own plight. 

Nothing divides Americans more than attitudes towards the poor. A recent Kaiser/Kennedy School pool on the causes of poverty asks the question, "Which is the bigger cause of poverty today — that people are not doing enough to help themselves out of poverty, or that circumstances beyond their control cause them to be poor?" 

Americans are split down the middle on this one. 48% says the poor aren't doing enough and 45% say circumstance beyond their control.  This issue almost defines the difference between Republicans and Democrats - Republicans go 63-31 on not doing enough while Democrats end up 57-37 on circumstances.  Not surprisingly,  Europeans with their vastly more expanded welfare state, go for circumstances by more than a 2 to 1 margin.  

Americans who believe the poor aren't doing enough are worried about moral hazard. 

Moral hazard hazard arises when an individual does not take the full consequences and responsibilities for their actions, and therefore has a tendency to act less carefully than they otherwise would, leaving another party to hold some responsibility for the consequences of those actions. 

The social safety net provides assistance to people who for one reason or another have fallen on hard times. Divorce or pregnancy might lead to poverty for a single woman with a child. Mental illness including addiction might lead to the loss of a job and eventually a home. A serious illness could lead to bankruptcy and poverty.  During today's recession, long periods of unemployment leave people with few or little resources to make ends meet.  

The degree to which  the safety net helps or hurts a person varies. In some cases,  the availability of unemployment insurance, welfare, food stamps or other benefits might lead to people postponing their job search, or avoid seeking mediation in marriage.  The assistance could insulate people from the adverse consequences of their actions. 

The problem is that there is no way to calculate the absolute level of moral hazard in social programs. In reality, most safety net programs benefit a mix of people and thus a wide mix of motivations and behaviors. The public policy question is does the amount of moral hazard created by the program exceed the net benefit to those in need? How much moral hazard are we willing to tolerate to meet the need of those in real need?  If there are 500,000 people on food stamps and 25 of them use the stamps at a casino, should the program be curtailed cutting off another 25,000 people to prevent the abuse? 

Unfortunately, most people derive the answer to this policy question based on values or ideology rather than empirical data. As we can see from the recent survey on the causes of poverty, the question of moral hazard versus needs essentially defines the two political parties in the U.S.   

Those who believe in moral character versus circumstances continue to hold to their beliefs even as conditions change radically. It doesn't matter if unemployment is 4% or 8% or if poverty rates change from 11% to 16% - the conclusion is always the same - the safety net will lead insulate people from taking action to change their situation. 

Today, in one of the hardest times in American history, a near majority of Americans appear to have little or no tolerance for moral hazard. For them, taking care of our own is merely a crutch. 

The Political Agenda

What determine what gets on the political agenda at the national, state and local level? Which issues get to be debated and considered,  which never see the light of day?

The most common answer to this question is interest groups. Interest groups invest money in campaigns and then in lobbying and their issues get considered and often accepted by policy-makers. There is no doubt that they exert enormous clout in determining the outcome of public policy issues.  However, I really don't think it is that simple. I don't think interest groups or even political parties actually get to decide most of what is considered in government. Looking at the policy agenda in the U.S. the key issues appear to be jobs and the economy, health care, gay marriage, immigration, education and the budget deficit . While interest groups may play a disproportionate role in determining many of the alternatives that are considered to solve these problems, they don't get to pick which ones draw the attention of policy-makers.

Author and professor, John Kingdon in his classic works Agendas, Alternative and Public Policy  identifies three policy streams that most often need to come together for an issue to be seriously considered by policy-makers.

1. Problems - problems come up and have to be dealt with. I worked with a former Federal Reserve Board economist during the Locke Administration who was always frustrated that the Governor's agenda never seemed to stay the course. For him, it was always issue du jour. You are working on economic development and then all of sudden energy prices skyrocket and you have to drop it and work on energy issues. Problems become the focus because citizens expect elected officials to deal with them. But problems in themselves aren't enough.

2. Solutions - if a policy-maker is going to consider an issue, she is going to want to know that the problem can be solved. Otherwise, an enormous amount of political capital will be spent and you will end up looking pretty foolish. The property tax is unfair because it doesn't include the value of financial assets in the valuation of property. But how would you do it? Could you administer it or would cheating be so prominent it wouldn't be worth it?  Tornadoes, earthquakes and Tsunamis are horrible events that should be stopped, but can you? A more realistic example might be health care reform - in a country so ideological devoted to the free market, can you have a solution that doesn't involve government ownership?

3.  Politics - there has to be the right political alignment for the issue to move through the political process. Somebody or some people who are policy-makers have to make it a priority. Health care reform wasn't politically ripe during the Cater Administration because it wasn't the priority of the president and the political mood of the country was souring on government solutions. On the other hand, the election of Barak Obama was accompanied by large majorities in the House and the Senate and Obama made it the #1 priority of his administration. Climate change was clearly on the agenda in 2008 with major Republicans and Democrats in Congress and the President seeking legislation. But the 2008 recession knocked it off the agenda as concerns moved away from the environmental protection to it's effect on jobs.

Politicians who understand these forces are often said to have a good sense of timing.  An advocate for education reform might hold off on passing major investments in education because they know that during a severe budget crisis there is no viable financial solution. But when the economy improves, and revenues are back on track, they may have a solution in hand and will work ensure that the public sees that it is a problem worth solving. When that time comes, they will jump on any news on comparative test scores or school failures try and put the issue on the agenda. Advocates for small government jumped on their chance to shrink government when the great recession and tax cuts led to huge budget deficits.

Given the problems we are facing today, the political climate and the availability of realistic solutions, what issues might be ripe for getting on the agenda?

Why is there so little emphasis on college cost containment?

Over the past 30 years one of the biggest issues policy-makers have been wrestling with is the issue of health care costs and health care access. Policy-makers have been gradually expanding access to health care starting with medicare and medicaid adding on medicare coverage of drugs, medicaid expansions by state and medicaid expansions for children. But even more prominent has been the emphasis on reducing healthcare costs. Over the years, cost-saving institutions such as HMOs have sprung up and the new health care law encourage competitive exchanges and evidence-based medicine as strategies to reduce costs.

Health care cost inflation pales in comparison with the cost of higher education. Between 1978 and 2008,  tuition has increased 9 fold while medical costs have risen 6-fold and inflation has tripled.

The cost of college dwarfs all costs including oil over the past 34 years. The last four years have made it worst as the recession has slowed medical inflation and the CPI but tuition has continued to sky-rocket as lawmakers push even more college costs off taxpayers onto students.

Health care policy started out much like higher education with little or no emphasis on cost. Doctors were beyond reproach and meddling in the work of medical industries was playing with human lives. But then along came evidence-based medicine which not only began to question to the efficiency of medical procedures but their efficacy as well. Higher costs procedures were often found to be worst for patient health. 

Up till now, higher education has dodged the conversation on both costs and outcomes.  Isn't it about time we started thinking about it?  Are the only options cutting instruction and dumping more costs on students?  





Combined Federal and State Tax Regressivity

There has been a fair amount of research done on the regressivity of Washington taxes. The Gates Commission report concluded in 2007, "Most people agree that fairness requires relative tax burdens on households (taxes as a percentage of household income) to be the same for all households, or higher for households with higher incomes (i.e., a progressive tax system). Correspondingly, a tax system that imposes higher relative burdens on households with lower incomes (i.e., a regressive tax system) is considered inequitable. Washington's tax structure is regressive. The lowest income households pay 15.7 percent of income for total excise and property taxes, while the highest income households pay 4.4 percent of income for the same taxes. Sales tax is the main cause of regressivity.

Our state's system is pretty much the opposite of the federal system. Despite all the recent rhetoric about tax inequality at the federal level, the fact remains that the federal system is progressive. According to the Congressional Budget Office, the top 1% pays an average of 31% of their income in taxes and the bottom 20%, pays about 4%. This includes the federal income tax, the incidence of the federal corporate, federal excise taxes and federal payroll taxes for social security and medicaid.

State taxes are quite regressive with top 1% paying about 1.8% of taxes and the bottom 20% paying 17% of their income in taxes.

When you combine the two results, the bottom line (the second chart above) is that the state tax system cancels out almost all of the progressivity of the federal system.  This is not true of taxes in other states. On average, taxes in other states are slightly progressive.

Washingtonians often seems themselves living in a "progressive" state. When it comes to paying for government, that is far from the case. 

The Federal Minimum Wage

Bloomberg Business Week on their opinion page editorialized in favor of raising the minimum wage to as a level as high as $9.80 an hour and with a CPI escalator.  Business Week writers argued that a "A low-wage bias is creeping into the economy" where in many cases minimum wage jobs are all that is available. The article argued that raising the minimum wage would have a "wage ladder" effect where employers would bump up salaries for slightly higher-paid employees too.

Throughout the United States, states have become passed minimum wages higher than the federal rate of $7.25 an hour. The variability of state rates along state border areas has given economists access to new empirical data from which to study the impact of the wage hike on employment. A team of Berkeley economists looked at changes in wages and employment in contiguous counties on both sides of state borders with variable minimum wages. The consolidated data showed little if any employment impacts from state who raised their minimum wage.

According to Business Week, "The Federal minimum wage was always meant to be a floor, not a ceiling. Today, someone earnings the minimum would have to work 749 hours to afford one year of health insurance premiums and 923 hours to afford a year's tuition at a public four year university.

Washington State already has the highest minimum wage in the country at $9.04 per hour. The Washington wage also has a CPI escalator which adjusts the wage with the Seattle Consumer Price Index. A prominent federal minimum wage bill sponsored by Senator Tom Harkin would raise the federal wage to $9.80 an hour.

Most of the strategies for improving living standards focus on education as the solution. For a large portion of the labor market, that makes a lot of sense. But our economy will always have a large, low-skill, low-paying labor market where education and skills will not lead to higher wages. For this sector, we have to focus on economic justice. The rest of us in society should pay a bit more for our services in order to ensure that all Americans have enough to live on.

Why do we tax business?

There is probably nothing more important to an individual or household today than a good, stable job. In countless surveys, nothing yields greater unhappiness than unemployment. There is good reason to believe that state policy-makers should focus on this issue above all others.


Creating and sustaining good jobs is all about competitive advantage. It means producing high quality goods at the lowest possible cost. It is simply about productivity. Taxes may not be the most important factor in global competitiveness but they are a factor that policy-makers can actually control.


Why do we tax business?  There are a couple of theories that are used to justify business taxes. One theory is benefits received. We tax business to insure that the price of goods reflects the social costs are spent on creating that good. These costs would include water, sewage, public safety, environmental protection and a skilled workforce. Many of these goods are goods that corporations receive for free but somebody has to pay for them - taxpayers. 


Another theory is ability to pay. Businesses should pay their share of taxes based on their ability to pay taxes. Since business owners make a lot of money, we can indirectly tax them by taxing their business.


Economists say that taxes have the effect of creating inefficiencies in both the process of production and in the distribution of goods. Taxes will change the mix of goods produced. Taxes create a deadweight loss in our economy by reducing the consumer and producer surplus by more than the actual amount of the tax itself.  


In general, taxes are most efficient when they fall on those who have the most difficulty avoiding them.  Big corporations can and do spend an enormous resources shifting avoiding taxes and the government spends enormous amounts of resources  trying to make rules to stop them.  They also spend enormous amounts of money on lobbyists to get them special tax breaks.


But most importantly, in a global economy business taxes can reduce competitiveness. They either reduce the amount of capital invested in a company or they increase the price of the good. In today's hyper competitive markets, small price differentials matter.


What if we created a serious competitive advantage for Washington by simply eliminating all business taxes. We could replace the taxes by fees on specific services and progressive taxes on individuals.


Many of the benefits received by businesses are already captured by specific fees on those services. The costs of sewage, water, electricity, and roads are already charged directly to businesses based on actual usage. Supply and demand for the specific service determine the price. We could extend this approach to directly charging businesses for additional services like education. Or perhaps we could even charge a large proportion of those services to individuals who earn money from companies rather than the companies themselves.


You can't tax a corporation; you can only tax a person  Ultimately all of the earnings of businesses go to individuals in the forms of interest, dividends, profits or wages. Rather than trying to indirectly get at that revenue through business taxes, why don't we just tax the income those individuals earn. The tax is thus based on the individuals ability to pay. There is no distortion on the productive process, no change in the mix of goods produced and no competitive disadvantage in global competition. The deadweight loss to the economy from business taxation is eliminated. 


If this is such a good idea why haven't we done this already?  I would venture to guess is that  policy-makers have never offered this specific trade-off.  Given the condition of our economy today, perhaps now is the time to look at it.

The Deficit and the Great Recession

I've thought about this for awhile, and I've come to the conclusion that the solution to the current deficit versus growth problem is pretty simple. Right now, the problem is growth. We appear to be finally in a nascent recovery. The stock market broke 13,000 for several days now. Unemployment claims have moved downward to an average which will bring down unemployment Fourth quarter economic growth is now measured at a healthy 3%.

Let me stress the word nascent. Now is still not the time to focus on deficit reduction. A contraction of government spending could send growth down into low digits and continue our economic stagnation. We need to maintain our current level of spending with longer unemployment benefits, the payroll tax deduction and maintenance of key safety net programs that will boost spending.

After growth appears to have stabilized, the problem for economic policy-makers should shift to inflation. All the money pumped into the economy will begin to tighten. This is now the time to begin cutting the deficit. You do this for two reasons. One to slow economic growth and prevent inflation. The other is to ensure that current generation pays its economic debts rather than shifting them to our kids.

The Eurozone Crisis - Things are not always what they seem

The popular story that has circulated in the richest countries is that this is a morality tale. The extravagant behavior of the Irish and Mediterranean Countries led to the crisis. Rather than working,they danced, rather than saving and investing, they spent. (known here as the Zorba the Greek Syndrome).

After the fall of communism, Germany, France, and other more developed countries sought to integrate Eastern Europe as well as countries on the periphery like Greece, Italy, Greece and Spain into the European economy. The Euro was created to avoid currency fluctuations and improve stability in trade.

The problem was that there was a European monetary system but separate fiscal systems in each country. This worked out fine until the stress of the great recessions exposed the weakness of the alliance. The nations on the periphery failed to manage their economies, spent more then they could afford and failed to invest. This led to a huge debt that would be difficult or possible to pay back. Follow this link to a comic version of the story

Consequently, the banks who had purchased government bonds from those countries were facing potential defaults from the peripheral countries. The potential of huge losses spread fear of a contagion that would lead to widespread bank failures throughout Europe and a double dip recession. Only through the generosity of the richer countries could Europe be saved from the proliferous periphery.

Here's the problem, with the exception of Greece, the debt problems of the peripheral countries was not much worse and in some cases better than the wealthier European countries. Furthermore, the moral faults of those nations was clearly misplaced. Investment and capital formation was as great or greater and the work ethic actually appears stronger (see the above graphs).

Then what was the cause of the crisis? The answer appears to be quite the opposite. The alternative explanation is that the adoption of the Euro resulted in a flow of capital to the periphery to take advantage of the cheaper labor and new markets. When the recession hit, the capital reversed it's direction leaving a massive current accounts deficit. Since all of the counties had one currency, they were unable to devalue their currency to balance the outflow. I'll cover more this in my next blog.