Arnold Kling  

Saving the U.S. Budget

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House Concert Recorded... To Cut or Not to Cut?...

In this paper, I describe an approach that relies on cuts to future entitlement spending. The most important idea is to transform Medicare into a combination of a voucher and extreme catastrophic insurance.


Under the proposal here, as the U.S. population ages, the spending on catastrophic coverage will go up, and the amount available for vouchers will decline, particularly on a per capita basis. By 2020, this plan will allow vouchers of $6,000 for seniors aged 75 and up, with only $2110 for seniors aged 65-74. By 2030, the voucher for seniors aged 75 and up would be $5,000, and the voucher for seniors aged 65-74 would be just $700.[7] Keep in mind that these figures would go up by the ratio of nominal GDP in those years to nominal GDP today. The net result is that by 2030 seniors would have to fund much of their health expenses, including health insurance, out of their personal savings.

Keep in mind that the status quo is for the U.S. government to pretty much go bankrupt by 2030. If you do not like these cuts in Medicare, you need to find some sort of alternative.

The paper has a lot of useful numerical analysis.


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COMMENTS (19 to date)
Fenn writes:

so what happens when the US does go bankrupt?
what would that look like?

jimbo writes:

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Matt writes:

@jimbo

The US government cannot simply continue to issue currency to cover its debts indefinitely (see Zimbabwe for why). Sooner or later, somebody has to pay the bill.

Jimbo writes:

Right on schedule, Matt changes the terms of the discussion. We move from "bankrupt" (which means "can no longer make it's payments", to "hyperinflation" (currency becomes worthless.

I will now make the point that Japan has been issuing vast amounts of Yen for the past 20 years, has no inflation, and is able to sell it's debt at 0% interest rates.

To this, you will respond either a.) "Well, that's because they have a trade surplus!", or b.) "Well, their economy has been in the dumps! Is that how you want to be?", which will again have redefined the term "bankruptcy" beyond any recognition.

Oh, and as for your (also predictable) shouts of "Zimbabwe!" read this:

http://bilbo.economicoutlook.net/blog/?p=3773

hint: hyperinflation has to do with supply shocks, not with money issuance per se.

wlu2009 writes:

To piggy back off Matt, printing currency to pay debt may eventually drive inflation (and therefore nominal rates) so high that rollover of debt becomes impossible. At the point the only option is true default or default by paying with massively inflated dollars. They are pretty much equivilant. Not paying your debts in full or paying them with currency that is worth far less than expected at debt issuance is a distinction without a difference.

Of course the likelihood of this is pretty much nil. We don't face a choice of spending cuts or bankruptcy. More likely we face the choice of spending cuts or massive tax increases a la Western Eurpoe. Still not an enviable dilemma, but "bankruptcy" is much less of an option than implied here.

jimbo writes:

Oh, and BTW: under a fiat money system in a floating exchange regime, there is no functional difference between "money" and "debt". Both are simply liabilities of the government.

When you (or China, for that matter) go to the government to redeem your Treasury bond, here is what happens: they debit your "Treasury Bond" account, and credit your (or your bank's, but the mechanics are the same) "reserve" account. It's the same as making a transfer from your savings account at your bank to your checking account. If China demanded all the money it has "lent" to the U.S. tomorrow, all that would happen is that the total amount of treasury debt would be reduced and the total amount of reserves increased. Since the total amount of financial assets wouldn't change, it would have no effect on aggregate demand and thus no effect on inflation.

bill shoe writes:

Arnold,

Thanks, good paper if somewhat depressing.

The paper indirectly drives home the reality that any Medicare reduction must make more use of incentives for the remaining spending. I think many people who oppose changes to current law dislike the use of incentives more than the reductions themselves. This would make it difficult to enact effective changes.

ad nauseum writes:

I think Arnold's point is that our entitlement spending is unsustainable. The comments, so far, don't help to refute that. All the comments have done so far is lead me to believe that our options are:

- bankruptcy

- really high inflation

- really high taxation

- Arnold's proposed cuts, or something similar to Arnold's proposed cuts

- any combination of the above four

Now, which one of those looks like the best option?

ad nauseum writes:

Hmm, I also found this article, which won't make Jimbo very happy. Here's an interesting excerpt:

"When governments go bankrupt, they pay off their debts by running the printing presses, which results in high inflation and perhaps hyperinflation. Under the condition of bankruptcy/hyperinflation, everyone gets poorer, including both workers and retirees. Argentina is a good example of a country that has been going through bouts of bankruptcy. A century ago, it had the world's third-highest per capita income and was on par with the U.S. But Argentina now ranks about No. 70 in the world with a per capita income of only around $13,000 per year as contrasted with the U.S. and Ireland with per capita incomes of about $41,000 yearly. "

Matt writes:

@Jimbo

Good work, you've successfully made the point that bankruptcy is not literally the same thing as hyperinflation. That doesn't change the fact that neither is a desirable state for the US economy, and sustained deficit spending at high percentages of GDP inevitably leads us to one or the other. Nor does it change the accuracy of Arnold's argument, that significant spending cuts are necessary.

Lo Statuz writes:

No rational politician is going to cut benefits today to prevent something really bad from happening 20 years from now. If there were the equivalent for Medicare of melting glaciers and drowning polar bears, something with real emotional impact, some political entrepreneur might be able to run with it. Talk about percent of GDP in 2030 and thumbs hit the remote controls.

This kind of analysis is still very useful. If Arnold Kling can do a couple of these a year, then by 2029 when things are obviously dire, he'll have established great credibility, and can propose legistlation that might actually pass.

I still wonder why investors today are willing to take 4.7% yield on 30-year Treasury bonds. Is there a way that Arnold Kling is right and the bond market is efficient?

Dan Weber writes:

We don't have to cut benefits today for today. However, we can cut benefits today for tomorrow.

Yancey Ward writes:

The key paragraph is this one:

The net result is that by 2030 seniors would have to fund much of their health expenses, including health insurance, out of their personal savings.

This cuts right to the heart of the problem with promised entitlements- they are basically unfunded at the moment. Far too many working adults today are making no provision for funding their lives after their working years. Such a system cannot survive much longer.

Randy writes:

I'd say bankruptcy is the most likely option. No progressive (and they all are) will find it acceptable to make the necessary level of cuts, so they will try to raise taxes, and eventually a generation of workers will simply refuse to pay.

P.S. As Fenn suggests above, bankruptcy is not inherently bad.

Mercer writes:

You do not mention that people in the US pay more for medical services then other countries. I would try to bring US medical costs closer to other rich countries:

Make it easier for doctors to immigrate to the US.

Let recipients use Medicare money to have medical treatment in other countries.

Let nurses do more medical procedures that are currently done by doctors.

Legalize prescription drug importation from Canada.

Justin writes:

Phase out Medicare, Medicaid, SCHIP, Indian Health, the whole deal by sometime in the fairly near but not so far future - say 2019.

Start cutting federal taxes which fund those programs as they are phased out.

Tell the states that figuring out a health care system is up to them, and they have until 2019 to get it ramped up. Send them this link: http://www.moh.gov.sg/mohcorp/hcsystem.aspx?id=102 for starters, but let them do whatever they feel like - they can try single payer, the Brad DeLong catastrophic plan, the Kling plan, the Obama/Romney plan, the Kotlikoff plan, whatever. After awhile it should be clear which types of programs are most effective, and you'll have states reforming their own systems to look more like the effective programs.

Fenn writes:

I reiterate my request (as a purchaser of books 1 and 2, /brownnose) that Arnold briefly describe what a modern depression might look like. Mad Max or http://www.overcomingbias.com/2008/11/modern-depressi.html?

there have been enough "have a nice day"s here lately that I'd like to know just how nice a day to have.

Rif writes:

Arnold,

Great paper. I've really been enjoying your blog.

I had a question. Suppose we were to try to get our government to fiscal stability entirely by raising taxes rather than cutting revenues. Do you have a pointer to numbers on what that would like? Looking at the numbers, it seems like we could be OK for another 50 years or so if we raised taxes by a few percent. Many of my colleagues who I've shared your paper with seem to strongly prefer that idea to your plan.

Arnold Kling writes:

Rif,
Raising taxes by "a few percentage points" means raising them by a few percentage points of GDP. It also means not really closing the fiscal gap, but keeping it so that it grows at the rate of GDP or a little less.

That is, many economists think of a sustainable fiscal policy as one in which the debt keeps growing, but at a slightly slower rate than GDP. It's like a sustainable mortgage where the outstanding principal keeps rising, but at a slightly slower rate than the price of the house.

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