April 22nd, 2012 at 12:25 am

Haven’t done one of these for a while, so let’s get to it (questions edited).

From this post on Media Matters punchy reaction to a misleading WaPo article re health reform and deficits:

Q: Medicare and Social Security are funded with a dedicated payroll tax.  If the dedicated taxes ended, would the programs end?  What would the general budget implications be if those revenue streams stopped?

A: Social Security is funded through a dedicated payroll tax, but Medicare is more complicated.  Part A pays for hospital insurance and comprises a bit more than a third of the program.  This part is primarily funded through such a tax which feeds into the Medicare trust fund.   It’s a DC tic to go around warning about the trust funds demise, but it is scheduled to pay full benefits until 2024—and note that it got an eight-year extension thanks to the Affordable Care Act.

Most people read that and reasonably think—aha!—after that the trust fund is bust and Part A ends.  Nope.  Remember, revenues keep coming into the fund and at that point it will be able to pay 90% of hospital insurance benefits.  The other parts of Medicare cannot go bankrupt or whatever you want to call it.  They must be funded through the general revenues we collect each year in taxes and by patient premiums.

The other parts of Medicare are also mostly paid for by general revenues and premiums from beneficiaries.

Of course, ending their funding would end the programs, but it’s rare to hear anybody blatantly suggesting that we go there.  Neither will the “revenue streams stop.” As long as we have an economy that delivers at least some measure of growth and jobs, we will continue to spin off revenues to support critical programs like this.

Instead, you hear lots of ideas about reducing costs through benefit cuts, including increasing the retirement age, and cost shifting, both through privatization (Soc Sec—private retirement accounts with variable returns, like 401(k)’s, as opposed to its current form as a guaranteed pension) and “premium support” where you get a voucher to purchase health insurance on the open market.

My punchline here is this: the reason every advanced economy has systems like Social Security and Medicare is because the private market will not efficiently, reliably, and affordably provide adequate retirement security for those past their working years.  There’s no question we need to slow the growth of health costs, but that’s not just a Medicare or a government budget problem—it’s a national problem (health costs actually grow faster in the private compared to the public systems).

Instead of trying to figure out how to shrink these programs, I’d think about how to protect and even expand them, especially Medicare.  For example, based on its efficiency relative to the private sector, in the interest of slowing the growth of national health care spending, instead of raising Medicare’s eligibility age, we should consider lowering it.

Social Security and Medicare are not problems to be snuffed out…they’re national treasures to be preserved, improved, and sustained for future generations.

Q: Regarding my post on what constitutes tax fairness, a commenter asks: “Isn’t the reason that so few people pay Federal income taxes fundamentally wage stagnation?”

A: Well, first, about half of households don’t pay federal income taxes, so that’s not “so few people.”  But you raise a fair point.  Since deductions and low marginal rates shield lower income households from this part of the tax code, stagnant wages and incomes will have the result you suggest.

BTW, this function of progressive taxation is a source of stimulus in recession.  As the demand contraction takes hold and incomes drop, tax payments do too, so after-tax income will fall less than pretax income.

Q: From that same post, a commenter argues that flat taxes are “the only way to go” in terms of fairness and simplicity.

A: I see your points, but disagree, especially regarding simplicity…and fairness too.

What makes the tax code complicated are not the number of rates.  It’s all the different rates on different types of income, the complicated international rules, the difference in debt vs. equity financing, and basically, the zillions of loopholes.  I read the other day that after the 1986 tax reform cleaned a lot of this junk out of the code, within five years Congress had made 5,400 changes to the tax rules.

If we had a progressive system with numerous graduated rates but nothing more than standard deductions, you could look your income up in a table and be done with it.  In fact, given the information the IRS now has, they could do it for you and send you a bill.

Now, re progressive rates vs. a flat tax, as I noted in my post, progressive taxation, meaning higher income households pay a larger share of their income in taxes, has always been the American norm for the federal income tax.  In fact, when the modern federal system of taxation first got underway in the early 1900s, the income tax fell almost entirely on the wealthy.   And while the top rates moved around a bunch, they were often much higher than they are now (see figure).

Source: Romer and Romer.

One historical rationale is that the economy that the tax system helps to support—the public infrastructure, the educated workforce, public safety, the regulatory structure–disproportionately benefits those with higher incomes, so it is legitimate for the wealthy to pay a disproportionate share.  Another is to avoid monopolies and the excessive concentration of wealth, conditions which can be an accident of birth (and to set a flat tax high enough to counteract those problems would be too tough on the middle class).

Yet another is to raise ample revenue to support the functions of government without undermining the economic opportunities of lower-income families.  There’s also the rationale based on the theory of the diminishing marginal utility of money—a dollar means a lot more to a poor person than to a rich person—but a) that’s not too convincing on its face…one can imagine rich people who love a dollar as much as a middle class person, and b) depending on the rate at which the utility function flattens, you could defend a flat tax using this rationale.

Q: After reading this post, a commenter asked: “Isn’t inequality a symptom of the “financialization” of the economy—the large and growing fraction of GDP comprised by the financial sector?  After all, what is the actual value added of the financial sector?”

A: Well, it’s certainly the case that the finance sector has been expanding as a share of GDP for more than 60 years (see figure) but that includes periods when inequality was growing and when it was not, so it’s not as simple a connection as you might like.  And it’s essential to recognize the critical role play by financial intermediation—the function by which the savings of some become the productive investments of others—in economies throughout history.

Source: Kaufman Foundation.

Economists of Keynesian bents typically stress the role of demand, but think of demand as the heart of the system and credit flows as the blood in the veins.  Then think about what happened when we had a credit aneurysm in 2008!

But that said, and this is a longer conversation, I think you have a point.  In recent years, financial and credit markets have been less likely to allocate capital to its most productive uses and more likely to blow it into inflating bubbles—dot.com bubbles, real estate bubbles, currency bubbles, etc.   Financial “innovation” often served to obfuscate the true risks of these bubbles at tremendous cost to the real economies of countries across the globe.

And yes, financialization has certainly served as a booster rocket to inequality in recent years, both before and since the Great Recession.

It’s notable in the above graph that after the Great Depression, the highly unstable financial market significantly downsized.  It’s too soon to tell whether something like that’s going to happen this time around–the figure only goes through 2010, and we do know that financial sector employment is well off of its recent peak.  But my guess is that the sector is much less likely to contract that much this time around.  It’s a lot more embedded in our political economy.

What’s the optimal size for the sector and what policies would help us get back to healthy capital allocation versus excessive speculation?  Good questions for another day.


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6 comments in reply to "YAIA"

  1. Michael says:

    The difference between the post-Depression and now is that then had FDR and now has Obama. Obama will never preside over a reduction in the size of the financial sector, as he shares our elites’ general belief that the purpose of the economy is to make hedge fund managers rich, not provide general prosperity.

    • Michael says:

      This is not to imply that we have an alternative, as Romney not only shares that belief, but is a member of that class himself and will be that much more diligent about his theft.

  2. oh4real says:


    Re: “It’s too soon to tell whether something like that’s going to happen this time around”

    Based on the two charts in your post, it strikes me that the top marginal tax rate is inversely proportional to the GDP sharee finance industry. GDP share peaked in 1932 and cliff dived the following year when the marginal tax rate jumped.

    Therefore, I don’t think it’s too soon, with the fat cat congress we have, top marginal rates are not likely to go up and so financialization is not heading down any time soon.


  3. perplexed says:

    -“I think you have a point.  In recent years, financial and credit markets have been less likely to allocate capital to its most productive uses and more likely to blow it into inflating bubbles—dot.com bubbles, real estate bubbles, currency bubbles, etc.” 

    But why would we expect the response to increasing WEALTH concentration to be any different from this? By providing monopolies and other government subsidies (lower tax rates, tax avoidance loopholes, free government insurance to corporations and TBTF banks that is more valuable to the mega-wealthy, etc.) our government systematically concentrates our national savings in the hands of fewer and fewer people. These mega-wealthy investors face a dramatically different risk profile than the general population does (extremely risk seeking vs. risk averse) and they invest accordingly. The same amount of wealth widely distributed would be invested very differently than it is now that its concentrated in the hands of few.

    -“Financial “innovation” often served to obfuscate the true risks of these bubbles at tremendous cost to the real economies of countries across the globe.”

    What it served to obfuscate was who was actually taking the risks and who was being compensated for taking them. The public was taking the risks while the oligarchs and their banker support systems were dividing up the profits. As your graph demonstrates, the last big spike in the financial sector percentage coincides with the last big spike in wealth concentration. If you’re making huge profits by taking huge risks (the largest of which are born by the public at large), what difference does it make if you pay a substantial premium to those booking the bets? What’s the price elasticity in this market? It would be good to see the Gini coefficient for wealth (not income), charted along with this financial sector size. As Keynes so well pointed out there is no advantage to concentrating savings among a small minority. We need government policies to stop generating these outcomes and then providing free insurance to the wealthy beneficiaries of this system and start supporting widely dispersed wealth accumulation, and the properly directed investment that will result from it. This has gone on for so long and to such a degree now that we probably can’t correct it without significant wealth and inheritance taxes.

    -” But my guess is that the sector is much less likely to contract that much this time around. It’s a lot more embedded in our political economy.”

    The sector contracted last time because the government intervened on behalf of the public to stop the abuses. We still have the same number of TBTF banks that we did in 2007 and they’re even more powerful than they were then. Five years is plenty of time to at least make some adjustments and put the public in a more secure position. Not only was it not done, we’re no longer even talking about it. Its not likely to happen on its own.

  4. Tyler says:

    Q: Medicare and Social Security are funded with a dedicated payroll tax. If the dedicated taxes ended, would the programs end? What would the general budget implications be if those revenue streams stopped?

    A: “The exercise of linking future benefits and projected payroll tax revenues is an accounting farce, done for political reasons. That farce was started by FDR as a way of protecting Social Security from cuts. But it has become a way of creating needless anxiety about these programs…” – James Galbraith

    “We don’t literally need [taxes] to pay for … spending.” – Dean Baker

  5. Th says:

    I will stick with my completely made up and unscientific theory that any time the top marginal tax rates dip below 40% we have finance driven bubbles leading to recessions. The wealthy use the financial services industry to make money for them without any additional work on their part. The 1920’s cut gave us the Great Depression, the 1986 cut gave us the S&L meltdown, Bush and Clinton’s increases didn’t get us back over the bar and we had the dot.com bubble and then Bush widened the gap and we got the mortgage bubble.

    I second oh4real above. Financial services will decline when we raise marginal rates above 40% and not before. A more scientific calculation may show the trip wire is really 50% or so and the S&L crisis was in the works before ’86.