A Fate Worse than Debt

A Fate Worse Than Debt:
What Are the Biggest Economic Challenges Facing the U.S.,
and What Policies Should Progressives Promote to Meet Them?

By Betsy Brown
May 10, 2011

For ordinary people, the US economy is in terrible shape. The unemployment rate has gone back up to 9 percent. Economist Dean Baker writes that the decline of US home prices since last July “has eliminated more than $1 trillion in housing wealth.” (This is important because for most ordinary people, any wealth they have is tied up in their homes.) Food and fuel prices continue to increase, according to the Bureau of Labor Statistics. The profit-driven health care system in the United States is still plagued by skyrocketing costs. Most folks are clearly having a very tough time making ends meet these days.
According to many commentators and experts, our biggest economic problem isn’t any of those things, it’s a rapidly escalating federal deficit and federal debt. A deficit occurs in any year when the federal government doesn’t collect enough in revenue to pay for all of its expenditures. The debt is the total of any unpaid deficits.
At first glance, there is widespread consensus about the urgent need to get our deficit and debt under control. Groups from the political right, such as the Peter G. Peterson Foundation and the Concord Coalition promote the notion that failing to lower the deficit will create an urgent economic crisis—if not immediately, for our children and grandchildren. A Congressional Budget Office report warns of dire consequences of waiting to address this issue. A bi-partisan commission appointed by President Barack Obama issued a report called “The Moment of Truth,” warning of economic devastation unless the deficit is reduced. House Republicans passed a budget that virtually eliminated Medicare for people born after 1956 as a way to curb deficits. The progressive Institute for Policy studies seems to argue that we face a “fiscal nightmare” unless we lower the deficit, and the Congressional Progressive Caucus has produced a “People’s Budget” that promises to eliminate the federal deficit by 2021.
These groups have vastly different recipes for deficit reduction. Conservatives insist that entitlement programs such as Social Security, Medicare, and Medicaid are out of control and that they’ll bankrupt us unless we cut them drastically. Paradoxically, these same conservatives call for cutting taxes as part of the plan to balance the budget. Progressives call for raising taxes on the wealthy and cutting defense spending. Moderates call for some combination of these approaches. But all of them seem to agree that cutting the deficit and the debt are a crucial national priority.
Using information from economists and commentators I trust, I’m going to argue that in the short and medium term, the deficit is the least of our worries. In the long term, our biggest problem is rapidly rising health care costs. Shifting these costs from the federal government onto individual taxpayers won’t solve the problem. If anything, it will make it worse. Progressives need to learn how to challenge the self-serving lies propagated by the right-wing noise machine and advocate an agenda that serves the needs of ordinary citizens. Being able to do that requires us to learn both about the budget and about our history.

A Little Bit of History

The story starts with the Great Depression. Before this, the United States government had a balanced budget except during times of war. There is a comparison that always seems to be used for this. The government budget is compared to the family budget. A family has to balance its budget, we are told. During the Great Depression, that idea had to give way. Wealth was extremely concentrated. Ordinary people didn’t have the resources to buy anything. Wealthy people couldn’t spend enough on their own to restart the economy. Businesses had no reason to invest in new equipment or hire new workers (or even to keep as many workers as they already had), because there was so very little demand for the goods and services they were producing. The United States was in the grip of extreme poverty. A person might read Timothy Egan’s The Worst Hard Time as an illustration of the misery US citizens suffered during this period.
            This was when the ideas of the economist John Maynard Keynes became popular. The US government, using these ideas, engaged in deficit spending to prime the economy. Some of the programs involved spending on public works, roads, bridges, dams, and the federal government employed the unemployed to work on these projects. The Great Depression also saw the birth of government programs such as Social Security and welfare payments for needy families, programs that were meant to ease the stress of hard times for ordinary people.
The results of this were helpful, though not perfect. The economy continued to struggle until the great economic boom that the Second World War brought about in the United States. Once the war began, relief programs were abandoned in favor of war spending, but the resultant gain in employment and spending caused great economic expansion, which in itself relieved the effects of poverty. (The United States was uniquely privileged during this war, because it benefited for the demand for materiel to supply the military of the US and its allies, but was not physically devastated by enemy attacks as so many of its allies were.)
As a result of their usefulness in ameliorating the Great Depression, for a time the economic ideas of John Maynard Keynes were economic orthodoxy. During bad times, when the economy was contracting, the government ought to run a deficit and reduce taxes in order to stimulate demand. During good times, when the economy was expanding, the government ought to balance its budget and raise taxes. During the almost fifty year period between the election of Franklin Roosevelt as president in 1932 and the election of Ronald Reagan as president in 1980, we saw the development of many social programs to blunt the impact of difficult economic times and difficult life situations for ordinary US citizens, programs such as unemployment insurance, Social Security, Medicaid, Medicare, and what was once called Aid to Families with Dependent Children.
For much of this time period, the country enjoyed unprecedented prosperity—enough that businesses enjoyed healthy profits and workers enjoyed growing paychecks. This was because the economy became more steadily more productive, producing more goods and services for each worker employed. In The United States Since 1980, Dean Baker says that productivity grew 2.8 percent per year during the post war era from 1947 to 1973, and real wages rose about 2 percent every year during that period. (Baker doesn’t say this, but that means that workers captured some, but not all, of the increase in productivity.) By 1973, however, what Baker calls the “Postwar Golden Age” had ended. Productivity growth fell sharply, to only one percent a year. Employers were no longer to continue the previous increases in wages and benefits. The country suffered from “stagflation”—substantial increases in unemployment and inflation at the same time. Under Keynesian theory, this wasn’t supposed to happen.
One popular theory is that Lyndon Johnson managed to wreck the economy by refusing to choose between “guns” (the war in Vietnam) and “butter” (expanding social programs under the “Great Society”) when he drew up his budgets. The idea is that he should have chosen guns or butter—or called for a substantial tax increase to pay for choosing both. Johnson, so this story goes, did not think the public would support the Vietnam War if they had to pay for it with higher taxes or fewer social programs. Thus, he chose to engage in deficit spending during an economic boom, touching off ruinous inflation that brought the golden era to a close.
Economist Dean Baker doesn’t buy this story. In The United States Since 1980, he says that several theories have been advanced to explain the slump in productivity that took down the US economy. There was an increase in foreign competition (because countries that had been devastated by the Second World War had rebuilt their economies and were now producing goods for themselves and for export). Some analysts blamed the power of labor unions for the slowdown, and others point to the increase in energy prices that took place during that era. Baker says that most economists agree that rising energy prices played some role in the economic downturn, but other than that there is little agreement. He specifically counters the “guns and butter” story in his readers’ guide to the anti-deficit film IOUSA.
No matter how it happened, the economic downturn inspired discomfort and anxiety among US citizens. These were anxious times in general for the United States. The postwar period that had brought such prosperity to the country had also brought about the convergence of several movements toward economic and social equality. The ascendance of Keynesianism and government intervention in the economy had helped to redistribute wealth downward. Sharing the increases in productivity had been understood to be the key to maintaining economic prosperity.
During this same time period, the labor movement gained a prominent role in US society and politics. Movements for civil rights for African Americans, other people of color, and women had grown widely, especially during the 1960s. A movement for the rights of gay men and lesbians was emerging. A widespread movement had grown around the country to oppose the Vietnam War, which was viewed as an unjust war that required an unpopular draft to raise troops. The Vietnam War ended in defeat. Movements for equality and social justice were disquieting, even to many ordinary people.
In some ways, the success of the New Deal and of Keynesian economic policies had had a paradoxical social result. In assuring the creation of a comfortable middle class, it had also helped to make the members of this middle class more conservative and more hostile to poor people who needed support from government programs. Conservatives who attacked social programs and government spending played to the racism of members of the white middle class, who managed to forget their own reliance on such “middle class entitlements” as Social Security and Medicare. 

The Reagan Revolution and Beyond

The collapse of the golden era led to the rise of a right wing backlash led by former B movie actor and Republican California governor Ronald Reagan who won the White House in 1980. He proposed to restore prosperity and national greatness by getting rid of social programs, increasing military spending, cutting taxes, and reducing government regulation. Reagan claimed that a large part of the country’s economic difficulties resulted from a soaring budget deficit.
The deficit would have increased under Jimmy Carter, of course, because of the existence of what are known as “automatic stabilizers”—programs such as food stamps and unemployment insurance that automatically boost spending when times are hard. These automatic stabilizers are deliberately designed, under a Keynesian analysis, not only to help people when they need help, but also to automatically create deficit spending to stimulate the economy.
Reagan argued that this approach was all wrong. Instead of fixing the economy by creating more demand, we needed to make it easier for businesses to supply jobs, goods, and services. The way to do this was to reduce government regulation and to cut taxes massively. Reagan promised to follow this new approach while increasing military spending. Getting government off the backs of businesses and high-earning individuals would spur productivity to such a great extent that more tax revenue would flow into government coffers, rather than less. The supporters of this theory called it “supply side economics.” One of Reagan’s rivals for the 1980 Republican presidential nomination famously called it “voodoo economics”—at least until that rival, George H.W. Bush was selected by Reagan as his running mate.
The practitioners of the Vodou religion might well be insulted by the comparison of their religion with supply-side economics, but skeptics about this theory seem to be right about its results. Economic prosperity did return under Reagan—at least in part because energy prices dropped once again—but deficits soared. A reasonable person might argue that this was a victory not for supply-side economics but for what Noam Chomsky and others have called “military Keynesianism.”
Reagan’s first budget director, David Stockman, once admitted to a magazine writer that
Reagan’s real economic goal was to create a tax cut for the wealthy and to drive up the deficit in order to justify cutting social programs. This strategy has been followed by Republican presidents ever since. Here are what the results have been: a dramatic upward redistribution of wealth and a dramatic increase in deficit spending. Because wealth and income were being redistributed upward, consumption began to depend more and more on individuals and families making purchases on credit.
This was able to happen partly because government and businesses pursued policies that made it easier for people to buy on credit. It was also true that the stock market and housing bubbles made people think they had more wealth than they really did, and thus more willing to purchase more and save less. When the stock market bubble collapsed in 2000, the economy faltered, but the Federal Reserve pursued policies that allowed a bubble in housing prices to take its place. When the housing bubble collapsed, it took both the stock market and the real economy with it. More than two years later, the economy is still in fragile shape.
During the administrations of Ronald Reagan and the first President Bush, annual deficits increased from $74 billion to $290 billion. The federal debt and federal interest obligations both quadrupled. During the Clinton administration, the federal deficit steadily decreased, and in 1998 Clinton produced the first balanced federal government in more than 30 years. Clinton gave credit to the frugal policies that had been urged upon him by Treasury Secretary Robert Rubin. Dean Baker says that the real cause was probably the way that the stock market bubble increased tax revenues. This would not have been sustainable under any circumstances, but massive tax cuts under the second President Bush and the costs of new wars in Afghanistan and Iraq quickly pushed the annual deficit and the national debt to new highs. The recession brought about by the collapse of the housing bubble and government spending to prevent a complete economic collapse drove the debt and the deficit even higher.
During this economic hard time, the wealthy and the powerful are doing quite well for themselves.  Fortune Magazine reported that profits for the 500 largest US corporations grew 81 percent in 2010. According to the Institute for Policy Studies, overall individual wealth in the US has increased to “$236,213 per American adult,” an increase of 23 percent since the year 2000. But, IPS notes, “our wealth has pooled at the top,” with the wealthiest one percent of the population holding more than 35 percent of all private wealth. And corporations are sitting on record amounts of cash, which they could be using to put people back to work—but aren’t.
I will argue that over the short term, the impact of budget deficits on the real economy has been greatly exaggerated. The best thing we can do for our economy over the short term is to increase government expenditures in order to restore prosperity. In the long term, raising taxes on the wealthiest Americans and cutting back on military spending are useful options. But the most important thing we can do to create genuine prosperity in the real economy and to keep deficits at a manageable level is to reduce health care expenditures.
But first, let’s talk a little bit about the money illusion and the real economy.

Money and the Real Economy

Economist Ellen Frank points out that real economic well-being is not necessarily the same thing as having lots of money. The idea that financial wealth equals real well-being is what Frank calls the "money illusion." This illusion has been perpetuated in recent years by holders of financial wealth who wish to maintain their own position of power and influence in US society at the cost of ordinary people. "Financial wealth, after all, consists of nothing more than bits of paper and entries in computer databases--stocks, bonds, bank accounts, brokerage and trust fund balances--signifying legal claims to real resources.”
The real economy counts much more than financial wealth, and we can’t survive by ourselves. We depend upon physical goods and actual services that are produced cooperatively, things such as "food, clothing, childcare, housing." How much this real economy produces ultimately determines "how much there is to go around,"
Simple arithmetic dictates that the average standard of living in a society cannot grow faster than that society's output. Therefore, no one person's share can grow by more than the average unless somebody, somewhere, gets stuck with a smaller slice of the economic pie. If the economy grows at, say, 4 percent per year, then there will be only 4 percent more stuff--cars, bread, haircuts, housing--to go around.
Steady expansion of the real economy is what guarantees growing prosperity for average citizens. This means the economy needs to grow at least as fast as the population,” with perhaps some additional growth as workers become more productive." Ordinary people need a reliable supply of jobs and an economy that operates smoothly without sharp recessions. Because the economy often fails to meet those conditions, most people rely on government programs that spread the risks of situations such as illness, aging, and unemployment over the whole population. Shared institutions such as public schools and public libraries are also necessary for public well-being. "Only for the already rich is prosperity tied to the growth of the money economy.”
When a very few people own almost all of the financial wealth, they are able to bid up the price of real goods and services so that only they can afford them. The idea that we can create economic democracy by giving ordinary people a chance to accumulate financial wealth is illusory. Remember, there’s a limit to how much the real economy produces, and if one person gets a greater than average share of this production, someone else will get less. The myth that everyone can be rich is just that, a myth.
Even most ardent defenders of free markets admit that there are some goods and services that the market can’t provide justly and efficiently. In those cases, individuals and families are best served by government programs that make financial wealth less important. In most democratic countries, governments have submitted to popular pressure to supply such services as health care, child care, education, unemployment insurance and pensions to their citizens.
In European countries, these services and benefits are much more generous than in the United States.” This is not communism,” Frank writes, “but a simple recognition that markets fail and citizens must band together to correct these failures.” Although US voters consistently say that they want the government to provide services such as unemployment insurance, Social Security, and yes, even healthcare, we are told that we can’t do that:
The difficulty, Americans are told, is that our nation—the richest in the world, indeed the richest country that the world has ever seen—is broke, burdened by past mismanagement with a crippling debt. And until the debt is paid, or reduced, or somehow addressed, which never seems to happen, voters' dreams must be deferred.
Frank was writing in 2004, but she could have been writing in 1980, and her statement still applies today. Over the past 30 years, conservative ideologues have used the fear of deficits and debt to undermine and remove valuable social programs—all while cutting taxes drastically for the wealthiest people and corporations. They haven’t achieved their stated goal of balancing the budget or reducing the debt, but they have undermined useful social programs. When the same cast of characters warns us one more time that the sky is falling, maybe we shouldn’t take their story at face value.

The Trouble with Entitlements

            When deficit doomsayers describe the cause of the crisis they claim is upon us, they blame what they call “runaway entitlements.” Entitlements are programs like Social Security, Medicare, and Medicaid. If you fit certain criteria, you are legally entitled to the benefits supplied by the program. For instance, if you’ve reached retirement age and you’ve had payroll taxes deducted from your paycheck over your working life, you are entitled to receive Social Security and Medicare. The government is obligated to provide these programs to you, no matter what. Deficit doomsayers insist that the cost of paying for these entitlement programs will bankrupt the federal government in the long term if not the short term, and that the only way to deal with this situation is to shift the cost of paying for retirement and health care away from the federal government and onto ordinary individuals and families. Let’s review the information that shows how wrong they are, and let’s start by examining the situation with Social Security.
            Social Security and Medicare were designed as pay-as-you-go programs. The payroll taxes of current workers and employers go to pay the benefits for today’s retirees. When today’s workers retire, their benefits are supposed to be paid by the workers of the future. The difficulty is that our population is aging. In the future, a large population of Baby Boomer retirees will have to be supported by a smaller pool of young workers, and there has long been concern that this situation would put insurmountable strain on the workers of the future.
            Back during the Reagan Administration, a special trust fund was established, supposedly to “prepay” the necessary benefits for the Baby Boom generation. Payroll taxes were raised to collect more than was necessary to provide for current benefits. Special non-negotiable bonds were issued to the Social Security Trust fund to account for the overage—while the money itself was used to pay other obligations of the federal government.
In theory, these bonds are being held in reserve to help pay for the cost of Social Security for many years once currently collected taxes are no longer enough to pay for benefits. Deficit doomsayers worry that the funds needed to pay off these bonds will need to come from general revenues and will worsen the deficit. Ellen Frank argues that there is a small grain of truth in their argument, because, “Unlike other financial obligations of the government, this debt cannot simply be `rolled over.’ Retirees will need an actual stream of income—a valid and reliable claim on the economy’s output.”
There is a certain irony in deficit hawks worrying about the possibility of using general tax revenues to fund Social Security in the future, because ever since we started “prepaying” Social Security, its dedicated payroll taxes have been subsidizing the general fund. As Ellen Frank points out, these payroll taxes hit lower income people harder than they hit those who are more affluent. They tax only wages (the major source of income for ordinary people), and not interest income, stock dividends, or capital gains (which are more likely to accrue to the wealthy). Furthermore, payroll taxes are collected on only the first $106,800 of income (as of 2011). Dean Baker shows that the time period during which this subsidy began is the same period in which Ronald Reagan began pushing through enormous tax cuts for the wealthy. (See Chapter 3 of The United States Since 1980.) As I interpret it, wealthy taxpayers have taken out a loan from poorer tax payers, but now they’re balking at paying it back.
Privatizing Social Security would be both wrong and unnecessary. The People’s Budget proposed by the Congressional Progressive Caucus would phase in an increase to the maximum amount of income subject to payroll taxes to include 90 percent of the wage base by 2016. In 2012, this would raise the maximum subject to payroll tax to $170,000. While this solution does not pay back the bonds in the trust fun, it is workable and fair, and is far preferable to the nation abandoning its commitment to its retirees.

The Real Problem is Exploding Health Care Costs

            According to the Congressional Budget Office, “Under current policies, the aging of the U.S. population and increases in health care costs will almost certainly push up federal spending significantly in coming decades relative to the size of the economy” Without policy changes, the CBO says, spending on mandatory government health care programs would increase from about 10 percent of gross domestic product to about 16 percent of GDP over the next 25 years.  In addition, without an increase in tax revenue, these costs would lead to large and rapid increases in the federal deficit and debt. (See the recent CBO report “Economic Impacts of Waiting to Resolve the Long-Term Budget Imbalance.”)
            In a speech to a Brookings Institution forum late last year, Dean Baker explained what’s really going on. It’s not so much a budget deficit problem as it is a problem of rapidly increasing health care costs:
I want to say first and foremost there is no real deficit problem and therefore there is no reason to talk about taking an ax to the country’s already weak safety net for the poor. The short-term story is one where a large government deficit is creating demand and sustaining employment due to a collapse of private sector spending. In the mid-term, we can point to deficits that are somewhat higher than desired, however this is largely a story of debt needlessly creating an interest burden for the country.
  In the long-term the country is projected to face a severe problem of exploding private sector health care costs. If this projection proves accurate then health care costs will impose an enormous burden on the economy. Since more than half of our health care is paid for through public sector programs like Medicare and Medicaid, this explosion in health care costs will also create a budget problem, however it is highly misleading to refer to this as a deficit problem.
            In a recent blog post, Washington Post Commentator Ezra Klein described the dimensions of this problem. In the US, we have a “crazy quilt” of public and private health care funding, which results in our having large numbers of citizens without health insurance and a health care cost of more than $7500 per person in 2008. In places where the government provides health care insurance directly, costs are much lower. Klein says that in 2008 the per person health care cost was $3129 in Great Britain, $3700 in France, and $4079 in Canada—“and no, we’re not living longer than they are, nor getting obviously better care.”
Klein uses a health care deficit calculator from Baker’s Center for Economic and Policy Research to prove his point. Almost all of the countries listed on this calculator have higher life expectancies than the US does, and all of them have lower health care costs. If our government paid directly for our health insurance, putting our cost in line with international standards, we wouldn’t have a budget deficit. As Klein points out, “We’re paying a very big premium to avoid becoming a socialist hellhole like Canada.”
The Republicans keep trying to repeal the tepid and ineffective health insurance reform measure passed by Congress last year, in order to score points with their ultraconservative base. In this political climate, everyone knows we’re not likely to have government paid health insurance (Medicare for all) any time soon.
But attempts to solve the health care cost crisis by replacing Medicare with a system of vouchers, as proposed by the Ryan Budget passed by the House of Representatives, also have raised a storm of public opposition. The Ryan Budget proposed to push the cost of health insurance onto individuals and families, but what it would have achieved is even worse than that. As a report from the CEPR points out, because private insurance is so much more expensive than Medicare, the Ryan plan would add more than $30 trillion to the cost of providing Medicare equivalent policies over the program’s 75-year planning period.”
We need to find a different way.

Over the long term, progressives need to develop the political will and power to take on the for-profit private health care industry, especially insurers and pharmaceutical companies. In the short term, we could do worse than to embrace the proposals in the “People’s Budget” of the Congressional Progressive Caucus. Modest proposals for creating a limited “public option” health insurance plan are joined with other proposals for health care savings such as allowing the government to negotiate with pharmaceutical companies for reductions in prescription prices for Medicare recipients. The People’s Budget would also reduce defense spending, raise taxes (mostly for wealthy individuals, but also to some extent for middle-income wage earners), raise the tax on dividends and capital gains to the same level as taxes on income, and preserve Social Security. This budget would also allow for investments in infrastructure, housing, education, transportation, and energy independence that would increase long-term prosperity for everyone. Even this modest proposal might seem extreme according to the conventional wisdom. But it is no longer wise or realistic—if it ever was—to pretend that an economic system that so greatly favors the wealthy and the powerful will work in the long run for anyone.

Sources (In Order of Appearance)

Continue to increase (food and fuel prices): http://www.bls.gov/news.release/cpi.nr0.htm

Peter G. Peterson Foundation: http://www.pgpf.org/

Egan, Timothy. The Worst Hard Time: The Untold Story of Those Who Survived the Great American Dust Bowl. New York: Houghton-Mifflin, 2006.

Baker, Dean. The United States Since 1980. New York: Cambridge University Press, 2005.

One popular theory: https://encrypted.google.com/search?q=guns+butter+johnson&ie=utf-8&oe=utf-8&aq=t&rls=org.mozilla:en-US:official&client=firefox-a  (You can find this by doing a Google search on “guns butter johnson.”)

Frank, Ellen. Raw Deal: How Myths and Misinformation about Deficits, Inflation, and Wealth Impoverish America. Boston: Beacon Press, 2004. (In this paper I relied mostly on her introduction and Chapter Three, “Debt Delusions.” In addition to the areas where I quoted her directly, I used her book for background on the Keynesian consensus.)

First $106,800 Taxed by Social Security:  http://cpc.grijalva.house.gov/files/The%20People%27s%20Budget%20-%20A%20Technical%20Analysis.pdf (This is the Economic Policy Institute’s technical analysis of The People’s Budget. See Page 7.)

CEPR Health Care Deficit Calculator:  http://www.cepr.net/calculators/hc/hc-calculator.html

This work is licensed under the Creative Commons Attribution-NonCommercial-ShareAlike 3.0 Unported License. To view a copy of this license, visit http://creativecommons.org/licenses/by-nc-sa/3.0/ or send a letter to Creative Commons, 444 Castro Street, Suite 900, Mountain View, California, 94041, USA.