For 'Faster Growth,' Soak the Poor?

Josh Barro is the lead writer for the Ticker, Bloomberg View's blog on economics, finance and politics. His primary areas of interest include tax and fiscal policy, state and local government, and planning and land use.
Read More.
a | A

(Corrects description of economy in 16th paragraph.)

This weekend, the Wall Street Journal assembled a redoubtable list of conservative heavies in economics (George Schulz! Gary Becker! John Taylor!) to produce a completely insane account of what is wrong with America's economy and how to fix it. The upshot of the piece is that the U.S. economy is in the tank because the government gives too much money to poor people, and so it should stop.

What's most amazing about this piece is what's not in it: any acknowledgement of the specific circumstances that led to the downturn of 2008 and the slow recovery from it. There's no discussion of the housing bubble and the financial crisis, of weak consumer demand as households struggle to deleverage, or of the vast number of job seekers for each available job.

Instead, the authors identify the country's pressing problems as "excessive spending and taxes, growing debt, interventionist monetary policy, and burdensome regulations that have slowed economic growth and job creation." Some of these conditions have indeed arisen from the 2008 crash: Recessions cause government spending and debt to rise relative to the economy. But the authors have the causation wrong: Slow growth has led to rising spending and debt, not the other way around.

So why focus on high spending and regulation rather than the actual cause of our economic woes? Conservatives have made these complaints for the past 30 years. The choice to ignore current economic conditions allows them to advance the same set of soak-the-poor policy solutions at any time and in any economic condition.

Take Medicaid, for example. The authors endorse Republican Representative Paul Ryan's approach of issuing block grants for the program and letting them increase only in line with inflation and population growth. Since medical inflation far exceeds general inflation, such a reform would require some combination of deep cuts to benefits and increases in state spending on Medicaid. Also, since demand for Medicaid grows in recessions but the block grants wouldn't, states would be left to manage the cyclical pressures on Medicaid, worsening state budget crises.

Of course, the authors hope to mitigate these problems by slowing medical inflation. But that's hard, and we don't know how well approaches to that will work. The right order of operations is to implement policies that slow medical-cost growth and use the savings to control the budget without withdrawing support from the neediest Americans. Roughly, this is the Democrats' approach.

Instead, the authors would cap Medicaid spending, reject price controls even though the countries with the most market-oriented health-care systems have the highest costs, and then hope that health-savings accounts and information sharing will drive costs down enough so that the poor don't get totally screwed.

When talking about the defense budget, the authors appropriately note that spending should be driven by "a national-security strategy" and not the need to hit a specific target for spending as a share of gross domestic product. They propose to limit federal spending on Medicaid to not just a fixed share-of-GDP target, but to one that would decline over time, without knowing how effective efforts to reduce medical inflation will be. It's the sort of faith-based approach you would take if you don't think it's very important whether people with low incomes can get health care or not.

For Social Security, they urge that "the indexing formula originally adopted in 1977 should be modified for future retirees so their inflation-adjusted benefits are the same as those received by today's retirees." This proposal is not the chained consumer price index reform favored by some Republicans and Democrats that would change the price inflation measure used for Social Security to a lower and more accurate one, modestly reducing benefits. It is a much more drastic change that would greatly reduce future retirees' Social Security benefits compared to what they are currently promised.

Currently, Social Security benefits are linked to both wages and prices. Your benefit in your first year of retirement is determined as a ratio to your taxable wages in your 30 highest earning years. So the average initial benefit grows over time in line with average wages. Then, once you are retired, your benefit grows annually in line with a measure of price inflation.

Schulz and his co-authors want to drastically lower benefits by abolishing the wage link entirely and tying the growth of all Social Security benefits to prices. The authors note that their proposal would reduce the expected benefits of a typical 25-year-old today by one third.

The authors say it's absurd to call such a proposal a "cut"; after all, on an inflation-adjusted basis, Social Security benefits would be held fixed. But over time, as economic output per capita grows, so does our idea of what constitutes a decent retirement income. The Schulz proposal would mean that even as the U.S. got richer over time, there would be no rise in the standard of living supported by Social Security, which accounts for half the retirement assets of the typical household.

The article is another great example of conservatives' empathy gap on economic issues. The authors emphasize that entitlement cuts must be done in a "humane" way. But they do not stop and think about whether a one-third reduction in Social Security benefits would seem humane to a middle-class person who depends on Social Security as his largest source of income in retirement, as most do. They don't reckon with the possibility that capping the federal commitment to Medicaid would have not just fiscal effects but also human ones: denying health care to people who need it and cannot afford it.

And because there is no consideration of these costs, there is no cost-benefit analysis of them. Deep cuts in Social Security benefits are one way to address long-term budget gaps; higher payroll taxes are another. The authors do not address the relative costs of these approaches, nor do they acknowledge the diminishing marginal utility of money: that is, that policies that disproportionately reduce the incomes of people at the middle and bottom of the income spectrum (like cuts to Medicaid and Social Security) create extra misery, as these people get the most value out of another dollar at the margin.

The authors' only journey into the mind of a poor person comes in their discussion of poverty traps, where they note that many people receiving government assistance face very high marginal tax rates. As they earn more money, they face the loss of government benefits, and so they are discouraged from working. This is a very real problem that the left sometimes ignores. But even here, their discussion is flawed for two reasons.

First, the authors do not admit that this problem is less important now than it has been at almost any time since the creation of the welfare state. The depressed economy means that there are more than three people looking for work for every job opening. Disincentives to work do not significantly reduce output because there is much less work available than there is demand for jobs. So this is a problem we don't have to fix right away -- the most important economic task we face today is raising aggregate demand, not inducing work.

Second, there are ways to deal with poverty traps besides cutting benefits. Rules like time limits and job-search requirements are other ways to encourage beneficiaries to get off benefits and into work. The Patient Protection and Affordable Care Act changes the loss of Medicaid benefits from a cliff into a slope, so poor people will not have to fear losing their health benefits if they take low-wage jobs. Austria pays unemployment benefits as a lump sum, so the unemployed are not penalized financially for returning to work. Economist David Autor at MIT has advanced ideas to reform disability programs so that they encourage companies to keep disabled people in the workplace. Fostering pro-work social norms can also play a role in making poverty traps less harmful.

So why respond to the poverty-trap problem by calling for big cuts to benefits? The answer, of course, is that every economic ill must be shoehorned into an argument for lower taxes and less government spending. If a proposed solution to an economic problem doesn't involve taking benefits away from poor people, then it's not a solution at all -- at least by the logic that prevails on the Wall Street Journal editorial page.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.