Integrity at Scale Blog

Chapter 18.

Another Failure Spiral

 

America's Special Interest Economy

What does the typical homeowner do when something turns out to be broken?  Perhaps there’s a puddle of water on the floor in front of the refrigerator.  Or the garbage disposal has seized up.  The heater fan in the car no longer works.  We have faced such problems before.   We know what to do.  We look around for a repair service.  Refrigerator guys fix refrigerators.  Appliance guys fix garbage disposals.  Auto repair shops replace broken heater fans.  Find the fix-it person.  It’s a simple paradigm. 

But what if the American economy is broken?  It hasn’t come to a dead stop, but it malfunctions badly.  Then what?  Years ago in my taxicab days I had a passenger who told me that he’d bought an old Hudson off a farmer and driven it thousands and thousands of miles without ever changing the oil.  Now the Hudson wouldn’t run.  Pretty simple diagnosis.  Operator error.  The vehicle stopped working because the operator hadn’t bothered to take care of it. It’s not a bad analogy for what ails the American economy.  It malfunctions rather badly because we, the American public, have committed a long string of operator errors. As business leaders, we have made operator errors, choosing corrupt answers that undermine the national interest.  As voters we have made operator errors, electing politicians who haven’t a clear sense of how to advance the national interest. The American economy malfunctions because operator error in high places is so common. 

Operator error is easy to fix when the rules are known.  One changes the oil in one’s car every five thousand miles. 

Operator error is more difficult to avoid when the rules are unclear.  It isn’t altogether clear which principles are best for running an economy.  Many of us firmly believe in operating principles that don’t work out well in practice.  We have absorbed a worldview that seems to make sense; by the millions, we proceed to act on that worldview, regardless of its flaws; in the long run, its principles end up damaging the nation. 

It is difficult to let go of deeply held beliefs.  Our habits teach us to defend them; our peers teach us to defend them.  We may be in the grip of a poorly chosen paradigm but we stay with it because it feels right.  Isn’t this the way the world is supposed to work?

When I hired on with Cummins, at its engine plant in Jamestown, New York, I landed in the midst of an exciting and tense time.  The old manufacturing paradigm wasn’t getting the job done.  Japanese rivals had shifted to a new paradigm, boosted their quality, cut their costs, and mounted a serious challenge to Cummins’ strong market position.  The old factory paradigm wasn’t adequate any more, but we couldn’t imagine anything different.  The old paradigm came to be called by many names.  “Push Manufacturing.”  “Just In Case Inventory.”  “Corrective Action Quality.”  It was the only paradigm that many people knew.

Had Cummins stayed with its old habits, it would have been a very serious case of operator error.  A new paradigm was needed.  Cummins executives were more than ready to shift paradigms, if that’s what it took.  The Jamestown Engine Plant got swept into the change.  We had to learn a new paradigm; we had to make the wrenching decision to let go of the old paradigm.  The rules had changed.  Old ways of doing business were now seen as a high level case of operator error. 

The new paradigm was built around new ideas, new concepts, new language.  Pull Manufacturing.  Just In Time Manufacturing.  Zero Inventory.  Total Quality.  In time the quality standard came to be called Six Sigma, statistical jargon for failure rates so low that they are six standard deviations away from the mean.

When an organization sets higher standards for itself, the consequences for its employees can be wrenching.  It takes many rehearsals, if you will, to unlearn the old dance and get the new dance embedded in muscle memory. 

Those who worked at the Jamestown Engine Plant made the transition.  Those who worked at Plant One, in Columbus Indiana, failed to make the transition.  They could not unlearn the old, they would not accept the new.  Cummins management grimaced in dismay, closed Plant One, and transferred its product line to Jamestown.  New ways of doing business take hold unevenly. 

This is America’s challenge in a nutshell.  We are wedded to ways of doing business that undermine our national interest.  Operator error is everywhere, but we don’t recognize it because we have yet to unlearn the paradigms that lead us astray.  Too much muscle memory from the past, too little ear for the music that awakens a successful future.

One cannot run a car forever on the idea that its oil never needs changing. One cannot run a modern economy on the idea that integrity at scale simply doesn’t count. It is time to acknowledge our errors and pledge ourselves to a better path in the years ahead. 

An earlier chapter used a Failure Spiral diagram to make the point that urban America is stuck because we have never acknowledged the cumulative impact of a long series of policy misjudgments.  It is time to employ a similar diagram to make a similar point.  The American economy of today is run on special interest principles.  Corruption at scale is more often the rule than integrity at scale.  Each compromise seems clever to its sponsors.  The cumulative impact is damaging.  Should a nation make one or two major errors of judgment, it will find it has dug itself into a modest hole.  Should that same nation make a succession of major errors, it will find itself in quite a deep hole.

This chapter offers a diagram of “America’s Special Interest Economy.”  In the urban diagram, the box in the center was labeled “Underclass Culture.”  A similar box in this diagram is labeled “Overclass Culture.”  It is a culture compounded of two major parts, the Overclass culture of the nation’s business elites, and the Overclass culture of the nation’s political elites.  It is a culture driven by reciprocal favors.  Political elites write laws that dispense special interest rewards; special interest elites make a point of rewarding their political friends and punishing their political enemies. 

 Arrayed around the outside of the diagram are three broad groupings: America’s Middle Class, at the bottom;  Business, on the left; Government, on the right.  Each is further subdivided. 

America’s middle class is represented by two broad headings, “Workforce” and “Retirees.”  Two distinct groups.  Two distinct sets of issues.

Business is divided into two broad categories, “Tangible Business” and “Financial Business,” and the tangible economy breaks out two major sectors for special consideration, the Energy Sector and the Medical Sector.  Each is exceptionally large, and each operates unwisely.  One might imagine adding other sectors as well; these two will get the discussion started.

Government is examined under four headings – Federal Reserve, Tax Collections, Spending Programs, and Borrowing.  The nation’s competence is tested differently in each.

Taken as a whole, the chart suggests the story of a nation that cannot bring itself to operate its economic affairs in a competent and responsible manner.   Its ideas lead it astray, its behaviors carry it astray.  On one front after another, this chart suggests a larger story of operator error.

Tangible Business

Begin in the upper left, with the non-financial side of American business.  Two major forms of operator error must be recognized.  Washington hasn’t protected America’s manufacturing sector.  And Washington has also given up on American Dream Capitalism. 

America cannot prosper without a competent manufacturing sector.  The Information Technology and Innovation Foundation identifies five major reasons to defend America’s manufacturing capabilities.  Only with healthy manufacturing can America restore its trade balance.  America’s ability to create good jobs requires a healthy manufacturing sector.  Manufacturing drives R&D, and vice versa.  Manufacturing and services require each other.  We cannot have a strong services economy unless we also have a strong manufacturing economy.  And manufacturing capabilities are essential to our defense and our national security. 

Yet manufacturing is in decline.  The Commerce Department tracks the nation’s manufacturing capabilities under nineteen separate headings.  The American economy is shrinking in fifteen of those nineteen. (The Information Technology and Innovation Foundation studies these trends; see http://www.itif.org/files/2011-national-manufacturing-strategy.pdf, pp 19-20) 

Both national parties have shown themselves to be incompetent defenders of America’s manufacturing capabilities.  Free trade ideology hampers the Democrats, free market ideology hampers the Republicans.  In a competent America, Democrats and Republicans would work together to protect America’s manufacturing capabilities.

The loss of American Dream Capitalism is another distressing indication of America’s economic incompetence.  The switch to Gated Capitalism depresses the earnings and the buying power of the American middle class.   Faltering demand within the middle class depresses America’s overall GDP growth rate.

A competent nation protects its manufacturing sector.  And it protects the earnings and the buying power of its middle class.  America has fallen behind on both counts.

Energy Sector

A competent United States would take a careful look at fossil fuel energy and ask the hard question.  What happens if the world’s energy industry stays with fossil fuels?  A competent nation would look at the Earth’s natural cooling system.  It would acknowledge scientific reality – the more carbon dioxide we humans dump into the atmosphere, the more we  interfere with the Earth’s natural cooling processes, and the more we tamper with all the different parts of the global climate.  The Earth gets irreversibly warmer.  Climate behaviors are irreversibly altered.  Carbon dioxide in vast quantities is just too dangerous.  Fossil fuel energy has to be phased out, as rapidly as possible.  Renewable energy has to be phased in, as rapidly as possible.

"We don't have to read the operator's manual for planet Earth," we are told.  "If we pretend that carbon dioxide doesn't matter, then it won't matter."  

Competence begins with integrity.  A rising stock of carbon dioxide has unavoidable consequences for the Earth's natural cooling system.  It is a fundamental law of physics, one that cannot be repealed.  Citizens of good character accept the laws of physics and adjust their behaviors accordingly.  And a truly competent nation does the same.  Its energy strategy affirms the dangerous link between fossil fuel consumption and irreversible climate change.  Its energy strategy also acknowledges the presence of renewable energy in abundance. 

That is not today's America.  Today's energy strategy is a toxic mess that gravely damages our nation's energy future.  "Operator error" is a polite term for a corrupt and dangerous course of action. 

Medical Sector

This topic got a thorough workout in the chapter before last.  Overpriced medicine damages the nation’s economic interests in a number of ways. Other nations have affordable medical care, and this gives their companies a significant – and unnecessary – competitive edge in global markets.  As the Boomer generation retires, American demand for medical care will rise sharply.  Organize the nation’s medical industry responsibly and the Boomer retirement surge has a chance of being manageable.  Allow today’s unaffordable system to continue, and the Boomer retirement surge will blow all the fuses.  Nothing as costly as medicine can make us stronger if the nation’s special interests are allowed to write the rules.

Financial Business

For many years, the nation’s financial sector served the nation reasonably well because New Deal rules forced it to operate with a measure of responsibility.  In the late 1990s, Republicans and Democrats together cast those rules aside.  A process of rational irrationality took over.[i]  Players maximized their own self-interest without regard for the consequences the nation might suffer.  The Federal Reserve looked the other way, federal regulators looked the other way, the Congress looked the other way.  And then the financial system seized up.  Supposedly impregnable firms were suddenly at the edge of bankruptcy.  The financial system as a whole had pushed the nation to the edge of a major Depression.  The whole process is best understood as a massive self-inflicted wound.  Rules that protected the national interest had been set aside; special interest priorities were given a green light.  A competent America would never have put itself in this hole.  But America isn’t run by those who pursue the national interest; America’s economic rules are being written on behalf of the nation’s special interests.

 Government (Federal Reserve)

The Federal Reserve can be a force that protects the national interest, but that’s never a given.  In the Greenspan years, the Federal Reserve operated in ways that undermined American Dream Capitalism and favored the advance of Gated Capitalism.  Chairman Greenspan’s policies fostered just enough unemployment to put the American middle class at a perpetual disadvantage. 

It is difficult to say where the Fed’s loyalties will be when/if the American economy finds its way back toward full employment.  Will the Federal Reserve be a force for full employment and equitable wage and salary growth for all Americans?  Or will it be a force for chronic unemployment?  Much depends on the nation’s larger sense of direction.

18.1 Version 2011-06-27.

---

[i] “Rational Irrationality” is a central concept in John Cassidy’s book, How Markets Fail:  The Logic of Economic Calamities.  Picador.  2010.

 

 

18.2 Government (Deficits & Debt)

A competent America would have the luxury of two competent political parties competing for the responsibilities of national leadership.  Either party might capture the White House or the Congress and the nation’s budget would be responsibly managed.  The government would play its proper role in keeping America healthy and strong.  Annual deficits would be modest and the Gross Federal Debt would be relatively modest as well - no more than a third of total GDP, say. 

By this standard, today’s political parties both flunk.  Deficits have been the recent drug of choice on both sides of the political aisle, and now the nation has its back to the wall.  In the following pages, we will let the numbers set the context.  And we will learn what we can from the stories they reveal.

Let’s begin with a high level summary, total Federal Receipts and total Federal Outlays, displayed as a percent of GDP.[i] 

In the line graph above, the numbers for 1947 through 2010 are based on history, while 2011 is shown as an estimate.  These are drawn from the federal accounting system - not a perfect system, as it treats Trust Fund surpluses as budget receipts rather than money lent – but for our purposes here, these numbers tell the story well enough.

The data series begins shortly after the end of World War II.  Outlays and Receipts have both stabilized.   Peacetime economics are once again the norm.  Outlays drop to 12% of GDP. 

Cold War realities quickly pull government spending to a higher level.  From the last years of the Truman Administration to the first years of the Nixon Administration, from the late 1940s to the beginning of the 1970s, Receipts and Outlays track one another  closely.  Republican Administrations practice fiscal prudence, Democratic Administrations do the same.

In the early 1970s, something changes.  Congress begins to run larger deficits, modestly at first, in the early 1970s, then more aggressively.  With the arrival of Reagan and a new conservative cohort, deficit spending really takes off.  A sea change occurs in those years.  Deficit spending hasn't always been the Congressional norm, but something shifts.  Congress becomes an engine of deficit spending, tentatively at first, then very aggressively.  

Look again at the twenty-four year period that begins with 1947 and ends with 1970.  Congress during that period manages its financial affairs with admirable responsibility  In only two of those years does the federal government run deficits that exceed 2% of GDP.  There are eight years of surplus, and fourteen years of very modest deficits.  Gross federal debt declines from 110% of GDP to only 36% of GDP.

Now look at the succeeding forty years, from 1971 through 2010.  In twenty-eight of those forty years, deficits exceed 2% of GDP.  In eighteen of those twenty-eight years, deficits exceed three percent of GDP.  There are very few years of surplus - only four.  And the gross federal debt?  As a percent of GDP, it very nearly triples. 

Two dramatically different periods.  One a period of fiscal responsibility and falling debt ratios; the second a period of habitual fiscal irresponsibility and rising debt ratios.  How is this very nearly overnight shift to be understood?

One might interpret it as little more than a symptom of increasing national difficulties.  Inflationary pressures marked the 1970s.  Foreign competitors showed their muscle; America’s manufacturing sector had let itself grow flabby.  Factories closed, manufacturing jobs disappeared.  Oil shortages stimulated an inflationary spiral in the economy.  Federal Reserve actions were direted at recovering jobs, not at halting inflation.  Labor agreements that indexed wages to prices played a role in fostering the inflationary rise.  It was unfamiliar territory. 

But these difficulties materialize a little later.  Fiscal responsibility visibly fades as early as 1971.   

Something about the stark shift in behavior that appears in 1971 suggests a cause that's intrinsic to Congress as an institution.  Why would an earlier generation of Congresses behave with fiscal responsibility, while a later generation behaves much less responsibly? 

The sea change that materializes in 1971 is almost surely rooted in three Supreme Court decisions from the early 1960s - Baker v Carr, Reynolds v Sims, and Westbury v Sanders.  In these decisions, the Court holds that all legislative and congressional districts within a state must be of equal population.  This had not been America's historical practice.  District boundaries had been based on geography and custom, not on the principle of population equalization.

In 1971, with Census results in hand, state legislatures unwrap the packaging on a delicious new opportunity.  Now they can redraw legislative and congressional districts lines however they like, so long as the final districts have equal populations.  The era of modern gerrymandering has begun.  Think of the excitement with which majority party legislators set to work.  Let's draw district boundaries that maximize partisan advantage.  Let's minimize the risk of incumbents losing their seats.  How delicious!

It was a dark turning point in the history of American democracy.  Representative democracy rests on a simple principle:  "Voters get to choose their legislators."  Modern gerrymandering turns this principle upside down:  "Legislators get to pick their voters."

In the new era of runaway gerrymandering, Democrats were given safe Democratic districts, Republicans were given safe Republican districts, and the nation's moderates were stripped of much of their voice.  An old breed of legislator gave way to a new breed.  The national interest didn't matter as much, because moderate voters didn't matter as much.  Both parties began to tip away from the center and toward the extremes.  Democrats spent money on social programs, bought votes on the left, and borrowed to make up the difference.  Republicans trimmed tax rates, bought votes on the right, and borrowed to make up the difference.  Each party used borrowed money to buttter up its base; each party blamed the other for the nation's deficits; partisan voters in both camps welcomed the funds and colluded in the hypocrisy.

The Clinton Administration took a short break from all this.  Clinton raised taxes.  His presidency also benefited from the late years of the dotcom stock market boom.  And he had held the line on federal spending.  For the first time in a good long while, the national government ran a surplus, not just once, but for four years in a row. 

The surplus evaporated like the morning dew once George W. Bush took the helm.  Tax rates were cut and receipts were slashed.  The war on terrorism drove up spending, first with war of necessity in Afghanistan, then with the war of choice in Iraq.  Conservatives returned to the charade of using deficits to fund tax cuts, Democrats resumed the charade of using deficits to fund social programs. 

The Deep Recession of 2008 brought matters to a head.  Tax collections fell sharply as the economy slowed.  The Obama Administration borrowed actively in hopes that a relatively modest stimulus package would be able to jump-start a flagging economy.  Receipts fell by four percent of (a smaller) GDP.  Spending rose by four percent of  GDP. 

It is a story with one central takeaway.  Gerrymander the nation's congressional districts as we do, and the addiction to annual deficits will be a very nearly unstoppable force.  Ideologues of the Republican persuasion will cut taxes, buy votes, create deficits, and blame Democrats.  Ideologues of the Democratic persuasion will boost social programs, buy votes, create deficits, and blame Republicans.  What is one to say of voters who want their fantasies coddled by spendthrift ideologues? 

Operator error on the Right, operator error on the Left.  America's budgets were pushed into deficit territory in the early 1970s and - with the brief exception of four surplus years in the late 1990s - they have remained in that territory ever since.

18.2, Version 2011-06-27

---

[i] Economic Report of the President 2011.  Table B-78.  Federal receipts, outlays, surplus or deficit, and debt, fiscal years, 1944-2012.

18.3 Federal Tax Receipts

The federal government records its tax receipts under a few broad headings.  We learn the most by taking each one separately.[i]

 

Corporate Income Taxes.  Many Americans no doubt imagine that corporate tax payments make a significant contribution to the federal budget, even today. The chart above tells a different story.  Receipts from corporate income taxes were almost four percent of GDP from the mid-1940s to the late-1960s, with brief moments during that time when corporate income taxes rose to five, six, even seven percent of GDP.

In the Nixon years, the corporate income tax fell noticeably, to a new plateau of just under three percent.  In the early Reagan years, corporate tax receipts took another sharp plunge, from almost three percent of GDP to barely one percent of GDP.

 Then there was a partial recovery. Corporate tax receipts today rise and fall within a band centered at two percent of GDP, with occasional spikes above that level and occasional dips below.  It has been some time now since corporate taxes provided receipts equal to four percent of GDP or better.

 

 

Individual Income Taxes.  The individual income tax takes in two distinct sets of taxpayers – small business owners, on the one hand, and employees of all sorts, on the other.  The broad story of the last six decades is one of relative stability.  Receipts from individual income taxes typically provide eight percent of GDP, with occasional upswings to ten percent and a couple of downswings to six percent.

Note the upswing of the Carter years, in the late 1970s, followed by the sharp downturn in the early Reagan years.  The Reagan downturn in individual income taxes accompanied a matching downturn in corporate income taxes, and played a very visible role in widening the gap between Outlays and Receipts.  Note also the upswing of the Clinton years. It was paired with a mild upturn in corporate income tax receipts, and played an important role in closing the gap between Outlays and Receipts. 

Note, finally, two noticeable drops during the Bush years.  The first illustrates the impact of Bush’s tax cuts; the second reflects the Deep Recession of 2008.

 

 
Excise Taxes.  In the graph above one senses a story that reaches back into old-time America. Imagine a time when the nation’s sales tax receipts were high enough to fund the federal government to the tune of two or even three percent of GDP.  And try to visualize the two main sources – taxes on tobacco and taxes on alcohol.  Not an easy image to bring to mind today. 

Not till 1957 did Americans create the Highway Trust Fund; not till 1971 were airports and airways given a trust fund.   Many other trust funds have made their way onto the list since then, yet the excise taxes that support them play a markedly smaller role today.  Excise taxes may once have equaled three percent of GDP; they barely top half a percent today.

Note the spike in receipts at the end of the Carter years and the beginning of the Reagan years. A windfall profit tax on crude oil was imposed in 1980; this, too, was an excise tax.  It caused a sharp uptick in federal receipts, especially noticeable in the first years of the Reagan presidency.  It tailed off quickly and was discontinued partway through President Reagan’s second term.  Its presence in the early Reagan budget partially offset the downturn in corporate and individual income tax receipts that also accompanied the Reagan presidency.

 

Social Security Taxes.  Social Security taxes are collected from employees and their employers on a 50-50 basis.  All salaries and wages paid below a defined salary cutoff are considered “taxable payroll;” they are currently taxed at 6.2% for employees and another 6.2% for employers. 

The tax rate rose steadily from Social Security’s inception until the early 1980s.  In the 1940s, the employee-employer tax rate was 1.0% apiece; by the end of the 1950s, it was 2.5% apiece; by the late 1960s it had risen to 4.2% apiece.  By 1980, it had climbed to 5.08% apiece.  The present rate, 6.2% apiece, has been in effect since 1990.[ii]  The graph above is primarily a story of the rising rate and its contribution to overall federal tax receipts. Note, though, the sudden collapse in collections as the Deep Recession of 2008 throws millions of Americans out of work.  Today’s unemployment dilemma seems likely to persist for quite awhile yet; Social Security collections will be depressed accordingly.

 

 

Hospital Insurance Taxes.  The hospital insurance tax was created in 1966 to support Medicare.  The rate was initially set at 0.35% for employees and a matching amount for employers.  It rose in steps to 0.6% (1968), then 1.0% (1973), 1.3% (1981), and 1.45% (1986).[1]   Unlike Social Security, there is no earnings cutoff; the HI tax applies to all earnings.  As of this writing, the Hospital Insurance tax is worth a shade less than one and a half percent of GDP. 

 

Social Insurance (All Other).  The federal government collects three small taxes, shown here as Social Insurance (All Other). One set of receipts supports unemployment insurance; another supports federal employee retirement; a third supports railroad retirement. Modest even in the 1940s, these three categories have declined over time.

 

Federal Tax Receipts (All).  Put all the pieces together.  Working upward from the bottom, the chart displays corporate income taxes, individual income taxes, excise taxes, Social Security taxes, hospital insurance, and other social insurance.

View the chart with the nation’s broad trends in mind.  Corporate income tax receipts have shrunk markedly as a share of the total.  Excise taxes have shrunk steadily over time.  Social Security expanded dramatically from the 1940s through the 1980s and then stabilized.  Hospital insurance has expanded its contribution, but not nearly as significantly.  Social insurance (other) has never been large and has diminished in recent decades.  Individual income taxes have been generally stable, but with interesting and significant fluctuations at key point in the narrative. 

The overall pattern is relatively stable from the beginning of the 1950s into the middle of the 1970s.  The lower edge of the band is roughly 16% of GDP; the upper edge roughly 18% of GDP. 

Then the pattern becomes considerably more volatile.  Receipts expand sharply in the Carter years, then shrink even more sharply in the early Reagan years.  President Clinton rides a combination of economic good fortune and higher taxes to a new peak, with federal tax receipts at almost 20% of GDP.  President George W. Bush turns the wheel sharply in another direction, and receipts plunge almost to 15% of GDP, a drop of more than four percentage points in only four years.  Then receipts bounce halfway back, but only for a moment.  They plunge another four percentage points in the next four years.

Thom Hartmann argues that such volatility is the natural consequence of income inequality.  When the wealthy have too much money to play with, they put their money not in goods but in equities and related assets.[iii]  Asset values rise, bubbles expand, the economy seems flush, tax receipts rise.  Then the bubble bursts.  The economy falters, tax receipts shrink.  The rising tide rises faster,  the falling tide washes away more rapidly.  We have had the Up-Down of the stock market boom that crested in the late 1990s.  We have had the Up-Down of the real estate market, which crested in 2005 and crashed in 2008. 

Add to that volatility the abrupt shifts in tax rates, government receipts, and the need for government borrowing.  The period that precedes the mid-1970s is one of stable economic growth, driven by rising middle class demand.  The period that begins in the 1980s, with the shift to Gated Capitalism, is one of slower GDP growth but faster stock market growth.  It is also a period of greater ideological intensity, both among conservatives and among liberals.  From an economic perspective, American government was more competently led in the 1950s and 1960s than it has been since the 1980s. 

There is a parallel analysis to be done at the level of state and local government.  It will find considerable stability in tax receipts, running at ten percent of GDP for two decades straight.  But it won’t be a story of matching stability in spending.  State and local spending totals on the whole have been outrunning their tax receipts.  Federal grants have placed even more money in their hands; not every federal dollar is spent at the federal level.  A proper analysis of this issue must examine each state separately; such a project is well beyond the reach of this book.

18.3, Version 2011-06-27

---

[1] Those were the major increments.  This account omits a number of smaller increases.

[i] All charts in the Federal Receipts section are drawn from the following sources.  Office of Management and Budget 2011: Table 2.1-Receipts by Source: 1934-2016.  Table 2.4-Composition of Social Insurance and Retirement Receipts and of Excise Taxes: 1940-2016.  Economic Report of the President 2011.  Table B-78. Federal receipts, outlays, surplus or deficit, and debt, fiscal years, 1944–2012.

[ii] http://www.ssa.gov/oact/progdata/taxRates.html.  Also covers HI tax rate changes.

[iii] Thom Hartmann.  Rebooting the American Dream: 11 Ways to Rebuild our Country.  Berrett-Koehler Publishers, Inc.  San Francisco.  2010.

 

18.4 Government (Federal Spending)

Now turn from receipts to spending, to “federal outlays” in the language of those who track these totals year in and year out.  Here we will group the major categories under six broad headings – Defense, Social Security, Medicare, Income Security, All Other Federal Programs, and Net Interest.  It will get us started.  Our story begins in 1962 and continues through 2012.  The final two years are estimates only – the overall story gives us the five decade overview.  What might we learn about national competence, on the one hand, and operator error, on the other?  Quite a bit.[i]

 

National Defense and Veterans Benefits 

As the story begins in 1962, national defense makes up half the national budget.  It represents 10% of Gross Domestic Product.  It declines briefly, but then America’s commitment to South Vietnam pulls it back to ten percent of GDP.  Again it begins a long decline, moderately interrupted by the Reagan years, eventually reaching only three and a half percent of GDP by the end of the Clinton years. 

Then 9/11 reshaped the nation’s priorities.  A war of necessity in Afghanistan and a war of choice in Iraq send defense spending back up.  It climbs from three and a half percent of GDP to almost six percent.  It has been a dramatic fifty years for this part of the federal budget.

Social Security Outlays 

Social Security outlays are at the end of a second major chapter and on the eve of an explosive new third chapter.  Federal outlays as a percent of GDP crept upward from Social Security’s launch in the 1930s until the early 1980s.  View this as a time of growing generosity, funded by a slowing rising payroll tax. Eventually Congress said “Enough” and stabilized Social Security’s benefit formulas as well as the payroll tax. 

(It should be noted that five-sixths of what we call Social Security represents retirement benefits and survivors’ insurance.  The remaining sixth represents disability insurance and disability benefit payments.) 

The second chapter in the Social Security story is now drawing to a close.  It has been a chapter of illusory stability.  As Baby Boomers retire, Social Security’s apparent stability will swiftly disappear.  The next chapter for Social Security history will be desperately stressful.

Medicare and Health

A modest share of the federal budget is devoted to a category known as “Health.”  It represents 0.21% of GDP, year after year.  Everything else in this category is for Medicare, a federal program created in the mid-60s.  Only a small portion of Medicare benefits are covered by receipts from the payroll tax; everything else essentially comes out of the general fund.

This wedge of the federal budget should also be shown in flashing red.  This part of the budget cannot be tamed until the entire medical industry has first been tamed. One cannot get affordable pricing from a cartel-like industry; one cannot have an affordable federal budget without first creating an affordable medical sector.

Income Security 

Quite a number of programs are funded under the general heading of “Income  Security.”  The larger ones include unemployment compensation, federal employee retirement and disability, food and nutrition assistance, housing assistance, the earned income tax credit, family and other support assistance, and several smaller programs. 

A small portion of this spending is supported by social insurance taxation, but as the Social Insurance chart from the previous section indicates, these proceeds amount to half a percent of GDP. 

Income security jumps from one and a half percent of GDP to three percent of GDP over a ten year period that begins in the late 60s.  It stays in the three percent range, or just below, for three decades.  Then the Deep Recession of 2008 puts millions of Americans out of work; federal spending on income security jumps by another percentage point plus.  Once the nation finds its way back toward full employment, this part of the budget will most likely return to its previous range, roughly three percent of GDP.

All Other Programs 

There is so much of what the Federal Government does that hasn’t been mentioned yet.  International Affairs.  General Science, Space and Technology.  Energy.  Natural Resources and Environment.  Agriculture.  Commerce. Transportation.  Education, Training, Employment, and Social Services.  Administration of Justice. General Government.  These are the programs that one commonly associates with the Federal Government.  Isn’t this what we want the federal government to do?  Build infrastructure, fund innovation, educate the nation’s scientists and engineers, and any number of other activities that create a strong America for tomorrow?  Work overseas, improve public health, sow the seeds for peace and democracy? 

It is striking just how small a portion of the federal budget these functions and purposes now command.  They peaked at 5% of GDP in the late 1970s.  By the late 1990s, in the latter part of the Clinton Administration, they had declined to little more than 2% of GDP.  These functions spiked upward, briefly, as President Obama’s Recovery Act sought to jump-start the nation’s economic recovery.  (A meaningful recovery act would have been two or three times larger, if one looks back to the kind of spending that finally ended the Great Depression.)  Looking forward, it appears likely that this set of functions will command no more than three percent of GDP, and perhaps less. 

Net Interest 

This series of numbers fascinates me.  The federal government spent two and a half percent of GDP paying interest on the national debt at the end of the George H.W. Bush Administration and the beginning of the Clinton Administration.  Today, for the moment at least, even with a federal debt that’s substantially larger, interest payments on that debt are considerably lower.  Thanks go to the Federal Reserve, as it promotes rock bottom interest rates in hopes of bringing the economy back.

Low interest costs are unsustainable over the long term, and a high national debt is also unsustainable.  Borrowing heavily from abroad is an unwise practice, and yet foreign borrowing now plays a much more significant role in Washington’s long-run practice of deficit financing. 

It should be noted that “Net Interest” masks the debt that the Federal Government owes to the Social Security Trust Fund.  By following this convention, we mask an important problem, but I won’t try to sort that out here.  These numbers tell a story of a temporary reprieve, not a story of a permanent pardon.  A nation that runs a high debt can expect to pay high interest charges in years to come.

Total Federal Outlays 

Now let’s pull it all together.  As before, the chart is best understood by starting at the bottom.  The first layer reflects National Defense and Veterans Benefits.  The second layer reflects Social Security.  And so on. 

From the late 1940s to the early 1970s, Outlays and Receipts were kept carefully in sync.  Then Outlays began to creep ahead of Receipts, and politicians in both parties lost their sense of fiscal discipline.  Here we can gain some clues as to how this unfolded.  Three broad story lines catch the eye.  Two are stories of contraction, one a story of remarkable expansion.

Begin with Defense.  It declines from ten percent of GDP in the late 60s to six percent in the Carter years, rebounds modestly during the Reagan presidency, and then declines to half that level at the end of the Clinton presidency.  Even the Afghanistan and Iraq wars have not driven it all the way back to its earlier levels.  The overall trend has been down.

Look next at the second layer from the top, All Other Programs – Science, Technology, Transportation, Agriculture, and all the rest.  They peak at 5.4% of GDP in the Carter years and then shrink to 2.2% in the late Clinton years. 

The third story line involves social programs, and here one sees extraordinary expansion. Start at the bottom, then look at the second, third, and fourth layers of the chart – Social Security, Medicare & Health, and Income Security. In 1962, as the chart begins, these categories taken together represented four percent of GDP.  In the 2012 estimate, they represent thirteen percent of GDP.  This portion of the federal budget has tripled. 

As we look ahead to future decades, can we expect this portion of the federal budget to level out?  It won’t be easy.  Boomer generation retirements will place crushing demands on Social Security and on Medicare.  Pressures to support Income Security programs will remain strong in a flagging economy. 

Both parties have special interest soft spots.  Republicans will run deficits in order to spend for defense.  Democrats will run deficits in order to spend on social programs.  There was a time when both parties kept deficits in check.  That sort of maturity evaporated back in the 70s and the 80s.

(18.4 Version 2011-06-27)

---

[i] All charts in the Federal Outlays section are drawn from Office of Management and Budget 2011: Table 8.5 Outlays For Mandatory And Related Programs: 1962–2016, and Table 8.7 Outlays For Discretionary Programs: 1962–2016, and from Economic Report of the President 2011.  Table B-78.  Federal receipts, outlays, surplus or deficit, and debt, fiscal years, 1944-2012.

18.5 Middle Class America, Workforce & Retirees

 

Middle Class America (Workforce) 

On the larger diagram, “The Special Interest Economy,” one finds the American middle class represented at the bottom with two entries.  Start with the Workforce. Americans show up at work, perform services, produce goods, grow their skills, and earn a living.  They go home, they make lives for themselves, they participate in their communities.  They pay taxes – income taxes, Social Security taxes, Medicare taxes.  In a healthy American economy, the American middle class will do well.  In today’s American economy, the middle class is struggling.

As we have just seen, the federal budget spends less and less on nation-building.  Science, technology, transportation, education – in one vital area after another, America’s elected officials ignore the national interest and invest very little in the nation’s future.

The medical industry takes far too much money out of everyone’s wallet.  No nation can afford $7500 per year per person for medical care. 

America’s banking industry isn’t in the stable economic growth business.  It is in the unbalanced growth, high risk, high profits, high bonuses business.  The Deep Recession of 2008 wasn’t an unforeseeable accident; it was the logical consequence of personal irresponsibility taken to great scale.   Its perpetrators are still doing well; its middle class victims have lost enormous ground.

Many parts of the nation’s manufacturing sector have been shrinking for some time.  Republicans haven’t protected manufacturing, Democrats haven’t protected manufacturing.  A key source of good jobs for middle class Americans has been allowed to languish.

The technical skills of the American middle class have been shrinking.  When manufacturing jobs disappear, older technicians lose the chance to share their skills with the younger generation.  A less skilled middle class foretells a less competent future for America. 

The shift to Gated Capitalism has hurt America’s middle class.  Those with lower-paying jobs have been held back the most.  Those in the mid-range of the workforce have been inching forward but not making the gains that were once America’s norms. 

Middle class Americans would love to be part of the solution.  But it isn’t happening as it should.  What shall we call it?  A failure spiral?  A mediocrity spiral?  The American workforce is suffering.  It could be a source of abundance; it isn’t being given half the chance it deserves.

 

Middle Class America (Retirees) 

The Baby Boomer generation has just begun to retire.  Social Security forecasters anticipate a near-doubling in the number of Americans age sixty-five and up, from forty million to seventy-five million.  The number of working age Americans will grow, too, but only half as much.  Social Security taxes collected from today’s working age population are sufficient to pay promised benefits to the retiree population of today.  Not the case twenty years from now, or even sooner.  Is there a light at the end of the tunnel?  If there is, it’s the fiery glow of red ink. 

That Social Security is heading toward insolvency is no mystery. 

The mystery is the behavior of the nation’s elected officials.  Democrats pretend the solvency crisis isn’t real.  Republicans pretend they can make the problem go away by replacing Social Security with individual retirement accounts, largely invested in the stock market.  Each party has its own Big Lie.  Democrats cannot bring themselves to tell the voters the truth about what lies ahead; Republicans cannot bring themselves to run the numbers and retract the nonsense they’ve been spouting about individual investment accounts. 

The Democratic strategy for Social Security has been roughly the same since the early 1980s.  Put on a blindfold.  Run a Social Security surplus from the early 1980s to the late 2010s.  Deposit that surplus in a special “Trust Fund.”  Then let the surplus disappear.  Clap your hands as the Trust Fund tops out.  Turn away as the Trust Fund is liquidated at an accelerating rate.  When the Trust Fund runs dry, in 2037 or so, take off your blindfold, look around, shake your head, and see if there’s a solution lying around. 

Republicans are no better.  Individual retirement accounts work – for individuals.  But for an entire workforce of one hundred fifty million Americans, all at the same time?  And tens of millions of retirees, in addition to current employees?  Some conservative scenarios, if taken to scale, create an investment fund so large that the entire American stock market would be swallowed whole, several times over. 

Which lie should Americans prefer?  The chronic lie told by the Democrats?  Or the chronic lie told by the Republicans?  Can one split the difference and find the right answer?  No – the two worldviews run at such cross purposes that splitting the difference simply won’t work.

An honest directional worldview would point us toward four central issues. 

First, Social Security needs an honest yardstick for measuring long-term solvency.  Its current yardstick is called “actuarial balance.”  It is a technically sophisticated tool for asking the wrong question and generating misleading advice.  It quantifies solvency, not in asset preservation terms, but in asset depletion terms.  Social Security is said to be “in actuarial balance” if its Trust Fund won’t go belly-up until one or two years after the end of its current forecasting period.  That’s like saying it’s okay to father a love child if the wife won’t find out till after you’ve gotten a divorce for other reasons. 

Unfortunately in today’s America, we don’t fire the politicians who tell us the lies we want to hear, we reelect them.

One cannot responsibly measure solvency with an asset depletion yardstick.  Solvency is solvency, and one measures it with an asset preservation yardstick, and only with an asset preservation yardstick.  Actuarial Balance has to be dumped at the earliest possible date and replaced with an honest yardstick.  “Trust Fund Ratio” would be a good tool.  If the size of the Trust Fund, as a percentage of annual benefits, doesn’t shrink over time, Social Security meets its solvency test.  If the Trust Fund Ratio shrinks over time, Social Security flunks its solvency test.

Second, the Social Security program needs to be given a permanent investment component.  The Trust Fund ought to be reconstituted as a permanent investment vehicle, one that invests not in Treasury bonds but in a broad-based and cautious portfolio of private sector securities.  A Trust Fund should be a permanent if modest booster rocket for the entire benefit program.  Modest individual accounts might also be tacked on to the existing program. Mandate a standardized portfolio to keep management costs low and to assure stable long-term gains for all participants.

Third, Social Security needs to trim its long-run benefit costs, at least a bit, and one of the most appropriate way to do this is by raising the retirement age for those whose career employment has not involved years and years of manual labor.  Some kinds of work shorten a person’s life expectancy; other kinds of work lengthen it.  Those whose working years give them greater life expectancies should have a later retirement age.  A modest amount of means-testing may also be necessary, if the overall size of the Social Security program is to be kept in bounds as the Boomer generation retires.

Fourth, Social Security also needs to increase its revenue collections.  Once American Dream Capitalism has been revived it would be appropriate to adopt a modest increase to the payroll tax.  The earnings cutoff should also be increased significantly. Why give a massive tax break to Americans in the upper ten percent, by relieving them of any Social Security obligations for the higher reaches of their annual earnings?  Raise the cutoff to half a million.  Or even a million.  Or, if Gated Capitalism cannot be de-clawed, eliminate the cutoff altogether. 

Four keys to lasting solvency for Social Security:  An honest yardstick for measuring solvency. A modest investment component.  A careful reduction in long-run obligations.  And an appropriate increase in program revenues.  Competent politicians would lead us into a competent discussion.  It is not today’s discussion, but it is the one America needs.

The Medicare challenge is even more daunting.  As the reader can imagine, what the federal government spends on medicare cannot be separated from the larger question of whether cartel-like pricing will persist in the medical sector.  Fix the medical sector as a whole, and we will find ways to keep Medicare costs under control.  Allow the nation’s medical industry to overcharge Americans by a trillion dollars a year and Medicare will blow its fuses.

America’s retiree challenges are extraordinary.  If the entire economy is wisely run, these challenges can be met.  If today’s runaway irresponsibility remains the norm, these challenges may well do us in.

18.5, Version 2011-06-27

18.6 Failure Upon Failure

 

We have gotten ourselves in trouble as a nation because we truly lack civic competence.  It isn’t that liberals are wrong and conservatives are right, or that conservatives are wrong and liberals are right.  We are all Americans, and our failure of competence cuts across the entire spectrum.

America has two choices.  Embrace integrity at scale as our standard, and be guided by its principles on a journey of growing national competence.  Or embrace special interest corruption as our standard, and be guided by its temptations on a journey of national decline. 

In the first choice, we give our loyalties to the national interest.  We want tomorrow’s America to be stronger and more competent than today’s America, and we will bend our special interest choices toward America’s larger purposes.

In the second choice, we give our loyalties to the special interests we know best.  Our behaviors are chosen for special interest reasons.  Harmful consequences are of no interest to us.

America is in the grip of a special interest economy just now because we have drifted badly toward the second choice.  Every facet of the American economy has been distorted and weakened.  Do we want a responsible Social Security program?  The nation’s Democrats can’t be trusted to act on behalf of the national interest; neither can the nation’s Republicans. 

Do we want affordable medicine?  It is out of reach.  Business elites profit too heavily from current practices; political elites benefit from protecting the status quo.  Do we want American business to compete effectively overseas?  Sorry, its medical costs are too high.  Do we want federal spending on medical care held in bounds?  Sorry, the industry collects a trillion dollars more than it should, and it isn’t willing to give that up. 

Do we want federal taxes spent on nation-building?  Sorry, our tax monies are committed to Medicare, because medicine costs so much.  Our tax monies are committed to income support, because Gated Capitalism has weakened the middle class, because the banking industry and the real estate industry crashed the economy.

Do we want good jobs for Americans?  Do we want a stronger manufacturing sector?  Sorry, we have just suffered through several decades of bipartisan disdain for America’s manufacturing capabilities.  Sorry, medicine costs too much. 

Do we want better wages for Americans?  Sorry, the executive class prefers to pay itself quite well.  It hasn’t the vision to help middle class Americans grow their earnings as rapidly as they should.  Sorry, America’s unions haven’t a helpful vision of their own role in a prosperous future. 

Do we want a faster rate of economic growth for the American economy?  Sorry, middle class buying power isn’t growing as rapidly as it should.  Sorry, we don’t have the energy we need from the nation’s manufacturing sector.  Sorry, the banking industry isn’t standing up for the American economy the way it should.  Sorry, the medical sector creates enormous drag. 

Do we want an energy industry that protects the global climate?  That frees America from its dependence on imported petroleum?  That accepts its moral responsibility to protect future generations?  Sorry, we live in a special interest nation.  The energy industry doesn’t have to serve the national interest.  It doesn’t have to be part of the solution. 

 

Ask the Right Questions, Awaken the Right Energies

A nation that asks itself the wrong questions is a nation that will invest its energies pursing the wrong goals.  Hold a mirror up to America.  That is who we are.  Today.  A nation that debates the wrong questions and pours its energies into yesterday’s priorities.  When we the American public give primacy to special interests, we make the worst kind of operator error.  We sacrifice the national interest to one special interest claimant after another.

There is a cure, should we wish to accept it.  Recognize the link between the nation’s weaknesses and the nation’s preference for special interest thinking.  Vow to leave those habits behind and invest our energies differently.  Change the questions we ask ourselves.  Invest our energies in answering national interest questions. 

Turn the special interest map into a source of national interest questions.

How do we restore the health of the American middle class?

How do we bring back American Dream Capitalism?

How do we revive American manufacturing?

How do we create a manufacturing economy that radiates a world-class appreciation for sustainability?

How do we rewrite the rules for American medicine so that tomorrow’s medical costs are where they should be?

How do we design the climate-safe energy industry of tomorrow?  How do we make the transition to clean energy as effectively and responsibly as possible?

How do we upgrade the American workforce?

How do we recharge the innovation potential of all fifty states?

How do we engage all young people in world class learning? 

How do allocate federal funds properly toward the nation-building we need? 

How do we manage the challenge of Boomer retirements so that the nation’s elderly are protected and the nation’s solvency properly managed?

How do we restore full employment and reduce the need for income security spending?

How do we design a responsible tax system?  Remove all the favoritism?  Clean up the rules?  Give precedence to the national interest?  Deliver at least a dollar’s worth of benefit for every tax dollar collected?

It isn’t enough to ask one or two good questions.  The national interest must be served by every part of the private sector; the national interest must be served by every part of the federal budget, by every part of our state and local budgets.  The national interest must be served by the way we write our tax codes. 

A self-disciplined nation becomes a wise and competent nation.  A wise nation overcomes operator error by setting aside corruption at scale and embracing integrity at scale.  A wise nation asks the right questions; it persists till it finds effective solutions.

Steven Howard Johnson, 18.6 Version 2011-06-27