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Rethinking Which Accounts Qualify For Deposit Insurance

David Howden — Mon, 17 Jun 2013 23:38:50 -0400

Publication

The dollars in our wallets are maintained by the Federal Reserve, and, as the sign on the door to every institution insured by the Federal Deposit Insurance Corporation (FDIC) reminds us, our “deposits are backed by the full faith and credit of the United States government.” For most purposes, currency in circulation is a direct substitute for funds deposited in a bank account. A deposit is only good if it can be redeemed into currency, which depends on the solvency of the depository. The FDIC safeguards the nation’s depositors by pledging to pay out all insured deposits in the event that the private depository is met with illiquidity or insolvency.

The FDIC does not receive direct congressional funding. Depository institutions pay premiums into a deposit-insurance fund, which is used to pay for any losses caused by an insolvent bank. Most of these losses are the insured deposits held by a failed bank, as well as any administrative costs of managing a failed bank held in receivership. As a result, defining which deposits qualify for insurance is of prime importance for the FDIC’s operations.

Section 1506 of the Dodd-Frank Act of 2010 required that a study be commissioned on core deposits and brokered accounts. The goals of this study were twofold. First, Congress wanted to reassess the definition of a “core deposit” used for the purpose of calculating the insurance premium assigned by the FDIC. Second, a closer look at the relationship between core deposits and the larger US economy was warranted, particularly concerning any stabilizing effects that could accrue to the banking sector by redefining core deposits.

In this paper I look at why deposit insurance exists, and to what extent different financial accounts should be insured. I construct alternative criteria to gauge the appropriateness of a funding source’s coverage by the FDIC and conclude with some further policy changes that would reduce the costs of insurance and promote the stability of the banking sector, as well as the broader financial arena.

I. Why Deposit Insurance?

Congress established the FDIC in 1933 as a response to widespread bank failures during the Great Depression. In a bid to restore confidence in the financial system, the federal government pledged to safeguard deposits through deposit insurance. The Federal Deposit Insurance Act of 1933 obliges the payment of deposit insurance “as soon as possible” to mitigate any disruption caused by a bank failure. These payments are enabled through the deposit-insurance fund, as well as through an emergency line of credit from the US Treasury if necessary. To its credit, no depositor has ever lost a penny of insured deposits in the FDIC’s history, and payouts to insured depositors generally happen within one business day.

One unfortunate side effect of a fractional-reserve banking system is the omnipresent possibility of bank illiquidity. A bank takes on deposits that are payable on demand while financing the asset side of its balance sheet with securities (typically loans) of longer maturity. Using short-term deposits to fund longer-term investment projects leaves banks open to the risk that new funding will not be renewed (or rolled over), thus rendering the bank illiquid. A bank will not generally be exposed to the illiquidity of the maturity mismatch it generates so long as withdrawals are largely uncorrelated with one another. Given the law of large numbers, on any given day only a small percentage of total depositors demand their funds. There remains a possibility, however, that a sufficient number of depositors will claim their funds simultaneously and the bank will become illiquid. The mix of illiquid assets with liquid liabilities can give rise to panics among depositors fearful of suffering a loss on their deposited funds. This incentive holds regardless of the actual financial position of the bank, as any fractional-reserve bank will be exposed to illiquidity and cannot perfectly predict when and to what extent depositors will make withdrawals.

The FDIC provides insurance to remove the possibility of a bank run. By guaranteeing a deposit to a sufficient amount, the FDIC has effectively eliminated the possibility of a bank run, because no depositor need worry that his funds will not be paid back on demand and at par value.

While deposit insurance solves the apparent problem of depositors withdrawing their funds en masse, it creates the secondary problem of moral hazard. Removing the threat of losses diminishes the incentive for a depositor to monitor the financial position of his bank. (Perhaps unsurprisingly, the first states in the United States to experiment with mandated deposit-insurance plans were also those with poorly capitalized, state-chartered banks.) In response, the FDIC also undertakes a monitoring and regulating role of the financial system to ensure that its potential payouts are minimized. It does so through two avenues, one active and the other passive.

The FDIC actively monitors the risk-based capital ratios of insured banks. When a bank’s capital ratio falls below 8 percent, it is given a warning. A drop below 6 percent can result in a mandated change of management or a forced corrective action. Finally, when the bank’s capital ratio falls below 2 percent, it is termed “critically undercapitalized,” the institution is closed, and the FDIC is appointed as the receiver of the bank. In this role the FDIC must resolve the failed institution and pay out the guaranteed amount to insured depositors.

The FDIC also passively monitors banks by limiting the types and amounts of liabilities it will guarantee. By limiting insurance to “core deposits,” it leaves large depositors and holders of noncore deposits exposed to potential losses. This exposure creates an incentive for these depositors (and lenders) to monitor a bank’s investment portfolio, and to allocate capital to only those banks deemed sufficiently strong to make good on their liabilities. Therefore, it is critically important that the FDIC accurately define which bank liabilities constitute core deposits. A sufficient amount must be included to remove the incentive for a bank run, but guaranteeing too many noncore deposits will reduce the incentive for depositors to aid in the monitoring of depository institutions and lead to an unnecessary increase in moral hazard.

Bloated Farm Bill Subsidies: Will the Farm Bill Cut the Fat?

Vincent H. Smith — Mon, 17 Jun 2013 16:43:05 -0400

Expert Commentary

A new study by the Mercatus Center at George Mason University analyzes current farm bill proposals by the House and Senate Agriculture Committees. The study’s author Vincent H. Smith, a professor of economics at Montana State University, examines how reducing farm subsidies by various levels would affect the structure of US agricultural policy.

Dr. Smith:

“American taxpayers spend more than $20 billion per year on farm subsidies—eighty percent of which flows to the largest and wealthiest 15 percent of farming operations, with annual incomes at least three-to-four times those of the average taxpayer.

“If Washington is truly looking to cut a little waste, the farm bill provides an exceptional opportunity. I found that farm subsidies could be reduced by at least half—saving about $9-10 billion per year, or about 10 percent of current farm bill spending—without any measurable effect on agricultural production.

“The concern is that Congress will instead do some cosmetic reduction in total farm bill spending, while creating new programs that appear to be funded at modest levels but put taxpayers on the hook for costs far greater than any savings they’ll claim to achieve.”

To view the full study and a brief summary, and to learn more about the author, please see “The 2013 Farm Bill: Limiting Waste by Limiting Farm-Subsidy Budgets.”

A Farm Bill Bait and Switch

Vincent H. Smith — Mon, 17 Jun 2013 16:40:02 -0400

Expert Commentary

The 2013 Farm Bill presents a real opportunity for substantive changes in U.S. agricultural policy. But instead of reform, both the House and Senate agricultural committees are offering classic bait-and-switch proposals to protect farm subsidies – more than 80 percent of which flow to households much wealthier than the average American family.

As I discuss in my new study for the Mercatus Center at George Mason University, the bills' bait is the elimination of the politically toxic Direct Payments program, introduced in 1996, which annually sends about $5 billion in welfare checks to people who own or farm cropland – whether or not they grow any crops. The switch is the introduction of new programs that would give farmers even larger subsidies if either crop prices or average per-acre crop revenues decline from their current record or near-record levels.

In the House farm bill, price supports, through a new Price Loss Coverage program, are the preferred subsidy vehicle. The PLC would establish target prices close to the current near-record market prices for crops like corn, wheat, rice, peanuts and oilseeds. Farmers would then receive payments when market prices fall below those target levels.

Peanut and rice farmers stand to benefit especially from the PLC. The bill's proposed peanut target price, for example, exceeds any of the Congressional Budget Office market price forecasts for the next five years. While the PLC may indeed benefit Southern-state farm industries, it appears to have little semblance to the "save the family farm" safety net program claimed by its advocates.

The Senate's farm bill would put taxpayers on the hook for a new program that triggers subsidies when a farmer's revenues for major crops fall below 88 percent of their recent five-year average. And both the House and Senate farm bills would require taxpayers to cover 70 percent of the costs of a new insurance program to give farms additional "double dip" subsidies if their revenues fall below 90 percent of expected levels.

CBO estimates the new farm subsidy programs will cost about $3.5 billion a year. In fact, several independent studies have shown that if crop prices drop, even quite modestly, American taxpayers will be shelling out far more for these new programs than the $5 billion in claimed savings for the elimination of the Direct Payments program. If crop prices shift towards longer-run historical levels, taxpayers could face an estimated $16 to $20 billion in new farm subsidy costs. That's a lot of money, and most of it would go to the wealthiest farmers, corporations and landowners in the farm sector.

2013 Cost Projections for Medicare Programs

Veronique de Rugy — Tue, 18 Jun 2013 12:20:50 -0400

Publication

The cost projections for Medicare programs outlined in the 2013 Trustees’ Report rely on unrealistic assumptions regarding current laws (e.g., Affordable Care Act and Medicare physician fee payments), cost-savings, and higher revenue. There is little reason to expect these cost-reduction aspects of the law to materialize.

Social Security and Medicare Public Trustee Charles Blahous explains why Medicare costs almost certainly will be higher than current law projections in the 2013 Trustees’ Report:

Like other federal scorekeepers, the trustees are required to project program operations under current law regardless of whether most people assume that current law will be sustained. This is particularly important with respect to Medicare projections because current law specifies that physician payments will be cut by nearly 25 percent in early 2014 under the statutory Sustainable Growth Rate (SGR) formula. Lawmakers have overridden similar payment reductions in every year since 2003 and are widely expected to do so again.

This week’s charts compare the Medicare cost projections under current law assumption with more realistic alternative assumptions measured as a percentage of the economy. The Medicare Trustees’ Report presents an illustrative alternative scenario that assumes a continuation of the historical pattern of SGR overrides; the report also shows an another alternative scenario in which, in addition to an SGR override, certain controversial elements of the 2010 Affordable Care Act (ACA) are either scaled back during the period from 2020 to 2034 or eliminated altogether.

Under the first alternative scenario, total Medicare costs will be 7.2 percent of GDP in 2087, as opposed to 6.5 percent under current law. In the second alternative scenario, total Medicare costs climb to 9.34 percent of GDP by 2087. If lawmakers continue to override the physician payment formula, total Medicare costs will be substantially higher than what we now projectin the long run, more than 10 percent higher. Medicare expenditures in 2080 could be about 45 percent greater than projected under current law.

Under current law, Hospital Insurance (HI) costs are projected to increase to 2.56 percent of GDP in 2080, or roughly 55 percent greater than their 2012 level. Under the illustrative alternative to current law, costs would be 3.87 percent of GDP in 2080, or roughly 135 percent greater than their 2012 level.

Under current law, Part B spending is projected to increase from 1.48 percent of GDP in 2010 to 1.65 percent by 2020 and 2.56 percent of GDP by 2080. For the alternative physician projection, Part B grows to 1.75 percent of GDP in 2020 and 3.21 percent of GDP by 2080. In the full alternative scenario, Part B is expected to increase more rapidly, reaching 4.09 percent of GDP by 2080.

Even these grim numbers may be too optimistic because some of the expected revenue or cost savings in the current law may never materialize, as a section at the end of the Trustees’ Report (p. 273), called “Statement of Actuarial Opinion,” makes clear. Paul Spitalinic, the acting chief actuary of the program, explains that “current law would require a physician fee reduction of an estimated 24.7 percent on January 1, 2014 — an implausible expectation.”

Regardless of which scenario plays out, rising Medicare costs threaten our economic health. Doing nothing is not a wise option.

Data note: It is customary to express long-range costs of Medicare, HI and Part B programs as a percentage of GDP to facilitate interpretation and comparison of costs over such distant period. The listed data findings are taken from the 2013 Trustees’ Report.

Better Solutions for More Jobs in Our Jobless Recovery

Keith Hall — Mon, 17 Jun 2013 12:33:03 -0400

Expert Commentary

Regarding Alan Blinder's "Fiscal Fixes for the Jobless Recovery" (June 11): Prof. Blinder is absolutely right that there is an unfortunate air of complacency in Washington about job creation. The seemingly low 7.6% unemployment rate is masking an extremely low employment rate of just 58.6%—about the same as midyear 2009. At our current pace, we are a decade away from a full labor market recovery. Where he is wrong, however, is putting the blame on a lack of growth in government employment.

Fueled by the surge in government spending, total government employment hit a record high of 22.6 million in 2009—the same year the private sector lost five million jobs. Today, government accounts for 16.1% of total employment, the same as in 2007, before the start of the recession.

The biggest problem remains basic economic growth in the private sector. Over the past year, the private sector's portion of real GDP grew 2.7%. At this point during the past two "jobless" recoveries (following the 1991 and 2001 recessions), the private sector was growing 5.2% and 3.8%, respectively.

If you ask most small-business owners, our biggest job creators, what they see as their single most important problem, you get an amazing answer. According to a survey by the National Federation of Independent Business, the two most common answers are "taxes" and "government regulations and red tape." "Poor sales" comes in a distant third. Also, with all the recent talk of the need for government-funded job training, only 6% responded "quality of labor."

We should listen to small-business owners. There is a great deal of economic policy uncertainty in Washington that needs to be resolved.

The Economic Situation, June 2013

Bruce Yandle — Mon, 17 Jun 2013 11:12:57 -0400

Publication

The US economy is creating new wealth and growing employment, albeit at a slow pace. But uncertainty is the key word that describes the economic situation at mid-2013. There are major unknowns with respect to Fed policy, taxing and spending, the effects of the Affordable Care Act on employment, the implementation of Dodd-Frank financial reform, regulatory policy affecting the production of electricity, and the prospects for Europe’s recovery from an extended recession. Add to this pallid picture reductions in growth in China, India, and the developing world taking some of the edge off the global boom, which, in spite of that growth haircut, is still tugging away on America’s export growth.

With the closing of the books on the 2012 economy, real GDP growth registered 2.2 percent. But the current picture suggests we will be lucky to break 2.0 percent in 2013 and a bit more in 2014. This compares with the results of the Federal Reserve Bank of Philadelphia’s Livingston Survey in December 2012, which predicted 2.1 percent growth in 2013’s first half and 2.3 percent in the second half of the year. It will be a while before Livingston speak again, but right now, Economy.com’s dynamic GDP growth meter indicates the economy is expanding at 1.8 percent.

As Goldilocks might put it, “It’s not just right.” Not by a long shot. We can see images of the slowdown in the Institute of Supply Management’s indexes for the manufacturing and nonmanufacturing (service) economies shown below. Both indexes are headed south of the border. Recall that 50 is the magic number that coincides with zero growth.

But there is a bit of hope seen in the MAPI business outlook index. As seen here, it took a swoon in late 2012 but is now pointed north, barely. This reflects the expected output effects associated with new capital investments and related production improvements. Again, 50 is the neutral point for the MAPI index. Right now, the index rests in positive territory.

So we are on a bumpy slow-growth highway, but there is growth. As a result, several major economic sectors have fully recovered from the Great Recession demise. These include manufacturing, retail sales, machinery wholesalers, and Federal revenues.

Housing in Recovery

Housing is the key sector still in recovery, but out of intensive care. I show national housing start data in the next chart. The yellow horizontal line marks 1.6 million annual starts, the longer-term norm. As shown, if the current trend continues apace, and I believe it will, housing will recover to the norm by around 2016.

Pick-ups Are Picking up

We see an indirect confirmation of housing’s recovery in another way. I’m always looking for real indicators of progress; in my early morning travels, I love to pull into one of those mega filling stations where lots of vehicles, especially pick-up trucks, are filling up for the day. Powered by the housing recovery, these are real people doing real work for other real people: carpenters, painters, drywall installers, heating and air conditioning folk. But here’s the good news: the number of trucks seen on-site is growing. And the trucks are getting newer.

Inspired by this, I created a pick-up truck economic indicator. Here you see a time series for autos mapped with a series for light trucks. Look at the most recent observations: pick-ups are outpacing autos. Yes, there is lot going on behind these numbers, but there’s also a lot going on in the numbers themselves.

America is building again. Things are getting better.

What’s Happening in Manufacturing?

US manufacturing was the locomotive that pulled the country out of the Great Recession. And within manufacturing, auto production was the lead engine. With the recession still visible in the rearview mirror, what can we say has happened? Is manufacturing still hot? Is there enough “reshoring” of production from abroad to see a return in data?

Consider some data. The next chart shows the nominal value of all manufacturers’ shipments for 1990 through February 2013. Here we see a fully recovered sector. The current level of shipments just barely exceeds the 2008 peak. And while the growth pace has slowed since 2011, the slope of the earlier part of the 2009–2012 recovery is steeper than its 2004–2007 counterpart. Put another way, manufacturing was really hot in 2010–11 but cooled more than a bit with Europe’s slowdown in 2012.

Looking inside the Box

When I open the manufacturing box and examine the contents, we can begin to identify which sectors seemed to have the most wind in their sails. I do this in the next chart, which reports growth in value added for some sectors from 2004 through 2011.

The boom in oil, gas, and related industries is clearly seen here. We also see a mini-boom in durable-goods production. Wholesale trade growth follows the manufacturing pattern.

I take a deeper cut by looking inside the durable goods category. The next chart reports a series of indexes where 2005 is equal to 100. With this in mind, the 2011 data suggest that if reshoring is occurring in a meaningful way, we should expect to find it in steel, computers and electronics, machinery, and aircraft. These are the leading growth categories.

What about Employment?

Economic recovery is important, but most people want to know about jobs. If manufacturing has recovered, they say, why don’t we see more cars in the parking lots? Generally speaking, when the economy slows down, it is only natural that people in every organization and industry look for ways to become more effective and more productive in their work. After all, the name of the game is keeping employed. Within manufacturing, becoming more productive means shuttering obsolete plants, contracting out activities to lower-cost providers, discovering new supply sources, and investing in new automation tools. Taking these actions can lead to a slimmer workforce, higher output, and lower costs.

The next chart on manufacturing employment tells the tale.

The chart vividly reports the imprint of two recessions, 2001–2002 and 2008–2009. In both cases, there were sharp employment reductions. As can be seen, the level of employment has fallen from around 17 million in 1992 to 12 million in 2013. And, as shown in the earlier chart, manufacturing shipments have risen from $25 billion to $50 billion. Employment has fallen about 30 percent and production has doubled. That is a huge increase in productivity.

Is There Evidence of “Reshoring”?

We have only indirect evidence that US manufacturing is getting a new shot in the arm and that production from across the water is coming this way. One last point can be made. Consider the employment chart and the data for the 2010–2012. Employment is increasing. Now look for similar data across the full series. We can see something close in 1995–1998, but not quite as hot. Conclusion? We may be experiencing a bit of manufacturing employment renaissance.

But why is it so hard to generate employment growth?

The next and final chart on robot employment provides some insight. In recent years, robots have become cheaper and labor has become more costly. Yes, wages are flat, but healthcare and other fringe-benefit costs are rising. The chart shows which of several countries are experiencing robot growth. The horizontal axis measures robots per billion of value added in manufacturing. The vertical axis shows change in intensity. As indicated, the United States is a high-growth robot country, but not as fast-paced as South Korea.

Measure Twice, Cut Once

There on the executive’s office wall was a framed motto: “Measure Twice. Cut Once.” He was CEO of a stainless steel fabricating company. Material costs are high. Errors are expensive in that business. As I looked at the motto, I couldn’t help but think of the many times I had redone a piece of carpentry work for lack of measuring twice. It occurred to me that my motto must be “measure once, cut twice,” or even worse, “don’t measure at all, and keep on cutting.”

So it is with deficits, budgets, sequestration and collective decision making. Some refer to the congressionally imposed sequestration as mindless budget cutting. There was no measuring, just cutting. But now—as when I do carpentry—adjustments are being made. Air flight controllers? Oh yes, we will adjust for that. (Irate business travelers matter a lot.) White House visits for middle school students? No, show them the door. (Middle school students apparently don’t matter much.) Auctions for offshore drilling in California waters? No, we can’t afford that. (Environmentalists matter a lot.) Politics enters at every margin, of course, but adjustments will take place as the people’s representatives nip and tuck to provide politically acceptable outcomes.

But let’s face it. This is how a democracy does business. We cut and then measure. Even so, for the first time since 2007, the Treasury is actually reducing the size of the federal debt. But before shouting a resounding hooray, we best look closer. Part of Treasury’s revenue surge was driven by unlikely-to-occur-again end-of-year capital-gains transactions taken to avoid higher 2013 taxes. Still, let’s not look a gift horse in the mouth.

The good news about possibilities for reducing the federal debt is supported by evidence that, as shown in the next chart, federal revenues have fully recovered to prerecession levels.

Now the bad news. Consider the next chart. It shows in nominal terms the level of federal receipts and expenditures for 1Q1990 through 4Q2012. Even with progress being made, there is a yawning gap waiting to be closed.

The Continuing Tax Rate Debate

If the gap is to be closed, there is no doubt but that it will take more revenue and less spending. But when it comes to getting revenue, there is a never ending political debate regarding tax-rate fairness and which taxpayer income group, if any, should pay the higher or lower tax rate. (After all, there could be a flat tax.) There is hardly any discussion of revenues, which seems odd, to say the least.

But of course, there is reason to be concerned about fairness. People understandably rebel when they perceive they are being treated unfairly by government. (Consider the current IRS controversy.) But if revenues are the chief concern, then how much revenue is collected may be an equally important consideration when politicians talk about taxes.

Writing in 1924, treasury secretary Andrew W. Mellon said this about the political manipulation of rates:

I have never viewed taxation as a means of rewarding one class of taxpayers or punishing another. If such a point of view ever controls our public policy, the traditions of freedom, justice and equality of opportunity, which are the distinguishing characteristics of our American civilization, will have disappeared and in their place we shall have class legislation with all its attendant evils. The man who seeks to perpetuate prejudice and class hatred is doing America an ill service.

But why pay attention to the thoughts expressed by Andrew Mellon? Does he have credentials that command attention? Yes, indeed. As Secretary of Treasury during the Harding, Coolidge, and Hoover administrations, Mellon led a successful effort to reduce the size and debt of the federal government. In the earlier part of his government service, the nation was adjusting to a post–World War I environment, with lots of debt overhang. Sound familiar? His arguments about the relative merits of lower tax rates to produce higher revenues won the day. And he saw higher revenues when rates were reduced. He literally discovered the basis of what we now celebrate as the Laffer Curve. In all fairness, we should call it the Mellon-Laffer Curve.

For those who may think that higher tax rates bring in more revenue, consider some data provided by Mercatus economist Antony Davies. The next chart reports the highest marginal income tax rate from 1954 through 2010. The chart that follows shows tax revenues as a share of GDP for the same years. There’s only so much wool the sheep will give.

Looking for Prosperity

People worldwide are looking for prosperity, and always have been. Population movement is our best evidence of greener pasture assessments made when people vote with their feet. For the United States, we know that some states are growing slowly, some rapidly, and only one, Michigan, is currently losing population.

All else equal, population growth is a good predictor of state real GDP and personal income growth. People, the ultimate resource, often bring income with them in the form of retirement and other transfer payments; they also bring investment income, and of course, those entering the labor force become producers of new income. It is difficult for a state to show income growth in the absence of population growth. Doing so requires increases in productivity for the existing workforce.

The next two charts speak to the relationship between population and income growth for the United States. The first in the series shows population growth for the most recent period. The faster growing states are green, which comes in three shades. States with the two darker hues are growing faster than the national growth rate of 1.7 percent. As can be seen, all of the highest growth states are located west of the Mississippi. The Southeast, with the exception of Alabama and Mississippi, is also growing faster than the national average.

Total personal income growth for 2011–2012 is reported next. The darker the hue, the higher the growth. While mapping from population to income growth is not perfect, the linkages between the two can still be seen.

The IRS and Political Influence

Recent revelations about the IRS targeting Tea Party-affiliated organizations for investigation and slow treatment reminds me of what Public Choice scholars learned long ago. All of government is political. Special-interest influence seeps through in unusual but systematic ways. On the IRS specifically, Jim Couch and colleagues at the University of North Alabama published research in 1999 that focused on statistical treatment of IRS audit activities as conditioned by political variables. The 1995 audit data were part of annual summaries for IRS districts reported in the Transactional Records Access Clearinghouse (TRAC) at Syracuse University.

The Couch et al. statistical model explained the frequency of those audits across states. Their explanatory variable included whether or not a state’s senator sat on the IRS senate oversight committee or a representative sat on the house oversight group, the share of votes cast for President Clinton in 1992, and other variables that are thought to be positively associated with audit activity, such as higher levels of earned income tax credits as proxied by the state poverty rate and gambling income.

A direct quote from and summary of the work and findings are shown below. As indicated by the plus and minus signs over variables, audit rates fall when senators or congressmen sit on IRS oversight committees. They fall when a larger share of a state population voted for Bill Clinton and rise for those states with a poor Clinton record. More agents in a state and more gambling mean more audits, as does a higher share of poverty.

In short, politics seems to matter in explaining IRS audit behavior.

These statistical results parallel others that focused on federal antitrust activity and presidential declarations of national disasters, an action that triggers a flood of federal support. The antitrust study shows that actions are taken less frequently against firms headquartered in the states and districts of congressmen who sit on antitrust agency oversight committees. The national disaster study examined FEMA activity, adjusted for severity of disasters, state population, and other variables. The researchers found greater frequency of disaster declarations for politically important states than for others. The authors reported that some 45 percent of FEMA actions were motivated by politics instead of disaster severity.

These Public Choice findings suggest two things. First, human beings respond to incentives, whether they are supplying houses, food, or politically determined actions. Second, since this is common knowledge, we must take action to reduce occurrences that corrupt the political process. How? By requiring transparency, regular agency reports that demonstrate choice neutrality, publicity, competition from the loyal opposition, and constant vigilance.

The Employment Impact of Regulation

Keith Hall — Tue, 18 Jun 2013 19:54:15 -0400

Publication

Honestly evaluating the impact of regulation on unemployment is not only in agencies’ best interests, it’s required by law. In 1993, Executive Order 12866 addressed the employment cost of regulation in the requirement that agencies develop an assessment of “any adverse effects on the efficient functioning of the economy, private markets (including productivity, employment, and competitiveness), health, safety, and the natural environment), together with, to the extent feasible, a quantification of those costs.” This requirement was clarified in 2011 when Executive Order 13563 stated, “Our regulatory system must promote public health, welfare, safety, and our environment while promoting economic growth, innovation, competitiveness, and job creation.” Most recently, in their Draft 2013 Report to Congress on the Benefits and Costs of Federal Regulations and Unfunded Mandates on State, Local, and Tribal Entities (April 2013), OMB states that “job creation is an important consideration in regulatory review.”

Unfortunately, the vast majority of agencies have never estimated the employment effects of proposed regulatory changes. Only recently have just a few agencies included employment effect in their Regulatory Impact Analyses. Even then, the analysis is not well done and the methodologies used systematically underestimate the employment cost of regulatory changes.

BASIC REASONS FOR REGULATING AND REGULATORY IMPACT ANALYSES

Regulation can play an important role in a market economy where there are significant market externalities, incomplete markets, information asymmetries, or public goods. Ideally, regulation identifies and focuses on correcting these market failures with minimal economic cost.

In practice, regulation often intervenes in markets for other, noneconomic reasons. For example, a regulation may be designed to redistribute income or to guarantee access to certain goods and services, such as health care or education. Here, too, the ideal situation is that goals are met with minimal economic cost.

Empirical work has made it clear that ill-designed regulation can cause significant economic distortions that damage investment and entrepreneurship, reduce competition, lower productivity and economic growth, and raise unemployment. Consequently, there has long been an interest in trying to insure that regulation is implemented when it improves social welfare or achieves the desired noneconomic goals with maximum net benefits or minimum net costs to society.

TYPES OF EMPLOYMENT IMPACT FROM REGULATION

There are three types of employment effects from regulatory changes.

First, there can be macroeconomic/dynamic effects of regulation. This includes regulation’s impact on such things as job growth, wage growth, and the long-run levels of unemployment and labor force participation. However, since agency analyses often focus on small regulatory changes, there is seldom a labor market impact large enough to estimate. The risk, then, is that we suffer a “death of a thousand cuts,” where hundreds of small changes impose small employment costs individually, but the cumulative effect ends up being quite large. There is no simple solution to this as long as the focus is on small changes rather than an overall evaluation of regulation levels.

Second, the reallocation of labor has a long- run effect on the level of output in the economy. Use of labor resources in less-than-optimal ways due to compliance with regulation results in a reduction in the level of productivity and is perhaps the most fundamental part of the economic cost of regulatory changes.1 This effect works primarily through higher prices paid by purchasing firms and consumers. Much like a tax, the effects are both direct (affecting prices in the regulated industry) and indirect (affecting prices in industries using the regulated good or service or affecting consumer buying power). This is a primary reason why the economic analysis of regulatory changes should, whenever practical, use multimarket models to fully identify the effects.

Third, there is the economic cost of job displacement. Regulation raises the cost of production, which leads to higher prices and reduced output. This causes job loss in the regulated industry. There is significant literature based on data from surveys from going back to 1968 that demonstrates that the economic cost of job displacement is significant and especially large during economically difficult times. The immediate impact of job loss includes lost wages, job search costs, and retraining costs. Further, research shows that even after reemployment it can take as long as 20 years for workers to catch up on lost earnings, largely due to skill mismatches between the jobs lost and the new jobs created in the economy. These losses occur at different lengths of job tenure, in all major industries, and with workers of any age. Recent estimates of earning losses range from 1.4 years of earnings in times of low unemployment to 2.8 years during times of high unemployment. OMB is finally recognizing the potential importance of this impact and has requested comment on the importance of including these impacts in regulatory impact analyses in the 2013 draft report to Congress cited above.

REGULATORY IMPACT ANALYSES

Particular types of regulatory changes that improve the function of specific markets may yield some positive employment impact, but more often ignoring the employment effects results in an underestimation of the economic cost of regulation.

Most major regulatory agencies that are required to conduct regulatory impact analyses simply ignore employment effects. While it might be true that regulatory changes that improve market function may yield some positive employment impact, regulations far more often have negative employment effects. The true economic costs of regulations are underestimated when agencies ignore these negative employment effects.

This is particularly true for regulated industries that have a broad effect on consumers and the economy and during times when unemployment is high and the economic cost of job displacement is large. Agencies can do much better.

Agencies should routinely include an estimate of the number and types of jobs likely to be lost as the economy adjusts to the higher prices from regulatory changes. This would be an estimate of the “job displacement” cost of regulation. There is now significant literature showing that these costs are high and agencies should be able to develop methodologies to add these costs into their analyses. Recent estimates put the economic cost at nearly three years of lost earnings for every displaced worker during bad economic times (like now).
Agencies should focus their economic analysis on the indirect as well as the direct effects of regulatory changes. That is, higher prices from regulation will displace workers in the regulated industry, but many more workers may be displaced indirectly from other industries. For example, the EPA itself estimated that a pro- posed Toxics Rule would raise electricity prices by nearly four percent, and this would raise costs of production in at least 19 downstream industries. They did not extend their analysis to the employment effects. If they had, they would have found that 11 additional workers each would have lost a job in a downstream industry for every one worker losing a job in the electrical generation industry.

Film Tax Credit Is a Raw Deal for Taxpayers

Antony Davies, James R. Harrigan — Fri, 14 Jun 2013 10:54:23 -0400

Expert Commentary

Pennsylvania Senate Majority Leader Dominic Pileggi has announced that he will introduce legislation to uncap Pennsylvania's Film Production Tax Credit (FPTC) in an effort to entice production companies to film in the commonwealth.

To justify this sweetheart tax break for the film industry, Sen. Pileggi cites a “detailed report from the Independent Fiscal Office” that “concludes that ‘uncapping' the film tax credit would have a significant positive impact on Pennsylvania's economy with a minimal cost in the coming fiscal year.”

This is partially true. The Independent Fiscal Office (IFO) did release a report. The rest of the senator's statement, like most of what the film industry produces, is pure fantasy.

On page 2, the IFO clearly states that “(the report) does not address the fiscal or economic impact of the FPTC in general, nor does it evaluate the overall effectiveness of the credit.” In fact, the report can be summarized in two points: The tax credit will cost us money and the tax credit will be good for the film industry. The report goes on to say that “for every one dollar in tax credit awarded, the Commonwealth recoups $0.14 in tax revenue from the associated economic activity.”

Put another way, the tax credit sells our tax dollars to the film industry for 14 cents each.

Pileggi's bill would uncap this giveaway, allowing the film industry to buy as many of our tax dollars as it likes at this bargain price.

Granted, these are tax credits — meaning that we aren't exactly giving away our tax dollars so much as failing to collect them. But the IFO admits in its report that it doesn't know how many films would have been made in Pennsylvania if the tax credit didn't exist.

If the answer is “all of them,” we really are giving away our tax dollars. Even if the answer is “only half of them,” we're selling our tax dollars for 28 cents each, not 14 cents each. That's still a raw deal for taxpayers.

Don't get us wrong — cutting taxes spurs economic growth. But to avoid favoritism, tax cuts need to be across the board.

When government picks winners, as Pileggi is doing, it invariably fails because politicians don't put their own money on the line. They put our money on the line. If the bet pays off, they win. It it doesn't, we lose.

If Pennsylvania has $130 million to throw around, then let's cut taxes across the board. Then taxpayers could decide for themselves which industries deserve their hard-earned money.

The job creation would be the same; the economic growth would be the same. What would be different is that the new jobs would be producing things that the people want, not things that the politicians think we should have.

The film tax credit is a slap in the face to the hardworking people of Pennsylvania, delivered by Pileggi as he woos one industry at the expense of the others. If lower taxes mean economic growth, then let's lower taxes for everyone.

And if Sen. Pileggi wants to invest in the film industry, let him do it with his own money.

Trustees Make Clear Social Security, Medicare Must Be Reformed

Veronique de Rugy — Fri, 14 Jun 2013 10:03:20 -0400

Expert Commentary

Each year, the board of trustees for Social Security and Medicare release reports highlighting the financial outlook and solvency for these massive entitlement programs.

"We are looking at over $30 trillion in total obligations that we have to find sources to pay for above and beyond projected payroll tax and premium revenues."

Basically, both Social Security and Medicare are on unsustainable paths and must be reformed.

Take Social Security, for instance. Since 2010, Social Security has been running a permanent cash-flow deficit. That means that taxes collected for the program aren't enough to cover the benefits paid to retirees.

To fill the gap, the program is drawing from the trust-fund balances (first using the interest, then the principal) to keep payments to retirees going. In concrete terms, Treasury will borrow money to repay the trust funds, thus increasing our debt load as we go.

In addition, the Social Security retirement trust fund will be exhausted by 2035, while the disability fund trust will hit the wall in 2016. This is bad news, because the dwindling trust fund determines the spending authority of the program.

Without a positive balance in the trust fund, the program won't have the authority to pay out full benefits, but only what the program collects in taxes -- which today means a 23 percent cut in benefits across the board.

Blahous explains that an alternative to the benefit cut would be to raise "tax revenues by the equivalent of an increase in the current tax rate from 12.4 percent to 16.5 percent -- an increase of nearly one-third in worker tax burdens."

Medicare is in bad shape, too. Medicare Hospital Insurance trust fund will run out of assets in 2026 -- that's two years later than projected last year.

However, we shouldn't pop the champagne quite yet. With less than one year's worth of benefit payments in the trust fund, it's unlikely that these projections will materialize.

The HI trust fund, like the SS one, determines the spending authority of the programs, which means that when the HI trust fund dries out, the program won't have the authority to pay out all benefits beyond what the program collects by itself, income from premiums and payments by states.

Finally, even these numbers are too optimistic since, among other things, some of the expected revenue or cost savings in the president's health care law (the so-called Obamacare) may never materialize.

Paul Spitalinic, the acting chief actuary of the program, for instance, explains at the end of the trustees' report that "current law would require a physician-fee reduction of an estimated 24.7 percent on January 1, 2014 -- an implausible expectation."

He then goes on to list a number of other cost-reduction or revenue raisers that shouldn't be expected to materialize making the rest of the projections in the report somewhat moot.

Our recent improved short-term fiscal outlook may give lawmakers a false sense of safety. This would be unfortunate since the trustee's report confirms once again that the long-term outlook of both Social Security and Medicare requires immediate attention and prompt reforms.

What's more, the longer Congress delays dealing with these issues, the worse the shock will be. The good news is that are many options to address our problems -- the most unacceptable one is to do nothing.

Adam Thierer Explains Why the US Should Not Model Data Collection After Europe for The Washington Post

Adam Thierer — Wed, 12 Jun 2013 11:24:47 -0400

Video

Adam Thierer says the United States does not want to head down the same path as the European data system with a top-down, more regulated approach to privacy online.

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Adam Thierer Discusses Data Collection by Government and Marketers for The Washington Post

Adam Thierer — Mon, 17 Jun 2013 17:33:16 -0400

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Adam Thierer explains why he cares more about the government collecting private data than companies collecting it.

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The 2013 Farm Bill: Limiting Waste by Limiting Farm-Subsidy Budgets

Vincent H. Smith — Mon, 17 Jun 2013 11:22:32 -0400

Publication

American taxpayers currently spend more than $20 billion per year on farm subsidies, the vast majority of which flow to the largest and wealthiest farming operations. The upcoming farm bill provides Congress the opportunity to eliminate the programs that simply transfer money from less-wealthy taxpayers to wealthier farm households. The question is, will the 2013 farm bill make these politically sensitive cuts?

In a new study from the Mercatus Center at George Mason University, Vincent Smith, a professor of economics at Montana State University, analyzes current farm bill proposals by the House and Senate Agriculture Committees. The study examines how reducing farm subsidies by various levels would affect the structure of US agricultural policy. The study concludes that farm subsidies could be reduced by at least $9–10 billion per year—about 10 percent of current farm bill spending—without any measurable effect on agricultural production.

To learn more, read “The 2013 Farm Bill: Limiting Waste by Limiting Farm Subsidy Budgets.”

REDISTRIBUTING INCOME TO FARMERS

The federal government spends approximately $100 billion per year on farm bill programs. Of this, $23 billion—nearly 20 percent—goes to farm subsidy programs, including:

$17.5 billion to the largest 15–20 percent of farm operations; of this, $14 billion is paid to the largest 10 percent.
$2.5 billion to private agricultural insurance companies.

SUBSIDIES TO INDIVIDUAL FARMERS

Since the 1960s, successive farms bills have funded subsidies going mainly to farm households which are much wealthier and enjoy much higher incomes than the average American household (see chart). Some subsidies to individual farmers are astonishingly large. The US General Accounting Office reported that in 2011 more than 50 farms received over $500,000 in crop insurance premiums. Many of these farms also obtained additional benefits from other subsidy programs, such as the Direct Payments program.

Under the Direct Payments program, payments to land owners and farms are unrelated to their actual production or crops raised. In other words, farmers receive the payment even if they have a great year with crop prices near record highs, as they are now.
Many of these farming operations are organized as partnerships that typically own multiple farms and thousands of acres of cropland. The families associated with these partnerships are much wealthier than the average American household.

THE ECONOMIC AND FINANCIAL CONDITIONS OF US FARMERS

A recurring justification for these subsidies is that farmers need a safety net because farming is such a risky business. This claim is inaccurate.

The annual failure rate for farms is 0.5 percent. The annual business failure rate, at 7 percent, is 14 times greater.
The average debt-to-asset ratio in farming is currently 10 percent and has not exceeded 15 percent since the late 1990s. This indicates that farmers generally face very little financial risk, and as a result, even less-efficient farming operations are able to survive.

HOUSE AND SENATE AGRICULTURE COMMITTEE PROPOSALS

Both committees continue to offer farm programs and policy initiatives that provide large subsidies to these wealthy farming operations.

House Agriculture Committee

The House-passed budget for FY 2014 established a goal of cutting $3.4 billion per year from the farm bill, all from farm subsidies. While the House Agriculture Committee subsequently approved $3.8 billion in cuts in H.R. 1947, it reduced subsidies by only $1.8 billion; the remainder of the cuts came from nutrition programs.

Termination of the ACRE program. The committee would terminate the Direct Payments program and the Average Crop Revenue Election (ACRE) program, which provides payments to farmers when their per-acre revenues fall below a percent of their average revenues during the previous five years.

While this would reduce annual farm bill spending by about $5.6 billion, the committee would use $3.8 billion of those “savings” to create new programs, thus achieving only $1.8 billion in actual farm subsidy cuts.

Introduction of new programs. H.R. 1947 would spend the $3.8 billion to create 1) the Price Loss Coverage program (a new price-support program), 2) a new shallow-loss program for cotton, and 3) a new shallow-loss and heavily subsidized program (the “Supplemental Coverage Option”) designed to offset the deductible associated with the federal crop insurance program.

Senate Agriculture Committee

The Senate Agriculture Committee’s farm bill also proposes termination of the Direct Payments and ACRE programs. But in their place, the committee would create a new and potentially more expensive shallow-loss program called Average Revenue Coverage (ARC). Under ARC, farming operations would seldom receive less than 89 percent of their expected income.

THE COST OF THESE PROGRAMS

If commodity prices decline from their current near-record levels towards their long-run trends, the new programs proposed by the House and Senate Agriculture Committees could cost American taxpayers as much as $10–20 billion per year. This is two to four times more costly than the farm subsidies the committees propose to eliminate.

If these new programs are included in the 2013 farm bill, the taxpayers—not the farming operations—will become responsible for almost all of the downside price and revenue risks associated with producing corn, cotton, peanuts, wheat, rice, and many other crops. This is in addition to the risks already being shouldered by taxpayers through the heavily subsidized federal crop insurance program.

A RATIONAL APPROACH TO REFORMING AGRICULTURAL POLICY

House Republicans, Senate Democrats, and the Administration have all proposed reducing farm subsidies by more than $3 billion per year. This study considers the potential outcome of a required cut in this range, as well as potential outcomes should Congress be required to make higher levels of cuts:

1. Require $3.1–3.4 billion a year in subsidy cuts. This could be achieved by ending the $5 billion per year Direct Payments program. Actual savings would be reduced to just over $3 billion, as participation in the Direct Payments program currently serves as a disincentive to participation in the ACRE program (participants in the ACRE program are required to take a 20-percent cut in their Direct Payments check). Thus, the elimination of Direct Payments would increase participation in ACRE, raising the program’s cost from $650 million to an estimated $2 billion.

2. Require $3.5 billion a year in subsidy cuts. Requiring a cut of $3–3.5 billion from current farm subsidy programs could spur the House and Senate Agriculture Committees to end both the Direct Payments program and the ACRE program. This would result in an estimated $5.7 billion in annual savings. It would, however, then give the committees enough room to introduce either a Price Loss Coverage program or Average Revenue Coverage (ARC) shallow-loss program. As noted above, these programs could expose taxpayers to as much as $18–20 billion in new subsidy outlays if the prices for major crops, such as corn and wheat, fell from their current near-record levels.

3. Require $5 billion a year in subsidy cuts. Requiring $5 billion in cuts per year would spur the committees to eliminate both the Direct Payment and current shallow-loss ACRE programs, resulting in $5.7 billion per year in estimated savings. Unlike the previous scenario, this would not leave enough in “extra” savings to introduce a new shallow-loss or price-support program. The committees would, however, have enough money to renew a suite of livestock disaster programs (with costs of $400–500 million per year) that expired in 2011.

4. Require higher cuts in farm subsidies. Requiring higher levels of cuts, in the range of at least $9–10 billion, would force the Agriculture Committees to reform other subsidy programs in addition to eliminating the Direct Payments and ACRE programs. Such a required cut would likely force the reform of the federal crop insurance program—the largest farm subsidy, for which taxpayers subsidize 70 percent of the total costs.

A Guide To the 2013 Social Security Trustees Report, Part II

Charles Blahous — Wed, 12 Jun 2013 09:43:09 -0400

Expert Commentary

As one of the programs’ two public trustees it has become my custom to publish such summaries soon after the annual publication of the reports. The first this year summarized the Social Security report, whereas this one will summarize the Medicare report. Following are some of the report’s key points:

The trustees’ projection for the depletion date of the Medicare Hospital Insurance (HI) Trust Fund is but one part of a much larger mosaic of Medicare finances. There is a tendency in press reporting to focus unduly on the trustees’ annual projection for the date of depletion of theMedicare HI trust fund. But Medicare is a large and complex program with different trust funds financed in different ways.

Medicare’s HI trust fund, which finances hospital, home health following hospital stays, skilled nursing facility and hospice care services, is only one piece of a larger Medicare program and indeed represents less than half of total program costs. Like Social Security, Medicare HI is financed primarily by a tax on worker wages and can theoretically become insolvent if its obligations exceed its financial resources. But Medicare’s Supplementary Medical Insurance (SMI) trust fund has even greater expenditures and includes Medicare Parts B (physician, outpatient hospital, and general home health services) and D (prescription drug coverage). SMI has no projected depletion date because by statutory construction it is automatically provided with whatever general fund revenues it needs (beyond tax and premium income) to remain solvent. Thus financial strains in SMI are manifested not in projected insolvency but as rising pressure on the general federal budget.

In 2012, HI expenditures totaled roughly $267 billion and SMI expenditures $307 billion. In the future this gap is projected to widen, with SMI becoming a relatively larger share of total Medicare expenditures. So while the projected duration of solvency of the HI trust fund is certainly an important piece of information, it does not speak to the substantial majority of Medicare operations.

The trustees have issued a Medicare “funding warning” for a seventh straight year. Because of the general budget implications of rising Medicare costs, the trustees are required to report whenever there is “excess general revenue Medicare funding,” defined as whenever the difference between total costs and dedicated (mostly tax and premium) revenues exceeds 45 percent of total program costs. This year we found such an excess again in 2013 and issued our seventh consecutive Medicare funding warning.

As with Social Security, the principal driver of Medicare cost growth for the next two decades is its rising number of beneficiaries.There is also a tendency for public discussions of Medicare’s financing problems to focus on general health care cost inflation. But a far more important factor in the near term is the sheer number of beneficiaries coming onto the Medicare rolls as the baby boomers head into retirement. Under current law the swelling beneficiary population will cause Medicare expenditures to rise dramatically through the mid-2030s. Only after then does general health cost inflation become the relatively more important factor. Overall, the principal driver of most projected Medicare cost growth relative to GDP is demographic.

This is visible on the following graph from the summary of the trustees’ reports showing projected costs in both programs relative to GDP. The growth rate for total Medicare (HI + SMI) is slightly higher than for Social Security (OASI + DI) because Medicare is also affected by health cost inflation. In both programs the biggest factor is the pre-2035 surge in baby boomer beneficiaries. Accordingly, we will not get a handle on rising Medicare costs unless we are willing to address the growth in the number of beneficiaries drawing benefits from it. My companion piece on the Social Security report details how we have failed to adequately adjust these programs for the demographic realities of changing fertility patterns and rising longevity.

Medicare costs are nearly certain to be higher than our current projections. Like other federal scorekeepers, the trustees are required to project program operations under current law regardless of whether most people assume that current law will be sustained. This is particularly important with respect to Medicare projections because current law specifies that physician payments will be cut by nearly 25 percent in early 2014 under the statutory Sustainable Growth Rate (SGR) formula. Lawmakers have overridden similar payment reductions in every year since 2003 and are widely expected to do so again.

If lawmakers continue to override the SGR physician payment formula, total Medicare costs will be substantially higher than what we now project – in the long run, more than 10% higher. The Medicare trustees’ report presents an illustrative alternative scenario that assumes a continuation of the historical pattern of SGR overrides; under this alternative scenario total Medicare costs will be 7.2% of GDP in 2087 as opposed to 6.5% under current law.

We also show an another alternative scenario in which, in addition to an SGR override, certain controversial elements of the 2010 Affordable Care Act (ACA) are either scaled back from 2020-2034 (e.g., the ACA’s aggressive annual reductions in most categories of provider payments) or eliminated altogether (e.g., implementation of the cost reduction recommendations of the ACA’s Independent Payment Advisory Board). There is great disagreement among analysts as to whether these features of the ACA will prove sustainable over the long term. We as trustees take no position on that controversy but we do estimate the financial consequences of their being overridden. In this second alternative scenario total Medicare costs climb to 9.8% of GDP by 2087.

Small changes in the projected HI depletion date are not statistically significant. Some reporting has overstated the financial improvement represented by the slight postponement in the projected date of HI trust fund depletion from 2024 in last year’s report to 2026 in this year’s. HI finances are basically balanced on a knife’s edge and even a slight change in cost growth assumptions can cause the projected depletion date to move by a few years.

At the start of this year HI’s “trust fund ratio” was 81, which means that there were only enough reserves in the trust fund to finance 0.81 years’ worth of benefit payments. HI finances over the next several years depend enormously on whether annual income will balance outgoing benefit expenditures almost exactly. Under our current projections HI’s trust fund ratio will hover at low levels throughout the next decade, declining steadily until depletion in 2026. In the accompanying graph I show how if our projected HI cost growth rates are understated just a little bit, its trust fund’s projected depletion date would move closer. If our projections are low by just half a percentage point per year, the HI fund would be depleted in 2024. If we’re low by one point per year, depletion would occur in 2022. Accordingly, no one should interpret small changes in the HI depletion date as signifying a substantial change in the Medicare financing outlook.

There is no reason to believe that the recent reported slowdown in health care cost growth will improve the long-term picture significantly relative to current projections. At our press conference announcing the release of the trustees’ report, I was surprised to hear questions asking in effect whether a recent slowdown in health care cost growth might have a significant effect on the outlook and debate surrounding the Medicare program. To my ear the questions reflected an incomplete understanding of the factors underlying current projections. It would be mistaken to conclude that the recent slowdown in health care cost growth (partially though not wholly attributable to the recent recession) should relax pressure for much-needed Medicare reforms.

It’s important to understand that our long-term projections already assumed a substantial slowdown in health care cost growth relative to historical rates. This is because the projections are based on demonstrated trends in the elasticity of health care cost growth – in layman’s terms, how much people’s health care consumption patterns change as a result of factors that include health care prices, income levels, and insurance coverage. To put it more crudely, we have never expected that historical rates of health care cost growth will continue to the point where health care services absorb our entire economy. We are not going to have a society in which we are all walking around homeless, naked and starving but with impeccable health care.

Thus even before the 2010 passage of the ACA, we were assuming that health care cost growth would eventually slow down. Adding the ACA’s aggressive Medicare cost restraints to that assumption means that we are in effect assuming over the long term that Medicare expenses will actually grow more slowly per capita than our general economy. This assumption is one reason why many have questioned whether the ACA’s cost restraints will be sustainable over the long term. At the very most, one might argue that the recent slowdown in health care costs renders current projections slightly more plausible, but no one should be assuming that things are going to look much better.

Summary: In sum, Medicare like Social Security faces substantial financing challenges and warrants significant legislative reforms. Whereas in Social Security the financing strains are manifested in projections of trust fund depletion, in Medicare some financing strains are manifested primarily in rising projected pressure on the general federal budget. As with Social Security, Medicare is being strained by the growing numbers of baby boomers moving onto its benefit rolls. Overall, Medicare financial projections are subject to greater uncertainty than Social Security’s due to the difficulty of projecting health cost inflation. For a variety of reasons including expected legislative actions, actual Medicare costs are likely to be higher than currently projected.

2014 Annual Retreat: Advancing Liberty, Creating Change

Wed, 12 Jun 2013 09:29:13 -0400

Events

Mercatus Center supporters and friends are invited to join us for our 13th Annual Retreat in Scottsdale, AZ, co-hosted with the Institute for Humane Studies (IHS).

Beyond Unemployment: Pennsylvania's Sluggish Labor Market

Keith Hall, Robert Greene — Wed, 12 Jun 2013 16:22:49 -0400

Publication

While the Great Recession had a moderately less severe impact on Pennsylvania than on the nation as a whole, the state’s recovery since the height of the recession has been slower than the national average. Sluggish economic growth is slowing the pace of the state’s labor market recovery. Most sectors in Pennsylvania have yet to rebound to prerecession levels. Employment in one sector—mining and logging—has experienced massive growth from a surge in oil and gas drilling, extraction, and support jobs. Lowering or eliminating Pennsylvania’s corporate tax rate, implementing a right-to-work law, and streamlining the state’s drilling regulations could stimulate more economic growth and job creation in the Keystone State.

THE GREAT RECESSION’S IMPACT ON PENNSYLVANIA’S LABOR MARKET

During the Great Recession, Pennsylvania experienced a lower peak unemployment rate than the nation as a whole—8.7 versus 10.0 percent.[1] Between the end of 2007 and early 2010, Pennsylvanian nonfarm payroll jobs declined by 4.40 percent, compared to a 6.33 percent decline nationwide (see Graph 1). However, between February 2010, when nonfarm payroll jobs were at their lowest recession level, and March 2013 the number of nonfarm payroll jobs in Pennsylvania grew only 3.23 percent (see Graph 2). Nationally, total nonfarm payroll jobs increased 4.63 percent—noticeably faster than the pace of Pennsylvania’s recovery.

Pennsylvania’s postrecession rate of job loss is now approaching the national average (see Graph 1). Pennsylvania has recovered only about 70.2 percent of the nonfarm payroll jobs it lost during the recession[2] while nationally only about 68.6 percent of lost nonfarm payroll jobs have been recovered.[3]Pennsylvania’s 7.9 percent 2012 unemployment rate has not improved significantly since 2010 and still rests well above the prerecession 2007 rate of 4.4 percent (see Graph 3). Unemployment rates for all age groups exceed prerecession levels.

AN UNEQUAL RECOVERY

Pennsylvania’s labor market recovery has been unequal between different sectors (see Graph 4). The state’s trade, transportation, and utilities sector—which makes up almost one-fifth of the state’s nonfarm payroll jobs[4]—has still not fully recovered to 2007 levels of employment. There are roughly 14 percent fewer jobs in Pennsylvania’s construction and manufacturing sectors, which before the recession made up almost 16 percent of the state’s total nonfarm payroll jobs.[5] However, these three sectors are outperforming the national rate of recovery, and the state’s construction sector has lost jobs at a significantly lower rate than the national average.

Over half of Pennsylvania’s nonfarm payroll jobs exist in its three largest sectors—trade, transportation, and utilities; professional and business services; and education and health services.[6] Before the recession (between 2004 and 2007) almost 82 percent of the state’s annual job gains, approximately 41,000 jobs per year, were created in these sectors (see Graph 5). From 2009 to 2012 just under 72 percent of annual job gains, approximately 31,300 jobs per year, were created in these sectors. The annual rate of job gains in Pennsylvania’s three largest sectors has slowed almost 25 percent since before the recession.

Just four sectors in Pennsylvania—education and health services; leisure and hospitality; professional and business services; and mining and logging—have realized significant net job gains since 2007 (seeGraph 4). Three—leisure and hospitality, professional and business services, and mining and logging—are outperforming the national sector rate of job gains. Mining and logging is by far Pennsylvania’s fastest-growing sector. In 2012, there were about 75 percent more mining and logging jobs in the state than existed in 2007.

THE SHALE SURGE

Mining and logging job gains in Pennsylvania have been primarily driven by increases in oil and natural gas extraction, drilling, and support activities jobs (see Graph 6). Since 2007, the rapid growth in drilling and extraction jobs—200 and 124 percent gains, respectively—has facilitated a massive 455 percent increase in support activity jobs for oil and gas operations. Pennsylvania’s mining and logging sector job gains made up approximately 12.5 percent of all new mining and logging jobs created in the United States between 2007 and 2012.[7]

These gains have in large part occurred because of the introduction of horizontal drilling technology and hydraulic fracturing to shale oil fields.[8] Increased drilling activity in the Marcellus shale formation, which covers northern and southwestern Pennsylvania, has helped increase Pennsylvania’s daily natural gas production over 500 percent since 2009.[9] A recent study conducted by a team of researchers at Pennsylvania State University finds that by 2020, daily natural gas output from the Marcellus Shale could likely grow an additional 175 percent and as many as 75,000 new Marcellus-supported jobs are estimated to be created in Pennsylvania.[10]

EXPLAINING THE SLOW RECOVERY AND ACCELERATING ITS PACE

Despite growth in the mining and logging sector, Pennsylvania’s real GDP grew just 1.2 percent in 2011, and Pennsylvania’s average state personal income grew just 1.5 percent in real terms in 2012—the 27th lowest rate of state personal income growth in 2012.[11]

This slow economic growth is impeding Pennsylvania’s labor market recovery. Comparatively high tax rates may be stifling the state’s economic growth.

Pennsylvania’s statutory corporate income tax rate is the second highest in the country at 9.99 percent.[12] Its effective corporate tax rate (the statutory rate minus deductions) is higher than all other states’.[13] Combined with the federal rate, Pennsylvania’s corporate tax rate may be, according to Pennsylvania’s secretary of revenue, the highest in the world.[14] Policymakers should consider lowering or eliminating the state’s corporate income tax. Corporate income taxes have a highly negative effect on economic growth and reducing the rate by just 1 percent can increase annual GDP growth by 0.1 to 0.2 percent.[15] Lowering or eliminating the corporate tax rate would make Pennsylvania more competitive with neighboring Ohio—which has no corporate income tax—and Maryland, New York, and New Jersey—which all have lower rates.[16] In 2010, the state’s corporate income tax accounted for just 3.7 percent of total state and local revenue.[17] Eliminating or reducing the corporate tax rate is fiscally feasible for the commonwealth.

In the Mercatus Center’s recent Freedom in the 50 States report, William Ruger and Jason Sorens score Pennsylvania’s regulatory environment below the national average.[18] One reason for their score is Pennsylvania’s lack of a right-to-work law. Studies show that these laws are likely to increase economic growth and are associated with higher employment levels.[19] To improve the state’s labor market, policymakers should consider adopting a right-to-work law in the Keystone State.

Complicated, expensive drilling regulations may be holding back job creation in Pennsylvania’s high-growth drilling sector. Drilling fees alone cost firms roughly $204 million in 2012.[20] Seven agencies regulate drilling in Pennsylvania through a maze of about 50 separate state regulations.[21] Experts claim that the cost to develop natural gas is made higher in Pennsylvania because of the state’s comparatively more complex regulatory environment.[22] Fortunately, Pennsylvania does not impose a natural gas severance tax, and the absence of such a tax offsets some of the costs associated with Pennsylvania’s comparatively complicated regulations.[23] Policymakers should avoid implementing a severance tax and focus on streamlining Pennsylvania’s complicated drilling regulations, which, according to one estimate, are a large reason why drilling is 20 to 30 percent more expensive in Pennsylvania than in other states.[24] These policies would likely stimulate even more drilling in Pennsylvania, and research links increased municipal drilling activity with less unemployment.[25]

CONCLUSION

Some of Pennsylvania’s largest sectors are still struggling to recover from the Great Recession. The annual rate of job growth for the state’s three largest sectors has slowed almost 25 percent since before the recession. Job gains in historically smaller sectors of the state’s labor market are helping drive Pennsylvania’s recovery. Gains in mining-and-logging-sector employment have added about 15,900 new jobs to the state since 2007, and studies estimate that by 2020 as many as 75,000 additional jobs may be created due to growth in this sector. Nevertheless, slow economic growth in Pennsylvania is preventing a more rapid recovery. Streamlining drilling regulations, implementing a right-to-work law, and—most importantly—lowering or eliminating the state’s extraordinarily high corporate tax rate could accelerate economic growth and facilitate a more rapid labor market recovery.

ENDNOTES

US Bureau of Labor Statistics. The national, seasonally adjusted unemployment rate peaked in October 2009 at 10.0 percent while Pennsylvania’s seasonally adjusted unemployment rate peaked in February and March 2010 at 8.7 percent.
US Bureau of Labor Statistics. In January 2008, there were 5.8225 million nonfarm payroll jobs (seasonally adjusted) in Pennsylvania. The number of nonfarm payroll jobs bottomed out in February 2010 at 5.5664 million nonfarm payroll jobs. By March 2013, there were 5.7463 million nonfarm payroll jobs in Pennsylvania.
US Bureau of Labor Statistics. In January 2008, there were 138.056 million nonfarm payroll jobs (seasonally adjusted) nationwide. The number of nonfarm payroll jobs bottomed out in February 2010 at 129.320 million nonfarm payroll jobs. By April 2013, there were 135.309 million nonfarm payroll jobs in the United States.
US Bureau of Labor Statistics.
Ibid.
Ibid.
Ibid.
US Energy Information Administration, “Horizontal Drilling Boosts Pennsylvania’s Natural Gas Production,” May 2012, http://www.eia .gov/todayinenergy/detail.cfm?id=6390.
See US Energy Information Administration, “Pennsylvania Drives Northeast Natural Gas Production Growth,” August 2011, http://www.eia.gov/todayinenergy/detail.cfm?id=2870. See also US Energy Information Administration, “Pennsylvania Natural Gas Production Rose 69% in 2012 Despite Reduced Drilling Activity,” March 2013, http://www.eia.gov/todayinenergy/detail.cfm?id=10471.
For 2012 daily natural gas output levels, see ibid. For 2020 estimates, see Timothy J. Considine et al., “The Pennsylvania Marcellus Natural Gas Industry: Status, Economic Impacts and Future Potential,” July 2011, 31, http://marcelluscoalition.org/wp-content/uploads/2011/07/Final-2011-PA-Marcellus-Economic-Impacts.pdf.
Bureau of Economic Analysis, US Department of Commerce.
See Tax Foundation, State Corporate Income Tax Rates, 2000–2013, http://taxfoundation.org/article/state-corporate-income-tax-rates-2000-2013.
See Public Hearing on Governor Corbett’s Tax Reform Proposal Before the Pennsylvania House Finance Committee (April 2013) (testimony of Tom Bowen, on behalf of the Pennsylvania Chamber of Business and Industry), 5n2, http://www.legis.state.pa.us/cfdocs/legis/TR/transcripts/2013_0072_0009_TSTMNY.pdf
The top federal corporate income tax rate is 35.0 percent. Ibid. See Pennsylvania Department of Revenue, “Tax Reform Initiative Focuses on Creating Jobs, Improving PA Business Climate, Growing Personal Income,” April 11, 2013, 2, http://www.portal.state.pa.us/portal/server.pt/document/1331485/tax_reform_initiative_focuses_on_creating_jobs,_improving_pa_business_climate,_growing_personal_income.pdf.
Åsa Johansson et al., “Taxation and Economic Growth,” (OECD Economics Department Working Papers, No. 620, 2008), Table
Tax Foundation, Tax Rates, n12.
Elizabeth Malm and Ellen Kant, Tax Foundation, “The Sources of State and Local Tax Revenues,” http://taxfoundation.org/article /sources-state-and-local-tax-revenues.
William Ruger and Jason Sorens, Freedom in the 50 States (Arlington, VA: Mercatus Center at George Mason University, March 2013).
See Richard Vedder, “Right-To-Work Laws: Liberty, Prosperity, and Quality of Life,” Cato Journal 30 (2010), http://papers.ssrn.com /sol3/papers.cfm?abstract_id=2256469. For a review of various studies on the effects of right-to-work laws on industrial growth and employment, see William J. Moore, “The Determinants and Effects of Right-To-Work Laws: A Review of Recent Literature,” Journal of Labor Research 19 (1998): 445. For a study on the relationship of right-to-work laws and employment, see Paul Kersey, Mackinac Center for Public Policy, “The Economic Effects of Right-To-Work Laws: 2007,” 2007.
Pennsylvania Public Utility Commission, Annual Report of Fund Revenue and Disbursements, December 2012, 4, http://www.puc .state.pa.us/NaturalGas/pdf/MarcellusShale/Gas_Well_Admin _Rpt_123112.pdf.
Governor’s Marcellus Shale Advisory Commission, Report, July 2011, 49–55, http://www.marcellus.psu.edu/resources/PDFs /MSACFinalReport.pdf.
Considine, “Marcellus Natural Gas Industry,” n10.
Ibid., 3.
Katrina M. Currie and Elizabeth B. Stelle, “Pennsylvania’s Natural Gas Boom: Economic & Environmental Impacts,” Commonwealth Foundation, June 2010, 3, http://www.commonwealthfoundation .org/doclib/20100607_marcellusshaledrilling.pdf.
Diana Furchtgott-Roth and Andrew Gray, “The Economic Effects of Hydrofracturing on Local Economies: A Comparison of New York and Pennsylvania,” Manhattan Institute, May 2013, http://www .manhattan-institute.org/pdf/gpr_1.pdf.

Philadelphia Supporter and Friend Lunch

Maurice P. McTigue — Tue, 11 Jun 2013 11:40:54 -0400

Events

Please join us for one of our special events and discussions with the Honorable Maurice McTigue. As a former New Zealand cabinet minister and now a Mercatus Center vice president, Maurice speaks from experience about solutions and reforms that can be made to address the serious economic issues our country faces.

The Mercatus Center’s clear-headed research is shaping the conversation on government spending, fiscal austerity, and financial market regulation. Come hear what the former New Zealand cabinet minister would do in this country to promote economic growth and fiscal responsibility.

This is not a fundraising event, and there is no charge to join us. We are pleased to have you as our guest to show our thanks and appreciation to our donors. Dress is business casual. Please invite friends or associates who might be interested.

Questions? Contact Elizabeth Leibundguth at 703-993-4967 or eleibundguth@mercatus.gmu.edu.

Capitol Hill Campus: Dr. Yandle's Quarterly Economic Report: The Mid-Year Economy

Bruce Yandle — Tue, 11 Jun 2013 11:02:58 -0400

Events

The nation's economy at mid-year is operating like a three-lane expressway with one lane closed. GDP growth is breaking 2.0% when it should be 3.0%. But worse than that, the cars moving in the two open lanes are running on borrowed fuel that will someday have to be paid back.

This session offers –

Data-based insights into the what and why of the slow economy.
Some good news about sectors and places that are prospering.
Forecasts for the rest of the year
A brief Public Choice interpretation of IRS audit actions and other regulatory activity.

Space is limited. Please register online for this event.

The event is free and open to all congressional and federal agency staff. This event is not open to the general public. Food will be provided. Due to space constraints, please no interns. Questions? Please contact Erin Connolly, Events Associate, at econnolly@mercatus.gmu.eduor (703) 993-9913.

The Science of Economics

Donald J. Boudreaux — Mon, 10 Jun 2013 23:29:57 -0400

Expert Commentary

Science has earned much respect in modern society. Scientific pursuits require maturity, open-mindedness, intelligence and hard work. And scientific findings hold regardless of the nationality, sex, religious beliefs and the political affiliation of those who uncover them.

Just glance into your kitchen. The microwave and refrigerator — and the electricity-distribution system that powers these appliances — would be impossible without modern science. Ditto for so many other features of our daily lives.

Yet we must be careful to keep science in perspective. A careless understanding of science promotes a very unscientific attitude.

Science, as we think of it today, covers only a partial range. The full range of science includes not only physics, chemistry, medicine and the other hard sciences but any and all searches for understanding that are systematic, unbiased and rooted in human curiosity that prizes reason and evidence above dogma and authority.

Economics, for example, is no science like physics, but it is indeed a science. Its practitioners seek with open minds and unobstructed intellectual give-and-take to better understand the operation of systems of human exchange — including, of course, the operation of commercial markets.

One of the scientific findings of economics — a finding as firm as any conclusion of the hard sciences — is that the mix of what should be produced and made available for consumption cannot possibly be determined by science. That determination, if it's to be remotely correct, can be made only by market competition in which everyone spends his or her own money.

The number and quality of sofas, MP3 players, automobiles, pairs of jeans, toasters, bulldozers — you name it — that is “correct” for the economy to produce is discovered only in an ongoing and unplanned market process. Suppliers spend their own resources in efforts to earn profits by producing goods and services that consumers willingly buy. Many of these efforts are competitive (for example, Amazon.com competing with Sears to sell retail goods) and many are cooperative (for example, Amazon.com using FedEx to deliver retail goods to consumers).

No genius or committee of scientists plans market outcomes. Importantly, no such genius or committee could possibly match, much less outperform, the unplanned competitive market at determining what should be produced.

To see why, ask yourself how many pairs of dress shoes are “right” for you to buy over the next two years. You might have in mind some rough number now, but you know that your precise answer depends on too many factors to account for today: Will your fashion sense change? Will you get a new job that requires you to dress up more (or less) than in your current job? Will you meet a new girlfriend or boyfriend who wants you to dress up more (or less) frequently than you do now? And importantly, what if the price of dress shoes skyrockets — or falls through the floor?

There is no scientifically correct answer to the question.

Making the matter even less scientific is the fact that each of us has different tastes in dress shoes. Whatever number of dress shoes you choose to buy over the next couple of years will be right for you but probably not right for me — and certainly not right for each of the other 310 million Americans.

If the above sounds obvious, it has surprising implications — as I'll show in my next column.