Balancing the Budget: It's Entitlements Stupid

This is the second installment of a multi-part series on suggested economic policies for the next government to consider. These are meant to be long-term solutions. Our current economic downturn has some short-term causes but a large part of the explanation lies in the worldview that governments of both parties have adopted, in small ways since maybe Abraham Lincoln but in significant ways since Franklin Roosevelt and in exaggerated extremes since Lyndon Johnson. The federal deficit, the mess we call a tax code and so forth were created over a long time and while the solutions can be implemented with greater haste it will take some time for the transition and full effects to be felt and the returns to be realized. The political class has seldom shown signs of long term thinking and the greater population seems less so, we can only pray and hope the message gets through. My second installment is on federal spending.

The brilliant and humorous French politician and economics writer, Frederic Bastiat may have summed up how government works as well as anyone:

The state is the great fictitious entity by which everyone seeks to live at the expense of everyone else.

In line with Bastiat, the three largest expenditure categories in the federal budget are programs that transfer wealth from some people to other people. Federal expenditures (since there is no enacted budget) totals approximately $3.6 trillion. Over half of that goes to the big three; Social Security, Medicaid/Medicare and income stability (welfare) programs. Eliminate these three and the budget is in surplus, which is a fascinating statement since these three programs have parallels in the private sector that are profitable.

However, it is not reasonable to make extreme changes to programs people have on which people have counted and planned. But, that reasoning cannot prevent the sort of long term changes that are needed. There is no denying the budget math:

Social Security, Medicare/Medicaid and Welfare are the major drivers of our budgetary problems.

Anyone denying this fact is irresponsible and should not be trusted with any decision-making authority.

Why The Waste?

I am often asked why the government wastes so much money. There is no denying this, even if you think the government is too small, $600 toilet seats is enough to make you a believer.

The answer to this question is really quite simple; the government has no incentive to be efficient. From a personal perspective, there are two sources of money; yourself and other people and there are two spending targets; yourself and other people. This leads to four possible combinations as displayed in the table below:

Level 1 Efficiency is you spending your money on yourself. This is efficient since you will purchase the quantity and quality you desire and nothing more. Your incentive is to get what you want but not pay a dime more than necessary.

Level 2 Efficiency is one of two options. If you are the target but using other people’s money you get what you want but overspend. This is the traveler on an expense account or the undisciplined teenager with dad’s credit card at the mall. The other level 2 is you spending your money on someone else, gift giving comes to mind this time of year. You have an incentive to be careful with the spending but you may well miss getting what it is the other person wants. The number of teens on credit card restriction, audits of travel accounts and return lines at the stores after Christmas attest to the inefficiencies of level 2.

Level 3 Efficiency is most of government spending, it is the government spending other people group A’s money on other people group B. There is no incentive to spend carefully since saving the money has no benefit to the spender and there is no incentive to actually purchase anything group B wants. So we get big, expensive one size fits all programs that no one likes. There is no common parallel in the private sector for a reason.

The goal is to move as much out of level 3 as possible. That is the only way to bring government spending under control.

Actions

With this framework in mind, below are my recommendations on federal spending.

Social Security (20 percent of federal spending)

In 1935, when social security went into effect, the life expectancy of an American was 63, so the retirement age was set at 65. Since 1935, we have had the audacity to live longer (about 80 years now) and so the system faces imminent collapse. The solution is for many of us to take up unhealthy habits and start dying earlier, it is your patriotic duty. Social Security is a typical government program, it is inflexible and designed to be optimal (if it was ever optimal) with the way things used to be.

Privatize and Choice: The statists talk about a public option for health care, how about a private option for social security? There is no economic or constitutional justification for a government-run pension program. To tax employers and workers to finance this near Ponzi scheme called a pension program reduces employment and income in exchange for lousy returns and a system under a cloud of bankruptcy. There should be an opt out clause available to anyone. People should be free to use ALL their income as they see fit. Let people choose and may the best program win.

Reform the System: The political reality is the government run system is here, maybe forever but certainly for some time but it needs to be adjusted. The original plan set the retirement age two years after half the population was expected to be dead. I do not believe we should be as deceptive as FDR but the plan should be indexed to life expectancy. Retirement is not a right and the notion that we could spend 20 plus potentially productive years in leisure is a relatively new and odd notion. The qualification age for social security should be set at 90 percent of life expectancy at the time of birth. The babies born this year would be eligible at age 72 (90 percent of the expected life span of 80 years).

Medicare and Medicaid (20 percent of federal spending)

The entire system should be scrapped and a means tested voucher program should replace it. A large number of people in these programs are older and wealthy and to tax the poor to give the wealthy a benefit is immoral. There is no constitutional or economic justification for either of these programs. This moves 20 percent of federal spending (over $650,000,000,000) from level 3 to level 1.

Income Security and other Transfer Payments (18 percent of federal spending)

A compassionate people should look after the poor and down trodden. However the federalization of these programs has converted charity into a government program moving a large amount of spending from level 2 to level 3. Ideally, these programs should all be localized and private; you know…charity. It is the local pastors, charity operators and so forth who know whom the free loaders are and who is truly in need. The closer we can connect the providers of the funds to recipient of the funds the closer we get to level 1.

Everything Else (42 percent of federal spending)

There are two aspects to everything else; waste and diseconomies of scale. I could discuss specific programs and agencies we should eliminate and that is a useful and necessary discussion, but these programs are pennies, especially since defense (19 percent of total spending) is almost half of this category. To put this in perspective, we could zero out every agency in this category; defense, education, state, interest, etc., and the federal government would still have a deficit. However, it does not mean we should ignore these agencies, they are too big and wasteful.

Just Cut Something

Every president in living memory has vowed to eliminate the fraud and waste in the government but none ever seem to have much to show for their efforts. So, the next government needs to abandon these silly and unfulfilled promises and just cut 10 percent across the board, including defense. Defense is an essential function but is also a government agency at level 3 efficiency.

Any organization that has had uninterrupted expansion for decades as the government has had, can be cut 10 percent without disrupting essential services. The federal government should move to a snow emergency schedule when only essential personnel report, the rest of these positions can be considered for elimination.

Just Too Big

The government is just too big. I do not mean this from a moral or constitutional perspective, although that is true, but from a management perspective. There is nothing special about the government, it is an organization that needs managed and any organization can be too big to manage. When an organization gets too large, management talent is spread too thin, resources are cannibalized and the organization not only fails to do the extra tasks well but has trouble with accomplishing its core duties as well. There is an efficient size for any organization, there is a reason McDonald’s stores are the size they are and Wal Marts are the size they are.

One example of diseconomies of scale in government is when the Johnson administration decided to fight poverty and the North Vietnamese. The government does not fight poverty very well but it had a pretty good record in fighting wars but in this case both of these efforts ended in failure. Interestingly enough it took about 30 years to recover from each, in one case with Gulf War I and in the other with the Clinton era welfare reform (which was more of a start of a solution rather than a finish).

Just Takes Political Backbone

The issue is easy to see and the solutions are not that complicated, firms all over the world have undertaken pension reform, changed their health care benefits and downsized, the difference is they were reporting to stock holders who wanted these changes and politicians report to voters who do not. In large part we have the government we want, we like government as Santa Claus, providing benefits to us paid for by people we do not know and are not even born yet. Politicians are jellyfish, we must give them their backbone, we must demand these changes or we will keep getting silly useless band aid programs that make people feel good but accomplish nothing.