Sunday, June 22, 2014

Downgrading the U.S. Federal Government's Creditworthiness

In 2011, major financial agencies reduced the rating of bonds and other forms of debt issued by the United States federal government. Simply put, the USA isn't as good a risk as it used to be.

This doesn't mean that the nation is teetering on the edge of bankruptcy. Yet. But it does mean that by standards as objective as any can be, we've not done a good job of managing our budget.

Naturally, efforts were made to hold someone responsible for this. Who to blame? The Democrats and Republicans blame each other; the liberals and conservative blame each other; the Congress and the President blame each other. Perhaps the most realistic, and least political, location in which to lodge blame is in the past, about forty years earlier.

President Lyndon Johnson, under his slogan of a "Great Society," orchestrated a mathematical impossibility, a sort of generational Ponzi scheme stretching over decades. One financial engine motivating the eventual downgrade of the nation's credit is the Medicare Plan. Kevin Williamson writes:

The blame for Standard & Poor’s downgrade of U.S. sovereign credit belongs almost exclusively to the president, the most socialistic American chief executive in living memory, but also to key congressional Republicans, who got carried away by their emotions. The president is Lyndon Baines Johnson, and the congressional Republicans are the 70 members of the House and 13 senators who, led by Rep. John W. Byrnes (R., Wis.), voted to create Medicare, a welfare handout disguised as an insurance program and structured as a Ponzi scheme. The handiwork of these illustrious gentlemen has taken some time to catch up with us, but catch up it has.

One definition of 'Ponzi scheme' in a common dictionary tells of "the payment of quick returns to the first investors from money invested by later investors." LBJ's Medicare setup was never financially viable; but it took forty years to reach critical mass. Exacerbating factors included other Great Society programs like Medicaid.

Medicare cannot go out of business, no matter how boneheaded its financial decisions. Because enrollment in Medicare is automatic rather than voluntary, because it is funded mainly out of payroll taxes, and because its premiums are mostly symbolic, Medicare encourages beneficiaries to make maximum use of it, which drives up both overall healthcare expenses and the deficit. We have managed to cut ourselves with both sides of that double-edged sword.

Hence the downgrading of the USA's credit. Medicare is an example of what some economic textbooks call a perverse incentive. Selling insurance for far less than its market value encourages consumers to buy it and use it - and those most likely to see the benefit to themselves in the arrangement are those least likely to need it: educated consumers, used to calculating comparative advantages, tend to come not from the lowest income classes. Kevin Williamson explains that while a number of various Great Society programs pose dangers to the nation's credit rating, Medicare is by far the most dangerous, precisely because it appeals to those savvy consumers who need it least:

And it’s really Medicare. Medicaid is a clear and present fiscal danger, but it will be relatively easy to fix, because it is easier to take benefits away from poor people than to take them away from well-off people, and the oldsters who collect Medicare are one of the most affluent and therefore politically powerful demographic groups in the country, age and wealth going together in our society more or less.

Medicare is also an example of a regressive tax. The poor are likely to put more money into it, while getting less out of it. Life expectancy alone would insure this regressiveness, but education does as well. Well-educated people tend to live longer and accumulate greater net worths.

It is worth keeping in mind that, as a National Bureau of Economic Research report found, “Medicare has led to net transfers from the poor to the wealthy, as a result of relatively regressive financing mechanisms and the higher expenditures and longer survival times of wealthier beneficiaries. Even with recent financing reforms, net transfers to the wealthy are likely to continue for at least several more decades.”

When the USA's credit rating was lowered in 2011, it was the fault of neither President Obama nor President Bush. It was a long time coming, and it was due to President Johnson.