The Big Picture Part II

Struggling to keep up with the Manhattan Contrarian, the Wall Street Journal this morning has an excellent op-ed piece by former congressmen Chris Cox and Bill Archer in which they try to get some kind of handle on the government's real debt and deficit numbers, as opposed to the fake numbers that everyone else discusses.

Let's start with defining the fundamental problem here.  The Federal government reports numbers on what is essentially a cash in cash out basis.  The so-called national debt is the difference between the cash receipts of the government since inception in 1789 and the cash expenses inception to date.  That type of accounting made reasonable sense when the government was mainly in lines of business that can be fairly described by cash receipts and expenses, like running the Defense Department, State Department, and Justice Department.  Today this is no longer applicable, not even close.  The best description of the Federal government is a gigantic insurance company, representing over 80% of its activities, with the appendage of relatively small and insignificant basic government enterprise, representing under 20% of the total business.  The idea that this massive insurance business can be fairly represented from a financial point of view by cash in cash out accounting is completely preposterous.

And yet the cash in cash out numbers are everywhere, and cited by all kinds of seemingly smart people as if they mean something.  Deficit exceeds $1 trillion!  Debt approaching $16 trillion!  It's hard to blame them, since these are the numbers that the government publishes, and it's very hard to find real numbers.   Frankly, even the idea that the cash numbers get published at all is just total deception.

I have made some previous efforts at estimating the real financial picture of the Federal government., here in "It's Good To Have An Infinite Credit Card," and here in "The Big Picture."

Cox and Archer are on the same trail.  What would a financial statement of the Federal government look like if actually prepared in accordance with generally accepted accounting principles, or some reasonable semblance thereof?  Cox and Archer accept the number of the Medicare trustees that the unfunded liability there is $42.8 trillion, and of the social security trustees that the comparable number there is $20.5 trillion.  I pointed out in "It's Great To Have An Infinite Credit Card" that independent estimates put these numbers at double or more; but, whatever.

There is one important number in Cox and Archer that I had not previously been able to find elsewhere:  "the average annual accrued liabilities for just the two largest entitlement programs."  They give a figure of $8 trillion, but after adding in the cash deficit, which is now around $1 trillion.  So the annual accruals for social security and Medicare are $7 trillion!  And they don't mention the many, many other commitments out there, from Medicaid, to Obamacare, to deposit insurance, to pension insurance, to flood insurance, to terrorism insurance, etc., etc., etc.

As Cox and Archer point out, the $8 trillion (on top of the $2.7 trillion annually currently produced by the tax system) is more than any conceivable tax system for the U.S. could potentially produce.  Obama is talking about soaking the high earners for $1.5 trillion over 10 years, while the government will be running up additional liabilities of at least $80 trillion.  The $8 trillion per year is more than the total annual income of not just the millionaires and billionaires, but also the entire middle class, and also of all corporations.

I'm sorry, but to get any kind of rational discussion going here, we need to stop talking about the $1 trillion deficits, and start talking about the real deficits of at least $10 trillion (Cox and Archer's number, plus estimates for all the other insurance programs that they omit).

Can anyone in the government -- administration or Congress, I don't care which -- kindly state how they plan to address this issue?

Big And Small Bubbles

Anyone who follows markets knows that bubbles, and succeeding crashes, are a recurring phenomenon.  Famous historical examples include the Dutch "tulip mania" of the 1630s, the French Louisiana Company bubble and British South Sea Company, both around 1720.  More recent examples include the American stock market bubble of the 1920s (and crash of 1929) and the Japanese stock market bubble of the 1980s (and crash of 1989).

Getting to the more recent time, we have the housing bubble of the early 2000s that led to our current economic difficulties.

It's easy to spot bubbles in hindsight.  But a better question is, are we in any bubbles right now, bubbles that have blown up really big and are getting ready for a big crash?

Over at Instapundit, Glenn Reynolds has a long-running series on what he calls the "higher education bubble."  The thesis is that the cost of higher education has soared under an umbrella of Federal spending and easy student loans, and that that bubble is set for a big crash over the next few years, as students realize that the education is not worth the cost and debt, and as internet alternatives replace ridiculously costly in-person college courses.  I'm willing to bet he's right.  On the other hand, higher education is only about 3% of U.S. GDP.  If that suddenly got cut in half over the course of a few years, it would be rather hard on colleges and professors, but not nearly the scope of the bursting of the housing bubble a few years ago.

But is there any other bubble out there that is much larger, a big multiple of the size of the higher education bubble?  Here's a hint:  private economic activity, although subject to bubbles, is also subject to self-correction.  There are limits to how large bubbles can blow up without the government credit card to back them.  With the backing of the government credit card, a bubble can start taking over an entire economy.

Here's my nominee for the really big bubble, the one whose bursting will be a multiple of anything previously seen:  health care.  In 1960, before Medicare and Medicaid, according to this article U.S. spending on health care was about 5% of GDP.  Today, 18%.  Those numbers are somewhat exaggerated compared to what I've seen elsewhere, but suppose it's 7% and 17%.   At 10% of GDP, we have $1.5 trillion of annual spending in play in excess of the best evidence of what private spending alone would support.  And, the 17% is rapidly increasing.  Medicare and Medicaid have grown at about an 8% CAGR since inception, and are not really showing signs of slowing down.

Proposition One:  Something that can't continue, won't.  Proposition Two:  When this one ends, it will not be pretty.

I do think that the higher education bubble will burst first.

The Infinite Credit Card Just Got More Infinite

Hurricane Sandy is giving us a chance to see whether there is anyone left other than the Manhattan Contrarian to dare to mention the issue that the Federal fisc is not infinite.

A little history.  In the nineteenth century, there were plenty of hurricanes, let alone other destructive storms and natural events, like earthquakes and tornadoes.  In that era, it never seems to have occurred to anyone that restoration of the pre-disaster situation was even a permitted function of the Federal government., let alone a good idea.

As just one example from the very end of that century, here is a brief history from the Texas Almanac of the response of Galveston, Texas to the devastating hurricane that literally wiped out the city in 1900.  At the time, Galveston was the fourth largest city in Texas, with a population of 37,789 in the 1900 census.  The storm of September 8 killed an estimated 6000 - 8000 people and destroyed the large majority of the buildings in the town.  To recover, the city formed a Central Relief Committee to collect donations, both monetary and in-kind. 

Donations poured in from cities around the United States and several foreign countries.

Money came from millionaires in New York, from black churches in Georgia, and from a little girl in Chicago, who sent 10 cents. Donations came from religious groups, labor and fraternal organizations and thousands of individuals. Relief funds were raised by an organ recital in Scranton, Pa., and by a baseball game in Anaconda, Mont. Money was sent by the German Turnverein of St. Louis, Mo., and the Rough and Ready Fire Company of Montrose, Pa. Sunday school classes sent their collections of pennies, nickels and dimes.

In all, donations exceeded $1.25 million. By far the most generous state was New York ($228,055), followed by Texas ($66,790), Illinois ($55,544), Massachusetts ($53,350) and Missouri ($52,116). Donations also arrived from foreign countries – among them, Canada, Mexico, France, Germany, England and South Africa.

Missing from that list:  the Federal government.  The State of Texas also did not assume responsibility for replacing people's lost private property.

Galveston then undertook a project to protect the city by building a gigantic sea wall and also the elevation of all buildings onto stilts.  Who paid for that?

The county agreed to pay for the seawall through a bond issue. Initially reluctant, the Texas Legislature finally agreed to a combination of tax abatement and sales of bonds to finance the grade elevation.

No mention that the Federal government paid a dime.

Fast forward to the modern era, where Federal contributions to disaster relief started as modest grants and gradually escalated.  By the time of Katrina in New Orleans in 2005, all constraints had been lost.  According to this article from USA Today a year after the storm, the Federal government had spent $122 billion, and that wasn't necessarily the end.

And now Sandy.  We know from Katrina that if you just demand loud enough the Federal government will pay for everything you can think of.  In fact, now is the time to make your wish list of anything you would like, because if you can come up with even the slightest connection to the hurricane, you can get the Feds to pay, and probably double, because the last thing they will want to do is to be seen cross-examining some victim.

From Crain's New York Business today, we have Governor Andrew Cuomo of New York putting forth his demand for Federal aid:  $40 billion.  "The governor said their estimates were conservative and may rise as the cost of recovery from Sandy continues to be tabulated."  And don't forget New Jersey.  Governor Christie there issued a number on Friday of $29.4 billion as what he will be seeking in Federal disaster aid.  Something tells me that that number is going to jump dramatically when he realizes that he has been topped in the bidding by New York.

And we thought it was a lot of money when the Federal government handed out a $20 billion blank check to New York for recovery from 9/11, plus the right to issue some tax exempt "Liberty Bonds" in excess of normal limits.  That money paid for such desperately-needed projects as a new $3 billion (!) station for the PATH subway to New Jersey, and the financing of new headquarters towers for Goldman Sachs and Bank of America.

So on Sandy, will the Obama administration or the Congress actually push back?  I'm dubious.  Is there anyone but me who thinks that this just can't continue?

Guest Post: It is Possible to be a Republican and an Equal Rights Supporter

I am 23 years old, a woman, a Republican, and a gay marriage supporter. And, yes, I believe it is possible to be all of these things at the same time. However, over the course of this last election, it has come to my attention that my generation does not believe a Republican can be socially liberal. As a result, many of my peers are voting Democrat based on social issues alone. This needs to stop, now.

Democrats try to claim the spotlight as the supporters of the movement for equal rights for gays. They have added a provision for gay marriage into their Official Party Platform for the first time this year. It may come as a surprise, then, that we can thank a few wealthy, Libertarian-minded Republicans for the legislative approval of gay marriage in New York. 

While fiscal issues often lead Libertarians to vote for Republican candidates, the principles of Libertarianism are those of ultimate liberty and personal freedom -- values which also lead to support of marriage equality. And, Republicans who support both fiscal conservatism and social liberalism can be the game changers and the tie breakers when it comes to social issues. The New York Times writes of Republican Hedge Funder Paul Singer, 

He was pivotal in rounding up about $250,000 apiece for the Republican state senators in New York whose votes for same-sex marriage provided its margin of victory in the Legislature.

Although Singer could not convince every Republican, particularly socially conservative Republicans, to vote for equal rights, he found the ones who would and he made sure their vote counted.  And, as we all know, in politics it’s the swing votes that really matter. 

Ultimately, Republicans need to spread the word that they, too, have a voice in the equal rights movement, no matter how small it is.  Republicans like Paul Singer continue to support gay marriage campaigns across different states, recently in both Maryland and New Hampshire. Additionally, Singer has also recently started a pro-gay Republican Super PAC to promote this issue. Meanwhile, Republicans should thank him for starting to change the perception of the party as die-hards for the Defense of Marriage Act.

My generation tends to be very socially liberal. A CNN poll found that 73% of those aged 18-34 support marriage equality.  Republicans need to show that they understand this trend and are willing to get in the game, or else risk losing the youth vote permanently. Plus, the sooner we get social issues signed, sealed, and out of the way, the sooner we can get back to talking about what really matters: the economy and how to fix it.

People Start To Notice The State/Local Income Tax Deduction

Here at Manhattan Contrarian, we try to pay attention to where the big money is.  When the talk turns to raising Federal revenue and avoiding or minimizing increases in marginal tax rates, then that must mean limiting deductions; and as soon as you start to look at limiting deductions, you realize that the real money is in one place:  the state and local income tax deduction.

Today Charles Lane of  the Washington Post has the story, also linked by Instapundit.  (Manhattan Contrarian was first on this story back on November 6, although the post was originally written as an e-mail newsletter on October 9).  From Lane:

What’s the least defensible special break in the U.S. tax code? With so many distortions to choose from, it’s hard to name just one. If forced to pick, I might say the deduction for state and local taxes, which cost $67 billion in fiscal 2011, according to the congressional Joint Committee on Taxation.

This one overwhelmingly benefits upper-income households in a handful of upper-income states, while rendering the entire nation’s finances less transparent.

$67 billion per year is only about 7% of the current annual deficit; but it's the most you will find in any one place.  Also, as Lane points out, this one benefits the highest income people way disproportionately.

The interesting tension will arise from the fact that the benefits of this deduction go mostly to a very small number of states.  And those states are almost entirely the "big blue" states:  California, New York, New Jersey, Connecticut, Illinois, etc.  According to Lane, residents of "California and New York reaped almost 30 percent of the deduction's value in 2009."  If you don't have an income tax (Florida, Texas, Nevada, Washington, etc.) you won't even notice when they eliminate this deduction.

The Republicans in Congress have the potential with this one to corner the left-wing Democrat California and New York delegations as defenders of the rich, which they are.  That could be fun.

I have mixed feelings about what elimination of this deduction would mean for New York and for me.  When I first moved here (1975), New York, and particularly New York City, were wildly non-competitive in income tax relative to everybody else, although most notably New Jersey and Connecticut, which then had no income tax at all.  Combined New York State/City income tax at that time was 18%, starting at income as low as about $25,000.  As I have mentioned elsewhere, in the 70s New York City lost over 10% of its population in a decade; the Bronx was burning; businesses were leaving; and New Jersey and Connecticut were booming.  After that bad time, New York State and City struggled to regain tax competitiveness, and the City has returned to prosperity (although it could be far better if we could get taxes and spending further under control). 

The elimination of the state/local income tax deduction would greatly exacerbate the uncompetitiveness of our current tax levels, not so much as against the immediate neighbors, but definitely as against the large no-income-tax states like Texas and Florida.  Our high-income investment community is substantially more mobile today than it was in the 70s.  Erosion of this business base could happen with a speed that could surprise everyone.  That would be terrible for everyone in New York who lives off the wealth generated by these businesses.

On the other hand, New York needs a kick in the pants to move it toward competitiveness.  Right now we are wastefully way overspending on things that other states somehow provide for far less.  It can't go on forever, and it's actually well time to get started on getting our costs in line.

Oh, and did I mention that I'm one of the people paying the big state/local income taxes?  Well, not for too many more years.

Update On Fire Island

Only a few weeks after the big storm, and the push is already on to get the Federal taxpayers to back a big beach repair project on Fire Island.  I'm sure this is no different from the other barrier islands, but I follow Fire Island more closely because we used to own a house out there.

Yesterday's New York Times  has the story, along with the pleas/presumption that of course the Federal government is going to have to pay for this with the infinite credit card.  Here is Suzy Goldhirsch, President of the Fire Island Association:

“We’re the first line of defense for Long Island, and the dunes are our first line of defense,” said Suzy Goldhirsch, president of the Fire Island Association, an umbrella group of community associations. “We’re self-reliant. We’re island people. But we need support.

“We won’t ask for more than anyone else, but we don’t want to be forgotten.”

(Suzy Goldhirsch was a neighbor and an acquaintance during our Fire Island days.)

And then of course the ever-present Senator Schumer:

On Monday, Senator Charles E. Schumer of New York called for the quick repair of the breach, saying it put the mainland at greater risk of flooding.

You don't even really have to mention Federal funding explicitly; it's just assumed.  "We don't want to be forgotten" is code for "We think we are entitled to a multi-million dollar Federal handout."

Exactly how big of a handout?  Well, it's not too hard to figure out.  Turns out that there was just a big beach restoration program in Fire Island in 2009!  The cost of that one, according to Wikipedia, was "between $23 and $25 million ($6,020 per housing unit)."  The home owners established taxing districts to pay for some of it, but according to this from the Army Corps of Engineers, the Federal government picked up an astonishing 75% of the cost.  With about 4000 homes on the island, that was a Federal handout of over $4000 per home.  And these are not poor people.  When we had the house there, residents included the likes of Mel Brooks and Calvin Klein.

Well, too bad, it's only three years later and the sand has been washed away by the next storm.  Time for another $4000 handout per homeowner!  Actually, I suspect that this new one will cost quite a lot more.than $4000 per house.

Ms. Goldhirsch is ready for the critics with this line, "We are the first line of defense for Long Island."  With all due respect, I don't buy it.  The storms do not eliminate the barrier island; they just move it around, knock some of the houses down and leave others in the water.  The amount of protection to the mainland is not really changed by any storm.  The benefit of a beach restoration goes almost entirely to the homeowners on the barrier island, and even within that group disproportionately to the ocean-front homeowners, who are of course the wealthiest of the bunch.  Sorry, but if they want a beach restoration, they should pay for it themselves.

And while we're at it, how about actuarially sound flood insurance premiums?