Why is the U.S. headed for fiscal disaster (if it is)? - Part One

Len Burman’s paper, “Catastrophic Budget Failure,” presented yesterday at Columbia Law School’s tax policy colloquium, describes how the end game of U.S. fiscal unsustainability could potentially play out. Short version: it might not be pretty.

Also, the paper shows that, with a couple of reasonable assumptions, such as about how interest rates might start to rise about ten years from now in response to the U.S. fiscal situation, the line showing our debt to GDP ratio might turn highly vertical by the early to mid 2020s, which really isn’t that far off.

I had thought I was done for now writing about fiscal issues, for a couple of reasons. The first is that I thought I had pretty much worked through my understanding of the very complex and multi-faceted issues raised. The second is that I get the sense sometimes that the market has spoken, in the sense that my input on these issues is less noticed and valued than on issues closer to my known professional specialization. People out there seem to think I’m more worth reading on, say, corporate or international tax policy or fundamental tax reform than on the long-term budget issues, for which they turn purely to economists.

Now, I don’t actually agree with this judgment – I think that my analysis of the budget issues is very good (if I may say so), and gets to the core of the issues as only the very best work by economists does, while also featuring a different mix of qualities (e.g., no number-crunching, but more value added on the normative and political science aspects). But people have their expectations, and I certainly don’t feel slighted in general by the market out there. Apparently, just as people don’t especially want a synth album from Neil Young, so they don’t seem to want this sort of stuff as much from me. Fine, so be it.

But I’m nonetheless tempted to write again about these issues, perhaps in Tax Notes or some such thing. So whether or not that happens (as I’d hate to take more time off from my ongoing and much-delayed international tax book), here are some rough preliminary thoughts as prompted by last night’s discussion at Columbia.

My understanding of why the U.S. might face a fiscal disaster has gone through 3 stages. First I understood it as a demographic problem, which I soon saw included as well a path-of-technology aspect. Then I came to understand it as more fundamentally a political problem. Finally, with help from Len’s paper, I’ve come to see it as perhaps even more fundamentally a problem of how financial markets (mal)function. But each new interpretation supplements rather than supersedes the prior ones.

The demographic and technological problem – Everyone knows about this bit. Rising life expectancies, baby bust after the baby boom, etcetera. The technological piece is that the long-term U.S. fiscal picture wouldn’t be nearly as bad, despite the plummeting worker to retiree ratios, if healthcare weren’t growing faster than GDP for technological as well as demographic reasons.

In theory, it’s ambiguous whether advances in medical technology should on balance make healthcare more expensive or less. E.g., for every costly new procedure that makes a previously untreatable problem something we can handle at great expense, there may also be a cost-saving innovation. E.g., you take a daily pill and, as a result, don’t need open heart surgery next year.

In practice, however, technological advances have unambiguously had the net effect of making healthcare more expensive, not less. Why is this? It could be something about the technological “space” at the frontier of current knowledge into which our R&D innovators are currently advancing. But it also could have a lot to do with the innovators’ incentives in a healthcare world in which consumers have only limited cost-consciousness due to tax-favored employer-provided healthcare, Medicare, Medicaid, etcetera.

I often quote Brad DeLong’s statement in a blog entry some years back to the effect that liberal economists think the big problem in healthcare is adverse selection while conservative economists think it’s moral hazard (i.e., consumers’ lack of cost-consciousness), to which I add (I don’t recall if Brad did) that the unfortunate thing is, both are right. The liberal economists like to point to evidence that consumers in healthcare don’t act quite the same as when buying a car or a breakfast cereal, seemingly weighing against the relevance of the conservative economists’ diagnosis. But I think the case that the latter (as well as the former) group is right is strengthened if you look at healthcare dynamically over time in terms of where the innovators find it profitable to go. When they won’t get rewarded for cost-saving to the same degree as for new treatments, you get the moral hazard story in full force.

This won’t change unless incentives in the healthcare sector do. Which I don’t see happening any time soon, though this of course gets us into the political story.

OK, that’s the demographic and technological piece. But the reason I no longer see that as the core problem (albeit a key precondition) could be summarized as follows. While current policies place us on an unsustainable path, all we have to do is change them. How could we do that? Well, here’s one easy way. Take one serious, principled liberal economist with healthcare and budgetary expertise, and one, serious, principled conservative economist. Say, perhaps someone at Brookings or Urban plus one of the good people at AEI. Give the pair of them full staff back-up for estimates and the like, and give them 2 weeks to come up with an answer that they have agreed to between themselves, and that the politicians then promise to implement. They could easily do it.

The end result wouldn’t be pretty (it would have changes that no one at any point along the political spectrum actually liked, in that we’d be forced to confront the nasty empirical fact of scarcity), but there would be no fiscal crisis. But this is not going to happen, because our political system doesn’t operate this way.
But one last point on the healthcare front before moving on to politics. This hypothetical compromise might lead to people more often NOT getting the best available healthcare in 20 years than they do today. But the best available healthcare in 20 years may be so much better than what we currently get (for technological reasons), that you’d have people getting much better healthcare than us absolutely, just worse than us relative to what is contemporaneously available.

OK, on to politics. But this blog entry is so long already that I think I’ll end it here and post a follow-up that continues the analysis, hopefully some time later today.