What percent of the economy should be redistributed by government?

Keith Hennessey has usefully focused attention on what I believe to be the most important long term policy choice facing our nation: what percentage of the economy should be redistributed via the federal government? He brackets the options:

Over the past 50 years federal taxes have averaged 18% of GDP.

Governor Romney proposes taxes “between 18 and 19 percent” of GDP.

The House-passed (“Ryan”) budget proposes long-term taxes of 19% of GDP.

President Obama’s budget proposes long-term taxes at 20% of GDP.*

The Bowles-Simpson plan proposes long-term taxes at 21% of GDP.

It is worth noting that average spending over the same 50 year period was just under 21% of GDP, and Hennessey judges the President’s budget as worthy of an asterisk for reasons that I won’t get into now because I want to wholeheartedly agree with his focus on the size of the federal budget expressed as a percentage of GDP as a key question.

On page 4 in chapter 1 of my book Balancing the Budget is a Progressive Priority, I say:

Conservatives have correctly identified a key question we must address as a nation:what proportion of our economy will be redistributed by the federal government? However, they have done so as a foil to argue for lower taxes, but have not identified the spending cuts required for a balanced budget given our current tax code, much less one that brings in even less revenue as a percent of GDP.

Answering this question and following through with policy choices to implement it is required if we are going to develop a sustainable federal budget….

Several points:

  • Even the Ryan budget calls for an increase in taxes collected as a percent of GDP over the 50 year historical average (though the tax reform details necessary to get there are non existent). Most importantly, because health care costs are the primary driver of the long term budget shortfall, the lower the percent of GDP you target, the more aggressive must your health reform cost control be. Go stare at this chart, especially if you want balance at 19% of GDP (During Rep. Ryan’s speech tonight at the convention he mentioned 20% of GDP).
  • Hennessey views Bowles-Simpson not as a compromise/bipartisan plan, but as a spending high water mark. This ignores the fact that it sets federal spending around the level of the past half Century, the only change is that we would now pay for our spending. A key part of Bowles-Simpson was the consequential health policy steps that it specified beyond its assumed implementation of the ACA. I think that 21% of GDP as a balance point in ~ 2035 is plausible, but aggressive. Keep in mind that we spent more than 21% of GDP in 1975, 1980 and 1985….and the baby boomers were paying taxes then instead of moving into Medicare and Social Security.
  • There are many budget plans that aim for balance between 18-23.5% of GDP, so the Bowles-Simpson chairman’s mark is an attempt at a bipartisan plan and not a high water spending mark. For example the Center for American Progress Budget aims for balance at 22.5%. If your singular goal is a balanced budget, the CAP budget has a much better chance of success than do some of the more aggressive plans that aim for balance at lower levels simply because it is far easier (technically) to raise the taxes necessary for balance at 22.5% of GDP than it is to actually pass and implement a health reform plan that achieves the health care savings necessary for balance at say, 19-20% of GDP (especially if your first step is repealing the ACA).
  • The hardest part of moving toward a sustainable budget is having a health reform framework that can address health care costs in a flexible manner while expanding coverage and improving quality. The ACA provides such a framework; the question is whether we will implement the law and move to the next steps/tweaks, or not. In this sense, the President has far more credibility at claiming a route to a long run sustainable budget than do Gov Romney and Rep Ryan since we have seen how hard it is to pass a health reform law. We have yet to see the President’s final “grand bargain” offer, but he does have a vehicle through which to do the hardest part–address health care costs.
  • The President has embraced the other inevitability of ever having a sustainable budget, an increase in taxes. However, we are stuck in the discussion of only what the highest marginal tax rate will be, which will not be enough to get to balance. I think this is a mistake and allows Gov. Romney and Rep. Ryan to say they want to cut rates but increase tax receipts, while not identifying the tax expenditures necessary to get there. A focus on the percentage of GDP that will be collected and spent by the federal government, and then working into the tax and spending side (esp health care) details needed to get there is the conversation we need to have.

cross posted at freeforall

Comments

  1. Ebenezer Scrooge says

    Given the amount of federal revenue sharing with the states, do we really want to use Federal taxes as a percentage of the GDP as a measure of redistribution? “Redistribution by the federal government” is a bit of an arbitrary measure of the size of government, especially because of the huge fiscal overlap between feds and states. Wouldn’t the total tax take be better?

  2. Zach says

    “the other inevitability of ever having a sustainable budget, an increase in taxes”

    You can maintain roughly the current scope of the Federal government without raising taxes by nationalizing healthcare — adopt any national system from the handful that are implemented in very similar countries (in terms of age and poverty rates) and you’ve instantly solved nearly all of the long-run budget problem. Depending on how well the US economy fairs in the next decade, you also might need to tinker around the edges on the spending (defense cuts, means test old-age benefits) and revenue (return to somewhere between GWB and Clinton tax rates).

    It’s perfectly fine to argue that healthcare nationalization is politically impossible, but you ought to make an argument as to why it’s more politically impossible than raising taxes to a similar degree (on the order of $1 trillion per year) in either a progressive way (fighting against Republicans) or a regressive way (fighting against lots of Republicans and all Democrats). The fact is that we spend (private+public) a trillion dollars on nothing every year and that’s the only trillion dollars that’s out there to keep taxes low; eventually, folks who want low taxes will turn against the much smaller number of folks who profit off of healthcare inefficiency and our perverse desire to subsidize medical innovation for the rest of the world.

    • says

      The question is not whether it is possible–let’s leave that aside for a moment. It’s whether it does what you say. If the United States nationalizes its health care system, will it be able to slash the salaries of doctors, nurses, and all the downstream personnel to levels seen in, say, Great Britain? Or even Canada? Can we fire all the specialized personnel who abound in American hospitals–the radiology techs and respiratory techs and so forth? Seems unlikely to me. Even if it were politically possible, those people have mortgages, car loans, etc that are pegged to much higher incomes. How long will your plan survive a rash of bankruptcies and/or system exits by those people? We could theoretically cut our social security distributions to what, say, Brazil spends. Practically, it’s a little more problematic. Government programs are path dependent–what we might have achieved had we nationalized in 1948, we can’t necessarily achieve now. Plus richer countries spend more on health care (Baumol’s cost disease), so we can’t go to the level of GB or Greece. Somewhere north of France or Switzerland seem more realistic which puts us in the 14-15% of GDP range.

      Unfortunately, while the US is an outlier in the level of medical spending, it is actually in the middle of the pack on spending growth. So it doesn’t take us that long to get back to “problem” level. Single payer is not some sort of broad spectrum cure for all economic ills.

      • Keith Humphreys says

        Zach write: “the much smaller number of folks who profit off of healthcare inefficiency”

        The problem with this framing is that it implies only a small group of stakeholders like the current system, when in reality the biggest barrier to reform has always been that most Americans are happy with health care they get. Nationalizing health care for example would in practical terms be a major cut to the coverage that Medicare recipients currently receive: Fewer specialists available to them (for the reason Megan notes) and longer wait times (both because of fewer medical specialists but also because tens of millions of people who currently don’t have insurance would start going the doctor more once the system was nationalized). Selling nationalized health care is thus not as a simple as overthrowing some venal profit seekers (as worthy a pursit as that is), it also involves convincing the 15% of the population that has Medicare that they are going to have to sacrifice something they consider their due.

        • Zach says

          “the biggest barrier to reform has always been that most Americans are happy with health care they get”

          Totally true, but what would be the result of a poll asking to pick between: (1) transition to something as closely resembling the NHS as possible within 5 years, saving hundreds of billions per year or (2) raise taxes across-the-board to raise hundreds of billions per year?

          Of course, this would also require a big transition from private to public spending, so option 1 would have a tax increase associated with it as well adding more political difficulty even if it’d effectively be transferring current private health benefits to the Feds.

          • Keith Humphreys says

            (1) transition to something as closely resembling the NHS as possible within 5 years, saving hundreds of billions per year or (2) raise taxes across-the-board to raise hundreds of billions per year?

            I expect, as I assume you do, that the response from most Americans would be to say that they would vote out of office anyone who took either approach.

          • says

            The NHS saves money in a way that most Americans would find frankly unacceptable. They ration treatments, maybe not cost-effective ones, but people would freak out. (And even in Britain, it’s breaking down, because people google and see what’s available in the US and demand treatment). Their hospitals are extremely spartan compared to the US–an acquaintance’s father ended up on an open ward after a bypass, with the television blaring nonstop. Open wards are much cheaper to manage, because the nurses can see the patients at all time, so you need fewer nurses. You can even make an argument that they’re better for patients, though I find that argument a little strained. But they’re noisy and Americans are now accustomed to the idea that virtually everyone gets a private or semi-private room.

            Which gets back to what I said about path dependence: thanks to the hospital commission in I think 1970, American hospitals now have private rooms: that’s standard. There’s no way to convert them to cheaper open wards, even if we could overcome the resistance from patients and nursing/auxiliary staff. The hospitals exist. If if could be accomplished at all, the retrofitting would be ferociously expensive.

            There’s no way to offer people in New York the NHS at considerable tax savings, any more than you can offer them a flat on St. James’. You could build a replica of Picadilly Circus and the nearby parks and streets, but that would not be the same as living in London–and it would be incredibly expensive to tear down what you have and replace it with an ersatz London neighborhood. Similarly, even if we could, with magic dicatorial powers, decree that the US would have the NHS, doing so would cost vastly more than the NHS costs Britain.

      • Zach says

        In practice, you wouldn’t nationalize healthcare overnight. It would presumably look less like a South American agricultural/industrial takeover than a transition of a decade or two during which insurance is first nationalized by expanding Medicaid and Medicare eligibility and offering public insurance to corporations and to individuals and current Federal insurance/care providers are unified. Healthcare would come later you’d eventually wind up with current facilities and employees provided the choice to be nationalized, operate within a suplemental care/insurance market, or give up. The economic consequences are similar in kind (and maybe magnitude?) to a carbon trading or taxation regime; ideally you’d pair healthcare nationalization with targeted aid to states and displaced employees.

        Obviously this isn’t as easy/fast as I made it out to be in practice, but it seems a lot more practical than imagining we can give hundreds of billions a year to the wealthy and cut thousands a year in benefits for every child in poverty without, you know, riots and things.

        Also, isn’t US GDP/capita a lot closer to GB than Switzerland? GB seems like a better comparison than Switzerland given that its more US-like poverty rate, life-expectancy, high population… I agree that it’s difficult to approach NHS costs from our starting point, though.

        • Keith Humphreys says

          Converting to an NHS in the US would be brobdingnagian task with enormous switching costs (Federal takeover of all hospitals and clinics, federal hiring and supervision of nearly one million physicians…) and also is unnecessary for acheiving full coverage.
          The UK approach is not the only way to provide universal care and is not even normative in Europe. Switzerland and I think Holland as well have insurance companies which compete in a managed market and everyone gets health insurance with government help. The easiest thing — though it would not be easy — in the states is simply to have the government expand health exchanges to cover everyone who isn’t covered now and pay their insurance premiums for them. Far less institutional and popular resistance and switching costs.

      • says

        Zack explicitly said “any national system from the handful that are implemented in very similar countries”. Megan instantly responds with anecdotes and canards about the British NHS. Why should US health care cost more than (relatively decentralised) France or Germany? BTW, in French hospitals – I’ve been there – ordinary hospital wards have 3 beds; many pay the extra from their mutuelles or privately for a single room. And spare us, both British and French hospitals have radiology technicians.

        • says

          PS: many NHS trusts (picked with a pin: here, here) offer aircraft-type bedside entertainment consoles with TV etc. and headphones. It’s all paying so there’s no cost to the hospital budget. The issues may be clutter in already quite crowded working spaces, and ripoff phone charges to patients’ relatives for incoming calls. The communal ward TV is not I think any longer typical.

        • SamChevre says

          One reason is the vastly higher pay of American health-care professionals, all up and down the ladder–the series on “The Incidental Economist” was quite clarifying in that regard.

  3. Zach says

    “However, we are stuck in the discussion of only what the highest marginal tax rate will be, which will not be enough to get to balance. I think this is a mistake …”

    The media and the Obama campaign should simply confront Romney in terms of his concrete proposals and not his asterisks. Any summary of his plans should basically start and end with his big ($100 billion or more per year), specific promises. Then, if Romney objects he can feel free to provide more specifics. Ezra Klein’s taken the right approach here, but few others have. From my point of view, these are Romney’s most significant proposals:
    1. $300+ billion tax cut; nearly all to people making $100k+; majority to people making $200k+
    2. $100-200 billion/year cut or more in anti-poverty spending (Medicaid, food stamps, housing)
    3. Take Medicaid away from millions in the middle class and healthcare subsidies from millions in middle to upper-middle class
    4. ~$100 billion/year corporate tax cuts
    5. Increase defense spending over $100 billion/year

    If Romney has a problem with the fact that his promised Presidency would be best summarized as “money for the wealthy, corporations and defense paid for by cutting benefits to the poor and middle class and issuing debt” he’s free to provide more details.

    There are a number of important regulatory changes (particularly with respect to unions and natural resources) in his plans, but these are the parts of his plans with huge, immediate economic effects.

  4. Benjamin Doyle says

    Don, I really think this is backwards and misguided. The correct approach is to answer two questions:

    1. How much revenue can the government raise without hurting the economy?

    2. For each potential spending item, how does the cost-benefit analysis work out?

    Then you fund positive CBA programs until you run out of good ideas, or reach constraint (1).

    If you start with a fixed target, as you do, instead of an upper bound, you’re either going to be spending on programs that aren’t worth the money (if the target is too high), or cutting spending that would have made us better off. I don’t see why we’d want to do that.

    • Senataur says

      That’s backwards. You want to raise as much revenue as possible without hurting the economy (which could turn out to be fairly little), then tax and spend more if and only if the benefits of the program under consideration outweigh its costs, including the economic damage of the accompanying taxes.

    • Don Taylor says

      I follow your logic and I certainly like CBA to inform decisions, but it is more likely of use within categories to tweak. There are only so many things that can be done quickly. The Fed budget is (1)Defense (2)Medicare and Medicaid (3)Soc Sec (4)everything else (5) interest on debt. To me, setting a level as a target then could enable a CBA like approach to thinking through priorities under constraints, and of course the target level could be iterative, either up or down. Maybe we try 20% say and the health care cost efforts are not palatable so we are willing to spend more….and maybe it harms growth at the new level so we readjust, etc.

    • Zach says

      Here’s the problem with this: 50% of America scores income redistribution a cost, 50% of America scores income redistribution a benefit and about 50% of the Federal budget is income redistribution. How do you determine what a Federal policy is worth? There’s an inherent subjectivity that makes it impossible to apply this principle to the whole government.

      • Benjamin Doyle says

        You’re right that the cost-benefit determination is subjective; I’m not trying to eliminate politics. My point is that we should argue over particular programs, unless and until we believe we’re nearing a danger zone of how much the economy can support. How does choosing 21% of GDP as a target help to resolve the redistribution question?

        • says

          21% mostly helps determine how aggressive health care cost containment has to be v. Defense. If you say 19% of GDP it will take some serious health care cost inflation steps that I suspect the country will not take….or large Defense cuts they won’t accept. This is of course my opinion….and there are many subjective and political determinations in all of this. I mainly think an overall target level helps to focus attention on these hard issues and force them to be debated. Put another way, given Gov. Romney’s stated preferences on defense, if he wants to curtail spending to 19% GDP, he needs a serious cost control strategy for health care and he not only doesn’t have one at this point….certainly the details of one haven’t been shown and there has been no affinity of Republicans to commit to the health policy details.

  5. SamChevre says

    what I believe to be the most important long term policy choice facing our nation: what percentage of the economy should be redistributed via the federal government?

    I’m going to say that this is maybe half of the important choice; the other (making up a word) is how “leveraged” the federal government spending should be in it’s impact–how many non-Federal dollars are affected by a given Federal dollar.

    To give illustrative examples:
    1) Social Security is a low leverage program: it affects people’s behaviour at the margins, but most of it is “here’s the money, spend it on what you want.”

    2) Medicare is a medium-leverage program: it affects consumer behaviour at the margins, but it has a very strong effect on provider cost structures and what treatments are and aren’t available, what specialties are well-paid and which are not, and so forth.

    3) Federal support of research is very-high-leverage; it can be used to impose constraints on any research institution, even constraints that have nothing to do with the funded activity. (e.g., the Solomon Amendment)

    4) Direct spending on regulatory bureaucracies has almost infinite leverage.

    Increasing low-leverage spending doesn’t change much, but even small increases in high-leverage spending can change the social landscape a great deal.

  6. LBerich says

    Why the obsequious “Gov Romney” and “Rep Ryan”? Does something about those two merit the *slightest* bit of respectful treatment? If so, how did I miss it? Do you do it for the same reason you adopt the euphemism “premium support” to mean a health-care voucher program that would replace the current system of guaranteed adequate care for the elderly with a one of decidedly inadequate care? You feel you need to observe a certain decorum or you’ll disqualify yourself from govt policy jobs, is that it? But why not stop when decorum grades over into mendacity? “Premium support”? Really? Whom do you help when you use this ridiculous euphemism?