The constantly criticized worker/beneficiary ratio is a load of garbage as an argument for the unsustainability of the system. Here’s a historical chart of the ratio (source):

By that argument, there should have been a crisis in about 1960 when the ratio fell by half from 8:1 to 4:1. But there wasn’t. The only adjustment needed was in 1983 to fund it for the forseeable future – and it worked for nearly thirty years, since 2009 is the first year since then which has a deficit on the account.

The exactly on-schedule declines to 3:1 and 2:1 won’t break the bank, either. Projected from now through 2080, Social Security’s income will be above 75% of its outlays; we need only the sort of minor tweak as was done in 1983 to make up the difference. One adjustment every 30 years is a pretty good deal for a program this big.

While I don’t by any stretch think that losing control of the House of Representatives is a political certainty for Democrats, I also don’t think that such a loss would necessarily be a bad thing. It would be a symbolic defeat for Democrats, but in an economy like this one, just barely losing the House while holding 55-ish seats in the Senate is a pretty good baseline scenario. So what would happen?

My first reaction is that it would make the Senate a very different place. Rather than facing bills sent over by Pelosi and her cadre of secret communists, the Senate would be considering real red-blooded American bills drafted and passed by a Republican-majority chamber It’s a lot harder to make a case for a filibuster when you’re voting on your own party’s bill, and a distinct possibility is that legislative obstruction won’t be as much of an issue.

The main question, then, is how new bills will be passed. Given present political attitudes, it’s very difficult for me to imagine a GOP House writing bills that would be acceptable to more than 50 Democratic senators; you’re still going to look for one party that can command a majority in both chambers.

One possibility is 45 Republicans trying to woo 5 or so Democrats over to vote for bills passed by a strict GOP majority, assuming that the other Democrats won’t go and filibuster that themselves.  Let’s think about that situation. Here’s Nate Silver’s chart of likely Democratic losses:

So we’re already looking at losing some of the most conservative Democrats out there. Who’s left? Namely, Nelson, Lieberman and Landrieu (and Crist, assuming he gets the spot). That doesn’t seem quite enough to me, so the danger is a Senate in which the majority isn’t strong enough to overcome a filibuster on its bills but the minority can’t find enough defectors to pass a bill, either – and certainly can’t overcome a filibuster.

On the flipside, for the Democratic Senate majority to pass a bill, they would have to find 5 or so Republicans, starting with Crist (if he wins), Snowe, Collins, and Brown, and then write a bill that would pass the House with support from just a few marginal GOP congressmen (Cao if he’s still around, otherwise probably some newly-minted moderates) and the whole Democratic caucus. However, the absolute majority power of the House means that any defectors would have to vote with Democrats a huge proportion of the time in order to win the constant procedural battles of the House – and at that point, they might as well be Democrats.

It’s going to be a tight spot, win or lose. But if Democrats lose the house, the key change is this: the end of the supposed “Obama-Pelosi-Reid Axis”. That means a clear desire for action in the GOP House caucus, which McConnell’s people will have to deal with like adults.

Every now and again in the discussion of the US tax system, a major reform proposal gets kicked around – not a measly Bush-style bracket readjustment or anything like that, but a real major reform. A consumption tax. A flat tax. A simplified tax. Most of the time they are looked at for a moment and then tossed aside, since heavy lifting like this is totally unrealistic to pass through two houses of Congress with the dreaded filibuster still breathing in the Senate. But thinking about tax reform is a good exercise anyway, because it does let us examine where the strengths and weaknesses of our current tax system lie.

When I looked at the aforementioned proposals, I wanted to think about what each one meant for the US income  distribution, for revenue, and  for growth. For reference, here’s the breakdown of the current US tax code (without accounting for the benefits it doles out via deductions and credits, since these are equivalent to expenditures):

I’ll take a second to explain the charts, since I’ll be using this format throughout the post. The first column is the tax bracket division (the minimum income required for the corresponding marginal rate). The next column shows the marginal rate within that bracket. The third column shows the average tax rate paid so far, and the fourth column shows the tax-adjusted income for someone at the noted pre-tax income level. On the chart, the dotted line shows tax-neutrality, that is, a point on the line means that no net taxes are paid, a point above it shows net gains from the tax system, and a point below shows net tax liabilities. It is important to have most points below the line so that the revenues can fund the actual operations of government.

Now let’s look at some alternative systems. First up is the flat tax, a conservative favorite. It suggests a single rate of 20% that comes into effect above $30,000 (for a family of four) and continues on at that flat rate for any level of income. Here’s the breakdown:

As we can see, the average level of taxation is very, very low. At lower levels of income, this is less progressive than the current tax system since a family can never receive a net benefit; at higher levels of income the flat tax has the same effect, since both the average and marginal rates on top earners are dramatically reduced. Clearly, the tax is taking from the poor to give to the rich, but that’s consistent with conservative social values. Not much else to say here.

Next, Megan McArdle has proposed a drastically simplified version of the tax system, including constant progressivity (including a negative tax rate for very low earners, replacing the current system of deductions and exemptions), removal of the distinction between income and capital gains, removal of the corporate income tax, and so on. I greatly appreciate the simplification that the system offers, but I feel that the actual part about taxation is not as fully thought out as the simplifications.

For example, a negative income tax does not max out at a nominal rate; the nominal rate goes to infinity if there is even a dollar of benefits given to a totally unemployed person. If it is the marginal rate McArdle is referring to in her post, then it is nearly impossible to raise revenues at all through taxation, even if the marginal rate peaks fairly quickly:

The last proposal is the straight consumption tax. I won’t go into this in detail, but the options are generally to tax at checkout (European-style) or to apply it as an income tax where some or all savings are exempt (certified by a W-whatever form from your bank or investment adviser, just as income is certified by a form from your employer). This latter form has the added benefit of allowing progressivity. What I’ve decided to do here is combine McArdle’s suggestion for the constantly progressive tax (with some bracket adjustments) and the savings-exempted consumption tax.

The way this would work is by first reporting two things: income (wages + capital gains) and annual net savings (at the bank or investment firm). First, the savings would be deducted from the income to report total consumption. Then, the consumption would be taxed at a rate determined by the total level of income. The chart below shows how this might work, assuming nobody saves anything (a best-case revenue scenario).

As you can see, the marginal tax rates are fairly high, and there is a small safety net (about $100/wk, much less than unemployment benefits pay now) built in at the very bottom of the bracket. The marginal rates also kick in very quickly at the $34,000 bracket. The purpose here is to encourage savings even from mid-level earners, while still raising a good deal of revenue from the reduced tax base. The system also leaves a great deal of room for tax-based stimulus in hard times because of the high marginal rates, and it ensures that any needed stimulus will go largely to consumption. I like it. What do you think?

I’ve taken a moment and cooked up some charts examining the relationship between tax rates and income equality. Here’s the most relevant one. It shows the effective tax rates on the top and bottom income quintiles and their effect on income equality (1979-2006).

As the relationships clearly demonstrate, increasing the tax rate on the top quintile correlates with increased after-tax income equality, as does decreasing the rate on the bottom quintile.  What’s impressive is how powerful the correlation is: R-squared values are near 0.7 for both correlations. This suggests that the tax code is a very effective tool to compensate for the huge income disparities of the United States.

Interestingly, though, the data brought up some questions about Bush tax cuts in particular. You can see clearly two packets of outliers on the chart above (highlighted here); these are the post-2001 Bush tax cuts. They also showed up way outside of historical trend on a separate analysis I’ve run of the Laffer curve:

The puzzle is really how the Bush cuts managed to break the trend so dramatically, and the answer is in the structure. We can see that the Bush cuts lowered effective tax rates on all groups, and by doing so dramatically reduced federal revenue:

The key seems to be that the tax cuts, while they reduced revenue drastically, were structured to disproportionately benefit the nation’s highest earners. What this meant was that the cuts cancelled out: the benefits to the poor were matched by even more benefits for the rich, and so the cuts did nothing to improve equality or maintain revenues.

Steve Benen posted his monthly update of job progress, but I wanted to get a closer look at the numbers. So I threw together this chart using private sector job numbers only (basically, ex-Census), and including a stimulus spending line based on February’s stimulus report (no data for this month yet, but it’s my understanding that the money is running out). The numbers track beautifully, and I didn’t have to adjust the axes at all to get it to do this. Check it out:

A recent repost over at Naked Capitalism brought to my attention the question of how US GDP is calculated. In particular, this snippet caught my eye:

No other country makes these so-called adjustments, using a hedonic price index. And the cumulative distortion is massive. In 2005, economist/investment advisor Michael Shedlock contacted the Bureau of Economic Advisers and they supplied some dated information on hedonics (including a spreadsheet). He found that hedonic adjustment to GDP was 2.257 TRILLION dollars, or 22% of then-current GDP.

So I checked. First of all, several other countries do indeed use hedonic measurements in GDP (source, click to enlarge):

Okay, so the problem isn’t so drastic when it comes to cross-country comparisons. But how bad is it when it comes to a real measure of prosperity? In order to find the answer, I checked out the Michael Shedlock claim cited above. It led me to this BEA paper, which contained the following table (click to enlarge):

So that’s where the $2.2 trillion figure comes from. But reading it carefully, it appears to me that the value of the adjustment is not $2.2 trillion, but only the value of the adjusted components is. I can’t find a figure for the value of the adjustment, but information in the same paper suggests that it might be as little as 2% of that amount, or $44 billion annually (0.4% of GDP). That seems like a reasonable magnitude of adjustment to me, assuming you agree with the underlying rationale for hedonic adjustment.

The next step was evaluating Shedlock’s paired claim regarding the impact of “imputed” GDP. These adjustments are made in order to account for the value of unbilled services, like owner-occupied housing and free checking accounts. Shedlock is correct in asserting that this accounts for a significant share of GDP – according to BEA, about 15% in 2006. Reviewing their policy, however, leads me to doubt that there is a significant concern here.

First, owner-occupied housing and employer-provided health care make up a full 70% of imputations. Obviously, these are huge non-marketed goods that have real value, and they are therefore included in GDP as their opportunity costs indicate they should be. In fact, for owner-occupied housing, the adjustment may be even too low, since market rates are clearly insufficient to convince the owner to rent out his house, suggesting he receives greater-than-market utility from owning his own home.

Half of the remaining imputations are covered by “financial services” and half are other miscellaneous items, so if we consider this entire segment to be unwarranted bunk, we end up shaving about 4.5% off of reported GDP. That’s a significant, but not massive, amount – it’s about 85% the size of the Recovery Act.

All this, of course, means that the hysteria is a bit misplaced, even taking the worst-case scenario that BEA is full of a bunch of monkeys who report GDP figures based on die rolls and dart throws. I guess we can sleep easy tonight knowing that the great government conspiracy hasn’t got totally out of control yet.

A great course on US economic history by Brad Delong. Listen to Lecture #22 for the best of the bunch.

Andrew Samwick asks:

“Restated, if these tax cuts raised revenue, then why not keep cutting them until the point at which revenues actually begin to fall?  I presume the reason is that none of the proponents of this line of argument have any idea what the revenue-maximizing tax rate is.”

From 25 years of trends, the “Laffer Curve” seems to be a line. There’s no peak in sight, so average tax rates have a lot of wiggle room before additional increases in taxes actually reduce revenue (or vice versa):

(Sources: OMB, Tax Policy Center)

Congress Rethinks Its Ban on Drugs

WASHINGTON — With pressure mounting on the federal government to find new revenues, Congress is considering legalizing, and taxing, an activity it banned: drugs.

On Wednesday, a House committee approved a bill that would effectively legalize marijuana and other drugs, overturning a federal ban that critics say merely drove drugs offshore.

The bill would direct the Treasury Department to license and regulate drug operations, while a companion measure, pending before another committee, would allow the Internal Revenue Service to tax such businesses. Income by dealers would also be taxed, as regular earnings are now. The taxes could yield hundreds of billions of dollars for the government over 10 years, supporters said.

The two measures are far from becoming law. The Congressional timetable has little spare room before the midterm elections, and the Obama administration has not taken a position.

But the vote suggests a willingness by Congress to look for unconventional ways of plugging holes in the budget and comes as struggling states have also been looking to extract revenue from the drug industry, which took a hit as consumers cut back on travel and entertainment during the recession but continues to reap billions of dollars in annual profits. The committee vote Wednesday was 41 to 22, with seven Republicans joining most Democrats on the panel in favor of the measure.

Last year, New Jersey legalized marijuana for medical purposes, adding its name to the list of 14 states and the District of Columbia which allow such use.

Opponents, who only four years ago, when Congress was controlled by the Republicans, secured a law that cracked down on trade over the Mexican border, said they were aghast. “People sometimes resort to drastic things,” said Representative Robert W. Goodlatte, Republican of Virginia, who called the new proposals “unfathomable.”

Representative Barney Frank, the Massachusetts Democrat who leads the Financial Services Committee, has been the legislation’s champion.

“Some adults will spend their money foolishly, but it is not the purpose of the federal government to prevent them legally from doing it,” Mr. Frank said.

The committee’s top Republican, Representative Spencer Bachus of Alabama, noting the passage of far-reaching changes in health care laws this year, said he was incredulous that members would vote to “open a drug dealership in every home and every bedroom and every dorm room, and on every iPhone, every BlackBerry, every laptop.”

Mr. Bachus said lobbyists had spent “tens of millions” to overturn the law. “They’ve had quite a bit of success in turning votes,” he said.

Supporters of legalization said fiscal considerations played a role in their thinking. “I was looking for the money,” Representative Jim McDermott, Democrat of Washington, said in an interview. He sponsored the companion measure to allow taxation of drug sales; he wants to dedicate the money to education.

Representative Brad Sherman, Democrat of California, said in an interview that the money was an attractive source of financing for other programs. “We will not pass an drug legalization bill,” Mr. Sherman predicted. “We will pass a bill to do something very important, funded by taxes on drug revenues.”

He added, “Hundreds of billions of dollars over 10 years has an effect.”

The legal status of marijuana has long been murky. The Justice Department asserts that federal regulations prohibit it, but prosecutors have largely left individual users alone in states where it is legal.

But enforcement actions have barely put a dent in the industry, experts say. Dealers have used online payment processors, phone-based deposits and prepaid credit cards to circumvent the ban. By some estimates, American drug use exceeds $60 billion a year.

“Today, any American with half a brain and ten dollars can engage in any form of drug use in any state,” Annie Duke, a professional enforcement ageent, testified in May on behalf of the Green Alliance, which hired a former Republican senator from New York, Alfonse M. D’Amato, to lobby for the bill.

Michael Brodsky, executive chairman of GanjaKits.com, an online site for marijuana sales, said, “As with Prohibition, illegal drug use is thriving as an underground economy.”

“Because drug use is essentially borderless activity, from a money-laundering and terrorism-financing perspective, it creates a regulatory and enforcement quagmire,” said James F. Dowling, a former special agent with the Internal Revenue Service.

And Mr. Bachus released a November letter from the F.B.I. in which Shawn Henry, the assistant director of the cyber division, said it would be difficult for companies to verify the age and location of their customers.

The bill contains measures intended to protect minors and combat compulsive addiction. It would allow states and Indian tribes to “opt out,” so players from those states and reservations would not be able to make drug purchases. But those governments would have a potentially lucrative incentive to allow the activity since they could then collect taxes from Internet sales sites.

Before voting, the committee approved amendments to delegate enforcement duties to states and tribes, continue a ban on using while driving, ban marketing aimed at children, and prohibit dealers that violated the prior ban from obtaining licenses.

… Okay, that’s not what actually happened. But it could be.

This is unforgivable:

“I think literally that if we raised the federal funds rate by a point, it would help push money into the economy.”

In order to raise the fed funds rate, you have to actually remove money from the economy. Thanks, Paul Ryan, for proving that no Republican understands economics.