An Update on Progress in the Labor Market Recovery Under Obama

Cumul Private Job Growth from Inauguration to Oct 2015

Cumul Govt Job Growth from Inauguration to Oct 2015

A)  Introduction

The Bureau of Labor Statistics released on November 6 its most recent report on the state of the job market.  It was a strong report, with net job gains of 271,000 in October and the unemployment rate falling to 5.0%.  One should not, however, put too much weight on the figures in just one month’s report.  Indeed, the report for October followed relatively weaker reports in the two previous months.  Rather, one should put all these reports in the longer term context of how the labor market has moved in recent years.  And what they show is continued, and remarkably steady, improvement.

This post will look at that longer term context by updating several labor market charts that have been discussed in previous posts on this blog.  It will look first at net job growth in the private sector and in the government sector in the period since Obama’s inauguration, with a comparison to the similar period during George W. Bush’s term.  The post will then look at the continued fall in the unemployment rate, with a comparison to the similar period under Reagan, and finally to the share of part time workers in total employment.  The last is to see whether there is any evidence to support the assertion coming from Republican critics that Obamacare has led to a shift by employers to part time workers so that they can avoid providing health insurance in the overall wage compensation package for their staff.  We will find that there is no indication in the data that this has been the case.

B)  Total Job Growth

The charts at the top of this post show total net job growth, in the private sector and in the government sector, in the period since Obama’s inauguration (up to October 2015) and under Bush (for his two full terms).  They update similar charts discussed in several earlier posts on this blog, most recently from June 2014.

Private sector job growth has been strong under Obama, and continues to be.  And the record is clearly far better than that under the George W. Bush administration.  There has been a net increase of 9.3 million new private jobs under Obama since the month he was inaugurated, versus just 4.0 million new private jobs over the similar period in the Bush administration.  Furthermore, this 4.0 million additional private jobs was close to the peak achieved in the Bush years, before it started to fall and then plummet as the housing bubble burst and the economy collapsed in the last year of his second term.  By the end of his presidency there were fewer private jobs than there were on the day he was inaugurated, eight years before.

Obama faced this collapse in the jobs market as he took office.  The economy was losing 800,000 private jobs per month, with the economy contracting at the fastest pace since the Great Depression.  The new administration was able to turn this around with the stimulus package and with aggressive Fed actions, with the fall in employment first slowing and then turning around.  The result has been a net growth of 13.5 million new private jobs from the trough just one year into the new administration until now.

Government jobs, in contrast, have been cut.  This hurt total job growth both directly (government jobs are part of total jobs obviously) as well as indirectly.  Indirectly, the government job cuts (as well as the fiscal austerity that began in 2010) reduced demand for goods and hence production at a time when the economy was still depressed and suffering from insufficient demand to keep production lines going.  As discussed in an earlier post on this blog, without the fiscal austerity introduced from 2010 onwards the economy would have recovered from the economic downturn by 2013 and perhaps even 2012.  The initial stimulus package in 2009 turned things around.  It is unfortunate that the government then moved to cuts from 2010 onwards, which reduced the pace of the recovery.

It should be recognized that government jobs as recorded here include government jobs at all levels (federal, state, and local), with federal government jobs only a relatively small share of the total (12.4%).  But government jobs have fallen at all three levels, federal as well as state and local.

The cuts on government jobs during Obama’s time in office stand in sharp contrast to the growth in government jobs during Bush’s two terms.  Yet Obama is charged with being a big government liberal while the Republicans claim to be small government conservatives.

C)  The Rate of Unemployment

Unemployment Rates - Obama vs Reagan, up to Oct 2015After peaking at 10.0% in October 2009, the rate of unemployment has fallen at a remarkably steady pace under Obama (aside from the monthly fluctuations in the reported figures, which will in part be statistical noise as unemployment estimates come from household surveys).  This was discussed in this earlier post on this blog.  The record is certainly better than that under Reagan.  The unemployment rate is now 5.0%, while it was still 6.0% at the same point in the Reagan presidency.

Furthermore, Reagan was not confronted, as Obama was, with an economy in collapse as he took office.  Rather, unemployment began to rise only about a half year after Reagan took office, as he began to implement his new budgetary and other policies.  The unemployment rate then rose to a peak of 10.8% in late 1982 before starting to fall.  And while the recovery was then rapid for a period, supported by rising government spending, it stalled by mid-1984 with unemployment then fluctuating in the range of 7.0% to 7.5% for most of the next two years.  One does not see the steady improvement as one has had under Obama.

With the unemployment rate now at 5.0%, it is expected that the Fed will soon start to raise interest rates.  This would be unfortunate in my view (as well as that of many others, such as Paul Krugman).  Inflation remains low (only 0.2% over the past year for personal consumption expenditures for all goods, or 1.3% over the past year if one excludes the often volatile food and energy costs).  And while wages ticked up by 2.5% over the year before in the most recent BLS labor market report, this is still below the roughly 3 1/2% increases that would be consistent (after expected productivity gains in a normally functioning job market) with the Fed’s 2.0% inflation target.  And if wages are not allowed to rise faster than inflation, then by definition there will be no increase in real wages.

It is of course recognized that the rate of unemployment cannot fall forever.  There will always be some slack in the labor market as workers transition between jobs, and if the unemployment rate is too low, there will be excessive upward pressure on wages, and inflation can become a problem.  But where that “full employment rate of unemployment” is, is not clear.  Different economists have different views.  It does not appear to be at 5.0% under current conditions, as the rate of inflation remains low.  But whether it is at 4.5% or 4.0% is not clear.  At some point, it would be reached.

When it is, the pace of job creation will need to fall to match the pace of labor force growth (from population growth).  Otherwise, by simple arithmetic, the rate of unemployment would continue to fall.  And this cut in employment growth would be the objective of the Fed in raising interest rates:  It would be to slow down the pace of job growth to the rate that matches labor force growth.

Once the Fed does start to raise interest rates, one should then not be surprised, nor criticize, that the pace of job growth has slowed.  That is the aim.  And it will need to slow sharply from what the pace of job growth has been in recent years under Obama.  Over the past two years, for example, employment growth has averaged 236,000 per month. The labor force has grown at a pace of 101,000 per month over this period.  As a result, unemployment has fallen at a pace of 135,000 per month (= 236,000 – 101,000), with this leading the unemployment rate to fall to 5.0% now from 7.2% two years ago.  If unemployment is now to be kept constant rather than falling, the pace of job growth will need to fall by more than half, from 236,000 per month to just 101,000 per month (or slightly more, to be precise, taking into account the arithmetic of a constant unemployment rate).

I have no doubt that when this happens, and the pace of job growth slows, that Obama will be criticized by his Republican critics.  But this will reflect a fundamental confusion of what full employment implies for the labor market.

D)  Part-Time Employment as a Share of Total Employment

Part-Time Employment #2 as Share of Total Employment, Jan 2007 to Oct 2015

Finally, it is of interest to update the graph in an earlier post to see whether there is now any evidence that the Affordable Care Act (Obamacare) has led employers to fire their regular full time workers and replace them with part-timers, in order to avoid the mandate of including health insurance coverage in the wage compensation package they pay to their workers.  Conservative politicians and media asserted this as a fact (see the earlier blog post cited for several references).  But as discussed before, and as confirmed with the more recent data, there is no indication in the data that this has been the case. Indeed, the share of part time workers in the total has been falling at an accelerated pace in the most recent two years, at a time when the Obamacare insurance mandate provisions have come into effect.

The acceleration in the pace of this improvement is consistent with the improvement seen in the overall labor market over the past several years, as discussed above.  As the economy approaches full employment, those who are working part time (not by choice, but because they have no alternative) are able to find full time jobs.  The share of part-time workers in total employment is still somewhat above (at about 4%) what would be normal when the economy is at full employment (at about 3%), lending support to those arguing that while the labor market is improving, we are not yet at full employment (and the Fed should thus wait longer before it starts to raise interest rates).  But it is getting better.

I have also added to the graph a line (in red) showing what the share of part-time employment workers were in total employment during the Reagan years.  At the comparable time in his presidency, the share was higher than what it is now under Obama.  Furthermore, it had improved only slowly under Reagan over the three years leading up to that point.  Yet Reagan is praised by conservatives for his purportedly strong labor market.

E)  Conclusion

The labor market has improved considerably in recent years under Obama.  It could have been better had the government not turned to austerity in 2010, but even with the government cuts, job growth has been reasonably good.  The unemployment rate has now fallen to 5%, and it is expected the Fed will soon begin to raise interest rates in order to slow the pace of job creation.  One should not then be surprised if fewer net new jobs are created each month, nor criticize Obama when it does.  That will be precisely the aim of the policy.  But I strongly suspect that we will nonetheless hear such criticisms.

Concrete Measures to Address Real Income Stagnation of the Poor and Middle Classes

Piketty - Saez 1945 to 2013, June 2015, log scale

I.  Introduction

The distribution of the gains from economic growth has gotten horribly skewed since around 1980, as the graph above shows (using a log scale so that distances on the vertical scale are equal relative changes).  Average real incomes of the bottom 90% of households have fallen by 5% in real terms since 1980, while the real incomes of the top 0.01% have grown by 325%.  This is astounding.  Something has changed for the far worse in recent decades.  The real incomes of these groups grew at roughly similar rates in the post-World War II decades leading up to 1980, but then diverged sharply.

An earlier post on this blog looked at the proximate factors which took substantial growth in GDP per capita (which grew at about the same pace after 1980 as it had before) down to median wages that simply stagnated.  As discussed in that post, this was principally due to a shift in distribution from labor to capital, and a shift within labor from the lower paid to the higher paid.  (Demographic effects, principally the increased participation of women in the labor force, as well as increases in the prices of items such as medical care relative to the prices of other goods, were also both important during this period. However, both have now become neutral, and are not factors leading to the continuing stagnation in recent years of median wages.)

The purpose of this blog post is to look at concrete policy measures that can be taken to address the problem.  The issue is not slow growth:  As noted above, per capita growth in GDP since 1980 has been similar to what it was before.  The problem, rather, is the distribution of the gains from that growth, which has become terribly skewed.

Discussion of this is also timely, as a consensus appears to be forming among political leaders in both major parties that something needs to be done about the stagnant incomes of the poor and middle classes.  Several of the candidates seeking the Republican presidential nomination have said they wish to make this a primary issue of the 2016 campaign.  This is good.  If they are serious, then they would support measures such as those laid out below.  I doubt they will, as they were strenuously opposed in the past to many of them, and indeed championed the changes in policy from the Reagan period onwards which are, at a minimum, associated in time with the deterioration in distribution seen in the chart above.  But one can hope.

This is a long blog post, as it discusses a long list of measures that could be taken to address the predicament of the poor and middle classes.  Many (although not all) of these policies have been reviewed in previous posts on this blog.  Thus the discussion here will in such cases be kept individually brief, with the reader encouraged to follow the links to the earlier blog posts for more substantive discussion of the points being made.  And the reader with limited time may wish to scan through the section headings, and focus on those topics of most interest.

II.  A Policy Program

A.  Labor Market

We start with the labor market, as it is fundamental.

1)  Raise the minimum wage:  The minimum wage is now less in real terms than what it was in 1950, during the presidency of Harry Truman.  This is amazing.  Or perhaps what is amazing is the argument made by some that raising it would price workers out of their jobs.  Real GDP per capita is now 3.75 times what it was then, and labor productivity has grown to 3.5 times what it was then.  But the minimum wage is now less in real terms than what it was then.  The minimum wage in 1950 was not too high to price low paid workers out of the market, and labor productivity is three and a half times higher now.

Obama has called for the minimum wage to rise to $10.10 per hour from its current $7.25 per hour (with this then indexed to the rate of inflation).  This would bring the minimum wage back only to where it was in the 1960s, a half century ago.  There is no evidence that such a rise will hurt low wage workers, and it would still leave a full time worker (at 40 hours a week, and with no vacation time, so 52 weeks per year times 40 hours per week = 2,080 hours per year) at such a minimum wage (2,080 x $10.10 = $21,008 per year) earning well less than what is needed to bring a family of four up to the poverty line ($24,250 per year for a family of four in 2015).  This is the minimum that should be done. Indeed, it should be more.

2)  Ensure predictable work hours:  Many workers, particularly in sectors such as retail and food service (whether fast food or traditional restaurants), are increasingly being required to accept “flexible” work hours, where their employer tells them only a short time ahead what days to come in, at what time to report, and for how many hours.  They might be told a few days before, or only the day before, or sometimes only on the day of possible work, whether they will be needed and should report to work.  This is sometimes called “just-in-time” scheduling (a term taken from just-in-time inventory management) or “on-call” scheduling, and managers are rewarded for what is seen as “optimizing” their use of labor.

But it plays havoc with the life of many workers.  They cannot take a second job in the evening to help make ends meet, if they do not know whether their primary job may sometimes require that they come in on short notice to work an evening shift.  Students cannot enroll in college classes in order to finish a degree if they do not know whether they might be called in during class time.  Parents and especially single mothers can have great difficulty in arranging for child care when their work schedules are unpredictable.  And an unpredictable number of weekly work hours, of perhaps 30 hours one week and 20 hours the next, makes budgeting impossible.

Recent developments in computer and communications technology have made on-call scheduling possible and increasingly common.  Establishments such as Starbucks can receive at some central office real-time information on coffee sales (from the cash registers, via an Internet connection), and together with other factors (weather forecasts; whether a convention is in town) can run sophisticated software algorithms predicting how many workers will be needed, exactly when, and which ones should be called in.

The problems this creates for low income workers has only recently come to be recognized.  An important spark was a story in the New York Times on August 13, 2014, on the impact on a worker at Starbucks.  This led Starbucks the very next day to announce it would change its practices, but a review a month later by another news organization raised questions as to whether anything of significance had really changed.

Starbucks can possibly be shamed into improving it working conditions, as it sells high-end coffee to those with significant disposable income.  And if the problem were solely with Starbucks and a few similar firms, a shaming approach might possibly be effective. However, while Starbucks may have become the symbol, the practice has unfortunately become increasingly widespread.  Furthermore, there is competitive pressure across firms to adopt such practices.  If Starbucks stops the practice, it may face coffee retailers who continue to “optimize” their use of labor through such practices, who can then take away business by charging less.  There is thus pressure on firms to impose the lowest standards they can get away with.

There is no federal law against such labor practices.  There may be state laws which might constrain the practices in some way in certain jurisdictions, but they are not widespread. What is needed is a legislated solution which will apply generally, and should be undertaken at the federal level.  This has been done before.

Abuses of labor had become common during the “gilded age” of the late 1800s / early 1900s (when income distribution was, not coincidentally, as bad as it is now).  Progressive Era and later New Deal reforms addressed some of the more egregious issues.  Work place safety and child labor laws were enacted, a minimum wage was established, and a 40 hour work week was set as the standard, where a worker is required to be paid overtime at the rate of “time and a half” (150% of their regular wage) for any hours worked beyond 40 in a week.

The issue of unpredictable work hours could be addressed similarly.  All workers would have a normal set of hours, defined individually and a function of their particular job.  They would always be paid for this set of normal hours.  But it is recognized that firms may have an unexpected need for additional workers at certain times (for example to substitute for a worker who is sick).  Workers could take on such additional shifts beyond their regular hours if they so chose, but as a financial inducement for the firm not to rely on such job calls, the firm would be required to pay 150% of normal wages for such time (as for overtime work).

This would lead firms to assess better when they need workers and when not, and build this into the standard work schedules.  Firms have little incentive to do this now, since the cost of unpredictable schedules is shifted onto the workers.  Note also that with this system there will not be an incentive to further split up jobs, as all workers will be assigned an individualized normal schedule.  The firms will gain no flexibility by splitting a 30 hour a week job into one of 20 hours and one of 10 hours.  They will still need to determine when workers are expected to be needed, in order to assign hours accordingly.  And to the extent they do not do this carefully, they will be penalized as they will then need to pay 150% of the wage when a worker needs to be brought in to cover those extra hours.

Predictability in hours is extremely important to low wage workers.  Indeed, it is quite possibly more important than raising the minimum wage.  It will shift some of the costs of unpredictability back onto the firm, where it had been until modern computer and communications technology (and lax labor laws that did not foresee this) allowed the firms to shift onto workers the cost of unpredictability.  Firms did this to raise profits, and business profits did indeed then rise while wage earnings stagnated.  This is precisely the issue that needs to be corrected.

3)  Manage policies to return the economy rapidly back to full employment when there are economic downturns:  While it would be ideal always to keep the economy at or close to full employment, economic downturns happen, most recently in 2008 in the last year of the Bush administration.  But when they do, the priority should be to return the economy to full employment as rapidly as possible.  Everyone can of course agree on this. Differences arise, however, on how to do it.

Monetary policy should be used to the extent possible, but there is a limit to how much it can do since interest rates cannot go below zero.  And they have been at essentially zero since late 2008, following the Lehman Brothers collapse.  The Fed can also try to reduce long term rates (such as through quantitative easing), and while its policy here has had some beneficial effect, it is also limited.

Monetary policy in a downturn such as that just experienced must therefore be supported also by expansionary fiscal policy.  Additional government spending is the most effective way to expand demand, as it does this directly.  Tax cuts can also help, but are less effective since a significant share of the reduction in taxes may be partly saved by households (and likely will be largely saved by higher income households).  There will thus be less stimulative effect per dollar from tax cuts than from direct spending.

Unfortunately, government spending was cut each year from 2010 up to 2014. This was the first time in at least 40 years that government has cut spending in a downturn.  Hence the economic recovery has been the slowest of any over that period, and only picked up in 2014, when government spending was finally allowed to increase.

Republicans have argued that to return the economy to full employment, one should instead reduce regulations.  But this makes no sense.  Regulations in the middle of a downturn are not far different from what they were before the downturn began, so how can they be blamed for the unemployment, and how would reducing them lead to less unemployment?  And if some regulations are wrong, one should change them, whether the economy has high unemployment or low unemployment.  Regulations do not serve as a macro policy to reduce unemployment, but rather serve a micro purpose to ensure the economy functions efficiently.

A slack labor market will have a direct effect on income inequality.  When there is available labor that is unemployed, a laborer will have little leverage to negotiate for higher wages. And unemployment has been higher, on average, in the three decades following 1980 than in the three decades before 1980.  A simple regression analysis suggests that if the average rate of unemployment after 1980 had simply matched what it had been before 1980, then the real incomes of the bottom 20% of households would not only have grown at a rate similar to how fast they had grown before, but also at a rate similar to that of the top 20% in the period after 1980.  That is, there would have been continued growth in the real incomes of the bottom 20% after 1980, instead of stagnation, and no increase in inequality relative to the top 20%.  Keeping the economy at close to full employment is critical to the poor and middle classes.

B.  Fiscal Policy

Fiscal policy is therefore an important instrument to keep the economy at full employment, or to return it to full employment from a downturn.  What specifically should be done?

1)  End the Congressional budgetary “pay-as-you-go” rules when in or recovering from a recession:  The Budget Enforcement Act of 1990 required that, as a budgetary rule, any increase in mandatory government spending or reductions in taxes must be “paid for” over the next five years as well as the next ten years by offsetting spending cuts or tax increases, so as to be budget neutral over these periods.  While the rules have been modified over the years, were not in place for a period during the Bush II administration, and were not always abided by (such as for the large tax cuts at the start of the Bush administration), they have acted in recent years to limit the government spending that was needed to recover from the downturn.

Over the course of a full business cycle, covering the full period over when the economy is at or close to full employment and when it is not, a limit on the size of the government deficit is warranted.  But by setting such a limit to apply identically and continuously both in a downturn and when the economy is booming, one limits the government expenditures that may be needed for a rapid recovery.  The rule should be suspended during any period when the economy is in a recession or recovering from one, to be replaced by a rule that applies over the course of the business cycle as a whole and which focusses on the government debt to GDP ratio rather than simply the government deficit.

2)  Stop cuts to important safety net programs such as food stamps and unemployment insurance, especially in a downturn:   Safety net programs such as food stamps (now called SNAP) and unemployment insurance are critically important to the poor and middle classes, and especially so in a downturn. They provide limited support to households who lost their jobs or other sources of income in the recession, due to no fault of their own.  (The 2008 downturn was a consequence of the reckless management of banks and other financial institutions in the US, and the policy decision of the Bush administration officials not to make use of their regulatory powers to limit it.  This led to very high bank leverage, a build-up of the housing bubble, and then collapse when the housing bubble burst.)

As unemployment rose and incomes fell, especially of the poor and near poor, many more households became eligible for food stamps and, having lost jobs, for unemployment insurance.  Expenditures on these and other safety net programs expanded, as they are designed to do in a downturn.  But Congressional Republicans then forced through cuts in the key safety net programs (e.g. unemployment insurance, and food stamps) by limiting eligibility, and have sought much more extensive cuts.

If one wishes to help the poor and near poor, one does not cut programs which help them directly, and especially not when they most need them.  These programs are also extremely efficient.  The food stamp program (SNAP) spends only 5% of its budget on administrative costs.  Few charities are anywhere close to as efficient, but at least some prominent Republicans think otherwise.  Former Congresswoman Michele Bachmann, at one point the leading contender for the Republican presidential nomination in 2012, asserted that 70% of food stamp funding went to “bureaucrats”.  This was absurdly wrong.

Safety net programs in the US, while efficient for the money spent, are however highly limited in how much they do spend.  US income inequality or poverty rates are actually not worse than those seen in other high income OECD economies in terms of wages and other income paid to workers. That is, the US capitalist market economy does not itself produce more unequal outcomes than those of other high income OECD economies.  The US is near the average in this across all the OECD countries.  But once one takes into account government taxes and transfers, the US turns out to be the very worst, both in terms of inequality (as measured by the Gini coefficient) and in terms of poverty (by the share of the population considered poor).  The problem is not that the US tax and transfer programs are not especially progressive:  They are in fact more progressive than in most countries.  The problem is that they are simply too small to matter.

3)  Implement a public infrastructure investment program:  American public infrastructure is an embarrassment.  Compared to other high income countries, US roads, bridges, mass transit, and other public structures, are clearly inadequate in scale, are in terrible condition due to inadequate maintenance, and constitute what is in effect a growing debt that will need to be repaid in the future when they finally have to be rebuilt (normally at much greater cost than if they had been maintained properly).

Public investment has been cut back especially sharply in recent years, whether measured as a share of GDP or simply in real per capita terms, as a consequence of Congressional cuts in the budget.  But while the cuts have been especially sharp since 2010, the problem is long-standing.  Amazingly, US non-defense public investment in structures in 2013 was less, in real per capita terms, than what it was in 1960, even though real per capita GDP almost tripled over this period.

It should therefore be no surprise that roads and bridges are in poor condition (with some bridges that have even collapsed), mass transit systems are in poor repair, and all are grossly inadequate to what we need.  This impacts especially the middle classes, who have to sit in traffic jams daily just to get to work.  Toll roads or tolled lanes built by private concessionaires have become fashionable in recent years to build roads that government is no longer willing to pay for, but they can be expensive.  The tolled lanes opened recently in Northern Virginia in the I95/I495 corridor have tolls that, for the entire length, could conceivably reach $40 or more per trip (and double that per day).  Rich people can afford this, but most of those with middle class incomes cannot.

Adequate public infrastructure is needed to raise productivity and for the economy to grow.  And the recent severe downturn should have been a time for a special effort to expand such investment, putting to work unemployed construction and other workers, in firms that had capacity to produce more than they could sell due to low demand in the downturn.  Furthermore, the government could have borrowed long term funds during this period at historically low rates, and even at times at negative real rates.  It was insanity not to utilize the unemployed labor and underutilized firms, financed by funds at low or even negative real cost, to build and repair infrastructure that the economy and especially the poor and middle classes desperately need.

But this was not done.  It instead will need to be done over the coming years (and at much higher cost, due to the lack of maintenance), when the economy is hopefully at full employment, interest rates have returned to normal levels, and anything extra spent on public infrastructure will need to come out of less being available for other goods and services, including for private investment.

4)  Increase public support to higher education:  At one time, students could pay for the total costs of attending a state university, including room and board, through work at just the minimum wage during summers and part time during the academic terms.  This is no longer the case.  In part this is due to the fall in the minimum wage in real terms from where it had been in the 1960s.  But it was also a consequence of the rising cost of university education (a result of Baumol’s cost disease) coupled with sharp cutbacks in the share of these costs covered by state support to their colleges and universities, shifting more of the cost onto students and their families.

This reduction in state support to their colleges and universities needs to be reversed, or soon state schools will in effect no longer exist.  They will have become essentially private schools catering to those who can afford them.  And while federal programs exist to help students (most importantly the Pell Grant program, which provides grants of up to $5,775 per year, in academic year 2015/16), they are limited and family income based.  The maximum Pell Grant goes only to the poorest households.

There are different ways to assist students from poor and middle class households to continue their schooling beyond high school.  President Obama, in this year’s State of the Union address, proposed for example that federal support be provided so that community colleges would stop charging tuition for students in good standing.  One would in essence be extending the availability of public schooling from 12 years now to 14 years.  The budget cost would be relatively modest at just $6 billion per year.  Others have suggested, constructively, that using such funds to expand the Pell Grant program would achieve the same aim, while assisting also those low income and middle class students who would do better by enrolling in a four-year college.

The response of the Republicans in Congress has, however, been in the opposite direction.  While rejecting Obama’s proposal for community colleges, the recent proposal from the House Budget Committee would instead freeze the maximum Pell Grant at $5,775 for at least the next ten years, thus leading to its erosion in real terms as prices rise (much as the minimum wage has eroded over time due to inflation).

C.  Tax Policy

Tax policy has a direct impact on income distribution.  But while most still accept the principle that taxes should be progressive (the principle that the rich should pay taxes at a higher rate than the poor), the tax system the US in fact has is regressive in many of its aspects.

1)  Stop the preferential tax treatment of income from wealth:  The wealthy pay a lower rate of taxes on their income from wealth than most of the population pays on their income from labor.  In terms of policy options to address inequality, little would be more straightforward than to end the practice of taxing income from wealth at lower rates than income from work.  Tax rates on all income groups could then be reduced, with the same total tax revenues collected.

The long-term capital gains tax rate on most assets is only 15% for most earners (there is an additional 3.8% for those households earning more than $250,000 bringing the rate to 18.8%, with this rising by a further 5% points to 23.8% for those earning $464,850 or more in 2015).  These rates on income from wealth are well below what is paid by most on income from labor (wages).  While the regular income tax rates (on wages) vary formally from 10% in the lowest bracket to 39.6% in the highest, one should add to these the social insurance taxes due.  These are often referred to loosely as Social Security taxes, but they include both Social Security at a 12.4% rate (up to a ceiling in 2015 of $118,500), and Medicare taxes at a 2.9% rate (with no ceiling).  Note also that while formally the employee pays half of this and the employer pays half, analysts agree that all of the tax really comes out of wages.

Once one includes social insurance taxes on wages, the effective tax rates on income from labor goes from 25.3% for the lowest bracket to 40.3% on those earning between $74,900 and $118,500, after which it drops down to 27.9% as the Social Security ceiling has been hit, and then starts to rise again.  The long-term capital gains rate is always below this even for the very richest, and normally far below.

To add further complication, preferential rates of 25% apply to long-term capital gains on certain commercial building assets (“Unrecaptured Section 1250” gains), and 28% apply to collectibles (such as fine art or gold coins) and certain small business stock. These are still well below what most pay in taxes on income from work.

This system not only worsens income inequality, but also creates complications and introduces distortions.  Many of those with high income are able to shift the categorization of their incomes from what for others would be wage income, to income which is treated as long-term capital gains.  Properly structured stock options, for example, allow CEOs and other senior managers to shift income from what would otherwise be taxed at ordinary income tax rates to the low rates for capital gains.  “Carried interest” does the same for fund managers.  With many fund managers earning over $100 million in a year, and indeed some earning over $1 billion, this preferential tax treatment of such extremely high earnings is perverse.

The reform would be simple.  All forms of income, whether from labor or from wealth, would be taxed at the same progressive rates that rise with total household income.  The one issue, which can be easily addressed, is that income from long-term capital gains should be adjusted for inflation, to put the gains all in terms of current year prices.  But this can easily be done by scaling up the cost basis based on the change in the general price level between when the asset was bought and when it was sold.  The IRS could supply a simple table for this.

2)  Reduce marginal effective tax rates on the poor:  Conservatives have long argued for cuts in marginal tax rates for the rich, arguing this would lead to faster growth (“supply-side economics”).  While there is no evidence that lower tax rates in recent decades have in fact led to faster growth, this was the stated rationale for the big tax cuts under Reagan and then Bush II.

Liberals have noted that if one were really concerned about high marginal tax rates, you would look at the high marginal effective tax rates being paid at the other end of the income scale – by the poor and those of moderate income.  Studies have found that these can range as high as 80 or even 100%.  The marginal effective tax rates take into account the impact of means-tested programs being phased out as one’s income rises.  When extra income is earned, you will pay not only a portion of this in taxes, but you will also lose a portion of benefits that are being provided (such as food stamps) in programs that phase out as income grows.  If the extra paid in taxes plus the amount lost in benefits matches additional earnings, the marginal effective tax rate will be 100%.

Conservatives have started to pay attention to this.  An opinion column in the Wall Street Journal last September by Senators Marco Rubio and Mike Lee (both Tea Party favorites) decried the 80 to 100% marginal effective tax rates that low income workers might face, arguing this can act as a strong disincentive to work.

In reality, the rates being faced by the poor are normally less, although still substantial. The issue is complex since the effective tax paid will depend not only on income, but on such factors as:  1)  Family composition (whether married and number and age of children); 2) Where one lives (what state and often what city or county); 3)  Particular benefit program qualification criteria (which will vary by program, and will often depend on many factors other than income); and 4) Whether the individual always enrolls in programs they are qualified for, as one may not be aware of certain benefit programs, or find the benefits to be too small to be worthwhile (because of difficulties and complications in enrolling, with these quite possibly deliberate difficulties in some jurisdictions).

The Congressional Budget Office, in a careful study issued in November 2012, concluded that the marginal effective tax rate for citizens with incomes of up to 450% of the federal poverty line averaged about 30% in 2012.  And under law as then in effect, this would rise to 32% in 2013 and 35% in 2014.  There was a good deal of variation within the average, with a marginal effective tax rate of as much as 95% (for example, for single mothers with one child with an income in the range of about $18,000 to $20,000, which was just above the poverty line for such a household).  But rates of 40% or more were not uncommon.

Such rates, even when not at the 80 to 100% extremes cited by Senators Rubio and Lee, are high.  Even at just 30% (the average) they are double what those who are far better off pay in long-term capital taxes.  While the conservative senators argue that such high marginal rates discourage work effort (there is in fact little evidence that this is the case – when you are poor, you are desperate for whatever you can get), such high marginal rates are in any case unfair.  If one wants to help those of low and moderate income, these effective tax rates should be reduced.

There are three ways, and only three ways, to reduce the marginal effective tax rates on the poor.  One is to get rid of the benefit programs for the poor altogether.  If they receive no food stamps to begin with, one has nothing to lose when incomes rise.  But this then penalizes the poor directly.

One could also phase out the programs more slowly, and pay for this by reducing the benefits to the poorest.  This is then a transfer from the poorest to the somewhat better off than the poorest.  Senators Rubio and Lee proposed this route (without explicitly calling it that) by reducing benefits such as food stamps and providing instead larger child tax credits for all households (including the rich).  This would be a transfer from the poorest to those of higher income (including the rich), and especially to those with large families.  The poorest would be penalized.

Finally, the third and only remaining option is to phase out the benefit programs more slowly.  This reduces the marginal effective tax rate that poor households will face if they are able to obtain jobs paying more than what they earned before.  It will not penalize the poorest, but it does of course require that budgets for the programs then rise.  But this will be support made available directly to the poor, and in particular to the working poor (as they are the ones facing the high marginal effective tax rates from additional earnings). If one is concerned about poverty and inequality, this is precisely the support that should be provided.

3)  Tax inherited wealth the same as any other wealth:  Wealth that is inherited enjoys significant tax benefits.  The only exception is wealth that is so large that it becomes subject to the estate tax (greater than $10.86 million for a married couple in 2015).  But few pay this due to that high ceiling, as well as since one can establish trusts and use other legal mechanisms to avoid the tax.  Indeed, in 2013 (the most recent year with available data), estate taxes were due on less than 0.2% of estates; the other 99.8% had no such taxes due.  This is down from over 6% of estates in the mid-1970s, due to repeated changes in tax law which narrowed and reduced further and further what would be due.

Any wealth that is passed along within the effective $10.86 million ceiling will never be subject to tax on capital gains made up to the point it was passed along.  That is, the cost basis is “stepped-up” to the value upon the date of death.  If one had purchased $100,000 of General Electric stock 40 years ago, the stepped-up value now would be roughly $3 million, and no taxes would ever be due on that $2.9 million of gain.

This is not fair.  Taxes on such wealth should be treated like taxes on any other wealth, and as argued in item #1 of this section above, all sources of income should be taxed the same (recognizing, importantly, that capital gains should be adjusted for inflation).

Some have argued that this cannot be done for inherited wealth since those inheriting the wealth may not know what the original cost basis was.  But this is not a valid excuse.  First of all, the two most important categories of wealth that are passed along through estates are homes and other real estate, and stocks and bonds and other such traded financial assets.  There are government land records on all real estate transactions, so it is easy (and indeed a matter of public record that anyone can look up) to find the purchase price of a home or other real estate.  And purchases of stocks, bonds, and other trade financial assets are done via a brokerage, which will have such records.

Second, if there are any other assets with special value (such as valuable coins or works of art) that will be passed along through an estate, the owner of those assets can include a record of their cost basis as part of the will or trust document that grants the asset to those inheriting the estate.

4)  Equal tax benefits for deductions should be provided for all income levels:  Under the current tax system, if a rich person in a 40% marginal income tax bracket makes a $100 contribution to some charity, then the government provides a gift to that rich person of $40 through the tax system, so that the net cost will only be $60.  If a middle class person in a 20% marginal tax bracket makes a $100 gift to the exact same charity, then the government will pay them back $20, for a net cost of $80.  And if a poor person in the 10% bracket makes a $100 gift to that same charity, the net cost to him will be $90.

This is enormously unfair.  There is no reason why deductions should be made more valuable to a rich person than to a poor person.  And there is an easy way to remedy it. Instead to treating deductions as subtractions from taxable income, one could take some percentage of deductions (say 20%) as a subtraction from taxes that would otherwise be due.  The $100 gift to the charity would then cost the rich person, the middle class person, and the poor person, the same $80 for each.

5)  Set tax rates progressively, and at the rates needed to ensure a prudent fiscal balance over the course of the business cycle:  I have argued above that all forms of income should be taxed similarly.  Whether you earn income from working or from wealth, two households with the same total income should pay taxes at the same rates.  This is not only for fairness.  It would also simplify the system dramatically.  And this is not only for the obvious reason that calculations are easier with one set of rates, but also because the current diverse rates interact between themselves in complex ways, which make computing taxes due a headache when there are different rates for different types of income.  Perhaps most importantly, it would eliminate the incentive to shift income from one category to another (e.g. from wage income to stock options) where lower taxes are due.  That creates distortions and wastes resources that should be used for productive activities.

There remains the question of what the new rates should be.  I do not have the data or the detailed tax models which would allow one to work that out, but a few points can be made.  One is that the new tax rates would be lower (at any given level of income) than what regular income tax rates (on wage income) are now.  This is because the tax rates on income from wealth (such as for capital gains, or inherited wealth) would be unified with the now higher tax rates on income from labor, so the new overall tax rates on regular income can be lower than before to yield the same level of tax revenues.  General income tax rates would come down.

Second, one should of course preserve the principle of progressivity in the tax code.  Rich people should pay taxes at a higher rate than poor people.  As Warren Buffitt argued eloquently in a New York Times column in 2011 (“Stop Coddling the Super-Rich”), there is no economic justification for the rich to pay taxes at lower rates than those with less income.  And it is grossly unfair as well.  Their secretaries should not pay at higher rates than the rich (fully legally) pay.

Third, one needs to recognize that the purpose of taxes is to raise revenues, and rates should thus be set at the levels required to cover government expenditures over time.  As argued above, the budgetary accounts should not be forced to balance each and every year, since fiscal policy is extremely important to move the economy back to full employment in an economic downturn (and fiscal policy is basically all that is available when interest rates are at the zero lower bound, as they have been since late 2008 in the US).

But over the full course of the business cycle, tax rates should be set so that the tax revenues collected suffice to keep the government debt to GDP ratio at a stable and reasonable level. This implies deficits when unemployment is high, and surpluses when the economy is close to full employment.  The economy was at full employment in 2006-07 (unsustainably so due to the housing bubble building up in those years) with the unemployment rate below 5% and as low as 4.4%.  Unfortunately, due to the Bush II tax cuts, the government’s fiscal deficit in those years was still significant.

Applying these principles, the tax rates needed for this would need to be worked out.  This can be done, but I do not myself have access to the data that would be required.  In the end, I suspect that regular income tax rates could be reduced substantially from what they are now, with this still sufficient to provide for adequate government expenditures over the course of the business cycle.  But the rich would pay more while those of low to moderate income would pay less, and whether this would then be possible politically is of course a different issue.

D.  Health Insurance

Access to health insurance is important.  A careful statistical analysis published in 2009 found that the likelihood of dying is higher for the uninsured than for the insured, and the lack of universal health insurance (as was then the case in the US) was leading to an estimated 45,000 more Americans dying each year than would be the case if they had health insurance.  This is greater than the number of Americans killed in action over the entire period of the Vietnam War.

The ObamaCare reforms have been a big step forward to making it possible for all Americans to obtain access to health care, but it remains under threat.  If Republicans are serious about helping the poor and middle classes, they should support the following.

1)  First, stop trying to block health care access for all:  ObamaCare, while not perfect (it reflects political compromises, and is based on the system of individual mandates first proposed by the conservative Heritage Foundation in 1989), is nonetheless working.  An estimated 16.4 million Americans now have health insurance coverage, which they did not have before ObamaCare became available.  And a Gallup poll found that there was a higher satisfaction rate among those obtaining health insurance policies through the ObamaCare exchanges, than among those with traditional health insurance policies (mostly via employers).

Despite this, Republicans continue to campaign aggressively to terminate ObamaCare, and have supported lawsuits in the courts to try to end this health care access.  A case now before the Supreme Court, with findings to be announced this month (June 2015), may declare that the federal government payments made through certain of the ObamaCare exchanges (those not run by the states) to those of low to moderate income, cannot be continued.  If the Supreme Court finds in favor of those opposed to such payments, these low and moderate income households will no longer be able to obtain affordable health insurance.

If the Republican presidential candidates are in fact in favor of helping the poor and middle classes, they should call for an end to the continued efforts by their Republican colleagues to terminate ObamaCare.  There are ways it could be improved (e.g. by taking more aggressive actions to bring down the cost of medical care to all in the US), but it is working as intended, and indeed better than even its advocates expected.

2)  Extend Medicaid in all states in the US:  The ObamaCare reforms built on the system of existing health insurance coverage.  Medicare would remain the same for those over age 65; employees in firms would normally pay for health insurance coverage through employer based plans; Medicaid would expand from covering (generally) those up to the poverty line to include also those with income up to 133% of the poverty line; and all those remaining without health insurance would be allowed to purchase coverage from private health insurers competing on internet-based health insurance exchanges, where those with incomes of up to 400% of the poverty line would receive federal subsidies to make such health insurance affordable.

The Medicaid expansion to cover all those with incomes of up to 133% of the poverty line was thus one of the building blocks in the ObamaCare reforms to enable all Americans to obtain access to affordable health care.  Because of its historical origins in health care programs for the poor that had traditionally been implemented in the states, Medicaid is implemented at the state level even though it is funded jointly with the federal government. For the Medicaid expansion to 133% of the poverty line, the federal government through the legislation setting up ObamaCare committed to funding 100% of the incremental costs in the first three years (2014 to 2016) with this then phased down to 90% in 2020 and thereafter.

Despite this generous federal funding, the Supreme Court decided in 2012, in its decision that also found ObamaCare in general to be constitutional, that Congress could not force the states to expand Medicaid to the higher income limits.  Thus the expansion became optional for the states, and as of April 2015, 21 states have decided not to.  The 21 states are mostly in the south or the mountain west, with Republican legislatures and/or Republican governors or mostly both.

Blocking this Medicaid expansion in these states is being done even though an expansion would cost little or nothing.  There is literally no state cost in the first three years as the federal government would cover 100% of the extra costs.  And while the federal share would fall then to a still high 90% for 2020 and thereafter, allowing more of the poor to be covered by Medicaid will reduce state costs.  The poor in this gap in coverage are forced to resort to expensive emergency room care, for which they cannot pay, when their health gets so bad that it cannot be ignored.  These costs are then partially compensated by the state.

A careful analysis for Virginia, undertaken for the state by Price Waterhouse Coopers, concluded that if Virginia opted in to the Medicaid expansion, the state would save $601 million in state budget costs over the period 2014 to 2022.  And this did not even include the indirect benefits to the budget from higher tax revenues, as a consequence of the additional jobs that would be created (nurses and other care providers, etc.) and the higher incomes of hospitals from less uncompensated care.

Denying affordable health care to the poor with incomes of between 100% and 133% of the poverty line is callous.  These are the working poor, and there really is no excuse.

3)  Ensure employers pay a proportionate share for health insurance for their part-time workers:  Employers have traditionally not allowed part time employees to obtain (through their wage compensation package) health insurance cover in employer-based plans.  There was a practical reason for this, as health insurance plans only provided cover in full.  It has been difficult to provide partial plans, so part time workers have traditionally gotten nothing.

This has now changed with the introduction of the ObamaCare health insurance market exchanges.  Those without health insurance coverage through their employers can now purchase a health insurance plan directly.  One could therefore now require that all employers make a proportionate contribution to the cost of the health insurance plans for their part time workers.  That is, for someone working half time (20 hours a week normally) the employer would contribute half of what that employer pays for the health insurance plans for their full time workers.

There would then be no incentive (and competitive advantage) for an employer to split a full time job with health insurance benefits into two half time jobs with no health insurance benefits for either worker.  Under the current system of normally no health insurance benefits for part time workers, employer are in essence shifting the cost of health insurance fully onto the worker and onto the federal government (and hence general taxpayer) if the worker earns so little that they are eligible for federal government subsidies to purchase health insurance on the exchanges.

The proportional employer contribution would be paid to the “account” of the worker in the same way (and at the same time) as Social Security and Medicare taxes are paid for the worker.  The funds from this account would then be used to cover part of the costs of the worker purchasing health insurance on the ObamaCare exchanges.  And if the worker was working in two (and sometimes three or more) part time jobs in order to make ends meet, the total paid in from all of the worker’s employers might well suffice to cover the cost of the health insurance plan in full.

4)  Allow competition from low cost public health insurance:  As part of the political compromises necessary to get ObamaCare passed in the face of steadfast Republican opposition, only private health insurers are allowed to participate in the ObamaCare health insurance exchanges.  Yet Medicare, which provides health insurance to all Americans age 65 and older, is far more efficient than private health insurance providers.  Giving Americans the option (not a requirement) to purchase Medicare administered health insurance on the ObamaCare exchanges would introduce much needed competition. There are often only a few insurers competing in the exchanges, which are all state-based (3 or fewer insurers in 15 of the 51 states plus Washington, DC, with only one insurer offering policies in West Virginia).

But even with multiple insurers competing on the state exchanges, the private insurers in general have high costs.  Private health insurers nationwide (and for all the policies they offer) have administrative costs plus profits equal to 14.0% of the health insurance benefits they pay out.  This is huge.  The same figure for Medicare is only 2.1%.  Medicare costs only one-seventh as much to administer as private health insurance.  And note these lower costs are not coming out of low payments to doctors and hospitals since the 14.0% and 2.1% are being measured relative to claims paid.

It would be straightforward to allow Medicare to compete on the health insurance exchanges.  One would require that Medicare charge rates sufficient (for the resulting client base, which will of course be younger than and generally healthier than Medicare’s senior citizens) to recover its full costs for such coverage.  But Medicare could use its existing administrative structure, including computer systems and contracts with doctors, hospitals, and other medical care providers at the rates that have already been negotiated.

Purchasing a Medicare administered health insurance policy on the exchanges would be fully optional.  No one participating in the exchanges would be required to buy it.  But with its lower costs, the competition Medicare would introduce into the exchanges could be highly effective in bringing down costs.

E.  Pensions

Probably the greatest failure of any social experiment of recent decades has been the switch of employer pension plans from the traditional defined benefit plans that were common up to the early 1980s, to defined contribution schemes (such as 401(k) plans) that have grown to dominance since the 1980s.  In doing this, employers not only shifted the investment, actuarial, and other risks on to the individual workers, but also typically reduced their matching funding shares significantly.

The end result is that workers are now typically woefully unprepared for retirement.  The funds accumulated in their 401(k) and IRA accounts for households (with head of household aged 55 to 64) with a 401(k) account, only amounted to $111,000 in 2013 (for the median household).  Such an accumulation, for households who will soon be in retirement, would suffice to provide only less than $400 a month by the traditional formulas, or $4,800 per year.

This is woefully inadequate, and these households will need to rely on what they can get from Social Security.  But Social Security payments are also not much.  For 2012 (the most recent year with such data), the median Social Security pension payment per beneficiary (age 65 or more) was just $16,799 per year, or per family unit (with head aged 65 or more) just $19,222 per year.  Furthermore, if nothing is done, the Social Security Trust Fund will run down to a zero balance in 2033 based on the most recent projections.

Fully funding Social Security is eminently solvable, as will be discussed below.  The annual cost (including for disability insurance) will rise from roughly 5% of GDP currently to 6% of GDP in 2030, as the baby boomers retire, or an increase of just 1% of GDP.  But what many do not realize is that on current projections, Social Security expenditures are then expected to remain stable (under current benefit rules) at that 6% of GDP for the foreseeable future, in projections that go out 75 years.  One can find 1% of GDP to save Social Security.  But the politicians in Washington will need to agree to do so.

There are several measures that need to be taken to ensure income security for the poor and middle classes in their old age:

1)  Raise, and certainly do not reduce, Social Security payments to those of low and modest income:  Social Security payments, while a crucial safety net, are low.  As noted above, the median payments in 2012 for those aged 65 and older were just $16,799 per beneficiary and $19,222 per recipient family (for the old age component). Such payments are minimal.  Yet these are just medians, meaning half of all recipients received less than even those figures.

Despite being so low, these Social Security payments are critical to many Americans. For the entire population of those aged 65 and older, Social Security accounted for half or more of their total regular income for two-thirds of the population (65% to be precise); Social Security accounted for 90% or more of their income for over a third of the population (36%); and Social Security accounted for 100% of their income for a quarter of the population (24%).  This is incredible, and shows the failure of the current pension systems in the US to provide a reasonable income in retirement for American workers.

The situation is, not surprisingly, worse for those of low to moderate income.  For the bottom 40% of the population by income, where 40% is by far not a small or insignificant share, Social Security accounted for half or more of their regular total income for 95% of them.  Social Security accounted for 90% or more of their income for three-quarters (74%) of them, and for 100% of their income for over half of them (53%).

Social Security benefits are by no means large.  Yet a large share of Americans depend on them.  They should not be cut, but rather should be raised, at least for those of low to moderate income who are critically dependent on them in their old age.

2)  Broaden the base for Social Security taxes to ensure the system remains fully funded:  As noted above, the Social Security Trust Fund will be depleted in 2033 (based on current projections, and including the disability component – while technically separate, the trust funds for old age and for disability insurance are normally treated together).  While some argue, with some justification, that the Trust Fund is fundamentally just an accounting tool, which can be “topped-up” with regular federal government transfers if necessary, there are also good reasons to stay with the Trust Fund rules.  They help keep the Social Security system out of routine Washington politics, and the temptation by conservatives to cut Social Security benefits in order to reduce the size of government.

Under the current Trust Fund rules, participation in the Social Security system is mandatory; taxes are paid on wage earnings (up to a ceiling of $118,500 in 2015); at a rate of 12.4% for Social Security pension and disability coverage for the employer and employee combined (excluding the 2.9% with no wage ceiling for Medicare); and upon retirement, these contributors will receive regular monthly payments from Social Security until they die, based on a formula which is linked to how much was paid into the Social Security Trust Fund during their working career (for the 35 years of highest inflation adjusted earnings).  The formula is complex, and “tilted” in the sense that those earning less will receive back somewhat more than they paid in, while those earning in the upper end of the taxable range will receive back somewhat less.  There is therefore some progressivity, but the degree of progressivity is limited.  Finally, the taxes paid into the fund will earn interest at the rate of the long-term Treasury bond yield of the time, so the taxes paid in to the fund grow over time with interest.

Based on these Trust Fund rules and on current projections of growth in worker earnings (and its distribution) and of what pay-outs will be as workers retire, the Trust Fund is expected to be depleted in 2033.  The basic cause is not that Social Security administration is inefficient and wasting funds.  It is, in fact, incredibly efficient, with a cost of administration of just 0.5% of benefits paid out (on the old age component).  Note this is not on assets, but on benefits paid.  As will be discussed further below, the typical expenses on savings in 401(k) and similar accounts will be 2 to 3% of assets each and every year.

The principal cause of the Trust Fund being depleted, rather, is that life expectancies have lengthened, and hence the period over which Social Security old-age payments are made have grown.  Crudely (and ignoring interest for this simple example), if life expectancy at age of retirement has grown by 50%, so that the number of years during which one will draw Social Security payments has grown by 50%, then the amount needed to be paid in to the Trust Fund to cover this lengthened life will need to grow by 50%.

Longer life expectancies are good.  The Social Security Trust Fund will run out of assets in 2033 not because the funds are being wasted (as noted above, administrative costs are incredibly low), but because people are living longer.  But this will need to be paid for.

But it is also critically important to recognize who is living longer.  As incomes have stagnated for those other than the rich since Reagan took office (see the chart at the top of this post), life expectancies for the poor and middle classes have in fact not increased substantially.  Rather, the overall life expectancy is rising principally because those at higher income levels are enjoying much longer life expectancies (in part precisely because their incomes have been growing so fast).

Specifically, life expectancy for a man at age 65 in the bottom half of earnings rose from 79.8 years in 1977 to 81.1 years in 2006, an increase of just 1.3 years.  But life expectancy at age 65 for a man in the top half of earnings rose from 80.5 years in 1977 (only 0.7 years longer than men in the lower half of the earnings distribution in that year) to 86.5 years in 2006, an increase of 6.0 years.  People are living longer, but it is mostly only those of higher income who are enjoying this.  Life expectancies have not changed much for those of low to moderate income.

It would therefore be perverse to penalize those of lower income to make up for the Trust Fund shortfall, when it is the lengthening of the life spans of those of higher income which is leading to the depletion of the Trust Fund.  Yet proposals to raise the retirement age, or to increase Social Security taxes on all, would charge the poor as much as the rich to make up for the Trust Fund deficit.

Rather than penalize the poor, Social Security taxes should be raised on those who are better off to pay for their increasing lifetime benefits.  And this is of course also precisely what one should want to do if one is concerned about inequality.

The obvious solution is to broaden the tax base for the Social Security tax to include incomes now excluded – which are also incomes that accrue to the rich.  First, note that the shortfall to be made up when the Social Security Trust Fund is expected to be depleted (if nothing is done) in the 2030s would require a 20% increase in revenues.  That is, following a transition between now and about 2030 as the baby boomer generation retires, the long term projection is that Social Security tax and other revenues will level off at about 5% of GDP, while Social Security obligations will level off at about 6% of GDP. That is, we will need revenues to increase by about 20% to make up the shortfall, to get to 6% of GDP from 5%.  (A more precise estimate, but from my blog post of a few years ago, is an increase of 19.4%).

Broadening the Social Security tax base would easily provide such an amount of funding. For wages alone, there is the current ceiling of $118,500 (in 2015) on wages subject to Social Security tax.  At this ceiling, only 83% of all wages paid are subject to this tax.  This is down from 89% in 1980 as an increasing share of wages are being paid to the very well off (those with wages above the ceiling).  If one were to tax 100% of wages rather than only the current 83%, one would in fact obtain the funds needed, as that alone would provide an increase of over 20% (100/83 = 1.205).

But broadening the base should not stop at simply ensuring the taxes paying for Social Security are paid by all wage earners equally, rich and poor.  There is no economic rationale why only wage income should be taxed for this purpose, and not also income from wealth.  And income from wealth is primarily earned by the wealthy.

Using figures from the National Income and Product (GDP) accounts, total private income (including not just wages, but also income from interest, dividends, rents, and so on, but excluding government transfers) in 2014 was 65% more than just wages alone.  (Note that while these income concepts from the GDP accounts are not the same as the income concepts defined in the income tax code, they suffice for the illustrative purposes here.)  A uniform tax rate of 7.5% rather than 12.4% (12.4/7.5 = 1.65), but on all forms of income and not just wage income, would thus suffice to generate the Social Security tax revenues to fund fully the Trust Fund for the foreseeable future.

But one important proviso should be noted.  Such tax rates (of either 12.4% on all wage income, or 7.5% on all forms of private income) would generate the revenues required to fully fund the system based on current benefit payment projections.  However, with benefit payments tied to one’s history of tax payments, one would also need to change the benefit payment formulae to reflect the broader tax base.  Otherwise the benefits due would also change to reflect the higher amounts paid in.

Finally, as noted above, current Social Security benefit payments are low and really need to be increased.  While I do not have the data and models that would be required to work out fully some specific proposal, the figures here can give us a sense of what is possible. For example, a possible balance might be to broaden the tax base to include all forms of income, but then to reduce the tax rate on this not all the way from 12.4% to 7.5%, but rather to the halfway point of 10%.  But this 10% rate would then suffice to permit a one-third increase in overall benefits (10/7.5 = 1.333), which one should want also to concentrate on those of low to moderate income.  The overall tax rate would be cut, but in broadening the tax base to all forms of income one could support a significant increase in benefits.  Overall taxes paid would be higher (everything has to add up, of course), and while low and moderate income earners would mostly see a reduction in the taxes they owe, richer individuals would pay more.

3)  Require that 401(k) plan administration fees are paid for by the entity choosing the provider:  Turning from Social Security to private pension plans, where defined contribution plans (401(k) plans and similar) are now the norm, the key issue is to keep fees low.  Unfortunately they are extremely high, and take away a large share of the investment returns on the funds saved.

One cause of this is that the fees being received by the financial advisors are often hidden in various ways, and charged in different ways by different entities.  There is no standard, and average levels are not made publicly available to provide a basis for comparison. The fees charged will also vary sharply depending on the type of investment product being used (i.e. direct equities, mutual funds of different types, insurance products including annuities, various complex products, and more).  Finally, while individual fees might sometimes appear to be low, they are imposed at several layers in the investment process, and in total come to very high levels.  Not surprisingly, according to one survey 93% of the respondents dramatically underestimated what their cumulative 401(k) fees will come to.

Estimates for what the average fees in fact now are vary.  At the base will be the fees charged by a plan administrator, chosen by the firm of the employee and responsible for the record keeping, for allocating the investments as chosen by the plan participant, and so on. These fees will vary depending on the size of the firm and the deal negotiated on behalf of the employee, but one set of estimates are that these fees average 0.5% of plan assets annually in large firms (plan sizes of $100 million or more), 0.9% in medium size firms (plan assets of $10 million to $100 million) and 1.4% in small firms (plan assets of less than $10 million).

On top of these base administrative fees one will then have to pay the fees charged by the investment vehicles themselves.  Mutual funds are perhaps most common, and the expense fees on these (normally subtracted from the investment returns, so the amount being paid will not be obvious) average about 1.1%.  But they can range widely, from less than 0.1% for standard index funds, to over 2%.  On top of this, one has the cost of buying and selling the investments (whether mutual funds or equities or the other products), which some estimate may average 1.0%.  But these too can vary widely.

Finally, one may have individual fees on top of these all, which depend on the services being requested (whether investment advice, or entry and exit fees, or loan advances against balances in the worker’s pension accounts, and more).  These will vary widely, but one estimate is that the median might be an annual cost of about 0.7% of assets.

The total amount lost in fees each year can therefore easily be in the range of 2 to 3% of assets, and 2.5% is a commonly taken average.  Note also that these fees (or at least most of them) will be taken by the financial managers regardless of whether the investments perform well in any given year.

Over time, these fees will take for the financial administrators a large share of the investment returns that were intended for worker retirement.  A simple spreadsheet calculation, for example, will show that over a 40 year time horizon, where (for simplicity) equal amounts are set aside each year for retirement, with an assumed 5% real rate of return but financial fees of 2.5% a year, the financial cost will have taken away by the 40th year 45% of what would otherwise be the balance saved.  (It will not equal 50% because of the way compounding works.)  This is 90 times the total fees that would be charged by Social Security for the old-age support it provides, which as noted above is only 0.5% of benefits paid out.  Note that I am not arguing that the private fees should be the same as what the cost is for Social Security to administer the accounts.  Social Security is an extremely efficient system.  The specific share taken by financial fees will also depend, of course, on what is assumed for the rate of return and other parameters. But anything like 90 times as much is a lot.

Furthermore, many of the fees being charged on the private pension accounts will continue into the retirement years, so the final amount paid out in benefits will be even less.  Assuming there will be 20 years of retirement following the 40 years of work, with returns and fees continuing as before, the annual amount that could be paid out to the worker in retirement will be only 44% of what would be paid out if the fees were at the 0.5% (of benefits only) of Social Security, a reduction of 56%!

Fees are therefore hugely important, but the worker can manage (through the decisions they make) only some of them.  In particular, the basic plan administration fees for managing the accounts are made at the firm level.  When firms had defined benefit pension plans, these costs were included in what the firm covered.  They kept track of, or contracted out to some specialist, the individual payment obligations and other bookkeeping.  But when firms switched to defined contribution schemes, most commonly 401(k)s, the firms chose to incorporate the costs of the plan administration into charges against the individual account balances, thus shifting these on to the workers.  But the workers had no choice between plan administrators:  They were chosen by the firm.  And with the firm not bearing the cost, the firm might not worry so much about what the cost was.  Rather, they might choose a plan administrator based on how good they were at making sales pitches, or whether they did other work for the firm where they might extend a discount, or based on who provided the fanciest annual conferences for their clients (the decision maker in the firm) at some resort in Hawaii.

Some firms of course make a sincere effort to choose the best balance between plan administrator cost and performance, but others do not.  But to resolve this, a simple reform would be to require that firms pay the cost of plan administration directly from the firm’s accounts, and not out of the pension savings of the workers.  This would return to what had normally been done with the traditional defined contribution pension plans, where firms had an incentive to ensure plan administration costs were kept low.

4)  Require low cost investment options be included in 401(k) and similar schemes:  One can also keep financial fees down by investing in low cost investment options, such as simple and standard index funds.  The Vanguard S&P 500 Index Fund, and now even the Vanguard Total Stock Market Index Fund, each charge an annual expense fee of just 0.05%.  This is far below the 1 to 2% charged by most managed mutual funds.

Such low cost options are included in many 401(k) plans, but unfortunately not all.  Such options should be required in all.

5)  Provide an option of investing in “Social Security Supplemental Accounts”:  One very low cost investment option would be to invest a portion of one’s 401(k), IRA, and similar balances, into a supplemental account managed by Social Security, which would then be paid out along with one’s regular Social Security checks.  Accounts would earn a return equal to the long-term US Treasury bond rate, the same as existing Social Security balances do now.  The option would take advantage of the extremely high efficiency of the Social Security Administration.

With the far lower cost of Social Security relative to what private financial institutions in the US charge, the net return on such investments would be attractive.  Given historical long term bond interest rates and the differences in fees, the returns would be comparable to what might be earned in pure equity investments, but far less volatile.  And the returns would be far better than what on average has been earned in actual 401(k) and IRA accounts, given how they have historically been managed.

The Social Security Supplemental Account would be purely voluntary.  No one would be forced to put a share of their 401(k) or IRA assets into them.  But this would be an attractive option for at least a share of the plan assets, earning a comparable return (after fees) but with far less risk.  It would be especially attractive to middle class families who may have significant but not huge assets in their retirement accounts, who are seeking to ensure a safe retirement.

F.  Conclusion

The returns to economic growth have become horribly skewed since Reagan took office, but there is much that could be done to address it.  This blog post has discussed a number of actions that could be taken, and if the Republican (and Democratic) candidates are truly concerned about the direction of income inequality, there is no shortage of measures to consider.  And this is not an all or nothing set of actions:  While complementary and mutually reinforcing, taking some actions is better than none, and more is better than some.  Nor are they in general administratively difficult to do.  Most are straightforward.

But action is clearly needed.


Part Time Workers and the Affordable Care Act: A Proposal to Address the Real Issue

Part Time Workers as Share of Total Employed, Dec 2007 to Dec 2014

A.  Introduction

The Affordable Care Act (ACA, and also often referred to as ObamaCare) has been working well by any objective measure.  There are now more than 10 million additional Americans who have health insurance who could not get affordable health care before; the share of the uninsured in the US population is now a quarter less than what it was before the individual mandate of the Affordable Care Act went into effect; and this has been achieved at premium rates for the new plans that are reasonable and well less than opponents charged they would be.  Health care costs have also stabilized under Obama, both as a share of GDP and in terms of health prices relative to overall prices, in contrast to the relentless increases in both before.  And while some have criticized this, it is good that there are now minimum quality and coverage standards in health insurance plans.  Such standards are good in themselves.  And without such standards, purported health care “plans” which offer next to nothing (due, for example, to extremely high deductibles) and which can then cost next to nothing, would lead to a death spiral for genuine health care plans that cover costs when you are sick and need treatment.

Gains from the ACA are also reflected in the findings of a recently published report from The Commonwealth Fund.  The Commonwealth Fund has been organizing a periodic survey on health care coverage since 2001.  The most recent survey (for 2014) found that for the first time since the question was first asked in 2003, there was a reduction in the number of Americans avoiding (because of cost) health care services that they needed.  And for the first time since the question was first asked in 2005, the number reporting medical bill or debt problems also fell.  Personal financial distress due to medical problems has been reduced, due to greater access to health insurance and due to health insurance plans that now meet minimum standards.

Despite this (but not surprisingly given the position they staked out against the reform), the Republican Congress continues to vote to repeal, or at least weaken, the law.  The most recent vote was aimed at the provision in the Act which complements the individual mandate to purchase health insurance, with an employer mandate requiring firms with 100 full time equivalent employees or more from January 1 of this year (and with 50 or more from January 1, 2016) to offer health insurance to their full time employees or pay a fee.  The proposed Republican bill would change the definition of a full time worker from one who normally works 30 hours or more a week, to one who works 40 hours or more a week.

The supporters of the change charge that the prospect that employers (with 50 or 100 employees or more) will soon be required to offer health insurance to their full time employees has led firms to cut working hours of their employees, to shift them from full time to part time status, and hence avoid the employer mandate of the ACA.  As a Republican congressman from Texas said:  “We have heard story after story from every state in the union that employers are dropping workers’ hours from less than 39 hours a week to perhaps less than 29.”

This accusation is confused on several levels.  This post will first look at whether there is in fact any evidence that workers are being shifted from full time to part time status as a result of the ACA (or indeed for any other reason).  The answer is no, at least at the level of the overall economy.  Second, there has been a good deal of confusion in the discussion on what the issue really is with regard to part time workers, including by prominent congressmen such as Paul Ryan.  Either Ryan does not understand what the employer mandate is, or if he does, then he has deliberately mischaracterized it.

The public discussion has also avoided altogether the real issue.  It is not that firms with 50 workers or more would be required to offer health insurance to their employees (most do already), but that this insurance is only made available to their full time workers.  Part time workers get nothing, no matter what size firm they work at.  The final section of this blog post will discuss a way to resolve this equitably.

B.  What is the Evidence on Whether the ACA Has Increased the Ranks of Part Time Workers?

The opponents of ObamaCare assert that as a result of the employer mandate, firms have been shifting workers from full time to part time status.  E.g., instead of employing one worker for 40 hours, they are choosing to employ two workers for 20 hours each.  If true, the ratio of part time workers to the total employed will rise.

The chart at the top of this post shows this has not been the case.  It is based on data from the Bureau of Labor Statistics, from its Current Population Survey.  This monthly survey of households is used to determine the unemployment rate among other statistics.  The households surveyed are asked whether household members are employed full time or part time (if employed), and if part time, whether this is by choice (because they only want to work part time) or because they want a full time job but cannot find one.  The chart above shows the ratio of workers who are working part time not by choice but for economic reasons, to all workers employed.  Note that the BLS data defines a part time worker as one with fewer than 35 hours of work per week.  While this differs from the 30 hour standard in the ACA, as well as the 40 hour standard in the recently passed Republican legislation, the results in terms of the trends should be similar.  The BLS does not publish data with a different cutoff in terms of hours per week for what is considered part time work.

As in any economic downturn, the ratio rose rapidly in the economic collapse of the last year of the Bush administration.  Regular jobs were disappearing, with some of them shifting to part time status.  Indeed, the absolute number of part time jobs was increasing at the time, even as the total number of jobs was falling, thus leading to two reasons for the ratio to rise, and rise rapidly.

The ratio reached a peak soon after Obama took office, and began to fall about a year later.  Since then it has fallen at a fairly steady pace in terms of the trend.  There were sometimes relatively sharp month to month fluctuations in the data, but this can be on account of statistical noise.  The data comes from a limited sample of households, with only 5 to 6% or so of those employed on part time status (for economic reasons) for most of this period, so the statistical noise in a relative sense (month to month) will be large.  But the downward trend over time is clear, and at a similar downward pace for close to five years now.

What one does not see is any shift in this downward trend linked either to the signing of the Affordable Care Act in March 2010, or to the start of the individual health insurance mandate in January 2014, or to the anticipation of the start of the employer health insurance mandate in January 2015.  Note that since the classification of a worker as a full time or part time worker (and hence the classification of the firm as crossing the 100 or 50 full time worker standard) will be in a period of up to 12 months before the employer mandate goes into effect, one would have seen an impact in 2014 if the 2015 mandate mattered.  There is no indication of this.

The data cover the overall economy.  The figures refer to millions of workers as well as millions of employers.  The US is a large place.  Within such a large place, it will undoubtedly be possible to find particular cases where employers will say that they reduced worker hours to part time status so that they could avoid the health insurance employer mandate.  And one could indeed probably find a long list of firms making such statements.  It would be even easier to find a long list of firms and other entities where working hours were cut, whether or not there was any employer mandate pending.  In a dynamic economy, there will always be a large number of such cases (along with a large number of cases of firms going in the opposite direction, converting part time jobs to full time jobs).

Such anecdotal information, and even a long list of such anecdotes, is not evidence of an issue of substantial scale.  As seen above, there is no evidence of it in the overall numbers.  But one should still recognize that the issue could exist in particular cases.  The question, however, is what is the real issue here, and if there is one, how can it be addressed.

C.  What the Employer Health Insurance Mandate Says

For better or worse, the US health care insurance system is built around health plans normally provided to workers through their place of employment, as part of their overall wage compensation package.  The system began during World War II and has expanded since, supported through substantial tax advantages.  By now, health insurance provision is close to universal among large employers, but substantially less so among small private firms:

Share of Private Firms Offering Health Insurance – 2013
< 10 employees 28.0%
10 to 24 employees 55.3%
25 to 99 employees 77.2%
100 to 999 employees 93.4%
≥ 1000 employees 99.3%
< 50 employees 34.8%
≥ 50 employees 95.7%
All private employees 84.9%
Source:  MEPS, Tables I.A.2 and I.B.2 (2013)

Overall, 84.9% of private sector employees are in firms that offer health insurance as part of their wage packages.  And 96% of firms with more than just 50 employees offer health insurance.

The Affordable Care Act built on this and did not replace it.  Liberals (including myself) would have preferred moving to a system where Medicare would be extended to cover the entire population rather than just those over age 65.  Medicare is an efficient and well managed program, and as an earlier post in this blog discussed, its administrative expenses come to only 2.1% of the benefits paid.  In contrast, administrative costs (including profits) of private health insurance are seven times higher at 14.0% of benefits paid, and an even higher 18.6% of benefits paid in the privately administered Medicare Advantage plans.

But Obama agreed instead to support an approach first proposed by the conservative Heritage Foundation, which was then put forward by Republicans in Congress as their alternative to the health reforms proposed by the Clinton administration (coming out of the task force Hillary Clinton chaired), and which was later adopted in Massachusetts when Mitt Romney was governor.  These plans were built around keeping the existing employer-based provision of health insurance for most of those employed, but to complement this with markets where individuals could purchase health insurance directly if they did not have employer-based coverage, coupled with an individual mandate to buy such health insurance.  The individual mandate is necessary to counter what would otherwise be a resulting death spiral of health insurance plans if everyone is granted access (including those with pre-existing conditions) but only the sick then purchased health insurance (for a description and discussion, see this earlier Econ 101 blog post).

It was not unreasonable to believe that the Republicans would not oppose a plan whose origins lies in their own earlier proposals, but that was not to be.

As noted, the individual mandate is necessary to avoid death spirals in health insurance plans for individuals.  Complementing this, an employer mandate to offer health insurance to their employees is necessary to counter what could otherwise be a “race to the bottom”.  If certain firms did not support such health insurance for their employees, thus reducing the cost to them of their workers, they could undercut competitors who did provide good health insurance support.  It could lead to a race to the bottom.  While not yet widespread in the US, especially for larger firms (see the table above), there has been increasing competitive pressure in the US over the last couple of decades to cut such health insurance support.  An increasing number of employers have done so.

Thus the ACA includes an employer mandate to complement the individual mandate.  However, while the individual mandate went into effect on January 1, 2014, the employer mandate has been twice delayed, and has now (as of January 1, 2015) gone into effect for firms employing 100 of more full time equivalent employees, and will go into effect on January 1, 2016, for firms employing 50 or more full time equivalent employees.  It is this provision that the Republicans in Congress are now trying to subvert.

The charge by Paul Ryan and others has been that medium to small size firms have been cutting the hours of their employees to shift the workers from a full-time classification to a part-time one.  The aim, they say, has been to reduce the number of their full time workers to below 50 so as to avoid the employer mandate.  For example, in a recent opinion piece published in USA Today, Congressman Ryan wrote:  “The law requires employers with more than 50 full-time employees to give them health insurance.  But because the law defines “full time” as 30 hours or more, employers are keeping employees below that threshold to avoid the mandate entirely.”

However, that is not what the law says.  Precisely to avoid such an incentive, the boundaries on the size of a firm subject to the employer mandate is defined in terms of full time equivalent workers (whether 50 or 100).  That is, if a job is split from one full time worker to two half time workers, the number of full time equivalent workers is unchanged.  The two half time workers count as one full time worker for the purposes of the statute.  Cutting back on the number of hours of individual workers to make them part time will not change the status of the firm when the total hours of labor to produce whatever the firm is producing remains unchanged.  And it would be foolish for a firm to produce and sell less when the demand exists for such sales, simply to avoid this mandate.

There is, however, a critically important issue here which Ryan and his colleagues have not discussed.  While splitting jobs of full time workers into multiple part time jobs will not change the status of the firm on whether it is subject to the employer mandate, shifting workers from full time to part time status does affect whether the firm would be required to include health insurance as part of their wage compensation package.  Firms subject to the mandate must offer an affordable health insurance plan available to at least 95% of full time (not full time equivalent) workers, or pay a fee.  The fee (of up to $2,000 per year per worker, less 30 workers per firm) is designed to partially offset (and only very partially offset) the cost of health insurance that they are shifting to others.

But such health insurance typically only is provided to full time workers.  This is true even for giant corporations.  Hence a firm can avoid making health insurance available to its workers by shifting them from full time to part time status.  This has always been the case, and is indeed a problem.

The Affordable Care Act addresses the issue only partially and tangentially.  By including a definition of what constitutes full time work at 30 hours a week or more, the ACA reduces the incentive to shift workers from the traditional 40 hours per week for full time work, to just under 40 hours in order to avoid providing health insurance cover.  A firm would need to cut a normal worker’s hours to below 30 hours per week to avoid providing health insurance, and is unlikely to do that for its regular work force.  But by moving the dividing line up to 40 hours per week, as the Republican legislation passed on January 8 would do, one opens up a loophole for firms to reduce worker hours from 40 to say 39 per week (or 39 1/2 or even 39.99 I would suppose).  Firms would be able easily to avoid offering health insurance to what are in reality their regular, full time, workers; use this to undercut competitors who do offer such insurance; and thus spark a race to the bottom on health insurance coverage in those industries.

D.  Addressing the Problem of Health Insurance for Part Time Workers

As noted above, the ACA does not do much to address the problem of part time workers receiving nothing from their employers for the health insurance everyone needs.  Setting the floor at 30 hours per week helps by ensuring workers close to the traditional 40 hour workweek will receive an employer contribution to their health insurance, and avoids the incentive to shift workers from 40 hours per week to just a bit below.  But part time workers of less than 30 hours per week will still normally receive nothing from their employer to help cover their health insurance.  And it creates an incentive for employers to structure positions as two workers at 20 hours per week, say, than one at 40.  While whether or not the firm was subject to the employer mandate would not be affected (since it is expressed in terms of full time equivalent workers), whether or not the firms would need to provide anything in terms of health insurance would be affected.

But there is a way to address this, now that the individual health insurance marketplaces are operational under the ACA.  All firms could be required to contribute an amount for their part time workers proportional to the hours of such part time work to what full time work would be.  That is, if two workers are each working half time, the firm would contribute an amount of 50% (for each) of the cost of the employer contribution to the health insurance for one full time worker.  The total cost would be the same whether the firm employed one full time or two half time workers.  There would also then not be an incentive to split jobs from full time workers to multiple part time workers.

The employer contribution to the part time worker’s health insurance costs would then be paid, along with taxes such as for Social Security or Medicare, to the government in the name of the specific part time worker.  These funds would then be used as a partial pay down of the costs of that worker purchasing health insurance on the individual health insurance market exchanges set up under the ACA.  And while other splits could be considered, I would recommend that those funds would be split half and half between what the worker would need to pay on the exchange for his or her health plan, and what the government subsidy would provide.

A simple numerical example may help clarify this.  Using made up numbers, suppose the full monthly cost of a standard (Silver level) health insurance plan on the individual exchange where the worker resides is $400.  Assume also that at the current income level of this (part time) worker, the government subsidy for such insurance would be $200 per month, while the worker would pay $200 per month.  Now assume that firms would be required to pay proportional shares of what they provide to full time workers for their health insurance, and that this would come to $100 per month for this part time worker.  This would be split half and half between what the government subsidy would be and what the worker would pay, so under the new approach the government would provide $150, the worker would pay $150, and the funds coming from the firm would cover $100, summing to the $400 total cost.

A few specifics to note:  Many part time workers hold down multiple jobs.  They would receive for their “account” the total proportional amounts from all of their employers.  Many part time workers are also part of married couples.  There could be a household account into which all the sums were paid (for each family member), which could be used to purchase a family health plan on the exchanges.  In the event that the family was not purchasing insurance through the exchange (perhaps, for example, because the spouse worked at a firm providing family coverage), the amount paid by the firm for the part time worker would be returned to the firm (or canceled from the start).

And if the total amounts paid in from the full set of employers for that individual (or family) led to the government subsidy falling all the way to zero, any excess would be allocated to what the individual would pay for the insurance.  This could be common in cases where the family income of the part time worker was close to, or above, the income limit on which government subsidies are provided.

It is only with the advent of the individual health insurance exchanges that this method for covering part time workers became possible.  Previously, firms were not in a position to purchase half of an insurance policy for a half time worker.  But now they can contribute an amount equal to half the cost, with this then used to help purchase coverage on the individual marketplace exchanges.

Note also that with this reform, it would matter less whether full time work was defined as 30 hours per week or 40 hours per week or whatever.  I would recommend keeping the 30 hour per week boundary as it would be a factor in determining what the employer contribution would be.  But it would not be as critical as now, where the boundary determines whether 100% of the employer share of the health insurance cost is paid or 0% is paid.  There would be a smooth transition (a worker of 39 hours when 40 hours is defined as the standard would still receive 39/40 of the payment, and not zero), without a drop straight to zero.

There would also be no reason to limit this extension of the employer mandate only to firms with 50 (or 100) or more full time equivalent workers.  All firms should make such a contribution to covering the cost of their workers’ health insurance needs, just as they all make a contribution to Social Security and Medicare taxes.  Indeed firms of whatever size (although this will soon apply only to firms with less than 50 full time equivalent workers) that do not have any health insurance plan for their staff should participate.  The amounts paid could be set as a proportion to the cost of the medium Silver level plan available on the individual health insurance exchanges in their area.

Undoubtedly, there will be assertions by the Republicans that requiring such a contribution to health insurance costs for their part time workers will lead to an end to such jobs.  This would be similar to the arguments they have made that raising the minimum wage will lead to higher unemployment of lower paid workers, and arguments that were made earlier that paying Social Security taxes would lead to higher unemployment.  But as was discussed in an earlier blog post, there is no evidence that increases in the minimum wage in the magnitudes that have been discussed have led to such higher unemployment.  Ensuring firms contribute proportionally to the health insurance costs of their part time workers would not either.

The Kansas Red State Experiment is Failing: Drastic Tax Cuts Have Not Led to Higher Employment Growth

State Employment Growth Relative to US, Kansas and others, Jan 2011 to Aug 2014

A.  Introduction

Republican Sam Brownback was elected governor of Kansas in 2010 and is now running for re-election.  An extreme Tea Party conservative, he has pursued a radically right-wing agenda in Kansas with little constraint from a Republican controlled state legislature (especially after he led a successful effort to purge relative moderates from his party by more extreme conservatives in the 2012 primaries).

Central to his program were drastic tax cuts enacted in 2012, with a further round of cuts in 2013.  They were one of the largest tax cuts ever enacted by a state in percentage terms, and were labeled by Brownback to be a “real live experiment” of the conservative vision of small government leading to fast growth.  The tax cuts would be like a “shot of adrenaline into the heart of the Kansas economy” he asserted, employment would boom, and the faster growth would lead to greater total tax revenues generated (despite the lower rates) due to a then larger economy.

But it has not happened.  Employment in Kansas has fallen relative to the rest of the US since Brownback took office.  This post will first describe in more detail the tax cut measures, and will then look at the impact on employment.

B.  The Brownback Tax Cuts

The tax cut measures have (so far) come in two major waves.  The first were passed in early 2012 and signed into law by Brownback in May 2012.  The second were passed and signed in mid 2013.  The first were the more important, and included:

a)  Cuts in personal income tax rates, especially for those in the higher brackets:

Income Bracket Old Rate New Rate % change
>$60,000 6.45% 4.90% -24.0%
$30,000 – $60,000 6.25% 4.90% -21.6%
<$30,000 3.50% 3.00% -14.3%

b)  Elimination of state business taxes for most companies in Kansas.  This covered over 200,000 firms in the state, and while purportedly aimed only to benefit small businesses, the definition included at least several of the subsidiaries of Koch Industries (owned by the multi-billionaire Koch brothers, which is based in Kansas and which has provided strong financial support to the campaigns of Brownback and other Tea Party favorites).  No other state has eliminated such taxes.

c)  And partially offsetting the personal income tax cuts, the state sales tax rate was raised.  Such a tax increase affects the poorest the most.

Tax rates were then cut further in 2013.  Among other measures, the rate for the top personal income tax bracket is being phased down from the 4.9% of the 2012 law to just 3.9% by 2018, a cut of over 20%.

The Institute on Taxation & Economic Policy along with the Center on Budget and Policy Priorities has calculated the impact of these tax changes by household income category.  They are hugely regressive.  The figure below (calculated from the ITEP and CBPP figures) shows the impact as a percentage of taxes previously due.  While the combined effect of the tax changes will lead to a 37% reduction in taxes due for the richest 1% in Kansas (whose average household income in 2010 was $1.025 million), the poorest 20% have seen their taxes go up by 14%:

Impact of Kansas 2012 and 2013 Tax Cuts by Income Category

And the regressive tax cuts came on top of a system that already taxes the poor more than the rich.  The poorest 20% will now be paying close to 11% of their income in state and local taxes in Kansas.  Those in the middle (between the 20th to the 80th percentiles) will be paying between 8 and 9%.  But the richest 1% will be paying less than 4%.

The tax cuts have not, however, led to an increase in government revenues.  As will be discussed below, employment has not gone up as a result of the cuts.  Rather, tax cuts have led to cuts in tax revenues received.  While most of us would find this not at all surprising, Brownback was advised by Arthur Laffer, famous for the so-called Laffer Curve, which posits that tax cuts will lead to such an increase in employment and income that tax revenues will rise despite the lower rates.  It has not happened.

A recent report from the Rockefeller Institute of Government found that state tax revenues in Kansas between the second quarter (April to June) of 2013 and the second quarter of 2014 fell by 22% in total, and fell by 43% for the state personal income tax only.  These reductions were larger than in any of the other 50 states.  The 2012 tax cuts went into effect as of January 1, 2013, and the taxes collected in the second quarter of that year will then mostly reflect what was due on incomes earned in 2012.  The reduction in revenues due and collected in the second quarter of 2014 (primarily on incomes earned in 2013) will then represent the first year impact of the 2012 law.

The reduction in tax revenues generated as a consequence of the sharp tax rate cuts should surprise few.  The non-partisan Legislative Research Department of the Kansas state legislature has estimated that, as a consequence of the tax cuts, state revenues will fall by an estimated $730 million in FY14, and by a cumulative $5.2 billion by FY18.  These are large amounts for a small state.  The predictable result has been sharp cuts in the government budget.  Much of this has been borne by education, which is close to inevitable simply because it constitutes such a large share of the state budget.  State funding for K to 12 education has been cut by over 15% during Brownback’s term in office, and he has proposed another 2% cut for FY2015.

Despite such expenditure cuts, the state budgetary situation is now precarious.  This has led to cuts in Kansas government bond ratings by Moody’s and S&P.  It will now be more expensive for Kansas to borrow for public investment and other needs.

C.  Impact on Kansas Employment

Governor Brownback claimed that the massive tax cuts would lead to a boom in Kansas employment.  The chart at the top of this post shows that relative to the United States as a whole, as well as relative to such Democratically controlled states as Colorado, California, Minnesota, and Massachusetts, Kansas has lagged since Brownback was inaugurated (in January 2011).  The data is from the Bureau of Labor Statistics.  The states chosen reflect two near-by states to Kansas with important agricultural sectors and with also Democratic control of the state political machinery (Democratic governors as well as Democratic majorities in both chambers of the state legislatures:  Colorado and Minnesota), and two normally Democratic states from the two coasts who are often charged as having especially high state tax rates (California and Massachusetts)

The chart shows what has happened to employment in each state expressed as a share of total US employment, normalized so that the January 2011 shares are all set to 100.  Thus it will show whether employment in the state grew at a faster, or a slower, pace than overall employment in the US.  The share will go up if employment in the state grows at a faster pace than in the US as a whole, and the share will go down if employment in the state grows more slowly.

Kansas has not performed well.  Its share in US employment has fallen, and more or less consistently fallen, since Brownback took office.  There is no indication that the massive tax cuts, passed into law in May 2012 and expected well before, have led to employers shifting to the state or expanding there.  In contrast, the Blue States of Colorado and California have done especially well, while the Blue States of Minnesota and Massachusetts have seen employment grow at roughly the same pace as the US as a whole.

D.  What This Does and Does Not Say

There is thus no evidence that the massive tax cuts Brownback was able to have enacted have led to the boom in employment he asserted would follow.  It was not a “shot of adrenaline into the heart”, as he asserted it would be.  But it is also important to be clear on what the evidence we have so far does not say:

a)  First, while there is no evidence that the tax cuts led to a boom in employment, there is also no clear evidence that the tax cuts led (at least so far) to major reductions in employment.  Rather, employment in Kansas has trended steadily downwards over this period relative to the rest of the country, with the tax cuts having little effect one way or the other.  State level employment depends on many things, and the state tax regime does not appear to be a terribly important one.  What matters more will likely be state structural issues, such as the mix of particular industries in the state (including agriculture), the age distribution of the population in the state, the mix of high skilled vs. low skilled workers in the state, and so on.

b)  While Kansas performed poorly relative to the other states depicted in the chart above, there were fifteen states that did even more poorly than Kansas over this period.  Overall US employment grew by 6.4% over this period as a whole (1.75% at an annualized rate), while employment in Kansas grew by only 3.7% (1.0% annualized).  But of the 50 states, employment growth was worst in Alaska, with growth of only 1.6% over the period (0.4% annualized).  As noted above, state specific structural issues will matter.

c)  Finally, one should recognize that the period so far has been short.  While Brownback can clearly no longer claim that there will be an immediate or even near-term positive impact on employment, he is (not surprisingly) now claiming that it will take more time.  One can of course not disprove this until more time has passed, but the question is how long does one need before one recognizes the failure.  But we do know that the tax cuts have devastated state finances, leading to the rating downgrades and to budget cuts that are slashing expenditures in important areas such as education.  There is good reason to expect that such cuts in education will have adverse impacts on employment in the longer term.  When the current generation of students graduate, a larger share will not have the level of skills required for good jobs, if any jobs.  Potential employers will shun a state where they cannot hire staff with the skills they need.  I would wager that the long term impact will be negative, not positive.

But what one can say now with confidence is that the evidence is clear that massive tax cuts of this Red State “experiment” have not led to a near term boom in jobs.  It is also clear that such tax cuts do lead to cuts, not increases, in tax revenues.  The experiment has failed to fulfill the claims originally set out for it.

The (Lack of) Recovery in the Employment to Population Ratio: Not the Concern It Might Appear to Be

Employment to Population Ratios, Jan 2007 to July 2014

Unemployment Rates, Ages 25 to 54, Jan 2007 to July 2014A.  Introduction

A critically important policy question is how close the US economy now is to full employment.  The unemployment rate has been falling, albeit slowly, from a peak of 10.0% in October 2009, to a current 6.2% as of mid-July (ticking up from 6.1% in June, but a 0.1% change is not statistically significant).  That is, the unemployment rate has come down by a bit less than 4% points from its peak.

However, some have noted that one does not see such a recovery if one focusses on the employment to population ratio.  Excellent analysts, such as Paul Krugman and Brad DeLong, have argued that one should.  If the unemployment rate has come down by close to 4% points, then the employment to population ratio should have gone by almost the same in percentage points unless people are dropping out of the labor force.  [It will not go up by exactly the same amount in percentage points since the base for the employment to population ratio is population while the unemployment rate is expressed as a share of the labor force.  But, all else equal, they will be close.  One could make the relationship exact by expressing the unemployment rate in terms of the share of population rather than share of the labor force, but this is not how the unemployment rate is normally reported.]

If the employment to population rate has not recovered by the same amount (in percentage points) as the unemployment rate has, then by arithmetic this is only possible if the labor force participation rate has come down.  The concern is that the pool of unemployed is coming down not because people are finding jobs (which would then be seen in a rising employment to population ratio), but rather because they are dropping out of the labor force after trying, but failing, to find a decent job (thus lowering the labor force participation rate).

There are of course demographic factors as well to take into account to explain what might be happening to the labor force participation rate, in particular the increasing share of the baby boom generation that is reaching normal retirement age.  One way to do this is to focus the analysis on the prime working age group of those aged 25 to 54 only.  All the charts in this post therefore do this.  But even with this refinement, the apparent concern remains:  The employment to population ratio does not show the same recovery that one sees in the falling unemployment rate.  What is going on?

B.  Recent Years

The chart at the top of this post shows the employment to population ratios from January 2007 to July 2014, for those aged 25 to 54, and for everyone together as well as for males and females separately.  The chart below it shows the unemployment rates for these same groups.  The data all come from the Bureau of Labor Statistics.  The peak unemployment rate was hit in October 2009, after which there was a fairly steady recovery.  [The month to month fluctuations mostly reflect statistical noise.  The employment, unemployment, and labor force participation figures are all based on surveys of households, and there will be statistical noise in any such surveys.]

For the group as a whole (male and female), the unemployment rate for those aged 25 to 54 rose by about 5% points between late 2007 / early 2008 and its peak in October 2009.  Over this period the employment to population ratio fell by a similar 5% points.

But this relationship then broke down going forward.  Over the two years between October 2009 and October 2011, for example, the unemployment rate for those aged 25 to 54 fell by 1.1 percentage points, dropping to 7.9% from 9.0% at the peak (for this age group).  But the employment to population ratio hardly moved.  And between October 2009 and the most recent figures (for July 2014), the unemployment rate came down 3.8% points, while the employment to population ratio rose by only 1.6% points.

The question for policy makers is whether the 3.8% fall in the unemployment rate is a reasonable measure of how far the economy has recovered from the 2008 collapse, or the 1.6% recovery in the employment to population ratio is.  As noted above, both the unemployment rate and the employment to population ratio deteriorated by 5% points during the 2008 collapse and follow-on into 2009.  If the 3.8% recovery in the unemployment rate is the right indicator, then we would have retraced about three-quarters of the fall (3.8/5.0 = 0.76).  But if the 1.6% recovery in the employment to population ratio is the right indicator, then we are less than one-third of the way (1.6/5.0 = .32) back.  This is a huge difference.

Since the difference between the two measures must be reflected, by arithmetic, in a declining labor force participation rate, one needs to look there to see what is going on.  For the January 2007 to July 2014 period, the picture is:

Labor Force Participation Rates, Jan 2007 to July 2014

The rates are all falling after October 2009, for males and females, and hence for the two combined.  What is interesting is that they appear to be falling at a fairly steady pace throughout the period (aside from the month to month squiggles that are mostly statistical noise).  And for males, the rate appears to be falling at a broadly similar pace before October 2009.  The trend is not so clear for females before October 2009, whose rate may have been rising until a few months before October 2009.  This then leads to little change in the overall rate for males and females combined, but the period is so short that the trends are not clear.

C.  A Longer Term Perspective

When one then takes a longer view, the trends do become clear:

Labor Force Participation Rates, Jan 1948 to July 2014

Going back to 1948 (the first year in the BLS series for all these labor market indicators), one sees a pretty steady fall in the labor force participation rate for males from around the mid-1950s (with the squiggles in the curves due to statistical noise), and a strong rise in the female labor force participation rate from the initial year with data (1948) to around 2000.  There was some acceleration in the rise for females in the 1970s, and then a deceleration from the early 1990s, leading to a leveling off around 2000.  Since then, the labor force participation rate for females has fallen, on a path that appears to parallel the similar fall in the rate for males, but at 14 to 15% points lower.

The data are consistent with the broader socio-economic story we have of the labor market in the post-World War II period.  Male labor force participation rates are quite high, but have fallen some over time.  Female rates started very low but then grew, and grew at an especially rapid rate starting in the 1970s.  Female labor market participation rates then reached maturity and leveled off around 2000, after which the female rates paralleled the downward path of the male rates, but at a certain distance below.

In this longer term perspective, the decline in the labor force participation rates since 2009 therefore does not appear to be unusual, but rather a continuation of the longer term trend.  There have been some small fluctuations around the long term trends in recent years that appear to coincide with the business cycle (in particular for the female rates), but they are small and dominated over time by the long term trends.  There have also been similar fluctuations in the participation rates in the past (such as in the mid-1990s) that did not coincide in the same way with the business cycle, as well as large business cycle changes in the past that did not show such fluctuations (such as during the big downturn in the early 1980s at the start of the Reagan presidency, that did not lead to such fluctuations in the labor force participation rates).

The implication of this analysis is that the reported unemployment rates are a better indicator of the state of the labor market than the employment to population ratio is.  The fall in the labor market participation rates in recent years has not been something new, driven by the 2008 economic downturn, but rather a continuation of the trend seen in these rates over the longer term.

Looking at unemployment rates for this age group going back to 1948 provides a useful perspective on what to expect for it:

Unemployment Rates, Jan 1948 to July 2014

Unemployment rates continue to be high in mid-2014.  Even though they have retraced about three-quarters of the deterioration in 2008/2009 (more for males, less for females), they are, at 5.2% currently (for males and females together) still well above the unemployment rates for this group of about 4% in late 2007 /early 2008, and of only 3 1/2% in late 2006 / early 2007.  And the unemployment rate for this group was only 3.0% in late 2000, at the end of the Clinton years.

There is therefore still a significant distance to go before the economy will have returned to full employment.  But the improvement since October 2009 is substantial, and is real.

D.  Implications of the Long Term Trends for Aggregate GDP

Finally, while the employment to population ratio might not be a good indicator of how much slack there is in the labor market in the short run, there are long term implications of the trends noted above.  Specifically, while the overall labor force participation rate rose steadily from 1948 (the earliest year for which we have this data) to about 2000, this was entirely due to the strong rise in the female rate over this period.  The male rate was falling, steadily but slowly.  Once the female rate peaked in the year 2000 and then began to fall at a rate similar to that for males, the overall rate began to fall.  There is no indication this will be reversed any time soon.  Indeed, the degree to which the female rate is now paralleling the male rate suggests that this really is a “new normal”.

A falling labor force participation rate is not necessarily an indication of something bad in itself.  It might reflect increased prosperity, which is being enjoyed by choosing not to work but to retire early, or to attend university or post-graduate education programs in your 20s, or to stay at home and raise a family.  But to the extent it reflects lack of free choice, such as being fired in your 40s or 50s and then not being able to find a job, or to remain a perpetual student due to lack of job opportunities, or to stay at home due to the unavailability of affordable child care, the implications are different.  But it is well beyond the scope of this blog post to dig into this deeper.

But there will be important long term implications of declining labor force participation rates on long term GDP growth.  With fewer in the labor force, aggregate GDP growth will be less.  Note that this does not imply growth in GDP per capita (or more precisely, GDP per worker) will be less.  GDP per worker is a function of productivity growth.  But with fewer workers than otherwise, aggregate GDP growth will be less.

Two final charts, then, to close this blog post.  The first shows the absolute number of people in the ages 25 to 54 population cohort, who are not in the labor force:

Population Not in Labor Force, Jan 1948 to July 2014

The number of males in this age group not in the labor force has been growing steadily since the late 1960s.  The number of females not in the labor force fell until around 1990, was then flat for a decade, and then began to grow.  Overall, the number aged 25 to 54 not in the labor force started to grow around 1990, and has continued to grow since.

Looking at the numbers of those in the 25 to 54 age group in the labor force:

Labor Force Number, Jan 1948 to July 2014

Due to a growing population in this age group (baby boomers, for example, but others as well), and the growing labor force participation rates of females until 2000, the total labor force in this group rose from the starting year (1948) until 2008.  It grew especially fast in the 1970s, 80s, and 90s.  But the absolute size of the labor force (in the 25 to 54 age group) then started to fall from 2008.  This is a historic change for the US, and based on the fall in labor force participation rates discussed above, as well as slowing population growth, should be expected to continue.  While GDP growth per capita (or per worker) might continue to grow as it has in the past (and it has grown at a remarkably consistent 1.9% a year since 1870 in the US, as discussed in this earlier blog post), one should expect aggregate GDP growth to slow.

E.  Summary and Conclusion

The unemployment rate has fallen substantially since hitting its peak in October 2009, but one does not see a similar recovery in the employment to population ratio.  The labor force participation rate therefore has to have fallen.  However, it does not appear that this fall in the labor force participation rate has been driven by the economic downturn, where high unemployment and poor job prospects led workers to drop out of the labor force on a widespread basis.  Rather it appears largely to be a continuation of longer term trends, that become clear when one separates out the paths for male and female labor force participation rates.

The implication is that the unemployment rate is probably a good indicator of how much slack there is in the labor force.  The unemployment rate has retraced about three-quarters of the rise during the 2008/2009 downturn, but is still high.  And it is substantially higher than what was seen as possible in late 2006 / early 2007, and especially the rate achieved in late 2000.

But there are longer term implications.  The analysis suggests that we should not expect much of a recovery in the labor force participation rate when the economy finally returns to full employment.  Rather, the labor force participation rate is on a downward slope, and has been since the year 2000 (when the female rates reached maturity).  This is likely to continue.  The result is that the absolute size of the labor force in the prime working age years of 25 to 54 should be expected to continue to fall for the foreseeable future.  Japan and most of the European economies have already been facing this.  While GDP per worker, which is driven by productivity change, need not necessarily slow, one should expect growth in aggregate GDP to be less than what one saw in the past.  The ability to adapt to, and manage in, this new economic environment remains to be seen.