Economics, Health Care, Pethokoukis

This may be ‘the single worst decision’ Obamacare planners made

Image Credit: Images_of_Money (Flickr) CC

Image Credit: Images_of_Money (Flickr) CC

The United States is the global leader in medical innovation. You can measure that by Nobel Prizes or biotech R&D or where breakthrough treatments are developed or commercialized. And as University of Michigan economist Miles Kimball points out, one reason healthcare spending is lower in other advanced economies is their ability to ” cheaply copy drugs and medical techniques developed in the US at great expense.”

But healthcare innovation isn’t just about miracle drugs and cutting-edge technology. Innovation can happen in how healthcare services are delivered and paid for. And it is in this area that the Affordable Care Act is particularly harmful to innovation. The law’s “medical loss ratio,” or MLR level is supposed to suppress costs by requiring insurance companies to pay out on health claims at least 80% of the revenue they take in from premium payments. The 20% left over can be used for  administration and profits. (Medicare has a 98% MLR. Then again, it also suffers from $60 billion a year in annual fraudulent payments.)

Here’s the big problem: Obamacare’s MLR rule heightens the entry barriers to entrepreneurial, innovative new companies entering the market against large, established insurance players who can spread their fixed cost across a deep customer pool. AEI healthcare expert Scott Gottlieb calls the MLR caps “the single worse decision” Obamacare planners made. Gottlieb:

The Affordable Care Act was designed so that you can only profit as much as the government says you can profit. … But you can lose as much money as you want. .. So your downside is uncapped, by and large, and your upside is tightly regulated. You basically guarantee that the only people who can play in this market are the incumbent players. And you’ve seen no entrepreneurial capital get into this marketplace for the purpose of launching a plan on the exchange.

With the exception of some hospitals trying to do it out in California — who are going to fail like they did in the 1990s — you’ve seen no new players in this marketplace. And that’s because when a new plan launches, early on its medical loss ratio is typically around thirty of forty percent because they need a lot of operating margin because launching a new plan costs a lot of money and you lose money in the early years. So when you tell an insurance company they can only take 20 percent of their premium revenue for their operating margin … a new insurance plan can’t launch unless they are willing to lose substantial amounts of money in the initial years.

MLR rules also are biased toward existing practices and technology. A big battle when developing the MLR rules was over what activities would count or not count as healthcare expenditures versus administrative expenditures. Wellness programs, for instance, were determined to count as healthcare spending but with narrow limits, as Ben Wanamaker and Devin Bean of the Clayton Christensen Institute explain: 

While federal regulations allow for wellness programs to count as health care expenditures, certain restrictions narrow the scope of these programs, including strict limits on accepted clinical practice, reliance on criteria issued by professional medical associations, and accounting regulations for cost-cutting activities. New entrants attempting to implement disruptive technologies that fall outside the narrow scope of insurance-sponsored wellness programs are thus further hindered.  … MLR limits increase the already- large entry barrier for to new entrants in the insurance market. They prevent new entrants from succeeding in the market because they mandate a “size and scale wins” profit model.

Disruptive innovation transforms industries by lowering prices, creating new products and services, and increasing value. But that sort of transformative change typically comes from the new guys on the block who are locked into existing business models. In this case, Obamacare has created a gated community with a big sign: Entrepreneurs Keep Out.

Follow James Pethokoukis on Twitter at @JimPethokoukis

Pethokoukis, Economics, U.S. Economy

So why, exactly, is labor’s share of income on the decline?

Credit: The Decline of the U.S. Labor Share

Credit: The Decline of the U.S. Labor Share

The share of national income flowing to labor hovered around 64% in the postwar era until the mid-1980s. Then began a downward trend to around 58% in recent years. One recent paper, “The Decline of the US Labor Share” sees globalization as the culprit:

Over the past quarter century, labor ’s share of income in the United States has trend ed down wards , reaching its lowest level in the postwar period after the Great Recession. Detailed examination of the magnitude, determinants and implications of this decline delivers five conclusions.

First, around one third of the decline in the published labor share is an artifact of a progressive understatement of the labor income of the self – employed underlying the headline measure.

Second, movements in labor’s share are not a feature solely of recent U.S. history: The relative stability of the aggregate labor share prior to the 1980s in fact veiled substantial, though offsetting, movements in labor shares within industries. By contrast, the recent decline has been dominated by trade and manufacturing sectors.

Third, U.S. data provide limited support for neoclassical explanations based on the substitution of capital for (unskilled) labor to exploit technical change embodied in new capital goods.

Fourth, institutional explanations based on the decline in unionization also receive weak support. Finally, w e provide evidence that highlights the offshoring of the labor – intensive component of the U.S. supply chain as a leading potential explanation of the decline in the U.S. labor share over the past 25 years

Yet as The Economist notes, there is more to it than trade:

Yet trade cannot account for all labour’s woes in America or elsewhere. Workers in many developing countries, from China to Mexico, have also struggled to seize the benefits of growth over the past two decades. The likeliest culprit is technology, which, the OECD estimates, accounts for roughly 80% of the drop in the labour share among its members. Foxconn, for example, is looking for something different in its new employees: circuitry. The firm says it will add 1m robots to its factories next year.

But e21′s Scot Winship trots out a differently theory (as seen below in a reverse-order Twitter exchange). He theorizes that the labor share of income used to be artificially high, reflecting overpayment to workers during the strong union era so wives could stay at home and raise the kids. Then as women entered the workforce, there was a “Great Correction” where male compensation stagnated, female compensation rose, and the labor share fell. Looking forward to Winship’s extended essay and research on the topic.





Economics, Health Care, Pethokoukis

What we learned about Obamacare today: November 4, 2013

Image Credit:

Image Credit:

This morning Scott Gottlieb, Joseph Antos, and Thomas Miller evaluated the rollout of Obamacare thus far and discussed its future. Here are some of the main points from each scholar. Watch the whole event here.


  • The Medicaid Part D site went through much more testing and has much more functionality than the Affordable Care Act one. The ACA site doesn’t even let you put in the name of your doctor.
  • In ACA’s case, you’re seeing a failed marketplace. Part D was designed to de-risk anyone who participated early on. It was difficult to lose a lot of money at the beginning of the program, so you saw a lot of entrepreneurs get into the market and create Part D plans. With ACA you can only profit as much as the government will allow, but you can lose without limit.
  • By capping the medical-loss ratios, you guarantee that only the incumbent players are in the marketplace. New insurers can’t launch without losing a lot of money in the initial years. Anyone who would have gotten in with ACA would have gotten in now.
  • You see some big insurers not getting involved with the marketplace because “offering plans on the exchanges is a bad business deal.” These insurers can go outside the exchanges and offer bronze only plans and thus create nice risk pools.
  • For more information, check out Gottlieb’s latest article on the subject.


  • Speaking about tech surges: a big factor is human nature- people do things at the last possible moment. One of those moments is the December 15th deadline. That’s the day for a tech surge. However, it’s also a week and a half before Christmas. People can think of a lot to do with money before Christmas other than buy insurance.
  • Another surge date is March 31st. The young healthy people who have held off will sign up if they feel something coming on. But if they don’t, they will wait until October.
  • The penalty was made to stop the “death spiral.” However, the penalty will never rise close to the cost of subsidized coverage. It is unlikely that the penalty will be collected. After March 31st sometime, Obama will probably announce that they will exempt people from a penalty for 2014. The mandate will have minimal if any impact this year.


  • The promises of ACA actually have to meet with “does it work” now, and there is a mismatch.
  • The inevitable was unavoidable in the way this plan was designed and going to unfold. What we are seeing are not bugs in the software but features of the system.
  • The administration is facing its worst nightmare- visible victims. Those losses are visible before the gains. The paternalism head pat is more visible now.
  • Can they patch this is up? The ACA is a chain, interconnected, so if one piece doesn’t work it cripples the next.
  • One political takeaway: the big thing at stake is tarnishing the bigger government brand. This doesn’t look good for the next election season for Senate Democrats. You’ll see internal and external blame shifting.

Now here are a few things we learned about Obamacare today.

1.) AEI’s Scott Gottlieb says that “2015 Will Be Worse For Obamacare Than Its 2014 Debut As A Result Of New Burdens The White House Is Saddling Onto Insurers”:

According to one recent analysis, just one or two insurance carriers are serving exchanges in more than half of the country’s 2,500 counties. The problem is that the law was tilted against the health plans at its inception. These challenges are being magnified by the Obama team’s present day decisions that will discourage plans that sat out of the market in 2014 from entering in 2015….

Hospitals and drug makers aren’t going to subsidize the purchase of healthcare for the healthy beneficiaries that insurers need in order to make these new exchanges viable…. Drug makers want to find patients who will use expensive medicines. Hospitals want to find local residents who are uninsured but are being frequently admitted to the hospital for chronic and costly conditions.

2.) Did you know: “Millions of people could qualify for federal subsidies that will pay the entire monthly cost of some health care plans being offered in the online marketplaces set up under President Obama’s health care law, a surprising figure that has not garnered much attention, in part because the zero-premium plans come with serious trade-offs.” Based on three separate estimates by “Wall Street analysts and a consulting firm…up to seven million people could qualify for the plans.”

3.) Sarah Kliff tells us “Five things we know about Obamacare’s shoppers.” Here are some of her graphs:

4.) Marc Thiessen, one of AEI’s own, weighs in on Obama’s “keep your plan” promise:

After Obama began telling Americans they could keep their plans, White House aides discussed using media interviews “to explain the nuances of the succinct line in his stump speeches.” But they decided not to do so, because “officials worried . . . that delving into details such as the small number of people who might lose insurance could be confusing and would clutter the president’s message.”

Yes, no need to “clutter” the president’s message with confusing details — like the fact that millions of Americans being told by the president that they could keep their plans were being knowingly misled.

5.) Read a Q&A with Matt Cartwright here to see why “‘History will smile’ on Obamacare.”

6.) Insurance premiums in Alamaba are on the rise, and it could be a result of “lack of competition”: “Because it covers about 90 percent of the Alabama individuals and families who buy policies directly, BlueCross faces little competition and few reasons to lower prices, critics say.” The situation is not unique to Alabama. Some other states that have “single companies dominat[ing] individual insurance” are North Carolina, New Hampshire, and Arkansas.

7.) Find out “How political fear was pitted against technical needs” with

For weeks that spring, a tug of war played out inside the White House….members of the economic team and Obama health-care adviser Zeke Emanuel lobbied for the president to appoint an outside health reform “czar” …. In the end, the economic team never had a chance: The president had already made up his mind, according to a White House official… Obama wanted his health policy team… in charge of the law’s arduous implementation….

By late summer, CMS officials were frustrated with CGI Federal, which repeatedly said that certain features of the exchange were ready when they were not, several officials said…. White House officials say they were focused on whether there would be enough insurance plans for sale in the new marketplaces and on whether enough people would enroll. They say they didn’t have a clue how troubled the Web site’s operation was. Only during the weekend after’s Oct. 1 opening did the president’s aides begin to grasp the gravity of the problems, the White House official said.

8.) Did Obama get “carried away with health care reform”? Glenn Harlan Reynolds at USA Today thinks so. “If the federal government can’t handle the website, how’s it going to do on the rest?”

9.) For an update on the issues and how Senate Dems are responding, Kaiser Health News has a round-up of articles, including “Critical Weeks Begin For Health Law Rollout,” “Health Site Flaws Test Democrats’ Unity as Attacks Rise,” and “Officials Rebuff Call To Suspend Health Site.”

10.) Megan McArdle asks “Can Small Business Handle Obamacare?” and examines “a new report from the National Federation of Independent Business, the trade association for small businesses.”

11.) Finally, check out this New Yorker cover:


Should the US offer paid maternity leave?

Credit: NBER "What Is the Case for Paid Maternity Leave?" by
Gordon B. Dahl, Katrine V. Løken, Magne Mogstad, and Kari Vea Salvanes

Credit: NBER "What Is the Case for Paid Maternity Leave?" by
Gordon B. Dahl, Katrine V. Løken, Magne Mogstad, and Kari Vea Salvanes

“What Is the Case for Paid Maternity Leave? by Gordon Dahl, Katrine Løken, Magne Mogstad, and Kari Vea Salvanes notes that all advanced economies other than the US have paid maternity leave — more than 40 weeks on average —  offering “high earnings replacement and employment projection.” The US mandates 12 weeks of unpaid leave. Based on this research, it would be hard to make the case that the US should mimic what other OECD nations are doing:

Taken together, our findings suggest the generous extensions to paid leave were costly, had no measurable effect on outcomes and regressive redistribution properties. In a time of harsh budget realities, our findings have important implications for countries that are considering future expansions or contractions in the duration of paid leave.

And here is the broader summary:

Paid maternity leave has gained greater salience in the past few decades as mothers have increasingly entered the workforce. Indeed, the median number of weeks of paid leave to mothers among OECD countries was 14 in 1980, but had risen to 42 by 2011. We assess the case for paid maternity leave, focusing on parents’ responses to a series of policy reforms in Norway which expanded paid leave from 18 to 35 weeks (without changing the length of job protection).

Our first empirical result is that none of the reforms seem to crowd out unpaid leave. Each reform increases the amount of time spent at home versus work by roughly the increased number of weeks allowed. Since income replacement was 100% for most women, the reforms caused an increase in mother’s time spent at home after birth, without a reduction in family income.

Our second set of empirical results reveals the expansions had little effect on a wide variety of outcomes, including children’s school outcomes, parental earnings and participation in the labor market in the short or long run, completed fertility, marriage or divorce. Not only is there no evidence that each expansion in isolation had economically significant effects, but this null result holds even if we cumulate our estimates across all expansions from 18 to 35 weeks.

Our third finding is that paid maternity leave is regressive in the sense that eligible mothers have higher family incomes compared to ineligible mothers or childless individuals. Within the group of eligibles, the program also pays higher amounts to mothers in wealthier families. Since there was no crowd out of unpaid leave, the extra leave benefits amounted to a pure leisure transfer, primarily to middle and upper income families.

Finally, we investigate the financial costs of the extensions in paid maternity leave. We find these reforms had little impact on parents’ future tax payments and benefit receipt. As a result, the large increases in public spending on maternity leave imply a considerable increase in taxes, at a cost to economic efficiency.

Taken together, our findings suggest the generous extensions to paid leave were costly, had no measurable effect on outcomes and regressive redistribution properties. In a time of harsh budget realities, our findings have important implications for countries that are considering future expansions or contractions in the duration of paid leave.

Follow James Pethokoukis on Twitter at @JimPethokoukis

Economics, Pethokoukis

Actually, America doesn’t have a trillion-dollar infrastructure crisis


If Democrats have one big economic idea, it’s this: build. Crank up the infrastructure spending. Last summer, for instance, President Obama floated a “grand bargain for middle-class jobs” to cut the US corporate tax rate and use billions of dollars in revenue generated by eliminating tax breaks to fund infrastructure projects. And in his State of the Union address, he called for $50 billion in new public works spending.

But that’s just a beginning. Progressives think the US suffers from a massive “public investment” deficit. They point to a much-hyped “report card” from the American Society of Civil Engineers —  folks who like infrastructure spending, mind you — that calls for an additional $2 trillion in spending to get US road, bridges, and water works up to a solid “B” grade from the current “D+” by 2020. And this chart (below) from BCA Research was much circulated recently by folks arguing for vastly more infrastructure spending:

Credi:  BCA Research

Credi: BCA Research

But dig a little deeper and you find claims of a supposed infrastructure crisis are wildly overstated. US public construction spending has averaged 1.8% of GDP since 1993, with a low of 1.6% in the first quarter of this year and a high of 2.2% in the second quarter of 2009. Over the past two years, it’s averaged about 1.7%.

But is that a lot or a little compared to what our needs are? A Bloomberg piece last August highlights research that finds US public investment has tracked the OECD average since at least 1970. “The US. is about where it should be — close to peer nations such as Canada, Germany and Australia,” concludes reporter Evan Soltas. “Nations that spend substantially more tend to be in a phase of catch-up growth, such as South Korea and Poland.”

That’s the view from 30,000 feet. Brookings economist and privatization advocate Clifford Winston looks at US infrastructure a bit differently. He says the lack of market forces in the transportation system — drivers, for instance, don’t have to pay a special toll for driving at the heart of rush — and a government-ownership monopoly means transportation is an underpriced commodity. As he said on a recent EconTalk episode:

 I think that the claims of the infrastructure crisis are grossly overstated, and what we really have is a pricing crisis. And if we can get the prices right, that will do an awful lot to improve the condition and service of our infrastructure.

Roads have an artificially low price. Cars are not charged for congestion, so they put pressure on peak capacity. Trucks are not charged efficiently for the damage they do to roads; they pay a gas tax when they really need to pay an explicit charge that reflects the damages they do to roads. This underpricing causes road capacity to fill up, causes the roads to wear out a lot sooner. And it generates a demand for more spending … I say let’s get the prices right. Now, the same thing is true for airports, same kind of thing; even ports. Same thing. My guess would be after getting the efficient prices, yeah, there probably is room for some efficient–and I mean efficient that would satisfy cost-benefit criteria–investments in highways in some high density areas. Certainly additional runways in high density airports. But not the trillions of dollars that people talk about and not nearly as much as people are led to believe. …We have this enormously expensive and valuable transportation system that’s the envy of the world. There’s no question it’s better than other countries’ systems when you look at the thing in toto. But there’s an enormous amount of waste, enormous amount of inefficiencies in terms of operations, and for what we spend, we could have something that’s even better, and in ways that people find hard to imagine.

In a 2010 piece Winston outlined three big benefits from privatizing roads and airports, apart from the billions in dollars that would go to cash-strapped state and local governments:

– First, private operators would have the incentive to minimize the costs of providing transportation service and can begin the long process of ridding the system of the inefficiencies that have developed from decades of misguided policies.

– Second, private operators would introduce services and make investments that are responsive to travelers’ preferences.

– Third, private operators would develop new innovations and expedite implementation of current advances in technology, including on-board computers that can improve highway travel by giving drivers real-time road conditions, satellite-provided information to better inform transit riders and drivers of traffic conditions, and a satellite-based air traffic control system to reduce air travel time and carrier operating costs and improve safety. The technology is there. But it hasn’t been deployed in a timely fashion because government operators have no incentive to do so. The private sector does.

That’s right. Private-sector innovation is the answer here, not government infrastructure banks and bullet trains with their 1960s technology. If we want driverless cars shooting down highways at 90 MPH — at least ASAP — it would sure help to have well-maintained, pothole-free private roads for them to run on. The center-right has said little on infrastructure spending recently, other than expressing opposition to more stimulus-driven spending. Conservatives have particularly missed the role of transportation as a quality-of-life issue for middle/low-income Americans. A recent study from the Equality of Opportunity Project suggests geographic isolation in areas marked by (a) sprawl and (b) poor transit systems hurts economic mobility.

But last week Senator Mike Lee, a Utah Republican, gave a big policy speech that recommended sharply cutting the federal gas tax and transferring highways authority back to the states:

Under our new system, Americans would no longer have to send significant gas- tax revenue to Washington, where sticky-fingered politicians, bureaucrats, and lobbyists take their cut before sending it back with strings attached. Instead, states and cities could plan, finance, and build better-designed and more affordable projects.

Some communities could choose to build more roads, while others might prefer to repair old ones. Some might build highways, others light-rail. And all would be free to experiment with innovative green technologies, and new ways to finance their projects, like congestion pricing and smart tolls.

We may need to spend somewhat more on infrastructure, but let’s make sure we do as efficiently and intelligently as possible — and not just as a way to create more jobs.

Follow James Pethokoukis on Twitter at @JimPethokoukis

Economics, International economy, Pethokoukis

Why we shouldn’t worry when US multinationals build R&D centers overseas

Image Credit: Simon Greig (Flickr) CC

Image Credit: Simon Greig (Flickr) CC

Hey, R&D jobs are the “good jobs” we want in America, right? But it doesn’t have to be a zero-sum game. “Do multinationals that expand abroad invest less at home?” by Theodore Moran and Lindsay Oldensk:

It may seem counterintuitive that the creation of new offshore R&D facilities could increase the amount of R&D carried out in the US, but this is what case studies sometimes show. The creation of an R&D campus in Chennai, India has allowed Caterpillar to create a 24-hour R&D cycle on engine propulsion and pollution control. The capital-intensive Caterpillar engine labs in Peoria, Illinois operate two shifts with hundreds of channels of temperature, pressure, and emissions data to map diesel performance and emissions.

These streams are sent overnight to Chennai, where the data is analysed and returned to Peoria ready for the US engineers when they come to work the next morning. The chief technology officer of Caterpillar points out that the cost for the engine tests would be much greater if Caterpillar instead had a third shift working in the US, making the company’s overall R&D process less efficient and leaving less room for US engineers to exercise their comparative advantage. Using the growing Indian talent pool affects US operations positively by increasing the through-put and lowering the cost of the asset-intensive US test facilities. Round-the-clock interactions between Caterpillar’s Indian and US test facilities help ensure the company’s international market leadership position, while enabling headquarters to hire more US engineers.

Follow James Pethokoukis on Twitter at @JimPethokoukis

Economics, Health Care, Pethokoukis

Assuming eventually gets fixed, then what? Some possible small fixes

Image Credit: shutterstock

Image Credit: shutterstock

Don Taylor, a professor of public policy at Duke, cooks up a deal that would a) make Obamacare more workable, b) get the GOP moving on fleshing out an alternative, and c) give both sides a political boost:

 – For 2014, make some amount of the premium paid by individuals buying coverage in the exchanges who are above 400% of poverty (and thus get no tax credit) tax deductible. This will then give everyone with insurance some federal subsidy (Medicare and Medicaid directly, those with employer sponsored health insurance lots via the tax exclusion of the amount paid by an employer, those receiving exchange subsidies directly, based on their income, and then those buying who are above 400% of poverty getting some benefit from the deduction). …


– For 2015, replace the individual mandate with the auto-enroll provisions envisioned by Rep. Paul Ryan’s Patients’ Choice Act. Strong auto-enroll policies enacted while allowing an opt out (presumably with some consequences, correct Libertarians?) could actually pool risk better than the weak individual mandate we now have. We will also have to develop a default insurance option to make auto-enroll work.

So what’s the point of this two-part plan?

The first bit is about gradually nibbling away at the problem of how the current tax-treatment of healthcare is tilted toward folks buying pricey, employer-based health plans. By giving a tax deduction to those who buy in the exchange but get no premium support, you would start to level the playing field with those who currently benefit greatly from the tax break for employer-sponsored insurance. At the same time, Taylor notes, you might want pay for the tax deduction — further reducing the tax distortion — “by bringing forward the Cadillac tax or more directly capping the tax exclusion.”

The second bit is about minimizing the adverse selection/death spiral risk. Here is how the Ryan plan dealt with auto-enrollment:

The exchange would make it easy for individuals to obtain health insurance by providing new and automatic opportunities for enrollment through places of employment, emergency rooms, the DMV, etc. If individuals do not want health insurance, they will not be forced to have it. Research has shown that auto‐enrollment mechanisms— which overcome inertia, complexity, and status quo bias—have achieved near universal levels of coverage. An auto‐ enrollment mechanism has also been demonstrated to increase the percentage of employee‐participation in employer‐ provided 401(k) plans by 70 percent – from 20 percent of new employees enrolled after three months under self‐ employment, to 90 percent of new employees participating under auto‐enrollment.

And Reihan Salam recently wrote about default insurance.

Follow James Pethokoukis on Twitter at @JimPethokoukis

Economics, Pethokoukis, U.S. Economy

Pethokoukis Podcast: Time for parents to get a tax cut? My chat with Robert Stein, architect of the conservative push for a pro-growth, pro-family tax agenda

Image Credit: shutterstock

Image Credit: shutterstock

Is it time for American parents to get a tax cut? That idea is at the heart of new conservative pro-growth, pro-family economic agenda. Recently Senator Mike Lee, a Utah Republican, introduced legislation that would help offset the parent tax penalty by providing an additional $2,500-per child tax credit, available to all parents of dependent children and applicable to payroll taxes as well as income taxes. Lee’s bill also, among other things:

– establishes two individual income tax rates: 15% on all income up to $87,850 – and twice that amount for married couples – and 35% on all income above that;

– provides a $2,000 personal credit to offset the removal of the 10% bracket and the personal exemption

– provided a new charitable deduction that would be available to all taxpayers, not just current itemizers;

– provides new mortgage interest deduction, also available to all home-owners, but capped at $300,000 worth of principal

– eliminates the state and local deduction.

The intellectual basis of that plan is a 2010 National Affairs essay by economist Robert Stein. In a new episode of my Ricochet Money & Politics podcast, I interviewed Stein about the political and policy impact of his proposal.

Stein is currently deputy chief economist at First Trust Advisors. Immediately prior to joining First Trust, Stein was assistant secretary for economic policy at the U.S. Treasury Department. Between 1996 and 2002  Stein was chief economist for the Senate Budget Committee on Capitol Hill and an economist for the Senate Banking Committee and Joint Economic Committee. Prior to his tenure on Capitol Hill and the Treasury Department, Stein was a journalist for Investor’s Business Daily.

Here are the lightly edited highlights of our chat:

In 2010, you wrote the following in a piece for National Affairs:  

 It is time to rethink how the tax code treats parents.  Too many free-market economists still consider families an afterthought, arguing that the tax code should be “neutral” about raising children, as if parenting were merely one hobby among many.  But raising children is hardly just another pastime: it is one of the most important services any American can perform for our country. Even if we ignore the societal and cultural implications of parenting and consider economic factors alone, no government can be neutral toward the very existence of future generations of taxpayers. By targeting tax reform, policymakers would both offer meaningful relief to American families and create political opportunities to enact other pro-growth policies.

Why don’t you just lay out a little bit what your general plan is and why you think it makes economic sense.

Well, basically, the plan originates from about three insights that I came upon when I was working on Capitol Hill.  So it really dates back a long time, the seed for the idea.  And it comes from three thoughts.

First is that Republicans, and conservatives in particular, generally talk about marginal tax rates.  And we should talk about that because that’s what really matters in terms of tax policy — the tax treatment of the next dollar you earn because that decides the incentive for engaging in a productive capacity or not.

Liberals tend to focus much more on the average tax rate, on what they deem to be the middle class and below.  And they really couldn’t give a rat’s behind about what the marginal rate is.  They just want to know what the after-tax living standard of these people are going to be in. I don’t think those two positions, the conservative position and the liberal position, can be reconciled.  They seem to be talking past each other a lot.

The second key insight is basically that the value of a child in the Social Security system and the Medicare system is not net zero.  What most conservatives —  and in fact what most economists do — is they assume that, well, if an additional child is born, that child will contribute to the Social Security and Medicare system.  But let’s assume that that child will get benefits as well and so on net it’s zero.

But that’s not really the case.  And the reason is because if an additional child is born, we need to impute to that additional child the same fertility rate that everybody else has.  And so if we have an additional child, whether or not that child himself or herself will be able to get benefits will depend on whether they move forward and have children.  If they don’t, well, then, they’re not going to get any benefits.  And so when you really look at society and if you were to assume one generation as additional children, the net contributions from that generation of children will be positive, not net zero.

The other key insight – and this is going to be tougher sell for supply-siders —  is that supply-side economics was dumbed down from the very beginning.  And it reached its nadir under President Bush, for whom I worked for four years at the U.S. Treasury Department, by the way.  And here’s why. If you look at the Bush tax cuts from 2001 and even 2003 – now, I happen to be a big fan of the tax cuts on dividends and capital gains — if you look at the changes in the income tax rates, when we carved out a 10 percent bracket out of the 15 percent bracket for people of low income, the vast majority of the income earned in that 10 percent bracket is not earned by people whose top rate is 10 percent.  Most of it – 90 percent of it – maybe a little bit more is earned by people above that.

And so it really wasn’t a supply-side tax cut.  That portion of it was a Keynesian tax cut.  But then as I looked further up the income tax brackets — at the other rates that were cut, like the 28 percent rate was I think cut to 25, each and every tax bracket — the same argument is true.  Even the tax bracket below the very top, most of the income earned in the tax bracket, just below the very top, is earned by people who have money in a higher bracket, the highest bracket.

So if you really want to do a supply-side tax cut, you should not do what Bush did.  The vast majority of his tax cut was Keynesian tax cut that was dressed up to masquerade as if it were a supply-side tax cut. What you really want to do with the supply-side tax cut is just cut rates at the very top.  And that’s even true from the very beginning.  What the Kemp-Roth bill really was to a great extent was a Keynesian tax cut.  When you cut tax rates across the board, it’s actually a Keynesian tax cut  because except for the tax rate cut at the top — where we cut the 70 percent bracket to 50 percent — the vast majority of those marginal rate cuts went to people who had money in a higher bracket.  And so it really was to a great extent a Keynesian tax cut.

And how does – how does this play into what you want to do for families?   

So in trying to design a tax cut that would appeal to both supply-side conservatives and liberals. we could cut the rate at the very top — which is now right around 40 percent — maybe cut that rate to 35 or 36, and then provide much more generous benefits to people who have children.  So the idea in the Lee plan, or as Senator Lee has incorporated it, it’s to create an additional credit of $2,500 per child.  The credit would have no income cap.  So we wouldn’t create these phase-outs that generate higher marginal tax rates for some people, like with the current $1,000 credit.

 It would be a universal tax credit? 

It would be universal, except it would not go to people who have zero payroll in income tax liability.

So you could apply against both the income and payroll taxes?

Exactly, Jim.  So let’s say, you know, you would look at your taxes and in the end, you know, you have maybe $6,000 in income tax liability.  Well, for every additional child – let’s say you have three kids, you would get $7,500 off of your taxes.

Now, if you have $6,000 in income liability, then it would go down, you’d get an income tax credit to offset your payroll tax liability.  And it would offset the burden on the payroll tax.  And the reason you want to do that is because the old age pension system, Social Security and Medicare, are largely, not completely, but largely financed by payroll taxes, not income taxes.  And that system has itself created what I believe is the worst distortion in life, whether at work or at home, created by fiscal policy.  And that’s the disincentive to raise children.

It seems that many supply-siders are universally focused on the incentives and disincentives associated with a workplace.  If you open a business, but when you leave that business door at the end of the day and before you get to it in the morning, they are completely blind to the incentives taking place in the household.

What Medicare and Social Security and combination have done is promised people that if they contribute to the system through payroll taxes, well, then they’ll be kept out of old age poverty.  Before these systems existed, you know, the only way to really keep out of old age poverty was either to accumulate financial assets or raise kids that would take care of you in old age.  And so it has implicitly deterred people from using that natural step, which is to raise children, try to get them to be able to generate an income in the future to support yourself in old age, or at least as old age insurance against poverty.

And the idea is that if that’s creating a distortion in the way people live, we should, as good Republicans, as supply-siders, focus on that distortion and not just what’s going on in the business sector.

So is this a demographic, fertility-rate issue  that people have more kids?  Is there some other positive, pro-growth economic impact?  Or is this  a fairness issue: “I have a big family, and I am creating future taxpayers to support Social Security and Medicare at my own expense.  Yet, I’m also paying these payroll taxes. So this would allow me to capture some of my economic investment in these kids.”  Is it more that issue? 

I think it’s all of the above, Jim.  In terms of messaging, I think fairness has to be at the heart of it that parents are essentially funding everybody’s future social – the parents of this generation are essentially funding everybody’s future Social Security and Medicare benefits.  But everybody will enjoy those benefits, whether they’ve raised kids or not.  And that’s unfair.  Parents are facing a double burden.  They have to pay into the system and raise kids.  And non-parents, you know, they just pay into the system.  They’re not carrying the full burden and are, in part, getting a free ride on the system.

So fairness has to be at the heart of messaging because I think it’s what most voters understand and will understand intuitively.  In terms of fertility and incentives, those are also why I think the program deserves support.

There’s been some work by economists  – Isaac Ehrlich and Michele Boldrin, as well as some others — looking at the effect of the old age retirement system, not just in the United States, but around the world on fertility.  And what they found is that countries with larger old age retirement systems, controlling for all other variables like labor force participation rates among women, education among women, literacy rates, size of government issues, otherwise – have found that countries with larger old age pension systems reduced fertility.  And there’re other reasons for reduction in fertility in the last, you know, 50, 60, 80 years, like more widespread use of financial assets.  And that’s OK.  And there’re other reasons obviously as well, both abortion and contraception.  And those are separate issues.  I’m not trying to address those either way.  But I am trying to get people to think and act in a way where the government is not interfering with their behavior.

 So what you think would be the impact on the US fertility rate? And I think the point here is not that this tax credit is going to encourage people to have more kids than what they would want, but to give them a bit of help and a nudge to have the number of kids they would prefer.

Exactly. The Agriculture Department, every year, does its analysis of the cost of raising a child per year.  It comes out that’s somewhere $13,000-$15,000 per child.  So an extra tax credit of $2,500 layered across what we already have, which is $1,000 tax credit and a deduction, that’s essentially for a middle class parent worth $500, so a total of say $4,000 is not going to – is not going to take raising children and make it a money-making opportunity in and of itself.  You’ll still be losing $10,000 a year as a parent.

And so we’re still treating it to some extent – to a great extent as consumption, consumer kids.  We have kids because we want them.  But if society as a whole benefits from people raising kids, we don’t want fiscal policy to deter people from having the family size they would otherwise prefer.  We are not trying to manage and manipulate people’s fertility behavior.  We’re trying to return it to what it would be in the absence of inadvertent government policies that have reduced it.

When I write about this, my libertarian friends accuse of not crony capitalism but crony familialism. But, no, what you’re doing is you’re removing a distortion rather than creating subsidy. 

That’s right. And to be frank, we’re not really removing the distortion.  I know that’s just a word you happen to use at this moment.  What we’re trying to do is offset a distortion.  And a lot of people have trouble coming to grips with the distortion even being there, and frankly, most of the people [in the policy wonk world] have the number of kids they want, regardless of Social Security and Medicare because frankly they have higher earnings.  And even if they do not, they would not accept money from their kids in old age.  They’ll just accumulate enough financial assets to do so because they know how to do that.

What we’re really talking about are middle-class people and below who are not particularly sophisticated in their long-term financial planning.  And that’s OK.  You know, a lot of people are good businessmen.  A plumber is really good at what he does.  An electrician is really good at what he does. But he might not be a financial planner and know what financial assets to accumulate to make his retirement work.

And so it’s quite normal for people in the middle class to raise kids – or at least was before Social Security and Medicare – to raise kids to take care of yourself in old age.  I mean, it was kind of explicit.  And to some extent, it was reinforced by religion.

One way to see how the Social Security and Medicare system can make a difference is imagine if we went back to 1936 and 1938, when they were first getting the Social Security system or thinking about it and getting started to get it up and running, imagine if they simply said you do not pay into the system as a whole.  You do not pay the government.  What we’re simply going to do is require each and every child, for whatever the Social Security wage base is, to make that payment to their own parents.

I think the light bulb would go off over most people.  They’ll realize, oh, obviously it can make a difference.  If people were required to make a mandatory payment of the same amount they pay now to the government to their own parents, well then those parents would have a different incentive structure in terms of – in terms of how they value and how they pursue their own spending.

You know, even today, do I get granite countertops in my new kitchen or do I send my kid to a better middle school, so that maybe he can earn a little more money when he or she i older.

So what would be the impact on fertility? And would it create enough additional economic growth that it would pay for itself over the long term? 

I don’t want it to necessarily be scored dynamically.  That’d be nice, but my expectation of that is minimal. What we would probably see is an increase in the fertility rate in the United States from around two child per lifetime per woman to around 2.4, 2.5.  It’s a little bit of a change.

Now, that doesn’t necessarily mean will immediately go up from 2 to 2.4.  It’ll take maybe a generation to get there as people – it dawns on people gradually that, oh, you know, people who raise children are better off relative to where they would have been in the absence of this program, compared to their non-parent peers.  It takes a while for that to happen.

When Social Security and Medicare were created, we didn’t immediately see a huge drop off in fertility and we still haven’t seen any particular decade where there’s a massive drop.  It’s a gradual process as it dawned on people that the incentive structure is a little bit different.

And you know, the research that’s been done shows that in Europe, where the old age pension system is even more generous, that those systems have reduced fertility by about one child per woman.  In the United States, where the pension system is a little bit smaller, at least the public pension system, it’s reduced it by about half of a child per woman.

So we gradually work ourselves back up there.  And these children would eventually generate more cash flow and it would make the system more solvent for everybody, both parents and non-parents alike.

So you’re helping the solvency of the social insurance system and perhaps you wouldn’t have to raise taxes to help make it solvent. But you would also be increasing the labor supply, and that’s a factor in economic growth, yes?

What I would expect to see – a couple of things – now, you would see a little bit of a faster pace of economic growth over the long term.  In the short term – in the medium term, you might not actually see that.  You might see families ordering themselves differently.  You know, if raising children is recognized as a social benefit by the tax system and we offset the pain that people are now feeling, you might have some people leave the labor force in order to focus more on raising their children than they do today.  If I don’t know what the effect on labor force participation would be, that’s only because labor force participation doesn’t include raising kids, which is – as we talked for the past half hour – it’s also a social benefit.  Just that, you know, the bean counters in the government don’t recognize it.  Or maybe some families will organize themselves by more parents going into the workforce, earning more to get the full benefit of this tax allowance, and then hiring somebody to take care of the kids if that’s what their preference is.

I see this is as sort of a different kind of capital gains tax cut, a human capital gain tax cut.  Is that the right way to think about it? 

That is absolutely the right way, but I think – I think conservatives have kind of bought into the way liberals talk about human capital.  And I want to make a distinction between two types of supply-siders now. There what I call the Golden Calf supply-siders, and what I guess I would call Ten Commandments supply-siders. And the golden calf supply-siders – I’m not going to name anybody in here, but you could probably figure out who they are. — the golden calf supply-siders tend to believe that the tax system that is right for the United States would be right for it regardless of the nature of our society as whole, our religious and cultural nature.  That the right tax system for the United States is the right tax system for a society that would pray before the golden calf.  Doesn’t matter.

A Ten Commandments supply-sider believes that the nature of our society is important in designing the tax system.  And we need to recognize our role as, for instance, getting rid – you know, getting rid of the marriage penalty because marriage is an institution within our society and the costs associated with raising kids for the next generation.  Because it’s been if nobody raises kids, well, you don’t even have a workforce in the next generation.

So it’s not just about a person who’s 18, going off to school and expensing their college education.  That’s what a golden calf supply-sider would look like.  It’s the cost of putting food and energy into your children and actually bearing children.  That cost should be deductible.  We should allow for deductions, in theory at least, for all the costs associated with raising children, in the same way that we allow for the expensing of plant equipment.  And so this is one way of getting to that area.

Now, some people say, well, maybe we shouldn’t allow expensing of plant equipment.  And I think that’s kind of ridiculous.  It’s an investment, just like raising kids is an investment.  And we ought to treat them roughly equally.

If you have a country where the population is shrinking and getting older, you’re going to get a less innovative risk-taking entrepreneurial society.  I think Gary Becker has written some about that. 

Yeah, I think that’s absolutely right.  Now, free trade kind of lets you short-circuit that price just a little bit because you can access the younger, cheaper workers abroad –

Right, and their innovations and entrepreneurship.. 

That’s right.  Now, one effect I think you might see is that people focus more on raising their children well, raising children and raising them well.  Then, you might see a little bit of a crowding out of immigration flows into the United States.  And there’re other reasons to think that immigration is going to slow down because fertility rates in the emerging world are dropping rapidly.  But you might see more endogenous growth of the, you know, so-called native population, versus population growth through immigration.

But this plan would not be scored dynamically. Is someone going to pay more taxes if parents are are paying less?    

So I’m assuming we’ll have some Republican president in the future, a Republican majority in the Senate.  And then there’ll be a choice essentially, whether or not try to push it through a reconciliation process, a budget reconciliation process like President Bush did with his tax cut, where you only need a simple majority in the Senate and the House.  But then, it’s only a temporary tax cut.

We’re trying to do it in a different way.  My best guess is – my personal preference is to do it on a permanent basis.  And to make adjustments to the Lee tax plan to make it revenue neutral, just in case it is scored as negative.  And it’s not that difficult to do it.  Instead of having a top rate of 35 percent, well, make it 37 or 38 percent, you know a little lower than it is now, but not much because really from going from 40 to 35 percent is not much of an incentive effect anyhow.  And then to kick that rate in at a somewhat lower level than the Lee plan would otherwise kick that rate in, whatever the top rate is.

So, yeah, in the end, if parents as a class are paying less, then some people are going to pay more.  I think that the plan is designed in such a way that the people who will pay more are essentially high-earning childless workers. So if you’re a high earner, if you’re – if you are – you know, you just graduated Yale.  You went to work on Wall Street.  You’re making $500,000 a year and you’re cruising the bars and clubs at night and you’re living fancy-free, you’re going to pay a boatload more in taxes under my design than under the current system, boatload more

But the plan you outline in “National Affairs,” there were some other – there were some other “pay fors.” Didn’t you mention the state and local tax deduction? 

Yeah, basically –

And there were also some other tax cuts, I think, the corporate rate or something. 

Yeah, the plan in National Affairs – and Senator Lee hasn’t really touched on the corporate side yet and the capital gains and dividend side yet — would also move to greater expensing of plant equipment and the double taxation of capital gains and dividends, basically adopting the old plan by Glenn Hubbard that he developed in the early 1990s to reduce taxes on capital investment.

So you know, in the end, somebody has to pay more and that will be high labor income, you know, people who make a lot of labor income, who aren’t investing, aren’t raising kids are going to pay more.  Parents will pay less.  And investors will pay less as well.

But for the money this would cost, why not just lower marginal tax rates?

Well, if you’re talking about lowering the top marginal tax rate, good luck.  I mean, our society seems to have an appetite for a rate that’s clearly about 28 percent and maybe below 40.  So I think it would be very difficult to get it below 35 in any circumstance.  It would also be difficult –

The House GOP is shooting for 25 percent. 

Yeah, well, they’re dreaming.  It’s just not going to happen.  And frankly, you know, back when I was at the Treasury Department, I had them run some special numbers for me and even after we cut the top rate to 35 percent, the average rate – the average rate, not the marginal rate — on labor income for people in the highest brackets was still in the low 30s. So the only possible way to lower the top marginal rate below the low 30s is to have a massive tax cut for the upscale.  And so that because of the budget reconciliation process would have to be another temporary tax cut, which would limit its own improvement in economic incentives.

So  they’re just dreaming.  And you know, let them dream, but eventually they’ll come back to reality and figure out the tax cut that can pass and can be essentially a camel’s nose under the tent for better incentives for capital gains and for parenting.

Where do you think this is going politically? Is this something that could happen as early as, you know, 2017, if there’s a Republican president?

I am very surprised at how little pushback we’ve gotten from areas you would expect to push back, and like The Wall Street Journal editorial page.  And so I’m pleasantly surprised at that.  And  anytime I talk to people outside the beltway about this, they’re very positive about it.  I’ve talked to Democrats about it.  They’re positive about it.  They like the idea about doing something for middle class parents as parents.  And they recognize the burden that – the actual burden those people feel.  So I think it’s hard to resist.

The candidate who, in the end, I think is most likely to take this up as a presidential candidate from the Republican side, and I’m just kind of reading the tea leaves here, is Chris Christie.  And the reason is because he is going to need something to appeal to social conservatives.  And I think this will because it recognizes the value of raising children that no other politician is out front recognizing.  And if he did that, I think it would bridge a gap for him that he needs to bridge in order to get the nomination and in order to bring conservatives home and feel good about supporting him.

One final question, since we’re talking about taxes.  What – when you look at government spending and how much tax revenues are coming in, when you’re at Treasury, what do you think is sort of reasonable as far how small we can keep government, given the aging of the population and the desire to have the world’s most lethal, power-projecting military over the next 25 years. Some folks who would like to get us back to, you know, spending 17 or 18 percent as a share of GDP. What do you think is reasonable?  

Given our global commitments militarily, given, you know, the debt servicing costs, which will eventually go back up to around 2 plus percent of GDP, where we were in the ’80s and ’90s for many years, given that we can reduce Medicare spending, Medicaid spending, and maybe gradually evolve Social Security into an old age poverty insurance program that has a minimum benefit, rather than really going up through the income classes, and the aging of the population and the public’s appetite for raising retirement age.  You know, if you look at the 75-year horizon, we’re going up 30 percent of – 30 percent plus of GDP by the federal government spending.   Or maybe, you know, 33-34.  My best guess if we really work hard, we can bring down that long-term trajectory to about 25 percent.

And it’s going to take a lot of smart policy to do it. 

Yeah, but the key here – and I hate to agree with Peter Orszag because I think he’s the devil incarnate – (laughter) – and yes, I know this will go out in public.  I hate to agree with him, but a lot of this is just rising health care costs over the past generation.  So that even our population we’re not aging, because the government has gotten into the business of promising health care, even before “Obamacare,” just with Medicaid and Medicare, and because of productivity growth in this sector, that you’re going to have – that you’re going to have a larger share of the federal budget just going to these things.  And it’s going to require more resources.

So even if you make efficiency improvements, you know, a larger share of our social revenue generation is going to go into these benefits.  And that’s also even if we increase retirement ages a little bit here and there.  And that’s unfortunate, in my view. If the government were only in the business of providing food and basic shelter, then we wouldn’t necessarily see this big blowout in government spending over the next generation.  But you know, because it’s medical care, we will.

Follow James Pethokoukis on Twitter at @JimPethokoukis

Economics, Health Care, Pethokoukis

Here’s exactly why Obama’s was doomed to fail


Big, established companies often become victims of their own success. They generate revenue in a particular way by selling a particular kind of product to a particular kind of customers. Their business model is formed from a complex web of assets, personnel, supplier and customer relationships, and decision-making process. Change is not only hard, it’s nearly impossible. Take the computer industry:

The personal computer entered the scene while minicomputer manufacturers where making 45% margins on $20,000 sales. No sane manager would ever have diverted existing resources towards making personal computers – the person who proposed taking engineers away from minicomputers to prioritize making a toy computer that sold for $2,000 with 25% margin would have been laughed out of the office!

We know how that turned out. And as with those mainframe and mimicomputers, explains Clayton Christensen Institute analyst Devin Bean, also “fell victim to the government’s own established resources, processes, and values (RPV).” More from Bean’s research note:

Because is a new, innovative task for the federal government, leveraging old resources, processes, and values inevitably created internal conflict that manifested itself in a long contracting process, drawn-out political conflict and unwillingness of any single party to accept responsibility for failure.

Imagine that you are a federal employee responsible for procuring contracts to build You see the problems, put out a call for applications, and receive a number of proposals. How do you choose which to accept? Ideally, you go with the companies who have experience dealing with the problems that you expect to confront. You find an IT company that has a history of delivering on time, and one that is good at dealing with unclear customer segments, refining as it goes.

But you can’t. You sit looking at the pile of applications, almost all of them from companies who have entire divisions dedicated to obtaining government contracts by navigating the obtuse system the applications has to navigate before they even reached your desk. Then, instead of picking the businesses that can best address the specific challenges of the situation, you pick up your congress-mandated rubric of criteria. Has this contractor completed government work in the past? Check (though you think to yourself, as you check the box, that they have never completed an IT project on time). Does this contractor promise the most features for the lowest price? Check (that line sounded better in legislation than it does in implementation – features never come in at the prices promised). Has the contractor demonstrated that they have sufficient technical and computer coding ability? Check (CGI, the primary contractor, had worked successfully on U.S. government technical projects before – but never of the type proposed now).

You sit with your completed rubric and realize that you have no choice. Either you pick the contractor who has no real and relevant experience but can check the boxes, or you do nothing. Concerned about keeping your job, you decide sign the paper and forward it to the next person in the command line. didn’t crash because people were inept or stupid. It just became a victim of federal procedure that aligns RPV in a manner useful for many projects but hostile to innovation.

Follow James Pethokoukis on Twitter at @JimPethokoukis

Pethokoukis, Economics, Taxes and Spending

Maybe the GOP should demand we tax the 1% like Clinton did

Image Credit: cvrcak1 (Flickr) CC

Image Credit: cvrcak1 (Flickr) CC

Many on the left have dismissed the sharp Obama 2013 high-end tax hikes as merely a return to Clinton-era rates. (And the economy did great back then, right?)

But that’s wrong.

1. Yes, under the fiscal-cliff tax agreement, the top bracket did rise to 39.6%, just what it was at the end of the Clinton years.

2. But a provision that phases out high-income taxpayers’ itemized deductions was also reinstated, adding another 1.2 percentage points to the effective tax rate, bringing it to 40.8%. That’s was also in place during the Clinton years, so the real top Clinton tax rate was 40.8%

3. Then you have Obamacare. AEI’s Alan Viard: “Under the healthcare law., the Medicare tax [rises] from 2.9 to 3.8 percent. Also, a new 3.8 percent tax, called the Unearned Income Medicare Contribution (UIMC), will be imposed on high-income taxpayers’ interest income and most of their pass-through business income that’s not subject to Medicare tax.”

In other words, virtually all of top earners’ ordinary income this year will be taxed at 44.6% vs. 40.8% during the Clinton yeas. You can also add the 1.2 percentage-point deduction phaseout and the UMIC to capital income tax rates. Combined with the expiration of the Bush tax cuts, most sources of capital income are also above Clinton levels

Credit: Alan Viard

Credit: Alan Viard

Follow James Pethokoukis on Twitter at @JimPethokoukis