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With Obama’s publication of his 2014 budget proposals this past April 2013, the current round of deficit cutting set in motion by Obama’s Simpson-Bowles Commission four years ago may be coming to a conclusion of sorts by this September 2013. The important question is: why now a conclusion after four years of deficit cutting negotiations by Obama and Congress? And what might this last act—the final phase in what has been a negotiations farce aimed at creating the appearance of major differences between the two sides—actually produce in terms of federal government spending and tax changes?

To understand the proposals in Obama’s budget it is useful to compare those proposals, and their economic impact on the deficit, with the Congressional Budget Office’s ‘baseline’ budget estimates. The CBO’s baseline represents estimates of the spending and tax revenue levels for the coming decade prior to Obama’s 2014 budget. The differences thus reveal how much Obama is proposing in his 2014 budget to cut (or increase) spending on programs andto raise (or cut) in taxes, as well as when (in what years).

Since Obama himself has been quoted as indicating Medicare is the main cause of future deficits, we can begin with that program.

Medicare in the 2014 Budget

The Medicare program has five basic spending categories: hospitals (Part A), doctors (Part B), nursing homes, prescription drugs (Part D), and government payments to private insurance group plans including the private insurance subsidy to ‘Medicare Advantage’.

The CBO baseline costs for Medicare for 2012-2023 shows Medicare costs for Part A (Hospitals & Nursing homes) and Part B (Doctors fees) rising by an increment of $195 billion from 2012 to 2023. However, receipts and revenues will rise by $227 billion. In other words, the two main programs will continue to show a net surplus of receipts over expenditures by 2023. So where’s the cost crisis?

The answer to that lies with the Prescription Drug program (Part D) and the Medicare program’s subsidies to Group Plans including Medicare Advantage private insurance supplement.

The Prescription Drug program (Part D) was introduced by George Bush in 2005. The legislation provided for no payroll tax to cover the cost of the program. From the very beginning of the program and continuing today, it has been totally paid for out of the general US budget—i.e. out of deficits. It has cost more than $500 billion since its initial passage, and is still rising in costs terms as pharmaceutical companies continue to inflate prices for their products at double digits every year. The Bush law specifically prevents any limits on drug company cost increases. States and cities cannot even negotiate drug price reductions. Nor can they legally purchase the same drugs from outside the US, often produced by the same company. Nor can individuals buy drugs legally from Canada. Free trade is ok for businesses, but not for government or consumers, in other words!

Part D cost increases in the CBO baseline are projected to rise by an additional $114 billion over the coming decade. But there are no receipts or revenues whatsoever to pay for the program for the next decade. That results in a negative incremental cost of $114 billion for the program through 2023. Similarly, Medicare program subsidies for group plans are projected to rise by an additional $127 billion by 2023. That’s a combined total of$241 billion in increased costs for the Medicare program overall through 2023. Subtract the $32 billion in excess receipts over cost for Hospital and Doctors fees (Part A and B), and the shortfall declines to $209 billion. Subtract further the $90 billion in cost cutting for Medicare called for in the March ‘sequestered’ spending cuts, and the result is a net shortfall in Medicare of $119 billion.

In other words, the total additional cost for the Medicare program in general over the coming decade is approximately equal to the cost for prescription drugs. The Medicare cost problem is therefore essentially the refusal to enact a payroll tax for prescription drugs and to allow drug companies to price gouge the public and government. So why not finally pass a tax to pay for Part D? Why not introduce some price cost limits on prescription drugs?

In short, if Prescription Drugs were properly funded by a payroll tax, as Hospital and Doctors have been from the beginning of the Medicare program, there would be no net cost increase in Medicare through 2023. Fund part D and there’s no Medicare cost crisis whatsoever. Even if not funded, the $209 billion shortfall hardly constitutes the ‘primary cause’ of the $7 trillion projected deficits through 2023, that Obama and others are claiming is the root problem with the deficits.

The root cause of the $7 trillion projected deficit is not Medicare; it’s not even prescription drugs. The root cause of the $7 trillion in projected deficits is the $4 trillion extension of the Bush tax cuts, plus the continued trillion dollar a year U.S. defense spending program.

Another simple solution to the $119 billion total incremental cost for Medicare over the decade is that proposed by the Trustees of the Social Security program themselves in their 2011 annual report. According to their own calculations, a mere 0.25% increase in the payroll tax for Medicare (now at only 1.45%) would solve all Medicare cost issues through 2022. Another 0.25% after 2022 would solve all shortfalls for a further second decade. But you won’t hear that mentioned in the press or media.

To summarize, even according to government estimates (CBO and Trustees), there is no Medicare cost crisis. There is a problem with escalating prices for prescription drugs. With no price controls, as is presently the case, Part D costs are projected in the CBO baseline to rise by 17% a year for the next four years and by 19% a year on average over the coming decade. And there is a problem with no tax to fund the Part D program. A simple addition to the payroll tax to cover Part D and some reasonable price controls on drugs would resolve the problem.

Up to now, the Obama administration’s solution to the ‘problem’ of runaway drug costs and escalating subsidies to Medicare Advantage and other group plans—which together are the true source of Medicare cost problems—has been to cut payments to Doctors and to draw down the surplus in the Part A hospital fund. Unlike the projected 17% a year increase in payments to drug companies, payments to doctors in the CBO baseline are to decline from current $68 billion in 2012 to $61 billion in 2016 when Obama leaves office. Cutting payments to doctors will mean more leaving the Medicare system and refusing to take medicare patients. That will accelerate the creation of a two tier health care system in the US already well underway.
But even cutting doctors payments and drawing down the surplus in the medicare trust funds are not long term solutions. Drawing down the trust fund surplus to pay for prescription drugs and group plans will exhaust the remaining trust funds by the end of this decade. Obama and Republicans know this and are therefore preparing to implement major cuts in medicare coverage and to raise Medicare recipients ‘out of pocket’ costs for reduced Medicare coverage. That comes next in the Medicare cost cutting plan that neither Republicans or Obama are ready to make public. Recall the Simpson-Bowles solution: make medicare recipients pay 20% more of Part A hospital coverage, pay more deductibles, and raise the eligibility age beyond 65. Or, as the Business Roundtable and Teaparty radical, Paul Ryan, have proposed: privatize medicare starting in 2022 and provide vouchers. Obama prefers the former; Republicans in the House prefer the latter. But whichever the case, it all amounts to rationing of health care services for all but the wealthy who can afford to pay out of pocket. That further rationing of health care services for seniors is implied in Obama’s 2014 budget.

In his Budget Obama has proposed to cut Medicare by $364 billion over the decade. Not included in that is a second proposal to freeze payments to doctors over the decade at 2013 payment rates, starting with an immediate 24% reduction in doctors payments in 2014 followed by a slow adjustment to the 24% cut thereafter. Unfortunately, the Obama 2014 budget does not indicate the total ‘savings’ from this reduction and freeze. But one can probably assume the total is somewhere around $100-$150 billion cumulative over the decade. The total cuts to Medicare alone are thus at least $500 billion in Obama’s 2014 budget.

Social Security in the 2014 Budget

To begin with, it is essential for readers to understand that the Social Security retirement trust fund (OAS) currently has a $2.77 trillion surplus, whose arguing social security is going to go broke soon conveniently ignore. Nor does the press and media bother to note that fact much. Like Medicare, the truth about the condition of Social Security lies in understanding the financial condition of its separate programs.

Like Medicare, Social Security is composed of several programs. There’s the retirement program (OAS) and there’s the disability insurance program (DI). The OAS has the massive $2.77 trillion surplus and, in addition, remains virtually fully funded from payroll taxes through 2023 without having to draw down the surplus. It is the DI program, on the other hand, has a funding trouble. Since the economic crisis erupted in 2007-08, approximately 2 million more workers went on disability. The lack of real job recovery has meant fewer payroll tax contributions to the DI fund. The result has been a shortfall in the DI fund of about $30 billion every year.

But the shortfall in the DI fund is used by opponents of social security to argue the entire program is in trouble. They then also use a base year of the recession and poor job recovery and extrapolate out for decades to create the false impression that social security revenues are insufficient while costs rise. That dishonest approach to calculating costs and revenues creates a false picture of tens of trillions of false liabilities for social security in general, requiring the major cuts to benefits that both Republicans and Obama now propose.

But here are the facts: For the OAS program, benefit payments are projected to rise at a rate of 11% a year from 2012 to 2023, from $773 billion in 2012 to $1.422 trillion in 2023. But revenues from the payroll tax are projected to rise at nearly the same annual rate, of 10.5%, from $570 billion to $1.125 trillion. Other revenues (interest, taxes on benefits, etc.) increase the revenue total by 2023 to $1.320 trillion. So we’re talking about a $100 billion shortfall at most by 2023, which is not bad considering 77 million babyboomers are expected to retire starting 2013.

So why not start drawing on the $2.77 trillion surplus, instead of making retirees pay the difference? After all, the payroll tax rate was increased in 1986, justified at the time as necessary to create the surplus in anticipation of the boomers retiring.
Another simple solution is to raise the annual income ‘cap’ to cover the 15% of wage earners whose income has risen faster than the income base since 1986. Currently, the payroll tax covers only 85% of wage earners, when the law intended 100%. Raising the cap would generate revenue by 2023 well in excess of the $100 billion shortfall, and do so for several additional decades to come with money left over.

But none of these, or other simple solutions, are being considered by Obama or House Republicans. Instead, both sides are in agreement to cut retirees annual cost of living adjustments to retirement benefits by changing the cost of living adjustment formula. And both continue to agree to raise the eligibility age for social security retirement benefits.
The first of these two alternatives—reducing the cost of living adjustment—is already baked into Obama’s 2014 budget. The second—raising the retirement eligibility age to 68 or higher—will likely come as part of the deal later in 2013 deal on the deficit.

The device by which Obama in his budget proposes to reduce annual cost of living adjustments for retirees is by changing the price index by which the adjustments are calculated. Instead of using the Consumer Price Index, he has proposed to substitute it with a ‘Chained CPI’ index. The latter will reduce the deficit by $232 billion, bringing the total deficit reduction from Medicare and Social Security retirement to more than $700 billion. (The amount Obama offered to cut the programs initially back in the summer of 2011). But this $700 billion is just the beginning offer to cut social security spending. Additional DI program spending cuts are being worked out administratively and through court action as well—all off budget. Eligibility for DI is being raised and benefits are being reduced in parallel. That will add at least another $100 billion in benefit reductions over the coming decade. So Obama is offering and presiding over no less than $800 billion in social security-medicare cuts. And that’s before further cuts are part of the final deficit cutting deal later this year, integrated with corporate tax cuts and the tax code revision.

It is clear, in other words, that both Republicans and Obama are targeting about $1 trillion in social security-medicare spending cuts over the decade. That $1 trillion, plus the $2.8 trillion already obtained in deficit reduction from the Fiscal Cliff and Sequestration, means only another $500-$600 billion in deficit cutting remains for a final deficit deal later this year.
But that is not quite accurate either. The tax code revisions will result in hundreds of billions more in corporate tax cuts that will have to be offset by further tax hikes and/or additional spending cuts. There is also the restoration of defense spending cuts of $500 billion required by the March 1, 2013 ‘sequestered’ spending provisions. Another $1 to $1.5 trillion will have to be extracted in tax hikes and/or spending reductions. Which raises the question of what does Obama’s 2014 budget suggest in terms of tax changes and additional spending cuts?

Tax Proposals in the 2014 Budget

Throughout the 2012 election period Obama was explicit in advocating a major reduction in the corporate tax rate, from current 35% to 28%. In that regard, his position was essentially that of Republican candidate, Mitt Romney. Obama also favored publicly working some compromise for Multinational Corporations, reducing their offshore tax liability to entice them to pay some part of the current $1.9 trillion they are hoarding in offshore subsidiaries without paying taxes. (Actually, the ‘offshore’ accounts are located in New York). His budget proposes taxing ‘international income’ only at the rate of $15 billion a year. At that rate it will take more than 50 years to tax the current $1.9 trillion.

Obama has also been an advocate of even more generous tax cuts for smaller businesses and for Research & Development. His budget proposes raising the business R&D credit to 17%, resulting in a tax cut of $118 billion, and allowing small businesses to write off equipment investment immediately, resulting in another $69 billion in revenue loss. Just these two items, plus the corporate tax rate reduction and letting multinational companies off the tax hook, will cost the US budget at least $700 billion to $1 trillion, and likely much more.

To pay for the tax cuts for corporate America coming later this year, Obama’s budget proposes to limit tax deductions and exclusions for businesses, especially for employer health insurance and pension contributions. That is projected to raise $493 billion. It will also mean the acceleration of employers abandoning their health insurance and pension plans for their workers and further exacerbate those crises and costs to workers. Minimal added taxes on tobacco would raise another $83 billion. An increase in the Estate Tax would only take place after Obama leaves office, which politically means not at all. A token ‘financial responsibility’ tax on banks is also another proposal likely ‘dead on arrival’ given the Republican dominated US House, as will prove similar for the proposal for a token ‘fair share’ tax on millionaires.

Netting out the tax cuts and the tax hikes, it means a net gain for businesses in terms of tax cuts of about $400-$500 billion, for which other tax hikes on the middle class and spending cuts will have to occur. That’s $500 billion plus the roughly $600 billion gap ($4.4 trillion minus $3.8 trillion). In short, another minimal $1 trillion in tax hikes and spending cuts—apart from and in addition to the social security-medicare cuts already proposed—will become part of a final deal later this year when the tax code revisions are integrated with the deficit cutting.

The additional, final $1 trillion will likely come from two general sources: eliminating deductions, credits, and exemptions for middle class tax payers and cutting further discretionary spending programs like education, transportation, and other non-defense discretionary programs.

Defense Spending in the 2014 Budget

Almost $500 billion in defense related spending was cut in the March 1 ‘sequestered’ provisions that went into effect. Obama has vowed to restore at least $400 billion of that. For 2013, the sequestered discretionary spending cuts amount to $64 billion. Obama has proposed restoring $40 billion of that $64 billion in defense spending.

Over the decade it is clear that the budget strategy involving defense is to ‘move the money around’. Spending for what is called ‘overseas contingency operations’ (which means for wars in Iraq and Afghanistan) would be reduced. Much of the reduction would be in turn transferred to spending on new military equipment, earmarked largely for the US Navy and Air Force, as US military strategy ‘pivots’, as they say, to the western Pacific. The US Army had its land wars in the middle east; now the money goes to the Navy and Air Force. US military equipment suppliers simply get to change their ‘product mix’ sales to the US government and the military industrial complex continues virtually unaffected.

Obama is engaging in what might be called a strategy of ‘moving the money around’. Defense spending on middle east wars are to be shifted to defense spending increases for the pacific region. Social Security retirement benefits are to be cut in order to offset the rising costs of disability benefits. Medicare benefits for hospital, and doctors fees, are reduced and costs shifted to retirees in order to offset continued runaway prices and costs for prescription drugs. Simple solutions like raising the cap on social security payroll tax, implementing a token percentage tax to cover prescription drugs, placing some kind of controls on runaway drug prices, addressing the reason why so many workers are now going on disability, etc., are totally ignored and boycotted in the press and media as alternatives for consideration. Instead, the focus is on reducing benefits and making retirees and workers pay more for less. What all these Obama-Republican measures represent is a shifting of the cost burden of social security, medicare, and other discretionary social program in the budget from one sector of the working and middle classes to another; from the wealthiest households to the remaining 95% rest. Meanwhile, the wealthiest households and their corporations continue to get still further tax reductions and the Pentagon and war corporations get to shift their profits from the middle east conflicts to the western pacific to address a ‘threat’ from China that doesn’t exist.

Jack Rasmus
Copyright June 2013

Jack is the author of the 2012 book, “Obama’s Economy: Recovery for the Few”; host of the weekly radioshow, ‘Alternative Visions’, on the Progressive Radio Network; and ‘shadow’ chairman of the Federal Reserve in the recently formed Green Shadow Cabinet. His website is: http://www.kyklosproductions.com, his blog: jackrasmus.com, and twitter handle: #drjackrasmus. (A longer version of this article summarizing the history of US austerity programs and deficit cutting since 2009 will appear in the June 2013 issue of ‘Against the Current’ magazine; also available on the author’s website in July).

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The third quarter (July-Sept.) U.S. GDP figures released last Friday, October 26, estimated the US economy grew by 2%. That compares to an average growth for the first nine months of 2012 of an historic low of 1.7%. The 2% reflects, at best, a continued stagnation of the economy and, in all likelihood, an actual continuing decline for the economy over a longer run.
Here’s why: to begin with, the 2% is an initial ‘advance’ estimate. Advanced estimates recently have tended to be reduced significantly in the 2nd and 3rd revisions. To recall, the previous 2nd quarter GDP also initially came in at 1.5% but was then reduced to 1.3%. It is quite likely therefore the third quarter’s 2% will be revised downward 0.1-0.2%, which will put it almost exactly at the past year’s 1.7% average.
Secondly, every four years just before national elections politicians typically turn on the spending spigots in the third quarter to get a brief boost just before the national election. And so it was this past third quarter. The Federal government in particular accelerated Defense spending. It appears this was done by deliberately holding back defense allocations in the previous quarters in order to have an especially large impact just before the national elections in the third quarter. Federal defense spending fell by-7.1% and -0.4% in the first and second quarters of this year. In other words, it appears defense spending was slowed in the first half of the year in order to get the bigger third quarter boost just before the elections. In fact, the third quarter’s big bulge in spending –attributable virtually all to defense—was the first time in two and a half years that government spending did not decline in every consecutive quarter! The two and half years of decline in federal spending, combined with the big declines in the same the first two quarters of 2012, suggests the third quarter’s inordinate surge in defense spending was consciously planned. Federal spending in the third quarter thus amounted to a a huge third, 0.7%, of the 2.0% reported GDP growth last quarter. It is highly unlikely any such additional surge in defense, or government spending in general, will follow this fourth quarter or subsequently in 2013. So this 0.7% is a one time event and the 2% (or revised lower) third quarter GDP number is actually less than 1.5% when the one time surge is backed out of the trend. That would mean the US economy continued to slow last quarter when considered in the context of a longer term trend.
The second big contributor to the third quarter’s 2% initial growth was consumer spending. It reportedly contributed 1.4% of the 2% total for the third quarter GDP. But one needs to look at the composition of such spending in order to determine if it too will be sustained, or whether temporary forces are at work here as well.
Consumer spending is being driven not by fundamentals of real household disposable income growth, but by temporary factors as well. This past year much of consumer spending has been driven by the top 10% wealthiest households, whose spending in turn is driven largely by stock market returns. And stocks have done extremely well in 2012, boosted in particular by the Federal Reserve’s early 2012 ‘operation twist’ quantitative easing program, and over this summer by investors’ anticipation that ‘quantitative easing 3.0’ would follow, which did. Federal Reserve QE is directly correlated with surges in stock prices, as banks and investors take advantage of the free Fed money and lend it to professional investors who in turn drive up stock prices by speculating. That brings more money into the stock markets, driving up stock prices and returns to wealthier households. Returns on corporate bonds have also boosted wealthy household earnings. It is not surprising then that the top 10% households, doing very well, are in turn driving much of consumer spending, or at least inordinately so. The remaining 90% households appear to be spending in the third quart—but not based on real income gains. Their spending is being driven by a surge in credit card issuance by banks, and usage, on the one hand, and by spending down savings on the other. Savings rates have fallen over this past summer. High on the spending list for the bottom 90% appears to continue to be auto sales, as auto companies, with bloated over production and inventories and still not fully recovered from the recent recession, compete more intensely with each other. Much of auto sales are due to deep discounting and purchase deals amounting to no interest loans stretched out over 60 months and more. But this kind of discounted sales, combined with credit and dissaving based spending cannot continue. Nor may even the stock market driven consumption of the top 10% households. In short, a scenario of declining consumer spending is likely, and this writer predicts it will begin in the present fourth quarter 2012 period once the national elections are over and the unnatural optimism of the US consumer hits a wall of reality immediately after the elections.
A third, much less important, contributor to the 2% GDP initial number is housing. Much is made of a nascent housing recovery. But there is little evidence of such. Housing will continue to ‘bump along the bottom’ for months to come, and likely for years. What indications of housing growth that has appeared last quarter is mostly ‘multifamily’ units, i.e. apartment building, as the 12 million homeowners foreclosed over the crisis are forced to rent.
Offsetting these ‘one time’ and weak factors behind the 2% GDP number are several serious negative areas in the economy that show every sign of getting worse.
After growing at a nearly 20% annual rate in the fourth quarter of 2011, business investment has declined precipitously every quarter. Spending on equipment and software in the third quarter collapsed to zero, and business spending on buildings turned a negative -4.4% last quarter. These figures represent a clear 12 month rapid decelerating trend. Fourth quarter will be no doubt negative again. Some pundits argue this is the business community registered its uncertainty and concern over the ‘fiscal cliff’ coming January 1, 2013. This writer disagrees. It is due to two factors: first, the rapid slowdown of the global economy now underway which is beginning to impact the US economy with a lag. That slowdown, moreover, shows all the signs of continuing. Second, it is due to an emerging ‘capital strike’ sending a message to Congress that business and investor tax cuts must be continued ‘or else’. Continuing, and deepening business tax cuts, of course will make the ‘fiscal cliff’ worse. So it is not a question of concern about the deficits; it is a question of business insistence upon more and more tax cuts.
Another negative area for the economy to come is reductions underway in business inventory spending. Still another is the sharp drop off in US exports (and thus manufacturing activity) as the aforementioned global economic slowdown continues to deepen. In the third quarter, US exports turned negative for the first time in more than three years—for the first time since the spring of 2009 in the midst of the last recession quarter. Something very serious therefore is now beginning to take place in global trade, US exports and therefore US manufacturing activity not seen for more than three years.
To summarize, the ‘positives’ in the third quarter GDP numbers are extremely tenuous and temporary, while the negatives in terms of business real investment, exports, trade, and global economic slowdown all appear to have long term ‘traction’ and staying power. It will be interesting to see if those politicians elected in November 2012 are able to accurately access the long term trends of importance to the US economy, or whether they are myopically intent on ensuring a collapse of consumer and government spending in 2013 while guaranteeing the wealthy continue to get their historically generous tax cuts for another decade.
Dr. Jack Rasmus, October 29, 2012
Jack is the author of the 2012 book, “Obama’s Economy: Recovery for the Few”, and hosts the radio show, ‘Alternative Visions’, on PRN.FM. He blogs at jackrasmus.com and can be followed on twitter at #drjackrasmus.

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