Allison Class Dinner Talk 10/26/12

October 26, 2012

Class Dinner Talk by Herb Allison: After the Election: Change We Can Believe In?

Thanks, Bob. I apologize for canceling last year. Thanks for re-inviting me. I’ve framed my topic as a question: Will this election finally bring change we can believe in? My main goal is to provoke a discussion among all of us after I’ve finished my remarks. Instead of talking about whether Obama’s or Romney’s platform is a better prescription for the country’s ills, I’ll focus on whether our political industry, also known as the Democratic and Republican parties, is capable of fixing the deep structural flaws in our economy and putting our country back on a path toward real, stable growth. The parties’ record in dealing with the worst financial crisis in history and one of our worst recessions doesn’t offer much hope that we’ll see real change in our prospects for growth and prosperity. In response to a 50% fall in the stock market; a 30-50% plunge in housing prices; a 50% drop in household savings; a 100% increase in unemployment; a wipeout of all the capital in the major banks and the mortgage system; and a collapse in demand for goods and services… Congress took just three significant actions: TARP, the American Recovery and Reinvestment Act and the Financial Reform Act—each passed by the narrowest of margins. All three were widely criticized as costly, socialistic infringements on our free-market system. Actually, the acts of Congress under presidents Bush and Obama accounted for just a fraction of government’s total assistance during the crisis and hardly affected the structure of our faulty financial system. Many condemned TARP as a $700byn loss to taxpayers that was wasted on bailing out undeserving big banks and auto companies. Actually, TARP invested “only” $391byn, was largely paid back by 2010, and will make a profit of roughly $20 billion. TARP was the essential first step to restoring financial stability, but it provided a minor portion of the $1 trillion-plus needed to recapitalize the banks. The much-reviled American Recovery and Reinvestment Act (“the stimulus”) totaled around $800 billion—again a small amount compared to the trillions of dollars of consumer demand vaporized by the crisis. The Financial Reform Act, despite its unnecessary complexity, actually preserved the “to big to fail” banks and their embedded conflicts of interest, thanks to their $300mm lobbying campaign. Most support for the financial system and the economy was provided, not by Congress, Bush and Obama, but by an institution outside the political industry, the Federal Reserve, which guaranteed $3 trillion of money market funds, purchased huge amounts of securities to support markets, and drove down interest rates to stabilize the housing market and enable banks to fatten profits and rebuild capital. In the years of slow growth following the crisis, Congress has taken no significant actions to bolster economic recovery. Both parties blame other. “Gridlock” has become the catchword for politics in Washington, and it’s been accompanied by deepening political differences within the general public. Fourteen years ago, a poll by the Washington Post and the Kaiser Foundation revealed that 41% of Republicans and 45% of Democrats were strong partisans. In the same poll taken last year, those percentages had climbed to 65% and 62%, respectively. The gaps between Republicans and Democrats have widened on many issues, including the role of government, the relative importance of balancing the budget versus creating jobs, the place of religion in politics, legalization of gay marriage and protecting women’s reproductive rights. Yet, even while the electorate has become more divided, the public has grown more exasperated about rigid partisanship. In a recent WSJ/NBC poll, 52% want one party to rule Washington; just 39% want divided government. That’s the first time that most voters supported one-party rule in the poll’s 30-year history. Apparently the public is concluding that political compromise isn’t possible, so one party must govern. However, because the public is split so evenly between parties, dominance by one party seems unlikely. So, to answer question of whether it’s possible for the public and politicians to agree on “change we can believe in”, we must first address two basic questions. First, why has the political split deepened and gridlock hardened, even as the country’s problems and the urgency of finding solutions have grown? To answer that question, we should heed Deep Throat’s advice to our classmate, Bob Woodward, almost 40 years ago: “Follow the money.” Although gridlock seems to be about ideology, it’s really about money. The animosity in DC and across country is more than political. It’s visceral, rooted in fear over who’ll gain and who’ll lose in the war over fiscal policy. The two parties have drawn lines that they’ve promised not to cross: on one side, the pledge is “no new taxes”; on the other it’s “no cuts in entitlements”. The parties have denied themselves room to maneuver, even to avert a looming fiscal crisis in coming weeks. Both make one-sided arguments for their positions. When Mitt Romney confided to his backers that the 47% who oppose him depend on government entitlements, he didn’t mention that most of his supporters also receive generous government benefits of a different sort: tax breaks. In reality, the portion of the public feeding from government’s trough isn’t 47%. It’s close to 100%. Government benefits of all kinds have grown greatly in recent decades, so they’re now much more important to us, and more worth fighting for. Spending on entitlements (such as Social Security, Medicare, Medicaid, unemployment insurance and poverty programs) totaled just 14% of federal spending in 1960. Today, entitlements consume 46% of federal spending, and they’re expected to reach 61% by 2030. Payments to the poor and unemployed grew 30-fold from 1960-2010, to $650 billion. Two-thirds of that emanates from the Medicaid program that didn’t exist in 1960. But payments to older Americans total almost twice the payments to poor people: $1.2 trillion in 2010. Those entitlements (mainly Social Security and Medicare) are paid mostly to those in the middle-income and affluent categories. Together, old-age entitlements soak up half of the federal government’s total revenues. Over the past 50 years, the two parties have worked in unspoken unison to increase entitlements. Interestingly, spending on entitlements grew faster under Republican administrations than Democratic ones (8% higher growth per year if the president was Republican). The other form of government benefits—tax breaks—mainly goes not to big corporations but to households, primarily upper-middle-class families that Democrats and Republicans have vowed to protect from new taxes. The assortment of tax breaks nearly doubled in past 25 years to include benefits for children, college tuition, retirement savings and investment. At the same time, some long-standing tax breaks, like the mortgage-interest deduction and tax-free health-insurance premiums paid by employers, have soared. The value of tax breaks now equals the government’s entire revenue from income taxes. In 2011, Federal taxpayers received about $1 trillion in credits, deductions and other perks while paying about $1 trillion in income taxes. Put another way, taxpayers lucky enough to qualify for tax breaks get more than a 50% discount from posted tax rates. Tax breaks now cost nearly as much as outlays by the Pentagon and all other federal agencies combined. If we view tax breaks as government spending, they’ve become main method for creating new spending programs. The reason: Congress and White House can give taxpayers a government benefit while reducing their taxes. Lawmakers can pose as tax cutters rather than spenders. Thanks to decades of growth in entitlements and tax breaks, we’re now tangled up in a bitter fight over how to divide a shrinking pie in order to cut deficits. That’s one reason why partisanship has risen and gridlock has hardened. But it’s not the only reason. Another is the political system’s insatiable demand for funding. The Republican and Democratic parties straddle a sprawling political industry not envisioned in our Constitution and not fully comprehended by the public. The parties sponsor thousands of elected officials, staffers, campaign advisors, lobbyists, pundits and think-tank gurus at national, state and local levels. The lifeblood of this large political industry is, of course, money. The public is increasingly concerned about the swelling gusher of funds poured into Presidential campaigns. The total for this four-year cycle has exceeded $2.5 billion. But that’s a fraction of the money flowing through the political system. Companies in the top 20 industries spend $2 billion every year on lobbying in DC. In other words, the spending of lobbyists is more than three times the rate of spending on national political campaigns. And spending by lobbyists is exceeded by the operating budgets of political media (including partisan cable channels and websites) that boost their profits and their partisans by fostering conflict. Their combined expenditures exceed those of the largest super PACs. The political parties know that they maximize funding by drawing sharp distinctions between each other and by stoking fear of the other party’s intentions. The parties have broadened and solidified the growing divide between Republicans and Democrats by convincing their followers that they’re at risk of losing what they have and the values they cherish. Today, 60% in both parties say that people sharing their values are losing influence in American life. Both parties energetically exploit that fear to incite their followers and raise money. The more fiercely they fight, and the more evenly they’re matched, the more money they raise and the more the political industry prospers. Blurring their brands by compromising with the other party would deplete energy and money flow. It follows that the two political parties, while competing ferociously, are actually co-dependent. Their conflict is the wellspring of their funding. The two parties are symbiotic components of a single political industry. And for them, gridlock is good for business. By accentuating their ideological differences and resisting accommodation as long as possible, they together maximize their total funding and their adherents’ fervor. Yet, although their brands and messaging differ sharply, their products don’t differ much in practice. If you don’t believe that, look again at their record for steadily expanding entitlements and tax breaks across Democratic and Republican administrations. Ross Perot was right when he declared, “there’s not a dime’s worth of difference between the Republicans and Democrats”. When they govern, they act pretty much the same. Romney’s abrupt shift toward the center near the end of his campaign is recent evidence. After espousing “deeply conservative” positions to secure nomination and ample funding for his campaign, and consequently fading in the polls, he suddenly became a safe moderate willing to negotiate with the other side. His right-wing backers didn’t peep; after all, for the well-heeled funders of both parties, it’s not as much about ideology as it is about their candidate winning—so they’ll be owed access and protection of their interests. And for the politicians and party leaders, winning is essential to extorting more contributions as the party in power, and assuring that their wing of the political industry maintains full employment. Both parties have demonstrated over many years that securing their jobs, power and funding trumps their professed ideology and, on fiscal matters, the national interest. Admittedly, the parties must occasionally reward their ideologues to strengthen their brands and sustain their funding. A party can do that without compromising on fiscal issues by confirming Supreme Court justices aligned with it on social issues. From a fiscal standpoint, those appointments can seem costless. Some might counter that passage of the Affordable Care Act (“Obamacare” or “ACA”) and the Financial Reform Act early in the Obama administration shows that deft policy-making and legislative strategy can sometimes override political gridlock. In fact, the ways those laws were crafted and enacted demonstrate the opposite. Passage of “Obamacare” was achieved by the narrowest of margins and only by creatively avoiding a direct vote by the Senate. The process of shaping the ACA and the fierce political wrangling surrounding it were great moneymakers for the political industry. In 2009-2011, the years surrounding the enactment of ACA, the health industry spent $1.5 billion on lobbying, mostly to influence ACA’s provisions and rules. The Financial Reform Act (”Dodd-Frank”) was also passed by thin margins in both houses on strictly party-line votes. On the surface, it’s a tough law bristling with provisions to constrain and monitor the banks’ behavior. But the wording in many of those provisions leaves room for rule making to dilute their effect. More significantly, Dodd-Frank preserves the too-big-to-fail banks and doesn’t expunge their embedded conflicts of interest. The bankers have spent at least $300 million so far in an all-out lobbying campaign to water down the law’s provisions and rules. In that respect, the legislative process was bipartisan. Both parties and their allies benefited from the bankers’ largesse. The parties’ ideological masquerading, fear mongering and use of lawmaking to raise money are not new. What is new is that the political industry and its appetite for funding have grown much larger, so the stakes for the parties have risen much higher. When we strip away all the rhetoric and posturing, we see that the growing partisanship within the electorate over entitlements and tax breaks, and the gridlock in Washington, have a common explanation: they’re battles over money. Even more troubling: they’re battles over how to split the money over the short run, not over how to allocate resources to address the long run, strategic challenges that face the country. Those challenges are obvious. Most politicians and ordinary citizens probably agree on what they are: –renewing growth of the economy, average incomes and savings; and –reducing government deficits. Let’s focus on the challenge of growing the economy, incomes and savings. The “real” economy and incomes, adjusted for inflation, have stagnated, not just for the last 10 years (as recently reported by the New York Times) but for more than a generation. A study by Brookings Institution shows a long, structural deterioration in jobs and wages for men. Median earnings for working men age 25-64 declined 4% from 1970 to 2010, adjusted for inflation. And that data ignores the falling percentage of men with jobs. In 1970, 94 percent of prime-age men worked. In 2010, only 81 percent had jobs. Adjusting for increased unemployment, the real earnings of the median male have declined 19% since 1970. We have to go back to 1964, almost 50 years ago, to find the last year when the median working male earned a real wage as low as the median male in 2010. For men with just a high school diploma, conditions have deteriorated much more. Their average real earnings fell 41% from 1970 to 2010. Women have done much better since 1970, but they started from a lower level. Their median earnings have risen 71%, and the percentage of women working has also grown, from 54 to 71%. But since 2000, women’s real earnings have fallen, too, by 6%. During the same period, the improvement of educational attainment has slowed, especially for men. The share of men 25 to 34 with a college degree has hardly grown in the last 30 years. Again, the trend has been much better for women. Today, the outlook for the next generation of workers is bleak. Many entering the workforce with college degrees will not only have to pay off tuition debt but will face pressures to support parents who haven’t saved enough to fund their retirements. Those without college degrees will be even worse off. They’ll compete for fewer, lower paying jobs with much smaller benefits than their parents enjoyed. And younger generations aren’t likely to enjoy the entitlements and tax breaks of the past. Our failure to generate growth in incomes for decades has inflicted huge costs. To sustain living standards, households took on unsustainable debt and put both parents to work (in families still having two parents). Economic stagnation has also distorted federal spending and exacerbated partisanship and gridlock. With our assent, government expanded transfer payments and tax breaks recklessly to compensate for failures to raise real incomes, expand opportunities for the middle class and the poor, and enable workers to save enough to live with dignity in old age. In effect, government has subsidized those outside the shrinking ranks of the affluent—the less educated and the unconnected as well as older people with inadequate savings. And government has provided tax breaks to the winners in our distorted economy so they’d willingly fund part of those federal subsidies. Transfer payments and tax breaks are embarrassing evidence of our unwillingness to make fundamental changes in our economy and society that are essential for broadly developing our human resources and expanding our capacity for future growth. While we’ve been literally papering over our failure to grow incomes and provide equal opportunity, we’ve also been starving investment in our country’s future. Federal spending on infrastructure, education, research and military equipment has shrunk from 32% of expenditures in 1962 to just 15% today. By under-investing in infrastructure and human capital, and redirecting spending toward padding our current incomes, we’ve become self-interested factions struggling for shares of a dysfunctional economy that, in its current form, is unlikely to preserve living standards in the years ahead, no matter who’s in office. The public and politicians sense that we face daunting challenges and must change course. That realization is a positive, an essential prerequisite for change. But even if one party regained control of Congress and the White House, its actions would likely be more cautious than its campaign rhetoric, given the expected 50/50 split of the popular vote. So how can we overcome the polarizing conflict between interest groups, and the gridlock between political parties? In the coming months, fear of the looming fiscal cliff may force compromises on cutting spending and increasing federal revenues. We could, as 80 CEO’s have recommended, limit the growth of health-care spending, make Social Security solvent and enact comprehensive and pro-growth tax reform, which broadens the base, lowers rates, raises revenues and reduces the deficit. It’s unlikely, though, that even that so-called “bold” agreement along lines of Simpson-Bowles will address the fundamental imbalances in the US economy. What’s sure, however, is that a serious attempt to cut entitlements and tax breaks will create an unprecedented bonanza of lobbying and fundraisers for the political industry. Every interest group will zealously protect its interests. If we aspired to go beyond taking expedient measures for alleviating the immediate fiscal crisis and, instead, resolved to restore real, lasting growth in national output as well as incomes and savings, we’d have to commit to a much bolder plan. It would include much greater investments in our people and infrastructure and much deeper reforms of government programs and our financial industry than we now contemplate. For instance, we’d have to transform our educational system so it offers opportunity for all young people and working adults to qualify for well paying jobs in a global economy. Making good education available and affordable would require replacing a rigid system that restricts access to excellent schools with more accessible, cheaper methods of learning such as “massive, open, online courses” at all levels, so students in poor communities could obtain education comparable to that in affluent areas. We’d also have to make investments in infrastructure similar in scale and breadth to those in the 1950’s-60’s. The long list of areas to modernize would include transportation, power generation and transmission, water management and efficiency of buildings. To free up funding for those investments, which would create hundreds of thousands of jobs, we’d have to transform entitlement spending to cut costs dramatically while better meeting real needs. That sounds far-fetched, but it could be done if we  consolidated the current hodgepodge of entitlements into fewer, needs-based programs tailored to people’s life situations. The streamlined programs could be far cheaper to administer. We’d also have to transform our financial system so it’s more competitive, stable, lower cost and aligned with the public interest. That overhaul would include restructuring the big banks that now dominate the markets, strengthening corporate governance and streamlining regulatory oversight—changes more fundamental than any attempted thus far. At the same time, we’d have to simplify our tax system in a manner with the goals of raising more revenue and reducing average tax rates. The byzantine complexity of the existing tax code distorts incentives, misallocates resources and slows economic growth. Government’s continual tinkering with the tax code influence market behavior invites interest groups to lobby and finance campaigns to secure favored tax treatment. Drastically simplifying the tax code would redirect funds away from the political industry toward more productive uses and would greatly reduce the clout of special interests. Making such ambitious changes to our economy may seem unrealistic. But they’re doable if we face the reality of our country’s situation and resolve to improve it. To move our citizens and politicians out of their entrenched positions toward broader consensus and national renewal, our leaders should engage the public in a candid, fact-based dialogue aimed at forging general agreement on long-term goals for our society and economy. Those goals might include global competitiveness, reliable growth of incomes and savings, access to excellent education in every community, conservation of the environment and natural resources, cost-effective health care for all and national security. At that strategic level, there’s probably more opportunity to create a broad consensus than there is at the baser level where we battle today. At that higher level of aspiration, we may finally envision change we can all believe in.