Our Declaration of Dependence

As we get into the final stretch of the 2012 Presidential election, both parties are trying to convince the voters that this is the most important election of their lifetime and their choice will determine the course of the nation for the generations to come.   

If this is truly the most important election of our lifetime, it surely does not look like from the problems being discussed and the solutions being prescribed by  the two candidates.   One of the biggest problems the new administration will face will be the cost of our growing entitlements.  None of the candidates are providing any serious plans to address this problem.

In a fantastic essay written by Nicholas Eberstadt (A Nation of Takers: America’s Entitlement Epidemic), author makes the case that entitlement mentality is fundamentally changing the American character, which may be sacrificed long before the credibility of the US economy.   In this blog, I will try to summarize key points from this article.

Eberstadt suggests that while the American republic has endured for almost two and a quarter centuries, over the past fifty years, American government has become an entitlement machine which devotes more attention and resources to public transfer of money, goods and services to individual citizens than to any other objectives.

Eberstadt shares some breathtaking numbers.   In 1960, US government transfers to individuals totaled about $24 billion.  By 2010 that total was almost 100 times larger! It was around $2.2 trillion.   In 1960, entitlement related payments accounted for well under a third of the federal government’s total outlays.  By 2010, this share accounted for about two-third of all federal spending, with all other responsibilities of the federal government including defense making up barely one-third.  US government budget divides entitlement spending into six baskets: income maintenance, Medicaid, Medicare, Social Security, unemployment insurance and all the others.  Broadly speaking, the first two baskets attend to entitlements based on income status, the second two based upon old-age status and the next two based upon employment status. 

Income related entitlements including health-care services account for over $650 billion in2010.  For older Americans-Medicare, Social Security  and other pension related payments amounted to about $1.2 trillion in 2010.  To put things in perspective,  total revenue collected by the federal government in 2010 was around $2.2 trillion which is equal to the total entitlement spending that year.  It means every other function of the government including defense was funded thru deficit funding.  Budget deficit in 2010 was more than $1 trillion.

Eberstadt argues that there has been a steady shift towards entitlement lifestyle especially in the last couple of decades.  At the time of the founding of the country, there was an affinity for personal enterprise and industry and a contempt for anything that will smack of entitlements.  That resistance of government entitlement was ultimately overcome.  Today more than half of all American households receive transfer benefits from the government. 

Author argues that omnipresence of entitlements have already altered the American way of life.   With personal dependence on government handouts not only destigmatized but being enshrined as a right, mass behavior is changing in highly uncivil directions.  How many times have we seen elderly protesting “hands off my Medicare”, without realizing that their consumption will be at the expense of those born after them.   They rationalize this behavior with the notion that they have “already paid for” these benefits not knowing that on an average they will take out three times from the system more than what they put in.  The fact is that neither Social Security nor the Medicare trust funds can honor the future promises they have made today.   Unless we make significant changes in entitlement spending, we have decided to mortgage our future for a more comfortable retirement today.

Current fiscal trajectory is unsustainable.   The 2010 Bowles/Simpson commission report dealt with this problem squarely.  Their report was aptly called “The Moment of Truth”.   They provided a framework, which can provide solid underpinning of a legislation to address this problem. 

It is incumbent upon the Presidential candidates to share their plans for addressing this most “predictable crisis” facing us.  Until they clearly articulate their plans to implement recommendations of Bowles/Simpson commission report, they have not earned our vote.

Thinking Fast and Slow

Recently I read the book "Thinking, Fast and Slow" by Daniel Kahneman who received the 2002 Nobel Prize in Economics. It is a fascinating book. In this post, I will try to summarize my understanding of key concepts from the book.

Kahneman starts by introducing two systems, named rather inaptly, System 1 and System 2, that drive the way we think. System 1 is fast, intuitive and emotional which can be somewhat manipulated. System 2 is slower, deliberate and logical but also somewhat lazy. We would like to believe that we are deliberate, rational and logical and hence System 2 is at works but most of the time, System 1 is in charge and funny thing is, we can not do much about it.

A lot of things we do, like answer to 2+2=?, or drive a car on an empty road, detect hostility in a voice, orient to the source of a sudden sound, all happen without much effort or attention from our side. We do these and similar things, involuntarily and can not prevent ourselves from doing even if we want to. This is all System 1 at work.

Operations of System 2, however, require attention and are disrupted when attention is drawn away. Few examples would be to search memory to identify a surprising sound, count the occurrence of letter "a" in a page of text, compare two washing machines for overall value, fill out a tax form.

According to the author, System 1 and System 2 are both active whenever we are awake. System 1 runs automatically and System 2 is normally in a comfortable low-effort mode. System 1 continuously generates suggestions for System 2. When all goes smoothly, which is most of the time, System 2 adopts the suggestions from System 1 with little or no modification. We generally believe our impressions and act on our desires, and that is fine - usually.

When System 1 runs into difficulty, it calls on System 2 for support. For example, when we are surprised, or someone asks a questions for which we do not have a ready made answer, like 17X24=?, System 2 is activated.

The division of labor between System 1 and System 2 is highly efficient. Arrangement works well most of the time because System 1 is generally good at what it does. System 1 has biases, however, systematic errors that it is prone to make in specified circumstances. It sometimes answers easier questions than the one it was asked, and it has little understanding of logic and statistics. Here is a good example.

Let us take a simple puzzle. Do not try to solve it but listen to your intuition.

A bat and ball cost $1.10.
The bat costs one dollar more than the ball.
How much does the ball cost?

What number came to your mind? If you are like most people, your intuitive answer is 10 cents. Now actually do the math. Correct answer is 5 cents. It is safe to assume that intuitive answer also came to the mind of those who ended with the correct answer - they somehow managed to engage their System 2 and resist the suggestion of System 1.

Author also introduces the concept of WYSIATI (What You See Is All There Is). System 1 is radically insensitive to both the quality and quantity of the information that gives rise to impressions and intuitions. It leads us to jumping to conclusions on the basis of limited evidence.

There are other important concepts in the book, all of which can not be described here. Kahneman uses these concepts to conclude that humans need help to make more accurate and better decisions and in some cases policies and institutions can provide that help. Libertarian approach assumes that humans are perfectly rational (System 2 is at works all the time) and they will make the right decision every time so we should not interfere with the individual's right to choose, unless the choice harms others. Kahneman makes a case for "Nudge", based on the book of the same name, written by Richard Thaler and Cass Sunstein. They advocate a position of libertarian paternalism, in which state and other institutions are allowed to "nudge" people to make decisions that serve their own long-term interest. A good example of Nudge would be the designation of joining a pension plan as the default option. It is difficult to argue that anyone's freedom is diminished by being automatically enrolled in the plan, when they merely have to check a box to opt out. Humans need help to make good decisions and there are informed and unintrusive ways to provide that help.

Downgrade of Our Political System

It seems we will ultimately not default. Just hours before the looming deadline, President signed the bill passed by both houses of congress which will allow treasury to borrow money and continue to pay its bills.

The whole spectacle forces one to wonder about the quality of our political system. If Moody's or S&P were in the business of rating political systems, they should have downgraded us to junk status.

While no one party or group came out looking good, I think following three entities especially came out diminished.

Tea party, which propelled republicans into majority in the house in the last years elections, seems to have misread their mandate. They looked irresponsible in this debate when they denied that defaulting on our debt is a big deal. They don't understand that complex problem like our debt which has been accumulated over decades requires thoughtful solution and can not be fixed overnight. They have one answer to all the problems of the world: tax-cuts.

Liberals on the other end seem to be living in a different planet where there are unlimited resources, country has no debt and more spending is the answer to all the problems. They believe in Keynesian economics and want to spend more and tax more. They blame corporations and rich people for almost everything that ails us today ignoring the fact that it is the private sector which drives our economic engine. According to them, if people are getting richer, they must be doing it on the backs of working poor.

President also came out of this debate diminished. Instead of showing true leadership on fiscal issues, in the beginning, he just offered lip service. Having taken a beating in health care debate, he could not muster the courage to take on this problem. He setup the debt commission but completely ignored its recommendations. His budget this year did nothing to address the probelm. He made a political calculation of not coming out with specific debt reduction plan of his own and in this he completely misread the mood of the country.

The real solution to our long term fiscal challenges will require entitlement reform and tax reform, not addressed in the current deal. Looking at what it took to just increase the debt ceiling, I am not very confident that we will solve this problem any time soon.

Chairman Ryan's Budget for 2012: Path to Prosperity

House budget committee chairman unveiled his budget for 2012. His budget is the first honest attempt to address the fiscal crisis facing the country. While I don't agree with all the proposals in the budget, he actually has a serious proposal. Same can not be said of administration or democratic controlled senate.

Last year President appointed Bowles-Simposon bipartisan commission to develop a framework to address our looming fiscal crisis. Commission submitted its findings to the President who has been missing-in-action on its recommendations. His budget blue print, submitted to congress in February, made no serious attempt at tackling what some have called "most predictable fiscal crisis". We just learnt that President will address the nation this week with his own proposal for deficit reduction. He is finally coming around.

As expected, Chairman Ryan is being blamed by democrats for balancing the budget on the backs of seniors. I think it was courageous of him to submit his proposal knowing that it will be used as ammunition against him. Some have even called his proposal "suicidal". It is little disheartening to note that nobody from Republican leadership, including 2012 potential Presidential candidates, have come out in support of the plan. It is clear that his plan will not be adopted as it is. Compromises will be made. However nobody can deny that he has set the agenda for the debate and others are following.

Libyan Crisis: Should we or should we not intervene

In Libya, Col. Gadhafi is massacring its people to keep his hold on power. He has been ruling Libya for more than 40 years and seems in no hurry to leave. To say that the man is insane is an understatement. In 1975, he published "The Green Book" and made it a required reading for all Libyans. It documents his political philosophy. In here, he rejects liberal democracy, capitalism and free press and touts "Direct Democracy" being practiced in Libya where he appoints all key office holders.

One Libyan scholar, Dirk Vandewalle, has described the following passage from the book as encapsulating Gadhafi thought best:

"While it is democratically not permissible for an individual to own any information or publishing medium, all individuals have a natural right to self-expression by any means, even if such means were insane and meant to prove a person's insanity."

The question for American administration is whether to intervene militarily or not to remove Col. Gadhafi from power. It seems to me that Libyan ruler currently does not represent a clear and present danger to United States and thus obviates any need for an unilateral military intervention.

Having said that, international community can not ignore the prospect of a full-fledged civil wire in Libya and thus a co-ordinated respond by the world community makes sense. Towards that goal, Arab League, last week approved creation of a "no-fly" zone over Libya. This is the first time Arab League has recommended such a measure against one of its own members. United States should now lead the effort in UN to get a security council approval for no-fly zone and work with its NATO member nations to implement it.

President Obama is being deliberate in this matter and I fully agree with his approach. We are still paying the price for hastily invading Iraq. We can not make that mistake again.

Tragedy in Tuscon

By now, a lot has been written and said about the tragedy in Tuscon last Saturday. In recent history, there have been very few incidents like this which have rallied the whole nation. Challenger disaster in 1986, Oklahoma city bombing in 1995 and September 11, 2001 come to mind. While we grieve and mourn for the dead and pray for the survivors, we also want to know why it happened and how can we stop it from happening in future.

It is very tempting to lay the blame for this tragedy on the door steps of people or policies we don't agree with. People on extreme right and left have pointed fingers at each other. This serves no purpose. Frankly, we may never know the reason. If this tragedy can help start the right debate about our policies about mental illness, gun control etc., it might serve some purpose but pointing fingers at this stage does more harm than good.

I thought President Obama struck the right tone at the memorial service on Wednesday. He was inspiring and comforting at the same time. He really rose to the occasion. It was one of the best moments of his presidency.

The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform

The moment of truth is upon us. The national commission on fiscal responsibility and reform issued its report, aptly named, "The Moment of Truth". If you are not convinced that we are facing a fiscal crisis, here is something that will convince you. This is a quote from the report....

"Over the long run, as the baby boomers retire and health care costs continue to grow, the situation will become far worse. By 2025 revenue will be able to finance only interest payments, Medicare, Medicaid, and Social Security. Every other federal government activity – from national defense and homeland security to transportation and energy – will have to be paid for with borrowed money. Debt held by the public will outstrip the entire American economy, growing to as much as 185 percent of GDP by 2035. Interest on the debt could rise to nearly $1 trillion by 2020. These mandatory payments – which buy absolutely no goods or services – will squeeze out funding for all other priorities."

By recommending some very tough choices, taken as a whole, the plan will:
␣ Achieve nearly $4 trillion in deficit reduction through 2020, more than any effort in the nation’s history.
␣ Reduce the deficit to 2.3% of GDP by 2015 (2.4% excluding Social Security reform), exceeding President’s goal of primary balance (about 3% of GDP).2
␣ Sharply reduce tax rates, abolish the AMT, and cut backdoor spending in the tax code.
␣ Cap revenue at 21% of GDP and get spending below 22% and eventually to 21%.
␣ Ensure lasting Social Security solvency, prevent the projected 22% cuts to come in 2037, reduce elderly poverty, and distribute the burden fairly.
␣ Stabilize debt by 2014 and reduce debt to 60% of GDP by 2023 and 40% by 2035.

This is a serious proposal. 11 of the 18 members including three Republican Senators voted yes for the plan. Considering how broken Washington is currently, this is an achievement. All three house Republican members voted no so did two liberal Democratic house members. I was surprised to find that Democratic senator Max Baucus, chairman of finance committee voted no and so did Andy Stern, former President of Service Employees Union, a Presidential appointee.

The questions is what now. I think it is another chance for Presidential leadership. President Obama should engage the Congress and the whole nation on a debate on how to implement the recommendations of this commission. If he does that and succeeds in implementing majority of the recommendations, he will leave behind a legacy similar to of some of our greatest Presidents like Abraham Lincoln or FDR.