Thursday, July 21, 2016

An Update on Costs of End-of-Life Care

For those interested in the health care costs in end-of-life care, Medicare data are the obvious place to look.Of the 2.6 million people who died in the U.S. in 2014,  2.1 million, or eight out of 10, were people on Medicare, making Medicare the largest insurer of medical care provided at the end of life. Spending on Medicare beneficiaries in their last year of life accounts for about 25% of total Medicare spending on beneficiaries age 65 or older." Juliette Cubanski, Tricia Neuman, Shannon Griffin, and Anthony Damico make this point at the start of their short "data note" entitled "Medicare Spending at the End of Life: A Snapshot of Beneficiaries Who Died in 2014 and the Cost of Their Care" (July 2016, published by the Kaiser Family Foundation). "

Average health care spending for Medicare recipients who died in 2014 was $34,529, nearly four times as high as the average Medicare spending of $9,121 for those who didn't die. This general pattern isn't surprising: after all, those who die often tend to have health issues beforehand.  The detailed data shows that the biggest part of this cost difference is driven by higher spending for in-patient care in hospitals for those who died in 2014. What's interesting to me is that the share of Medicare spending going to those who die in that year seems to be diminishing.

Figure 3: The share of total traditional Medicare spending on traditional Medicare beneficiaries who died at some point in the year has declined over time

What explains this shift? The report lists these causes:
"In addition, we find that total spending on people who die in a given year accounts for a relatively small and declining share of traditional Medicare spending. This reduction is likely due to a combination of factors, including: growth in the number of traditional Medicare beneficiaries overall as the baby boom generation ages on to Medicare, which means a younger, healthier beneficiary population, on average; gains in life expectancy, which means beneficiaries are living longer and dying at older ages; lower average per capita spending on older decedents compared to younger decedents; slower growth in the rate of annual per capita spending for decedents than survivors, and a slight decline between 2000 and 2014 in the share of beneficiaries in traditional Medicare who died at some point in each year."
(A couple of notes here: 1) The graph and all the data here refer to "traditional Medicare," which is the two-thirds of Medicare recipients who are not in "Medicare Advantage" plans. In traditional Medicare, the government pays health care providers on a fee-for-service basis, and thus has good data on what the costs were for services each year. In Medicare Advantage, Medicare makes monthly insurance-like payments to a managed care organization--like a health maintenance organization--and so the government does not have readily available data on the costs of what actual health care was provided at any given time. 2) The 13.5% in the graph above for 2014 doesn't match the 25% at the top. The difference is that this figure looks at the health care costs incurred in 2014 for those who died in 2014. The 25% figure refers to health care costs incurred in the 12 months before death--which usually reaches back into the previous year. For looking at trends, either approach can work fine, but plotting data for costs in the 12 months before death and comparing it to other spending in the same time interval is a more complicated tas, and the official data is organized on an annual basis, so that's what is reported here.)  

A misconception which seems popular, at least based on the kind of questions I hear, is that end-of-life spending is especially high for the very elderly. That doesn't seem to be true. This figures shows spending of those who died in 2014 by age: for example, Medicare spending on 65 year-olds who died in 2014 averaged $38,840, while for those over age 100 it averaged $14,985. Conversely, Medicare spending on those who survived 2014 tends to rise by age.
Figure 9: Medicare per capita spending for decedents over age 65 declined with age in 2014, while spending for survivors increased
This pattern seems like a positive one to me, in the sense that I suspect there is more that health care can do for the average person who is 65 or 70, compared to the average person who is 100 or 105. A more detailed breakdown of this data shows that when just looking at health care costs of those who died in 2014 by age, those who were in their late 60s had much higher expenditures on in-patient hospital costs (the orange bars), while the older age groups tended to have higher spending on hospice or skilled-nursing facility care. 
Figure 10: Medicare spending declined with age for decedents over age 65 in 2014, mainly due to lower inpatient hospital spending

End-of-life patients do tend to be high-cost patients, and in general terms, that pattern seems appropriate. But I've written before that a main goal for end-of-life care, shared both by many patients and health care professionals, is to make greater use of hospice, skilled-nursing, and at-home care at the end of life, rather than intensive care units in a hospital setting. The evidence shows that over time, the costs of end-of-life care are a diminishing share of US health care spending, and it is consistent with the belief that a shift toward greater use of hospice and other options at the end of life is gradually underway.

Wednesday, July 20, 2016

Public Higher Ed: State Support Down, Tuition Up

State and local financial support for higher education is falling, and the share of costs covered by student tuition is rising. Perhaps not coincidentally the number of students enrolled in US public higher education is has fallen in the last few years. That's the evidence from the State Higher Education Executive Officers Association in it annual report, State Higher Education Finance 2015, released in April

The report notes: "In 2015, states invested $81.8 billion in higher education ... Local governments invested $9.1 billion from property tax revenue in 2015 primarily for local district community colleges." Here are some estimates over the last quarter-century, from 1990 to 2015, about the contributions of state and local spending on a per-student basis. The dollar figures are adjusted for inflation, so back in the early 1990s state and local spending on higher education was about $8,500 per student, but from 2011-2015 (despite a bump up in the last few years) it has been under $7,000 per student. Meanwhile, average tuition paid per student has more than doubled, from less than $3,000 back in the early 1990s to over $6,000 in 2015.

Putting those two trends together, it's no surprise that the share of public higher spending covered by tuition is rising. Indeed, this figure shows that the share has nearly doubled, from 25% back in 1990 to approaching 50% at present. The report discerns a pattern here: "Net tuition revenue per student tends to increase most rapidly during periods of recession, shifting more of the cost of higher education to students and families. ... During economic recessions, student share increases quickly and a new level is established during periods of recovery. Traditionally, the student share has not
declined significantly as state and local funding has been restored. It is likely that student share will surpass 50 percent during the next economic downturn."

Of course, rising student loans have helped students to pay the higher tuition during the past 25 years. But student loans now total $1.3 trillion, and the dip in higher education enrollments in the last few years (shown by the red line in the first figure) suggests that ever-higher tuition and loans are not the way to expand the effectiveness and enrollments in higher education.


Tuesday, July 19, 2016

How Well Does GDP Measure the Digital Economy?

Digital technologies aren't just changing the way existing companies communicate and keep records, but are creating new kinds of companies (think Uber, AirBnB, or Amazon) and products (think and "free" products like email and websearch or an app like Pokemon Go). Can the old-style methods of measuring GDP keep up? Nadim Ahmad and Paul Schreyer of the OECD tackle this question in "Are GDP and Productivity Measures Up to the Challenges of the Digital Economy?" which appears in teh Spring 2016 issue of International Productivity Monitor, which in turn is published by the Ontario-based Centre for the Study of Living Standards. Perhaps a  little surprisingly, their overall message is upbeat. Here's the abstract:
"Recent years have seen a rapid emergence of disruptive technologies with new forms of
intermediation, service provision and consumption, with digitalization being a common
characteristic. These include new platforms that facilitate peer-to-peer transactions, such
as AirBnB and Uber, new activities such as crowd sourcing, a growing category of the
‘occasional self-employed’ and prevalence of ‘free’ media services, funded by advertising and ‘Big data’. Against a backdrop of slowing rates of measured productivity growth, this has raised questions about the conceptual basis of GDP, and whether current compilation methods are adequate. This article frames the discussion under an umbrella of the Digitalized Economy, covering also statistical challenges where digitalization is a
complicating feature such as the measurement of international transactions and knowledgebased assets. It delineates between conceptual and compilation issues and highlights areas where further investigations are merited. The overall conclusion is that, on balance, the accounting framework for GDP looks to be up to the challenges posed by digitalization. Many practical measurement issues remain, however, in particular concerning price changes and where digitalization meets internationalization."
The article employs a refreshingly down-to-earth strategy: it discusses, one by one, certain kinds of transactions in the digital economy, how the digital economy has altered (or in some cases created) these transactions, and how well they are captured in GDP.

For example, one set of digital economy activities is what the authors cal "intermediation of peer-to-peer services," which is hooking buyers up to sellers through Uber, AirBnB, eBay, new ways of getting loans, and others. The quantity and value of these kinds of web-based transactions has surely risen. But by and large, the value of these transactions are captured pretty well through the recordss of the companies involved. In these areas, one could argue that these underlying economic activities might be better captured as part of the digital economy than it was before. In the past, activities like unlicensed or off-the-meter cab drivers, informal off-the-books rentals, and garage sales were  not well-captured in official economic statistics.

Sure, some tricky issues do arise here. For example, if I use my car as an Uber driver, then my car is no longer solely in the economic category of "durable goods consumption," and now is also in part a form of "business investment." But it also true that people who work from home, in one form or another, have been mixing the "consumption" and "investment" categories for quite some time now.

A different set of issues arises thinking about how the digital economy has enabled consumers to take over certain tasks previously provided by producers. Here's their explanation:
Perhaps the best example is the use of internet search engines or travel websites to book flights and holidays, previously the preserve of a dedicated travel agent. But there are many other examples that merit consideration under this broad umbrella where market production blurs with non-market activity: self-check in at airports, self-service at supermarkets, cash withdrawal machines and on-line banking to name but a few. These innovations have all helped to transform the way consumers engage with businesses and brought with them associated benefits but they also involve greater participation on the part of consumers, and indeed involvement in activities that used to be part of the production process. Because the involvement of the consumer displaces traditional activity, the question is whether this increased ‘displacing’ participation should be included in GDP, one of the main arguments being that GDP would be higher, for
example, when a travel agent acts as an intermediary to conduct the search compared to when the individual conducts the search his/herself.
But of course, this issue isn't new either. GDP has always been about what is actually bought and sold in the economy, not about what might have been bought and sold. There are lots of goods and services for which households have some degree of choice between making or buying: cooking, cleaning, child-care, assembly (say, of new furniture), home maintenance or decorating, transportation various leisure activities, and others. The authors argue that in this broader context, "the scale of ‘digitalized’ participation activities is likely to be significantly less than those for other non-market services outside the production boundary." The usual approach to these activities for government statisticians is to set up "satellite" accounts in addition to GDP that offer estimates of their value, without actually adding them to GDP.

Some of the hardest issues arise in the areas of digitally-based consumer products that are free or subsidized to the consumer, like email, web-search, computer storage space, free software for computers, free apps for smartphones and tablets, and much more. Ahmad and Schreyer point out that "it is important to note that the provision of free services by corporations to households is not a new phenomenon. Households have long been accustomed, for example, to receiving free media services (television and radio) financed implicitly via advertising." Historically, what you pay for a daily newspaper has mostly covered the delivery costs, while the cost of news-gathering and production was supported by advertising. In addition, it has been a fairly standard marketing approach in the past to give away a good or service at a free or reduced price, and in that way to try to encourage buyers to spend more afterwards.

Of course, some puzzles arise here for GDP statisticians. For example, one view is that "the
value of the free service provided to the consumer can be equated with the value of the corresponding
advertising services." Another view considers "the time spent by households watching advertisements as an act of production, for which they are paid by the advertising firm, and in turn pay for the (previously free) services to the service provider." Various complexities arise here, but the differences in thinking about advertising-supported services are not fundamental in nature.

However, greater complications arise when part of the tradeoff for "free" digital services involves information. As the authors point out, the advertising approach to measuring GDP can be applied here, but it's a bit of a conceptual stretch. After all, advertising can be linked in a fairly direct way to the number of eyeballs or clicks, but the contribution that additional information makes in building up an overall database is harder to value:
"The second avenue for the financing of free digital products is collecting and commercially exploiting the vast amounts of data generated by users of digital products. In many ways, this financing model resembles the advertising model: there is an implicit transaction between consumers (who provide data) and producers (who provide digital services for ‘free’ in return). A third party may or may not be involved. Economically speaking, the service provider finances its free services by building up a digital asset (volumes of data) that is subsequently used in the production of data services. ... However (unlike the advertising model) the analogy is slightly more complicated here as there is no obvious proxy to establish the value of the services provided for free."
I won't try to do justice to their entire argument here, but a few other points are worth mentioning. There is a problem of valuing digital public goods, like Wikipedia or Linux. With conventional GDP, it's also difficult to value the 8 billion hours or so of volunteer time that Americans donate each year for other purposes. It seems clear that the value of "knowledge-based assets" is rising in companies, and for workers as well, and measuring the production and consumption of these assets is very hard. Digital transactions that cross international borders may cause ever-greater problems for GDP measurement, as well.

What seem to me the biggest challenges here are some classic issues for GDP statisticians that involve quality. Just to be clear, these issues of quality and variety aren't brand new in the digital economy. Even when just looking at goods, the many gradual improvements in quality can be very hard to capture. When thinking about services, the problem gets worse. When thinking about cost of a "unit" of health care services," or  "unit" of banking service, or  "unit" of legal services, it's quite hard to think about what the "unit" should be. In health care, for example, a day in an hospital, or a specific procedure like a colonoscopy, are quite different in their qualities now than they were a decade or two ago. Having dozens or hundreds of TV channels available is different in quality than than having only a few channels, just as the continual expansion of what is freely available on-line makes use of the internet a different quality experience.

The problems of measuring quality play out in a number of ways. When measuring output, an improvement in quality should should be viewed as a gain in actual real output, but it's not clear that the actual value of what is bought and sold captures that rise in value. An underlying problem here is that when it is hard to measure quality, it is also hard to measure prices and inflation. For example, the price of a day spent in a hospital room has risen dramatically over time. Presumably, some part of this increase is due to higher quality of what service is being provided, so it should be a rise in output. Indeed, perhaps the rise in the cost of a hospital room doesn't capture all of the rise in quality--so the rise in true output is actually bigger than the cost. Or perhaps some of the rise of the cost of the hotel room is just inflation. Economic researchers can make a career of delving into these kinds of issues, and the digital economy means that all the old questions need to be considered in new context.

However, there's one line which shouldn't be crossed. One sometimes hears the argument that the digital economy is understated in the GDP statistics because it doesn't measure the welfare or pleasure that people receive from various digital goods and services. But GDP is a measure of final goods and services bought and sold. GDP isn't welfare. It never has been welfare. To be sure, a high or a rising GDP is often correlated with many positive aspects of life for everyday people, But from the birth of the concept of GDP up to the present, no serious economists has ever argued that GDP is equal to welfare. Ahmad and Schreyer write:
"[I]t is clear that consumer valuation should not attempt to measure total consumer welfare arising from the use of free digital products, just as the value of traditional market products is not a measure of consumer welfare. Measures of the total value of consumer welfare such as consumer surplus are at odds with the conceptual basis of measuring GDP and income, let alone any welfare measure that goes beyond consumption and encompasses quality-of-life dimensions. There is no question about the importance of such measures ... However, measuring production and income is a different objective from measuring welfare." 

Friday, July 15, 2016

The Collapse of California's Carbon Cap-and-Trade Market

Back in 2006, the state of California enacted a law to establish a cap-and-trade market for selling carbon emissions. The market covers about 85% of state carbon emissions. The broad idea was that the state would use a mixture of regulatory rules and the carbon market to cut emissions. Moreover, the state would raise money through regular auctions of "allowances" to emit carbon. But in early 2016, the price of carbon allowances being bought and sold in the secondary market fell below the minimum "price floor" that the state of California would charge for these allowances. Because it was cheaper to buy allowances in the secondary market from those who already owned them than from the state, 90% of the available carbon allowances went unsold in the May 2016 auction, and California received about $880 million less than expected.

Danny Cullenward and Andy Coghlan describe what happened in "Structural oversupply and credibility in California’s carbon market," which appears in The Electricity Journal (June 2016, 29, pp. 7-14). (The article isn't freely available on-line, but many readers can probably obtain access through library subscriptions.) But the broader issue here goes beyond the California auctions and should be a concern to anyone who advocates a cap-and-trade approach to reducing carbon emissions. A couple of years ago, prices for carbon allowances in the European Union carbon trading market also dropped dramatically. Is what went wrong in the California cap-and-trade market for carbon emissions related to what happened in the EU--and do these experiences point to an underlying problem with this approach?

Here are a couple of figures from Cullenward and Coghlin about the recent California experience. The first figure shows how many carbon allowances remained unsold after each auction since 2011. The solid line shows unsold allowances for current carbon emissions. The auction also sold allowances for emissions up to three years in the future, which are shown with the lighter bars. You can see that in the past, most of the allowances were sold, but not the pattern changes in early 2016.

This figure shows prices of carbon allowances in California. The darker line shows the price in the secondary market for buying carbon allowances in California. The shaded area shows the price floor for the state auctions--that is, the state would not accept a lower price than this level. The price in the secondary market had been hovering just above the state price floor for a couple of years, and then in 2016, buying carbon allowances in the secondary market became cheaper than the price floor in the state auction--which is why so many carbon allowances went unsold in the May 2016 auction. The authors describe it this way:
"The history of California’s carbon market can be separated into four phases: (a) an initial speculative trading period prior to the first quarterly auction; (b) an intermediate phase following the launch during which the market regulator informally indicated its goal of relaxing cross-border resource shuffling regulations; (c) a period of stability following the formal adoption of resource shuffling reforms, with secondary prices stable at a small transaction cost above the auction price floor; and (d) a new phase in which government-run auctions fail to sell all available allowances and secondary market prices fall below the auction price floor."
Cullenward and Coghlan point to several main issues for the California carbon market. One issue is that California wasn't just relying on the carbon market to reduce emissions: instead, the state was also enacting an array of standard regulatory rules to reduce carbon emissions. I had not known that even back before the market started, the official plan was for regulatory steps to account for 80% of the reduction in carbon emissions, and the carbon market for only 20%. As the authors write:  "As a result of these design choices, the carbon market’s role in driving climate mitigation and ensuring the economic efficiency across sectors is far less significant than at first it might appear."

In addition, there are always issues that arise in the fine print of how carbon emissions are happening and what counts as a reduction in carbon emissions. In California, one of the issues involved electricity companies that received energy generated from out of state. When the 2006 law went into effect and the carbon market was looming in the near future, many California utilities started signing contracts with their out-of-state suppliers specifying that they were not buying the electricity from coal-burning generators, but only the electricity from natural gas-burning generators, hydroelectric power, and wind or solar. This "resource shuffling" meant that the California utilities could be legally credited with lower carbon emissions, although the actual way that electricity was generated didn't change. The state of California tried to pass various rules to limit this kind of resource shuffling.

Given these issues, a prominent group of California energy economists had forecast back in 2014 that, as Cullenward and Coghlin put it, "the most likely market outcome was a persistent condition in which the supply of compliance instruments (including both allowances and CARB-approved [California Air Resorces Board]  carbon offset credits) would exceed market demand."

One final kicker is that the 2006 legislation had an end-date of 2020, and without new legislation, California apparently cannot plan for its carbon  market to exist after that date. Thus, carbon emitters in California only need to figure out if they are likely to have sufficient allowances to make it through to 2020--and it certainly appears that plenty are available.

The issues with the European Union cap-and-trade market (which I discuss here) are different in details, but broadly similar. If you have a strict regulatory regime which is tamping down carbon emissions, demand will fall for carbon allowances in the market. If you allow carbon emitters to reduce their emissions with various kinds of offsets that involve signing contracts about what will happen in other places, demand will fall for carbon allowances in the market. If the legal and institutional future of the carbon market looks uncertain a few years off in the future, demand will fall for carbon allowances in the market. If a carbon cap-and-trade market is going to function as a way of reducing carbon emissions, the ability of legislators and regulators to manage these kinds of issues needs to be taken into account.

Thursday, July 14, 2016

US Financial Literacy: Distressing and Disempowering

Over the years, I've had disheartening conversations with a number of college students and recent graduates about their personal finances. The main problem isn't student loans. Instead, it's that they managed to run up an extraordinary amount of credit card debt while still a student, and sometimes also managed to borrow funds (or sign a lease) to have a car that was far more nice-looking than they needed. One student, a few years back, had received a check from his parents for next semester's tuition a couple of months in advance, and wanted my advice on how to make a big profits in the stock market in two months. Many more stories like these are probably lurking in the background of the statistics collected by the FINRA Investor Education Foundation in its triennial survey of 25,000 US adults. The results of this National Financial Capability Study have just been published in the report, Financial Capability in the United States 2016

The tail end of the survey has a six-question multiple choice financial literacy survey. You can take the quiz on-line here, if you prefer, but here are the questions and choices. I won't bother giving answers here, but I'll note that the percentage of Americans able to answer four of the first five questions correctly has fallen from 42% when these questions were asked in 2009 to 37% by 2015.

Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow? 
  • More than $102
  • Exactly $102 
  • Less than $102 
  • Don’t know 
  • Prefer not to say
Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account? 
  • More than today
  • Exactly the same
  • Less than today 
  • Don’t know 
  • Prefer not to say
If interest rates rise, what will typically happen to bond prices?
  • They will rise 
  • They will fall
  • They will stay the same
  • There is no relationship between bond prices and the interest rate
  • Don’t know
  • Prefer not to say
Suppose you owe $1,000 on a loan and the interest rate you are charged is 20% per year compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double? 
  • Less than 2 years
  • At least 2 years but less than 5 years
  • At least 5 years but less than 10 years
  • At least 10 years
  • Don’t know
  • Prefer not to say 
A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less. 
  • True
  • False
  • Don’t know 
  • Prefer not to say 
Buying a single company’s stock usually provides a safer return than a stock mutual fund.
  • True 
  • False
  • Don’t know
  • Prefer not to say
I'll readily confess that if I were drawing up a short financial literacy test, I might use some different questions. It's not obvious to me that knowing about interest rates and bond prices is important for the average person, for example. But that said, my guess is that any plausible set of questions you draw up will give results similar to these.

But more distressing than answers to quiz questions are the answers that people give to questions about their own personal financial situation. For example:

Only 39% of those surveyed say that they have tried to figure out their retirement saving needs. Only 30% report having some form of non-retirement investments. Even in 2015, 9% of the survey respondents say that what they owe on their home mortgage is more than the current value of the home. When it comes to credit cards, 77% have at least one, 26% have four or more, and only about half pay their bill in full every month. Among those with a student loan, 28% report that did not complete the education for which the loan was taken out. About one-fourth of those who answered the survey used "non-bank borrowing" in 2015 like a pawn shop, a payday loan, a rent-to-own store, or an auto title loan. Forty percent of respondents say they have too much debt right now.

The good news, I suppose, is that at least we feel good about our financial literacy. For example, 60% of respondents believe they have an "above average" credit score and 41% believe their credit score is "very good."  When people were asked assess their own financial knowledge on a scale from 1-7, 67% graded themselves as 5 or higher in 2009, which rose to 76% by 2015.

For perspective, here's a Survey of the States 2016 from the Council for Economic Education on the subject of high school teaching of personal finance. As you can see, 45 states include personal finance in their "standards," which sounds pretty good until you look at the other lines. It falls to 37 states that actually require the standard to be implemented, 22 states that require a personal finance course to be offered, and 7 states that have standardized testing of personal finance concepts.

Here's an earlier post on "Financial Literacy" (March 17, 2014), which uses a three-question version of the above survey and offers some additional thoughts.  

Wednesday, July 13, 2016

What's Driving the Long-Run Deficit Forecasts?

The headline finding from The 2016 Long-Term Budget Outlook just published by the Congressional Budget Office is that the ratio of federal debt/GDP is projected to rise from its current level of 75% in 2016 to 141% in 2046--which would be the highest level ever for the US economy.

As a starting point, the long-run pattern of federal debt-to-GDP looks like this when looking back over US history and then projecting forward 30 years. Previous peaks for federal debt include World War II, World War II, the Civil War, and the Revolutionary War, as well as rises in debt incurred during the 1930s and the 1980s. But the CBO projectionssuggest that US borrowing isn't on a sustainable path.

What driving these estimates? Essentially, the CBO estimate is a status quo projection. It's based on current laws,  combined with existing trends for population (like the aging of the population) and a few other estimates (like interest rates and health care costs). Of course, the report also includes how the estimates would be affected by changes in laws and economic parameters. But for the moment, let's just focus on the central estimates for spending and taxes, which look like this:


As an overall statement, the CBO projects a large rise in the debt-to-GDP ratio because under current law government spending is projected to rise over time as a share of GDP, while taxes are not. In  the major categories of federal spending shown in the top panel, the two categories with the biggest projected rise over the next few decades are major health care programs and net interest payments. The tax projections are, again, a status quo projection of not much change over time, although individual income taxes rise a bit because (under current law) some taxpayers will be bumped into higher tax brackets over time and because in 2020, taxpayers who are receiving  high-cost health insurance from employers are scheduled to start owing some income tax on some of the value of that insurance.

Of course, projections like these are mutable. As Ebenezer Scrooge says to the Spirit of Christmas Future, before he looks at his own gravestone: “`[A]nswer me one question. Are these the shadows of the things that Will be, or are they shadows of things that May be, only? ... Men’s courses will foreshadow certain ends, to which, if persevered in, they must lead,' said Scrooge. `But if the courses be departed from, the ends will change. Say it is thus with what you show me!'"

Net interest payments are essentially determined by two factors: how much the federal government has borrowed, and what interest rate it needs to pay. The CBO estimate is based on the (real, 10-year) interest rate that the federal government needs to pay hanging at 2%--more-or-less its current level. If interest rates keep falling so that the applicable rate was 1% or less, or started rising to be 3% or more the debt forecast moves considerably.

The level of health-care spending, on the other hand, is at least to some extent determined by the size of the government subsidies for health care through Medicare, Medicaid, the Children's Health Insurance Program, the "marketplace" health insurance exchanges, and other methods. For example, a previous CBO study found that the federal subsidies to the "marketplace" health insurance exchanges will be about $110 billion this year. The share of Medicare spending which is covered by either payroll taxes of workers or premiums paid by the elderly keeps falling, so an ever-larger share of the cost of Medicare is covered by general funds.

If health care spending wasn't projected to keep rising, then federal borrowing wouldn't climb as much, and interest costs wouldn't be as much of a problem, either. In that sense, health care spending is at the heart of the distressing forecasts for where federal borrowing is headed in the long-term.  It's not novel to say, but still worth pointing out, that higher health care spending is already crowding out other government   at both the state and federal level. It would be a lot easier to contemplate lasting boosts in spending on education or a cleaner environment or anti-poverty programs if not for the looming specter of rising health care costs.

But in addition, it's useful to think about what the CBO budget forecasts leave out. Past sharp rises in the debt-to-GDP ratio have often been associated with war, or with the aftermath of Great Depression or Great Recession. History suggests a reasonable chance that the next 30 years will bring one or both of these. The future may also bring other public priorities, like dealing with what is likely to be a very large expansion in the population of elderly needing long-term care, or rebuilding America's 20th century transportation, energy, and communication infrastructure for the 21st century.

The overhanging shadow of rising health care costs influences other policy choices, too. Given that health care spending is already projected to drive federal borrowing to unprecedented levels, further expansions of government health care spending seem less appropriate. If raising taxes mainly just funnels more money to government health care spending, it will be be even less attractive. Given the projections of federal borrowing rising to unprecedented levels, state and federal legislators will be especially tempted by regulatory policies that don't impose a direct budgetary cost. The economic and political tradeoffs of high government health care spending are already with us, and are only going to bind more tightly over time.

Tuesday, July 12, 2016

Financial Stability Reform: Lots of Activity, Not Enough Progress

There has been lots of sound and fury about improving financial regulation in the seven years since the Great Recession ended in 2009. But have the necessary changes been made? In "Financial Regulatory Reform Afterthe Crisis: An Assessment," a paper written for the 2016 European Central Bank Forum on Central Banking held at the end of June, Darrell Duffie basically says "not yet."

Duffie argues that there are four core elements of financial-stability regulation: "1. Making financial institutions more resilient. 2. Ending “too-big-to-fail.” 3. Making derivatives markets safer. 4. Transforming shadow banking." He writes: "At this point, only the first of these cores element of the reform, `making financial institutions more resilient,' can be scored a clear success, although even here much more work remains to be done."

On the first goal of making financial institutions more resilient:
"These resiliency reforms, particularly bank capital regulations, have caused some reduction in secondary market liquidity. While bid-ask spreads and most other standard liquidity metrics suggest that markets are about as liquid for small trades as they have been for a long time,4 liquidity is worse for block-sized trade demands. As a tradeoff for significantly greater financial stability, this is a cost well worth bearing. Meanwhile, markets are continuing to slowly adapt to the reduction of balance-sheet space being made available for market making by bank-affiliated dealers. Even more stringent minimum requirements for capital relative to risk-weighted assets would, in my view, offer additional net social benefits.  I will suggest here, however, that the regulation known as the Leverage Ratio has caused a distortionary reduction in the incentives of banks to intermediate markets for safe assets, especially the government securities repo market, without apparent financial stability benefits."
On the second goal of ending "too-big-too-fail":
"At the threat of failure of a systemically important financial firm, a regulator is supposed to be able to administratively restructure the parent firm’s liabilities so as to allow the key operating subsidiaries to continue providing services to the economy without significant or damaging interruption.  For this to be successful, three key necessary conditions are: (i) the parent firm has enough general unsecured liabilities (not including critical operating liabilities such as deposits) that cancelling these “bail-in” liabilities, or converting them to equity, would leave an adequately capitalized firm, (ii) the failure-resolution process does not trigger the early termination of financial contracts on which the firm and its counterparties rely for stability, and (iii) decisive action by regulators. ... [T]he proposed single-point-of-entry method for the failure resolution of systemic financial firms is not yet ready for safe and successful deployment. A key success here, though, is that creditors of banks do appear to have gotten the message that in the future, their claims are much less likely to be bailed out."
On the issue of making derivatives markets safer:
"Derivatives reforms have forced huge amounts of swaps into central counterparties (CCPs), a major success in terms of collateralization and transparency in the swap market. As a result, however, CCPs are now themselves too big to fail. Effective operating plans and procedures for the failure resolution of CCPs have yet to be proposed. While the failure of a large CCP seems a remote possibility, this remoteness is difficult to verify because there is also no generally accepted regulatory framework for conducting CCP stress tests. This represents an undue lack of transparency. Reform of derivatives markets financial-stability regulation has mostly bypassed the market for foreign-exchange derivatives involving the delivery of one currency for another, a huge and systemically important class. Data repositories for the swaps market have not come close to meeting their intended purposes. Here especially, the opportunities of time afforded by the impetus of a severe crisis have not been used well."
On the issue of transforming shadow banking:
"A financial-stability transformation of shadow banking is hampered by the complexity of non-bank financial intermediation and by the patchwork quilt of prudential regulatory coverage of the non-bank financial sector. ... The Financial Stability Board (2015) sets out five classes of shadow-banking entities: 1. Entities susceptible to runs, such as certain mutual funds, credit hedge funds, and real-estate funds. 2. Non-bank lenders dependent on short-term funding, such as finance companies, leasing companies, factoring companies, and consumer credit companies. 3. Market intermediaries dependent on short-term funding or on the secured funding of client assets, such as broker-dealers. 4. Companies facilitating credit creation, such as credit insurance companies, financial guarantors, and monoline insurers. 5. Securitisation-based intermediaries. ... While progress has been made, the infrastructure of the United States securities financing markets is still not safe and sound. The biggest risk is that of a firesale of securities in the event of the inability of a major broker dealer to roll over its securities financing under repurchase agreements. While the intra-day risk that such a failure poses for the two large tri-partyrepo clearing banks has been dramatically reduced, the U.S. still has no broad repo central counterparty with the liquidity resources necessary to prevent such a firesale. More generally, as emphasized by Baklanova, Copeland, and McCaughrin (2016), there is a need for more comprehensive monitoring of all securities financing transactions, including securities lending agreements."
Finally, I was struck by one of Duffie's comments in passing about the costs of financial regulation:
"The costs of implementing and complying with regulation are among the tradeoffs for achieving greater financial stability. For example, in 2013 (even before the full regime of new regulations was in place) the six largest U.S. banks spent an estimated $70.2 billion on regulatory compliance, doubling the $34.7 billion they spent in 2007. Compliance requirements can accelerate or, potentially, decelerate overdue improvements in practices.  The frictional cost of complying with post-crisis regulations is easily exceeded by the total social benefits, but is nevertheless a factor to be considered when designing specific requirements and supervisory regimes."
Appropriate financial regulation is an admittedly difficult policy problem. Still, it's disconcerting that seven years after the end of the Great Recession, some obvious gaps and concerns remain--and of course, the concerns that we haven't been able to anticipate remain as well.