Tag Archives: children

four-kids

Why do so many Americans pay no income taxes?

Today many are discussing how many Americans do not owe income taxes. The traditional debate splits along partisan lines. Many Republicans and conservatives argue it is both unfair and politically dangerous to have (almost half / more than one-third, depending on who’s measuring) of Americans not owing any income taxes. Many Democrats argue the rich should pay more, and that it’s good that low and even moderate-income people owe no income taxes.

I wonder how many Republican Members of Congress remember that they are, in large part, responsible for this outcome?

First, here’s a quick refresher on the difference between a tax deduction and a tax credit:

  • Suppose you make $60,000 per year. If you donate $5,000 to charity, you get a $5,000 deduction. You pay income taxes on only $55,000.
  • Suppose a married couple finds they owe $12,000 in income taxes before accounting for the child credit. If they have three kids, they get a $1,000 tax credit for each child, for a total of $3,000 in tax credits. They subtract this $3,000 from their $12,000 of income taxes owed, leaving them owing $9,000 after accounting for the child tax credit.
  • Suppose this same family owed only $2,500 in income taxes before accounting for their three children and the child tax credit. Since the child tax credit is refundable, the $3,000 credit wipes out all of their $2,500 of income tax liability and they get $500 from Uncle Sam.

The reason so many Americans don’t owe income taxes is because we have two big tax credits in the code: the Earned Income Tax Credit (EITC) and the child tax credit. I hope the above explanation shows the power of a tax credit: one dollar of tax credit wipes out one dollar of tax liability. So if you provide a big tax credit to someone who owes only a small amount of income taxes, you’re probably going to move them into the non-payer category.

The EITC benefits low-wage earners. Legislative support often splits roughly along party lines, with most Democrats wanting a bigger EITC, and many Republicans wanting a smaller (or, at least, no bigger) EITC. Republicans like to complain about the EITC on a day like today.

But most of the increase since the mid-1990s in the number of people who owe no income taxes is the result of the child tax credit. This policy was created by Congressional Republicans and expanded with Republicans in the lead.

The nonpartisan Tax Foundation has measured the top nonpayer threshold. This is the highest income taxpayer that owes no income taxes, setting aside unusual tax situations. They looked at how the top nonpayer threshold changed from 1993 to today for a married couple with two kids. All figures are in 2010 dollars for comparison:

  • In 1997 every “normal” married couple with two children that earned $24,000 or more (in today’s dollars) had to pay at least some income taxes. The top nonpayer threshold for a family of this size was just under $24,000. This means there were some four-person families with income just below $24,000 that owed no income taxes.
  • In 1997 a Republican majority Congress and President Clinton enacted the Balanced Budget Act. At the insistence of Congressional Republicans, this law created a $400-per-child tax credit which began in 1998. This caused the top nonpayer threshold to jump more than $7,000, to about $31,300. Millions of families with kids with incomes between $24,000 and $31,300 were “taken off the rolls” because the child tax credit wiped out the small income tax liability they owed.
  • As a result of the 1997 law, in 1999 the child tax credit automatically increased to $500 per child, and the threshold for a married family with two kids grew to $32,800 in today’s dollars.
  • In 2001 President Bush and the Republican Congress enacted a major tax law that increased the child tax credit to $600. This law also introduced the 10% income tax bracket, which lowered by 5 percentage points the lowest income tax rate. The combination of these two tax changes raised the top nonpayer threshold to $38,700. That law further phased in over time increases in the child credit to $1,000 per child.
  • The 2003 tax law enacted by President Bush and the Republican Congress accelerated the $1,000 per child amount to be effective immediately. This increased the threshold to $47,400 in 2003. That’s a huge jump. It was incredibly popular, and it helped create political impetus for the 2003 law which also accelerated rate reductions and cut capital gains and dividend rates.
  • The 2008 stimulus (President Bush + Democratic majority Congress) included stimulus checks of $1,200 per married couple, plus another $300 per child. This increased the threshold to $56,700. This was a one-time increase, however, and the non-stimulus threshold for 2008 was about $44,500.
  • In 2009 President Obama and a Democratic majority Congress increased this threshold to $51,400 with the new “making-work-pay” tax credit. This was enacted on near party-line votes. That threshold drops slightly to about $50,300 this year.

What can we conclude from this?

  • The huge number of Americans who owe no income taxes is the result of the interaction of three tax policies:
    1. a progressive rate structure and a standard deduction;
    2. the Earned Income Tax Credit, which significantly reduces tax liability for the lowest earners;
    3. the per-child tax credit, which significantly reduces tax liability for low- and moderate-income families with kids.
  • Different political coalitions support these three policies:
    • There is broad-based political support spanning both parties for a progressive rate structure. Republicans split on this point, with some conservatives favoring a flat tax. Even many flat tax supporters support some progressivity with a large(r) standard deduction.
    • Support for expanding/keeping EITC tends to be center-left. Many on the right oppose it at its current size.
    • Support for the per-child tax credit is nearly universal, but it started on the right.
  • The large number of people who owed no income taxes until the mid-90s was driven largely by the first two factors and especially by the Earned Income Tax Credit, a policy driven by the Left.
  • The dramatic increase in the number of people who owed no income taxes since the mid-90s was driven almost entirely by the creation and expansion of the per-child tax credit, a policy driven by the Right.
  • This was a “pro-family” tax credit created in the 1994 Contract with America, pushed to a veto by Congressional Republicans in 1995, negotiated with President Clinton in 1997, and expanded by President Bush and Republicans.

Behind closed doors Republicans split on the per-child tax credit. Economic types oppose it or hold their noses. Social/family conservatives vigorously support it, as does almost anyone running for office.

It’s easy for Republicans to complain today about the end result. They (we) have an out in that they can point to the EITC as one of the causes. But much of this outcome is driven by tax policy changes initiated and expanded by Republicans.

If you wanted to work within the current income tax system and reverse some of this trend, broadening the income-taxpaying base, you’d be hard pressed to get a big effect just by raising the bottom rates. To affect millions of people you’d need to either scale back EITC or the per-child tax credit. I think both are highly unlikely.

(photo credit: hope and megan)

pelosi_01

Understanding the House Democrats' health care bill

Yesterday I posted and described the draft Kennedy-Dodd health care bill. Today I would like to do the same for an outline produced by House Democrats.

Here is a three-page outline of “Key Features of the Tri-Committee Health Reform Draft Proposal in the House of Representatives,” dated yesterday (June 8, 2009).

The three committees are:

  • The House Ways & Means Committee, chaired by Rep. Charlie Rangel (D-NY). The Health Subcommittee is chaired by Rep. Pete Stark (D-CA).
  • The House Energy & Commerce Committee, chaired by Rep. Henry Waxman (D-CA). The Health Subcommittee is chaired by Rep. Frank Pallone, Jr. (D-NJ).
  • The House Committee on Education & Labor, chaired by Rep. George Miller (D-CA). The Health, Employment, Labor and Pensions Subcommittee is chaired by Rep. Robert Andrews (D-NJ).

The document suggests this is a joint product of the three committees and/or their subcommittees. My sense, however, is that it is Speaker Pelosi who is driving the bus. This is in contrast to the Senate, where the committee chairmen (Kennedy/Dodd and Baucus) appear to have the pen, in less well-coordinated efforts.

Kennedy-Dodd and the House bill outline are remarkably similar. Whether this represents House-Senate coordination or parallel thought processes is unclear.

I think the easiest way for me to present the House bill outline is in comparison with the Kennedy-Dodd bill. So here my description from yesterday of the Kennedy-Dodd bill, with today’s comparison to the House bill outline in red. I hope it’s comprehensible and useful this way. If you read yesterday’s post, you can skim the text in black and focus on the new text in blue.

Here are 15 things to know about the draft Kennedy-Dodd health bill and the House bill outline.

  1. The Kennedy-Dodd bill would create an individual mandate requiring you to buy a :qualified” health insurance plan, as defined by the government. If you don’t have “qualified” health insurance for a given month, you will pay a new Federal tax. Incredibly, the amount and structure of this new tax is left to the discretion of the Secretaries of Treasury and Health and Human Services (HHS), whose only guidance is “to establish the minimum practicable amount that can accomplish the goal of enhancing participation in qualifying coverage (as so defined).” The new Medical Advisory Council (see #3D) could exempt classes of people from this new tax. To avoid this tax, you would have to report your health insurance information for each month of the prior year to the Secretary of HHS, along with “any such other information as the Secretary may prescribe.” The House bill also contains an individual mandate. The outline is less specific but parallel: Once market reforms and affordability credits are in effect to ensure access and affordability, individuals are responsible for having health insurance with an exception in cases of hardship.
  2. The Kennedy-Dodd bill would also create an employer mandate. Employers would have to offer insurance to their employees. Employers would have to pay at least a certain percentage (TBD) of the premium, and at least a certain dollar amount (TBD). Any employer that did not would pay a new tax. Again, the amount and structure of the tax is left to the discretion of the Secretaries of Treasury and HHS. Small employers (TBD) would be exempt.The House bill outline also contains an employer mandate that appears to parallel that in Kennedy-Dodd: “Employers choose between providing coverage for their workers or contributing funds on behalf of their uncovered workers.”
  3. In the Kennedy-Dodd bill, the government would define a qualified plan:
    1. All health insurance would be required to have guaranteed issue and renewal, modified community rating, no exclusions for pre-existing conditions, no lifetime or annual limits on benefits, and family policies would have to cover “children” up to age 26.The House bill outline is consistent with but less specific than the Kennedy-Dodd legislative language. The House bill outline would “prohibit insurers from excluding pre-existing conditions or engaging in other discriminatory practices.” I will keep my eye on what “other discriminatory practices” means in the legislative language. Does that mean that a health plan cannot charge higher premiums to smokers? Like the Kennedy/Dodd bill, the House bill outline would preclude health plans from imposing lifetime or annual limits on benefits: “Caps total out-of-pocket spending in all new policies to prevent bankruptcies from medical expenses.” This would raise premiums for new policies. The House bill outline “introduces administrative simplification and standardization to reduce administrative costs across all plans and providers.” I don’t know what this means, but suggest keeping an eye on it.
    2. A qualified plan would have to meet one of three levels of standardized cost-sharing defined by the government, “gold, silver, and bronze.” Details TBD. Same: “… by creating various levels of standardized benefits and cost-sharing arrangements…” It also contains this addition relative to Kennedy-Dodd: “… with additional benefits available in higher-cost plans.” But note the “various levels of standardized benefits.” This appears to be more expansive government control of health plan design than in the Kennedy-Dodd draft.
    3. Plans would be required to cover a list of preventive services approved by the Federal government.This is unspecified in the House bill outline. We’ll have to wait to see legislative language.” The House bill would require plans to “waive cost-sharing for preventive services in benefit packages.”
    4. A qualified plan would have to cover “essential health benefits,” as defined by a new Medical Advisory Council (MAC), appointed by the Secretary of Health and Human Services. The MAC would determine what items and services are “essential benefits.” The MAC would have to include items and services in at least the following categories: ambulatory patient services, emergency services, hospitalization, maternity and new born care, medical and surgical, mental health, prescription drugs, rehab and lab services, preventive/wellness services, pediatric services, and anything else the MAC thought appropriate.This appears parallel but is less specific for now: “Independent public/private advisory committee recommends benefit packages based on standards set in statute.” I find the “standards set in statute” interesting. It suggests that provider and disease interest groups will have two fora in which to lobby for their benefits to be mandated: Congress, and the advisory committee.
    5. The MAC would also define what “affordable and available coverage” is for different income levels, affecting who has to pay the tax if they don’t buy health insurance. The MAC’s rules would go into effect unless Congress passed a joint resolution (under a fast-track process) to turn them off.The House bill outline is silent on this.
  4. Health insurance plans could not charge higher premiums for risky behaviors: “Such rate shall not vary by health status-related factors, … or any other factor not described in paragraph (1).” Smokers, drinkers, drug users, and those in terrible physical shape would all have their premiums subsidized by the healthy. The House bill outline says it would “prohibit plans [from] rating (charging higher premiums) based on gender, health status, or occupation and strictly limits premium variation based on age.” If the bill were to provide nothing more, this would appear to parallel the Senate bill and preclude plans from charging higher premiums for risky behaviors.
  5. Guaranteed issue and renewal combined with modified community rating would dramatically increase premiums for the overwhelming majority of those Americans who now have private health insurance. New Jersey is the best example of health insurance mandates gone wild. In the name of protecting their citizens, premiums are extremely high to cover the cross-subsidization of those who are uninsurable.The House bill outline is silent on guaranteed issue and renewal. I’m going to make an educated guess that the bill includes these provisions as part of “other discriminatory practices,” and they have just left them out of the outline. Given the philosophy behind this outline (with which I disagree), it would be a striking omission. But for now, the outline says nothing specific on these topics.
  6. The bill would expand Medicaid to cover everyone up to 150% of poverty, with the Federal government paying all incremental costs (no State share). This means adding childless adults with income below 150% of the poverty line.The House bill outline “expands Medicaid for the most vulnerable, low-income populations,” so we have no specifics other than that there’s an expansion.” I cannot tell if this is expanding eligibility or benefits. The outline also “improves payment rates to enhance access to primary care under Medicaid.” I assume this means the bill would expand the Federal share paid of each dollar spent by a State Medicaid program on primary care, rather than the Federal government actually mandating specific payment rates to be implemented by States. Federal micromanagement of specific Medicaid provider payment rates was eliminated in the mid 1990s.
  7. People from 150% of poverty up to 500% (!!) would get their health insurance subsidized (on a sliding scale). If this were in effect in 2009, a family of four with income of $110,000 would get a small subsidy. The bill does not indicate the source of funds to finance these subsidies.The House bill outline has a sliding scale up to 400% of poverty. If this were in effect in 2009, a family of four with income of $88,000 would get small subsidy.
  8. People in high cost areas (e.g., New York City, Boston, South Florida, Chicago, Los Angeles) would get much bigger subsidies than those in low cost areas (e.g., much of the rest of the country, especially in rural areas). The subsidies are calculated as a percentage of the “reference premium,” which is determined based on the cost of plans sold in that particular geographic area.The House bill outline is not specific on this point. I would not expect it to be – this is something you can tell only from legislative language.
  9. There would be a “public plan option” of health insurance offered by the federal government. In this new government health plan, the federal government would pay health care providers Medicare rates + 10%. The +10% is clearly intended to attract short-term legislative support from medical providers. I hope they are not so naive that they think that differential would last.The House bill outline “creates a new public health insurance within the Exchange … the public health insurance option competes on ‘level field’ with private insurers in the Exchange.” There are no specifics on how the public plan would work, or on provider payment rates.
  10. Group health plans with 250 or fewer members would be prohibited from self-insuring.” ERISA would only be for big businesses.The House bill outline is silent on this point.
  11. States would have to set up “gateways” (health insurance exchanges) to market only qualified health insurance plans. If they don’t, the Feds will set up a gateway for them.The House calls it an Exchange rather than a Gateway. While the Senate bill would tell each State, “Create a Gateway or we’ll create one for you,” the House bill outline says to each State, “We’re creating a single new national Exchange. You’re in it unless you develop your own State or Regional Exchange.”
  12. Health insurance plans in existence before the law would not have to meet the new insurance standards. This creates a weird bifurcated system and means you would (probably) be subject to a different set of rules when you change jobs.The House bill outline appears to parallel the Kennedy-Dodd draft: “Phases-in requirements to benefit and quality standards for employer plans.” This means that new plans will be more expensive than old plans. It also means they’re creating a bifurcated system with all sorts of perverse unintended consequences for employment flexibility.
  13. The bill does not specify what spending will be cut or what taxes will be raised to pay for the increased spending. That is presumably for the Finance Committee to determine, since it’s their jurisdiction. The House bill outline lists specific topics for changes to Medicare reimbursement:
    • Changing (how?) the Medicare reimbursement for doctors, called the “Sustainable Growth Rate” (SGR).
    • “Increasing reimbursement for primary care providers”
    • “Improving” the Medicare drug program. I won’t be surprised if, when I see the specifics, I disagree that their changes are “improvements.” In the past this has meant having the federal government mandate specific prices for drugs.
    • Cutting payments to Medicare Advantage plans.
    • Expanding low-income subsidies for seniors and eliminating cost-sharing for all preventive services in Medicare.

    The House bill outline also uses positive language to describe things that might generate budgetary savings from Medicare and/or Medicaid. The hospital readmissions point is specific. The first two points could increase or decrease federal spending, depending on the specifics.

    • “Use federal health programs … to reward high quality, efficient care, and reduce disparities.”
    • “Adopt innovative payment approaches and promote[s] better coordinated care in Medicare and the new public option through programs such as accountable care organizations.”
    • “Attack the high rate of cost growth to generate savings for reform and fiscal sustainability, including a program in Medicare to reduce preventable hospital readmissions.”
  14. The bill defines an “eligible individual” as “a citizen or national of the United States or an alien lawfully admitted to the United States for permanent residence or an alien lawfully present in the United States.” The House bill outline is silent on this point.
  15. The bill would create a new pot of money for state gateways to pay “navigators” to educate people about the new bill, distribute information about health plans, and help people enroll. Navigators receiving federal funds “may include … unions, …” The House bill outline is silent on this point.

This would have severe effects on the more than 100 million Americans who have private health insurance today:

  • The government would mandate not only that you must buy health insurance, but what health insurance counts as “qualifying.”
  • Health insurance premiums would rise as a result of the law, meaning lower wages.
  • A government-appointed board would determine what items and services are “essential benefits” that your qualifying plan must cover.
  • You would find a tremendous new disincentive to switch jobs, because your new health insurance may be subject to the new rules and would therefore be significantly more expensive.
  • Those who keep themselves healthy would be subsidizing premiums for those with risky or unhealthy behaviors.
  • Far more than half of all Americans would be eligible for subsidies, but we have not yet been told who would pay the bill.
  • The Secretaries of Treasury and HHS would have unlimited discretion to impose new taxes on individuals and employers who do not comply with the new mandates. (The House bill outline is not specific on this point.)
  • The Secretary of HHS could mandate that you provide him or her with “any such other information as [he/she] may prescribe.” (The House bill outline is not specific on this point.)

I strongly oppose the Kennedy-Dodd bill and the House Tri-Committee bill.

If this topic interests you, I highly recommend Jim Capretta’s blog Diagnosis.

(photo credit: speaker.house.gov)

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Understanding the Kennedy health care bill

Over the weekend a draft of Senator Kennedy’s (D-MA) health care bill leaked. After playing with Adobe Acrobat, here is the text of the draft Kennedy bill as a text file (173 K), and as a single Acrobat file (3.4 MB). Update: I fixed the broken link to the PDF. Unlike the leaked version, both of these are searchable.

Calling it the “Kennedy” bill is something of an overstatement. Senator Kennedy chairs the Senate Health, Education, Labor, and Pensions committee, and his staff wrote the draft. By all reports, however, Chairman Kennedy’s health is preventing him from being heavily involved in the drafting. Senator Reid has designated Senator Chris Dodd (D-CT) to supervise the process, but as best I can tell, it’s really the Kennedy committee staff who are making most of the key decisions. For now I will call it the Kennedy-Dodd bill.

As the committee staff emphasized to the press after the leak, this is an interim draft. I assume things will move around over the next several weeks as discussions among Senators and their staffs continue. This is therefore far from a final product, but it provides a useful insight into current thinking among some key Senate Democrats.

Update: I now have a three-page outline of the House Democrats’ health care bill. I have a new post which contains all of the content below, and compares it to the House bill. If you read the new post, you’ll get two for the price of one: Understanding the House Democrats’ [and Kennedy-Dodd] health care bill[s].

Here are 15 things to know about the draft Kennedy-Dodd health bill.

    1. The Kennedy-Dodd bill would create an individual mandate requiring you to buy a “qualified” health insurance plan, as defined by the government. If you don’t have “qualified” health insurance for a given month, you will pay a new Federal tax. Incredibly, the amount and structure of this new tax is left to the discretion of the Secretaries of Treasury and Health and Human Services (HHS), whose only guidance is “to establish the minimum practicable amount that can accomplish the goal of enhancing participation in qualifying coverage (as so defined).” The new Medical Advisory Council (see #3D) could exempt classes of people from this new tax. To avoid this tax, you would have to report your health insurance information for each month of the prior year to the Secretary of HHS, along with any such other information as the Secretary may prescribe.”
    1. The bill would also create an employer mandate. Employers would have to offer insurance to their employees. Employers would have to pay at least a certain percentage (TBD) of the premium, and at least a certain dollar amount (TBD). Any employer that did not would pay a new tax. Again, the amount and structure of the tax is left to the discretion of the Secretaries of Treasury and HHS. Small employers (TBD) would be exempt.
    1. In the Kennedy-Dodd bill, the government would define a qualified plan:
        1. All health insurance would be required to have guaranteed issue and renewal, modified community rating, no exclusions for pre-existing conditions, no lifetime or annual limits on benefits, and family policies would have to cover children up to age 26.
        1. A qualified plan would have to meet one of three levels of standardized cost-sharing defined by the government, gold, silver, and bronze. Details TBD.
        1. Plans would be required to cover a list of preventive services approved by the Federal government.
        1. A qualified plan would have to cover “essential health benefits,” as defined by a new Medical Advisory Council (MAC), appointed by the Secretary of Health and Human Services. The MAC would determine what items and services are “essential benefits.” The MAC would have to include items and services in at least the following categories: ambulatory patient services, emergency services, hospitalization, maternity and new born care, medical and surgical, mental health, prescription drugs, rehab and lab services, preventive/wellness services, pediatric services, and anything else the MAC thought appropriate.
        1. The MAC would also define what “affordable and available coverage” is for different income levels, affecting who has to pay the tax if they don’t buy health insurance. The MAC’s rules would go into effect unless Congress passed a joint resolution (under a fast-track process) to turn them off.
    2. Health insurance plans could not charge higher premiums for risky behaviors: “Such rate shall not vary by health status-related factors, … or any other factor not described in paragraph (1).” Smokers, drinkers, drug users, and those in terrible physical shape would all have their premiums subsidized by the healthy.
    1. Guaranteed issue and renewal combined with modified community rating would dramatically increase premiums for the overwhelming majority of those Americans who now have private health insurance. New Jersey is the best example of health insurance mandates gone wild. In the name of protecting their citizens, premiums are extremely high to cover the cross-subsidization of those who are uninsurable.
    1. The bill would expand Medicaid to cover everyone up to 150% of poverty, with the Federal government paying all incremental costs (no State share). This means adding childless adults with income below 150% of the poverty line.
    1. People from 150% of poverty up to 500% (!!) would get their health insurance subsidized (on a sliding scale). If this were in effect in 2009, a family of four with income of $110,000 would get a small subsidy. The bill does not indicate the source of funds to finance these subsidies.
    1. People in high cost areas (e.g., New York City, Boston, South Florida, Chicago, Los Angeles) would get much bigger subsidies than those in low cost areas (e.g., much of the rest of the country, especially in rural areas). The subsidies are calculated as a percentage of the “reference premium,” which is determined based on the cost of plans sold in that particular geographic area
    1. There would be a “public plan option” of health insurance offered by the federal government. In this new government health plan, the federal government would pay health care providers Medicare rates + 10%. The +10% is clearly intended to attract short-term legislative support from medical providers. I hope they are not so naive that they think that differential would last.
    1. Group health plans with 250 or fewer members would be prohibited from self-insuring. ERISA would only be for big businesses.
    1. States would have to set up “gateways” (health insurance exchanges) to market only qualified health insurance plans. If they don’t, the Feds will set up a gateway for them.
    1. Health insurance plans in existence before the law would not have to meet the new insurance standards. This creates a weird bifurcated system and means you would (probably) be subject to a different set of rules when you change jobs.
    1. The bill does not specify what spending will be cut or what taxes will be raised to pay for the increased spending. That is presumably for the Finance Committee to determine, since it’s their jurisdiction.
    1. The bill defines an “eligible individual” as “a citizen or national of the United States or an alien lawfully admitted to the United States for permanent residence or an alien lawfully present in the United States.”
  1. The bill would create a new pot of money for state gateways to pay “navigators” to educate people about the new bill, distribute information about health plans, and help people enroll. Navigators receiving federal funds “may include … unions, …”

This would have severe effects on the more than 100 million Americans who have private health insurance today:

    • The government would mandate not only that you must buy health insurance, but what health insurance counts as “qualifying.”
    • Health insurance premiums would rise as a result of the law, meaning lower wages.
    • A government-appointed board would determine what items and services are “essential benefits” that your qualifying plan must cover.
    • You would find a tremendous new disincentive to switch jobs, because your new health insurance may be subject to the new rules and would therefore be significantly more expensive.
    • Those who keep themselves healthy would be subsidizing premiums for those with risky or unhealthy behaviors.
    • Far more than half of all Americans would be eligible for subsidies, but we have not yet been told who would pay the bill.
    • The Secretaries of Treasury and HHS would have unlimited discretion to impose new taxes on individuals and employers who do not comply with the new mandates.
  • The Secretary of HHS could mandate that you provide him or her with “any such other information as [he/she] may prescribe.”

I strongly oppose this bill.

Update: If this topic interests you, I highly recommend Jim Capretta’s blog Diagnosis.

(photo credit: kennedy.senate.gov)

inside_hospital

Health spending fallacy

The President emphasized the importance of health care reform in Tuesday evening’s press conference. One of his arguments was that reforming health care would help address federal and state government fiscal problems:

What we have to do is bend the curve on these deficit projections. And the best way for us to do that is to reduce health care costs. That’s not just my opinion; that’s the opinion of almost every single person who has looked at our long-term fiscal situation.

His statement is excellent but incomplete. There are two problems driving future deficits: rising health care costs, and the aging of the population. Both factors drive projected Medicare and Medicaid spending increases, and demographics helps drive projected Social Security spending increases. To fix our long-term deficit problem, we need to address both factors, and spending trends in all three programs.

The President then defended the increased health spending proposed in his budget:

What we’ve said is, look, let’s invest in health information technologies; let’s invest in preventive care; let’s invest in mechanisms that look at who’s doing a better job controlling costs while producing good quality outcomes in various states, and let’s reimburse on the basis of improved quality, as opposed to simply how many procedures you’re doing. Let’s do a whole host of things, some of which cost money on the front end but offer the prospect of reducing costs on the back end.

This is the health care investment myth: if only government will spend more money on health care, then that will reduce costs and, eventually, government health spending.

The correct response is a tautology: if government spends more money on health care, then government health care spending will go up, not down.

The President argues this spending is an investment that will address the sources of health care cost growth and “ultimately” drive down costs for the federal and state government. I dispute that, and will expand on my argument in the future.

But there’s a more important point. The President’s budget would increase health spending by $634 B over ten years. That’s a full order of magnitude larger than the current law program to subsidize health insurance for children (known as “S-CHIP”). You cannot spend $634 B on health IT, preventive care, and outcome measurement. You’ll run out of things on which to spend it.

When you’re setting aside that enormous sum, you’re doing it to expand taxpayer-subsidized health insurance coverage, as the Congress began to do in the so-called stimulus bill. That’s a policy choice that I’m happy to debate. But it is irrefutable that an expansion of taxpayer-funded health insurance coverage will dramatically increase government spending on health care, not reduce it.

The flawed logic goes like this:

  • Health care spending is a big problem for government finances.
  • Therefore, we will increase health spending in the federal budget to cover more people.

Proponents of this argument point out that federal, state, and local governments indirectly subsidize the uninsured through subsidies to cover some of the costs of uncompensated care (in clinics and hospital emergency rooms). By subsidizing health insurance coverage, they argue, we will keep them out of the emergency room and reduce total health care spending. They claim that we can cover more people and reduce spending without hurting anyone (except the taxpayer who is footing the bill).

This is incorrect, for three reasons:

  1. People receive more and better medical care if they have health insurance than if they are relying on free care. That’s a good thing for those people. It’s also more expensive for the payor.
  2. Every proposal to expand taxpayer-subsidized health insurance would have the government pay all or almost all of the cost of health insurance, while today the government pays only part of the cost of charity care.
  3. Medical expenditures tend to be highly concentrated in a relatively small proportion of the population. For each uninsured catastrophically sick person whose costs go down because they are receiving better or preventive care, you will get many more who would not use medical services if they were free, but will do so if someone else pays for it. When government is subsidizing pre-paid health insurance, the taxpayer will spend a lot to pay the premiums of a healthy previously uninsured person who may use no medical care at all. In the aggregate, government spending on heatlh care will increase.

Some argue that it’s worth it — that we have a moral obligation as a society to ensure that everyone has health insurance. That’s a separate question. I am instead disagreeing with the budgetary point. Expanding taxpayer-subsidized health insurance coverage by $634 B will increase government spending on health care, not reduce it. The President’s proposed $634 B health reform fund would severely worsen our long-term entitlement spending problem.

If this subject interests you, the best health policy writing I know is Jim Capretta’s blog Diagnosis.

financial_markets

The President's speech on financial markets and the world economy

President Bush spoke at the Manhattan Institute today on financial markets and the world economy.

This speech is a prelude to the financial summit the President will host this weekend. I’ll write separately about the Summit, and about the elements of today’s speech that talk about principles for reform.

I want to draw your attention to two parts of the speech.

The first is where the President reprises his explanation for the economic causes of our current situation.

Over the past decade, the world experienced a period of strong economic growth. Nations accumulated huge amounts of savings, and looked for safe places to invest them. Because of our attractive political, legal, and entrepreneurial climates, the United States and other developed nations received a large share of that money.

The massive inflow of foreign capital, combined with low interest rates, produced a period of easy credit. And that easy credit especially affected the housing market. Flush with cash, many lenders issued mortgages and many borrowers could not afford them. Financial institutions then purchased these loans, packaged them together, and converted them into complex securities designed to yield large returns. These securities were then purchased by investors and financial institutions in the United States and Europe and elsewhere — often with little analysis of their true underlying value.

The financial crisis was ignited when booming housing markets began to decline. As home values dropped, many borrowers defaulted on their mortgages, and institutions holding securities backed by those mortgages suffered serious losses. Because of outdated regulatory structures and poor risk management practices, many financial institutions in America and Europe were too highly leveraged. When capital ran short, many faced severe financial jeopardy. This led to high-profile failures of financial institutions in America and Europe, led to contractions and widespread anxiety — all of which contributed to sharp declines in the equity markets.

These developments have placed a heavy burden on hardworking people around the world. Stock market drops have eroded the value of retirement accounts and pension funds. The tightening of credit has made it harder for families to borrow money for cars or home improvements or education of the children. Businesses have found it harder to get loans to expand their operations and create jobs. Many nations have suffered job losses, and have serious concerns about the worsening economy. Developing nations have been hit hard as nervous investors have withdrawn their capital.

The second is the last two pages of the speech. I tried to summarize and excerpt from this, and instead have concluded that the best thing I can do is allow the President’s words to speak for themselves.

All this leads to the most important principle that should guide our work: While reforms in the financial sector are essential, the long-term solution to today’s problems is sustained economic growth. And the surest path to that growth is free markets and free people. (Applause.)

This is a decisive moment for the global economy. In the wake of the financial crisis, voices from the left and right are equating the free enterprise system with greed and exploitation and failure. It’s true this crisis included failures — by lenders and borrowers and by financial firms and by governments and independent regulators. But the crisis was not a failure of the free market system. And the answer is not to try to reinvent that system. It is to fix the problems we face, make the reforms we need, and move forward with the free market principles that have delivered prosperity and hope to people all across the globe.

Like any other system designed by man, capitalism is not perfect. It can be subject to excesses and abuse. But it is by far the most efficient and just way of structuring an economy. At its most basic level, capitalism offers people the freedom to choose where they work and what they do, the opportunity to buy or sell products they want, and the dignity that comes with profiting from their talent and hard work. The free market system provides the incentives that lead to prosperity — the incentive to work, to innovate, to save, to invest wisely, and to create jobs for others. And as millions of people pursue these incentives together, whole societies benefit.

Free market capitalism is far more than economic theory. It is the engine of social mobility — the highway to the American Dream. It’s what makes it possible for a husband and wife to start their own business, or a new immigrant to open a restaurant, or a single mom to go back to college and to build a better career. It is what allowed entrepreneurs in Silicon Valley to change the way the world sells products and searches for information. It’s what transformed America from a rugged frontier to the greatest economic power in history — a nation that gave the world the steamboat and the airplane, the computer and the CAT scan, the Internet and the iPod.

Ultimately, the best evidence for free market capitalism is its performance compared to other economic systems. Free markets allowed Japan, an island with few natural resources, to recover from war and grow into the world’s second-largest economy. Free markets allowed South Korea to make itself into one of the most technologically advanced societies in the world. Free markets turned small areas like Singapore and Hong Kong and Taiwan into global economic players. Today, the success of the world’s largest economies comes from their embrace of free markets.

Meanwhile, nations that have pursued other models have experienced devastating results. Soviet communism starved millions, bankrupted an empire, and collapsed as decisively as the Berlin Wall. Cuba, once known for its vast fields of cane, is now forced to ration sugar. And while Iran sits atop giant oil reserves, its people cannot put enough gasoline in its — in their cars.

The record is unmistakable: If you seek economic growth, if you seek opportunity, if you seek social justice and human dignity, the free market system is the way to go. (Applause.) And it would be a terrible mistake to allow a few months of crisis to undermine 60 years of success.

Just as important as maintaining free markets within countries is maintaining the free movement of goods and services between countries. When nations open their markets to trade and investment, their businesses and farmers and workers find new buyers for their products. Consumers benefit from more choices and better prices. Entrepreneurs can get their ideas off the ground with funding from anywhere in the world. Thanks in large part to open markets, the volume of global trade today is nearly 30 times greater than it was six decades ago — and some of the most dramatic gains have come in the developing world.

As President, I have seen the transformative power of trade up close. I’ve been to a Caterpillar factory in East Peoria, Illinois, where thousands of good-paying American jobs are supported by exports. I’ve walked the grounds of a trade fair in Ghana, where I met women who support their families by exporting handmade dresses and jewelry. I’ve spoken with a farmer in Guatemala who decided to grow high-value crops he could sell overseas — and helped create more than 1,000 jobs.

Stories like these show why it is so important to keep markets open to trade and investment. This openness is especially urgent during times of economic strain. Shortly after the stock market crash in 1929, Congress passed the Smoot-Hawley tariff — a protectionist measure designed to wall off America’s economy from global competition. The result was not economic security. It was economic ruin. And leaders around the world must keep this example in mind, and reject the temptation of protectionism. (Applause.)

There are clear-cut ways for nations to demonstrate the commitment to open markets. The United States Congress has an immediate opportunity by approving free trade agreements with Colombia, Peru*, and South Korea. America and other wealthy nations must also ensure this crisis does not become an excuse to reverse our engagement with the developing world. And developing nations should continue policies that foster enterprise and investment. As well, all nations should pledge to conclude a framework this year that leads to a successful Doha agreement.

We’re facing this challenge together and we’re going to get through it together. The United States is determined to show the way back to economic growth and prosperity. I know some may question whether America’s leadership in the global economy will continue. The world can be confident that it will, because our markets are flexible and we can rebound from setbacks. We saw that resilience in the 1940s, when America pulled itself out of Depression, marshaled a powerful army, and helped save the world from tyranny. We saw that resilience in the 1980s, when Americans overcame gas lines, turned stagflation into strong economic growth, and won the Cold War. We saw that resilience after September the 11th, 2001, when our nation recovered from a brutal attack, revitalized our shaken economy, and rallied the forces of freedom in the great ideological struggle of the 21st century.

The world will see the resilience of America once again. We will work with our partners to correct the problems in the global financial system. We will rebuild our economic strength. And we will continue to lead the world toward prosperity and peace.

Address by President Bush on financial markets

President Bush gave a major policy address on the State Floor of the White House this evening.

THE WHITE HOUSE

State Floor

9:01 P.M. EDT

THE PRESIDENT: Good evening. This is an extraordinary period for America’s economy. Over the past few weeks, many Americans have felt anxiety about their finances and their future. I understand their worry and their frustration. We’ve seen triple-digit swings in the stock market. Major financial institutions have teetered on the edge of collapse, and some have failed. As uncertainty has grown, many banks have restricted lending. Credit markets have frozen. And families and businesses have found it harder to borrow money.

We’re in the midst of a serious financial crisis, and the federal government is responding with decisive action. We’ve boosted confidence in money market mutual funds, and acted to prevent major investors from intentionally driving down stocks for their own personal gain.

Most importantly, my administration is working with Congress to address the root cause behind much of the instability in our markets. Financial assets related to home mortgages have lost value during the housing decline. And the banks holding these assets have restricted credit. As a result, our entire economy is in danger. So I’ve proposed that the federal government reduce the risk posed by these troubled assets, and supply urgently-needed money so banks and other financial institutions can avoid collapse and resume lending.

This rescue effort is not aimed at preserving any individual company or industry — it is aimed at preserving America’s overall economy. It will help American consumers and businesses get credit to meet their daily needs and create jobs. And it will help send a signal to markets around the world that America’s financial system is back on track.

I know many Americans have questions tonight: How did we reach this point in our economy? How will the solution I’ve proposed work? And what does this mean for your financial future? These are good questions, and they deserve clear answers.

First, how did our economy reach this point?

Well, most economists agree that the problems we are witnessing today developed over a long period of time. For more than a decade, a massive amount of money flowed into the United States from investors abroad, because our country is an attractive and secure place to do business. This large influx of money to U.S. banks and financial institutions — along with low interest rates — made it easier for Americans to get credit. These developments allowed more families to borrow money for cars and homes and college tuition — some for the first time. They allowed more entrepreneurs to get loans to start new businesses and create jobs.

Unfortunately, there were also some serious negative consequences, particularly in the housing market. Easy credit — combined with the faulty assumption that home values would continue to rise — led to excesses and bad decisions. Many mortgage lenders approved loans for borrowers without carefully examining their ability to pay. Many borrowers took out loans larger than they could afford, assuming that they could sell or refinance their homes at a higher price later on.

Optimism about housing values also led to a boom in home construction. Eventually the number of new houses exceeded the number of people willing to buy them. And with supply exceeding demand, housing prices fell. And this created a problem: Borrowers with adjustable rate mortgages who had been planning to sell or refinance their homes at a higher price were stuck with homes worth less than expected — along with mortgage payments they could not afford. As a result, many mortgage holders began to default.

These widespread defaults had effects far beyond the housing market. See, in today’s mortgage industry, home loans are often packaged together, and converted into financial products called “mortgage-backed securities.” These securities were sold to investors around the world. Many investors assumed these securities were trustworthy, and asked few questions about their actual value. Two of the leading purchasers of mortgage-backed securities were Fannie Mae and Freddie Mac. Because these companies were chartered by Congress, many believed they were guaranteed by the federal government. This allowed them to borrow enormous sums of money, fuel the market for questionable investments, and put our financial system at risk.

The decline in the housing market set off a domino effect across our economy. When home values declined, borrowers defaulted on their mortgages, and investors holding mortgage-backed securities began to incur serious losses. Before long, these securities became so unreliable that they were not being bought or sold. Investment banks such as Bear Stearns and Lehman Brothers found themselves saddled with large amounts of assets they could not sell. They ran out of the money needed to meet their immediate obligations. And they faced imminent collapse. Other banks found themselves in severe financial trouble. These banks began holding on to their money, and lending dried up, and the gears of the American financial system began grinding to a halt.

With the situation becoming more precarious by the day, I faced a choice: To step in with dramatic government action, or to stand back and allow the irresponsible actions of some to undermine the financial security of all.

I’m a strong believer in free enterprise. So my natural instinct is to oppose government intervention. I believe companies that make bad decisions should be allowed to go out of business. Under normal circumstances, I would have followed this course. But these are not normal circumstances. The market is not functioning properly. There’s been a widespread loss of confidence. And major sectors of America’s financial system are at risk of shutting down.

The government’s top economic experts warn that without immediate action by Congress, America could slip into a financial panic, and a distressing scenario would unfold:

More banks could fail, including some in your community. The stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet. Foreclosures would rise dramatically. And if you own a business or a farm, you would find it harder and more expensive to get credit. More businesses would close their doors, and millions of Americans could lose their jobs. Even if you have good credit history, it would be more difficult for you to get the loans you need to buy a car or send your children to college. And ultimately, our country could experience a long and painful recession.

Fellow citizens: We must not let this happen. I appreciate the work of leaders from both parties in both houses of Congress to address this problem — and to make improvements to the proposal my administration sent to them. There is a spirit of cooperation between Democrats and Republicans, and between Congress and this administration. In that spirit, I’ve invited Senators McCain and Obama to join congressional leaders of both parties at the White House tomorrow to help speed our discussions toward a bipartisan bill.

I know that an economic rescue package will present a tough vote for many members of Congress. It is difficult to pass a bill that commits so much of the taxpayers’ hard-earned money. I also understand the frustration of responsible Americans who pay their mortgages on time, file their tax returns every April 15th, and are reluctant to pay the cost of excesses on Wall Street. But given the situation we are facing, not passing a bill now would cost these Americans much more later.

Many Americans are asking: How would a rescue plan work?

After much discussion, there is now widespread agreement on the principles such a plan would include. It would remove the risk posed by the troubled assets — including mortgage-backed securities — now clogging the financial system. This would free banks to resume the flow of credit to American families and businesses. Any rescue plan should also be designed to ensure that taxpayers are protected. It should welcome the participation of financial institutions large and small. It should make certain that failed executives do not receive a windfall from your tax dollars. It should establish a bipartisan board to oversee the plan’s implementation. And it should be enacted as soon as possible.

In close consultation with Treasury Secretary Hank Paulson, Federal Reserve Chairman Ben Bernanke, and SEC Chairman Chris Cox, I announced a plan on Friday. First, the plan is big enough to solve a serious problem. Under our proposal, the federal government would put up to $700 billion taxpayer dollars on the line to purchase troubled assets that are clogging the financial system. In the short term, this will free up banks to resume the flow of credit to American families and businesses. And this will help our economy grow.

Second, as markets have lost confidence in mortgage-backed securities, their prices have dropped sharply. Yet the value of many of these assets will likely be higher than their current price, because the vast majority of Americans will ultimately pay off their mortgages. The government is the one institution with the patience and resources to buy these assets at their current low prices and hold them until markets return to normal. And when that happens, money will flow back to the Treasury as these assets are sold. And we expect that much, if not all, of the tax dollars we invest will be paid back.

A final question is: What does this mean for your economic future?

The primary steps — purpose of the steps I have outlined tonight is to safeguard the financial security of American workers and families and small businesses. The federal government also continues to enforce laws and regulations protecting your money. The Treasury Department recently offered government insurance for money market mutual funds. And through the FDIC, every savings account, checking account, and certificate of deposit is insured by the federal government for up to $100,000. The FDIC has been in existence for 75 years, and no one has ever lost a penny on an insured deposit — and this will not change.

Once this crisis is resolved, there will be time to update our financial regulatory structures. Our 21st century global economy remains regulated largely by outdated 20th century laws. Recently, we’ve seen how one company can grow so large that its failure jeopardizes the entire financial system.

Earlier this year, Secretary Paulson proposed a blueprint that would modernize our financial regulations. For example, the Federal Reserve would be authorized to take a closer look at the operations of companies across the financial spectrum and ensure that their practices do not threaten overall financial stability. There are other good ideas, and members of Congress should consider them. As they do, they must ensure that efforts to regulate Wall Street do not end up hampering our economy’s ability to grow.

In the long run, Americans have good reason to be confident in our economic strength. Despite corrections in the marketplace and instances of abuse, democratic capitalism is the best system ever devised. It has unleashed the talents and the productivity, and entrepreneurial spirit of our citizens. It has made this country the best place in the world to invest and do business. And it gives our economy the flexibility and resilience to absorb shocks, adjust, and bounce back.

Our economy is facing a moment of great challenge. But we’ve overcome tough challenges before — and we will overcome this one. I know that Americans sometimes get discouraged by the tone in Washington, and the seemingly endless partisan struggles. Yet history has shown that in times of real trial, elected officials rise to the occasion. And together, we will show the world once again what kind of country America is — a nation that tackles problems head on, where leaders come together to meet great tests, and where people of every background can work hard, develop their talents, and realize their dreams.

Thank you for listening. May God bless you.

Food prices & food aid

The President spoke this afternoon about high food prices and food aid. If you’d like more detail, here’s our “fact sheet.” And if you really want to dive down deep, here is a transcript of a press briefing done by three senior administration officials after the announcement: OMB Deputy Director Steve McMillin, CEA Chairman Ed Lazear, and Deputy National Security Advisor for International Economic Affairs Dan Price.

I’d like to zoom out a bit and discuss how food prices interact with policy.

Let’s consider the following questions:

  • How much are food prices increasing?
  • Why are food prices increasing?
  • What kind of effect is this having in the U.S., and what are we doing about it?
  • What about overseas effects?
  • What did the President announce today?
  • Is the ethanol mandate contributing to the increase in food prices?

How much are food prices increasing?

Much of the increase in food prices worldwide is due to increases in grain prices. Since March of last year:

  • wheat prices are up 146%
  • soybean prices are up 71%
  • corn prices are up 41%
  • and rice prices are up 29%.

Why are food prices increasing?

  • Increased demand in “emerging markets” (like China) accounts for about 18% of the rise in food prices. As people in poor countries get richer, they consume more meat. Since it takes a lot of grain to produce a little meat, as the proportion of meat in diets increases, the demand for grains increases.
  • Rising energy costs have increased the cost of growing food, accounting for up to another 18% of the increase.
  • Bad weather has harmed wheat harvests, especially in Australia, China, and Eastern Europe.
  • Dollar depreciation accounts for a portion of the increase in U.S. food prices.
  • Increased biofuel production has increased the demand for corn, but accounts for only 3% of the overall increase in global food prices.

What kind of effect is this having in the U.S., and what are we doing about it?

Food price inflation in the U.S. is up 4.5% over the year that ended in March, only slightly faster than the overall inflation rate of 4.0% (CPI). Certain staples are up by greater percentages: milk is up 23% over the same period, bread is up 16%, and eggs are up 35%.

Obviously, this inflation hurts, and family budgets get squeezed. On average, Americans spend about 14% of their total expenditures on food. But grain price increases don’t affect American food prices as much as they do food prices in developing countries, because grain prices are a relatively small portion of total food expenditures in the U.S. About half of all food dollars in the U.S. are spent dining out, and Americans eat more heavily processed food. Service costs (waiters, chefs) and food processing costs account for a large proportion of U.S. food spending.

There are two big federal programs that spend money on food. The U.S. government spends about $40 B a year on food stamps, helping about 28 million people this year. The food stamp program automatically adjusts to food price increases. In addition, the President’s budget proposes some changes to expand the food and vegetables component of food stamps, and to keep savings and combat pay from reducing eligibility for food stamps.

The Women, Infants, and Children (WIC) program will spend about $6 B this year on about 8.6 million people. This year we have increased funding for WIC by more than 18%. And in mid-April we transferred about $150 M from a reserve to account for higher costs in WIC.


What about overseas effects?

Let’s look at Mozambique as an example of a developing country, and compare it to the U.S.

  • Americans spend on average 14% of their total expenditures on food. In Mozambique, it’s 68% for those making under $1 a day.
  • Food prices have increased 4.5% over the past year in the U.S., and 15.4% over the past year in Mozambique.
  • The effect of one year of current food price inflation therefore means that an American has, on average, 0.5% less income to spend on other things. But in Mozambique, one year of current food price inflation squeezes out 10% of their income.

This is why international food experts talk about a food crisis – poor countries are acutely affected by grain price increases.


What did the President announce today?

To address this problem, two weeks ago my administration announced that about $200 million in emergency food aid would be made available through a program at the Agriculture Department called the Emerson Trust. But that’s just the beginning of our efforts. I think more needs to be done, and so today I am calling on Congress to provide an additional $770 million to support food aid and development programs. Together, this amounts to nearly $1 billion in new funds to bolster global food security. And with other food security assistance programs already in place, we’re now projecting to spend nearly — that we will spend nearly $5 billion in 2008 and 2009 to fight global hunger.

This funding will keep our existing emergency food aid programs robust. We have been the leader for providing food to those who are going without in the past, and we will continue to be the leader around the world. It will also allow us to fund agricultural development programs that help farmers in developing countries increase their productivity. And of course this will help reduce the number of people who need emergency food aid in the first place.

In addition, the President reiterated his call on Congress to support his proposal to allow U.S. dollars to be spent in poor countries to buy food from local farmers. This makes U.S. taxpayer dollars go farther to help more people, and it helps develop local agricultural infrastructure. (Teach a man to fish…)

Countries are moving in two different directions in response to higher food prices. Some are moving in the right direction: eliminating tariffs, permitting genetically modified foods, and increasing food assistance for their poor citizens. Others are moving in the wrong direction, restricting exports and imposing price controls on specific goods. These wrongheaded policies ultimately hurt the people who need the food, by restricting efficient trade and causing supply shortages.


Is the ethanol mandate contributing to the increase in food prices?

Right now it is not, because the price of oil is high, and other policies are supporting demand for ethanol. I’ll explain.

  • Increased global demand for biofuels is increasing the price of food, but only a little. Our experts think about 3% of the global food price increase is a result of increased demand for biofuels.
  • Two of three U.S. ethanol policies are contributing to that increase (the subsidy and the import tariff).
  • But the mandate is not now big enough to affect ethanol demand, because oil prices, the ethanol subsidy, and the import tariff together produce more ethanol than the mandate requires.
  • Given other ethanol policies and current market conditions, the ethanol mandate therefore is not affecting the price of corn or other food.

We have three domestic policies that affect ethanol supply and demand: the 51 cent /gallon tax credit (subsidy) for ethanol blended into fuel, the 54 cent /gallon ethanol import tariff, and the renewable fuel standard (RFS) mandate.

Our experts tell us that, given today’s high oil prices, the current RFS mandate is not “binding.” In other words, given the existence of the subsidy and the tariff, fuel blenders would be choosing to buy the same amount of ethanol as they are right now, even if the mandate did not exist. As evidence, the mandate in law is for 9B gallons of ethanol to be blended into fuel this year. But fuel blenders are blending about 9.15 B, more than this year’s mandate. When oil is in the $110-$120 range, and ethanol is subsidized 51 cents/gallon, you don’t need the government to tell you to buy ethanol, you do it because it’s cheaper than blending gasoline. If the subsidy weren’t in place, it would be a different story: the mandate probably would be binding and would be distorting fuel blending decisions. And the mandate could bind in the future, if the price of oil drops substantially, or in future years as the mandate increases. It could then affect the price of corn and other grains. But the President’s action last year, which was to propose an increased mandate, is not increasing the amount of ethanol used this year, and therefore is not now increasing fuel or food prices.

Our experts believe that increased use of corn to produce biofuels in the United States accounts for about 19% of the increase in the global price of corn. That’s 19% of the 41% increase in the price of corn over the last year, meaning that corn prices are about 8% higher in the U.S. as a result of increased domestic demand for ethanol. Corn is obviously only one of many grains, and grains are a subset of food, and food spending also includes food processing costs and the service costs of a waiter and cook if you go out to eat. When our experts combine all these factors, they conclude that increased worldwide use of biofuels has increased food prices by about 3%.

While increased demand for biofuels are responsible for some of the corn price increase, this does not mean that the increased RFS mandate is responsible for the 8% increase. Regular gasoline can contain up to 10% ethanol, and fuel blenders have to make a decision about how much ethanol to substitute for gasoline into a gallon of fuel (between zero and ten percent ethanol). There are two reasons why a blender might substitute more ethanol in place of gasoline:

  1. the RFS mandate in the law requires him to use more ethanol;
  2. or ethanol is less expensive than gasoline.

Let’s look at $116 oil (this morning’s opening price). That’s $116 for a barrel of West Texas Intermediate Crude (WTI), which is the really good stuff. Refiners use a mix of good and not so good stuff, so that on average the price they pay for oil run through their refinery is about $6 a barrel less than the WTI price. A barrel of oil contains 42 gallons, so crude oil costs 110 / 42 = $2.62/gallon. Add in refining, distribution, and marketing costs of roughly 50 cents/gallon to turn oil in to gasoline (it varies a lot), to get about $3.12 per gallon of gasoline, before taxes.

Now let’s turn to ethanol. Corn is currently trading for around $6/bushel. Estimates vary, but the break-even price for corn, which is the price per bushel a blender would be willing to pay to produce a gallon of ethanol and just break even, is currently above this price. This means that a fuel blender has an incentive to substitute ethanol for gasoline, no matter what the government tells him to do. It’s rational for this fuel blender to go all the way up to 10% ethanol in the fuel he sells, the maximum that U.S. vehicles can tolerate without modification.

So yes, increased ethanol usage has made corn about 8% more expensive over the past year. But it has not affected wheat prices, which have recorded the biggest grain price increase. And the higher U.S. ethanol prices right now are driven not by the higher renewable fuels government mandate, but instead by market forces that are looking for alternatives to $100+ oil. In contrast, the ethanol subsidy (51 cents per gallon) and the ethanol import tariff (54 cents per gallon) are subsidizing ethanol production relative to food production. Note that these two policies have been in effect since long before the President took office.


Conclusions

  • World grain prices are up. Way up. Especially for wheat.
  • U.S. food prices are up, but by a lot less, because raw inputs account for much less of our total spending on food.
  • More meat-eating in developing countries, higher energy costs, bad weather, the $, and increased demand for biofuels all contribute to higher food prices.
  • Poor countries are more severely affected by grain price increases than rich countries like the U.S.
  • The President’s recent and new proposals total almost $1 B of new money to bolster food security. When combine with pre-existing plans, the U.S. will spend about $5 B this year and next to fight world hunger.
  • Other nations can make the situation worse by raising protectionist barriers or imposing price controls. Either can cause a supply shortage.
  • Increased demand for biofuels is contributing to the higher price of corn and soybeans, and that is in part attributable to subsidies in U.S. law. But the expanded ethanol mandate (“Renewable Fuel Standard”) has little to no effect on the current ethanol price, because the high world oil price creates a market incentive for fuel blenders to choose ethanol over gasoline.