Understanding the House Democrats' health care bill

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)

Understanding the Kennedy health care bill

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)

Working in the West Wing: Doing a TV news interview on the North Lawn

Working in the West Wing:  Doing a TV news interview on the North Lawn

This is the second in a series of occasional posts about the nitty gritty of working in the West Wing of the White House. I am describing things as they were in the Bush Administration. YMMV in the Obama Administration. Again, it seems a bit silly to write about such trivial details, but given the positive feedback on the first post in this series, here goes.

I did my first TV interview at the beginning of 2008 shortly after being promoted. At first it was stressful, and it took me a while to get used to it. Now that I’m on the outside, I do an occasional interview on CNBC, Fox, or CNN. Today I’d like to describe the mechanics of doing a TV news interview from the North Lawn of the White House. Even though I had worked in the White House for more than five years before my first on-camera interview, I did not know any of this until I actually had to do it.

Today is Jobs Day: the first Friday of the month, when the Labor Department releases the monthly employment report. The employment report is generally the most important economic data point of the month, and the business news channels (CNBC, Bloomberg, and Fox Business) always cover it. They always ask for someone from the Administration to comment on the data and what it means for the economy and the policy agenda. I see the Vice President’s economic advisor, Jared Bernstein, is doing CNBC now. In 2008, CEA Chairman Dr. Ed Lazear and I typically did this duty.

The jobs report is released at 8:30 AM on Friday. As with all economic data releases, Administration officials are embargoed from talking about it publicly for one hour after the release. This gives the markets time to process the data without the Administration’s viewpoint.

For each show broadcasting at 9:30 AM, a network producer negotiates with a staffer in the White House press shop. For us it was Eryn Witcher, a top-notch professional with prior experience in TV news who now works as the communications director at Stanford’s Hoover Institute. Eryn would negotiate with the producers and set Ed and/or me up with interviews.

Ed and I would talk the night before about the upcoming data and what we might say about it on the air. We were among a handful of officials who got the data reports before they were released, so that we could advise the President. Ed and his staff also used that data to prepare the daily “economic data memos” that the President received each morning.

We would generally watch the CNBC commentary immediately after the data release (at 8:30 AM sharp) to see if we had missed anything, and to take a temperature check on the initial market reaction and expert analysis. We would generally be prepped by Ed’s chief of staff, Pierce Scranton, who had an uncanny ability to predict what questions we would be asked, and coached us on how to give a short effective answer. If he wasn’t fighting other fires, Deputy Press Secretary Tony Fratto would also sit in the prep session.

A little after 9 AM someone would do my makeup in my office. Around 9:15 Eryn and I (or Eryn and Ed) would walk out to the North Lawn. You need a good TV tie (no busy patterns), straight collar (I was often scolded for button down collars), and American flag pin. After a while I got my own earpiece that I would bring out with me, so I wouldn’t have to use the common one that everyone else uses. It’s also nice to know you won’t lose the earpiece during the interview.

Each network has a TV camera set up in an area on the North Lawn next to the driveway from Pennsylvania Avenue to the West Wing entrance. The networks semi-permanently set up shop there in 1998 during the Monica Lewinsky scandal, and the gravel-filled area became known as Pebble Beach. It was refurbished during the Bush Administration with slate and the cameras and tripods are covered with heavy green canvas when they’re not being used. It is now referred to as Stonehenge, to which it bears a vague resemblance.

The cameras are in a long line next to each other. Each is set up so that the person on air has the north entrance to the White House residence in the background. Because of the different camera positions, each has a slightly different angle on the White House. On the night of a big Presidential speech from the White House, try quickly switching channels and you can see the different angles.

Here’s a diagram for CNBC (roughly). As always, you can click on the picture for a larger view.

north_lawn_stonehenge

The West Wing is the square building in the lower-left (southwest) corner. The residence is in the lower-right corner, and that’s Pennsylvania Avenue up top.

The blue box surrounds Stonehenge with all the TV cameras. When you’re on CNBC you stand at the red dot, facing the camera at the orange dot. The yellow line shows the camera angle, extended to capture the north entrance to the Residence in the background.

If you look closely, to the right (east) of the blue box you can see the driveway that heads south from the Northwest Appointment Gate to the West Wing entrance. Visitors with appointments in the West Wing walk up this driveway, and you can occasionally see them passing behind someone being interviewed on TV (especially on the evening news broadcasts). If they’re walking from left to right on your screen, they’re arriving at the West Wing. Right to left, they’re leaving.

About 9:15 AM Eryn and I would walk out to Stonehenge. We would greet the cameraman and a producer, and I’d get miked up. All the producers I met were friendly and professional, and the cameraman are universally great. I would stand at the red dot facing the camera. My earpiece cord would clip to the back of my jacket collar. The cameraman would connect an audio cable to that cord, and there’s a small box at about waist high with a volume dial. He attaches a tiny microphone to my lapel and I’m all set.

The cameraman then adjusts the camera for the shot. I’m generally looking at myself on a monitor below the camera: tie is straight, flag pin is upright. (Left and right are reversed from what you’re used to in a mirror. That takes getting used to.)Around 9:25, I’ll hear audio of the show in my earpiece, and then a voice:

Voice 1: Mr. Hennessey, this is [Bob] at CNBC headquarters. Can you hear me?

Me: Yes I can, Bob.

Voice 1: And you can hear the program?

Me: Yes.

Voice 1: Great. Can you count to ten for me, please, so we can do an audio check?

Me: 1,2,3,4,5,6,7,…

Voice 1: That’s perfect. Thank you.

After another minute, another voice, the producer for my segment of the show.

Voice 2: Mr. Hennessey, this is [Tom]. We’re going to a commercial break, and will be going to you in about 2 minutes. You’ll be interviewed by [Erin / Mark / Erin & Mark].

Me: Sounds great. Thank you.

During my first few interviews, the substance wasn’t that difficult for me. I had been prepping principals for interviews and writing talking points for more than 13 years, now I just had to do the talking. The hard parts were the nerves and the physical mechanics:

  • Look at the camera lens. Don’t let your eyes wander.
  • Smile.
  • Try not to “um” and “you know” too much.
  • Slow down.
  • Relax.

Also, TV moves very quickly. Long answers don’t work, so I had to train myself to make my point in one or two sentences, rather than four or five. (That’s difficult for me.) If you go on too long, you’ll start hearing the anchor trying to jump in and move things along. And before you know it, you’re done.

After the interview, you unmike, thank the cameraman and producer, and you’re done. If you have another interview, you move down the line and repeat. If not, head inside, take off the makeup, and get feedback from your colleagues and friends who email that they saw you on TV.

I only did a few in-studio interviews, and guest hosted CNBC’s Squawk Box once. I was blown away by the ability of the anchors to multitask, and how quickly they think and react. While one of them is talking on camera, another is checking market news or data on their screen, or scanning email. Their producers are talking to them in their earpieces, and they are talking on camera with each other and the guests. The coordination, reaction times, ability to adapt and improvise, and teamwork among the anchors and their producers are amazing. Beginning that day, and ever since I have developed tremendous respect for those business news anchors hosting live fast-moving discussions. I have enough trouble doing a single five minute segment, and they do it for 2-3 hours five days a week.

Will the stimulus come too late?

I began this blog at the end of March after the stimulus bill had become law. I had been struck by how much the stimulus debate had focused on whether the bill was efficient. (It clearly was not.) There was much less discussion of whether the stimulus would be effective, and of the timing of the macroeconomic boost.

Everyone wants to know when the U.S. economy will start growing. I will focus on a related question: when will the stimulus law begin to have a significant positive effect on U.S. economic growth? And could it have come sooner if the Administration had done something different?

I believe the Administration made an enormous mistake in its legislative implementation of the stimulus. As a result, the boost to GDP will come six to nine months later than it needed to (maybe more). Given the President’s desire to do a large fiscal stimulus, and given his policy preferences, he could have had a different bill that would have been producing significant GDP growth beginning now, rather than in the middle of next year. That’s a huge mistake with real consequences for the U.S. and global economies.

To illustrate this point, let me classify four types of fiscal stimulus:

  1. a permanent tax cut;
  2. a temporary tax cut;
  3. one-time checks to people independent of their tax liabilities; and
  4. increased government spending through federal and state bureaucracies: infrastructure, energy spending, etc.

There is of course a fifth option: no fiscal stimulus law.

If you’re going to do a fiscal stimulus (big if), the best kind is a permanent tax cut. It is effective, efficient, and fast:

  • effective - People spend a large proportion of a permanent tax cut. This is derived from Milton Friedman’s “permanent income hypothesis.”
  • efficient - People spend their own money on themselves, so they waste very little of it, and they spend it on things that matter to them. Again, see Milton Friedman.
  • fast - Checks are delivered quickly, and people spend most of their own money soon after they get the check.

This was part of the short-term logic behind the 2003 tax cut, which we designed to foster both short-term and long-term economic growth. I also have a strong general policy preference for lower taxes rather than more government spending, but that’s a separable question from how it works as short-term stimulus.

In 2008 we knew we could not get a Democratic Congress to enact a permanent tax cut. Q: Do you then go for a temporary tax cut, or do nothing? The President thought the risks of an economic slowdown in 2008 were significant enough that it made sense to pursue a (second best) temporary tax cut with the Congress.

Like the 2003 law, the 2008 law got the bulk of its short-term GDP boost by advancing tax refunds from the year to come, and delivering them as checks from the IRS to taxpayers. As in 2003, the checks were delivered to taxpayers in the summer (mid-June to early-August), and consumers immediately started spending a portion of their rebates.

Because the 2008 law was a temporary tax cut, taxpayers spent a smaller proportion of it than anyone would have liked. While designing the law, we assumed about 1/3 would be spent, and much of that fairly quickly. The rest would be saved, which is also good but doesn’t help short-term GDP growth. Economists agree that GDP in Q3 and Q4 of 2008 was higher than it otherwise would have been because of the 2008 stimulus law. It was efficient, fast, yet only partially effective, with a smaller GDP boost than we would have liked:

  • efficient - People were again spending their own money on themselves. You get very little waste, and people know what they want and need.
  • fast - Checks were delivered quickly, and much of the spending that did occur happened in Q3, with some in Q4, and with very little left by Q1 of 2009.
  • only partially effective - Because it was a temporary tax cut, people saved a lot of their checks, as we expected. Still we got a GDP bump in Q3 and Q4, and in retrospect we certainly needed it.

The 2008 law was mostly (2) from my list above – a temporary tax cut. Some of the money went to (3), checks to people who didn’t pay income taxes. This was necessary to reach a compromise with a Democratic Congressional leadership that placed a high priority on the distributional effects of the law. Speaker Pelosi insisted that poor people who owed no income taxes still get “rebate” checks, and that high-income taxpayers get nothing. So the 2008 stimulus law was mostly (2) with a little bit of (3).

Now fast forward to January of 2009, when President Obama proposed an enormous fiscal stimulus. The President’s mistake was in largely deferring to Congress on the composition of the stimulus bill. Rather than allowing Congress to pump hundreds of billions of dollars through slow-spending and inefficient bureaucracies, the President should have insisted that Congress instead send all the funds directly to the American people and let them spend it quickly and efficiently. Given his policy preferences, he could have directed a large share of those funds to poor people who don’t pay income taxes. He could have again mislabeled these payments as “tax cuts,” or just correctly labeled them as one-time entitlement payments. I would not have liked that policy, but it would have generated a faster macroeconomic boost than what he allowed Congress to do instead.

Let’s compare the two scenarios. The enacted 2009 stimulus is:

  • effective (eventually) – Most of the spending through government bureaucracies will (eventually) increase GDP. Some of the funds transferred to State governments will be used to offset State spending or tax cuts that otherwise would have occurred, so there’s a loss. But clearly the proportion of the $787 B that will eventually increase GDP will be high, and much higher than if all the funds were given to individuals and families.
  • inefficient - It will be inefficient in two senses. The spending represents the policy preferences of legislators (and all their ugly legislative deals and compromises), rather than the choices of hundreds of millions of Americans who presumably know better how they would like money spent on them. The spending will also be wasteful, and we are starting to see signs of this in the press.
  • s-l-o-o-o-w - CBO says that $25 B of spending had gone into the economy by May 22nd. That’s less than 4% of the total budgetary impact of that bill. Other news reports suggest that about $40 B is in the economy if you include the revenue side. Remember that almost all of the 2008 stimulus was in private hands by August 1. We will get very little GDP boost from fiscal stimulus in Q3 of 2009, and not much in Q4 either. The stimulus will begin to ramp up in Q1 of next year, and be in full swing by Q2 and Q3 of 2010.

Had the President instead insisted that a $787 B stimulus go directly into people’s hands, where “people” includes those who pay income taxes and those who don’t, we would now be seeing a stimulus that would be:

  • partially effective but still quite large - Because it would be a temporary change in people’s incomes, only a fraction of the $787 B would be spent. But even 1/4 or 1/3 of $787 B is still a lot of money to dump out the door. The relative ineffectiveness of a temporary income change would be offset by the enormous amount of cash flowing.
  • efficient - People would be spending money on themselves. Some of them would be spending other people’s money on themselves, but at least they would be spending on their own needs, rather than on multi-year water projects in the districts of powerful Members of Congress. You would have much less waste.
  • fast - The GDP boost would be concentrated in Q3 and Q4 of 2009, tapering off heavily in Q1 of 2010.

Why did the President not do this? Discussions with the Congress began in January before he took office, and he faced a strong Speaker who took control and gave a huge chuck of funding to House Appropriations Chairman Obey (D-WI). I can think of three plausible explanations:

  1. The President and his team did not realize the analytical point that infrastructure spending has too slow of a GDP effect.
  2. They were disorganized.
  3. They did not want a confrontation with their new Congressional allies in their first few days.

I think the Administration now recognizes this problem. Last month when they released a CEA paper “Estimates of Job Creation from the American Recovery and Reinvestment Act of 2009,” the paper danced around the timing of job growth and government outlays in 2009 and 2010. Tips for reporters: (1) ask the Administration to give you OMB estimates of quarterly cash flows for the stimulus law, and (2) ask them to give you the quarterly GDP and job growth estimates behind this CEA paper. I know the first one exists, and I’d bet heavily the second does as well.

Fortunately, CBO Director Doug Elmendorf just gave a presentation titled “Implementation Lags of Fiscal Policy” to the IMF’s conference on fiscal policy. All of the following data are from his presentation.

The final 2009 stimulus law broke down like this:

10-yr total

% of total

Discretionary spending (highways, mass transit, energy efficiency, broadband, education, state aid)

$308 B

39%

Entitlements (food stamps, unemployment, Medicaid, refundable tax credits)

$267 B

34%

Tax cuts

$212 B

27%

Total

$787 B

100%

The problem is that only 11% of the first line (discretionary spending) will be spent by October 1 of this year. In contrast, 31-32% of the entitlement and tax cuts lines will be out the door by that time. (I have questions about the speed of the entitlement part. The bulk of that is Medicaid spending, and it’s not clear to me that a Federal payment to a State means the cash is immediately flowing into the private economy.)

If we extend our window to October 1, 2010, then less than half the discretionary spending will be out the door, while almost 3/4 of the entitlement spending and all of the tax cuts will be out the door and affecting the economy. The largest part of the stimulus law is therefore also the slowest spending part. This is fine if you’re trying to increase GDP growth over the next 2-4 years. If you’re going for short-term GDP growth, it makes no sense.

Director Elmendorf drills down further into discretionary spending and shows that defense spending happens quickly, highways and water extremely slowly:

  • If you allocate $1 to defense spending, 65 cents has been spent within one year.
  • If you allocate $1 to highway spending, 27 cents has been spent within one year.
  • If you allocate $1 to water projects, only 4 cents has been spent within one year.

In fact, the infrastructure spending in the stimulus law will peak in fiscal year 2011, which goes from October 1, 2010 to September 30, 2011. That’s too late from a macro perspective.

The Director further points out that the 2009 stimulus law created many new programs. This slows spend-out, as it takes time to create and ramp up the new programs.

The Administration has made much of working with federal and state bureaucracies to find “shovel-ready” projects to accelerate infrastructure spending. All of my conversations with budget analysts suggest this claim is tremendously overblown, and Director Elmendorf asks, “Is this practical on a large scale?”


The 2009 stimulus law will increase U.S. economic growth. But the actuals are matching the budget analysts’ projections for the speed at which that effect will occur.

I would not have liked a stimulus law that would have given cash to people who didn’t pay income taxes. But from a macroeconomic perspective, we need the faster economic growth now. Had the President and his team insisted on giving money to people (taxpayers or not) rather than to bureaucracies, we would be seeing a huge growth spurt in Q3 and Q4 of this year.

It is sad that instead we have to wait until the middle of next year because the White House deferred to Congressional desires to spend on infrastructure. This strategic mistake was avoidable, and the recovery will be delayed because of it.

Parsing the President’s health care reform letter

Parsing the President’s health care reform letter

The White House has released a letter from the President to the two Senate Chairmen who are working on (different) versions of health care reform: Senator Kennedy (D-MA), Chairman of the Health, Education, Labor, and Pensions (HELP) Committee, and Senator Max Baucus (D-MT), Chairman of the Senate Finance Committee. The letter is dated yesterday and was delivered as part of a White House meeting between the President and Senate Democratic leaders, including the two Chairmen.

This important letter attempts to shape the pending legislation. It makes new proposals, and it tries to set boundaries to constrain the work of the Chairmen. I am going to walk through the letter and explain what I think it means. I will walk through it in sequence, but will cut out the fluff, and occasionally add emphasis in bold. Each of these quotes could merit a post by itself. I will instead provide a survey of the whole letter. The first notable text is the second paragraph:

Soaring health care costs make our current course unsustainable. It is unsustainable for our families, whose spiraling premiums and out-of-pocket expenses are pushing them into bankruptcy and forcing them to go without the checkups and prescriptions they need. It is unsustainable for businesses, forcing more and more of them to choose between keeping their doors open or covering their workers. And the ever-increasing cost of Medicare and Medicaid are among the main drivers of enormous budget deficits that are threatening our economic future.

This is fantastic, especially as 2. He is focusing on health cost growth as the underlying problem, rather than just focusing on the uninsured, which is only one symptom of the problem. I wrote about this in mid-April: By focusing only on covering the uninsured, are we solving the wrong problem? Here’s the key picture from that post. We need to focus on the red box, and not just the blue box.

hc cost flowchart

The President’s letter continues:

We simply cannot afford to postpone health care reform any longer. This recognition has led an unprecedented coalition to emerge on behalf of reform — hospitals, physicians, and health insurers, labor and business, Democrats and Republicans. These groups, adversaries in past efforts, are now standing as partners on the same side of this debate.

There is a less noble explanation for the existence of this coalition. I wrote in mid-May, “[The provider groups] want to share in the spoils of increased government spending on health care, they want to avoid being the political and policy targets of legislation, and they see no political downside to supporting a popular and powerful President with Democratic supermajorities in both the House and Senate.”

At this historic juncture, we share the goal of quality, affordable health care for all Americans. But I want to stress that reform cannot mean focusing on expanded coverage alone. Indeed, without a serious, sustained effort to reduce the growth rate of health care costs, affordable health care coverage will remain out of reach. So we must attack the root causes of the inflation in health care.

This is an astonishing paragraph from a Democratic President. As he has done in the past, he says his goal is health care for all Americans, rather than health insurance for all Americans. This language will allow him to declare victory with a bill that does not provide universal pre-paid health insurance.

He then reiterates that expanded coverage is insufficient. A bill “must attack the root causes of the inflation in health care.” This is fantastic and unexpected from a Democrat.

The President’s letter then veers wildly off course. That paragraph continues:

… So we must attack the root causes of the inflation in health care. That means promoting the best practices, not simply the most expensive. We should ask why places like the Mayo Clinic in Minnesota, the Cleveland Clinic in Ohio, and other institutions can offer the highest quality care at costs well below the national norm. We need to learn from their successes and replicate those best practices across our country. That’s how we can achieve reform that preserves and strengthens what’s best about our health care system, while fixing what is broken.

Geographic disparities in health spending are enormous, and if we could somehow magically reduce spending in high-cost areas to match that in low cost areas, without sacrificing too much quality, then we would make major progress in reducing the level of national health spending. Budget Director Peter Orszag is the primary proponent of this argument, since before he entered the Administration.

But the Administration has no plan and no proposals that would actually reduce geographic disparities in health care. They have proposals which would provide people with more information about the health care they use, but they have not proposed to change the incentives people have to use that care. If you don’t change the incentives, you will make no significant progress in reducing geographic spending disparities or slowing health cost growth. I wrote about this in late April: Slowing health cost growth requires information AND incentives, and then found that CBO had already made this point.

More importantly, it is absurd to say that geographic disparities are “the root causes of the inflation in health care.” We know what drives health cost growth: (1) technology, (2) income growth, (3) increases in third party payment, and (4) aging of the population. Some argue that administrative costs also contribute to growth, but I’m skeptical. We also know that the first three reasons account for two-thirds to nearly all of cost growth, depending on which study you prefer.

The President’s letter correctly identifies the problem to be solved as health cost growth, and then completely misdiagnoses the sources of that growth. The Administration continues to grossly foul up the problem definition, not propose a solution, and get a free ride from a lazy and compliant press corps. You cannot slow health spending growth merely by stating a vague intent to do so.

The letter continues:

The plans you are discussing embody my core belief that Americans should have better choices for health insurance, building on the principle that if they like the coverage they have now, they can keep it, while seeing their costs lowered as our reforms take hold.

Two things jump out from this sentence. The first is a clear and oft-repeated signal that “if [you] like the coverage [you] have now, [you] can keep it.” The President says this is a core belief. It also protects the Administration from one of the most effective attacks on expansions of government health care: that it will squeeze our your private care. This is tactically smart.

The second is the return to “seeing their costs lowered as our reforms take hold.” This addresses the first box on the right side in my diagram above, and I compliment the President and his team for identifying that growing health spending hurts the more than 100 million Americans who now have health insurance, and not just those who lack it.

But for those who don’t have such options, I agree that we should create a health insurance exchange … a market where Americans can one-stop shop for a health care plan, compare benefits and prices, and choose the plan that’s best for them, in the same way that Members of Congress and their families can.

  • A (singular) exchange, or 50 State exchanges? There’s a big difference.
  • I have never been enamored of the “one-stop shopping” argument. I’m not opposed to it, it just doesn’t excite me. Mostly I fear that exchanges become vehicles for Washington-directed redistribution.
  • It is fascinating that he takes the traditional liberal argument that “you deserve health care that is good as Members of Congress get,” and turns it into “Americans can … choose the plan that’s best for them, in the same way that Members of Congress and their families can.” This is creative.

None of these plans should deny coverage on the basis of a preexisting condition, …

The hardest problem in health care reform is how to deal with the small percentage of Americans with predictably high health costs. To quote Harvard’s Dr. Kate Baicker:

Uninsured Americans who are sick pose a very different set of problems. They need health care more than health insurance. Insurance is about reducing uncertainty in spending. It is impossible to “insure” against an adverse event that has already happened, for there is no longer any uncertainty. If you were to try to purchase auto insurance that covered replacement of a car that had already been totaled in an accident, the premium would equal the cost of a new car. You would not be buying car insurance – you would be buying a car. Similarly, uninsured people with known high health costs do not need health insurance – they need health care. Private health insurers can no more charge uninsured sick people a premium lower than their expected costs. The policy problem posed by this group is how to ensure that low income uninsured sick people have the resources they need to obtain what society deems an acceptable level of care and ideally, as discussed below, to minimize the number of people in this situation.

We need to distinguish between the uninsured and the uninsurable. The uninsured lack health insurance for a wide variety of reasons. Some uninsured are healthy, some are sick.

The uninsurable are those who are already sick or injured, and who have predictably high future health costs. If you have an incurable disease, you are uninsurable, because there is little uncertainty about your future spending. (I’m oversimplifying -there is little uncertainty that you will have high health costs.) As Kate points out, “Uninsured people with known high health costs do not need health insurance – they need health care.”  The policy problem posed by this group is how to ensure that low income uninsured sick people have the resources they need to obtain what society deems an acceptable level of care.

So when the President says that “None of these plans should deny coverage on the basis of a preexisting condition,” the practical effect is that health insurance plans will be required to provide health care to the uninsurable, label it as “insurance,” and then charge healthy people higher premiums than are merited by their own health status. It’s a way of hiding the cross-subsidization.

… and all of these plans should include an affordable basic benefit package that includes prevention, and protection against catastrophic costs.

The word “basic” is unusual from a Democrat. The traditional Washington health debate has Republicans (generally) arguing that we should want more people to be able to afford access to “basic” health insurance, while Democrats (especially those farther Left) saying everyone has a right to “good” health insurance. Setting aside the access vs. right debate for the moment, the word “basic” is a more centrist choice than I would have expected from this President.

He then runs into one of the classic problems of government-designed health care reform: who defines the benefit package? By saying that all of these plans should include X, he is punting the question of who gets to define X, and how specific will they be?Governments have a terrible track record of political micromanagement of medical benefits.

I strongly believe that Americans should have the choice of a public health insurance option operating alongside private plans.

Note that he chose “I strongly believe that Americans should have” rather than the stronger “Americans must have.” Despite the urgings of the Left, the President is leaving himself room to jettison the “public option” if that is the price of getting the Republican votes he may need. Also, he says “alongside private plans,” again emphasizing that the public option will not, in his view, squeeze out private coverage. I think he’s wrong and it will squeeze out private coverage, and would point to what his Administration is trying to do to Medicare private plans as proof.

I understand the Committees are moving towards a principle of shared responsibility — making every American responsible for having health insurance coverage, and asking that employers share in the cost. I share the goal of ending lapses and gaps in coverage that make us less healthy and drive up everyone’s costs, and I am open to your ideas on shared responsibility. But I believe if we are going to make people responsible for owning health insurance, we must make health care affordable. If we do end up with a system where people are responsible for their own insurance, we need to provide a hardship waiver to exempt Americans who cannot afford it. In addition, while I believe that employers have a responsibility to support health insurance for their employees, small businesses face a number of special challenges in affording health benefits and should be exempted.

This is a fairly hard slap at a mandate (individual or employer). “I understand [you] are moving toward … I share the goal … and I am open to your ideas on shared responsibility” is not a ringing endorsement of a mandate. He then guts the universal nature by saying that it should exempt “Americans who cannot afford it” as well as small businesses. These exemptions would create tremendous distortions and inequities. The resulting patchwork mandate would be a mess. With this paragraph, I think the President weakens the prospect of a mandate becoming law.

Health care reform must not add to our deficits over the next 10 years — it must be at least deficit neutral and put America on a path to reducing its deficit over time. To fulfill this promise, I have set aside $635 billion in a health reserve fund as a down payment on reform. This reserve fund includes a numb

er of proposals to cut spending by $309 billion over 10 years –reducing overpayments to Medicare Advantage private insurers; strengthening Medicare and Medicaid payment accuracy by cutting waste, fraud and abuse; improving care for Medicare patients after hospitalizations; and encouraging physicians to form “accountable care organizations” to improve the quality of care for Medicare patients. The reserve fund also includes a proposal to limit the tax rate at which high-income taxpayers can take itemized deductions to 28 percent, which, together with other steps to close loopholes, would raise $326 billion over 10 years.

I am committed to working with the Congress to fully offset the cost of health care reform by reducing Medicare and Medicaid spending by another $200 to $300 billion over the next 10 years, and by enacting appropriate proposals to generate additional revenues. These savings will come not only by adopting new technologies and addressing the vastly different costs of care, but from going after the key drivers of skyrocketing health care costs, including unmanaged chronic diseases, duplicated tests, and unnecessary hospital readmissions.

  • “It must be at least deficit neutral” – Good.
  • “and [must] put America on a path to reducing its deficit over time” – Even better, if he were to actually propose a policy that might do this. Without such a proposal, this is empty and weak.
  • “I have set aside $635 billion in a health reserve fund as a down payment on reform” – Horrible. He wants to create the entire new obligation, but fund only about half of it.
  • “… cut spending by $309 billion over 10 years” – True, but his budget hides $330 B in additional spending on doctors and $17 B to expand Medicaid, so the net is a Medicare/Medicaid spending increase of $38 billion over 10 years. (See table S-5 on page 121 of the President’s budget.) The President’s budget increases spending on these entitlements, and uses a baseline game to claim budgetary savings to offset a new health entitlement.
  • “… cutting waste, fraud and abuse” – This is the old chestnut to suggest that the cuts are good policy and won’t hurt. There is waste, fraud, and abuse, but the cuts will also involve real reductions in payments to health providers, and they will hurt (which doesn’t make them wrong to do).
  • “… a proposal to limit the tax rate at which high-income taxpayers can take itemized deductions to 28 percent” – Democrats in Congress rejected this months ago.
  • “… by reducing Medicare and Medicaid spending by another $200 to $300 billion over the next 10 years” – Excellent. Will he provide specifics? I would be happy to suggest some.
  • “… and by enacting appropriate proposals to generate additional revenues.”- aka “raise more taxes” – Horrible from my perspective.
  • “… going after the key drivers of skyrocketing health care costs, including unmanaged chronic diseases, duplicated tests, and unnecessary hospital readmissions.” – As I said earlier, these are not the key drivers of skyrocketing health care costs, and it is misleading and irresponsible to claim they are.

To identify and achieve additional savings, I am also open to your ideas about giving special consideration to the recommendations of the Medicare Payment Advisory Commission (MedPAC), a commission created by a Republican Congress. Under this approach, MedPAC’s recommendations on cost reductions would be adopted unless opposed by a joint resolution of the Congress. This is similar to a process that has been used effectively by a commission charged with closing military bases, and could be a valuable tool to help achieve health care reform in a fiscally responsible way.

This is new and interesting to me. “A commission created by a Republican Congress” is odd, since MedPac is not known as a nonpartisan advisory group. It is also odd to imagine giving MedPac real decision-making authority, given that it is comprised of representatives of provider groups (doctors, hospitals, nurses, etc.)

I know that you have reached out to Republican colleagues, as I have, and that you have worked hard to reach a bipartisan consensus about many of these issues. I remain hopeful that many Republicans will join us in enacting this historic legislation that will lower health care costs for families, businesses, and governments, and improve the lives of millions of Americans. So, I appreciate your efforts, and look forward to working with you so that the Congress can complete health care reform by October.

I can read this either way. My gut says this means, “Get me a bill by October.” I would prefer it be broadly bipartisan, but don’t let the lack of Republican support prevent you from getting me a bill.

Summary & Conclusions

The news in this letter is:

  • The President continues his rhetorical focus on reducing long run health costs in addition to expanding coverage.
  • While appearing to push for a public option and universality, he is leaving himself room to compromise on both if needed to get a bill to his desk.
  • He has made a mandate harder to legislate by insisting on large exemptions, and he has not signaled any support for a mandate. Goodbye mandate, I think.
  • He is insisting on deficit neutrality over 10 years and reducing the deficit in the long run, while not proposing policies that achieve either goal. He is opening the door to more Medicare and Medicaid savings to reach these goals and has floated a $200-$300 B number without specifics.
  • He has opened the door to a binding commission to cut Medicare and Medicaid spending, modeled after the Base Realignment and Closure (BRAC) process.

I have mixed conclusions:

  • At the 30,000-foot level, he has broken new ground for Democrats in defining the problem correctly as unsustainable health cost growth, rather than the subsidiary problem of the uninsured. I compliment him for this.
  • At the 5,000-foot level, he botches the problem definition by focusing on geographic disparities while ignoring the commonly acknowledged major drivers of health spending increases: technology, income growth, and third party payment. This is a fatal flaw.
  • He continues to assert that we must slow cost growth, without proposing any policy changes that would do so in a measurable way. This is an abdication of leadership and irresponsible.
  • To genuinely slow health cost growth, you need to change incentives. Doing so involves political pain. Congress will not want to do that pain, and will not do so if the President doesn’t propose specifics.
  • In addition, the short-term budget numbers still don’t add up. He has problems with the “down payment” meaning they’re not paying for the full new obligation, ignoring the doctors and Medicaid spending hidden in the baseline, and Congress rejecting his biggest tax increase proposal.
  • I am glad that he is leaning against, or at least undermining, the case for a mandate.
  • The MedPAC idea is interesting. It probably won’t work, but I don’t want to dismiss it out of hand.

The President’s letter makes it harder, not easier, to get a bill. While I like some elements of the letter, it is inconsistent with the President’s actual proposals. You cannot magically slow health spending growth without proposing policy changes that affect incentives and behavior. If the President is not willing to bite the bullet and lead on slowing long-term health cost growth, he will instead get a bill which is just a straight entitlement expansion, partly offset by Medicare Advantage cuts and tax increases, and obscured by budget gimmicks. His advisors will then have to construct a bogus argument that they have addressed long-term spending growth.

That would be a terrible outcome.

Understanding the GM bankruptcy

Many of you are new to this blog since I wrote extensively about autos six weeks ago. As background, I coordinated the auto loan process for President Bush last fall as the Director of the White House National Economic Council (the position now held by Dr. Lawrence Summers). I wrote a series of posts on the auto loans beginning when the President made his late-March announcements, and continuing into the spring. For reference, here are those posts:

  1. Auto loans: a deadline looms
  2. Auto loans: options for the President
  3. Auto loans: the Bush approach
  4. Auto loans: Chrysler gets an ultimatum, GM gets a do-over
  5. Auto loans: the press forgot to ask about the cost to the taxpayer
  6. Should taxpayers subsidize Chrysler retiree pensions or health care?
  7. The Chrysler bankruptcy sale
  8. Mixed results on the Chrysler announcement

This morning I posted some basic facts on the General Motors announcement. Now it’s time for some analysis. Like my post Understanding the President’s CAFE announcement, this is a monster post. I hope you find it valuable despite its length.

I want to try to tease apart the various questions that get conflated in the public forum. My primary goal is to give you a structure for thinking about the issue. My secondary goal is to persuade you to agree with my views on each question. I will be satisfied if you give me credit for achieving only the primary goal.

Here is how I tease apart the questions:

  1. What are the arguments for further government intervention?
  2. Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?
  3. Is the pre-packaged bankruptcy likely to succeed?
  4. Is it fair?
  5. Did the government structure the taxpayer financing correctly?
  6. Will the Administration run GM?

Let’s take them one-by-one.


1. What are the arguments for further government intervention?

Today the President explained why he chose to put another $30.1 B of taxpayer funds at risk to prevent GM from liquidating now. Speaking about his decision on March 30th, he said today:

But I also recognized the importance of a viable auto industry to the well-being of families and communities across our industrial Midwest and across the United States. In the midst of a deep recession and financial crisis, the collapse of these companies would have been devastating for countless Americans, and done enormous damage to our economy — beyond the auto industry. It was also clear that if GM and Chrysler remade and retooled themselves for the 21st century, it would be good for American workers, good for American manufacturing, and good for America’s economy.

This is more expansive than what President Bush argued last December:

In the midst of a financial crisis and a recession, allowing the U.S. auto industry to collapse is not a responsible course of action. The question is how we can best give it a chance to succeed. Some argue the wisest path is to allow the auto companies to reorganize through Chapter 11 provisions of our bankruptcy laws – and provide federal loans to keep them operating while they try to restructure under the supervision of a bankruptcy court. But given the current state of the auto industry and the economy, Chapter 11 is unlikely to work for American automakers at this time.

The distinction is important. President Bush’s arguments were time-dependent: (a) we should try to prevent our weak economy from taking another big hit right now, and (b) let’s buy GM and Chrysler time to get ready to restructure. He also argued (c) that it was unfair to dump a liquidating auto industry on his successor (even if his successor might do something different than he would). It was a “too big to fail now” argument.

Today President Obama made it clear that he made the decision to commit additional funds, if his conditions were met, at the end of March. He then added new reasons to those expressed by President Bush: that America needs “a viable auto industry,” and that it would be good for America if GM and Chrysler survived. While he emphasizes what he would not do, “I refused to let these companies become permanent wards of the state,” President Obama defines a national interest in having auto manufacturers headquartered in the U.S. He reinforced that with his closing line, which was surreal:

And when that happens, we can truly say that what is good for General Motors and all who work there is good for the United States of America.

This is a big expansion of the justification for government intervention in the market. Ford is not failing, and Chrysler is emerging from bankruptcy. President Obama is arguing that American taxpayers need to fund the survival of a third (the biggest) U.S.-based auto manufacturer, because it is important “to the well-being of families and communities across our industrial Midwest and across the United States” and because “it would be good for American workers, good for American manufacturing, and good for America’s economy.” This argument could be extended to almost any large U.S. firm, at almost any time.

My view: I am extremely uncomfortable with the President’s expanded argument for further government intervention. Had the President instead argued, “The economy is beginning to recover, and we cannot jeopardize that with another major shock,” I would have been less uncomfortable with today’s commitment of additional taxpayer funds.


2. Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?

The public debate has evolved in the past two months. Earlier this year the question posed was, “Should the Administration bail out GM?” The basic options were “yes,” “no,” and “only if they enter bankruptcy, and if they do they should try to pre-package it.” The President chose the last of these options. The President decided to put $30.1 B of additional taxpayer funding at risk to help prevent GM from liquidating in the near future, and to help them through a restructuring process.

The benefits and costs are similar to what I described in late March. Here’s the updated version:

Benefits

  • If the firm survives the bankruptcy process intact, it has a higher probability of being viable in the long run (than in a restructuring outside of bankruptcy).
  • If the firm survives restructuring, the taxpayer has a higher probability of being repaid.
  • Old equity holders faced the full costs of the firm’s failure (by being wiped out). No additional moral hazard is created.

Costs

  • There are still significant risks to GM’s survival:
    • Will GM and the Administration defeat the objecting unsecured creditors in court? (however unfair that might be)
    • Will the bankruptcy process conclude quickly (within 90 days)?
    • Will GM continue to lose market share? Can GM make cars and trucks that people want to buy?
    • Will the new fuel economy and emissions rules restrict GM’s ability to make attractive vehicles?
  • This is a big new cash outlay from the taxpayer. This costs the taxpayer, and further constrains available TARP funds.

The President made clear his answer to this question on March 30th. At that time he laid out the conditions under which he would provide additional funding, and those conditions were met. No one should be surprised that he is now putting more taxpayer funding at risk. I am surprised that they only need $30 B.

My view: We crossed this bridge back in late March. It is not a new decision today to put more taxpayer funding at risk. I don’t like it, but I am at least glad that some incentives have been restored: the firm has to go through a bankruptcy process, shareholders are wiped out, and management was fired. I remember arguments from last fall and earlier this year that GM should get more taxpayer dollars outside of a bankruptcy process. That would have been far worse, and today’s actions mitigate some moral hazard.

Given the relative strength of the U.S. economy now compared to last December, I would have preferred an outcome of a pre-packaged bankruptcy + private DIP financing, and not exposing taxpayers to any additional risk. If GM is really as viable as GM and the President claim it now is, then they should have no problem convincing capital markets to provide them with short-term financing. (Judge Richard Posner argues this.) I will guess that this was not actually a viable option, because the pre-packaging could only come together with the direct involvement of the government. I think the real options would have been expose taxpayers to $30B more risk, or allow GM to liquidate. I would go with the latter: if GM can’t find private financing, they’re on their own. I assume this means they would liquidate. This would have been harsh and painful for those affected. I believe the consequences of further intervention now are worse for a larger number of people in the long run.


3. Is the pre-packaged bankruptcy likely to succeed?

There are two components to this question:

  • Is the bankruptcy process likely to be quick and successful?
  • Will the resulting company succeed without additional taxpayer aid?

I do not feel well-qualified to comment on the first question. The talking heads all repeat that “GM’s bankruptcy is more complicated than Chrysler’s,” with little detail about why. I would point out that the Administration is one for one in this process. Their use of this part of the bankruptcy code (section 363), and the process where the old GM sells the good stuff to a new GM, and then the remaining parts are liquidated, appears to have worked for Chrysler. From my perspective, the burden of proof now shifts to those who argue this bankruptcy will take more than 90 days. I didn’t like it because of the precedent it set, but I wouldn’t bet against the Administration succeeding again.

Other than the “good for GM is good for America” quote, the biggest surprise in the President’s remarks was how heavily he was betting that a restructured GM will succeed. He could easily have taken the posture, “GM has made some hard decisions, and they have a tough road ahead if they want to survive and succeed.” Instead, he attached his own credibility to GM’s future success and said:

So I’m confident that the steps I’m announcing today will mark the end of an old GM, and the beginning of a new GM; a new GM that can produce the high-quality, safe, and fuel-efficient cars of tomorrow; that can lead America towards an energy independent future; and that is once more a symbol of America’s success.

Even with a cleaned up balance sheet and more taxpayer funding, it is by no means certain that GM will survive for the long run. If GM fails in the next few years, the taxpayers will have lost an additional $30.1 B that the President committed today. In addition, the above quote will come back to haunt the President. I understand wanting to set a positive and optimistic tone. I am confused why he did so at such great political risk to himself.

I found it useful to return to my first post on the autos and review what this new pre-packaged bankruptcy + DIP financing does to the wide range of challenges faced by GM:

Revenues

  • The economic slowdown means fewer vehicles are being purchased from all auto manufacturers, foreign and domestic.
  • Even apart from the economic slowdown, U.S. auto manufacturers have been losing market share over time.
  • This is in part because they made a bet on light trucks versus smaller cars. This product mix doesn’t work when gas prices are high. Think of the proliferation of SUVs in the past 10 years. (Note that this was in part the fault of U.S. government policies. SUVs are technically light trucks, and so they qualify for lower fuel economy requirements.)

Costs & productivity

  • The Detroit 3′s ongoing labor costs are higher than those of foreign-based firms. This is still true when you compare an American worker in a GM plant in Michigan, for instance, with an American worker in a Nissan plant in Mississippi.
  • Productivity is lower in U.S. plants of U.S. firms than it is in U.S. plants of foreign-based firms. Some of this is because of the UAW contract that mandates certain inefficiencies. Some of it is poor management.
  • The Detroit 3 have huge dealer networks that are costly to the manufacturers. These dealer franchises are often protected by state laws that make it hard for the manufacturers to make these networks smaller and more efficient.
  • Auto manufacturers face a burdensome and unpredictable legislative and regulatory environment.

Balance sheets

  • The Detroit 3 have enormous legacy costs from their retirees. Past UAW contracts provided generous benefits that continue to burden these firms. This drains profits (when they earn them) away from productivity-enhancing investments.

So can GM survive, and for how long? Can they profit and flourish, as the President suggests they will?

  • The Administration and GM argue that a restructured GM can break even in a national market of only 10m vehicles sold in America each year. (We’re now around 9.5m/year. “Normal” is around 16m/year.) If accurate, this is astonishing.This would appear to address all three of the bullets under revenues. Addressed? I’m skeptical. I need to review the assumptions in GM’s new plan, especially about market share.
  • I have seen no evidence that GM and UAW have reduced significantly GM’s ongoing labor costs to be competitive with the transplants. Maybe I have missed it. Unaddressed.
  • Productivity is still lower in U.S. plants of U.S. firms that it is in U.S. plants of foreign-based firms. As a result of high compensation costs per worker and low productivity, it appears that labor cost per vehicle produced will still be uncompetitive with the transplants. Unaddressed.
  • GM’s dealer network is being dramatically reduced. Addressed.
  • The CAFE and emissions requirements are even more burdensome than predicted, but now have at least some degree of stability, given the national standards. On net, worse than before.
  • The balance sheets will be relieved of enormous debt and legacy health and pension obligations. Addressed.

My view: I need to look more at what GM is assuming for market share. The removal of the legacy obligations, combined with a big chunk of taxpayer change, will buy then many months of survival.

The Administration is stressing the balance sheet improvements, and they deserve credit for that. Conservative critics focus on the additional burdens of the fuel economy and emissions rules, and they’re right, too.

I would focus even more on the questions asked by several commenters: “Will people want to buy GM cars and trucks?” Additionally, can GM make a profit with still high labor costs, still low productivity, still burdensome work rules, and still slow product development cycles?

I want to GM to survive and be profitable in the long run. Their chances are now drastically improved, assuming they survive bankruptcy. But I don’t know if that’s an improvement from a 1% chance to a 20% chance, or from a 1% chance to an 80% chance. A lot more needs to change beyond just cleaning up the balance sheet, and many of those needed changes are deep-seated in the culture, structures, and processes of America’s third-largest company.


4. Is the pre-packaged bankruptcy fair?

Absolutely not. But I want to be precise in my criticism.

The easiest thing to do in Washington is to criticize the negotiator. “I could have gotten a better deal,” we say. I should begin my expressing my sympathy and offering my congratulations to Steven Rattner and the Obama team for closing what was undoubtedly a complex and difficult set of negotiations. I’m sure this one was not easy, and theirs was a thankless task.

At the same time, I share the concerns of many that the deal was not even-handed, and that the precedent will damage future business lending. I have grave concerns about how far they were willing to stretch bankruptcy processes and the traditional capital structure to get a deal.

First I need to correct the Administration, as well as some bad reporting today by the Washington Post. In last night’s background briefing for the press, an unnamed Senior Administration Official claimed (emphasis added):

Secondly, as you know, the UAW has reached a new agreement with GM and that agreement has been ratified that involves significant concessions by the UAW … concessions that are in virtually every respect more aggressive than what the previous administration demanded in its loan agreement.

In the term sheet for the December loan we (the Bush Administration) made to General Motors, we set out “targets,” which we took directly from the Corker amendment offered the week prior on the Senate floor:

  1. Reduce outstanding unsecured debt by not less than 2/3 through conversion into equity or other debt;
  2. Reduce the total amount of compensation, including wages and benefits, paid to their U.S. employees so that, by no later than December 31, 2009, the average of such total amount, per hour and per person, is an amount that is competitive with the average total amount of such compensation, as certified by the Secretary of Labor, paid per hour and per person to employees of Nissan Motor Company, Toyota Motor Corporation, or American Honda Motor Company whose site of employment is in the United States.
  3. Eliminate the jobs bank.
  4. Apply work rules no later than 12/31/09 “in a manner that is competitive with Nissan … Toyota or Honda in the U.S.”
  5. Not less than half of their VEBA payment should be in the form of stock.

As best I can tell:

  • They more than accomplished target #1.
  • They did little to nothing on #2. I have seen no evidence that compensation of current workers has been changed. UAW Chief Ron Gettelfinger claimed in a message to his members, “For our active members these tentative changes mean no loss in your base hourly pay, no reduction in your health care, and no reduction in pensions.” Maybe there’s a distinction between this statement and “total compensation.” If so, it would be great if someone could help me understand this. But it appears GM and UAW did nothing to address target #2.
  • UAW agreed to #3 in late March.
  • They made no apparent progress on target #4. I have neither seen nor heard evidence that the work rules have been relaxed. I am happy to be corrected.
  • They accomplished #5.

It was incorrect for the Senior Administration Official to call these “demands” of the Bush Administration. They were targets, not hard conditions. It is an overstatement to say that they “are in virtually every respect more aggressive than what the previous Administration demanded,” unless “virtually every respect” means “except for compensation and work rules.” (I am happy to be corrected if I have just missed the changes.)

The Washington Post then further flubbed it by writing:

Critics say it is unfair that the restructuring plan gives the union health trust a larger share of the new GM than the bondholders. But administration officials defend the plan, offering several justifications.

First, they note that the terms of the proposed GM restructuring echo the terms laid out by the Bush administration in December, when it extended $13.4 billion in loans to GM.

The Bush administration’s loan agreement required a 50 percent reduction or “haircut” for the union trust, but a 66 percent cut for the bondholders. The Obama deal requires larger cuts for both sides, though more for the bondholders.

The agreement does more than meet three of the five targets laid out by the Administration. It appears to make no progress on the other two targets. Thus the terms do not “echo the terms laid out by the Bush administration in December.”

More importantly, the targets we (Bush team) laid out said nothing about the distribution of equity shares. The criticism is not that the deal doesn’t cut the VEBA enough, or reduce unsecured debt enough. The criticism is that someone lower in the capital structure (UAW’s VEBA) got a much greater equity share than someone higher in the structure (unsecured creditors). It is disingenuous to point to the targets in the Bush Administration’s December loans to justify this inequity.

The deal is unfair to unsecured creditors, because they get a worse deal than someone standing behind them in line (the UAW’s VEBA). It has nothing to do with who those parties are (labor vs. creditors). It is about the importance of maintaining a stable and predictable set of rules to govern the capital structure of a firm, and the value that stability creates for firms’ ability to raise capital. All these arguments boil down to the cardinal rule of waiting in line for the kindergarten bus: it’s not fair to cut in line. If that rule is broken too often, chaos ensues.

The Administration could be arguing, “Sure it’s unfair, but UAW had more leverage on us than the creditors, so we struck the best deal that we could. We needed UAW to sign onto the deal, while we thought we could roll the creditors in court.” This would better justify the disproportionate equity shares than claiming, “This is a fair deal.”

The objecting creditors will now defend their rights in court. If the Chrysler precedent is an example, you should bet against them. It is interesting that the President did not attack them as “speculators” this time, so at least the rhetorical leverage against them is weakened.

My view: I am more concerned with the signals this unfair treatment sends to future investors. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain firms. I wish I knew whether a different prepackaging was possible, one which would have maintained the precedence of the capital structure and did not stretch the bankruptcy process again. Unfortunately, it is impossible to know.


5. Did the government structure the taxpayer financing correctly?

Judge Richard Posner argues the government should have provided a loan rather than taken an equity stake in GM. The President suggested one reason why they preferred an equity stake: a loan would further burden GM with a stream of near-term interest payments to the government.

I think Judge Posner strikes a nerve with his suggestion. It seems that much of the public discomfort comes from the government now being the owner of GM. It’s the 60% number that made me gasp. It highlights a tradeoff between two goals on which conservatives focus: value for the taxpayer, and avoiding government interference and control. There is a tradeoff between the two.

I believe the U.S. government could auction its equity shares late this year and divest itself completely from General Motors.This would solve the government ownership problem. In doing so, I presume that taxpayers would recoup far less than the $30 B of cash provided.

Question for conservatives: How much of a loss are you willing to take on the $30 B to get the U.S. government out of GM quickly?

My view: I assume there is a non-trivial chance that GM may still fail in the next several years. I like the President’s and his team’s strong language today that this $30 B is the last taxpayer aid, but I would like to reinforce that by ending the government’s ongoing involvement in GM as quickly as possible. I am willing to sacrifice a significant portion of the $30 B to achieve that goal. I therefore recommend that, if GM emerges from bankruptcy, the Administration then establish a much more rapid timetable for selling its equity stake, even if that means the taxpayer loses much of the $30 B. Get us out of GM before the end of 2010. This will strengthen the bulwark against providing additional taxpayer funds if GM fails again.

Note:

  • Under current law, the authority to provide any firm with additional TARP funding expires December 31, 2009. Correction: Secretary Geithner can, after notifying Congress, extend the TARP authorities to October 3, 2010.
  • The “set a timeline” argument has direct parallels to a certain national security debate.

6. Will the Administration run GM?

Here I give the Administration credit for good intent and good initial execution. I take at face value the President’s statement that he does not want to run or control GM, and I give him points for saying so explicitly. I am sure there are others, including some in his Administration and some on Capitol Hill, that would love to run GM as Government Motors. I will trust the President when he says he is not one of those people.

I further give the Administration credit for the “Principles for Managing Ownership Stake” they released in today’s fact sheet. While they are being released in the specific context of the U.S. government’s new equity stake in GM, the White House writes more generally “(T)he Obama Administration has established four core principles that will guide the government’s management of ownership interests in private firms.”

  • The government has no desire to own equity stakes in companies any longer than necessary, and will seek to dispose of its ownership interests as soon as practicable. Our goal is to promote strong and viable companies that can quickly be profitable and contribute to economic growth and jobs without government involvement.
  • In exceptional cases where the U.S. government feels it is necessary to respond to a company’s request for substantial assistance, the government will reserve the right to set upfront conditions to protect taxpayers, promote financial stability and encourage growth. When necessary, these conditions may include restructurings similar to that now underway at GM as well as changes to ensure a strong board of directors that selects management with a sound long-term vision to restore their companies to profitability and to end the need for government support as quickly as is practically feasible.
  • After any up-front conditions are in place, the government will protect the taxpayers’ investment by managing its ownership stake in a hands-off, commercial manner. The government will not interfere with or exert control over day-to-day company operations. No government employees will serve on the boards or be employed by these companies.
  • As a common shareholder, the government will only vote on core governance issues, including the selection of a company’s board of directors and major corporate events or transactions. While protecting taxpayer resources, the government intends to be extremely disciplined as to how it intends to use even these limited rights.

Given that I trust the President’s statements on this point, the risks here are unintended consequences, from within his own Administration and from the Congress. They are big risks, and these are dangerous waters. I hope the Administration treads carefully.

My view: Given the undesirable situation of government equity stakes in, and even controlling ownership of, firms like GM and AIG, as well as potentially Citigroup and other banks, these are good principles. They are also easy to monitor. It is interesting and good that the White House fact sheet says, “The [UAW's] VEBA will have the right to select one independent director and will have no right to vote its shares or other governance rights.” (emphasis added)

I urge the President to:

  • Enshrine the principles from today’s fact sheet in the term sheets for the taxpayer investments in GM (and other firms). We did this last December in the GM and Chrysler term sheets. Tie yourself to the mast. This will give you an easy excuse later when someone pressures you to vote those shares in a way that conflicts with the taxpayer’s interest.
  • Set clear rules for Administration contacts with GM – it’s probably best to funnel all contacts through specific Treasury or NEC officials on the autos task force. No freelancing phone calls to the Administration-appointed directors or “informal chats” with them from White House staff, or from DOT, EPA, USTR, DOE, even State. Put a firewall around interactions with GM.
  • Come out hard and quickly against the first proposal from a Member of Congress to leverage the ownership stake for a non-taxpayer goal. Nip it in the bud, especially if the idea comes from a friend.

It’s easy to criticize a huge decision like the one made by the President today. I strongly disagree with where we are headed, and I am concerned with the precedent that this deal sets for capital investment in American firms. The alternative, however, is that you have to be willing to allow GM to fail. I would be willing to do so, and it is therefore easy for me to express my views. In summary, they are:

  1. I am extremely uncomfortable with the President’s expanded argument for today’s government intervention.
  2. My first choice would have been to push GM to get private DIP financing. Assuming that was infeasible, I would have recommended denying GM the DIP financing, even if that meant they would liquidate. The economy is sufficiently healthier now than it was last December that I would be willing to risk the additional shock. But I agree the President crossed this bridge at the end of March.
  3. I would bet in favor of GM emerging from bankruptcy, and against them surviving as an intact firm for 5 years without additional taxpayer funding.
  4. The pre-packaging deal was unfair to unsecured creditors, to the benefit of UAW retirees. The Administration loses credibility with me by trying to argue this was a fair deal. They would have been more credible if they had argued it was the only deal they could get. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain U.S. firms.
  5. If a loan rather than an equity purchase had been possible, I would have preferred that – I find Judge Posner’s arguments persuasive. Given the equity investment, I urge the Administration to divest as quickly as possible, even if it means a loss to the taxpayer.
  6. Given the undesirable situation of the U.S. government owning GM and other large firms, the Administration’s new “Principles for Managing Ownership Stake” are solid. They need to lock them in, and corral or beat back all those people who work in the Executive Branch and Congress who have other goals in mind for GM and will be tempted to exert some leverage.

I thank you for making it through this extremely long post, and again want to thank all of the fantastic commenters. If you dislike the President’s announcement, I urge you to consider this question: Suppose the deal announced today were the only possible pre-packaged bankruptcy, and your choice was to take it or allow GM to liquidate now. What would you do?

The Smoot-Krugman carbon import tariff

I wrote last Friday about the China/India hole in the American climate strategy:

America appears to lack a high-probability strategy for how to get China, India, and Russia to agree to self-impose a significant positive carbon price.

The Administration and its Congressional allies are trying to impose a significant carbon price in the U.S. through something like the Waxman-Markey bill, while entering an international negotiation process in which as much as 60% of global carbon emissions could face little to no carbon price. The likely outcome would dramatically tilt the global economic playing field, harming U.S. workers and firms relative to their counterparts in China and India.At the same time, it would make little progress toward addressing the risk of severe global climate change, as a large portion of global carbon emissions would remain effectively uncapped.

In that post I identified two questions that American policymakers need to answer to fill that hole. The first of those was:

What tools should we use to try to convince the government of China to impose a positive carbon price as part of a global effort? (choose one or more)

  1. Leadership: U.S. goes first and self-imposes a price. Then we use diplomacy to try to convince the Chinese to do the same.
  2. Carrots: The U.S. pays the Chinese to reduce their emissions.
  3. Sticks: The U.S. imposes import tariffs on Chinese goods as long as the government China does not impose a carbon price.

I now see that I was eight days behind Dr. Paul Krugman in identifying this challenge. On May 14th, he wrote in his New York Times column “Empire of Carbon“:

(T)he people I talk to are increasingly optimistic that Congress will soon establish a cap-and-trade system that limits emissions of greenhouse gases, with the limits growing steadily tighter over time. And once America acts, we can expect much of the world to follow our lead.

… But that still leaves the problem of China, where I have been for most of the last week. … But China cannot continue along its current path because the planet can’t handle the strain. … And the growth of emissions from China … already the world’s largest producer of carbon dioxide … is one main reason for this new pessimism.

I’d like to compare where I think Dr. Krugman stands on various elements of the strategic question I posed, and compare them with my own views. We differ in our concern about the risks and costs of severe climate change, and that difference leads us to radically different policy recommendations.

I should state at the outset my views on the science and risk of climate change. There is a significant amount of evidence that there is a long-term risk of severe climate change. But there is little discussion about the numbers: How big of a risk? How much warmer? How quickly? How certain are we? And the numbers matter a lot. If we knew with certainty that Earth would warm 10 degrees over the next 20-30 years, I would be screaming for an immediate big carbon tax. If instead we think Earth is likely to warm one degree over the next century or two, then climate change is a trivial concern and we needn’t worry about it. The problem is that nobody knows where we are between these two extremes. This uncertainty matters a lot, and it makes the problem hard.

Given this uncertainty, I believe there is a small but non-trivial risk that there will be severe climate change over the next century or two. And so I am willing to consider significant and effective policy actions to slow the growth of greenhouse gas emissions to reduce that risk. I do not, however, believe that risk is so great or so certain that we must immediately commit to drastic changes in our economy, or that we must ignore the costs of those policy actions. I treat this like any other policy question: Given tremendous quantitative uncertainty, what are the marginal costs and benefits of our current emissions path, compared with various recommended policy options? I will quantify my thinking on these questions in a separate post. I am willing to consider policies to set a domestic carbon price, if I can be convinced that they’re worth it and will work. So far I have not seen any carbon pricing proposal that I think (a) would have benefits that exceed the costs, and (b) is feasible in the real world of nation-states with differing national interests. But I’m open to suggestions.

For now, let’s focus on two different answers to the China/India question in the American climate strategy.

  • Dr. Krugman appears to believe that, if China does not slow its global greenhouse emissions growth, actions by the rest of the world will be insufficient to significantly slow global emissions. Krugman: “In January, China announced that it plans to continue its reliance on coal as its main energy source and that to feed its economic growth it will increase coal production 30 percent by 2015.” That’s a decision that, all by itself, will swamp any emissions reductions elsewhere.” I agree with him on this point.
  • I agree with Dr. Krugman’s read of the official Chinese position: “So what is to be done about the China problem? Nothing, say the Chinese. Each time I raised the issue during my visit, I was met with outraged declarations that it was unfair to expect China to limit its use of fossil fuels.” This is consistent with what I know about the Chinese position from our Administration negotiators in 2007 and 2008 , and with what the Financial Times reported last Friday: “Beijing reiterated its belief that developing countries, including China, should curb emissions on a voluntary basis, and only if the cuts ‘accord with their national situations and sustainable development strategies.’” Translation: We’re not setting a domestic carbon price. The Chinese are proposing that the U.S. and other rich nations choose answer (B) Carrots from my menu above: rich countries pay China to reduce their emissions.
  • It appears that Dr. Krugman believes Chinese leaders will not be swayed by option (A) Leadership: “And once America acts, we can expect much of the world to follow our lead.” But that still leaves the problem of China – I largely agree with him on this point.
  • Dr. Krugman appears to presume that we must slow the growth of global greenhouse gas emissions starting now. I disagree with Dr. Krugman on this point, and am more persuaded by Dr. Bjorn Lomborg. The state of technology is such that economic costs of near-term emissions reductions are high, and the long-term climate benefits are small. As an example, Dr. Lomborg estimates that $1 expended through the Kyoto agreement would produce the equivalent of about 30 cents of long-term climate benefits. To the extent you believe long-term climate change must be addressed, we are better off devoting resources to technology pushes that try to reduce the cost of carbon-reducing technologies. The less expensive these technologies, the easier it is for everyone to make significant emissions reductions, and the easier it would be to get a global emissions reduction agreement that includes China and India (presuming you think such an agreement is necessary).
  • Since Dr. Krugman believes that we must persuade the Chinese to change their growth path “because the planet can’t handle the strain,” he appears to conclude that we should threaten a carbon import tariff. His phrasing is quite careful, but he is clearly floating the idea:

As the United States and other advanced countries finally move to confront climate change, they will also be morally empowered to confront those nations that refuse to act. Sooner than most people think, countries that refuse to limit their greenhouse gas emissions will face sanctions, probably in the form of taxes on their exports. They will complain bitterly that this is protectionism, but so what? Globalization doesn’t do much good if the globe itself becomes unlivable.

  • Technically, Dr. Krugman does not say (1) the U.S. (2) should propose (3) a carbon import tariff. He instead predicts that “sanctions, probably in the form of taxes on their exports” will be imposed by unnamed countries “sooner than most people think.” By itself, this is only a prediction. But in the following two bolded sentences, he endorses such “sanctions, probably in the form of taxes on [Chinese] exports” by unnamed countries. With this clever phrasing, Dr. Krugman has floated an aggressive but ultimately deniable policy proposal: a carbon import tariff.
  • I believe there are cures that are worse than the disease. An import tariff would be protectionist (Dr. Krugman concedes this point). In the context of a global climate change negotiation in which different countries are establishing different domestic carbon prices, and in which two of the world’s largest economies (China and India) refuse to do the same, it is easy to see how a carbon import tariff by the U.S. could set off a global trade war, with potentially devastating effects on the world economy. It appears that Dr. Krugman is willing to bear the increased risk of a global trade war for the benefit of an increased probability that China (and India?) will slow their greenhouse gas emissions. I am not.

For completeness, my answer to my own strategic question is “(D) None of the above.”

  • Even if the U.S. establishes a domestic carbon price through a cap-and-trade or carbon tax, diplomacy alone will be unable to convince the Chinese and Indian leaders to do the same in their countries. Option (A) Diplomacy won’t work by itself.
  • Without reductions in Chinese and Indian emissions, I expect that the total climate benefits of the likely global reductions in future emissions growth would not be worth the economic costs to the U.S. of a domestic carbon price (in the near term).
  • I oppose the U.S. paying large developing countries like China and India to reduce their emissions. I am confident the U.S. Congress would agree with this view. Option (B) will not happen in the U.S., nor should it.
  • Because I think the risks of significant damage from severe climate change are small, and the costs of near-term emissions reductions using current technology are high, and because I am deeply concerned that a carbon import tariff might provoke a global trade war, I strongly oppose option (C) Sticks, including any form of carbon import tariff. Free trade, including with China, is more important to me than the possibility of creating leverage on Chinese leaders to try to change their energy development path.
  • We are not talking about small numbers here. China thinks developed countries should contribute 1/2 to 1 percent of GDP to help poorer countries cut their emissions, and the economic effects of domestic carbon prices are measured in the same orders of magnitude. When you’re measuring things in percent of GDP, you’re shooting with real bullets. I oppose imposing such a tariff, threatening one, or even floating the idea as Dr. Krugman has done.
  • Therefore, I conclude the best policy is for the U.S. not to impose a domestic carbon price in the near future. To the extent policymakers believe severe climate change is a risk that should be addressed, I instead recommend they focus on pushing carbon-reducing technology R&D, and reducing tariffs and other trade barriers to the exchange of such technologies, as Dan Price has recommended.
  • I would be comfortable with the U.S. contributing taxpayer funds to a joint international R&D effort, if it were an alternative to a domestic carbon price, and as long as U.S. firms maintained their property rights to such research.

I have tremendous respect for Dr. Krugman’s past work as an international economist. I am surprised that he is willing to risk a global trade war, and that he would apparently fire the first shot when the global economy is so weak.

Understanding the President’s CAFE announcement

Understanding the President’s CAFE announcement

(Editorial note: I was doing so well moving to shorter posts. I fail miserably in achieving that goal here. I went the comprehensive route instead. I promise to return to shorter posts in the future. Buckle up – this is a long ride. I hope you find it’s worth it.)

(Update: There’s an important correction in #3 below. The estimated job loss for the option I think most closely approximates the Administration’s proposal should be about 50,000 over five years, rather than about 150,000 over five years. I apologize for the error.)

There is not yet much data available on the President’s CAFE announcement. Luckily, we have a huge base of analysis that the National Highway Traffic Safety Administration (NHTSA) did in 2008 that allows us to infer a lot from what was announced. Here are the specific data points we have from the President’s announcement:

  • The average fuel economy standard will be 35.5 mpg in 2016. That’s a weighted average of all cars and light trucks sold in the U.S.
  • Assuming that the Wall Street Journal’s reporting is accurate, they would require cars to hit 39 mpg by 2016, and light trucks to hit 30 mpg by 2016.

These fuel standards are the implementation of a law proposed by President Bush in January 2007, and passed by (a Democratic majority) Congress and signed by President Bush in December, 2007. The Bush Administration developed rules to implement the law and brought them right up to the goal line, but did not finalize them before the end of the Administration.The Obama Administration has now significantly modified the Bush rules.

Technically the Administration is today announcing that they will release a new proposed rule. While the news coverage makes it sound like this is a done deal, this is the beginning of a regulatory process, not the end. Still, the starting point is extremely important.

In developing the Bush proposal, NHTSA developed six options. I will show you four of those. Conveniently, what we know about President Obama’s proposal lines up almost perfectly with one of those options. This allows us to use NHTSA analysis of this option to make some initial estimates of the effects of the President’s new proposal. As always, you can click on the graph to see a larger version.

CAFE comparison

This graph shows the fuel economy requirements, in miles per gallon (mpg), for a nationwide fleet average. In actuality there will be two standards, one for cars and one for light trucks (SUVs are light trucks). It gets even more complex than that, because the standard adjusts for vehicle footprint (the shadow made by the vehicle when the sun is directly overhead). This incorporates an element of vehicle size in the requirement as a proxy for safety. If everyone just moved to tiny little vehicles, we would get much better fuel economy, but we would also have more highway fatalities. So the NHTSA methodology balances fuel efficiency and safety. The “S” in NHTSA stands for Safety. For reasons that I fail to understand, safety sometimes gets taken for granted in the Beltway policy debate relative to fuel efficiency, environmental benefits, and economic costs.

The four lines are from NHTSA’s analysis for the rule that we (the Bush Administration) did not quite finalize:

  • Green is the baseline – what the standard would be if the Administration did nothing.
  • Yellow shows the Bush proposal. This line is the result of a methodology that tries to maximize net societal benefits (= total societal benefits minus total societal costs).
  • Blue shows a different methodology, in which the standard is raised until total societal costs equal total societal benefits, so net societal benefits equals zero. This is the highest you can go before the model says that the rule is making society (in the aggregate) worse off, taking into account all costs and benefits. This line and option are labeled TC=TB.
  • The red line is the extreme upper end of what NHTSA thinks can be done if all manufacturers use every fuel economy technology available, without regard for cost. No one suggests it is a viable policy option, but it is a useful reference.

The purple dot is what we know about the Obama proposal. We only have a 2016 figure, which is conveniently right in line with the TC=TB option analyzed by NHTSA last year. So I’m going to make an assumption that the Obama proposal roughly matches this blue line in the intervening years. When I compare the separate numbers we have from the Administration for cars and light trucks with the six NHTSA options, they line up in a similar fashion with the TC=TB option, reinforcing my view that this is a solid assumption. This means I will use the NHTSA estimates of the TC=TB blue line option as a proxy for the effects of the Obama proposal. Technically, someone can quibble that it’s not precisely identical, but until I see data to the contrary, that’s just quibbling.

This means the Administration can dismiss the entire analysis that follows by saying their proposal differs from the TC=TB option. I cannot disprove such a claim if they make it, but my response would be, “How different? Show me.” I feel quite comfortable using this option for my own analysis, and will do so until presented with an alternate set of numbers by the Administration. (I helped coordinate much of this policy process for President Bush in 2007 and 2008.)

Here are ten things you might want to know about President Obama’s new fuel economy proposal. I will reference some tables and analysis from the NHTSA analysis done for the near-final Bush rule. This is a long list, so this summary will let you skip around as you like:

  1. It’s aggressive.
  2. Rather than maximizing net societal benefits, this proposal raises the standard until (total societal benefits = total societal costs), meaning the net benefits to society are roughly zero. This is not an invalid framework for making a policy decision, but it is unusual. It represents a different value choice.
  3. NHTSA estimated that a similar option would cost almost 150,000 50,000 U.S. auto manufacturing jobs over five years.
  4. NHTSA guesses that under a similar option, manufacturers will make huge increases in dual clutches or automated manual transmissions, a big increase in hybrids, and medium-sized increases in diesel engines, downsizing engines, and turbocharging.
  5. It will have a trivial effect on global climate change.
  6. The national standard = the California standard (roughly).
  7. The auto manufacturers got rolled by the Governator.
  8. Granting the California waiver means California has leverage for next time.
  9. In Washington, EPA is now in the driver’s seat, not NHTSA.
  10. Today’s action will accelerate EPA’s regulation of greenhouse gas emissions from stationary sources. While Congress is futzing around on a climate change bill, EPA is getting ready to bring their “PSD” monster to your community soon.

1. It’s aggressive.

You can see this from the graph above. Within the Bush Administration we considered a range of options that would raise average fuel economy by between 1% per year and 4% per year. Our near-final rule would have raised this combined car/truck average about 4.7% per year from 2010 through 2015. My math shows that the Obama proposal would raise this same measure about 5.8% per year through 2016. That’s really aggressive. (In this post all years are Model Years for vehicles.)

Note: The press is reporting that Team Obama says they’re doing about +5% per year. They’re measuring starting in 2011.I use 2010 so I can compare Bush and Obama.

2. Rather than maximizing net societal benefits, this proposal raises the standard until (total societal benefits = total societal costs), meaning the net benefits to society are roughly zero. This is not an invalid framework for making a policy decision, but it is unusual. It represents a different value choice.

The NHTSA analyses look at a range of benefits to society, including economic and national security benefits from using less oil, health and environmental benefits from less pollution, and environmental benefits from fewer greeenhouse gas emissions (this is new). They also consider the costs, primarily from requiring more fuel-saving technologies to be included by manufacturers. NHTSA assumes these increased costs are passed on to consumers. More expensive cars mean that fewer cars are sold, which means that fewer auto workers are needed. NHTSA calculates economic costs to car buyers and to society as a whole, and job losses among U.S. auto workers.

A standard rule-making methodology is to look at all the costs to society, and all the benefits, and make them comparable (by converting them into dollar equivalents). You then ask, What policy will maximize the net benefit to society as a whole, taking into account all costs and benefits? This is the approach NHTSA used in building the yellow line.

The blue line represents a different approach. (See the TC=TB line on Table VII-6 on page 613 of the NHTSA analysis.) You take the same analysis of costs and benefits, but instead ask, How much can we increase fuel economy before the costs to society as a whole outweigh the benefits to society as a whole? This results (in theory) in no net benefit (and no net cost) to society, but allows you to maximize the fuel economy subject to this constraint.

The Obama Administration’s numbers are in line with this latter approach. It’s not wrong. The Obama approach is quite different. It represents a different value choice, in which a higher priority is placed on the benefits of increased fuel economy, and lower priorities are placed on increased costs to car buyers and job loss in the auto industry.

3. NHTSA estimated that a similar option would cost almost 150,000 50,000 U.S. auto manufacturing jobs over five years.

Update: I was sloppy and missed the note on page 585 which said that table VII-1 shows cumulative job losses. Thus, the total over five years is 48,847 (which I’ll write as “almost 50,000″), and not the 148,340 I earlier calculated. I apologize for the error, and thank James Kwak for catching my mistake.

See Table VII-1 on page 586 of the NHTSA analysis. NHTSA estimated that the TC=TB option, which I’m using as a proxy for the Obama plan, would result in the following job losses among U.S. auto workers:

MY 2011

MY 2012

MY 2013

MY 2014

MY 2015

5-yr total

8,232

24,610

30,545

36,106

48,847

148,340

Compared to the Bush draft final rule, this is 118,000 37,000 more jobs lost.

Since I know this table is inflammatory, I will anticipate some of the responses:

  • This is an estimate for the job loss from the TC=TB option analyzed by NHTSA in 2007. This is the closest proxy for the Obama rule, and I’m convinced it’s a good proxy until someone demonstrates otherwise. But technically, it’s not a job loss estimate for the Obama proposal.
  • This estimate was done in a different economic environment (late 2008), and before the U.S. government owned 1.5 major U.S. auto manufacturers. My guess, however, is that these changed conditions should push the estimated job loss up from the above estimate, rather than down.
  • There’s a false precision in the above table. It’s just what NHTSA’s model spits out. I draw this conclusion: The Obama plan will increase costs enough to further suppress demand for new cars and trucks. This will cause significant job loss, and probably in the 150K 40K range over 5-ish years, with a fairly wide error band. I don’t put any weight on the precise annual estimates.

4. NHTSA guesses that under a similar option, manufacturers will make huge increases in dual clutches or automated manual transmissions, a big increase in hybrids, and medium-sized increases in diesel engines, downsizing engines, and dialing back turbocharging.

NHTSA does a detailed analysis of the costs of new technologies to improve fuel efficiencies, and they talk to the manufacturers and examine their product plans. They then guess what technology changes the manufacturers might make to comply with a higher fuel efficiency standard. Here are their estimates for increased penetration in MY 2015 for various technologies under the TC=TB / Obama proxy option. This is from Table VII-7:

Baseline

TC = TB

(Obama proxy)

Increased penetration

Dual clutch or Automated manual transmission

8%

60%

+52%

Hybrid electric vehicles

0%

24%

+24%

Turbocharging & engine downsizing

11%

24%

+13%

Diesel engines

0%

12%

+12%

Stoichometric gasoline direct injection

30%

39%

+9%

It would be great it if a commenter could educate us a little on these technologies.

5. The proposal will have a trivial effect on global climate change.

I always chuckle when elected officials boast about the number of tons of carbon that a policy proposal will not inject into the atmosphere. The White House is doing so today, emphasizing “a reduction of approximately 900 million metric tons in greenhouse gas emissions.” That sounds like a a lot, but who the heck knows?

We are fortunate that NHTSA analyzed the climate effects of all six options in terms more amenable to our comprehension.Here are their estimates for baseline, the Bush option, and the TC=TB (Obama proxy) option. This data is from Table VII-12 in the NHTSA analysis:

CO2 concentration (ppm)

Global mean surface temperature increase (deg C)

Sea-level rise (cm)

2030

2060

2100

2030

2060

2100

2030

2060

2100

Baseline

455.5

573.7

717.2

0.874

1.944

2.959

7.99

19.30

37.10

Bush

455.4

573.2

716.2

0.873

1.942

2.955

7.99

19.28

37.06

TC=TB(Obama proxy)

455.4

573.0

715.6

0.873

1.941

2.952

7.99

19.27

37.04

OK, this still doesn’t mean a lot to me. Let’s take some more data from the same NHTSA table, and see the change from the baseline of not raising fuel economy standards at all. Now we can see the direct climate benefits of these proposals:

CO2 concentration (ppm)

Global mean surface temperature increase (deg C)

Sea-level rise (cm)

2030

2060

2100

2030

2060

2100

2030

2060

2100

Bush

.1

-.5

-1.0

-.001

-.002

-.004

0

-.02

-.04

TC=TB (Obama proxy)

.1

-.7

-1.6

-.001

-.003

-.007

0

-.03

-.06

Ah ha! This is useful information. As you can see, the effects are trivially small:

  • Both options would reduce the global mean surface temperature by one-thousandth of one degree Celsius by 2030. The Obama option would reduce the global temperature by seven thousandths of a degree Celsius by the end of this century.
  • The effects on sea level are too small to measure by 2030. By 2100, the Obama proposal (technically, the TC=TB proxy) would reduce the sea-level rise by six hundredths of a centimeter. That’s 0.6 millimeters.

Hmm. That’s not too much, especially when you consider this is the policy that will affect the #2 source of greenhouse gas emissions in our economy. (#1 is power production.)

In anticipation of some pounding by the climate change crowd:

  • These are NHTSA’s calculations using the MAGICC model, not mine. I’m just reporting their results.
  • If you have different estimates, I’m happy to consider posting them for comparison. I am less open to arguments about why the MAGICC model is wrong, or why NHTSA’s inputs into that model are wrong. I don’t know the model well enough to debate the points.

Again, the point is not the precise estimates. It’s the order of magnitude. Please don’t tell me this model is flawed. If you disagree with these calculations or this model, give me some numbers you think are better, and that lead to a different conclusion.

Imagine if the President had instead said today, “This new fuel economy and greenhouse gas emissions rule will slow the increase in future global temperature seven thousandths of a degree Celsius by the end of this century, and it means the sea will rise six tenths of a millimeter less than it otherwise would over the same timeframe.” It loses some of its punch, no?

Similarly, when the Supreme Court pushed in Massachusetts v. EPA toward regulating greenhouse gases from new cars and trucks to protect the public health and welfare from “endangerment,” I wonder if they understood that an aggressive proposal would reduce the future sea level increase by 0.6 mm?

6. The national standard = the California standard (roughly).

Technically, the Administration will be setting two standards: one for fuel economy, and another for CO2 emissions from tailpipes. In theory, the two will (basically) match up, hand-waving past a lot of second-order things like flexible fuel vehicle credits and new vehicle air conditioning standards.

During the Bush Administration there was a tussle between California and the federal government. California wanted a waiver to be able to set their own standards for CO2 emissions from cars and light trucks. Another 13 or so States wanted to follow a new California standard. The proposed California standard was significantly more aggressive than anything discussed in Washington.

We argued that having multiple emissions standards would be inefficient. Auto manufacturers would then have either to make cars to meet two different standards, or just dial up the fuel efficiency on all vehicles, so that the California standard would become the de facto national standard.

The President resolved this today by (basically) setting one national standard for fuel economy, and a roughly parallel standard for CO2 tailpipe emissions, that approximate the higher California standard. California is happy that they got their higher numbers. The auto manufacturers avoid the inefficiencies of multiple standards, while having to eat (actually, pass on to customers) the higher costs of making even more fuel efficient vehicles.

7. The auto manufacturers got rolled by the Governator.

The heads of several auto manufacturing firms stood with the President today and smiled. They lost this fight. They pushed incredibly hard during the 2007 legislative battle, and during the subsequent regulatory process, for a fuel economy standard that rose about 2% per year. They dug in hard against a growth rate greater than 3% per year, and told us that 4% per year would destroy them. Our near-final rule averaged about 4.7% per year. The Obama rule averages about 5.8% per year. Either way, this is way, way more than the auto manufacturers wanted.

They had no leverage, of course, and an outcome similar to this was predictable after the November election. So they’re putting the best face they can on it. Interestingly, the press statement from Ford CEO Alan Mulally does not say that he endorses the specific numbers proposed by the President, but instead (emphasis is mine):

Today’s announcement signals the achievement of a crucial milestone - an agreement in principle on a national program for increased fuel economy and reduced greenhouse gases.

This national program will allow us to move forward toward final regulations that all stakeholders can support. We salute the cooperative efforts of the Obama Administration, the state of California, environmental groups and others that played a constructive role in this process.

The framework of the national program will give us greater clarity, certainty and flexibility to achieve the nation’s goals. We will continue to work with the federal agencies to finalize the standards that we are committed to meeting.

Tip for reporters: Ask Ford (and the other manufacturers) if they support the specific numbers proposed by the President today. The statement above is trying to leave Ford wiggle room to argue for smaller numbers in the rulemaking process. If the auto manufacturers wiggle, then you have a repeat of the situation from last week’s health care announcement.

And of course, 1-2 of the U.S. auto manufacturers are now controlled by the U.S. government.

8. Granting the California waiver means California has leverage for next time.

As I understand it, the Administration is technically granting California its EPA waiver, and California has agreed not to invoke it for this process (MY 2011 – MY 2016). Assuming the waiver doesn’t get un-revoked (can it be?) by a future Administration, this means that next time around California will begin the process with the authority to set its own tailpipe emissions standard.

This means that, when we do this again in about five years, California holds all the cards. To quote the Governor in another context (wait for it), “Ill be back.” California will have leverage to set its own standard, which means they can again dictate the national standard. The Obama Administration has moved the primary decision-making locus for future vehicle fuel efficiency rules from Washington DC to Sacramento.

9. In Washington, EPA is now in the driver’s seat, not NHTSA.

The Administration has said there will be two rules. NHTSA will set a fuel economy rule, and EPA will set a tailpipe emissions rule. We know that EPA will always be more aggressive than NHTSA. This means that, to the extent Washington remains involved in future standards (see #8 above), the primary decision-maker becomes EPA rather than NHTSA, since auto manufacturers will have to comply with the more aggressive of the two. NHTSA does not become irrelevant, but the bureaucratic strength is definitely shifting.

This bureaucratic power shift suggests a higher priority will be placed in the future on environmental benefits, and a lower priority on economic costs and safety effects, as we see with today’s proposal.

10. Todays action will accelerate EPA’s regulation of greenhouse gas emissions from stationary sources.While Congress is futzing around on a climate change bill, EPA is getting ready to bring their “PSD” monster to your community soon.

EPA is in the midst of taking comments on an “endangerment finding” that is a huge deal in the climate change policy world. If the EPA Administrator finds that greenhouse gas emissions from new cars and trucks “endanger public health and welfare,” then it starts a regulatory process. It appears the President is prejudging the result of this regulatory comment process:  “the Department of Transportation and EPA will adopt the same rule.”

As a former colleague has taught me, a proposal to regulate greenhouse gases (under section 202 of the Clean Air Act) would greatly accelerate when greenhouse gases become “subject to regulation” under the Clean Air Act. This would trigger ramifications that reach far beyond cars and trucks. As early as this fall, greenhouse gases could become “regulated pollutants” under the Clean Air Act. Once something becomes a “regulated pollutant,” a whole bunch of other parts of the Clean Air Act kick in, and EPA is off to the races in regulating greenhouse gases from a much (much) wider range of sources, including power plants, hospitals, schools, manufacturers, and big stores.

One of the scariest elements of this is called the “Prevention of Significant Deterioration” permitting system. In effect, EPA could insert itself (or your State environmental agency) into most local planning and zoning processes. I will write more about this in the future. It terrifies me.

Thanks for making it to the finish line!

Budget: Baby Terminator

Budget:  Baby Terminator

Today the Administration released more detail for the President’s budget. The President tried to emphasize his fiscal responsibility by highlighting some of the programs he proposes to terminate or reduce. Budget Director Orszag released the Terminations, Reductions, and Savings volume.

This morning the President said,

But one of the pillars of this foundation is fiscal responsibility. We can no longer afford to spend as if deficits don’t matter and waste is not our problem. We can no longer afford to leave the hard choices for the next budget, the next administration — or the next generation.

That’s why I’ve charged the Office of Management and Budget, led by Peter Orszag and Rob Nabors who are standing behind me today, with going through the budget — program by program, item by item, line by line — looking for areas where we can save taxpayer dollars.

Today, the budget office is releasing the first report in this process: a list of more than 100 programs slated to be reduced or eliminated altogether. And the process is ongoing.

Here is a comparison of the budgetary savings from President Obama’s proposed discretionary program terminations and reductions, compared to those proposed by President Bush in his last budget:

comparison of discretionary savings

Some observations:

  • President Bush proposed $6.6 B (57%) more in discretionary program terminations and reductions than President Obama.
  • Three-fourths of President Obama’s T&R savings come from defense.
  • President Bush proposed 6.7 times more non-defense T&R savings than President Obama. (= 18.1 / 2.7)

Now this graph covers only the proposed savings from annually appropriated (“discretionary”) programs. The bulk of federal spending is in the mandatory programs. I will cover that separately.

Today the President said, “But these savings, large and small, add up.” It’s too bad they don’t add up to more.

Mixed results on the Chrysler announcement

The President’s Chrysler announcement last Thursday produced mixed results.

The agreement among Chrysler, Fiat, UAW, the Administration, and the large banks appears to increase the probability (from almost zero) that Chrysler will survive for the long run, albeit as a part of Fiat. This is clearly a good thing.Is it worth the cost to taxpayers and the broader damage caused by government interference in the economy?

Taxpayers will sustain Chrysler during its restructuring. (Fiat is putting up no cash.)The Administration has committed $8.1 billion of new taxpayer funding for a bankruptcy process that they think will take 60 days, followed by a transition period of unknown duration. I think the final cost will exceed this additional $8 B, in part because I doubt the 60-day timeframe. Since the Administration agreed to forgive about $4 B the taxpayer has already loaned to Chrysler, I am also pessimistic about the taxpayer’s chances of getting back this new $8+ B outlay of funds.

It appears the Administration reached agreement first with UAW and the big bank creditors, and then tried to “jam” the dissident creditors with a tough and possibly unfair take-it-or-leave-it offer. When those creditors rejected the Administration’s offer, the President publicly excoriated them.

The result may be a firm that survives, but there are serious adverse consequences of this process and dangerous precedents for the broader economy:

  1. Industrial policy
    1. Leveraging TARP banks - It appears the Obama team pressured TARP-recipient big banks to forgive much of their loans to Chrysler. If so, they have taken a huge step toward making these banks instruments of public policy rather than private firms. This is a primary fear of “managed capitalism” – political leaders start leveraging one sector to influence another.
    2. Bypassing the capital structure and bankruptcy process - There is no such thing as a level playing field when the government negotiates with private parties. The Obama team set themselves up as both the arbiter of the negotiation and a participant in it. It now appears that they are trying an end-run around the Chapter 11 process through a section 363 sale. If they are successful, they will have interfered with the rights of others who thought they could rely on the traditional bankruptcy structure to protect their interests. The Obama team is introducing significant political risk into future business loans by undermining the traditional bankruptcy process. This makes future loans more expensive for firms.
    3. Leveraging Fiat to meet new and arbitrary fuel efficiency goals - The fuel efficiency goals mandated by CAFE come from legislative bargaining. The new targets for Fiat (e.g., a 40 mpg vehicle made in the US) were created from thin air by the Obama negotiators. Suppose they had said Fiat cannot make blue cars. Would that be OK? When combined with the apparent cross-sector leveraging of TARP banks, this suggests a scary level of micromanagement and political interference.
  2. The deal appears to favor the President’s political allies — UAW is part of the deal, “investment firms and hedge funds” are not. The fuel efficiency crowd is presumably happy with the new requirements imposed on Fiat. The appearance the Administration has created, reinforced by the President’s public bashing of the dissident creditors, is that they used carrots with their friends, threatened the big banks with a stick, and then hit the dissident creditors with that stick when they refused the Administration’s offer. If the reality reflects this appearance, then the Administration has abused its power in structuring the proposed deal.
  3. Demagoguery – The President attacked people for asking to be paid back the money they loaned. These “investment firms and hedge funds” have a legal right and a responsibility to the people whose money they invested.

It is easy to criticize the Administration’s approach and say what they should not have done. It is harder (and more responsible) to say what you would have done instead, and to accept responsibility for the downsides of that choice. If you disagree with what the President did, I challenge you to recommend an alternate path. I will give you five options. To make it hard, please assume the probabilities listed:

  1. Withhold all additional taxpayer funds. (99% chance Chrysler liquidates by July 1)
  2. Tell the negotiating team to set a goal (a viable firm without permanent taxpayer subsidies) and a limit on taxpayer funds, and then stay out of the negotiations among private parties. (70% chance Chrysler liquidates by January 1 because the Chapter 11 process drags on and Chrysler’s sales plummet)
  3. Do what the Obama team did, but don’t use the section 363 process to jam creditors and don’t publicly bash those creditors when they dissented. (50% chance Chrysler liquidates by January 1)
  4. Tell the negotiating team to lead /”help” the negotiations, but strictly instruct them not to pursue non-taxpayer goals (like fuel efficiency), and not to favor UAW over creditors. Use the section 363 process if necessary to jam an objecting party, but don’t publicly bash them. (30% chance Chrysler liquidates by January 1)
  5. Do what the Obama team did, and be willing to add more funds if necessary to keep Chrysler alive. (15% chance Chrysler liquidates by January 1)

Also, please assume that a Chrysler liquidation increases the chance of a GM liquidation by 10-20% through a chain reaction of parts suppliers failing.

These probabilities are my somewhat-wild guesses. If you find yourself arguing with me in the comments about the probabilities, you are missing the point of the exercise. Please assume these probabilities (even if you disagree with them) and tell us what you would do, not just what you would not do.

I will start the bidding by choosing (B).

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