Blog2017-06-03T09:45:07-07:00

The China/India hole in the American climate strategy

The House Energy and Commerce Committee marked up the Waxman-Markey cap-and-trade climate change bill this week. Much of the discussion focused on the domestic impacts of the legislation, and how the policy design would affect various American constituencies. I would like to zoom out and think about how a policy like Waxman-Markey fits into a global strategic climate context, from the perspective of American policymakers.

I’m going to punt on the scientific questions in this post. I want to focus on strategy instead. For now I will stipulate that there is a significant enough risk of long-term environmental damage that policy actions should at least be considered to address that risk. I reserve the right to reconsider this later. From a practical standpoint, U.S. policymakers are headed down a path that makes this presumption, and I want to explore the consequences of their lack of a complete climate strategy.

I will use data from the Energy Information Administration (EIA) at the U.S. Department of Energy. EIA produces rigorous, reliable, and unbiased data and analysis. This data is for CO2 emissions in 2006. Ideally we would have data that compared all greenhouse gas emissions, but I think the CO2 emissions data should serve our purpose.

The international climate change debate centers on two ways to divide up countries for a climate discussion: big vs. small, and rich vs. not rich. Before 2007, global climate change negotiations were structured based on countries that were either “developed” (rich) or “developing” (not rich). The United Nations Framework Convention on Climate Change (UNFCCC) calls the developed countries “Annex II” countries, and assumes that these rich countries will bear a disproportionate share of the economic burden of reducing global greenhouse gas emissions:

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[Annex II countries] are required to provide financial resources to enable developing countries to undertake emissions reduction activities under the Convention and to help them adapt to adverse effects of climate change.

According to EIA, in 2006 seventeen countries accounted for about three-fourths of all CO2 emissions. Let’s think of these as the “big” nations. The other 175 countries account for the other quarter of CO2 emissions. I think of them as relatively “small” in this context.

In 2007, President Bush created the Major Economies process, in which the largest economies meet as a group to see if they can reach agreement on climate change. If they are successful, that agreement can serve as the starting point for a broader discussion involving all 192 countries in the UNFCCC. The Major Economies process has been productive so far, and has been continued by the Obama Administration.

This table shows how these two approaches divide countries into four groups. The UNFCCC developed/developing breakdown is the separation between the rows of the table, in which there are greater obligations imposed on countries in the top row than in the bottom row. The Major Economies process is the separation between the columns of the table, based on the presumption that if the seventeen countries that represent about three-fourths of global emissions can reach agreement, then it should be much easier to get agreement with everyone else. It is hard to negotiate with 192 countries in the same room, and clearly China has a bigger impact on the global climate than Burkina Faso.

Major Not major
Developed  

 

 

 

 

AustraliaCanada

European Union

France

Germany

Italy

Japan

United Kingdom

United States

 

 

 

 

(9 countries, about 36% of global CO2 emissions in 2006)

AustriaBelgium

Denmark

Finland

Greece

Iceland

Ireland

Luxembourg

Netherlands

New Zealand

Norway

Portugal

Spain

Sweden

Switzerland

 

 

 

 

(15 countries, about 5% of global CO2 emissions in 2006)

Developing  

 

 

 

 

BrazilChina

India

Indonesia

Korea

Mexico

Russia

South Africa

 

 

 

 

(8 countries, about 38% of global CO2 emissions in 2006)

everyone else  

 

 

 

(160 countries, about 21% of global CO2 emissions in 2006)

Source: U.S. Energy Information Administration for CO2 data

To simplify even further, we can see that the four biggest CO2 emitters in 2006 accounted for half the global total:

Rank Millions of Metric Tons of CO2 (2006) % of world total cumulative % of world total
1 China 6,018 21% 21%
2 U.S. 5,903 20% 41%
3 Russia 1,704 6% 47%
4 India 1,293 4% 51%
5 Japan 1,247 4% 55%
6 Germany 858 3% 58%

Source: U.S. Energy Information Administration for CO2 data

China and the U.S. dominate everyone else in CO2 emissions. Each is larger than the next five biggest emitters combined. China has recently passed the U.S., and the gap is expected to grow as China industrializes at a rapid rate. If you believe that we need to slow the growth of global emissions, the arithmetic demands that you slow the growth of emissions not just from the U.S., but also from (China + Russia + India). It is arithmetically infeasible to get significant reductions in future total global greenhouse gas emissions if this >30% of the total is allowed to grow unchecked. This point is only strengthened if you include the additional 7% from the five other major developing economies: Brail, Indonesia, Korea, Mexico, and South Africa, or if you include the additional 21% from the 160 small developing countries.

There are huge national differences in the effects of climate change. Some differences are geographic: Russia would probably benefit from a warmer planet, as they would face lower heating costs and have more arable land. Low-lying island states are at greater risk from a significant sea rise. Other differences are economic: a rich country like the U.S. can better adapt to a changed environment than can a poor country. These differences mean that that countries will have different views on the importance of addressing the risk of severe long-term climate change. As an example, if one ignores diplomatic considerations, from a pure national self-interest standpoint it is hard to see why the government of Russia should sacrifice anything to keep the planet from warming.

For the sake of this discussion, the form of a national policy that limits a country’s carbon emissions is less important than the size of that effect. There are important differences between a cap-and-trade policy and a carbon tax, but for the sake of this discussion I think we can hand-wave past them and just think of a country imposing an incremental price added to the cost of carbon emissions, either directly through a tax, or indirectly through a quantity-limiting cap. A positive carbon price addresses some or all of the damage that we’re stipulating is done to the (global) environment by your carbon emissions. This price results in slower economic growth in your country, as it generally raises the price of energy.

The strategic challenge (for the world, not just the U.S.) is that the governments of China, Russia, and India are big economies with big shares of total world emissions. They have so far not indicated any willingness to self-impose a positive carbon price, and its resulting economic burden, on their economies.

What, then, is the rational American strategy? Let me construct a much simpler example to crystallize the negotiating issues. Let’s pretend we live in a two-country world, the U.S. and China, and that each emits half of the world’s total carbon emissions. Let’s further assume that a ton of carbon emissions does $30 of damage to the world, and that the damage is again split evenly, so that a ton of carbon emissions from either nation does $15 of damage to the U.S. and $15 of damage to China.

I imagine a member of Greg Mankiw’s Pigou Club might say, “Just impose a global carbon tax/price of $30 per ton of carbon and you’re done. The market will handle everything else, as long as you have solid and consistent enforcement. Individual actors will then appropriately balance the costs and benefits of their carbon-producing actions. It is clean, simple, and fair.”

But suppose the government of China says, “We’re not going to impose any additional cost on the Chinese economy to limit our carbon emissions. No carbon tax, or if we agree to a cap, it will be sufficiently high that we are confident it won’t require us to slow our economic growth. We are happy to do things like adopt energy efficiency technologies and limit more traditional forms of pollution, and some of those actions will also result in reduced greenhouse gas emissions. But we are not going to impose a positive price of carbon on the Chinese economy. Near-term economic growth is far more important to us than possible long-term climate change benefits decades or centuries from now.”

What, then, are the U.S. options? I think there are two decisions U.S. policymakers need to make to have a complete strategy:

  1. 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.
  2. What carbon price should we set in the U.S. while the government of China is telling us they’re at zero?
    1. $30 – We are altruistic and will account for all damages that U.S. emissions do to the world.
    2. $15 – We will account for all damages that U.S. emissions do to the U.S.
    3. $0 – We will wait until China joins us.

On decision (1), we need to consider the effectiveness of each tool: how likely is it to convince the government of China to change their policy? This is a question for the intelligence community and diplomats.

The risk of (1A) is that it could be ineffective. In a true global context (rather than my simplified two-country example), I believe there is power in moral and diplomatic suasion, but I question how much of a $30/ton gap diplomacy alone can close.

In (1B), the payments can be direct through higher U.S. taxes and direct transfers to China. Or we could follow the path of the Waxman-Markey bill and cap U.S. emissions. If the U.S. policy then allows U.S. emitters to buy carbon offsets from Chinese firms, we would be choosing a policy that will transfer American resources to China as the most efficient path to reductions in carbon emissions. This what the Europeans have been doing. I think this is probably unacceptable to most Americans and their representatives in Congress.

(1C) risks starting a global trade war. In a world with more than two countries, it is also possible that we would impose a tariff that would hurt American consumers of Chinese goods, and other nations would not do the same. The government of China might then choose not to change their carbon policy, and instead just sell more goods to countries other than America.

On decision (2), we need to consider that firms and workers in China compete with firms and workers in the United States. The difference between the self-imposed U.S. and Chinese carbon prices is a direct and measurable disadvantage to U.S. firms and workers relative to their Chinese counterparts. So if we preemptively impose a $30/ton of carbon price in the U.S. while China has a zero carbon price, then we are significantly handicapping American firms and American workers relative to their Chinese competitors.

The Waxman-Markey bill attempts to solve this problem by having U.S. taxpayers subsidize those disadvantaged firms. Setting aside the impossibility of a government accurately targeting those subsidies, and ignoring the likelihood that this will become a rent-seeking regulatory process, this solution merely shifts the costs from one subset of the U.S. to another. The underlying economic disadvantage to Americans would remain unaddressed.


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.

From an American standpoint this seems extremely unwise. It is an incomplete climate change strategy, with a hole about how to deal with China, India, and other large developing nations.

Here are questions for the Administration and those House Members supporting the Waxman-Markey bill:

  1. Given that China, India, and Russia account for 30% of global carbon emissions, and given the apparent lack of a high-probability American strategy to convince their governments to impose a carbon price on their workers and firms, how large of an additional cost are you willing to impose now on U.S. workers and firms before knowing the likely economic and emissions endpoints?
  2. What is your strategy to get the governments of China, India, and Russia to impose a carbon price on their economies that is comparable to the one you would impose on American workers and firms?
  3. Given the competitive effects on American workers and firms, how big of a difference between the carbon price imposed by the U.S. and that imposed by China and India is acceptable at the end of the international negotiating process? How much of a competitive disadvantage are you willing to impose on U.S. workers and firms because the U.S. is comparatively wealthy relative to China, India, Russia, and other developing countries?

I believe the answers to these questions are more important than any detail of the Waxman-Markey bill, and that legislation should not move forward until Congress has answers to each of these questions.

If the Administration and its Congressional allies are going to propose imposing large costs on American workers and firms, let’s at least have a complete strategy.

(I would ask and challenge commenters to focus on these strategic questions, rather than the usual scientific back-and-forth. And please remember the comments policy: I hope we can have a vigorous and yet civil debate.)

Friday, 22 May 2009|

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!

Tuesday, 19 May 2009|

Third party payment in health care (part 3): Technology drives cost growth

Imagine that Sony plans to bring to market a new TV that is twice as good as the old $500 TV but costs $200 more to produce. If instead it is twice as good but costs $2,000 more, they will probably hold off and look for a less expensive way to improve quality.

Now imagine that TV insurance covers 90% of the incremental cost, so the consumer only sees a price increment of $200 for a TV that costs $2,000 more to make. You, and many others, would demand this new TV, which is high quality but probably low value for you, since the true incremental cost is probably more than you’re willing to pay for that quality increase.

Knowing this, Sony will likely make lots of new high-tech TVs, and will expand their R&D programs to push the limits of TV quality improvement. They won’t care much about the higher costs, because demand for any new quality-improving technology is increased by the presence of TV insurance.

This is likely to be true even if you were also told that your TV insurance premium comes out of your wages, because the cost of that insurance depends mostly on how many of your work colleagues buy new and better TVs. In addition, that insurance premium is both hidden to you and distant when you’re at the store buying the TV.

Americans would have the best TVs in the world, and companies would compete based on who can produce the highest quality TVs, almost regardless of cost.

We don’t have TV insurance today, and yet TV quality improves fairly rapidly. The market, as an aggregated collection of individual purchasing preferences, determines a balance of improved quality and high cost that results in “high value technology improvements.” Sony and its competitors try to meet the demand for high value technology improvements, rather than for any technology improvements without regard to cost.

The hidden nature of employer-provided health insurance and the tax subsidy for that insurance distort people’s decisions so that they purchase health insurance with low deductibles and high premiums. This encourages us to use lots of health care without too much regard for the cost of that care.

In her testimony before the Senate Finance Committee, Kate Baicker explained why insurance causes greater consumption of health care:

Insurance, particularly insurance with low cost-sharing, means that patients do not bear the full cost of the health resources they use. … The RAND Health Insurance Experiment (HIE), one of the largest and most famous experiments in social science, measured people’s responsiveness to the price of health care. Contrary to the view of many non-economists that consuming health care is unpleasant and thus not likely to be responsive to prices, the HIE found otherwise: people who paid nothing for health care consumed 30 percent more care than those with high deductibles. This is not done in bad faith: patients and their physicians evaluate whether the care is of sufficient value to the patient to be worth the out-of-pocket costs.

This is why Kate (and I, having learned from Kate) talks about “high value health care.” As a policy matter, we should not want to encourage people to use either more or less health care. We should instead want people to be free to choose high value health care without distortion, in which each person decides how to get the greatest value per dollar spent and what is the right balance of improved quality and higher cost.

Everything that I have explained so far about third party payment in health care contributes primarily to a high level of health spending. None of these factors alone, however, explain the extraordinary growth of health spending. This is where we grasp the rose by the thorn: the primary driver of long-term health care cost is technology. America spends more on health care each year primarily because we demand more and better health care each year. We just don’t know that we’re demanding it, because government policies push us toward high-premium low-deductible health insurance that increases our demand for high-quality but low-value technology improvements.

In January of 2008, the Congressional Budget Office reviewed three studies of the sources of cost growth in real per capita health care spending in the U.S. Here is their summary of two of the studies in chart form. (The third study had ranges and was too difficult to graph. It assigned a range for technology of between 38% and 62%.)

health cost growth graph

You can see that technology explains half to two-thirds of the long-term growth in real per capita health spending. Another 10-13% is the direct result of changes in third-party payment that further insulate us from the cost of the medical care we use (mostly the creation of Medicare and Medicaid).

There are two points here:

  1. Our employer-based health insurance system hides the cost of premiums and subsidizes those premiums. This encourages those with employer-provided health insurance to ignore some of the higher premium costs, and pushes us toward policies with low deductibles and copayments (at the expense of higher hidden subsidized premiums). These low deductible policies encourage us to use low value health care and result in unsustainably high and rapidly growing insurance premiums that crowd out wage growth.
  2. These low deductible policies also reduce our sensitivity to the costs of new medical technologies. We choose improved technology without proper regard for whether that technology is worth the higher cost, because government policies are distorting our decisions.

According to the two studies shown above, the interaction of these two factors is responsible for 2/3 to 3/4 of health care cost growth. This is where we get to the politically uncomfortable part.

  • Health care costs are on an unsustainable path. We must slow the growth of those costs.
  • 2/3 to 3/4 of health care cost growth comes from policies that push us toward low deductible policies and cause us to demand technology improvements without much consideration of the cost of those improvements.
  • Any solution that addresses the “change in third-party payment” source of cost growth will mean that people pay more out-of-pocket when they go to the doctor or hospital. In exchange they will get lower premiums. Still, this higher out-of-pocket spending is higher for some politicians to swallow (especially Democrats).
  • Any solution that addresses the technology source of health care cost growth will mean that new medical technologies will be developed less rapidly.

Nobody in Washington wants to tell you that last point. We argue about administrative costs, about medical liability costs, about insurance company profits, and about waste, fraud, and abuse. All of those are important contributing factors to high levels of health spending, and we should definitely make reforms that try to lower those levels. But our long-term problem is principally about the growth rate, and addressing the growth rate involves a real tradeoff. New medical technologies and drugs will still be developed, but not quite at the breakneck rate that we’re used to. This is grasping the rose by the thorn.

The only question left then becomes who will make those determinations. Should determinations of “high value health care”and “high value technology improvements” be made by the government, or as the result of the decisions of millions of Americans acting independently based on their own preferences?

You can probably guess my answer.

Monday, 18 May 2009|

Third party payment in health care (part 2)

Yesterday I explained that there is a tradeoff between employer-provided health insurance and wages, and that health insurance provided by an employer looks less expensive to the employee than it is. Today I want to focus on the second element of the “third party payment” problem, the tax treatment of employer-provided health insurance.

The tax system is biased in two ways:

  1. It gives more tax relief to those who get health insurance through their job, penalizing people who buy it on their own; and
  2. It gives more tax relief for more expensive health insurance policies, penalizing people who choose to purchase inexpensive policies, pay for routine care out-of-pocket, and take higher wages instead.

Let’s return to the Thompson family from yesterday. They had a combined income of $80,000, and got a $12,000 family health insurance policy through Kelly’s job. Kelly’s employer paid $9,000 of the premium, and the Thompsons paid the other $3,000. Now we’re going to introduce taxes into the discussion.

Remember from yesterday that in 2008 Kelly’s total compensation looked like this. We were ignoring taxes at the time:

2008
Total amount Kelly’s employer can afford to employ her $69,000
minus 3/4 of Kelly’s $12,000 health insurance premium – $9,000
equals Kelly’s salary = $60,000

Kelly and her husband Chet will pay income taxes on the $60K of wages — they’re in the 25% income tax bracket. Kelly will also pay 7.65% of $60K ($4,590) in payroll taxes. Her employer will pay the same amount on her behalf. As in the discussion yesterday about health benefits, those employer-side payroll taxes are actually a part of Kelly’s compensation, but invisible to her. So, from her employer’s perspective, Kelly’s compensation actually looks like this:

2008
Total amount I can afford to employ Kelly $73,590
minus payroll taxes I pay on Kelly’s $60K of wages – $4,590
equals Kelly’s post-employer-side payroll tax compensation =$69,000
minus 3/4 of Kelly’s $12,000 health insurance premium – $9,000
equals Kelly’s salary = $60,000

Notice that Kelly’s employer pays payroll taxes on her $60K of wages, but not on the $9K he pays of her health insurance premium. The amount of the premiums paid by her employer is exempt from payroll taxes.

The same is true for the payroll taxes and income taxes that Kelly pays. She calculates these based on $60K of wages, not on $69K of compensation.

This is called a tax exclusion for employer-provided health insurance. A deduction is when you pay no income taxes. An exclusion is when you pay neither income taxes nor payroll taxes (employer or employee). For most taxpayers an exclusion is worth more to a taxpayer than a deduction.

Let’s look at how this tax preference is unfair to those without employer-provided health insurance. Kelly’s twin sister Sarah is in exactly the same situation as Kelly, except that her employer pays her higher wages and does not offer health insurance. Let’s compare Kelly and Sarah’s situations:

Kelly Sarah
Total amount employer can afford to employ Kelly or Sarah $73,590 $73,590
minus payroll taxes paid by employer on wages – $4,590 – $5,230
equals post-employer-side payroll tax compensation = $69,000 = $68,360
minus health insurance premium (if any) –  $9,000 – 0
equals salary = $60,000 = $68,360
minus Sarah’s additional 25% income taxes on higher wages – $2,090
minus Sarah’s additional 7.65% payroll taxes on higher wages – $640
equals comparable salary (they’ll pay the same taxes on these amounts) = $60,000 = $65,630
Memo: Has health insurance? YES NO

Kelly and Sarah each cost their employee $73,590. Kelly has $60,000 of wages and her employer paid $9,000 of her health insurance premium. Sarah has $65,630 of wages and no health insurance. They will pay the same taxes, because I included Sarah’s incremental taxes in the table above. Kelly got something worth $9,000, and Sarah got something worth $5,630. The tax code treats the two differently (Kelly better), even though they have the same total compensation.

Now suppose, because of an improvement in productivity, Kelly’s employer will give her $100 more in compensation. $100 in additional compensation cost to the employer will buy Kelly $100 more health benefits, or $60 more in after-tax wages. The tax code tilts the playing field toward taking the marginal dollar of your compensation in the form of better and more expensive health insurance, rather than as wages.

There is a broad and bipartisan policy consensus that the tax treatment of employer-provided health insurance is both unfair to those who choose higher wages and less expensive health insurance policies, and unfair to those who are not fortunate enough to get health insurance through their job. It is also inefficient, in that it subsidizes more costly health insurance plans at the expense of higher wages.

Health insurance provided by an employer looks less expensive to the employee than it is. This lack of transparency distorts compensation toward higher health insurance premiums, since employees are not aware of how much of their compensation is being spent on their behalf to buy more expensive health insurance. In addition, even if an employee is aware of these costs that appear to be borne by the employer, the tax code subsidizes taking the marginal dollar of compensation in the form of more generous health insurance benefits, rather than as higher wages.

Both factors contribute to price insensitivity in the purchase of health insurance, and both are key contributors to the out-of-control growth of health insurance premiums.

Thursday, 14 May 2009|

Thanks, Wall Street Journal!

Thanks to Brendan Miniter at the Wall Street Journal‘s Political Diary, for awarding me “Quote of the Day” today for part of Monday’s health care post, The President’s silly health care announcement. Here’s the quote:

<

blockquote>The President is attempting to claim credit for

[health care] savings that (a) do not yet exist, (b) are not backed up by any specific changes in industry practices or government policies, and (c) are related to him only in that the groups announced they were adopting his quantitative goal. For all three of these reasons, the President’s claim that these savings will materialize is wildly unrealistic, and it is absurd to attach a per-family savings number to it. This is like the Mayor claiming credit for the 40 additional wins now, and telling fans that he will be responsible for the team winning the pennant. No one should take these claims seriously.

Thanks also to Phil Izzo at the Journal’s Real Time Economics for the link today.

Thursday, 14 May 2009|

Third party payment in health care

The Senate Finance Committee hosted a huge panel of experts yesterday to discuss health insurance. The best testimony was given by Dr. Kate Baicker of Harvard, a former White House colleague of mine. I highly recommend you read anything Kate writes. I will crib from her testimony to link three concepts that I think mutually reinforce to contribute to our national problem of exploding health care expenditures. All three concepts fit under the umbrella of third-party payment — people spend more of other people’s money than they do of their own, and less wisely.

Here are the three concepts:

  1. There is a tradeoff between employer-provided health insurance and wages. Health insurance provided by an employer looks less expensive to the employee than it is.
  2. The tax code distorts compensation decisions away from wages and toward expensive health insurance.
  3. Low-deductible health insurance encourages over-utilization of medical care.

I will take these one per day. The first one is the easiest.

Here is Kate on the first concept:

Employees ultimately pay for the health insurance that they get through their employer, no matter who writes the check to the insurance company. The view that we can get employers to shoulder the cost of providing health insurance stems from the misconception that employers pay for benefits out of a reservoir of profits. Regardless of a firm’s profits, valued benefits are paid primarily out of workers wages. While workers may not even be aware of the cost of their total health premium, employers make hiring and salary decisions based on the total cost of employment, including both wages and benefits such as health insurance, maternity leave, disability and retirement benefits. They provide health insurance not out of generosity of spirit, but as a way to attract workers  – just like wages. When the cost of benefits rises, wages fall (or rise more slowly than they would have otherwise), leaving workers bearing the cost of their benefits in the form of lower wages.

I’m going to create an example family, Charlie and Kelly Thompson, and their son Fred. In 2008 Kelly earned $60,000 per year, and Charlie $20,000, providing an annual family income of $80,000, which put the Thompsons near the top of the third quintile — their income was greater than that of about 60% of similarly-sized American families, and less than the other 40%.The Thompsons got a typical family health insurance policy through Kelly’s job. Their total premium cost was $12,000 in 2008.Kelly’s employer paid $9,000 of that premium, and the Thompsons paid the other $3,000 out of pocket.

Today I’m going to ignore the tax exclusion for employer-provided health insurance and just focus on the first point. To be clear, the numbers I use here are incorrect, in that they ignore a major distortion from our tax code. I will introduce that distortion tomorrow.

I want to focus on how Kelly is doing this year, relative to last year, and compare what she sees with reality.

Here is what Kelly’s employer saw in 2008:

2008
Total amount I can afford to employ Kelly $69,000
minus 3/4 of Kelly’s $12,000 health insurance premium – $9,000
equals Kelly’s salary = $60,000

Here is what Kelly sees in 2008:

2008
My salary $60,000
minus 1/4 of my $12,000 health insurance premium -$3,000
equals my salary after paying for health insurance = $57,000

Kelly’s employer thinks, “It’s costing me $69,000 to employ Kelly in 2008.” Kelly thinks, “I’m getting $57,000 plus health insurance in 2008.” Since Kelly thinks her health insurance costs only $3,000, there is a huge ($9,000) perception gap. You can see the tradeoff between Kelly’s wages and her health insurance costs, and that she thinks her health insurance costs less than it does.

Fast forward to 2009.

  • Assume Kelly’s employer can pay 3% more to employ her in 2009 than he could in 2008. $69,000 + 3% = about $71,100.
  • Assume the premium for the family health insurance plan chosen by Kelly’s employer has increased by 6%, from $12,000 in 2008 to $12,720 in 2009.

Here is what Kelly’s employer sees in 2009:

compared to 2008
2009 $ change % change
Total amount I can afford to employ Kelly $71,100 + $2,100 +3%
minus 3/4 of Kelly’s $12,720 health insurance premium – $9,540 – $540
equals Kelly’s salary = $61,560 + $1,560 +2.6%

While Kelly’s employer paid 3% more in 2009 than in 2008 to employ her, Kelly’s salary went up by only 2.6%, because the employer’s contribution to her health insurance premium went up by 6%.

Put in $ terms, the 6% growth in health insurance premiums swallowed up $540 of Kelly’s compensation increase. She never sees or knows about that amount — it’s invisible to her.

Here is what Kelly sees in 2009:

compared to 2008
2009 $ change % change
My salary $61,560 + $1,560 +2.6%
minus 1/4 of my $12,720 health insurance premium – $3,180 – $180
equals my salary after paying for health insurance = $58,380 + $1,380 +2.4%

Kelly says, “Sure, you gave me a 2.6% salary increase (while her employer protests that it was actually 3%), but my higher health insurance premiums swallowed up some of that, so I really only got a 2.4% salary increase, plus I kept my health insurance.”

Kelly’s employer knows he is paying her $2,100 more in 2009 than he did in 2008, but Kelly thinks that she “kept her same health insurance” and got only a $1,380 wage increase. There is a $720 difference between the two views. That’s one percent of Kelly’s compensation. Rapidly growing health insurance premiums are squeezing out a portion of Kelly’s wage increases.

As Kate Baicker testified yesterday,

When the cost of benefits rises, wages fall (or rise more slowly than they would have otherwise), leaving workers bearing the cost of their benefits in the form of lower wages.

Why does this matter? It is important for policymakers to recognize that they cannot force employers to compensate employees more. They can, however, shift the form of that compensation by placing requirements on employers, either to provide health insurance (an “employer mandate”), or to make that health insurance more generous and therefore more expensive (by mandating certain benefits or premiums rules, for instance). Kate Baicker adds two important points:

When it is not possible to reduce wages, employers may respond in other ways: employment can be reduced for workers whose wages cannot be lowered, outsourcing and a reliance on temp-agencies may increase, and workers can be moved into part-time jobs where mandates do not apply. … This also means that the claimed connection between health care costs and the “international competitiveness” of U.S. industry is murky at best: higher health costs primarily lower current workers’ non-health compensation, rather than firms’ profitability.

Every time Congress tries to make health insurance more generous (and therefore expensive) through coverage or benefit mandates, they are reducing workers’ wages. They are also reducing workers’ freedom to choose the form of their compensation. It’s easy to imagine that if the Thompson family had $69,000 and a competitive well-functioning individual market in which to shop for health insurance, they might choose to spend less than $12,000 on health insurance so they would have more money for other needs.

If Congress tries to mandate that employers provide health insurance to their employees, they will be:

  • reducing the wages of those workers who now lack employer-provided health insurance, or
  • turning their jobs into temporary jobs, or
  • pushing that work overseas, or
  • just eliminating those jobs entirely.

Finally, expanding taxpayer-subsidized health insurance to the uninsured will do nothing to help the Thompson family that already has employer-provided health insurance. As long as private health insurance premiums rise faster than total compensation, their wages will grow more slowly. The proposals being considered by the Senate Finance Committee to spend more than $600 billion dollars over the next ten years (as a “down payment”) do nothing to address this problem.

And there are more than 100 million Americans in families like the Thompsons.

Wednesday, 13 May 2009|

The President’s silly health care announcement

The President spoke about health care in the cross-hall today, flanked by the heads of several major health lobbying groups (“trade associations,” in Washington vernacular):

  • hospitals — the American Hospital Association (“AHA”);
  • doctors — the American Medical Association (“AMA”);
  • insurance companies — America’s Health Insurance Plans (“A-Hip”);
  • the drug manufacturers — Pharmaceutical Research and Manufacturers of America (“Pharma”);
  • the medical device manufacturers — Advanced Medical Technology Association (“AdvaMed”); and
  • health care worker unions — the Service Employees International Union (“SEIU”).

The President announced,

[T]hese groups are coming together to make an unprecedented commitment. Over the next 10 years — from 2010 to 2019 — they are pledging to cut the rate of growth of national health care spending by 1.5 percentage points each year — an amount that’s equal to over $2 trillion.

This is one of the sillier White House announcements I have seen. Let me draw a sports parallel.

Imagine if the mayor of your nearest big city were to hold a press conference with the General Manager of the city’s Major League Baseball team. The Mayor announces that the GM, working with the coaches and players, has committed that he will work to develop plans for the team to hit the Mayor’s new goal of winning 40 more games this season than they otherwise would have won. Those plans will improve the team’s hitting, pitching, and fielding. The Mayor also announces that the manager’s plans, combined with the Mayor’s new policy initiative for better parking at the stadium, will make fans happier and help the team win more games.

Baseball fans would reply, “Great, I’m all for it.” They might then ask a few questions:

  • What do you mean the GM “will develop plans”? Doesn’t he have any specific plans yet? How will he improve hitting, pitching, and fielding?
  • How are we supposed to verify that the team won 40 more games than they otherwise would have, since we will never know how many games they would have won?
  • Other than picking the number 40, why is the Mayor involved in this press conference? What does the Mayor’s new parking initiative have to do with the coaching changes, and how will the new parking initiative help the team win more games?
  • If this is such a good idea, what has changed to make it happen now? Is the Mayor claiming that his persuasive powers alone are worth 40 more wins? Why didn’t the GM make these changes before?

The only substance to this announcement is that the manager agreed to the Mayor’s target of winning 40 more games.Everything else is fluff or unrelated.

The same questions apply to the President’s announcement today. The letter from the provider groups says:

We will do our part to achieve your Administration’s goal of decreasing by 1.5 percentage points the annual health care spending growth rate — savings $2 trillion or more. … To respond to this challenge, we are developing consensus proposals to reduce the rate of increase in future health and insurance costs through changes made in all sectors of the health care system.

Not “We have developed proposals and here they are,” but instead “We are developing consensus proposals.” So today the groups actually announced (1) that they accept the President’s quantitative goal, and (2) they will work together to reach that goal. Neither the interest groups nor the Administration announced any substantive plan to achieve the goal.

The letter from the groups states some warm-and-fuzzy non-specific ideas:

  • Implementing proposals in all sectors of the health care system, focusing on administrative simplification, standardization, and transparency that supports effective markets;
  • Reducing over-use and under-use of health care by aligning quality and efficiency incentives among providers across the continuum of care so that physicians, hospitals, and other health care providers are encouraged and enabled to work together towards the highest standards of quality and efficiency;
  • Encouraging coordinated care, both in the public and private sectors, and adherence to evidence-based best practices and therapies that reduce hospitalization, manage chronic disease more efficiently and effectively, and implement proven clinical prevention strategies; and,
  • Reducing the cost of doing business by addressing cost drivers in each sector and through common sense improvements in care delivery models, health information technology, workforce deployment and development, and regulatory reforms.

This is the parallel to the baseball manager saying he will improve the team’s performance by improving their hitting, pitching, and fielding. Everyone agrees that it makes sense, and everyone wants to know how he’s going to do it. The same applies here. Without specifics, these are empty promises. Nothing in this list is concrete enough to translate into specific actions by anyone.

The letter does urge some increased spending on health care, for “health promotion and disease prevention to reduce the prevalence of chronic disease and poor health status, which leads to unnecessary sickness and higher health costs.” This is a repeat of a common health policy fallacy — that increased government spending on preventive care will reduce overall health expenditures. While it is true for specific individuals, it is generally false for the population as a whole, because you end up spending money on preventive care for people who would not otherwise have gotten sick. The Congressional Budget Office takes a skeptical view toward the claim that this will save money, at least in the 5-10 year short run.

The second problem with the announcement is that it is unverifiable. We obviously cannot wait ten years to test the claim, and countless other factors will have changed during that time, making it impossible to know what the growth rate would otherwise would have been.

The third problem is that there is no obvious linkage between today’s announcement and the government, much less the President. Today the President said,

Their efforts will help us take the next and most important step — comprehensive health care reform — so that we can do what I pledged to do as a candidate and save a typical family an average of $2,500 on their health care costs in the coming years. Let me repeat that point. What they’re doing is complementary to and is going to compatible with a strong, aggressive effort to move health care reform in Washington with an ultimate result of saving health care costs for families, businesses and the government.

The President is attempting to claim credit for savings that (a) do not yet exist, (b) are not backed up by any specific changes in industry practices or government policies, and (c) are related to him only in that the groups announced they were adopting his quantitative goal. For all three of these reasons, the President’s claim that these savings will materialize is wildly unrealistic, and it is absurd to attach a per-family savings number to it. This is like the Mayor claiming credit for the 40 additional wins now, and telling fans that he will be responsible for the team winning the pennant. No one should take these claims seriously.

This artfully constructed sentence misleads:

What they’re doing is complementary to and is going to be compatible with a strong, aggressive effort to move health care reform in Washington with an ultimate result of saving health care costs for families, businesses, and the government.

If the groups had specific plans to change industry practices to hit their new quantitative goal, then those changes in private-sector behavior would save money for families, businesses, and government.

The President deserves credit for proposing some modest changes to Medicare and Medicaid that would slow the growth of government spending, although not nearly enough.

But the President has not yet proposed any policy changes as part of “health care reform in Washington” that would save families or businesses any money. He has proposed government spending increases that would improve the information available, but has proposed no changes to the financial incentives that people or firms have to use that information.Information by itself won’t significantly slow the growth of health care spending. You need incentives as well. (The Congressional Budget Office agrees.)

While the President’s announcement was silly and meaningless as a policy matter, it is tactically significant as the legislative battle over expanding taxpayer-financed health care heats up. The health insurance companies were a major industry opponent of HillaryCare in 1993-1994, and it appears they are trying to ingratiate themselves with the new President. Similarly, the drug manufacturers, who have historically aligned themselves with Republicans, are doing everything possible to get on the President’s good side. They 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.

Today’s announcement was about a budding political coalition that could support the President’s legislative push. Nothing more.

Monday, 11 May 2009|

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.

Thursday, 7 May 2009|

Understanding the President’s international tax proposal

Let’s look at three factories, each of which produces $100 of income.

  1. Your factory A is in the U.S. Your corporation pays a 35% U.S. corporate income tax rate ($35).
  2. Your factory B is in China. Your corporation pays a 15% Chinese corporate income tax rate ($15). You owe the U.S. government $35 in taxes, minus a credit for the $15 you paid to China. China gets $15, and the U.S. government gets $20.
  3. Your British competitor’s factory C is also in China. He pays a 15% Chinese tax rate ($15), and no taxes to his home government.

Factory B shows the effect of a worldwide tax system, in which the firm pays the same total tax wherever the income is earned. Taxes are based on the nationality of the payor, not the location at which the income is earned.

Factory C shows the effect of a territorial tax system. Income is taxed only where it is earned.

The U.S. actually has a hybrid. You can defer the taxes you owe from factory B until you bring that income back to the United States. This is an advantage relative to a pure worldwide system.

Left-leaning and other protectionist elected officials like to argue that a worldwide system “discourages U.S. firms from moving their factories overseas.” Senator Kerry argued this in the 2004 Presidential campaign. A worldwide system also raises more money for the home government to spend on other programs.

The territorial system creates a level playing field for American firms when they are competing overseas. Your factory B in China is at a severe disadvantage compared to the British factory C in China. You might consider moving your headquarters to London and turning your firm into a British corporation. As the global economy grows more interconnected this is increasingly easy to do.

The President’s new international tax proposal moves us toward a worldwide system. I think we should move in the opposite direction, toward a territorial system.

I think that lower taxes are good, and worldwide tax systems are a throwback to a time when the world economy was less global. Yes, in a territorial system companies can open factories overseas to avoid higher taxation in the U.S. But the more relevant comparison is whether Intel’s chip fabrication plant in China will be disadvantaged relative to the Malaysian, Brazilian, or French plant in China. If you are worried about a tax system encouraging U.S. firms to build factories overseas, you should worry that in a worldwide system, entire U.S. firms will move to a country with a territorial system.

A worldwide system fails if most other major economies are using territorial systems, and most are. Unless you think you can prevent increased globalization, or that you can convince other countries to change to a worldwide system, I think the international competitive pressure is inevitably toward a territorial system. In a world of increasingly mobile capital, it it both fair and smart for the U.S. to make sure we do not give firms based in other nations an unfair advantage. I also think that international competition to lower taxes is a good thing.

The President thinks this is good policy. He also needs revenues to offset his desired spending increases, especially for health care. (He has proposed that the revenues be used to offset the R&D tax credit, but that linkage will soon collapse in Congress.)

This issue does not break strictly on partisan lines, but instead more on an internationalist vs. economic isolationist split. The man to watch is Senate Finance Committee Chairman Max Baucus (D-MT), who has for years worked with Senator Orrin Hatch (R-UT) to move the U.S. toward a territorial system. Chairman Baucus’ Monday statement emphasizes that the business environment is increasingly global, and that American policymakers should not disadvantage American firms in that competition: “I want to make certain that our tax policies are fair and support the global competitiveness of U.S. businesses.”

Will Chairman Baucus be able to withstand pressure from the White House, Leader Reid, and his Democratic colleagues to raise these taxes to help pay for new health spending? The Senate Finance Committee has a longstanding tradition of bipartisan cooperation and an internationalist bent, and Chairman Baucus has worked harder and longer on this issue than anyone in the Administration. His key ally, Senator Hatch, will in 2011 replace Senator Grassley as the senior Republican on the committee, so it would be tactically smart for Chairman Baucus to renew and strengthen the Baucus-Hatch alliance on this issue and resist pressure from the economic isolationists who are looking for some money to spend. Ultimately this will become a test of Chairman Baucus’ strength.

If this issue excites you, start with pages 102-105 (284-287 in the Acrobat file) of this report from the tax reform panel created by President Bush.

Then read Bob Carroll’s papers here and here.

Wednesday, 6 May 2009|
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