The Price Paid for a Complex Tax Code

Andrea Louise Campbell has penned an awesome article on the US tax system in Foreign Affairs.It is titled America the Undertaxed: U.S. Fiscal Policy in Perspective. She opens with this terse summary:

"Compared with other developed countries, the United States has very low taxes, little redistribution of income, and an extraordinarily complex tax code. These three aspects of American exceptionalism deserve more attention than they typically receive."

We have discussed Campbell’s comments on the issues of tax level and income redistribution in The United States: Undertaxed Nation. Here we will cover her points with respect to the characteristics of the US tax code.

The US taxpayer who would choose to tackle the task of filing personal income taxes on his/her own faces a formidable foe.

"To get a sense of the immense complexity of the U.S. system, consider that the Internal Revenue Code is almost 12 times as long as the New Testament. The 2012 instruction booklet for the 1040 individual tax form and the accompanying schedules is 188 pages long; the one for the "EZ" [easy] form is 43 pages."

Not surprisingly, a large and prosperous industry has grown up around the task of helping people make their way through this maze of forms and questions. Computer software can now be purchased to minimize the pain. Sadly, even the poorest tax return filer, one who has no tax to pay, but who would receive a significant payment from the Earned Income Tax Credit, feels the need to share some of that benefit with a professional tax preparer in order to insure that the forms are filled out properly and that they receive their money with no delay.

"A 2003 IRS [Internal Revenue Service] report estimated that individual taxpayers pay $18.8 billion, spending 25 hours and $149 per taxpayer, on compliance each year, mainly through payments made to accountants and agencies to help them sort out their taxes. Corporate taxes are even denser. According to the U.S. Treasury Department, large corporations spend over $40 billion annually on compliance."

That is a lot of money; and it involves a lot of people. Consequently, there exist lobbyists who actually argue against simplifying the tax code.

To avoid the appearance of creating programs that spend funds, Congress creates tax deductions, grants, refunds, and subsidies that distribute money in the hope of accomplishing something. Besides being dreadfully inefficient, they add complexity to the tax code because forms must be filled out to determine both eligibility and the amount of money involved.

"The tax expenditure system is one major reason for this intricacy. Each exclusion, deduction, and credit adds another layer of complexity to the code and increases the time needed to prepare one's taxes. Taxing families rather than individuals complicates the system even more, since this method makes it difficult to calculate the proper tax withholding for each partner. Another culprit is the Alternative Minimum Tax (AMT), which is meant to prevent high-income taxpayers from using exclusions and deductions to avoid paying the federal income tax. This system requires some taxpayers to calculate their tax liability twice, once under the regular income tax and then again under the AMT, and pay whichever is higher."

Not surprisingly, Campbell can point to countries that have better ways of doing things.

"Several dozen countries utilize a return-free system for most taxpayers. They can do this because they tax individuals rather than families and withhold taxes from both income in the form of wages and income in the form of interest. These two features allow countries to precisely calibrate withholdings to actual tax liabilities. It is also much easier to implement such a system when governments hand out tax breaks either as credits that are equal for all taxpayers or as deductions that are set at a flat rate. In the United Kingdom, for example, the equivalent of the U.S. home mortgage interest deduction is a flat 15 percent reduction on the interest paid on the mortgage applied directly by the bank."

Campbell provides the effort required to deal with allowances for children as an example of how matters could be handled more efficiently.

"Many advanced-country governments calculate and send allowances to families with children. In the United States, however, households with children must navigate and administer a complex system of tax breaks themselves, such the Child Tax Credit and the Earned Income Tax Credit. And if they file their returns incorrectly, the IRS may fine them. That is why even many low-income families rely on tax-preparation firms, which have lobbied against periodic attempts to simplify the tax-paying process, such as having the IRS mail out draft returns for households in straightforward situations."

Does that last quote imply that the US does not have an "advanced-country government?"

There is another cost—one that does not show up directly in terms of dollars and cents.

"....it [complexity] undermines public trust in the system, with taxpayers fearing that those with better knowledge of how to navigate the system of loopholes, particularly the rich, get away with not paying their fair share."

People often claim that we are accumulating so much debt that we run the risk of becoming Greece. Debt is not going to make us into another Greece. Our major problem involves the large number of people who have no trust in government. If that distrust ever bleeds over into tax compliance, then we have a big problem. Right now, most people pay their taxes. If distrust in the government, and its tax code, ever reaches the stage where people feel free to avoid paying their share of taxes, then we will have become Greece.

The Myth of Profligacy and the Confidence Ogre

Paul Krugman devotes a considerable segment of his book, End This Depression Now!, to the Eurozone situation as a means of explaining how not to address economic problems. He claims that Europe is under the sway of a "Big Delusion" which asserts that the nations with debt problems fell into trouble because of excessive spending and fiscal irresponsibility. Let us refer to this delusion as the myth of profligacy. The countries in question are Greece, Ireland, Portugal, Spain, and Italy (the GIPSIs). Krugman recognizes Greece as a country that had committed fiscal sins, but not the others. He provides this chart:

The average debt to GDP ratio was steadily declining until the economic crisis struck. How does one arrive at the conclusion of profligate behavior?

"Yet many Europeans in key positions—especially politicians and officials in Germany, but also the leadership of the European Central Bank and opinion leaders throughout the world of finance and banking—are deeply committed to the Big Delusion, and no amount of contrary evidence will shake them. As a result, the problem of dealing with the crisis is often couched in moral terms: nations are in trouble because they have sinned, and they must redeem themselves through suffering."

As is often the case in his book, Krugman turns to Keynes for illumination. He quotes Keynes to explain the allure of a belief in a pure, free-market approach to society.

"That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely on the whole to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the free individual capitalist, attracted to it the support of the dominant social force behind authority."

What Krugman implies by summoning this quotation is that the myth of profligacy took hold because it is what many in power wished to believe. They wished to believe it because it would justify taking actions that they would have wanted to take no matter the circumstances.

Abraham Newman pondered the same questions as Krugman and arrived at a more pointed implication. His article appeared in Foreign Affairs under the title: Austerity and the End of the European Model. Perhaps even more pertinent is his lede:

"How Neoliberals Captured the Continent"

Newman agrees with Krugman about the profligacy myth, but adds further insight into its popularity.

"What is clear is that austerity will transform Europe’s political economy in the long term, lending credence to neoliberal ideas of limited government and loosely regulated markets. The irony of this transformation is that it reinvigorates the very ideas that helped cause the financial crisis in the first place; after all, it was the unyielding faith in markets and weak regulation that allowed the financial bubble to swell. At the same time, a response to the sovereign debt crisis based on austerity precludes any alternative social-democratic framework that would emphasize growth and protect citizens from the vagaries of the market."

Newman sees the economic crisis as opportunity for the conservative-minded to recast the nature of European society.

"Given the need to conserve public sector resources, proponents of austerity argue, firms and individuals are required to step in to provide core services, as is the case with the Big Society initiative in the United Kingdom. At the same time, governments are increasingly forced to privatize segments of their economies; Spain and Ireland have put everything from electricity to airports up for auction. What’s more, in the name of labor productivity, workers are asked to bear the burden of economic recovery through cuts to wages, pensions, and other benefits."

"Austerity politics in Europe is not simply a short-term fight between the surplus countries in the center and the deficit countries on the periphery. It is a long-term political agenda that privileges lenders over debtors and capital over labor and, as such, should be seen through the lens of partisan politics. Center-right governments in Germany, the Netherlands, and Spain have been among the most vocal proponents of austerity."

Right wing politicians are claiming that social support policies in Europe are too expensive; too much has been promised; they must be scaled back if economies are to thrive. The exact same scenario is playing out in the United States. Republicans blame the financial crisis not on greed and market abuses, but on a misguided attempt by the government to encourage home ownership for low-income families. This lie is told over and over in order to hinder any attempt by the government to reign in financial recklessness. Profligacy on the part of the federal government is the cause of the deficit. Again, we are told that too much has been promised.

The term "confidence" is used often on both sides of the ocean to justify fiscal austerity—and by association—free market solutions. It has often been stated that cutting spending in order to lower government deficits will instill "confidence" and induce investors to commit more funds to the economy. In this way, austerity and economic contraction will lead to economic expansion. Krugman coined a catchy phrase when he described such notions as belief in the "confidence fairy."

Catchy as that phrase may be, it relegates those who would believe in austerity-driven growth to the status of the merely befuddled. Confidence is not an illusion apparent only to the terminally incoherent; it is also a weapon to be wielded by those who are not befuddled, but rather, completely focused and purpose-driven.

Krugman tells us how "confidence" can become a weapon in a free-market society.

"As long as there are no routes back to full employment except that of somehow restoring business confidence....business lobbies in effect have veto power over government actions: propose doing anything they dislike....and they can issue dire warnings that this will reduce confidence and plunge the nation into depression."

This issue of investor’s confidence is trotted out over and over again to explain why corporations are sitting on huge sums of capital rather than investing, why we need to trash attempts to regulate business in any way, why we need to elect a Republican president, why we need to cut back on anything that redistributes income..... No real activity is required to win over the faint of heart, merely the issuance of comments and campaign contributions. These are easily recognized as the threats they are intended to be.

Krugman would have better served us by coining a more startling phrase. It is misleading to think of the world being driven by those awaiting a visit from a beneficent fairy spreading pixy dust. It might have been more appropriate to ponder a pen where a "confidence ogre" is held at bay until needed. When released, its aim is not beneficence; its mission is to tear up turf and demolish structures.

Autism and the Epidemic of Epidemics: Us, Microbes, and Now Parasites

Humanity has been rather successful at protecting itself from the viral and bacterial invaders who would do us harm. However, somewhere along the way, we have been beset by a suite of other diseases that seem to fall in the noncommunicable category. These diseases are rapidly growing in incidence, seemingly in defiance of our comfortable modern lifestyles. One might include in this category obesity, diabetes, numerous food allergies, asthma, autism, and mental illness. The conditions of obesity and diabetes are interrelated and are generally ascribed to a poor personal lifestyle. It is much harder to associate the other diseases with personal habits.

We recently discussed in Microbes and Us: Health, Disease, Inheritance, and Fecal Transplants a new way of evaluating the human condition. The basis of this approach was to recognize that humans evolved in concert with a suite of bacteria that are an integral part of our human condition. The term coined to describe this human-microbe entity is microbiome.

These microbes perform functions that are critical to our health. Research is beginning to show correlations between the actions these bacteria and a number of noncommunicable diseases. Data is accumulating that indicates imbalances in these bacterial populations, or other malfunctions in their performance, can cause human distress as surely as a malfunction in hormone production, for example. While obesity can be attributed to poor eating habits, that is not always the case. There is evidence of a connection between diseases of nourishment and intestinal bacteria.

Given highly suggestive evidence, but not yet clinical proof, there is great excitement in the medical research community, because there is hope that some of these troubling diseases may ultimately be attributable to a treatable condition.

This research is also of great interest because it suggests a fundamental principle: don’t mess with Mother Nature. We are complex creatures—more complex than we suspected—and minor changes in lifestyle can cause difficulties.

One of the conditions that researchers sought to explain by invoking bacterial action was autism. The hypothesis involved a bacterial imbalance that caused increased consumption of sulphur in the intestines to the point of restricting its availability to the developing brain. That seemed to be pure hypothesis.

Another hypothesis with respect to autism was encountered shortly thereafter which seems to have a host of suggestive data to support it. It is interesting in that it also postulates a cause associated with modern deviation from the traditional human condition.

Moises Velasquez-Manoff provided a fascinating article in the New York Times: An Immune Disorder at the Root of Autism. He presents this thesis:

"So here’s the short of it: At least a subset of autism — perhaps one-third, and very likely more — looks like a type of inflammatory disease. And it begins in the womb."

"It starts with what scientists call immune dysregulation. Ideally, your immune system should operate like an enlightened action hero, meting out inflammation precisely, accurately and with deadly force when necessary, but then quickly returning to a Zen-like calm. Doing so requires an optimal balance of pro- and anti-inflammatory muscle."

"In autistic individuals, the immune system fails at this balancing act. Inflammatory signals dominate. Anti-inflammatory ones are inadequate. A state of chronic activation prevails. And the more skewed toward inflammation, the more acute the autistic symptoms."

The author indicates several studies that indicate that episodes of inflammation experienced by the mother during pregnancy can increase the probability of autism developing in the infant. Given that modern hygiene has been reducing the incidence of infections, while the number of autism diagnoses is growing rapidly, suggests a more subtle connection.

"Better clues to the causes of the autism phenomenon come from parallel "epidemics." The prevalence of inflammatory diseases in general has increased significantly in the past 60 years. As a group, they include asthma, now estimated to affect 1 in 10 children — at least double the prevalence of 1980 — and autoimmune disorders, which afflict 1 in 20."

"Both are linked to autism, especially in the mother. One large Danish study, which included nearly 700,000 births over a decade, found that a mother’s rheumatoid arthritis, a degenerative disease of the joints, elevated a child’s risk of autism by 80 percent. Her celiac disease, an inflammatory disease prompted by proteins in wheat and other grains, increased it 350 percent. Genetic studies tell a similar tale. Gene variants associated with autoimmune disease — genes of the immune system — also increase the risk of autism, especially when they occur in the mother."

The author suggests the principle question to be answered is:

"Why are we so prone to inflammatory disorders? What has happened to the modern immune system?"

The answer seems to be associated with modern humans diverging from the conditions under which they evolved.

"There’s a good evolutionary answer to that query, it turns out. Scientists have repeatedly observed that people living in environments that resemble our evolutionary past, full of microbes and parasites, don’t suffer from inflammatory diseases as frequently as we do."

"Generally speaking, autism also follows this pattern. It seems to be less prevalent in the developing world. Usually, epidemiologists fault lack of diagnosis for the apparent absence. A dearth of expertise in the disorder, the argument goes, gives a false impression of scarcity. Yet at least one Western doctor who specializes in autism has explicitly noted that, in a Cambodian population rife with parasites and acute infections, autism was nearly nonexistent."

"For autoimmune and allergic diseases linked to autism, meanwhile, the evidence is compelling. In environments that resemble the world of yore, the immune system is much less prone to diseases of dysregulation."

The author arrives at this general conclusion:

"Since time immemorial, a very specific community of organisms — microbes, parasites, some viruses — has aggregated to form the human superorganism. Mounds of evidence suggest that our immune system anticipates these inputs and that, when they go missing, the organism comes unhinged."

Given this assumption, a path back to normality would include an attempt to reproduce the conditions experienced when humans were fully loaded with their complement of bacteria, parasites and viruses. The author refers to this as an "ecosystem restoration project."

As it turns out, some are experimenting with the reintroduction of parasites in an attempt to counter this inflammatory response in autistic adults. The work of William Parker of Duke University is referenced.

"Dr. Parker has more radical ideas: pre-emptive restoration of "domesticated" parasites in everybody — worms developed solely for the purpose of correcting the wayward, postmodern immune system."

"Practically speaking, this seems beyond improbable. And yet, a trial is under way at the Montefiore Medical Center and the Albert Einstein College of Medicine testing a medicalized parasite called Trichuris suis in autistic adults."

"First used medically to treat inflammatory bowel disease, the whipworm, which is native to pigs, has anecdotally shown benefit in autistic children."

Medical science is getting stranger and stranger.

It is encouraging to be able to begin to think of autism as a medically treatable condition.

The United States: Undertaxed Nation

Andrea Louise Campbell has written the most concise and most relevant article on the US tax system that I have ever encountered. It appears in Foreign Affairs under the title: America the Undertaxed: U.S. Fiscal policy in Perspective. Most discussions one finds in the media concentrate on the federal income tax and the federal budget and focus on assessing the fairness or unfairness of the system. Campbell forces us to consider that the federal income tax is only one part of the tax collection apparatus of the nation. One must also consider payroll taxes, state and local taxes, excise, and corporate taxes if one is to obtain a clear view of who is paying what and who is receiving what. She also provides clear comparisons of what other wealthy countries are paying in taxes, and what they receive in benefits.

Campbell gets things rolling with this crisp statement:

"Compared with other developed countries, the United States has very low taxes, little redistribution of income, and an extraordinarily complex tax code. These three aspects of American exceptionalism deserve more attention than they typically receive."

To prove the first point she presents this OECD chart:

The United States exceeds only Chile and Mexico among OECD nations in the amount of tax it collects relative to its GDP. Campbell suggests that a more relevant picture would be obtained if one looked at data from 2006, before the Great Recession, rather than the 2009 data in the chart.

"But it is important to look at pre-recession data, which better reflect long-term trends. In 2006, before the financial crisis struck, OECD tax statistics showed that total taxes in the United States -- at all levels of government: federal, state, and local -- were 27.9 percent of GDP, three-quarters the percentages in Germany and the United Kingdom and about half of those in Denmark and Sweden. Among the rich democracies in 2006, only South Korea had lower taxes."

So—long term, we were actually the second lowest in taxation rather than the third lowest.

Campbell’s greatest service is to provide a breakdown of the various types of taxes and illustrate how the US diverges from the policies of it counterparts.

"The reason for this discrepancy is not that the United States has lower personal income tax revenues than its OECD counterparts. In fact, in 2006, personal income taxes at the federal, state, and local levels in the United States came to 10.1 percent of GDP, just above the OECD average of 9.2 percent. Instead, the disparity results from the low effective rates -- or nonexistence -- of other forms of taxation."

Corporate taxes collected are similar: 3.4% of GDP for the US versus an OECD average of 3.8%. Social insurance taxes in the US brought in 6.6% of GDP, somewhat lower than the OECD value of 9.2%.

The biggest difference lies in the utilization of consumption taxes. The US collects sales taxes at the state and local levels, and the federal government and states tax certain products like tobacco and alcohol, and there are customs duties. These taxes are not nearly as efficient at generating revenue as the value-added taxes (VATs) collected by most OECD countries. A VAT appears to the end consumer as the equivalent of a sales tax, but it is a more complex beast in that a manufactured object, for example, is taxed for the value added in each step of the process as it proceeds from raw materials to finished product.

"OECD statistics show that VATs bring in an average of 6.7 percent of GDP among the OECD nations, accounting for the majority of the difference in total tax revenues between the United States, which does not have a VAT, and the rest of the OECD."

Sales taxes and VATs are highly regressive taxes that are a greater burden on those with lower incomes. The other OECD countries can get away with a regressive tax system by redistributing that revenue in the form of social support services. This is a major mechanism for reducing the income inequality that is common in wealthy countries.

"The economists Smeeding and Katherin Ross Phillips have shown that rates of market-income poverty -- the proportion of people living in households with incomes that are below 40 percent of the median disposable income -- are quite high across the advanced democracies. In fact, according to Smeeding and Ross Phillips, the United States' market-income poverty rate of 17.2 percent for working-age adults is only slightly higher than Germany's (14.9 percent) and Sweden's (15.8 percent) and even lower than Canada's (18.4 percent) and the United Kingdom's (25 percent)."

"Smeeding and Ross Phillips found that after the implementation of universal transfer and social assistance programs, poverty among those aged 25 to 64 fell: to 6.9 percent in Canada, 5.9 percent in the United Kingdom, 3.5 percent in Germany, and 1.8 percent in Sweden. Meanwhile, in the United States, it remains at 10.9 percent."

One tends, in the US, to think of Europe as the place where high incomes are taxed to the point of depressing individual initiative in order to redistribute money to the poor. Campbell tells us that the greater difference between the US and Europe is in the use of regressive taxes to alleviate income inequality.

It is not that the US does not have a mechanism for supporting socially desirable outcomes; it is just that it is a particularly dumb and inefficient mechanism: tax expenditures. Lawmakers avoid creating dedicated programs that would show up as spending in a budget, and instead they try to encourage prosocial behavior by creating a maze of rebates, subsidies and deductions that take tax revenue and give it back. This process is slightly less efficient than throwing dollar bills in the air and hoping the wind will blow them where they need to be. Because the federal income tax code is used to generate the revenue, it also serves as the mechanism for redistributing the revenue. Since the wealthy pay a higher income tax rate, they also receive the majority of the redistribution—for which they are quite grateful, and are rather satisfied with the efficacy of the system.

"The Urban-Brookings Tax Policy Center estimates that in 2011, households with incomes in the top fifth of the income distribution received two-thirds of the benefits from tax expenditures, with the top one percent receiving a quarter of them."

Campbell does not make the direct comparison, but she points out that these tax expenditures used to redistribute revenue add up to about $1.1 trillion. That is about 7% of US GDP, and, interestingly, is almost equal to the average VAT collections that she says make up the major difference in tax collections between the US and other OECD countries. The US is a higher tax nation than it would appear from the OECD data, however, it chooses to waste a lot of the money it collects.

Campbell performs a great service by explaining the US tax system to US citizens. This is a service that our normal media outlets never quite get around to delivering—leaving the general public woefully misinformed about tax issues.

The focus on federal income taxes and tax rates injects a bias in favor of the conservative assumption that the wealthy pay at much higher rates and thus contribute a much higher fraction of tax revenue than anyone else. When one considers total taxes, including the regressive payroll taxes and the state and local taxes, the tax distribution is not very progressive at all, and each income class more nearly contributes an amount proportional to its income.

"According to the Institute on Taxation and Economic Policy, a fiscal think tank, in 2011, the lowest fifth of earners received 3.4 percent of total income and paid 2.1 percent of total taxes, the middle fifth received 11.4 percent of income and paid 10.3 percent of taxes, and the top one percent received 21 percent of income and paid 21.6 percent of taxes."

Campbell also provides numerous other insights into the particulars of the taxing process.

The US claims that it has about the highest corporate income tax rate in the world, but what is important is not the stated rate, but what is actually collected.

"As Republicans are quick to point out, the United States does have one of the highest statutory corporate tax rates in the developed world. Combining the federal and state levels, the top rate of these taxes is 39 percent, compared with an average of 36 percent across the G-7 and 31 percent across the OECD. Yet as with the individual income tax, the United States applies these statutory rates to a narrower base of taxpayers than other advanced countries do, due to various corporate tax credits and breaks, such as the accelerated depreciation of machinery and equipment and the deferral of taxes on income earned abroad. As a result, according to a report issued by the U.S. Treasury Department, between 2000 and 2005, on average, U.S. businesses paid an effective tax rate of only 13 percent, nearly three percent below the OECD average and the lowest rate among the G-7 countries."

Federal tax revenue is usually considered in the context of income tax. Campbell tells us that in 2010, payroll taxes provided 40% of revenue, compared to 42% from personal income tax. She also points out that the federal government gives back more in tax expenditures than it actually collects as income tax revenue—a truly strange way to run a country.

Campbell’s article is required reading for anyone who wishes to understand the US tax system and the issues associated with budgets and deficits. And there is more of interest in the article than was appropriate to discuss here. Many thanks to her!

ANDREA LOUISE CAMPBELL is Professor of Political Science at the Massachusetts Institute of Technology.

Germany’s Growth Is Unsustainable?

Two articles have appeared recently that express concern about the health of the German economy. The first appeared in The Economist under the title: German economy: Europe’s tired engine. The author expressed concern that Germany might not be able to remain the vibrant, wealthy economy to which others could turn for assistance. This chart was provided to support that worry.

A more detailed, and a more pessimistic account of Germany’s future prospects appeared in Foreign Affairs in an article by Adam Tooze: Germany’s Unsustainable Growth: Austerity Now, Stagnation Later.

Tooze grants Germany its current reputation as an economic juggernaut with strong exports, little debt, and minuscule borrowing costs.

"But beneath the glowing headlines lies a darker story: Germany's economic position is simply unsustainable. For starters, much of its trade surplus has been earned at the expense of the corresponding current account deficits of the European countries in crisis. At the same time, this outsized surplus goes hand in hand with major imbalances within Germany's domestic economy. German businesses have invested their profits abroad, helping finance foreign imports. Meanwhile, as German money has flowed out of the country, domestic investment has languished at unprecedentedly low levels."

"Germany, like other rich, polluting, and aging countries, faces enormous long-term challenges. Its work force is shrinking, its energy sector needs to be remade, and its public infrastructure has gone too long without improvement. For all the talk of its financial strength, Germany has so far squandered the opportunity to secure long-term economic growth by addressing these challenges through badly needed domestic investments."

Germany will have to make major investments in its domestic economy at a time when the debt required to pay for those investments nearly comes free, but the country is unable to take advantage of the opportunity.

"And yet due to a 2009 constitutional amendment requiring both the federal and the state governments to maintain balanced budgets, the German public sector has denied itself the opportunity to borrow and invest. To make matters worse, rather than try to extricate itself from this self-inflicted trap, Berlin is insisting that the eurozone as a whole adopt this model, in the form of the European fiscal compact, a treaty that will mandate balanced budgets across the continent. That Germany is seeking to fashion the rest of Europe in its own image makes it all the more urgent to understand the fault lines that underlie its economic model."

Many issues have been neglected as Germany focused on its export-driven economy. General infrastructure upgrades have fallen far behind.

"Since the millennium, net investment in Germany as a share of GDP has been lower than at any time in recorded history, outside the disastrous years of the Great Depression. The German corporate sector has invested its more than ample profits, but it has done so outside the country. The effect of this flight of private money has been compounded by Berlin's campaign to enforce balanced budgets, which has prevented meaningful investment on the part of the public sector."

Its once vaunted universities attain only mediocre rankings today, and its spending on education is below the OECD (wealthy countries) average.

Germany has a declining and aging workforce which will require greater dependence on immigrants, yet it has always had difficulty in dealing with its non-German population.

"Berlin has stepped up its efforts to recruit foreign workers. But the large-scale guest-worker programs of the 1960s and early 1970s, which brought immigrants in droves from Turkey and Europe's Mediterranean periphery, carry a mixed legacy. Already, 35 percent of new children in Germany are born to immigrants, placing strains on an educational system that still has no coherent strategy for teaching German as a second language, let alone maximizing the potential of all students. Despite considerable attempts to integrate these immigrants, Germany remains uneasy about multiculturalism."

A worker shortage could be alleviated by encouraging more women to join the labor force, but, incredibly, conservative politicians have made a habit of discouraging women from working outside the home.

"Another way to bolster the German work force would be to enact child-care policies that would make it easier for women to raise children while pursuing careers. A major obstacle to such policies has been the conservative political culture of the Christian Democratic Union (CDU), Germany's dominant political party for much of the last 60 years, which tends to disapprove of mothers working outside the home....Despite persisting and fierce resistance from the conservative wing of her party, Merkel has sought to continue to bring mothers into the work force by building a comprehensive, high-quality child-care system that will cover all children up to the age of six. Between 2006 and 2011, Germany created 230,000 new places for preschool students, and local governments now face the challenge of creating a further 260,000 places by 2013. The bill for this project will come to billions of euros."

Germany has embarked on an ambitious, but risky, plan to increase its utilization of renewable energy as it quickly phases out nuclear sources.

"Even more imposing a challenge is Merkel's proposal for an Energiewende, or energy transformation. Following Japan's Fukushima nuclear disaster in 2011, Germany resolved to close all its nuclear plants by 2022. Rather than replace them with cheap but dirty coal-fired plants, Berlin envisions a huge investment in green technology, aiming to cover 35 percent of the country's energy needs with renewable energy by 2020....This energy transformation will likely end up costing over 200 billion euros."

Germany has also built up a debt to its workers that will likely have to be repaid.

"Between 2000 and 2009, while corporate profits soared, exports boomed, and capital fled the country, real wages in Germany fell by one percent. According to the OECD, over the last 20 years, income inequality in Germany, as measured by the Gini coefficient, has risen only fractionally less than in the United States and twice as rapidly as the OECD average. How long can German employers expect their workers, faced with creeping tax increases and budget cuts, to continue to consent to this inequitable tradeoff?"

Given that Germany has essentially forbidden itself to borrow money and increase its debt, how is this investment going to occur?

"With new borrowing frozen, Germany projects that its debt-to-GDP ratio will steadily decline. Yet since revenue from taxes on corporate and household income has been dropping as a share of GDP in Germany, as in much of the rest of the developed world, the government's budget will be much smaller. If, faced with this squeeze, Berlin is to make good on its promises of investment in energy infrastructure, preschools, universities, and research and development, it will have to engage in relentless cutting of every euro of nonproductive public spending -- a painful and politically unpopular proposition. German leaders must therefore be hoping that their strategy of shrinking and rebalancing the state will trigger a dramatic revival of private investment. What is remarkable about this model, which Merkel is now advocating not just for Germany but also for the rest of Europe, is how un-European it seems. The scenario sounds awfully like a 1980s-era supply-side utopia."

"Even if Merkel's government gets exactly what it wants -- massive investment from the private sector alongside public investments financed without any increase in public borrowing -- the pain will be real. The government will be forced to pay for these investments by raising taxes, clawing back exemptions, and, above all, charging consumers. Already, because of steep energy charges, Germans pay more than three times as much for electricity as Americans, and those costs will likely rise by at least 50 percent over the course of the Energiewende."

What does Tooze recommend for Germany to do to correct all the problems he has enumerated?

"The best chance for Germany to emerge from the current impasse with a strategy for growth -- for both itself and the rest of Europe -- would be for it to treat austerity not as a permanent economic policy but as a form of shock therapy. After the market regains confidence in the euro, after German states and the rest of Europe pay down some of their debts, and after several years of fiscal pain, low investment, and low growth, Berlin can hopefully reconsider its course."

That seems a rather optimistic note to end on. Given the rate at which Europe’s economies are plummeting in the chart above, it would seem that "several years of fiscal pain" are no longer available.

　

ADAM TOOZE is Professor of History, a Fellow at the MacMillan Center for International and Area Studies, and Co-Director of International Security Studies at Yale University.

The United Kingdom’s Austerity Experiment

Paul Krugman is probably the foremost proponent of traditional Keynesian thinking. He is certainly the most outspoken proponent. He has taken many occasions to rail against the idiocy of economic austerity during a time of high unemployment and low economic growth. In his book, End This Depression Now!, he devotes a chapter to what he refers to as "Austerians"—those who would believe that fiscal contraction will lead to economic expansion.
"But a funny thing happened in 2010: much of the world’s policy elite—the bankers and financial officials who define conventional wisdom—decided to throw out the textbooks and the lessons of history, and declare that down is up. That is, it quite suddenly became the fashion to call for spending cuts, tax hikes, and even higher interest rates even in the face of mass unemployment."

Krugman describes the OECD as the repository for such "conventional wisdoms."

"And what was the advice this bellwether of conventional wisdom gave to America in the spring of 2010, with inflation low, unemployment very high, and the federal government’s borrowing costs near a record low? That the U.S. government should immediately move to slash the budget deficit and that the Federal Reserve should raise short-term interest rates dramatically by the end of the year."

The US decided to ignore this advice and pursue a more traditional approach. But the UK, with its new prime minister, was all in for giving austerity a go.

"For the most part, countries adopting harsh austerity policies despite high unemployment have done so under duress....But there was one dramatic case of a government engaging in unforced austerity because it believed in the confidence fairy: Prime Minister David Cameron’s government in Britain."

Did the confidence fairy drop by to bless the UK?

"On the contrary, business confidence fell to levels not seen since the worst of the financial crisis, and consumer confidence fell even below the levels of 2008-2009."

Krugman does point out that while Britain managed to maintain low interest, so did the US and Japan, two countries with even higher debt levels.

How have the US and UK fared given their two differing approaches? The US emerged from the recession with modest, but sustained growth. Here is a plot provided by The Economist of British quarterly growth.

The economy seems to have begun going downhill in 2010 and has now officially fallen back into a recession according to these numbers.

One can go to the very handy IMF Data Mapper and extract all sorts of interesting data. How have the two countries weathered the Great Recession thus far? Using the IMF’s estimated numbers for 2012, we find that between 2006 and 2012 the US GDP grew by 16.7%, while that of the UK grew by 0.16%. The IMF has an estimated GDP growth of 0.8% for the UK in 2012, a number they will have difficulty in meeting. The US economy has also performed much better than that of the UK over the last few years.

But what about debt one might ask. Surely the austerity measures have succeeded in bringing that burden down, and this brief period of pain will be rewarded in the near future. Again, using data on government gross debt (as a fraction of GDP) from the IMF database, we find that between 2009 and 2012 the US debt (as a fraction of GDP) has increased by 18%, while that of the UK has increased by 33%.

Krugman continues to be correct. When in desperate times, grow the economy and concentrate on the debt when better times return.

Thankfully, we had a leader who was better versed in economics than many other national leaders. Perhaps some appreciation is in order.

Microbes and Us: Health, Disease, Inheritance, and Fecal Transplants

If one is not yet familiar with the term microbiome, the time has come to learn about some interesting scientific developments. Wickipedia tells what the term means.
"A microbiome is the totality of microbes, their genetic elements (genomes), and environmental interactions in a particular environment. The term "microbiome" was coined by Joshua Lederberg, who argued that microorganisms inhabiting the human body should be included as part of the human genome, because of their influence on human physiology."

There is also an associated theory of evolution:

"The hologenome theory proposes that the object of natural selection is not the individual organism, but the organism together with its associated microbial communities."

The human microbiome is the subject of significant scientific studies.

"The Human Microbiome Project (HMP) is a United States National Institutes of Health initiative with the goal of identifying and characterizing the microorganisms which are found in association with both healthy and diseased humans (their microbial flora). Launched in 2008, it is a five-year project, best characterized as a feasibility study, and has a total budget of $115 million. The ultimate goal of this and similar NIH-sponsored microbiome projects is to test if changes in the human microbiome are associated with human health or disease."

A fascinating article in The Economist summarizes for the lay reader some of the developments that are emerging from this field of study.

"WHAT’S a man? Or, indeed, a woman? Biologically, the answer might seem obvious. A human being is an individual who has grown from a fertilised egg which contained genes from both father and mother. A growing band of biologists, however, think this definition incomplete. They see people not just as individuals, but also as ecosystems. In their view, the descendant of the fertilised egg is merely one component of the system. The others are trillions of bacteria, each equally an individual, which are found in a person’s gut, his mouth, his scalp, his skin and all of the crevices and orifices that subtend from his body’s surface."

"A healthy adult human harbours some 100 trillion bacteria in his gut alone. That is ten times as many bacterial cells as he has cells descended from the sperm and egg of his parents. These bugs, moreover, are diverse. Egg and sperm provide about 23,000 different genes. The microbiome, as the body’s commensal bacteria are collectively known, is reckoned to have around 3m."

A human plus the resident bacteria has come to be viewed as an inseparable system.

"In exchange for raw materials and shelter the microbes that live in and on people feed and protect their hosts, and are thus integral to that host’s well-being. Neither wishes the other harm. In bad times, though, this alignment of interest can break down. Then, the microbiome may misbehave in ways which cause disease."

An example is provided to support the notion that humans and their resident microbes have coevolved. Mothers’ milk provides numerous forms of carbohydrates called glycans, but it is only the bacteria we carry that are capable of breaking down these compounds into nourishment.

"They are also better at extracting nutrition from mother’s milk because they turn out lots of an enzyme known as glycoside hydrolase. This converts carbohydrates called glycans, of which milk has many, into usable sugars.’

"That detail is significant. Glycans are indigestible by any enzyme encoded in the 23,000 human genes. Only bacterial enzymes can do the job. Yet natural selection has stuffed milk full of them—a nice example of co-evolution at work."

A number of interesting studies are emerging that indicate the role of these bacteria in regulating bodily functions. One study suggests the bacteria play a role in obesity.

"In 2006 Dr Gordon, who works at the Washington University School of Medicine, in St Louis, Missouri, published a study that looked at the mixture of bacteria in the guts of fat and thin Americans. Fat people, he discovered, had more Firmicutes and fewer Bacteroidetes than thin ones. And if dieting made a fat person thin, his bacterial flora changed to match."

"Experiments on mice suggest this is not just a question of the bacteria responding to altered circumstances. They actually assist the process of slimming by suppressing production of a hormone that facilitates the storage of fat, and of an enzyme that stops fat being burned."

If the web of bacteria can control important hormones and enzymes, then there may be many functions and diseases that are dependent on the behavior of the microbiome.

"Even more surprising than the microbiome’s contribution to diseases of nutrition, though, is its apparent contribution to heart disease, diabetes, multiple sclerosis and many other disorders."

There is, for example, recent data that suggest a role for intestinal bacteria in multiple sclerosis.

"In the case of multiple sclerosis, a confirmatory study was published last year by Kerstin Berer and her colleagues at the Max Planck Institute for Immunobiology and Epigenetics in Freiburg, Germany. They showed, again in mice, that gut bacteria are indeed involved in triggering the reaction that causes the body’s immune system to turn against certain nerve cells and strip away their insulation in precisely the way that leads to multiple sclerosis."

These few studies mentioned are sufficient to motivate researchers to look far afield for other areas in which these bacteria can affect human function. One of the most intriguing involves the hypothesis that bacteria could affect brain function by altering chemical compositions. A particular means by which autism might be triggered has been hypothesized.

"It has been known for a long time that people with autism generally have intestinal problems as well, and that these are often coupled with abnormal microbiomes. In particular, their guts are rich in species of Clostridia. This may be crucial to their condition."

"A well functioning microbiome is not one without internal conflicts—there is competition in every ecosystem, even stable, productive ones. Clostridia kill bacteria competing for their niches with chemicals called phenols (carbolic acid, the first antiseptic, is one such). But phenols are poisonous to human cells, too, and thus have to be neutralised. This is done by adding sulphate to them. So having too many Clostridia, producing too many phenols, will deplete the body’s reserves of sulphur. And sulphur is needed for other things—including brain development. If an unusual microbiome leads to the gut needing extra sulphur, the brain may pay the price by developing abnormally."

"But it is telling that many autistic people have a genetic defect which interferes with their sulphur metabolism. The Clostridia in their guts could thus be pushing them over the edge."

This is clearly an unproven hypothesis—one of many addressing the incidence of autism—but it is not an outrageous idea, and it is an avenue worth pursuing that would not have arisen if researchers had not begun to evaluate people as human microbiomes.

Researchers are also beginning to ask if these bacteria can play a role in inheritance. There seem to be conditions that appear to be inherited, but for which no direct genetic link can be established. Often infants will inherit not only traditional genetic material, but also the genetic material contained in the mother’s microbiome and her immediate environment.

"Though less reliably so than the genes in egg and sperm, microbiomes, too, can be inherited. Many bugs are picked up directly from the mother at birth. Others arrive shortly afterwards from the immediate environment. It is possible, therefore, that apparently genetic diseases whose causative genes cannot be located really are heritable, but that the genes which cause them are bacterial."

One of the reasons these types of findings are so exciting to scientists is that they have the potential to provide an entirely new means to address diseases and conditions that previously were difficult to understand and to treat.

There is one treatment described in the article that appears very effective, although far from ready for FDA approval.

There is a bacterium, Clostridium difficile, that contains strains that are highly resistant to antibiotics. Some people harbor this bacterium in their intestines, but it is generally kept under control by the other resident bacteria. Sick patients in hospitals are susceptible to exposure to this bacterium, and if they are on antibiotics that are strong, but not strong enough to eliminate the Clostridium, the controlling bacteria can be killed leaving the Clostridium to thrive. The result is a dangerously severe case of diarrhea that can cause death.

An approach that seems to work in attacking this bacterium is to reestablish the intestinal bacteria via what has the curious label of "fecal transplant."

"Dr Mellow has found that treating patients with an enema containing faeces from a healthy individual often does the trick. The new bugs multiply rapidly and take over the lower intestine, driving C. difficile away. Last year he and his colleagues announced they had performed this procedure on 77 patients in five hospitals, with an initial success rate of 91%. Moreover, when the seven who did not respond were given a second course of treatment, six were cured. Though faecal transplantation for C. difficile has still to undergo a formal clinical trial, with a proper control group, it looks a promising (and cheap) answer to a serious threat."

Life just keeps getting more complex—and more interesting.

The Healthcare Decision: Parsing the Supreme Court

The Supreme Court decision on the constitutionality of the Affordable Care Act has come and gone. The movement towards universal healthcare in this country has survived and now moves on. Supporters are happy, but concerned that the commerce clause has been weakened and will suffer further attack in the future. Opponents of the law are outraged that John Roberts broke ranks and failed to do the job for which he had been hired—he was a traitor to the Republican cause.

Ronald Dworkin provides us with insight into the viewpoints of the various justices and hints at what might be expected in the future. He also concludes that progressives should be happy with the decision because they gained more than they lost. Dworkin’s article appeared in the New York Review of Books and bore this catchy title: A Bigger Victory Than We Knew.

It was clear before the trial that the five conservative justices were unlikely to look kindly on anything that could be construed as an extension of the powers available under the commerce clause. The critics of the law were clever in turning the argument into one of regulating "inactivity" rather than "activity." The conservative five bought this argument and ruled against the mandate based on inapplicability in terms of regulating interstate commerce. Roberts made it clear in his opinion that he agreed with this position, but he said he supported the government’s secondary argument that the mandate was legal under the government’s power to tax. What are the ramifications of these rulings?

Dworkin is unsure if the precedent set here will have significant impact in future cases. The justices merely forbad the government from regulating inactivity, an issue that apparently never came up before—presumably because it is a strange legal question upon which to base important decisions.
"....the distinction between action and inaction is always suspect, in legal contexts as well as everywhere else, because inaction can always be described, differently, as an action. Is running a stop sign the action of driving through the sign or the inaction of failing to put on the brake? If I choose not to buy commercial health insurance, that is, from one perspective, inaction: there is something I failed to do. But from another perspective it is action: I chose deliberately to run a risk—the risk of falling ill without the benefit of the insurance I could have bought. The distinction between action and inaction depends only on a choice of description; it is frightening to think that a matter of such enormous political consequence—whether Congress can construct a national health care scheme—should be thought to turn on a verbal preference."

Given that lack of clarity, it is unsure how any future case might be impacted.
"Roberts’s ruling therefore creates a new constraint on the powers of the national government, though it is impossible now to predict how significant that new constraint will turn out to be."

In spite of disdain for the legal arguments over regulation of interstate commerce, Dworkin is thrilled that Roberts chose to highlight the power of the government (society) to impose a tax in order to arrive at a common good. It seems absurd that this should be something needing discussion, but in these times perhaps a reminder is required.
"For centuries the most powerful and influential argument for social justice has been essentially an insurance-based argument. Justice within a political community requires that the most catastrophic risks of economic and social life be pooled. Everyone should be required to acquit his moral responsibilities to fellow citizens, as well as to guard against his own misfortune, by paying into a fund from which those who are in the end unlucky may draw. This conception of social insurance has been the rationale of the great social democracies of Europe and Canada, and taxation has been the traditional—indeed the only effective—means of pooling those risks. Insurance has been the rationale, in this country, of all our great welfare programs: Social Security, Medicare, Medicaid, federal disaster relief, among many others."

Dworkin says the details of the Affordable Care Act are posed differently, but at its core it is just another "pooling of risk." And he thanks Roberts for an "unwitting" reminder of one of the fundamental characteristics of a government and of a society.
"The Chief Justice’s reasoning contains an unwitting insight. The national power to tax is not just a mechanism for financing armies and courts. It is an indispensible means of creating one nation, indivisible, with fairness for all."

On lighter note, it seems we cannot compel someone to buy broccoli, but we can tax them if they don’t.

Dworkin provides us some legal insights that are rather interesting. For example, eight of the justices at least upheld the basic concepts behind regulating interstate commerce. One did not. Clarence Thomas provided his own thoughts on the matter in a separate opinion.
"Thomas wants to repeal eight decades of constitutional law by denying what the other eight justices accept: that Congress has the power to regulate economic activity that takes place within one state but has a substantial impact on the national economy. It would have been a catastrophe had Thomas prevailed: we would have been sent back to the unregulated economy of a pre–New Deal era."

Dworkin is not a John Roberts fan. He all but accuses him, Scalia, Thomas, and Alito of being Republican Party operatives. How else to explain the decision to install George W. Bush as president? What other explanation for the decision to allow the wealthy to provide as much money as they wish in support of Republican candidates. The twisted logic used to attack the healthcare law is understandable if one has the goal of trashing Obama and helping a Republican get elected president (and create more justices just like them).

Dworkin can’t quite give credit to Roberts for, in this case, making a politically brave decision.
"Recent polls have shown that the American public has become increasingly convinced, by the drum roll of 5–4 decisions mainly reflecting a consistent ideological split, that the Supreme Court is not really a court of law but just another political institution to be accorded no more respect than other such institutions. Roberts, as chief justice, must feel threatened by this phenomenon; the chief justice is meant to be a judicial statesman as well as a judge, and it is part of his responsibility to protect the public’s respect for the Court as above politics."

Of course, Roberts must have an ulterior motive for his decision.
"He might have thought this particularly wise in view of the large number of politically charged cases scheduled for hearing in the Court’s next term, beginning in October, a month before the presidential election. The Court will have the opportunity to overrule its 2003 decision allowing state universities to take an admission candidate’s race into account, as one factor among others, in seeking a diverse student body. The conservative justices might wish to abolish affirmative action altogether, or to impose more stringent restrictions on it. They will also have the opportunity to reverse lower courts by upholding the Defense of Marriage Act, which forbids federal agencies to treat gay marriages as real, for example by allowing a gay couple to file a joint income tax return."

"The same justices will also be asked to strike down an important part of the Voting Rights Act of 1965, which requires states with particularly bad voting rights records to seek federal permission for new changes in their election laws. No doubt, moreover, they will soon find a chance further to constrict or even to abolish abortion rights. Roberts may want to blunt the anticipated accusations of political partisanship that any right-wing decisions in these cases will likely attract by supporting Obama’s health care program now."

It seems clear that the conservative justices have political opinions and these will color their legal opinions. Conservatives can target the liberal justices with the same accusation. Dworkin, in a brief, almost throwaway comment, provided a description of the philosophy that he believes motivates and informs Roberts—a philosophy that liberals will find even more dangerous than mere political bias.
"Liberty, as he might put it, always trumps necessity at the national level."

That is a rather extreme philosophy. However, it does explain why 30 million people can be denied healthcare coverage in order that one person is not compelled to purchase insurance. It also explains why democracy, as the masses have known it, can be overturned in order that one person is not forbidden to spend as much money as he wants in electing his favorite candidate.

So—individual liberty is more important than national purpose. No society has ever been based on that principle—at least none have survived long enough to have been noticed.

Abrupt Global Climate Change

Some time ago we pondered the future of humanity in the context of changing global climate (Can—and Will—Mankind Survive). We came across suggestions that climate change can be calamitous not only on the long timescale, but also on short timescales. We had this quote from John Terborgh: "The earth maintains a stable environment because it is a dynamic system and dynamic systems possess stable equilibriums. Less widely recognized is that the earth is a complex dynamic system. A cardinal feature of complex dynamic systems is that they can attain multiple forms of equilibrium."

This quote describing a prediction by James Lovelock makes clear what the previous statement implies.
"In his latest book....he argues that Earth’s system of self-regulation is being overwhelmed by greenhouse gas pollution and that Earth will soon jump from its current cool, stable state into a dramatically hotter one. All climatologists acknowledge the existence of such climatic jumps—as occurred for example at the end of the last ice age....A new climatic jump, he concludes, will occur within the next few years or decades, and will involve an abrupt increase in average global surface temperature of 9 degrees Celsius—from 15 to 24 degrees Celsius (59 to 75 degrees Fahrenheit). Such a shift, he contends, will trigger the collapse of our global civilization and the near extinction of humanity."

Recall that current climate models predict major effects from just a few degrees Celsius change. Are these purely hypotheses, or is there any evidence for abrupt climate changes?

The American Institute of Physics (AIP) provides an excellent summary of how data and the beliefs of earth scientists have evolved over time. The answer provided to the above question is a definite "yes."

Scientists became ever cleverer and more precise in interrogating the earth to determine historical records of temperature changes.
"By the 20th century, scientists had rejected old tales of world catastrophe, and were convinced that global climate could change only gradually over many tens of thousands of years. But in the 1950s, a few scientists found evidence that some changes in the past had taken only a few thousand years. During the 1960s and 1970s other data, supported by new theories and new attitudes about human influences, reduced the time a change might require to hundreds of years. Many doubted that such a rapid shift could have befallen the planet as a whole. The 1980s and 1990s brought proof (chiefly from studies of ancient ice) that the global climate could indeed shift, radically and catastrophically, within a century — perhaps even within a decade."

A shocking moment came when two groups extracted ice cores from deep within Greenland’s ice field. The cores were taken from locations 30km apart and, arriving at the same results, confirmed each other’s surprising results.
"Ice core analysis by Dansgaard's group, confirmed by the Americans' parallel hole, showed rapid oscillations of temperature repeatedly at irregular intervals throughout the last glacial period. Greenland had sometimes warmed a shocking 7°C within a span of less than 50 years. For one group of American scientists on the ice in Greenland, the ‘moment of truth’ struck on a single day in midsummer 1992 as they analyzed a cylinder of ice, recently emerged from the drill hole, that came from the last years of the Younger Dryas. They saw an obvious change in the ice, visible within three snow layers, that is, scarcely three years! The team analyzing the ice was first excited, then sobered — their view of how climate could change had shifted irrevocably. The European team reported seeing a similar step within at most five years (later studies found a big temperature jump within a single year). ‘The general circulation [of the atmosphere] in the Northern Hemisphere must have shifted dramatically,’ Dansgaard’s group eventually concluded."

It was necessary to determine if these variations could be found in other locations in order to associate global change with the Greenland observations.
"The first results, from the Norwegian Sea in 1992, confirmed that the abrupt changes seen in Greenland ice cores were not confined to Greenland alone. Later work on seabed cores from the California coast to the Arabian Sea, and on chemical changes recorded in cave stalagmites from Switzerland to China, confirmed that the oscillations found in the Greenland ice had been felt throughout the Northern Hemisphere."

Once the data was in hand, scientists began to hypothesize about possible causes. They were able to identify a disturbingly large number of potential triggers. It was also recognized that existing climate models were not likely to be able to predict such rapid transitions. In the simplest words possible: small things can have big effects, and one thing can lead to another.

Hardly a day goes by that there isn’t some news release discussing the thinning arctic ice cap, surprisingly rapid melting of the ice fields of Greenland and Antarctica, changes in oceanic flows, massive icebergs breaking off and floating away—all potential signs of accelerated climate change. One might want to start paying close attention.

The purpose of this piece was to give the reader something else to worry about besides the sorry state of the world’s economy. Now—don’t you feel better?

Protecting Medicare: Projecting into the Future

The Medicare Program has taken center stage in the 2012 presidential election race. Everyone seems to agree that projecting past cost growth into the future leads to an untenable fiscal situation. The Democrats want to keep benefits essentially the same and control costs by making healthcare delivery more efficient. It is not generally agreed that this is a viable path. The Republicans wish to limit costs by converting from a defined-benefit program to a defined-contribution program. A fixed amount of money will be provided to seniors to purchase commercial medical insurance and beyond that they are on their own. The argument is made that the market will find a cost-effective solution and all will turn out well. There is no intention in intervening in the market to encourage efficiency. It is generally agreed that the motive of the Republicans is to eliminate federal government involvement in society to as great an extent as possible.

The projection of Medicare costs into the future is at the heart of this issue. Such projections are not simple. The Boards of Trustees of the two main components of Medicare are responsible for issuing a report to Congress each year. The latest version was issued in April of this year. Let’s look at what it has to say about Medicare and its fiscal future.

First we must define some terms. There are two components to the Medicare Program: Hospital Insurance (HI), more familiar as Medicare Part A, and Supplementary Medical Insurance (SMI), known as Medicare Parts B and D which cover non-hospital-related costs and drug expenses.

This chart is provided to compare expected costs as a percentage of GDP.

The curve labeled "Current Law" considers the full implementation of the recent legislation (Obamacare) with credit applied for some efficiencies built into the law. It also includes a reduction in physician payment schedules that Congress always overrides. If one assumes they are overridden again then one arrives at "Alternate to SGR." The top line assumes that all the legislated improvements in efficiency are phased out over the period 2020-2035.

One thing that is clear is that there is room for efficiency. Obamacare, as implemented, and with estimated efficiencies, cuts costs tremendously in the out years. The second thing to notice is that the cost increases significantly, from about 3.7% of GDP today to about 6% in 2040, and about 6.7% in 2085.

This chart indicates the expected sources of funds required to meet the costs as incurred assuming the current law is in place.

General revenue transfers are already being made to cover costs. Congress treats HI and SMI separately. In any event, when accumulated funds for HI run out (projected in 2024) the shortfall will also have to be covered by general revenue.

Now let’s examine the numbers used in making these projections.

This table includes a projection of SMI costs against expected growth in GDP. HI costs are projected to closely follow SMI costs so this provides a respectable comparison with total costs. Note that the table has SMI per capita cost increasing at 9.2% per year over the interval 2002-2011. Drug coverage was introduced in 2006 and caused a step function in costs. When that year is eliminated the annual growth rate was 6.4%. In the out years the annual growth is estimated to be in the range 4-5%.  GDP growth is expected to be about 4.6% over the entire period. The excess in costs, mainly from growth in the number of retirees, explain the rising share of GDP that must be devoted to Medicare.

Projecting medical costs into the future is extremely difficult. One thing we know for sure is that there is a lot of waste in the system. We also know that there has been little success in controlling costs in the past. The effects of technological advances are unknown, but it must be recognized that new technologies have, in the past, tended to drive up costs. The projections by the Trustees have consequently been conservative. The text they provided indicates that they are even doubtful that the efficiencies assumed to be realized from the current law can be attained.

On the other hand, the current legislation has been in place for about three years. Although not fully implemented yet, it is assumed that it will be. Perhaps more importantly, the constant and passionate discussion about cost has convinced the medical industry that they must change their ways if their profit stream is to be maintained. We have written here numerous times of examples in which industry participants have taken the initiative to implement more efficient procedures—and with considerable success. Given that there appears to have been progress made in recent years, is there any data that might enlighten us as to what the future might hold?

　
Data on costs are provided by S&P and can be accessed here.
"The S&P Healthcare Economic Indices seek to reflect the monthly rate of change in the principal cost components of the U.S. healthcare market. The indices are designed to estimate the per capita change in total allowed claim costs incurred each month by patients (through their co-payments) and their healthcare benefit programs for services rendered by hospitals and physicians."

This chart is provided.

There is a subtle but definite trend downward for these indices. Consider the Medicare Index where change is more dramatic. It was at about 5% in annual growth in 2009, but in the last two years it has been in the 2-3% range. If these numbers adequately represent the trends in Medicare expenditures, then it would seem to indicate that efficiency measures are succeeding and cost is coming under control. If one can arrive at growth in expenditure that is less than the growth in GDP, then the budget impact of Medicare will go down rather than up.

Let us hope that these numbers are representative of what the future actually holds in store. Let us not panic and do something foolish like destroying Medicare in order to save Medicare.

An update for this article exists.  See Medicare: The Fiscal Outlook Continues to Improve.

Should We Stop Worrying About Iran?

Few things have caused more angst and more political turmoil than the threat of a nuclear-armed Iran. Kenneth N. Waltz presents a contrarian view that suggests an Iran in possession of nuclear weapons would be an agent of stability in the Middle East. His argument is simple and thought provoking. He presents his case in an article in Foreign Affairs: Why Iran Should Get the Bomb: Nuclear Balancing Would Mean Stability. "Most U.S., European, and Israeli commentators and policymakers warn that a nuclear-armed Iran would be the worst possible outcome of the current standoff. In fact, it would probably be the best possible result: the one most likely to restore stability to the Middle East."

Waltz bases his argument on rather scant historical data. The fear and the predictions of doom over Iran becoming a nuclear power are the typical response whenever another state decides to join the nuclear club.
"Yet so far, every time another country has managed to shoulder its way into the nuclear club, the other members have always changed tack and decided to live with it. In fact, by reducing imbalances in military power, new nuclear states generally produce more regional and international stability, not less."

The example most closely resembling Israel and Iran is India and Pakistan. Given the history of religious, ethnic, and territorial strife between those two countries, the acquisition of nuclear capability by one would have been terrifying to the other—and to the rest of the world.
"In 1991, the historical rivals India and Pakistan signed a treaty agreeing not to target each other's nuclear facilities. They realized that far more worrisome than their adversary's nuclear deterrent was the instability produced by challenges to it. Since then, even in the face of high tensions and risky provocations, the two countries have kept the peace."

Would anyone now believe the world to be a safer place if only India or only Pakistan possessed nuclear weapons?
"Israel's regional nuclear monopoly, which has proved remarkably durable for the past four decades, has long fueled instability in the Middle East. In no other region of the world does a lone, unchecked nuclear state exist. It is Israel's nuclear arsenal, not Iran's desire for one, that has contributed most to the current crisis. Power, after all, begs to be balanced. What is surprising about the Israeli case is that it has taken so long for a potential balancer to emerge."

"Of course, it is easy to understand why Israel wants to remain the sole nuclear power in the region and why it is willing to use force to secure that status. In 1981, Israel bombed Iraq to prevent a challenge to its nuclear monopoly. It did the same to Syria in 2007 and is now considering similar action against Iran. But the very acts that have allowed Israel to maintain its nuclear edge in the short term have prolonged an imbalance that is unsustainable in the long term. Israel's proven ability to strike potential nuclear rivals with impunity has inevitably made its enemies anxious to develop the means to prevent Israel from doing so again. In this way, the current tensions are best viewed not as the early stages of a relatively recent Iranian nuclear crisis but rather as the final stages of a decades-long Middle East nuclear crisis that will end only when a balance of military power is restored."

Waltz also denies the validity of the argument that the Iranians are unstable and likely to act irrationally.
"Despite a widespread belief to the contrary, Iranian policy is made not by "mad mullahs" but by perfectly sane ayatollahs who want to survive just like any other leaders. Although Iran's leaders indulge in inflammatory and hateful rhetoric, they show no propensity for self-destruction. It would be a grave error for policymakers in the United States and Israel to assume otherwise."

Waltz also disposes of the concern that Iran would aid terrorists with its nuclear capability.
"Some analysts even fear that Iran would directly provide terrorists with nuclear arms. The problem with these concerns is that they contradict the record of every other nuclear weapons state going back to 1945....Maoist China, for example, became much less bellicose after acquiring nuclear weapons in 1964, and India and Pakistan have both become more cautious since going nuclear. There is little reason to believe Iran would break this mold."

Iran would presumably recognize that the terrorist organizations it might be expected to assist are the ones who are most likely to be unstable and irrational.
"Moreover, countries can never entirely control or even predict the behavior of the terrorist groups they sponsor. Once a country such as Iran acquires a nuclear capability, it will have every reason to maintain full control over its arsenal. After all, building a bomb is costly and dangerous. It would make little sense to transfer the product of that investment to parties that cannot be trusted or managed."

Waltz makes an interesting argument. It is probably true that a nuclear Iran could lead to a stable balance of power in the Middle East. But, that does not make the case that stability is inevitable. The analogy with Pakistan and India is imperfect. How much of the "stability" between the two countries can be attributed to a nuclear standoff is arguable.

The political situation in the Middle East is complicated, and it is difficult to see how a nuclear Iran addresses any of the political issues. Some might applaud a countervailing nuclear capability, but some countries would also see a more potent Iran as a threat to their political prowess in the region. And one should remember that a balance of power requires two rational actors. One has to worry that Israel might be the country most likely to act impulsively or "irrationally."

I’m still worried about Iran—and about Israel.

　
KENNETH N. WALTZ is Senior Research Scholar at the Saltzman Institute of War and Peace Studies.

How Economists Corrupted Economics and Then Corrupted Law and Society

Economists like to think of their profession as a "science." One can call any field of study a science if one chooses, but a true science involves researchers putting forth hypotheses that are then confirmed or rejected based on experimental evidence. In economics the evolution of an hypothesis seems to follow this path: if a majority of economists can be convinced of an hypothesis’s correctness, then it becomes a fundamental law.

At present, most academic economists are enthralled by two assumptions: the efficient-markets hypothesis that states that markets are perfectly efficient at determining prices, and the rational-investor hypothesis that concludes that people will properly balance risk versus reward in making decisions that support their self-interest. Observers who do not have a vested interest in the correctness of these conclusions will look around and find plenty of evidence to support the notion that these beliefs are utter nonsense. Yet they persist.

The allure of these hypotheses arises from the great simplification they provide to help explain what would otherwise be a messy world. With these approximations in hand, one can produce strings of academic studies replete with equations and charts and all the other trappings of science. The fact that these hypotheses were fundamentally incorrect does not mean that they are useless. After all, one can live a long and profitable life laboring under the assumption that the earth is flat. Eventually, however, people wander into situations in which this flat-earth assumption breaks down and they are forced to change their assumptions.

For economists, the eye-opening moments should be the continual recessions that befall the economy. According to their theories, these things are not supposed to happen. Unfortunately, when economists’ reputations and livelihoods depend on the correctness of an assumption, the assumption becomes dogma that must be defended with religious zeal. So if economic catastrophe strikes, the explanation has to be that something has temporarily perturbed the perfect system and normalcy will return if we just wait long enough. It follows that any attempt to "help," such as government intervention, will be counterproductive and must be avoided at all costs. Thus if the government does step in and save their bacon, it can be claimed that the assistance actually delayed the inevitable. They have created an intellectual construct in which nothing can be proven, but in which everything can be explained.

Given this firm "scientific" foundation, these people looked around for another discipline that they could rescue from success. Given their belief in man as a rational actor, the legal professions seemed like ideal prey.

Lynn Stout spends a good deal of time in her book, Cultivating Conscience: How Good Laws Make Good People, describing and discussing the impact of economic thinking on the legal system. It has been wildly—and frighteningly—successful. The merger of the two disciplines is generally referred to as "law and economics."

Law and economics views humans thusly.
"’Economic Man’ does not worry about morality, ethics, or other people. He worries only about himself, calculatingly, and opportunistically pursuing the course of action that brings him the greatest material advantage."

What has this assumption led to in practice?
"In the nations law schools, students are routinely instructed in ‘law and economics,’ an approach that treats law as a kind of pricing system that requires people to pay damages for negligence or breach of contract in order to increase the ‘price’ of bad behavior."

"A generation weaned on the idea of rational selfishness has graduated from our nation’s universities and moved into leadership positions in the worlds of law, business, government, and higher education. They have brought with them an unquestioned belief in the power of material ‘incentives’ that undergirds almost every policy discussion. Are people cheating on their taxes? Increase the penalty for tax fraud. Are CEOs taking dangerous risks with their firms? ‘Incentivize’ them with deferred stock grants. Are America’s children failing to learn their ABCs? Tie teachers’ salaries to their students’ test scores."

It is easy to see why such a legal approach would take hold. It promises to take complex and uncertain issues and render them simple and quantifiable. It provides certainty where before there was intellectual churning. But nevertheless, it is based on a false premise, and it produces incentives that tend to encourage people to behave as if they actually were "economic man."

Does anyone of us actually believe that we act in the manner described by the economists? Would a family of such people survive? Would friendships survive? And most importantly of all, would a society survive? The answer to all is no!

Stout spends the first section of her book providing evidence that people are actually predisposed to "prosocial" behavior. They are willing to share and collaborate with others even if it means a lesser reward personally. This type of behavior is demonstrated universally in psychological gaming experiments, for example.

It is also consistent with evolutionary theory in which it appears humans were not the vicious, territorial beasts, "red of tooth and claw" who would gladly kill to protect territory, mates, or esteem. Humans seem to have survived the rigors of evolution by learning how to collaborate and form social attachments in order to obtain support in times of need. Why fight with a neighboring band when you can exchange gifts, breeding-age males and females, and become an extended family with social obligations?

What Stout’s study of gaming experiments showed, is that it is easy to modify a person’s social response if it appears that they are in an environment where selfish behavior is actually being encouraged or rewarded. Her fear is that laws and regulations are being created that provide incentives that undermine prosocial behavior. Given that it is prosocial behavior that holds a society together, there is reason for concern.

Consider this example provided by Stout. A school has adults who look after working parents’ children until they pick them up at the end of the day. A time for pickup is specified in hope that parents will be on time, and the caretakers can then go home and tend to their own families. The number of parents who were picking up their child late was deemed unacceptable, so a system was initiated in which a fine was levied on the parent who was late. This is good law and economics thinking. But the result was that the number of late arriving parents increased when the fine was levied. Concern for the welfare of others was a stronger source of motivation than a monetary fine. Transforming the transaction from a personal one into an economic one encouraged antisocial behavior.

One can argue that it would merely be necessary to raise the fine to a sufficient level that tardiness would be inhibited, but that entirely misses the point. Putting a monetary value on an interaction changes the very nature of the interaction. To the extent that laws, regulations, and schools encourage people to think in terms of material risk or gain for themselves, they are incentivized to think selfishly. Healthcare legislation is found to be unpopular. Providing benefits for 30 million people in great need is irrelevant if it is thought to impose a minor cost on all others. Is it any longer possible to pass legislation that requires sacrifice on the part of all? Are we becoming a nation of "economic men?" The very fabric of society seems to be coming unraveled.

Consider Tony Judt’s quote on the subject from Ill Fares the Land.
"There is nothing mysterious about this process: it was well described by Edmund Burke in his critique of the French Revolution. Any society, he wrote in Reflections on the Revolution in France, which destroys the fabric of its state, must soon be ‘disconnected into the dust and powder of individuality’....As for the dust and powder of individuality: it resembles nothing so much as Hobbes’s war of all against all, in which life for many people has once again become solitary, poor and more than a little nasty."