Oil limits lead to state budget squeezes

When oil consumption is rising, it is possible for the economy to expand, and more jobs be added. But as oil limits are reached (really based on higher prices of oil, relative to other goods), fewer and fewer private sector jobs are added, and the economy stagnates. The government sector tries to make up for what the private sector is lacking (through expanded programs), and gets itself into financial difficulty, because tax revenues decline. (See also my earlier post on whether it is even possible to raise taxes enough. I don’t think  it is.)

Below the fold is a guest essay by Michael Cain on how this squeeze is playing out in Texas.

For much of the last two years, newspaper headlines have regularly declared that state governments are facing a budget crisis. Those declarations are absolutely true. However, few voters have an idea of what that statement really means because they know relatively little about how their state government spends money, or how the budget is put together. I am confident of the accuracy of that statement because as a member of a state legislative budget staff, I helped with new member orientation every two years, and incoming members of the legislature were often clueless. Budget work can be deadly dull, and the mainstream media seldom covers the details. This essay provides an accessible (and hopefully interesting) look into the possible consequences of the budget crises on state government spending.

The states’ budget crisis is largely the result of decreased revenues. State government revenues from all of the normal sources – personal and busi-ness income taxes, sales taxes, etc 1 – have fallen sharply since the recession began in late 2007. Almost all of the states are required to have a balanced operating budget so state legislators and governors have been juggling madly to match their spending to the available revenue. For the past two fiscal years, very large program cuts have been avoided for the most part by making use of one-time revenue sources. The one-time sources included increased federal funds, and redirection of moneys collected for one purpose (e.g., fees for hunting licenses) for other purposes.

For the upcoming 2011 legislative season, when the budgets for fiscal year 2011-12 must be set (state fiscal years begin at various points in the calendar year), most of the one-time revenue sources appear to be exhausted. Congress does not seem inclined to pass another package of funding for the states. There is a possibility that revenues will increase dramatically, although no one seems to be forecasting that.

Without increased revenue, legislatures will have no choice but to make deep cuts in spending. Some argue that peak energy in general, and peak oil spe-cifically, implies that the current levels of revenue are a “new normal.” If that is the case, the cuts made next year may well be permanent.

The budget problem, and the need to make program cuts, is especially painful to address because many of the services provided by state gov-ernments are counter-cyclical in nature. That is, demand for state services increases during a recession, at the same time that revenues are declining. More people apply for unemployment insurance (UI) benefits; more apply for other forms of public assistance, such as Medicaid; more stay in school, or return to school for additional training. In a very real sense, state government business booms during a recession.

Putting together a state budget is complicated because there are many revenue streams that must be spent for specific purposes. UI taxes go into a trust fund and can only be spent to pay benefits and administrative expenses associated with the UI program. Federal grants almost always come with strings attached that restrict usage. Gasoline taxes are almost always dedicated to transportation projects. These parts of a typical state budget are pretty much on autopilot: if gasoline tax revenue declines, road construction projects get delayed or cancelled in order to match ex-penditures to income. The real “action” in most state budgets involves the General Fund (GF), whose moneys can be used for many purposes.

Examples usually make things clearer. I’ll use the Texas state budget for this purpose. It’s not the state budget that I know best, but there are four reasons for using it. First, Texas is a large state in terms of population as well as area. Large states often function as leaders: the choices made by large states may restrict other states’ options. Second, the Texas state budget is already lean; Texas ranks among the states spending the least on a per-capita basis. Third, Texas’ conservative state government has become even more conservative as a result of the recent elections. Texas Monthly magazine says that this may be the most conservative government that Texas has ever elected. This is a legislature whose members ran on a promise not to raise taxes, and with a natural inclination to cut government spending. Fourth, the conservative shift that occurred in Texas also occurred, to a lesser degree, in Congress. If the trend continues in 2012, today’s Texas may be an indicator of future Congressional attitudes.

Let me begin by dismissing a question that is often raised regarding state budget problems: public employee pension plans. In February 2010, the Pew Center on the States published The Trillion Dollar Gap, whose title reflected their estimate of the aggregate shortfall in state retirement system funding. There are many public pension systems in Texas rather than a single very large one. One of the larger state funds is the Employ-ees Retirement System of Texas. As of August 31, 2010, the System had an accrued liability of $28.4 billion and actuarially valued assets of $23.6 billion, a $4.8 billion unfunded liability. I’ll make two remarks about the situation. Amortized over 30 years at 5%, the state (or its employees) would need to make annual payments to the fund of about $260 million to cover the liability. That is about 0.6% of the state’s GF budget. And with $23.6 billion in assets, the point at which the System might be un-able to meet its annual obligation is many years in the future. Yes, there’s a pension problem, but it is relatively small2 and occurs much farther in the future than the balanced budget problem the state legislature must address starting in January.

How does the Texas General Fund get spent? The following table is from the Legislative Budget Board’s Texas FactBook 2010, and shows the original GF appropriations for the major areas of state government for FYs 2009-10 and 2010-11 in millions of dollars, and as percentages. The Texas legislature meets only once every two years, unless called back for an emergency session. The Budget Board is a permanent joint committee of the legislature with an extensive staff. Many state legislatures have similar committees and staffs.

This table is a typical of the situation in most states3: in round numbers, 95% of the GF is spent in just four areas: K-12 public education; health and human services (HHS) largely for Medicaid ($22.9 billion in the case of Texas); higher education; and public safety (includes state police, courts, prisons, and probation officers). Call those the Big Four – state governments do lots of things, but most of the GF money is spent in only four areas. In normal times, this 95% is largely off-limits because each of those areas has politically influential advocacy groups. There may be additional constraints in the form of specific funding requirements written into the state constitution, or in the form of federal laws and court decisions.

These are not normal times. Absent a large and unexpected infusion of revenue, estimates are that the Texas legislature needs to reduce spending for the next two fiscal years by somewhere between $10 billion and $30 billion from the levels shown in the table. Wiping out everything but the Big Four, and the non-Medicaid portion of the HHS funding, won’t get them to $10 billion. Some cuts will need to come from the normally off-limits group. In the next few paragraphs, I’ll talk about what constraints there are on making cuts in the Big Four, still using Texas as the major example, with references to some other states as appropriate.

Article 7 of the Texas Constitution requires that the legislature establish, support and maintain an efficient system of free public schools. Certain revenue sources are dedicated to the public school system. If those sources are insufficient, the constitution allows (but does not require) the legislature to appropriate GF moneys to meet its obligation. State GF spending for public schools in Texas, as in many states, began as an equalization program. School districts in poorer areas of the state could not realistically raise enough money through property taxes to provide the same quality of education as richer districts, so the state provided money to “equalize” per-student funding. Reducing the funding for K-12 education is always politically difficult. States that have already reduced K-12 funding have tended to trim around the edges, reducing in areas such as prekindergarten and enrichment programs. Texas is likely to do the same. Cuts to per-student classroom funding might be challenged in court as a violation of the constitutional mandate.

Medicaid is a voluntary federal/state program that provides health care for the poor. If a state chooses to participate, its program must meet certain federal requirements. There are an extensive set of services that must be covered, including hospital care, physician’s services, and labo-ratory and x-ray services. State Medicaid payments to care providers are required to be high enough so that care and services are available to the Medicaid population to at least the same extent they are available to the general population in a geographic area. Several states are, in my personal opinion, already skating on thin ice with respect to this reimburse-ment requirement. For example, some states have entire counties where none of the doctors will accept new Medicaid patients. The federal Affordable Care Act (ACA) passed this year freezes all states’ eligibility standards4. In short, if a state chooses to participate – and all 50 currently do so – there are limits to how far they can reduce their payment schedule, and they can no longer tighten the eligibility standards. For Texas, whose covered services have never extended very far past the minimum set, and whose payment schedule has never been particularly generous, reducing Medicaid expenditures is largely an all-or-nothing proposition: continue spending at nearly the current rate, or withdraw from the program.

As with most states, reducing the public safety budget significantly in Texas means reducing the cost of prisons. There are limits to how far conditions in prisons can be allowed to deteriorate. For example, federal courts have placed limits on how many prisoners can be housed in a given space, and on the level of medical services that must be provided5. In California, the state prison health care system was placed in receivership by a federal judge, and the state is required to fund the level of medical service specified by the receiver. Because of these limits, reducing prison costs generally means reducing the number of prisoners, which means letting people out early. To quote an anonymous state budget analyst who had worked on the corrections budget for several years, “The problem with letting prisoners out early is that, in order to wind up in a state prison, you have to have originally done something really nasty.”

Like most states, the vast majority of criminal cases in Texas are settled by plea bargain. In the case of non-violent and victimless crimes, the charge is generally reduced to a point that the perpetrator serves their time on probation, or in a county lockup, or at a less expensive private prison. The violent cases are the ones that end up in state prison. When Colorado instituted a program to find people in the state prisons that might be suitable for supervised early release, the Parole Board identified only a handful.

And finally, the state higher education system sits there, with what amounts to a big fat target painted on it. Small amounts of the state funding for the Texas system are protected by the state constitution, but the large majority of the funding has no protection except the voice of advocates. This is very much the situation that exists in most states. California has cut funding for its once-fabled system deeply; Illinois stopped making the funding transfers to some of its state schools; the Colorado legislature required state colleges and universities to submit written plans explaining how they would deal with large cuts in state funding. Higher education is one of the few areas with heavy GF funding that has an alternate source of revenue – tuition – that can be increased. Large tuition hikes are occurring in many of the places where state law allows that to happen. Absent something extraordinary, higher education will almost certainly take a major cut.

There is the possibility of something extraordinary happening. The Wall Street Journal, as well as more specialized publications, has reported that several states, including Texas, have raised the question of withdrawing from the Medicaid program. I have asserted for years that Medicaid as currently constituted is a slow-motion train wreck for state budgets; the recent recession simply sped the process up a bit. Medicaid program costs have grown faster than state economies for years; state and local governments are up against the political limits of how much of the state economy they can take as taxes; so now Medicaid is beginning to crowd out the traditional state functions, starting with higher education. At some point, some state will withdraw, and once it is no longer “unthinkable,” a number of other states are likely to follow quickly thereafter. In fact, it appears that only one aspect of the program is seriously holding states back: long-term and nursing home care.

Long-term care currently accounts for about one-third of total Medicaid spending, but it is the fastest growing covered service. A typical situation might go as follows. Grandma has had a couple of strokes, but is otherwise very healthy. The strokes have left her with permanent cognitive disabilities. Now that her blood pressure is under control and she’s taking a blood thinner, she can live happily in a nursing home for a decade or more, puttering in the flowerbeds, but never recognizing those nice young people who come to visit her each week. Her assets have been sold and her pension plus Social Security benefits won’t cover the full cost of 24/7 supervision. Medicaid makes up the difference. Getting Grandma kicked out of the nursing home is not something on which state legislators want to campaign.

Let me conclude by speculating on what the Texas legislature is likely to do. This is purely speculation – I have no insider knowledge, and based on my own experience, legislators are full of surprises. I’m going to assume that Congressional Republicans stick to their position that it is more important to reduce the federal deficit than to provide aid to the states, and that the Texas Republicans stick to their promise that they won’t raise taxes. The key question remaining is whether the Texas leg-islature has to cut $10 billion, or $30 billion. If they need to cut “only” $10 billion:

• They’ll find on the order of a billion dollars in incremental reve-nue and cuts in areas outside of the Big Four. Lots of states are doing lots of little things: delayed payments, hiring freezes, fur-lough days for employees, reduced hours at the Department of Motor Vehicles, etc.

• They’ll find on the order of a billion dollars in public safety. The prisons will get more crowded and health care for prisoners will get worse. It will be more dangerous to be a prison guard.

• They’ll cut about three billion dollars from K-12 education. Enrichment and other “discretionary” programs will go away, and there will be small cuts in the per-student classroom funding.

• They’ll take five billion dollars out of higher education.

If they have to find another $20 billion in cuts, I believe that the unthinkable will happen, and they will withdraw from Medicaid. My estimate is that will leave them enough wiggle room to balance the budget and still fund a state-only program to provide partial nursing home assistance, making it more palatable to voters (the other poor who will be losing their health insurance generally don’t vote in large numbers). I also think the withdrawal will be the first move in a complicated game with the federal government. As part of that, I would expect members of the Texas Congressional delegation to introduce legislation that would make Medicaid a block-grant program with minimal state spending requirements. This would be the same type of change that was made to the federal welfare system during the Clinton administration.

Notes

1There are exceptions to these standard revenue sources. Some states are able to tax specific industries such as tourism or mineral extraction at a high enough rate to generate the necessary revenue. Such states are effectively able to tax other states rather than their own citizens.

2Other states may be better or worse off than Texas. A handful of states have fully funded public pension programs. Some states are facing significantly greater amortization costs than Texas. The situation may be further complicated depending on whether state law requires the state government to bail out under-funded local public pensions.

3There are exceptions to the typical breakdowns of GF spending. New Hampshire, for example, spends no money at the state level on K-12 education, leaving it to local government to fund public education. “Poor” states pay a smaller portion towards Medicaid because the federal government reimburses a greater portion of the state’s expenditures.

4The Arizona legislature had the unfortunate experience earlier this year of be-ing required to roll back eligibility changes they had made as part of balancing their budget. If they had made the changes a few weeks earlier, before the ACA was signed, they would have been all right.

5The US Supreme Court has agreed to hear a case involving crowding and medical care in state prisons during its current term. The current rules may get changed.

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to inadequate supply.
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21 Responses to Oil limits lead to state budget squeezes

  1. majorian says:

    How important is a social safety net?
    The right-wingers think the important thing is to reward productive individuals (rich people) and if that means punishing the poor, well that’s just too bad.
    As Dr. Rand Paul said “Everybody either works for or sells stuff to a rich person “.
    In the case of medicine, since most people are not rich, Uncle Sugar is paying the bill
    and the size of the medical industry has grown gigantic. Patients are a commodity and a busy doctor will limit his intake of time-consuming Medicare patients to boost his
    income. Doctors also look at the lower salaries in countries with public health systems
    with horror—who wants to spend a day with cranky old people when you could be golfing!
    The social safety net can only work if people are committed to the concept from the beginning. The solution is Medicare for everyone (as they have in Canada at half our cost) which would cut out insurers and Wall Streeters intent on milking the aging demographic. This would also unburden the states.

    I agree that the pension crisis is being hyped but if it is crucial just roll them into SS.
    It’s stupid for public workers to get their own pensions outside of SS which are dependent on Wall Street returns rather than gov’t bonds.

    Our safety net has holes in it caused by corporate lawyers.
    If we believe in the system
    then we should fix it nationally.
    If not, the US will look a lot less ‘exceptional’, more like Mexico or Brazil.

    • Social security is an as bad shape as other pensions (or will be within a few years). If is really difficult to fund a program for a growing group of individuals when we are facing declining energy resources.

      It would be great to have enough funds for a social safety net, but I expect that to a significant extent that will be going away, just because it will be unaffordable. Over the long-term, I expect that families will need to provide more of the social safety net, the way they have in the past. But it is not easy to do, when medical services are now expensive (and not something families can provide) and families no longer include multiple generations living together.

    • Kenneth says:

      The problem with Social Security is that it is a pay as you go system. Tax receipts collected by today’s workers pay for those drawing benefits. There is not a fund from which it draws benefits from. Promises have been made to those who have worked that they will be entitled to a set benefit when they retire, but all of their contributions have been spent. A private pension fund has collateral. Social Security does not.
      Social Secuirty does have non interest bearing notes from where overpayment into the trust fund account was transferred into the general fund. To collect, the government must take funds out of the general fund – which currently runs a deficit of 1.3 trillion dollars and will run a deficit for the foreseeable future.
      Social Security was never meant to be a sole support retirement system and already is running a deficit between contributions and benefits paid.
      Will Social Secirity go broke? Not likely. Politicians will try to avoid that at all cost. But will it provide benefits promised? No, or not at the comfort level of today’s recipients.

      Higher income retirees are likely to means tested and have their benefits reduced by taxation on benefits. Retirement ages raised.

      Reduced COLAs or no COLAS are likely. There are none for 2010 and 2011 now. Expect more of this.

      When Peak Oil begins to drive up the cost of energy, goods and services. inflation will eat up more and more of your income. The government’s revenue will also decline from a Peak Oil recession. Higher unemployment and lower economic activity will depress tax collections. The govenment will find it difficult to borrow because of its high debt load and may decide to print money to cover expenses and meet its promises. Inflated money buys less, but the government meets their obligations.

      Is your retirement fund better off run by the government? Not likely. It would have the same problems as Social Security with its collateral spent in the general fund and a bond issued for future payment – that will lose its value rapidly as Peak Oil runs up inflation. Private funds will fare poorly too, but some may do ok. There is always money to be made , even in bad times.

      I work for the federal government and have seen budget constraints come and go. The government budget is going to be very tight for the next two years. They are already saying they are broke. when you ask for something besides pencils and the new fiscal year began only 2 months ago. President Obama wants to freeze wages for the next two years.

      Social Security, Medicare and Defense make up the majority of the budget and are not likely to be cut — so real deficit reduction is not likely to occur before 2012. By November 2012, our debt will be near 18 trillion dollars. The Presidential campaign of 2012 will be about getting the debt under control. The Social safety net is going to be cut and taxes will be raised. The economy will suffer stagnation and Oil is projected to hit $1oo the first quarter of 2011 and $120 in 2012.

      I’m afraid I’m a glass half full guy.

      • Kenneth says:

        I meant a glass half empty.

      • majorian says:

        The way to increase the stability of SS, which is fine now is to increase payroll taxes (right now ~15 % of income). I don’t see a problem with this. We need to decouple SS, Medicare from the budget as it used to be–the politicans won’t like it as it reduces the amount of money they get to play with but as they are incapable of managing the money we send them now we need to put them on a shorter leash to being with.
        Everything is a big mishmash—Simplify!
        Investing in Wall Street is mainly a matter of luck. If you invested heavily when the market was strong you did well, otherwise not so much. One reason states, municipalities and pension funds are in bad shape is that they invested on Wall Street.
        Post Peak I expect the stock market will be horrid, dominated by rumor and manic electronic trading. Eventually it will have to be closed permanently.
        But Post Peak we’re going to need that social safety net the alternative we already know…Katrina.

        • Kenneth says:

          In all likelyhood, if Peak Oil decline rates are 3 to 5 % per year and the IEA forecasted new discoveries and unconventional oil do not sufficiently cover the oil deficit – we are probably going to have some sort of rationing system set up, but not until things get really bad first. Ration cards were used during the World Wars and probably an electronic one such as an EBT card will be put in place.
          The Social safety net will grow to encompass the majority of us, including the middle class, but it will not be at the level we enjoy today.
          If Peak Oil is a severe event, then the United States may be transformed into some form of National Socialism where the government mandates the activity of industry and rations its production back to its citizens.
          Healthcare would be nationalized, but rationed also. Things like hip replacements and heart surgery will no longer be available. The healthcare of the Soviet Union after they collapsed in 1991 was awful. Post Peak healthcare may not stink quite as bad as Russia’s, but it won’t be good.
          Today the poor in this country live ok. Not great, but ok. Post Peak, the middle class will live worse off than today’s poor.

  2. Joe Clarkson says:

    As long as most governments within the US retain their republican nature, there will come a point at which there will be enough desperate people needing assistance that they will vote for higher taxes. Higher tax rates are a certainty.

    In fact, as the number of unemployed voters reach levels at which they become a significant minority (perhaps even a majority), their support needs will be such that taxes on income and consumption will no longer suffice. Voters will then demand programs of asset taxes and transfers.

    I expect we shall see confiscatory estate taxes and dramatically increasing real estate taxes in the not too distant future. How that will affect those of us who own a bit of debt-free agricultural land, with which we hope to survive the coming depression, remains to be seen. But, it may be that all our retirement savings must be husbanded just to pay taxes and we will be able to live off only that which we can provide for ourselves from our land (if we can protect even that).

    I am almost afraid to think of what comes when even wholesale asset transfers are not enough.

  3. Dan says:

    I don’t think that a large nation like the US can fund the retirement of its people in advance, like the SS trust fund tried to do. The excess funds collected had to be reinvested in the economy someway. If they were just left to sit, it would have been a huge drain of maybe one percent or more of GDP per year. I don’t know the exact numbers but if you subtracted 1% off the GDP every year since the 70s, there would have been more and longer recessions than we actually had.

    So what choice did they have? Invest in equities or bonds of private companies? This would probably have led to much fraud. Who would decide which companies got the funds and how much would the government have to oversee those companies. Look at all of the bitching about GM and the banks. What would it be like if all of the S&P 500 companies got SS trust funds? And for companies receiving the funds, would they make good investments or blow the money knowing that next year they would get another injection of funds?

    So the excess SS trust funds were used by the General Fund and the income tax was lower than it would have been otherwise. The economy grew, people earned more and the SS trust fund grew even more. Most people are better off now.

    In the future, when there are more retirees to support and the payments are greater than the receipts, changes will be made. Unless we can keep printing money and other nations will keep on taking it.

    • Social security payments this year are already greater than current revenue, and one plan is to reduce Social Security funding next year.

      • Dan says:

        I read that the estimate is that it will go positive again in 2012 and might stay that way until 2017.

        http://www.angrybearblog.com/2010/12/what-is-social-security-crisis.html#more

        I agree that PO and the resulting higher oil prices aren’t helping our economy and unemployment situation.

        • These estimates are about contributions going positive are made by the folks who think the economy will bounce right back, and we won’t have to worry about people taking out Social Security benefits because they don’t have jobs. Of course, quite a few of these people have already been added to the roles (which is part of the reason the payout ratio is high), and I expect more will be added in the future. It is also not all that clear that the amount being paid in is going to increase either, if jobs are very much tied to energy availability (which I think they are).

          Mario Giampietro and Kozo Mayumi (two of the folks at the energy conference I spoke at in Barcelona–Mario was the chief organizer) have written a book called The Biofuel Delusion. One of the things the book talks about is the relationship between exosomatic energy flows and jobs. While the book doesn’t explicitly analyze what would happen when net energy goes down, it seems to me that it would likely result in fewer jobs.

      • Don Millman says:

        I think the plan to cut two percentage points from the payroll tax for Social Security is seen as a “one time” stimulus measure for 2011. Of course, such a big cut will substantially increase the federal deficit, but on the other hand it will tend to increase the disposable income of wage earners by a significant amount, perhaps 1.4%.

        If disposable income goes up, then consumption spending will rise, and this increase in consumption will boost nominal GDP per capita.

        One nice thing about cutting payroll taxes is that it does not amount to much of a tax cut for the wealthy.

        • majorian says:

          A payroll tax holiday is aimed at defunding SS which is the anchor of the safety net–all to give the top 1% a tax cut on income earned over $250k.
          It is the true embodiment of class warfare.
          That, and the blatant lie that tax cuts create jobs.

    • Michael Cain says:

      “I don’t think that a large nation like the US can fund the retirement of its people in advance, like the SS trust fund tried to do. The excess funds collected had to be reinvested in the economy someway.”

      Recall that the original 1983 Greenspan Commission (yes, same Greenspan) on Social Security actually described a detailed plan. Excess contributions made by the Boomers would be used to buy Treasuries roughly equal to the amount of the national debt that would otherwise have been retired each year, plus something for GDP growth. When the Boomers retired, the SS Treasuries would be paid off by selling a corresponding amount of debt to the public. In effect, about the time the Boomers finished dying, the federal government would have the same debt relative to GDP that it had in the mid-1980s, and Social Security would still be solvent. Adjusted for inflation, things are playing out pretty much the way the Commission described it: they got the demographic part and the tax rates remarkably close to right. Of course, their assumption that the federal government would run a balanced budget outside of Social Security — an assumption that both Reagan and Congress assured them was accurate — didn’t quite work out.

      The long-term Social Security “crisis” in a BAU world is actually due to the Commission getting another assumption wrong. They assumed that increases in productivity would be shared equally across the income spectrum. As a result, the rate at which the cap on wages subject to the SS tax increased was based on percentage increases in the median wage. Unfortunately, productivity gains for the last 20 years have gone predominantly to people already making more than the cap. If the cap had been increased based on percentage increases in the 90th-percentile wage instead, the cap and corresponding revenues would be enough higher that the politicians would be discussing permanent reductions in SS taxes, not reductions in benefits.

      The more serious problem, and Gail alludes to it regularly, is that both public and private pensions are dependent on steadily increasing productivity (my remarks on that are here). Historically, productivity gains have been closely correlated with increased use of external energy. In an era of decreasing energy availability, it is difficult to see how the productivity gains will be sustained.

      • I hadn’t realized that productivity gains have mostly gone to people making more than the cap. Do you have any references where it is possible to learn more about this?

        The earnings of people involved in manufacturing and transport of goods are basically below the cap. Above the cap we find doctors, and lawyers, and financial people (including actuaries). I am not certain how one even talks about the productivity of their work. Number of pages of numbers produced? There are now more doctors relative to population than at any point in the past (I haven’t checked the numbers recently, but I am pretty sure this is true). The doctors are supported by a huge number of physician assistants and nurse practitioners. Health care takes a bigger and bigger share of GDP, and our life expectancy is below that of many other countries. It is hard to understand how all of this could be associated with “more productivity”.

        • Don Millman says:

          You are quite correct that measuring “productivity” in many service industries is a can of worms. How on earth can you measure the productivity of a school teacher?

          Nevertheless, in national income accounting, numbers are assigned to “productivity” of doctors, lawyers, school teachers, and professional astrologers. How this is done is rather arbitrary and gets more complicated all the time. Now the productivity of doctors has definitely increased over time because they use fancier and fancier equipment, get blood tests done faster and more accurately than in the past, and they have much better drugs to prescribe than, say, fifty years ago. To take an example, how do you measure the productivity of a prescription for Viagra that works to restore an older man’s sexual performance to what it was when he was decades younger? How on earth can you come up with a number for that?

          Economic statisticians are happy with bushels of corn or barrels of oil or tons of steel. The techniques they use to come up with for productivity numbers in many of the service industries are, to put it mildly, highly questionable.

        • Michael Cain says:

          There’s been an enormous amount of study by labor economists on where productivity gains have been going. Here’s a link to one fairly representative paper from the Federal Reserve Bank of Kansas City. From the conclusion section:

          …strongly indicates that the gains from increased productivity have not been equally shared across households. In the recent period, low-income households have seen no increase in real income. At most, only the top 10 percent of income earners experienced real income growth equal to or greater than average labor productivity growth, with most of the gains likely concentrated in the top 1 percent of income earners.

          Lots of different reasons have been proposed for why the already well-paid are capturing the productivity gains. Ben Bernanke says it’s all about returns to education; the paper above attributes a large part of it to the outlandish gains that CEOs and other senior corporate management made over the last decade.

          Myself, I don’t care so much about the “why” as I do about the probable outcomes if the trend continues. If it does, I think it likely that we will experience a variety of serious social problems long before SS is “bankrupt”.

          • I knew the well paid were capturing the income gains. It hadn’t occurred to me that this was somehow being associated with these folks also being more productive (although I am sure that is the rationale).

            My experience is with an actuarial consulting firm. There, the allocation of revenue is between consultants and support staff. If the support staff aren’t well paid industry-wide (competition from India for tech support; number of secretaries going down in all industries, as computers take their place), then the higher revenue goes to the consultants. Whether that is higher productivity, or less direct competition for jobs from computers and other nations, I am not sure.

  4. Dave C. says:

    It seems to me that Gail T. said, in one of these response messages on this site, that she was doing this site partly because some people at TOD (the oil drum) seemed uncomfortable with the expression of the idea that the US could “collapse”. Let me mention that idea here now (someone wrote, on TOD, that the forecasts, at the last ASPO conference, of the timing of the next big “oil price shock” seemed to center around late 2012) – maybe see my site at http://davecoop.net/

  5. Don Millman says:

    Gail,

    Sometimes very high salaries can be pretty closely related to very high productivity. Look at the salaries of star baseball (or football or basketball) players. The top ten percent of major league athletes probably average at least half of a team’s payroll, and perhaps substantially more than that. Productivity in baseball is usually easy to measure–earned run average and innings pitched for pitchers, fielding percentages, batting average, number of at bats, number of home runs, runs batted in, and so forth.

    What research I’ve seen suggests that star athletes are actually being paid less than their marginal revenue product–i.e., less than their productivity. The economist Robert Frank has written extensively on the tendency of our economy to distribute income more and more into a “winner take all” type of competition. Thus it is not surprising that the lower 90% of the income distribution have not shared in productivity gains.

    Once you get into the details, there are all kinds of surprises. For example, in real terms the net income of most kinds of doctors have been falling over the past forty years–both in absolute terms and also relative to compensation in other fields, such as finance. Why should real incomes fall even as the productivity of doctors has increased greatly? The short answer is that the American Medical Association has not been successful recently in limiting the number of doctors who practice in the U.S. In earlier decades, admissions to medical schools were strictly limited, and indeed ways were found to keep all but a few women from being doctors. Also, many foreign-educated doctors now practice in the U.S., thus increasing competition for a piece of a growing but still limited “pie” of total amount of money spent on doctors. And of course, horrendously increasing premiums for malpractice insurance have greatly lowered the real net income of doctors.

    • Part of the lower income per doctor is the fact that there are so many physicians now that the number of patients they are seeing has been falling. Also, reimbursement limits especially for primary care are having an impact.

      I expect actuaries and financial people have been able to save businesses a fair amount in taxes and in malpractice premiums. (One of the areas I worked in was in setting up captive malpractice insurance companies, and calculating rates and reserves for them.) The number of actuaries has been pretty well limited too. So actuarial fees could be quite high, and clients didn’t object. (Also, they didn’t have good alternatives that were much cheaper.)

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