Did Social Security and Medicare Crash the Economy?

November 27, 2012

Dean Baker
The Exchange (Yahoo! Finance), November 26, 2012

See article on original website

The talk in Washington these days might lead people to think that the main cause of the economic downturn is the Social Security and Medicare benefits being paid to retirees. After all, we have people from both parties giving us assurances that cuts to these programs are an essential part of any budget deal. This is the sort of topsy-turvy thinking that passes as conventional wisdom in Washington.

In case it’s necessary to remind people, our economy plunged due to the collapse of a Wall Street-fueled housing bubble. The loss of demand from the collapse of the housing bubble both led to a jump in the unemployment rate from which we have still not fully recovered and also the large deficits of the last five years.

Prior to collapse of the bubble, the budget deficits were quite modest. In 2007 the deficit was just 1.7 percent of GDP, a level that can be sustained indefinitely. Furthermore, the Congressional Budget Office projected that the deficits would remain small for the near future, with the scheduled expiration of the Bush tax cuts in 2011 projected to push the budget into surplus.

The reason that we suddenly got large deficits was the economic downturn, which caused tax revenue to plummet and increased spending on programs such as unemployment insurance. We also had temporary measures that included tax cuts such as the payroll tax holiday and various spending programs that further raised the deficit.

However these stimulus measures were temporary and were quite explicitly designed to boost the economy. Had it not been for the downturn, they would not have occurred. There is very little by way of permanent changes from the pre-recession tax and spending policy that would raise the budget deficits from the low levels that had been projected in 2008. This means that the story of current deficits is the story of the collapsed housing bubble.  

In a sane world we might be looking to square the deck with the folks who brought us the bubble. One obvious way would be a modest financial speculation tax like the one that the UK has had in effect on stock transfers for centuries. A modest tax on trades of stock, options, credit default swaps and other derivative instruments could raise enormous amounts of money while barely affecting normal investors.

The Joint Tax Committee estimated that a 0.03 percent speculation tax proposed by Sen. Tom Harkin and Rep. Peter Defazio would raise almost $40 billion a year. This bill would imply a tax of just $3 on $10,000 of trades. Since computerization has caused trading costs to plummet, this tax would just raise transactions costs back to where they were 10-15 years ago.

The big hit would be on the high speed traders and other fast turnover types who are flipping stock and other assets by the hour or even by the second. This trading is a drain on the economy and cutting it back would free up resources for productive activity.

But in Washington policy circles, taxing Wall Street is off the agenda, cutting Social Security and Medicare is on the agenda. And, best of all, many of the people at the center of the housing crash are playing leading roles in this drive to cut retirees benefits.

Last week, many people might have seen Lloyd Blankfein, the CEO of Goldman Sachs, talking about the need to cut Social Security benefits and raise the retirement age. The last time that Mr. Blankfein was very visible in policy debates he was desperately seeking a bailout for Goldman Sachs which was facing a bank run that pushed the company to the edge of bankruptcy.

It was granted special protection from the Federal Reserve Board and the Federal Deposit Insurance Corporation. This protection, coupled with tens of billions of dollars in loans at below market interest rates allowed Goldman Sachs to regain its health. Now its CEO wants to cut our Social Security.

An even more amazing apparition in this story is former Federal Reserve Board Chairman Alan Greenspan. More than anyone in the whole country, Greenspan deserves blame for the economic downturn. As the bubble was growing to ever more dangerous levels, Greenspan was cheering it on, insisting that there was no bubble, and that even if there was a housing bubble its collapse would pose no special problem for the economy.

In a sane world, Greenspan would be hiding away somewhere enjoying his high six-figure pension. But this isn’t a sane world, this is Washington. Therefore we could find Greenspan telling us that another recession would be a price worth paying, if it led to cuts in Social Security and Medicare.

So welcome to the Washington policy world. Cuts to Social Security and Medicare are on the agenda and Wall Street speculation taxes are off the agenda. Don’t we have much to be thankful for?

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