2013 March 02 Saturday
Rising Discount Rate On US Government Spending

People who have a high discount rate place greater value on money they can spend today for a benefit today than money they can spend tomorrow for a benefit tomorrow. They place greater value on a benefit (or, if you prefer, consumptio) tomorrow than a benefit or consumption next week or next year. This struck me as I read piece in The Economist about how much of total tax revenue goes to fund the welfare state. The welfare state is overwhelmingly concerned with delivering immediate benefits. The welfare state amounts to spending driven by a high discount rate.

In 2012, by my count, about 65% of federal non-interest spending went to health care, income security and pension programmes. The bulk of it, of course, went to Social Security, Medicare and Medicaid. Altogether, in 2012 the federal government spent some $2.3 trillion on what amounts to a gigantic social safety net.

This means the US government is heavily focused on providing for immediate wants and needs. The two thirds of federal spending that goes to health care and welfare payments (and Social Security checks really are welfare payments in a Ponzi scheme) does not get spent for long term benefit. It does not fund medical research or energy research or research into worsening global environmental problems. It does not go go build infrastructure such as highways, bridges, light rail, or better air traffic control systems. It does not go toward an asteroid defense system or try to cut soil erosion or toward border security.

Politically controlled spending is rising. At the same time, the discount rate on politically controlled spending is high and rising. So government efforts aimed at solving long term problems are declining as negative government impacts are rising.

That gigantic amount of money aimed at short term needs and desires is not enough to pay for all currently eligible recipients of federal medical aid. Medicaid and Medicare payouts (and insurance company payouts that are tied to Medicaid and Medicare) have been cut so far that some doctors, especially in rural areas, are going broke.The Medicaid eligible have a much more difficult time finding doctors who will see them. It is easier politically to cut payouts for doctors while at the same time increasing the number of people eligible for Medicaid and Medicare.

Higher taxes can not solve the welfare state funding problem because the US government (and a number of European governments as well as the Japanese government) is spending way beyond its tax revenue. Large tax increases would be needed just to balance the budget today. An aging population, a growing lower class, and declining average living standards make economic growth and tax revenue growth an even bleaker prospect.

As regular readers know, I think the US economy's potential growth rate (as well as that of Britain, France, and other Western countries) has shifted down and will likely shift even lower. Therefore current funding levels for Western welfare states can not be sustained. A Washington Post piece looks at how a growing number of economists across the political spectrum are thinking we've lost the ability to sustain the post-World War II economic growth rates.

What if something has changed, thanks to fallout from the recession, or a string of bad policy choices, or both, and growth has shifted into a lower gear? What if this slow and fragile expansion is as good as we’re likely to get for a while?

Since the economy can't grow as much we need to get smarter about government spending and shift more of it toward longer term goals. But the opposite it taking place: the ROI on government spending is dropping.

Share |      By Randall Parker at 2013 March 02 12:46 PM 

DirkY said at March 2, 2013 3:04 PM:

Medicaid gets a pretty good bang for its buck given its extreme cost controls. Stopping the able bodied poor and poor children from going completely without healthcare does not strike me as inefficient. None of the doctors in my wealthy CA neighborhood take it, or else take a tiny number of patients they are brutal about scheduling.

Treating poor children and working poor adults in other words is just not that expensive via Medicaid. The fact coverage requires some hoop jumping also keeps costs down and makes high IQ people down on their luck more likely to get care than low IQs and highly dysfunctional people.

Medicaid cost growth is mostly from two sources: nursing home care and kidney dialyses. This may be moral do cover but does not help the economy at all as neither group will ever work much again, and costs for both can exceed 50k a year. A lot of the recipients started as middle class, but these costs rapidly can destroy a pretty good nest egg.

I agree with your main points about gov spending should be more forward thinking and capital intensive. But you overstate the case a bit. In a deflationary recession government spending does not crowd private spending. Also, good health is a luxury good and as are economy grows, even weakly, its share if spending should be expected to rise. Also, the rich benefit from welfare spending and investment in the health of the poor, and also have the security of knowing these benefits may accrue to them if they are in need. That doesn't mean the benefits outweigh the cost to them of taxes, but it is hardly flushed down the crapper.

DirkY said at March 2, 2013 3:20 PM:

As a very long time reader, I am a bit concerned about the "Austrian-curious" tone of some of your Econ posts. The economists with math degrees from MIT who publish quality work consider them hacks, rubes, and cranks. They are these days just an arm of the Bush/Neocon GOP establishment, which hasn't the slightest concern for the truth, as evidenced by their embrace of global warming denialism and creationism, and the even a more absurd belief that the American military can turn the inbred low IQ Muslim barbarians of the Middle East into a string of dusky liberal democracies.

If you were inclined to give the Austrian crowd any credit at all a few years ago, by now you should see their various gold to 10,000 and hyperinflation predictions were absurdly wrong. As were their earlier housing bubble denialism and Dow 36,000 crap.

Unfortunately paleocons lack quality HBD-aware economic pundits, especially macroeconomics. Borjas sort of counts but he is a labor economist, which is grouped with micro.

Bill said at March 2, 2013 3:21 PM:

"the US government (and a number of European governments as well as the Japanese government) is spending way beyond its tax revenue."

Spending beyond tax revenue results in deficits. Deficits are necessary for there to be any net private savings. Without deficits, there can be no net private savings. Only deficits can create net savings dollars. Banks cannot create net dollars. For every dollar created by a bank, a loan obligation also is created –- the new dollars are offset by new obligations, so they net to zero. If everybody wants to save, there must be deficits.

The rest of the world wants to net save the world's reserve currency, the US dollar, which is why there are deficits. And the Japanese all want to net save the Yen, which is why there are Japanese deficits.

Here's a pure derivation:

The real (inflation-adjusted) national income, Y, is defined as
Y = G + X – M + PX + I

G = Govt' spending
X = exports + foreign transfers + property income
M = imports
PX = Private spending
I = Private investment (note, I left this out by mistake the first time. Sorry!)

Subtract T from each side, where T is taxes and government transfers we get

Y – T – PX - I = [G – T] + [X – M]

Private Net Savings = [G – T] + [X – M]

Private Net Savings is GNP - taxes - private spending (PNS is private disposable income less taxes less private spending on consumption less private investment).

So, by identity, PNS equals the Federal deficit (G-T) + the current account surplus (X-M).

James Bowery said at March 2, 2013 4:22 PM:

Click on the second link at this description of demurrage currency's role in a virtual political economy for a presentation on long-term investment incentives inherent in demurrage currency.

There is no reason that private savings must depend on on going government deficit spending as that virtual political economy shows.

Mike M said at March 2, 2013 8:00 PM:

"Since the economy can't grow as much we need to get smarter about government spending and shift more of it toward longer term goals."

The fatal conceit continues. That the government must spend "its" money more wisely has been the mantra of politicians, especially on the left, for decades. The problem is that government central planners (spenders) will never be smarter than its private citizens in correctly determining how to allocate their money. I hope what you really mean is that government needs to cut its spending by approximately 65% and allow the taxpayers to retain control of those dollars rather than just letting the government dole those dollars out to some other ill-conceived programs.

Andrew Neather said at March 3, 2013 7:10 AM:

If you import low quality people you get a low quality economy. Simples.

[ParaPundit edited this to remove an insult aimed at another commenter]

Mike M said at March 3, 2013 8:08 AM:

Andy still gets it wrong - it's not low quality PEOPLE that get you a bad economy, it's low quality political institutions.


Institutions that permit or encourage predation, that is, those that don't protect an individual's person and property rights, enforce contracts, etc. result in poor economies and countries dominated by a small, wealthy ruling class. Institutions that protect individuals' rights end up with prosperous economies - until they allow predation, e.g. wealth redistribution, to seep in.

LeRoy Matthews said at March 3, 2013 9:11 AM:

Study my Letter on Diana@Philosophyinaction.com.

(Instead of searching for Crazy Inbox, try p=6498 June 5, 2012.)

The so-called'federal government" is not only Bankrupt, it's Head- Over- Heels in Debt, & Operating Way in the Red, & It Has A Huge, & Increasing, Budget Deficit. There's virtually zero $ for anything whatsoever.

Randall Parker said at March 3, 2013 10:38 AM:


The privately funded health payers pay more than Medicare or Medicaid. This means the private effectively subsidize the government-funded health care. Since government funded health care continues to rise as a percentage of total health care and the government payouts haven't kept pace with inflation the subsidies from private pay have grown. This is not sustainable. Not surprisingly, some doctors opt out of Medicare and many more opt out of Medicaid.

Medicaid and kidney dialysis: It is inevitable that the American government can't just do only the most efficacious forms of medical spending. So the ROI on Medicaid is much lower than it could be.

In a deflationary recession government spending does not crowd private spending.

Government spending accumulates debts. Once government debt gets up near 90% of GDP (or is it 80%?) the empirical evidence is that GDP growth slows. Britain and Japan are in that situation now, as well as assorted southern European basket cases. We can't afford to fiscally stimulate ourselves out of the recession.

The economists with math degrees from MIT: Well, what have they accurately predicted? Certainly not the financial crisis. The predictive value of economics is exaggerated. Ditto the predictive value of most fields of expertise. See Philip Tetlock's work on accuracy of expert prediction.

Austrian-curious: Could you clarify?

Neocons: Definitely harmful to the Republic. Global warming: Real problem. Ditto overpopulation, overfishing, soil loss, deforestation, fossil fuels depletion. I only wish the people who are most vociferous about global warming would mention that it would be a much smaller problem if people made fewer babies.

Mike M says:

it's not low quality PEOPLE that get you a bad economy, it's low quality political institutions.

Why is it that Finland is the least corrupt country in the world? Shy smart people (I should capitalize PEOPLE) create high quality political institutions. High quality people create high quality governments.

Investment and government: I see big market failures around knowledge generation where government has a positive role to play. I therefore support government funding of research. Infrastructure: well, it is still too hard to privatize all the roads.

LeRoy Matthews,

You could try a URL.

Andrew Neather,

Stop calling Mike M names. I've got the power to delete posts. I've been too busy to do it lately. But I'll get around to it.

Vektor said at March 4, 2013 6:38 AM:

" I only wish the people who are most vociferous about global warming would mention that it would be a much smaller problem if people made fewer babies."

^ Bingo ^

Engineer-Poet said at March 4, 2013 7:40 AM:

GW would also be a much smaller problem if the West banned immigration from non-Western (low-emitting) nations.  Letting people adopt a high-emitting lifestyle without building the infrastructure themselves makes the trend far worse than it needs to be.

Mike M said at March 4, 2013 7:54 PM:

Randall - Evidently, we disagree on whether it's the institutions or the people that are the critical factor in prosperity. While I do appreciate all the studies that point to inheritability of intelligence - there are studies that conclude the opposite, but I don't find them convincing - I cannot find any good studies showing that human nature varies across borders. Indeed, when we read literature from different times and different cultures, we are struck with the constancy of the human condition. As such, I am more convinced that political institutions are a much larger factor in determining whether country X is prosperous or poor.

Now, given that the genetic studies regarding intelligence demonstrate a superiority for Asians, if it's the people (and not the institutions) that is the dominant factor, why has the US been more prosperous than Asian nations over the last two centuries?

Randall Parker said at March 5, 2013 9:35 PM:

Mike M,

Griffe's Smart Fraction Theory II.

Studies: You need to read psychometricians. I'm pointing you at them. If you haven't read them you haven't read the evidence. Proper study of the evidence requires a substantial time investment. But even a small time investment reading psychometricians will alter your view of humanity.

Constancy of the human condition: No, that's wrong. Another book you should read: A Farewell To Alms.

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