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Monday, July 24, 2006

 

Entitlements Crisis - Part 3

To review this series, you can re-read the first two parts in the archives. In Part 1, dated March 29, 2005, I teed up the issue placing the entitlement programs in their historical and economic contexts. Part 2 made the case that a funding crisis already exists, and that private accounts were the only reasonable alternative to benefit cuts or increased payroll taxes, attacking the problem from the earnings yield side. Since private accounts failed politically, at least for the forseeable future, Part 3 will explore the case for benefit cuts and higher payroll taxes.

Benefit cuts are easy. Social security already provides much more than was originally conceived, even taking inflation into account. One of the problems is the COLA adjustment. COLA's are put in place because of inflation expectations. The trouble is that such expectations themselves feed inflation. A viscious cycle develops, increasing the real value of benefits provided to unnecessarily high levels.

The most obvious benefit cut to make would be to end COLA's - forever. Take them out of the program. The real value of social security benefits will gradually decrease but not as much as one might think, since I would expect that this change will reduce inflationary expectations and the growth of government expenditures, both reducing inflation versus what it would otherwise be. If a benefit increase achieves a political consensus at some point, let Congress vote for it, but no more automatic increases triggered by anything.

We conservatives have a harder time recommending payroll tax increases. These taxes damage the economy, because when you tax something (payrolls), you get less of them. However, social security taxes are regressive, not because they are flat (that's neutral, not regressive) but because there is a maximum wage base subject to the tax. This is doubly offensive because of the obscene compensation being taken down by corporate senior executives (with the aquiescence of their hand picked boards) and Wall Street investment bankers. The vast majority of this swollen pay is beyond the SS wage base.

Now how does a sensible proposal like the Forbes flat tax get anywhere when paired with the regressive payroll tax? I would propose that the flat tax (eliminating most deductions and reduing the weight of the tax code by about 95%) be implemented in conjunction with the elimination of the cap on the wage base. Make all wages (and option gains) part of the SS wage base - then see if Corporations don't rein in some of this outlandish pay. The favorable impact of the flat tax will offset the negative economic impact of the higher payroll taxes. A larger proportion of government revenues will go to social security, which I would take off budget again. Let Congress live on the flat tax and other government revenues while social security is funded back to solvency in what would be perceived as a much fairer system.

In part 4, the conclusion of this series, we'll look at the really hard stuff, Medicare and Medicaid.

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Another day of positive Market fireworks today, which will mean nothing again if we don't see some follow - through. I don't expect to see any - I think the bears are still in control. These big positive days interrupting the market slump are largely short covering exercises. The next day, the shorts are back to reestablish new positions.

However, I don't try to time the market. My system is based on asset allocation, and I still have too much cash. On July 17, I bought 100 shares of WTS at 29.45. On July 19, I established a new position, SHLM with 100 shares at 23.31. Today, I bought 200 of slumping ADCT at 11.98.

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