The Unsustainability of the US Economy

I don't know about you, but I don't deserve it. For decades the US has been on a financially unsustainable path, it has been unable to reform entitlement systems that clearly will break the bank if nothing is done, it has engaged in various costly and pointless military adventures, it has eroded privacy rights and civil liberties in the name of protecting us from the dangers of terrorism, which are orders of magnitude smaller than those of driving to work, it has catered to special interest and subsidized whole industries, and so on ad nauseam.

Whenever a system is not working, it is a good idea to look at the incentives that shape the decision maker's actions. We routinely do this to explain people's behavior and even financial crises. CEOs get paid if risky bets pay off, move to a different company or retire if they don't. Strangely enough, we rarely apply the same type of reasoning to politics.

Election Expenditures

Given the vast sums of money spent on election campaigns, we can safely assume that politicians are motivated by a desire to get (re)elected. In order to succeed, they need need to give voters what they want. Panem et circenses (bread and circuses) is said to have worked well enough in ancient Rome, but today most people want money in the form of entitlements, tax breaks, make work programs, subsidies, etc.

In a democracy, a politician has two options. He or she can enact policies to transfer assets from a small group of voters to a large group of voters. This will have a net positive effect on election results as the number of receiving a benefit outnumbers the people paying for it.

Stats by Income Quintiles (Dollar values are lower boundary)

The imbalance in US household income

This is happening routinely in all western democracies. In the US, 'rich' households, the 20% making over $93,784, account for 25% of the population, make 50% of the money earned in the US, but pay 73% of the taxes. The data comes from this Bureau of Labor Statistics report.

To be fair, there may be other, more valid reasons to enact such policies besides simply buying votes. For example, a civilized society has some responsibility to care for members who can't take care of themselves. For the purpose of the present discussion, we will leave such considerations aside and focus only on the pressures that inform the decisions of a typical self-interested politician.

The second option is to buy votes on credit by running a budget deficit. This has the enormous benefit that it is unnecessary to render any group of voters seriously unhappy by taking all their money. The politician can buy votes from everybody today, and the payment will not come due until after the politician has retired.

This is how the US political system and other western democracies have worked for the last 60 years or more. Without borrowing ever increasing amounts, the tax rate on the top group in the chart above would be much higher.

It is no surprise that there is virtually no difference between Democrats and Republicans in this context. Both have the same incentives to buy votes on credit. Both distribute the borrowed money to essentially the same large voting pools.

The urge to borrow

It is worth pointing out that the urge to borrow money and give it to those who have a say in the political process is universal. In democracies, the recipients are generally the voting poor, because there are many and their votes are cheapest to buy. Democratic systems run into trouble, when the entitlements overwhelm the state's ability to tax or borrow.

In monarchies or aristocracies, only the the monarch and some aristocrats have a political voice. Consequently they normally concentrate borrowed and earned assets in the hands of those few. Monarchies run into trouble when the peasants get too hungry and revolt or when the state has exhausted its ability to borrow. 

The bank CEOs' bonus (used to) depend on how the bank did in the preceding year. This encouraged them to take big risks with big potential payouts, because they would make out like bandits if it worked, but didn't have to take the consequences if it didn't. New financial regulation may curb this behavior to some extent.

Politicians drive up the deficit to buy votes, because that gets them elected. They too don't have to take the consequences of their actions unless they happen to be unlucky enough to be in office when the sovereign debt crisis strikes.

An ideal constitution would include a mechanism to counter the incentives to buy votes on credit. Without such a mechanism, fiscal irresponsibility is guaranteed. We don't deserve that, but given politicians' incentives to preserve the current system, it is what we will continue to get.

Posted by Martin Gremm

About the author

Marc Schindler, CFP®

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