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Friday, February 2, 2018

Damn the Deficits: Entitlements Advance!

And so, it happened again. A conservative think tank has succumbed to the lure of the egalitarian welfare state. This time it is the Independent Women's Forum that has thrown its weight and clout behind the idea of a federal paid family leave program. Their contribution - which adds to a plethora of more or less radical proposals - skillfully combines the two most problematic features of the paid family leave idea.

Before we get to the details, it is worth noting that IWF is late to the paid leave debate. Other conservative think tanks, like the American Enterprise Institute and the American Action Forum, have been pushing their own versions of this entitlement for well over a year. Yet their contribution does not attempt to explain how their idea stands in relation to the versions already out there.

The omission of the public debate context makes it more difficult for the consumer of public policy research to determine why their idea is better than any other.

Fortunately, the IWF proposal is so weak that this really does not matter. The weakness stems from the combination of two features: economic redistribution and a fiscally heavily under-balanced entitlement. When we combine these two into one spending program, the result is entirely fiscally and economically negative. 

Here is how the IWF program would work. Two prospective parents work and pay Social Security taxes for a period of time. This accumulates benefits through the Social Security system, benefits that - as per the program's current design - they will cash in when they retire. Instead, says the IWF, they would take out a portion of their pension entitlement when they have a child, and for compensation forfeit a proportionate amount of their future pension.

The money they take out when having a baby would be their paid parental leave.

The IWF suggests that for every two weeks of paid parental leave, they would only have to give up one week of pensions in the future. The reason would be the individual income trajectory of taxpayers throughout a lifetime of work. This is a debatable assumption: on the one hand, my own paper on privatization of the Social Security system would affirm their income advancement argument; on the other hand, GDP growth - and thereby growth in personal income - is slower nowadays than it was during the first 60 years of the Social Security system. With slower personal income growth, the equation underlying the IWF's conclusion might change for the worse. 

For now, though, let us assume that their assessment is correct. We will return to its budget consequences in a moment; first, let us explore the meaning of the proposal's economic redistribution feature. 

Benefits paid out to parents will be slanted in favor of low income families (p. 3):
Under this formula, recipients’ Social Security parental benefits would amount to 90 percent of the first $895 of their average indexed earnings to date, 32 percent of earnings between $895 and $5,397, and 15 percent of earnings over $5,397, up to a maximum of $2,788 per month. For example, the program would offer an average-wage worker approximately $1,175 per month in Social Security parental benefits. 
In other words, this is yet another entitlement program that steepens the financial threshold for parents who want to climb the income ladder. It compounds the disincentives of programs such as the Earned Income Tax Credit, food stamps (SNAP) and Medicaid. As I demonstrate in my latest book, The Rise of Big Government: How Egalitarianism Conquered America, the combination of higher income taxes and lost entitlement benefits creates a marginal income tax for a $35,000-income family that is comparable to what one would pay on a $400,000 income. 

This point has shifted somewhat after the Trump tax reform, but the principle still very much applies. In fact, the Trump tax reform steepens the marginal income-tax ladder, reinforcing the existing structure of disincentives.

By making it even more costly to increase one's own income through education, career advancement and entrepreneurship, the IWF advances an egalitarian agenda of economic redistribution. The families who benefit the most from these parental-leave benefits when having their first child, are likely to take the loss of benefits relative their income, into account when considering options that can advance their own income. If the income loss from a raise is too high - both financially in terms of lost benefits and professionally in the form of expanding responsibilities at work - they are likely going to stay at their lower level of income. 

The second feature of the IWF proposal is the the upfront payout of entitlements balanced up by deferred entitlement payouts later in life. This feature, they say, is budget neutral because the individual gives back to the system - forfeits later entitlements - for everything he takes out of it. 

This is undue violence on the term "budget neutral", and here is why. Suppose the women who give birth in any given year are evenly spread between the ages of 20 and 40. Assuming the fathers are of the same age, the median age of having a child is 30. If the median retirement age is 65, it means that there are 35 years between when a parent takes his or her parental-leave entitlement, and when they repay the system with their forfeited pensions. 

During these 35 years there will be more cash going out of the Social Security system, but no more cash going into it. This will only compound the insolvency problems already plaguing Social Security. As we all know, Social Security is a pay-as-you-go system, and any benefits accrued are just IOUs paid for with current cash revenue; benefits being taken out of the system today are funded by taxes paid by today's taxpayers. 

For this reason, unless the IWF is planning on supporting an increase in the Social Security tax, the cash to pay for the parental leave benefits would have to come out of the trust fund. This will in turn deplete the system faster than is already happening. 

When the IWF proposal allows people to cash out their IOUs as parental leave benefits, it exacerbates the federal budget deficit. Some - IWF included - would argue that this is not much to worry about, as the program, by their estimates, would only cost $7 billion per year. However, this argument falls flat to the ground if we make some small adjustments to the program. For example, let us raise the income replacement rate from an estimated 45 percent of average household income, to the 67 percent that the New York paid-leave program will offer when fully expanded. All other things equal, this would raise the cost of the IWF program to $11 billion. 

Let us then expand the number of covered weeks to the median for OECD countries, which - conservatively estimated - would be 20 weeks. Now, all of a sudden, the cost of the program is closing in on $19 billion. 

Then we come to the utilization rate, or take-up rate as it is called in the IWF paper. Here, the IWF suffers from the same conundrum as other conservative think tanks entering egalitarian waters. On the one hand, the IWF wants their program to be good for parents - why else would they propose it - but on the other hand they want to remain fiscally conservative. To prove the schizophrenia of their proposal, the IWF explains (p. 5):
It is true that even if Social Security parental benefits were offered, the take-up rate may be low. California has offered paid parental leave since 2004, and it is estimated that between 25 to 40 percent of eligible women have participated in the program. The take-up rate for this proposal might be even lower, as some new parents might decide that paid parental leave is not worth deferring their Social Security retirement benefits. But even if participation were low, the potential impact of this proposal would still be enormous. Even assuming a take-up rate that is half that of the lowest estimate for California’s program, or 12.5 percent, that would amount to about a million new parents per year who would receive Social Security parental benefits and thus be able to spend invaluable time caring for their new child. 
In other words, slowly but quickly. A few is a lot.

The truth is that once a program like this is in place, Congress has no formal control over how many of the eligible population will use it. They can change the incentives - as is evident from the California example that the IWF discusses - but they can also seriously misinterpret the propensities of parents to use paid leave.

Even more importantly, once the program is in place, it will likely follow the same route as state programs, primarily the just-mentioned California model. There, benefits have been slowly expanding since the program went into effect, predictably expanding the utilization rate. If we place the IWF proposal at the higher utilization rate estimated for California, the cost - that we expanded to $19 billion by making small adjustments - is now at $30 billion per year. This is more than four times the IWF estimate. 

If the utilization rate climbed to the OECD average, the $19 billion quickly become $38 billion. With Scandinavian-level utilization, the cost surges past $55 billion.

But we are not done yet. The New York state paid-leave program allows people to take time off to care for other things than just a newborn baby. Therefore, suppose we added coverage for people to care for a sick child or other relative. We have now opened the door to a cost for this program that would easily run deep into the hundreds of billions of dollars per year.

Are these expansions realistic? Just as a hint: after a couple of expansions, the Canadian paid-leave program currently gives all parents 50 weeks off, with government benefits. The California system has undergone at least two eligibility expansions. The New York program is even rolled out through step-by-step expansion.  

In other words, on the one hand we have a system that is promoting people to stay in low-income jobs; on the other hand we have a structural under-funding that can only be fixed if the economy grows faster and thereby expands tax revenue more quickly. However, the first effect precludes a solution to the second: slower growth - a logical effect of keeping the low-income workforce in their jobs and on current wages - even aggravates the under-funding problem.

To sum up: the IWF proposal for paid family leave advances the egalitarian welfare state, opens a Pandora's box of politically driven add-ons and expansions to the program, and contributes solidly to the federal budget deficit.  

With such friends, we who fight for limited government have no need for progressives and liberals...

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