- The Washington Times - Thursday, February 27, 2003

WASHINGTON, Feb. 27 (UPI) — The UPI think tank wrap-up is a daily digest covering opinion pieces, reactions to recent news events and position statements released by various think tanks. This is the second of two wrap-ups for Feb. 27.


The Ludwig von Mises Institute

(The LVMI is a research and educational center devoted to classical liberalism — often known as libertarianism — and the Austrian School of economics. LVMI seeks a radical shift in the intellectual climate by promoting the market economy, private property, sound money and peaceful international relations, while opposing government intervention.)

AUBURN, Ala.— Deficits do matter

By Hans Sennholz

In their election oratory politicians usually stress their love of fiscal discipline and balanced budgets. But as soon as they are elected they tend to discover a great number of exceptions that require more funding. President Bush clearly made the election pledge to avoid budget deficits, but, ever since Sept. 11, 2001, his budget proposals built on exceptions project a deficit of more than $300 billion for each of the next few years. Yet, he also argues for prompt tax reduction, which signals a brand-new course of action in the annals of fiscal policy.

The prospect of soaring deficits and simultaneous tax reductions alarms a few economists. On this new fiscal road they foresee deficits of $500 billion or even $600 billion annually, which in time may cast doubt on the credibility of the federal government as debtor.

Every few months the Congressional debt ceiling needs to be lifted by a few hundred billion dollars. Congress last raised it by $450 billion to $6.4 trillion on June 30, 2002; it needs to be lifted right now as the official Treasury debt again has reached the ceiling. At the present rate of spending it will need to be lifted in June or July of this year and, in case of war with Iraq, even earlier.

The federal deficits are compounded by the budget shortfalls of most state governments, estimated at some $105 billion in 1992-93. State governments are required legally to balance their budgets, which forces them either to raise taxes or cut expenditures. Undoubtedly, most prefer to boost their fees and exactions; the proposed federal tax reduction, if and when it finally passes the U.S. Congress, may even compound their problems as many state systems are based on the federal tax structure.

Both deficits, the federal and the state, constitute a heavy burden on the capital market, which keeps no idle savings amounting to hundreds of billions of dollars. They force the Federal Reserve System to come to the rescue; it can print any amount of money and create any volume of credit.

The Fed is the financier of last resort, the ultimate source of funds that enables the federal government to finance any conceivable expenditure and cover any possible deficit. Without the Fed, fiscal deficits of such magnitude would soon depress the American economy and cause serious political repercussions. Its ability to create dollars that enjoy worldwide acceptability enables it to distribute the burden of U.S. government deficits to countless millions of dollar holders all over the globe. They pay for the deficits through depreciation of the dollars in their pockets. Japanese and Chinese, Arabs and Hindus, French and Germans and all others with dollar savings join Americans in bearing the burden of federal deficits.

This ability to place the economic cost of government spending on millions of trusting victims rests on the extraordinary position of the U.S. dollar as the world's primary reserve currency. The dollar acquired this distinction by international agreement reached at Bretton Woods in New Hampshire in 1944, which committed the United States to provide an anchor for world prices by pegging the dollar at $35 per ounce of gold and envisioned a world economy linked by fixed dollar exchange rates.

When the United States suffered chronic gold losses and finally faced inability to make payments in gold, President Nixon severed the dollar's gold link in August 1971, devalued the dollar against major foreign currencies in December 1971, and finally floated it in March 1973. The world has been on a floating dollar standard ever since. It is a fiat standard, unbacked and irredeemable, which can be inflated and depreciated at will. Managed by the Federal Reserve System, it is a useful standard in the financial service of the U.S. government.

Other countries are narrowly limited in their ability to inflate and create credit; if they indulge in expansion rates greater than those of their neighbors and trade partners, they soon face payment difficulties as imports increase and exports decline. They then have to reduce the expansion rates and fall in line with their neighbors and partners.

The Federal Reserve System as the manager of the world dollar standard has no such narrow limits. It can inflate and create credit as long as its expansion does not exceed the worldwide demand for its currency. It may generate trade deficits year after year and aggravate its maladjustments as long as foreign banks and investors hoard the dollars or invest them in American obligations. It is bound to cause worldwide financial upheavals, however, when it depreciates the dollar at excessive rates and thereby inflicts painful losses on those foreign investors.

The floating system based on the U.S. dollar has been a precarious structure ever since its inception. During the 1970s the country suffered the worst inflation in decades. By the end of the decade the inflation rate stood at 13 percent, the Federal Reserve discount rate at 12 percent, and the prime lending rate at 15.75 percent, the highest of the century. The dollar had fallen notably in relation to the currencies of other trading countries and especially to gold.

The 1980s saw some economic recovery but also brought new difficulties and more maladjustments. They led to an explosion of personal, business and government debt, which cast a shadow on the future of the financial structure. Federal government debt soared from approximately $950 billion to nearly $3 trillion. A growing share of this debt was acquired by foreign banks and investors who used the widening imbalance of American imports over exports to invest their earnings in the United States.

The 1990s, finally, seemed to defy all rules of economic behavior. Easy money and credit spurred the most explosive stock market boom in U.S. history, creating enormous speculative wealth and spawning new companies. With financial markets booming, the federal government even reported a budget surplus, borrowing from Social Security trust accounts. The balance-of-payment deficit became a major concern as imports soared and exports stagnated, which further raised the mountain of debt.

Toward the end of the decade, in 1998, the floating dollar standard suffered a number of financial shocks that began in Asia and eventually struck fragile economies around the world. American equity markets continued to surge until 2000 when an economic slowdown became evident also in the United States. In 2001, finally, the American economy slipped into recession for the first time in 10 years. The Federal Reserve immediately cut interest rates, a record 11 times in one year; the U.S. Congress passed a large multi-year tax cut, and the U.S. Treasury even sent out tax rebates to boost consumer spending. Yet, the markets continued to plunge following the terrorist attacks on Sept. 11.

According to various market analyses, foreign investors now own some $7 trillion of U.S. assets, 13 percent of American corporate stock, 35 percent of U.S. Treasury obligations, 23 percent of corporate bonds and 14 percent of ownership in American companies. They obviously do not take kindly to Federal Reserve policies that depreciate the dollar and depress its exchange rate.

Last year alone, European investors in the S&P; 500 lost 38 percent on their property compared to just 24 percent suffered by U.S. investors because of the fall of the dollar versus the euro. Suffering such losses, their interest in American investments is bound to decline. They may even liquidate and withdraw their holdings, which could lead to a crushing stampede to the exits.

We now face a situation that resembles the late 1970s when the world began to abandon the dollar and liquidate American investments. It took two years of Federal Reserve inactivity and 20 percent interest rates to restore foreign confidence and lure foreigner investors and creditors back.

Today, the Fed is doing the opposite; it is making every effort to stimulate the economy by flooding the money market while the U.S. Treasury is accelerating its deficit spending. Both point towards monetary upheavals and deep global recession straight ahead, and both cast a shadow on the future of the floating dollar standard.

(Hans F. Sennholz, emeritus professor of economics at Grove City College, is an adjunct scholar of the Mises Institute.)


The Heritage Foundation

WASHINGTON — State opportunities to provide affordable health coverage under the trade law

By Nina Owcharenko and Edmund Haislmaier

The Trade Adjustment and Assistance Act that was signed into law last year provides health care tax credits for the purchase of insurance for two specific groups of Americans without health coverage: trade-affected workers who lost their jobs and Pension Benefit Guaranty Corporation beneficiaries. The federal health care tax credit will be equal to 65 percent of the health insurance premiums of these individuals and can be applied only to specific types of coverage that states can play a key role in offering.

States that elect to provide health care coverage to these tax credit recipients can choose among a range of approaches and access National Emergency Grants to design and administer the coverage options. The federal grant money provides states with a unique opportunity to explore creative approaches that incorporate greater choice and competition and that build an infrastructure that could accommodate a wider range of residents seeking coverage. All states, regardless of the number of residents who qualify for the health care tax credits, should take advantage of this opportunity.

The TAA Act authorizes the use of the credits for a select group of coverage options. Certain tax credit recipients will have access to COBRA coverage, through which workers can continue their participation in the plan provided by their former employers; the health plan of a spouse's employer; or coverage through an individual policy that was purchased previously. In addition to these options, states may elect to offer other coverage options that would qualify for the tax credit.

Under the TAA Act, states may choose to offer one or several of the following options:

— State-based continuation coverage. Several states have established COBRA-like provisions for employees of firms that have fewer than 20 employees. Under this approach, recipients of the tax credits could apply their credit to this "mini-COBRA" coverage option.

— State high-risk pool. Many states have established high-risk pools for individuals who are difficult to insure. States could choose to allow qualified tax credit recipients to enroll in such a pool and to use their tax credits toward their premium payments. (States that establish and maintain high-risk pools are eligible to receive additional federal funds.)

— State employee health plans. States could elect to open the health plan established for state employees to the TAA tax credit recipients. Since there would be no employer (state) contribution, tax credit recipients would apply their tax credit to the full cost of the policy.

— A plan similar to the state employees' plan. States could elect to design a separate pool for tax credit recipients, providing them with a benefits package that would be similar to that offered to state employees but would be administered separately. The tax credit would then be applied to the cost of the benefits package.

— Other state group-plan arrangements. States could elect to contract with a group health plan, an insurer, an administrator, or an employer to provide coverage for the tax credit recipients. If such an approach included insurers of individual policies, tax credit recipients could have the ability to obtain a plan that is better tailored for their individual needs.

— Purchasing pool. States could design an arrangement through which tax credit recipients could choose from an assortment of competing health plans. This approach could be modeled after the highly successful Federal Employees Health Benefits Program and could easily be expanded to accommodate residents other than the tax credit recipients.

— State-operated health plan. States that administer a health plan with no federal assistance could elect to offer such state-based coverage to tax credit recipients. As with the other approaches, the tax credit recipients would apply their credits to the premium for this insurance and would be responsible for paying any remaining costs.

It is likely that many recipients of the health care tax credit will apply their credits to conventional coverage options such as COBRA coverage or to participating in their spouse's coverage. In addition, states with a qualified high-risk pool could be an attractive option for tax credit recipients with serious, high-cost medical conditions.

Although recipients of the tax credits have the potential to use their credits for a range of options, the TAA Act prohibits recipients from using their credits for the most direct and sensible option: purchasing an individual plan in the private market. Nevertheless, the fact that federal grant money is available to set up the infrastructure to accommodate these recipients gives states an opportunity to think creatively about how to improve existing private health insurance markets and to enhance choice, competition, and portability.

The FEHBP, through which federal employees and Members of Congress can choose from a menu of competing private health care plans, could serve as an ideal model for states. Through such a system, states could allow tax credit recipients to select the health plan that best suits their financial and medical needs, offering them a choice of plans while developing an infrastructure that could be extended to and benefit other populations.

In developing such a system, states should:

— Create a health insurance "service center." This center, which could be either a state or a private entity, would serve as a clearinghouse for a variety of qualified, competing plans from which participating individuals could choose. The service center would enroll individuals in the various plans and would administer an annual open enrollment through which participants could switch coverage. In addition, the center would function as a financial aggregator. It would put in place a system for collecting premiums from multiple sources, matching them with the coverage that had been selected, and transmitting them to carriers.

— Determine a core group of participants. Due to the small population receiving the TAA tax credits, states should consider expanding the participating population beyond tax credit recipients. A beginning point could be to incorporate state employees and their dependents within the system. Participation in the system could also be opened to one or more additional groups such as county and municipal employees, employees of small businesses, the self-employed, families eligible for SCHIP, or some Medicaid recipients.

— Establish rating rules that ensure portability of coverage offered through the service center. The TAA Act already establishes certain requirements regarding the coverage that is provided to tax credit recipients. To promote portability, the model approach should allow anyone with sufficient previous coverage (e.g., 18 months or more) to switch his or her plan once a year during the open season, with payments being adjusted only with regard to the age and geography rate scales of the new plan and without medical underwriting or the exclusion of coverage for preexisting condition.

Furthermore, to encourage eligible individuals to keep continuous coverage and prevent adverse selection, plans participating in the program should be allowed to impose limited rating surcharges and preexisting condition exclusions on individuals who lack continuous coverage.

— Set in place a reinsurance pool mechanism to cope with adverse selection. To address the concerns of possible adverse selection (whereby healthier persons gravitate disproportionately to less expensive plans), the state could establish a nonprofit, self-governing corporation that would be administered and financed by the participating health insurers and would create a pool to which insurers could cede the financial risk of higher-cost individuals without disrupting their continuity in coverage.

States can design an FEHBP-style approach in a variety of ways. For example, a state could create an independent purchasing pool, redesign a state employee health plan, or choose a combination of options. As long as the tax credit recipients were included in the pool, the state could apply for federal grant money to help set up a system that offers coverage options to a variety of participants.

States should seize the opportunity to offer coverage options for their tax credit recipients. While such efforts are intended initially to serve a small and select group, states can take advantage of the opportunity to use federal grants to build an infrastructure that has longer-lasting benefits.

During this legislative session, Congress and the Administration are expected to consider a variety of health care initiatives that will affect the states, including health care tax credits for the uninsured and Medicaid reform. States that capitalize on present opportunities and develop adaptable models, such as the FEHBP model discussed above, will also be better prepared for forthcoming policy initiatives.

(Nina Owcharenko is a health care policy analyst, and Edmund Haislmaier is a visiting research fellow in health care, at The Heritage Foundation.)

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