NCPA-Cigarette Arithmetic, Medicare Fraud, Tax Cuts

National Center for Policy Analysis

POLICY DIGEST

Thursday, June 26, 1997

In Today's News

CIGARETTE ARITHMETIC

The proposed tobacco industry settlement announced last week involves some peculiar economic effects, some analysts point out. While the $368 billion cost is supposed to be paid by cigarette makers, economists expect that smokers will eventually pay the price. And there is considerable evidence that smokers already pay in excise taxes four times more than the additional costs involved in their medical care.

•Studies show that demand for cigarettes is only modestly influenced by price -- with a ten percent price increase reducing sales by far less than ten percent.

•At least two-thirds of the settlement bill will come directly out of smokers' pockets, says Harvard economist Joseph Newhouse.

•Analysts estimate that the cost of a pack of cigarettes -- now $1.80 to $2 -- will rise by between 50 cents and $1.

Studies show that the total lifetime outlays for smokers' medical care are actually not much higher than for non-smokers, totaling about $50 billion annually, but the excise taxes collected from smokers are nearly four times that amount.

However, the arithmetic isn't quite so straightforward: since smokers die earlier than non-smokers, they collect less from Social Security and other pensions.

A Rand Corporation study in the late 1980s estimated that the cost of smoking not paid by smokers themselves came to just 15 cents a pack -- less than federal and state excise taxes. Today the federal excise tax on a pack of cigarettes is 24 cents a pack, with state excise taxes ranging from 2.5 cents in Virginia to 82.5 cents in Washington.

Source: Peter Passell, "Who Will Pay the Tobacco Industry's Huge Bills? Smokers," New York Times, June 26, 1997.

See NCPA's Brief Analysis on Cigarette Taxes and Uninsured Children www.public-policy.org/~ncpa/ba/ba231.html

MEDICARE HELPING FINANCE HOSPITAL TAKEOVERS

The Department of Health and Human Services' inspector general says Medicare is partially responsible to the hospital acquisition binge this decade. Because of an accounting rule, federal programs stand to pay out, in total, $500 million or more to companies that take over financially shaky hospitals.

The inspector general's office wants the payments stopped by Congressional action, saying they are "hard to justify."

•Analysts say acquirers often snap up ailing hospitals at fire-sale prices, frequently putting their finances back into shape in a surprisingly short time.

•According to the inspector general's report, Medicare routinely enters the financial picture with what are known as "depreciation adjustments," if a target hospital is bought at a price different from its book value.

•In an analysis of 317 hospital deals since 1990, payments by Medicare averaged $2.3 million per hospital -- with some payments exceeding $10 million.

•According to the report, Medicare has already paid out a net $223 million in connection with hospital sales, and stands to pay an additional $289 million for transactions now underway.

Further payments are likely for similar adjustments required by the Medicaid program, experts report.

Source: George Anders, "Medicare Has Role in Hospital Takeovers," Wall Street Journal, June 26, 1997.

CUT CRIMINALS IN MEDICARE REFORM, TOO

By addressing fraud and abuse in the Medicare program, no one takes a cut except those who deserve it most -- the criminals.

Treasury Secretary Robert Rubin announced in June 1996 that the Medicare program will go broke by 2001. According to economic forecasts, the program's costs are expanding exponentially:

•Spending for Medicare totaled $160 billion or about $440 million per day in fiscal year 1994.

•Spending will mushroom to $380 billion -- more than $1 billion per day -- by fiscal year 2003, according to Congressional Budget Office (CBO) estimates.

One place to cut costs is fraud control. According to June Gibbs Brown, Health and Human Services Department Inspector General, up to 10 percent of Medicare's budget is lost to fraud -- $17 billion annually.

A few examples of discovered fraud in the Medicare program:

•Ben Carroll of Kissimee, Fla., collected $51 million by charging Medicare $8.45 per "female-urinary-collection device," commonly known as an "adult diaper" and sold for 35 cents each.

•National Medical Enterprises Inc., the nation's largest psychiatric hospital chain, paid the U.S. government the largest settlement ever ($362.7 million) for running a kickback and bribery scam to get patient referrals.

•This conspiracy included more than 50 doctors.

But the biggest culprits are not the individual rackets, but those who uniformly scam the system through double billing. An attorney at the Justice Department estimates about 4,600 hospitals nationwide are engaging in this fraudulent practice.

Lawrence Criner, "Medicare Con Game Lurking Out of View," Washington Times, June 26, 1997.

For more on Medicare go to www.ncpa.org/pi/health/hedex1.html

SEARCHING FOR THE "WEALTH EFFECT"

Economists have been earnestly searching for signs of the wealth effect -- the boost that soaring stock prices are supposed to give to consumer spending. If people's investments are growing rapidly, the theory goes, they can spend more and still meet their savings goals.

Until now, however, researchers have had very little success in finding the wealth effect. If it exists, it shouldn't be hard to find, since equity market values have increased by more than $4 trillion since 1994.

Economists at Salomon Brothers say they now believe proof of the wealth effect has been hidden in flawed Commerce Department economic data.

•They have found a wide gap in Commerce's two measures of gross domestic product -- one of which measures the value of goods and services produced in the U.S. by counting up how much people, firms and the government spend.

•The other measurement of GDP is based on the total amount of money which people, firms and the government get from work, investments, business profits and taxes -- that is, total income.

•Although the two measurements should be equal, the income measurement was $98.2 billion bigger in the first quarter of this year than the product figure.

•The Salomon analysts believe that booming income tax receipts "indicate that the income side measure is more accurate."

After hitting a record $80.5 billion in 1993, the gap -- product minus income -- began to shrink. It turned negative in late 1995, finally reaching the $98.2 billion figure.

So they expect that when the Commerce Department releases revised GDP figures for 1995 and 1996 next month, consumer outlays will be revised markedly upward. That would be the missing wealth effect: consumers on a spree, spending some of those delicious stock market profits.

But if the revised figures fail to show large spending increases, they will vindicate those economists who don't believe consumers run out and buy clothes and luxuries just because their stocks are up.

Source: Perspective, "Buried Treasure?" Investor's Business Daily, June 26, 1997

TAX CREDIT OR ANOTHER WELFARE PROGRAM?

Some tax-policy analysts charge that President Clinton wants to turn the $500-per-child tax credit into another welfare program, so that those too poor to be obligated to pay any taxes at all get a check for $500 anyway.

•Critics of this ploy point out that the budget already includes $1.2 trillion in welfare spending over the next five years.

•That amounts to 14 times the $85 billion Congress is trying to provide in tax relief.

•The tax cut represents less than 1 percent of the total federal tax burden between now and 2002.

•From 2002 to 2007, the tax cut is $165 billion -- or about 1.5 percent of federal revenues during that time.

But from 2007 to 2017, the tax cut will be less than 0.5 percent of national economic output.

Critics of Clinton's tactics are demanding that he resist the temptation to create yet another federal welfare program and give American taxpayers a break for a change.

Source: Sen. Spencer Abraham (R-Mich.), "Tax Cuts for Life," Investor's Business Daily, June 26, 1997.

Fore more on Tax Cuts www.ncpa.org/pi/congress/cong2.html

CLASS WARFARE ON TAX CUTS

The White House has been attacking the Republican tax plan as targeted for the rich (by 73 percent) and Democrats in Congress have accused it of excluding the poor. But a Joint Economic Committee analysis shows Treasury has twisted the statistics to greatly inflate the level of middle-class income to support both these attacks:

•The Office of Tax Analysis at Treasury uses a formula called "Family Economic Income" to redefine middle-class family income.

•The formula includes "potential" income -- though maybe never used -- to compute family income, such as rental value of one's own home, the built-up value of pension benefits, Individual Retirement (IRA) Account balances, employer fringe benefits, etc.

•For example, using this formula, a family earning $50,000 and living in a house with potential monthly rent value of $1,000 would be reported as having total annual income of $62,000 ($50,000 plus 12 x $1,000).

•Though the number of families earning between $50,00 and $70,000 are only 14 million, the formula jumps the number to 17.3 million by including these additional potential sources of revenue.

Donald Lambro, "Keeping an Eye on Total Tax Burdens," Washington Times, June 26, 1997.

For more from the Joint Economic Committee on this topic go to www.house.gov/jec/press/06-19-7.htm

In Other News

MORE WELFARE IN DEMOCRATS' TAX CUT PLAN

One of the major issues in the tax bill being considered by Congress is whether those who pay no taxes should still get a tax cut. Democrats say yes, Republicans say no. The outcome could determine whether anyone gets a tax cut this year.

It may sound like a trick question, but in fact millions of Americans with no income tax liability already get a "tax cut" through the Earned Income Tax Credit (EITC). The EITC gives low-income workers a credit against their taxes of up to $3,556. However, if their actual income tax liability is less than this, they get a refund of the difference. Thus if a worker qualifies for $2,000 in EITC but only owes $800 in taxes, she gets a check from the Treasury for $1,200.

This year the EITC is expected to cost the federal government $26 billion. Of this amount only $3.6 billion actually offset peoples' tax liability. The rest, $22.4 billion, will be "refunded" to taxpayers who have no tax liability and get a check from the government instead.

In other words, although it is a provision of the tax law, the EITC essentially is a welfare spending program.

Although it is in fact a spending program, the EITC is important for tax policy because it allows politicians to say they are cutting taxes for the poor even though they pay no taxes.

Now Democrats are in effect trying to expand the EITC so that even more people will get government checks from the program. The way they propose to do this is by saying that taxpayers will be allowed to use the proposed child credit before calculating the EITC.

•Under the Republican tax bill, all families with children would receive a credit against their income taxes of up to $500 per child; however, the credit would not be refundable.

•Families owing no taxes due to the EITC or other tax provisions would not be able to use the credit because they have no liability to offset.

•Under the Democrats' plan, if a family uses the child credit to eliminate their income tax liability before calculating the EITC, they will get a larger EITC check from the government.

This arcane debate is being fought through the use of distributional tables. These tables purport to show the effects of the tax bill on families with different incomes. Since those with low incomes pay no income taxes to begin with, the only way they can get a tax cut is by making it refundable. That is why the Democrats appear to offer a bigger tax cut to those with low incomes.

Republicans respond that expanding the number of people getting a check from the government is no way to conduct tax policy. They are right. But the bigger problem is the obsession with the distributional effects of tax legislation, to the exclusion of all other considerations. Sound principles of tax policy are being cast aside, the impact of taxes on the economy is getting short shrift, and the tax code is being made even more complex just to make the tables look right.

For these and other reasons, some tax theorists are saying that distribution tables should be abandoned altogether. Professor Michael Graetz of the Yale Law School is the strongest proponent of this view. Writing in the April 1995 Columbia Law Review, Graetz attacks the distribution tables as imprecise, inaccurate, misleading and dangerous.

He concludes that "the information transmitted to policymakers through the current practice of producing distributional tables is simply bad information."

The debate over tax cuts for those who pay no taxes is further evidence that Graetz may be right.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, June 25, 1997.

WATTENBERG'S SOCIAL SECURITY SOLUTION: MORE PEOPLE

The American Enterprise Institute's Ben J. Wattenberg is proposing two ways to prop up the ailing Social Security system. Both stem from the fact that fewer and fewer workers are going to be around to support benefit payments to more and more retirees as the baby boom generation ages. This "dependency ratio" has been shrinking from nearly nine workers supporting each retiree in 1955 to only 3.3 workers per retiree today.

By 2035 there will only be 2 workers paying Social Security taxes to hand over to 1 retiree.

Wattenberg says this trend could be reversed if (1) people had more babies, and (2) we opened the door to more immigrants -- letting them help pay the bills.

•He proposes helping to raise American fertility rates by raising the $500-per-child tax credit to $1,500 or $5,000.

•He cites statistics from the Urban Institute which show that if the standard dependent exemption had kept pace with income and inflation growth since 1940, it would be worth $10,042 today.

•If the fertility rate just went up to the 2.1 child replacement rate, that would knock 14 percent off the Social Security Administration's 75-year shortfall -- or $700 billion.

Then there is the "immigration solution."

•The median age of a legal immigrant to the U.S. is 28. •They typically pay into Social Security and Medicare for about 40 years before drawing on them.

•The typical immigrant pays $80,000 more in taxes than he or she receives over the course of a lifetime -- but $198,000 more among those with at least a high school education.

Wattenberg admits that any plan to increase legal immigration would not succeed politically unless it also included a measure to clamp down on illegal entries. He envisions millions of legal, educated immigrants coming into the American workforce and contributing their Social Security withholdings to America's retirement-fund pot.

Source: Ben J. Wattenberg, "The Easy Solution to the Social Security Crisis," New York Times , June 22, 1997.

For more on Social Security go to www.ncpa.org/pi/congress/cong5.html

HOW SIGNIFICANT ARE THOSE TAX CUTS?

Not very, according to a number of tax analysts. Here are some comparisons which make the $85 billion in cuts, spread over five years, look pretty puny.

•Without any economic growth at all, U.S. gross domestic product over the next five years will amount to $40 trillion -- with the tax cut amounting to only 0.2 percent of that figure.

•Factoring in the $71 billion involved in the $500-per-child tax credit, taxpayers in the 15 percent bracket would see their taxes fall to only 14.7 percent; those in the 28 percent bracket, to 27.5 percent; and those in the 39.6 category, to 38.8 percent.

•The $3 billion reduction in estate taxes over five years amounts to only 5 percent of estate tax revenues.

Some tax analysts call the cuts statistically insignificant and are urging the GOP to make substantial cuts or forget the whole thing. They call the tax package so inconsequential as to not be worth the effort.

Source: Paul Craig Roberts (Institute for Political Economy), "The GOP Should Pass a Real Tax Bill -- Or None At All," Business Week, June 30, 1997.