Jack Lew Complicates Resolution of Fiscal Imbalance, Financial Regulatory Reform
As an aide to President Clinton, Jack Lew argued that fiscal prudence was necessary to protect the long-run solvency of Social Security and Medicare. By running surpluses, Lew argued, the government would pay down existing debt, increase future financial capacity, and be better able to finance the explosion in outlays associated with the retirement of the baby boom generation. The stability of the welfare state was closely associated with fiscal prudence in 2000 when Lew expressed this view. After its financial crisis in the 1990s, Sweden embraced an annual 1% of GDP surplus target largely to ensure the government had the capacity to make good on its promises. To Lew, there seemed to exist a meaningful relationship between the value of the promise and the government’s capacity to meet it.
As President Obama’s budget director and Chief of Staff, Lew seemed to take a much different view. From formally proposing trillion dollar deficits as budget director to presiding over the ridiculous exercise of evaluating the merits of issuing a trillion dollar platinum coin as chief of staff, Lew has forfeited whatever reputation he had for fiscal seriousness. The only real constant from Lew since his time in the Clinton Administration has been a steadfast refusal to consider programmatic changes to the entitlement programs driving current and long-run deficits.
Lew has a toxic nostalgia for the Social Security reforms of 1983, which rescued the system from collapse through a combination of tax increases and benefit cuts. The most salient outcome of the 1983 reforms was the accumulation of a huge “trust fund” due to tax revenue dramatically exceeding benefit outlays between 1990 and 2010. The existence of this enormous trust fund – currently valued at $2.5 trillion, or 16% of GDP – is viewed by many as evidence that the 1983 reforms were designed to “prefund” the baby boomers’ retirement. As explained by Social Security Trustee Charles Blahous, nothing could be further from the truth. The members of the 1983 “Greenspan Commission” simply aimed for system balance over 75 years with no knowledge or intention of having large surpluses followed by deficits (see the quote from Commission staff director Robert Myers on this point). Indeed, if prefunding really were the preferred solution, it would be extremely odd that it would occur through the accumulation of Treasury securities that represent a claim of the government on itself.
Yet, in a 2011 appearance before the Economic Club of Washington, Lew actively embraced the false narrative of 1983:
In 1983, we put Social Security on firm financial footing and it’s one of the things that I’m proudest of in my professional career. I think the challenge is you mix it with deficit reduction and it confuses the issue. There are people who think that Social Security is the cause of our deficit. It’s not the cause of our deficit. Social Security ran a surplus for decades. 1983 worked. The principle of 1983 was have enough income come in so that we can build up reserves and then when the baby boom retires, draw them down.
As an aide to then-Speaker Tip O’Neill, Lew was uniquely positioned to know whether or not prefunding was indeed the Commission’s objective. That is what makes his revisionist history so troubling: uninitiated observers are likely to be inclined to believe his version of events even if they have no basis in the historical record. The “facts on the ground” of huge surpluses have done quite a bit to advance the notion that the trust fund was intentional and Lew’s false reminiscence only bolsters that misimpression.
As Blahous points out, the misimpression is not something of interest solely to academic historians. Lew (and others) manipulates the historical record to create a narrative that the 1983 reforms involved a “societal compact” where the baby boomers would overpay their payroll taxes beyond what was then needed, to pre-fund their own future retirement benefits. This creates the impression that society has a moral responsibility to maintain benefit schedules – no matter how unaffordable for future generations – because future beneficiaries were previously overtaxed to pay for them. The senselessness of trust fund accounting becomes secondary to the ethical case for “honoring” the 1983 compact.
Lew argues that Social Security should be excluded from budget negotiations, with any adjustments taking place on a “parallel” track. Lew argues that the problem is not accelerating costs in Social Security, but rather that the rest of the government borrowed from Social Security so heavily since 1990. But without permitting the Social Security Administration to acquire financial assets, the surpluses would always be loaned to the general fund to pay for unrelated government spending. Senator Pat Moynihan recognized that as soon as surpluses became apparent in the 1990s and tried to cut the payroll tax to levels necessary to fund current outlays. Since the trust fund represents a tally of funds that have been spent rather than saved, Moynihan reasoned it would be senseless to base “solvency” assumptions on the fiction that the trust fund has real economic value. Yet, this history has now been ignored in favor of a false narrative of a “societal compact” aimed at making Social Security benefit schedules untouchable.
While Lew’s nomination is hugely counterproductive on the fiscal front, his lack of experience or interest in financial markets and institutions makes him an odd choice for Treasury Secretary. Aside from three years as an administrator at Citigroup, Lew has spent virtually his entire career in government or the nonprofit sector. While this may seem like a positive, in that Lew’s independence is not obviously tainted by a lifetime working inside of too-big-to-fail institutions, it is not obvious that Lew has any real understanding of how our contemporary financial system works. Indeed, Lew responded to a question about the banking industry’s basic regulatory structure: “I don't consider myself an expert in some of these aspects of the financial industry.”
The U.S. is unusual in that Treasury Secretaries often come from “Wall Street” or the financial community more generally. In other cultures, tabbing a CEO of a “too big to fail” bank as finance minister would be viewed with a great deal of suspicion, as the proverbial rooster would now be tending to the hen house. The goal should not be to appoint a neophyte or dilettante as Treasury Secretary in place of a Wall Street CEO. The hope is that the Treasury Secretary would be someone who actually understands the financial system over which he or she is presiding, just not someone whose former institutions’ liabilities are implicitly backed by taxpayers. Indeed, ignorance about the basic operation and regulatory structure of banks often makes policymakers more dependent on bank lobbyists and executives for information. Described as a Robert Rubin protégé, Lew would almost certainly close any knowledge gap that arises by contacting his former colleague or others predisposed to think the interests of taxpayers and the institutional interests of the largest financial institutions are always and everywhere the same.
Jack Lew is an unfortunate choice for Treasury Secretary. His hard-left policy leanings on entitlements are entirely out-of-step with the current fiscal crisis and his ignorance of finance makes him ill-equipped to deal with a crisis or cross-border banking regulatory reform. It would be difficult to find someone less attuned to the types of reforms necessary to put U.S. public and private finance on sound footing.