Ten Key Elements of Economics

by James Gwartney, Richard L. Stroup, and Dwight R. Lee

1. Incentives Matter.

All of economics rests on one simple principle: that incentives matter. Altering incentives, the costs and benefits of making specific decisions, alters people’s behavior.

Understanding incentives is an extremely powerful tool for understanding why people do the things they do because the impact of incentives can be seen on almost every level, from simple family decision making to securities markets and international trade.

In fact, markets themselves work because both buyers and sellers change their behavior when incentives change. If buyers want to purchase more of something than sellers are able or willing to provide, its price will start to rise. As the price increases, however, sellers will be more willing to provide the good or service. Eventually, the higher price will bring the amount demanded and the amount supplied into balance.

2. There Is No Such Thing as a Free Lunch.

The reality of life on our planet is that productive resources are limited, while the human desire for goods and services is virtually unlimited. Would you like to have some new clothes, a luxury boat, or a vacation in the Swiss Alps? Most of us would like to have all of these things and many others! However, we are constrained by the scarcity of resources, including a limited availability of time.

Because we cannot have as much of everything as we would like, we are forced to choose among alternatives. But using resources—time, talent, and objects, both man-made and natural—to accomplish one thing reduces their availability for others. One of the favorite sayings of economists is, “There is no such thing as a free lunch.”

Of course, a good can be provided free to an individual or group if others foot the bill. But this merely shifts the costs; it does not reduce them. Politicians often speak of “free education,” “free medical care,” or “free housing.” This terminology is deceptive. These things are not free. Scarce resources are required to produce each of them. Governments may be able to shift costs, but they cannot avoid them.

3. Decisions Are Made at the Margins.

If we want to get the most out of our resources, we should undertake actions that generate more benefits than costs and refrain from actions that are more costly than they are worth. For example, a family that wants to purchase a home will save for a down payment by working long hours to earn money and by spending less on entertainment and eating out. High school students who want to go to college will spend more time studying and devote less time to video games than they would if they didn’t care about college. This weighing of costs and benefits is essential for individuals, businesses, and for society as a whole.

Nearly all decisions are made at the margin. That means that they almost always involve additions to, or subtractions from, current conditions, rather than an “all-or-nothing” decisions. The word “additional” is a substitute for “marginal.” We might ask, “what is the marginal (or additional) cost of producing or purchasing one more unit?” Marginal decisions may involve large or small changes. The “one more unit” could be a new shirt, a new house, a new factory, or even an expenditure of time, as in the case of a high school student choosing among various activities. All these decisions are marginal because they involve additional costs and additional benefits.

4. Trade Promotes Economic Progress.

The foundation of trade is mutual gain. People agree to an exchange because they expect it to improve their well-being. The motivation for trade is summed up in the statement: “If you do something good for me, I will do something good for you.” Trade is productive because it permits each of the trading partners to get more of what he or she wants. There are three major sources of gains from trade.

First, trade moves goods from people who value them less to people who value them more. Second, trade makes larger outputs and consumption levels possible because it allows each of us to specialize more fully in the things that we do best. Third, voluntary exchange makes it possible for firms to achieve lower per-unit costs by adopting mass production methods.

It is difficult to exaggerate the importance of trade in our modern world. Trade makes it possible for most of us to consume a bundle of goods far beyond what we would be able to produce for ourselves. Can you imagine the difficulty involved in producing your own housing, clothing, and food, to say nothing of radios, television sets, dishwashers, automobiles, and telephones?

5. Transaction Costs Are an Obstacle to Trade.

Voluntary exchange promotes cooperation and helps us get more of what we want. However, trade itself is costly. It takes time, effort, and other resources to search out potential trading partners, negotiate trades, and close the sale. Resources spent in this way are called transaction costs, and they are an obstacle to the creation of wealth. They limit both our productive capacity and the realization of gains from mutually advantageous trades.

Transaction costs are sometimes high because of physical obstacles, such as oceans, rivers, and mountains, which make it difficult to get products to customers. In other instances, transaction costs are high because of the lack of information. Frequently transaction costs are high because of political obstacles, such as taxes, licensing requirements, government regulations, price controls, tariffs, or quotas.

People who help others arrange trades and make better choices reduce transaction costs and promote economic progress. Such specialists, sometimes called middlemen, include campus bookstores, real estate agents, stockbrokers, automobile dealers, publishers of classified ads, and a wide variety of merchants.

6. Profits Direct Businesses Toward Activities that Increase Wealth.

The people of a nation will be better off if their resources—their land, their buildings, their people—produce valuable goods and services. At any given time, a virtually unlimited number of potential investment projects are under consideration. Some of these investments will increase the value of resources by transforming them into goods and services that increase the satisfaction of consumers. These will promote economic progress. Other investments will reduce the value of resources and reduce economic progress. If we are going to get the most out of the available resources, projects that increase value must be encouraged, while those that use resources less productively must be discouraged.

This is precisely what profits and losses do. Business firms purchase resources (raw materials, intermediate goods, engineering, and secretarial services, etc.) and use them to produce goods or services that are sold to consumers. If the sales of the products exceed the costs of all the resources required to produce them, then these firms will make a profit. This means that profits result only if firms produce goods and services that consumers value more than the cost of the resources required for their production.

The value of a product to the consumer is measured by the price the consumer is willing to pay. If the consumer pays more than the production costs, then the decision by the producer to bid the resources away from their alternative uses was a profitable one. Profit is a reward for transforming resources into something of greater value.

In contrast, losses are a penalty imposed on businesses that use up resources without converting them into something more valuable. The losses indicate that the resources would have been better used producing other things.

7. People Earn Income by Helping Others.

People differ in many ways—in their productive abilities, their preferences, their opportunities, their specialized skills, their willingness to take risks, and their luck. These differences influence people’s incomes because they affect the value of the good and services that individuals are able or willing to provide to others.

People who earn large incomes do so because they provide others with lots of things that they value. If these individuals did not provide valuable goods or services, consumers would not pay them so generously. There is a moral here: if you want to earn a large income, you had better figure out how to help others a great deal. The opposite is also true. If you are unable or unwilling to help others, your income will be small.

8. Economic Progress Comes Primarily Through Trade, Investment, Betters Ways of Doing Things, and Sound Economic Institutions.

First, investments in productive assets (tools and machines, for example) and in the skills of workers (investment in “human capital”) enhance our ability to produce goods and services. Second, improvements in technology (the use of brain power to discover new products and less costly methods of production) spur economic progress. Third, improvements in economic organization can promote growth.

Investment and improvements in technology do not just happen. They reflect the actions of entrepreneurs, people who take risks in the hope of profit. No one knows what the next innovative breakthrough will be or just which production techniques will reduce costs. Furthermore, entrepreneurial genius is found in unexpected places. Thus, economic progress depends on a system that allows a very diverse set of people to try their ideas to see if they will pass the market test but also discourages them from squandering resources on unproductive projects.

9. The “Invisible Hand” of Market Prices Directs Buyers and Sellers Toward Activities that Promote the General Welfare.

As Adam Smith noted, the remarkable thing about an economy based on private property is that self-interest will further the general prosperity of a community or nation. The individual “intends only his own gain” but he is directed by the “invisible hand” of market prices to promote the goals of others, leading to greater prosperity.

The principle of the “invisible hand” is difficult for many people to grasp. There is a natural tendency to associate order in a society with centralized planning. Yet Adam Smith contends that pursuing one’s own advantage creates an orderly society in which demands are routinely satisfied without a central plan.

This order occurs because market prices coordinate the actions of self-interested individuals when private property and freedom of exchange are present. One statistic—the market price of a particular good or service—provides buyers and sellers with what they need to know to bring their actions into harmony with the actions and preferences of others. Market prices register the choices of millions of consumers, producers, and resource suppliers. They reflect information about consumer preferences, costs, and matters related to timing, location and circumstances that are well beyond the comprehension of any individual or central-planning authority.

The invisible hand works so quietly and automatically that the order, cooperation, and vast array of goods available to modern consumers are taken for granted.

10. Too Often, Long-Term Consequences, or the Secondary Effects, of an Action Are Ignored.

Especially in politics there is a tendency to stress the short-term benefits of a policy while completely ignoring its longer-term consequences. In politics we hear an endless pleading for proposals to help specific industries, regions, or groups without consideration given to the impact on the broader community, including taxpayers and consumers.

Much of this is deliberate. When seeking political favors, interest groups and their hired representatives, lobbyists, have an incentive to put the best spin on their case. They will exaggerate the benefits (most of which they will capture if the policy is enacted) and minimize the costs (most of which will be borne by others). Such interest groups are most effective if the benefits are immediate and easily visible to the voter, but the costs are less visible and mostly in the future. Under these conditions, interest groups can often mislead voters.

Consider the case of rent controls imposed on apartments, usually in response to claims that rent controls will keep rents from rising and make housing more affordable for the poor.

Yes, this is true in the short run, but there will be secondary effects. First, the market for apartments will stagnate. Existing apartments will not be transferred to those who want them most. It will be expensive for someone to give up a rent-controlled apartment, even if another apartment is closer to work, and it will be hard to find a closer one because others are holding onto theirs at the below-market rent.


This article is excerpted from Common Sense Economics: What Everyone Should Know About Wealth and Prosperity, by James Gwartney, Richard L. Stroup, and Dwight R. Lee. Copyright ©2005 by the authors. Reprinted with permission from St. Martin’s Press, LLC. 

Government-Controlled Investment: The Wrong Answer to the Wrong Question

by Daniel J. Mitchell

SOME ARGUE THAT PERSONAL RETIREMENT ACCOUNTS would be a mistake and that the government instead should set up its own investment fund to help finance future benefit payments. The good news is that this indicates a growing awareness that “pre-funding” (i.e., accumulating assets) is a necessary component of Social Security reform.

The bad news, however, is that government-controlled investment is the wrong answer to the wrong question. It assumes that policymakers should focus solely on balancing the program’s revenues and expenditures. This ignores the other Social Security crisis—the fact that the tax burden on today’s workers is extraordinarily high compared to the benefits received (often referred to as the rate-of-return crisis).

But even if balancing Social Security’s long-term finances were the only goal, government-controlled investment would be the wrong answer. This is because a government-controlled pension fund would not face the competitive pressure and legal obligation to make investments solely for the economic benefit of future retirees. As Nicole Gelinas in the Winter 2005 issue of City Journal has explained:

[U]nlike a private fund manager, who only wants to see the value of his investment rise and who will sell it if he loses confidence in the company or its managers, highly political public pension trustees are free to pursue political as well as economic objectives.

Giving the federal government that power and control would create large risks for the economy and for the retirement security of today’s workers. The Congressional Budget Office warned, in a 2003 paper, “Acquiring Financial Assets to Fund Future Entitlements”: Government ownership of stocks could affect corporate decision making, interfere with the nation’s competitive market system, and impede the operation of financial markets—potentially limiting economic growth.

For example, evidence at the state and local levels with public employee pension funds—as well as evidence from similar arrangements in other nations—demonstrates that politicians and their appointees often are tempted to steer the government-controlled pot of money toward special interests, political allies, or corporate contributors.

In addition, even well-intentioned policymakers are not qualified to invest funds and manage money. Simply stated, they do not face the bottom-line pressures that force private businesses and investors to allocate resources wisely. Yet poor investment decisions have serious consequences. Most important, workers would earn lower returns on their money, and even small differences in rates of return translate into less retirement income.

It certainly would be difficult for workers to wind up with less than they are promised currently from Social Security. Nonetheless, it would be a mistake to enact a policy—such as government-controlled investment—that offers less in return and risks more. Federal Reserve Board Chairman Alan Greenspan has testified before Congress that such approaches “would arguably put at risk the efficiency of our capital markets and thus, our economy.”

The Risks of Politically Driven Investment Politics

The Social Security system is actuarially bankrupt and will not be able to meet its future obligations. Over the next 75 years, the program will face a cash shortfall of $27 trillion. If no changes are made in the program’s design, bringing Social Security into balance will require a monumental policy change: a 50 percent–plus increase in payroll tax rates, a 33 percent reduction in benefits, a big hike in the retirement age, or a combination of these three possibilities.

These choices are economically risky and politically unpopular. Moreover, tax increases and benefit reductions would serve only to exacerbate Social Security’s other crisis—its poor rate of return—and make it an even worse deal for American workers. Many younger workers today already face negative returns from the taxes they pay into the Social Security system, after adjusting for inflation. Forcing them to pay more to receive even less hardly represents fair and compassionate public policy. On the other hand, policies that would increase the current system’s rate of return, such as reductions in the tax rate and increases in benefits, would drive the system into bankruptcy even sooner.

Faced with this Catch–22 dilemma, many Washington policymakers are considering a shift from the current “pay-as-you-go” program to a pre-funded system. For example, all 13 members of the 1994–1996 Advisory Council on Social Security endorsed some form of investment in private assets as a way to address the program’s long-term unfunded liability.

An important debate is occurring, however, over how best to tap the benefits of private investment. Opponents of reform argue against personal accounts and assert that the current Old Age and Survivors Insurance program can be salvaged by allowing politicians and their appointees to invest excess Social Security payroll tax revenues. This is the option supported, for instance, by the AARP.

There are, however, four broad concerns about such government-controlled investment proposals.

Concern #1: Government-controlled investment would mean the partial nationalization of major businesses, which would allow politicians direct involvement in the economy.

Under a system of government-controlled investment, the government would be able to purchase a significant percentage of publicly traded companies. Once it had become a dominant shareholder, the government could use its power to insist, for example, that a company place politicians on its board of directors. Even if politicians were not placed in positions of direct power, they could use their voting power to impose control. And when politicians control business decisions, political incentives become more important than economic ones. Invariably, this leads to less prosperity.

Consider the experience of other countries. Much of Western Europe suffers from stagnation and high rates of unemployment. High tax rates and excessive welfare benefits certainly deserve part of the blame, but the widespread direct and indirect state control of business has had severe consequences too.

Concern #2: Government-controlled investment invites crony capitalism—industrial policy that allows politicians to control the economy indirectly by attempting to pick winners and losers.

The managers of private pension funds are legally obligated to make investments that are in the best interest of workers. In other words, they must try to get the highest possible return, adjusted for risk. Would such a standard apply under a system of government-controlled investment, and could it even be enforced? This is a significant concern because legislators sometimes believe that the marketplace is not producing the right results; they try to help or punish certain industries or companies through spending programs, tax breaks, and regulatory exemptions. They also can do this by providing special access to capital—another risk that would arise if politicians controlled how retirement funds were invested.

The downturn in Asia during the 1990s illustrates the danger of this approach. Decades of industrial policy, or crony capitalism, left these countries with debt-laden banking systems, inefficient industries, and companies that cannot compete.

Concern #3: Government-controlled investment opens the door to corruption by allowing politicians to steer funds toward well-connected interest groups or corporate contributors.

Politicians frequently use the levers of power to counteract markets by steering resources in certain directions. These same levers of power could be used for more narrow political purposes as politicians provide favors or steer resources to constituents and allies. A large pot of government-controlled money would create the opportunity to divert money to satisfy the demands of special interests. This is what has happened in many countries in the less-developed world.

Advocates of government-controlled investment argue that U.S. political institutions are too transparent to allow blatant corruption to exist. This is a fair response, but there is an ill-defined boundary between special-interest investing for purposes of industrial policy and special-interest investing that is done in exchange for campaign contributions and political support.

Concern #4: Government-controlled investment invites “politically correct” decisions at the expense of retirees because politicians could forgo sound investments in unpopular industries (such as tobacco) to steer money toward feel-good causes that are likely to lose money.

When operating private pre-funded systems, fund managers pick well-balanced portfolios designed to maximize long-term returns. This is a legal requirement, largely because it is the best way to ensure that workers will have a comfortable and secure retirement. Fund managers may or may not approve of the goods and services produced by the companies in which they invest, but their fiduciary responsibility is clear: They must invest with the workers’ interests in mind.

Regrettably, it is not clear that managers in a system of government-controlled investment would have the same incentives. Politicians routinely go after certain industries and/or companies, and withdrawing investment funds would be one way to show their displeasure. Conversely, some causes are politically popular. Allocating investments to these ventures, even if they are expected to lose money, could be advantageous for politicians.

Conclusion

Some proponents of government-controlled investing assert that the Thrift Savings Plan for federal employees is a model for Social Security. This is true, but only if workers are given personal retirement accounts. As the Congressional Budget Office explains:

A crucial feature of the TSP is that its assets are owned by federal workers, not the government. The board that oversees the program has a fiduciary responsibility to manage those assets for the sole benefit of the owners of the individual accounts.

The AARP and other interests want the opposite: to have the government make private investments in order to increase government’s control of national economic output. This would be the wrong approach. It would not help workers get a better deal from Social Security, but it would open the door for political mismanagement and intervention in America’s capital markets.


Daniel J. Mitchell is McKenna Senior Fellow in Political Economy in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

How Washington Will Spend Your Taxes In 2005

by Brian M. Riedl

THE APRIL 15 TAX DEADLINE provides taxpayers the opportunity to examine how their elected officials will spend their hard-earned tax dollars.

Washington will spend $22,039 per household in 2005—the highest inflation-adjusted total since World War II, and $4,000 more than in 2001. The federal government will collect $18,248 per household in taxes. The remaining $3,791 represents the budget deficit per household, which, along with all prior government debt, will be dumped in the laps of our children.

Here’s a breakdown of how Washington will spend that $22,039 per household:

Social Security/Medicare: $7,245. The 15.3 percent payroll tax, split evenly between the employer and employee, covers most of these costs. This system can remain sustainable only if there are enough workers to support all retirees, which is why it risks collapsing under the weight of 77 million retiring baby boomers. If nothing is done, taxes will need to be raised by the current equivalent of $5,200 per household by 2030 and $13,500 per household in 2050 to pay all promised benefits. The unpredictable costs of the new Medicare drug entitlement could add thousands more to each household’s tax bill.

Defense: $4,451. The defense budget covers everything from military salaries to operations in Iraq and Afghanistan to the research, development and acquisition of new technologies. Lawmakers drastically reduced defense spending following the collapse of communism in the early 1990s. The 9/11 attacks reversed this trend, and the $1,500 per household increase since 2001 has returned defense spending to its historical levels.

Low-Income Programs: $3,559. Nearly half of this spending subsidizes state Medicaid programs that provide health services to poor families. In line with economy-wide health-care trends, Medicaid costs are rising 9 percent per year. Other low-income spending includes: Temporary Assistance for Needy Families (TANF), food stamps, housing subsidies, child-care subsidies, Supplemental Security Income (SSI) and low-income tax credits.

Interest on the Federal Debt: $1,582. The federal government is $8 trillion in debt. It owes $4.7 trillion to public bond owners, and the rest to other federal agencies (mostly to repay the Social Security trust fund, which lawmakers raid annually). Record-low interest rates have reduced the interest payments by $1,000 per household since 1998. As interest rates rise back to normal levels, so will these costs to taxpayers.

Federal Employee Retirement Benefits: $838. This spending funds the retirement and disability benefits of federal employees, including the military. Interest from federal trust funds covers part of this spending.

Education: $627. Primarily a state and local function, 9 percent of education spending comes from Washington. Federal education spending has surged 100 percent since the 2001 enactment of the No Child Left Behind Act. Most federal dollars are spent on lowincome school districts, special education and college student financial aid.

Health Research/Regulation: $614. Health research spending has doubled since 1999, and nearly all of that growth has been concentrated in the National Institute of Health. This category includes the Food and Drug Administration and dozens of grant programs for health providers.

Veterans’ Benefits: $606. The federal government provides income and health benefits to war veterans. Spending is up 51 percent since 2001.

Highways/Mass Transit: $388. Most highway and mass-transit spending is financed by the 18.4 cent per-gallon federal gas tax. Washington subtracts an administrative cost and sends this money back to the states with numerous strings attached. Some economists suggest it would be more efficient to let states collect this tax and decide how to spend the money themselves.

Justice Administration: $361. Justice spending includes federal attorneys and prisons, as well as law enforcement grant programs. New homeland security costs have added $80 per household to justice spending.

Unemployment Benefits: $338. Unemployment costs fluctuate based on the number of unemployed Americans. Recent costs have ranged between $220 per household in 2000 and $526 per household in 2003. This year, unemployment costs are decreasing as job growth continues.

International Affairs: $284. This includes foreign economic and military assistance, operation of American embassies abroad, and contributions to organizations such as the United Nations. International spending has doubled since 9/11.

Natural Resources/Environment: $275. This includes national parks, federal lands, water projects and environmental clean-up.

Agriculture: $271. Despite rhetoric about supporting small family farms, the vast majority of farm subsidies are distributed to large farms with average household incomes over $135,000.

The programs listed above cover $21,441 per household. The remaining $598 is allocated to all other federal programs, including social services, space exploration, air transportation and community development.

Taxpayers must decide for themselves if they’re getting their money’s worth.


Brian Riedl is Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

Top 10 Examples of Government Waste

by Brian M. Riedl

PRESIDENT GEORGE W. BUSH HAS PROPOSED terminating or strongly reducing the budgets of over 150 inefficient or ineffective programs. This is a step in the right direction to pare back the runaway spending that has pushed the budget deficit over $400 billion. In less than three years, the first baby boomers will begin to collect Social Security. Lawmakers must therefore begin to reduce spending now to make room for the massive Social Security and Medicare costs that will follow.

The first place to trim runaway federal spending is in waste, fraud, and abuse. A real war on government waste could easily save over $100 billion annually without harming the legitimate operations and benefits of government programs. As a first step, lawmakers should address the 10 following examples of egregious waste.

1. The Missing $25 Billion

Buried in the Department of the Treasury’s 2003 Financial Report of the United States Government is a short section titled “Unreconciled Transactions Affecting the Change in Net Position,” which explains that these unreconciled transactions totaled $24.5 billion in 2003.

The unreconciled transactions are funds for which auditors cannot account: The government knows that $25 billion was spent by someone, somewhere, on something, but auditors do not know who spent it, where it was spent, or on what it was spent. Blaming these unreconciled transactions on the failure of federal agencies to report their expenditures adequately, the Treasury report concludes that locating the money is “a priority.”

The unreconciled $25 billion could have funded the entire Department of Justice for an entire year.

2. Unused Flight Tickets Totaling $100 Million

A recent audit revealed that between 1997 and 2003, the Defense Department purchased and then left unused approximately 270,000 commercial airline tickets at a total cost of $100 million. Even worse, the Pentagon never bothered to get a refund for these fully refundable tickets. The GAO blamed a system that relied on department personnel to notify the travel office when purchased tickets went unused.

Auditors also found 27,000 transactions between 2001 and 2002 in which the Pentagon paid twice for the same ticket. The department would purchase the ticket directly and then inexplicably reimburse the employee for the cost of the ticket. (In one case, an employee who allegedly made seven false claims for airline tickets professed not to have noticed that $9,700 was deposited into his/her account). These additional transactions cost taxpayers $8 million.

This $108 million could have purchased seven Blackhawk helicopters, 17 M1 Abrams tanks, or a large supply of additional body armor for U.S. troops in Afghanistan and Iraq.

3. Embezzled Funds at the Department of Agriculture

Federal employee credit card programs were designed to save money. Rather than weaving through a lengthy procurement process to acquire basic supplies, federal employees could purchase job-related products with credit cards that would be paid by their agency. What began as a smart way to streamline government has since been corrupted by some federal employees who have abused the public trust.

A recent audit revealed that employees of the Department of Agriculture (USDA) diverted millions of dollars to personal purchases through their government-issued credit cards. Sampling 300 employees’ purchases over six months, investigators estimated that 15 percent abused their government credit cards at a cost of $5.8 million. Taxpayer-funded purchases included Ozzy Osbourne concert tickets, tattoos, lingerie, bartender school tuition, car payments, and cash advances.

The USDA has pledged a thorough investigation, but it will have a huge task: 55,000 USDA credit cards are in circulation, including 1,549 that are still held by people who no longer work at the USDA.

4. Credit Card Abuse at the Department of Defense

The Defense Department has uncovered its own credit card scandal. Over one recent 18-month period, Air Force and Navy personnel used government-funded credit cards to charge at least $102,400 for admission to entertainment events, $48,250 for gambling, $69,300 for cruises, and $73,950 for exotic dance clubs and prostitutes.

5. Medicare Overspending

Medicare wastes more money than any other federal program, yet its strong public support leaves lawmakers hesitant to address program efficiencies, which cost taxpayers and Medicare recipients billions of dollars annually.

For example, Medicare pays as much as eight times what other federal agencies pay for the same drugs and medical supplies. The Department of Health and Human Services (HHS) recently compared the prices paid by Medicare and the Department of Veterans Affairs (VA) health care program for 16 types of medical equipment and supplies. The evidence showed that Medicare paid an average of more than double what the VA paid for the same items. The largest difference was for saline solution, with Medicare paying $8.26 per liter compared to the $1.02 paid by the VA.

Medicare also overpays for drugs. In 2000, Medicare’s payments for 24 leading drugs were $1.9 billion higher than they would have been under the prices paid by the VA or other federal agencies.

Nor are inflated prices for drugs and supplies the most expensive examples of Medicare’s inefficiencies. Basic payment errors—the results of deliberate fraud and administrative errors—cost $12.3 billion annually. As much as $7 billion owed to the program has gone uncollected or has been written off.

Putting it all together, Medicare reform could save taxpayers and program beneficiaries $20 billion to $30 billion annually without reducing benefits. That would be enough to fund a $3,000 refundable health care tax credit for nearly 10 million uninsured lowincome households.

6. Funding Fictitious Colleges and Students

In 2002, the Department of Education received an application to certify the student loan participation of the Y’Hica Institute in London, England. After approving the certification, the department received and approved student loan applications from three Y’Hica students and disbursed $55,000.

The Education Department administrators overlooked one problem: Neither the Y’Hica Institute nor the three students who received the $55,000 existed. The fictitious college and students were created (on paper) by congressional investigators to test the Department of Education’s verification procedures. All of the documents were faked, right down to naming one of the fictional loan student applicants “Susan M. Collins,” after the Senator requesting the investigation.

Tracking students across federal programs, verifying loan application data with IRS income data, and implementing controls to prevent the disbursement of loans to fraudulent applicants could save taxpayers billions of dollars.

7. Manipulating Data to Encourage Spending

The Army Corps of Engineers spends $5 billion annually constructing dams and other water projects. Yet, in a massive conflict of interest, it is also charged with evaluating the science and economics of each proposed water project. The Corps’ “strategic vision” calls on managers to increase their budgets as rapidly as possible, which requires approving as many proposed projects as possible. Consequently, the Corps has repeatedly been accused of deliberately manipulating its economic studies to justify unworthy projects.

Investigations by the GAO, The Washington Post, and several private organizations have found that Corps studies routinely contain dozens of basic arithmetic errors, computer errors, and ridiculous economic assumptions that artificially inflate the benefits of water projects by as much as 300 percent. In one case, a study’s authors inflated a project’s benefits by using a 2.5 percent interest rate that dated back to 1954. In many cases in which the Corps calculated that a project would be a net benefit, arithmetic corrections revealed that the costs would be many times greater than the benefits. By that point, of course, the unnecessary and wasteful project is often underway and cannot be stopped.

8. State Abuse of Medicaid Funding Formulas

Significant waste, fraud, and abuse pervade Medicaid, which provides health services to 44 million low-income Americans. While states run their own Medicaid programs, the federal government reimburses an average of 57 percent of each state’s costs.

This system gives states an incentive to over-report their Medicaid expenditures in order to receive larger federal reimbursements. Not surprisingly, the GAO has identified state schemes that shift money between state accounts to create an illusion of higher Medicaid expenditures. Similarly, some states have spent their federal Medicaid dollars on non-Medicaid purposes. Tight state budgets like those experienced by most states today have increased the pressure to use such deceptive tactics.

Minor reforms enacted by HHS in 2001 and 2002 are expected to save Medicaid $70 billion over the next decade. A small sample of financing schemes uncovered in a few states suggests that, if Congress acts, even larger savings are available.

9. Earned Income Tax Credit Overpayments

The earned income tax credit (EITC) provides $31 billion in refundable tax credits to 19 million low-income families. The IRS estimates that $8.5 billion to $9.9 billion of this amount—nearly one-third—is wasted in overpayments.

The complexity of the EITC law leads to many of these mistakes. Calculating the credits is more complex than calculating regular income taxes. While the credit amount depends on the number of children in a household, the tax code does not clearly define how a child qualifies for the credit. In addition, fraud and underreporting of income are common, and the IRS lacks the resources to verify the qualifications of all EITC claimants.

Efforts are being made to address this problem, but Congress can do more by requiring better verification of incomes and by clearly defining the standards by which a child qualifies for the EITC.

10. Redundancy Piled on Redundancy

Government’s layering of new programs on top of old ones inherently creates duplication. Having several agencies perform similar duties is wasteful and confuses program beneficiaries who must navigate each program’s distinct rules and requirements.

Some overlap is inevitable because some agencies are defined by whom they serve (e.g., veterans, Native Americans, urbanites, and rural families), while others are defined by what they provide (e.g., housing, education, health care, and economic development). When these agencies’ constituencies overlap, each relevant agency will often have its own program. With 342 separate economic development programs, the federal government needs to make consolidation a priority. Some of the worst redundancies: 130 programs serving the disabled, 130 programs for at-risk youth, and 90 early-childhood development programs.

Conclusion

Lawmakers have an opportunity to take a strong stand for efficient government and spending restraint. Reforming wasteful programs will build essential momentum for the larger reforms that are needed to bring the budget under control.


Brian M. Riedl is Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

Tech High Hopes: Think Tank Founds Atlanta’s First Charter High School

by Mary Katharine Ham

DONTERIO CULLINS HAS ALWAYS FELT comfortable hunched over a greasy truck engine. After school, the ninth-grader often gets in hours of work on his mother’s truck, replacing valves, tinkering with spark plugs. Last month, he put a whole new engine in a car and sold it to his stepdad.

“Yeah, I put an engine in it,” Cullins said, smiling broadly as he remembers the project. “I can basically say I love it,” he said of the work he does at home in his driveway.

Under the hood, Cullins knows exactly what makes pistons move; he locates problems and solves them; he understands every connection. There are other connections, he admits, that didn’t come so naturally to him—like the one between his education and his future.

Cullins is in his second semester of ninth grade at Tech High, a charter school in downtown Atlanta. He spent almost 10 years of his education drifting through his school days—until this semester.

“I knew that if I didn’t make a change, things wouldn’t go as well as they could for my future,” he said. “I committed to make a change—to myself, my mother, my teachers.”

Alan Gravitt is one of those teachers—an energetic physics teacher who also has several start-up technology companies and the founding of the state’s alternative teachers’ union on his resume. He puts his hand on Cullins’ shoulder and beams as Cullins talks about his new resolve.

Cullins explains “The Plan,” an assignment from another teacher, in which he has to map the way from his ninth-grade desk to the career of his choice. He’s interviewing auto mechanics and engineering students, visiting auto shops and college classes, and writing a paper about his experiences. Gravitt offers to arrange a visit with a friend of his—the mayor of College Park, Georgia who also owns an auto body shop.

“Wow, thanks Mr. Gravitt,” Cullins says before he leaves for his required afterschool study hall, one step farther along “The Plan” for his life.

Cullins’s story is the vision of Tech High, established this school year by the Georgia Public Policy Foundation. The school gives its 100 students—most of them transfers from under-performing inner-city Atlanta schools—math and technology-focused education designed to ready them for technical schools and the workforce. Teachers have advanced degrees, private sector and military experience, and high expectations. They teach small groups of students so they can be there to put a hand on a shoulder or arrange a meeting with a mechanic.

Transformations like Cullins’s have not been easy or immediate for Tech High, 70 percent of whose students are on free and reduced lunch, but they’re happening, said the school’s CEO Barbara Christmas. Christmas is a long-time public school teacher and administrator, and former head of the state’s alternative teachers’ union, who now calls herself an “entrepreneur in the field of education.” As Tech High CEO, Christmas deals with raising support while the Principal Byron White tends to education and discipline.

“A lot of our students say they couldn’t learn where they were,” Christmas said. “Many of them were shocked. It shocked them to see how much they didn’t know. We’ve had some attrition, but we’ve had some big success stories.”

According to the school’s internal testing, the average improvement in reading scores from first semester to second semester was more than one grade level, she said.

Putting Policy into Action

It’s the kind of change Holly Robinson of the Georgia Public Policy Foundation always knew could happen. Robinson, senior vice president of the Foundation, had been a teacher, an advisor, a deputy superintendent, and an education analyst in Georgia.

When a group in Atlanta started talking about starting a charter school in 2003, Robinson and her colleagues went from studying schools to founding a school in a hurry. The Foundation seemed a logical choice to get Atlanta’s first charter high school off the ground. It was already running the Charter School Resource Center, training educational entrepreneurs around the state, and Robinson knew everyone in the Georgia education scene, on both sides of the aisle.

The Foundation’s bipartisan ties proved extremely valuable. At a time when education policy battles often devolve into tough politics, the Tech High charter was approved unanimously by both the Atlanta school board and the state board of education. Christmas, a prominent Democrat and former candidate for state superintendent, signed on as CEO. Atlanta entrepreneur and prominent Republican Don Chapman headed up the Tech High Foundation board, raising money for the new venture. Christmas’s and Chapman’s reputations and experience earned Tech High supporters at every major foundation and business in Atlanta. And state school superintendent Kathy Cox was behind the charter all the way, Robinson said.

“It has just been a wonderful and exciting thing—for Atlanta and for the whole charter school movement,” Robinson said. “We’ve had tremendous support both from the business and the academic community.”

By avoiding a political storm, Tech High—governed by a board that includes Foundation Executive-Vice President Kelly McCutchen, Foundation board member Craig Lesser, three parents, and two faculty members—was able to start putting policy into action by the fall of 2004. The school opened in a renovated corner of a former children’s science museum downtown, much of it bearing the mark of the local business community’s generosity—computers from Hewlett Packard, cafeteria chairs from AT&T. Paint and carpet transformed the cavernous insides of the science museum into school hallways and classrooms. And, in the shadow of the Atlanta skyline, a new philosophy started transforming students.

High Quality

Tech High’s Spanish teacher is a native Spanish-speaker with experience as an information systems analyst. Principal Byron White is a Marine who later became an engineer for Motorola. And Joseph Gibson, Jr. boasts degrees in History and Physics, and experience as an Army officer in Operation Iraqi Freedom.

A start-up school, much like a start-up business needs employees who are flexible, dedicated, and willing to work long hours, Christmas said. Christmas also wants teachers who have both education and real-life experience.

“They can help kids relate what they’re learning to real-world experiences,” she said. “You’ve got to be really smart to figure out how to reach some of these kids.”

All of Tech High’s teachers are dual-certified, meaning each of them teaches both math and science, or English and history. This cuts down on the number of students each teacher must get to know and improves relationships, Christmas said.

High Expectations

From dress code to daily lessons, Tech High sets the bar high for students. For many of them, coming from large Atlanta public schools, the experience was jarring at first.

“In the first half of the year, it was a lot of shock,” said White. “They were saying, ‘Nobody’s ever held my feet to the fire. This is serious.’”

The Tech High dress code requires that students wear polo shirts and slacks every day. School policy dictates that students come to tutoring sessions with teachers after school and on Saturdays if they ever fall behind in schoolwork.

Tech High also hosts professional development days, on which students are required to wear professional attire—skirts and suits for girls, and shirts and ties for guys. Professionals from around the Atlanta area come to share their career stories with students, and students get a chance to practice basic etiquette and interaction with adults.

Robinson has always believed that, “if you give the students high expectations…that you can turn things around. They want those lines in the sand.”

Traditional public schools are often bogged down by discussion about funding, transportation, and buildings, Robinson said, giving short shrift to their real purpose—producing results in students. Tech High, working with about 2/3 the budget per student of Atlanta Public Schools, is focused on getting more academic achievement for less money. (Atlanta Public Schools operate on about $9,000 per student; Tech High operates on $6,500 per student.)

“They’re our customers and that’s what we’re in business to do,” Robinson said.

Bethaney Wright notes the difference between her experience at Tech High and her public school.

“My learning experience at Tech High School has been very rigorous. Only two quarters have passed, but I feel like I’ve acquired enough knowledge for an entire year,” she wrote in an essay posted outside her classroom door.

Highly Personal

When Christmas walks down the halls of Tech High, she can name every student she meets; she inquires about their lives, other activities, progress in certain classes. White speaks fondly of the times he gets out from behind the principal’s desk.

“I can go in the classroom and actually teach a math class,” he said. “You don’t get that at a mega high school.”

You also don’t get Individual Learning Plans at a mega high school. But at Tech High, White sits down with every family in the school once a year and goes through a lineitem list of every grade and assignment the student received. He and the parents use those conferences to come up with a plan of action to address the grades. White said giving parents a seat at the table in their children’s education inspires parental involvement.

Parent attendance at these meetings isn’t perfect, but White calls back if parents don’t respond. And, if they don’t respond on the second try, he sets up a home visit.

Another advantage of Tech High’s personal atmosphere is that it makes discipline easier, White said.

“They feel like, since I know every one of them…I know what each one of them is doing or has done,” he said. “The element of care reduces discipline problems.”

Arthur Bell, another Tech High freshman, notices the difference: “It’s . . . almost totally different [from my last school]. You can make up a lot more things; there’s more individual focus.”

High Hopes

After 2004-2005, Tech High will add one grade a year until it is a four-year high school of about 500 students. The Georgia Public Policy Foundation and the Tech High staff are excited to see their idea keep growing. Robinson has always been convinced that this is the way to get great results with less money.

“I really feel that this is an enormous opportunity to see what can happen given the right circumstances,” she said.

This spring, the Foundation and Tech High will wait to see if a couple weeks of testing reflects the years of dreaming and hard work that have gone into creating Atlanta’s first charter high school. The Tech High faculty and board are confident that testing will reinforce what they’ve already seen in the halls of Tech High.

“About 90 percent of what it’s taken is to convince them they can do it,” Gravitt said of his students. “They’ve not been challenged. They’ve not been expected to do the work. They’ve just been drifting.”

But when Donterio Cullins walks the halls of Tech High, thinking about his plan for becoming a mechanical engineer, he’s not drifting anymore.


Mary Katharine Ham is Editor of The Insider.

Marketing Your Message: How to Reach the Media

by Mary Katharine Ham

FOR CONSERVATIVES, IT’S EASY TO RAIL against Rather and bemoan media bias. But when it comes to getting media coverage for conservative ideas, whining won’t get you anywhere. So, don’t make it a stumbling block for marketing your message, says Khristine Bershers, Director of Media Services for The Heritage Foundation.

“Don’t ever think of the media as the enemy—that’s the biggest mistake conservatives make,” Bershers said.

No matter how liberal the media outlet, Bershers says, it’s possible to have friends among the reporters. They don’t have to be on your side; just getting a couple of fair, representative quotes in a story is a victory for your message, she says.

Once you’ve gotten over that psychological hurdle, Bershers recommends a few simple things you can do to increase your chances of good media coverage:

Do the Legwork

Always educate yourself on the media outlet you’re approaching. If you’re sending out information on Social Security, find out which reporter is covering Social Security. If your press release on Personal Retirement Accounts ends up in an education reporter’s inbox, it will never see the light of day.

If you’re planning an editorial board meeting, check the newspaper to make sure it hasn’t already taken a strong stand on your issue. If you don’t have access to a media directory, just keep an eye on the newspaper and TV coverage in your local area. After a few weeks, you’ll know who’s on what beat.

Get Friendly

Get to know reporters before you approach them with story ideas. Reporters are dealing with a flood of story ideas and criticism from all quarters on any given day. If you approach them with something different—praise, for instance—it will get you noticed.

“Reporters are human beings,” Bershers says. “We forget that sometimes.”

For instance, if the health reporter you’ve been working with does a story that has nothing to do with Health Savings Accounts, but you enjoyed it, tell the reporter. The next time you approach him with an issue, he’s more likely to listen.

Correct Kindly

Reporters have biases, and they make mistakes. How you deal with mishaps in print will determine the coverage you get in the future. For instance, if the reporter writes a story about a woman who is losing a government service due to budget cuts but doesn’t ever mention taxpayers, you can approach the reporter politely and ask that if he ever visits the subject again, you’d really like to have the other side represented.

Always try to work with a reporter on problems first instead of going over his head to an editor. Sometimes there are serious factual mistakes or misquotes that have to be addressed by the higher-ups, but “make sure you have a very legitimate complaint,” Bershers advises. There’s no sense in picking fights if you don’t have to.

Sound Bites, Please

Local radio and TV can be great ways to get coverage, especially in small markets where reporters are sometimes eager for content. But you must be conscious of how your organization’s representative looks and sounds.

For TV, make sure nothing in your physical appearance distracts viewers from your message. For radio, avoid phone interviews if you can travel to the radio station. Sound quality is much better in the studio.

For either medium, have sound bites ready and act natural. The best way to prepare for radio or TV interviews is to sit down with a friend or a helpful reporter to do mock interviews.

These tips work with local and national media alike, Bershers says. So, conservatives, get out there and market your message!


Mary Katharine Ham is Editor of The Insider.

 
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