The Fiscal Times

A Deficit-Reduction Plan Rife With Problems

The draft proposal of the leaders of President Obama’s deficit commission arouses strongly mixed emotions. On the one hand, authors Erskine Bowles and Alan Simpson deserve credit, along with others who are addressing the problem of long-term budget deficits, for trying to alert the American public and their elected officials to a problem that most of us would like to disregard.

The solutions to this problem will be painful and divisive. On the other hand, the plan is profoundly disappointing. Although it contains a number of proposals that budget analysts of both parties have long advocated, it sets unnecessarily strict targets that make needed political agreements needlessly difficult and it is vague where specificity is badly needed.

All responsible budget analysts agree that the United States faces a daunting deficit problem. It should be addressed soon. But how soon is not clear. After the recovery is well under way, most would agree, and certainly before the debt/GDP ratio gets too large. What is not clear is what “well under way” means and whether it will happen soon enough to prevent to debt/Gross Domestic Product ratio from getting too large. The Bowles-Simpson plan would start deficit reduction in fiscal 2012, which starts on October 1, 2011, not even eleven months from now. Since unemployment is likely then to still be in the vicinity of 9 percent or higher, that is too soon, as premature deficit reduction could intensify and lengthen the recession. This is not a minor issue, as nothing more effectively depresses revenues and generates deficits than a weak economy.

Even more troubling than timing, is the program itself. Over the first nine years, 70 percent of the deficit reduction under the Bowles-Simpson “mark” would come from spending cuts, 30 percent from added taxes. The steady-state spending level, as a share of GDP, would be 20.5 percent of GDP. That is lower than spending averaged from 1980 to 2008 when none of the baby boomers had yet retired and claimed Social Security and Medicare and when spending on health care per person was a minor fraction of what it will be in 2020.

Other problems:

● The plan calls for a reduction from baseline in federal health care spending of about one-third by 2040, but doesn’t say how that target will be achieved.

● The plan would block grant Medicaid payments for long-term care, which would increase the marginal cost to the states of Medicaid—benefit levels and coverage—by anywhere from 100 percent to more than 200 percent. The result would be powerful incentives to cut benefits.

● The plan presents four options for modifying the tax system, but doesn’t endorse any. All would tax capital gains as ordinary income, which means doubling the rate on them.

● All tax plans would end or curb deductions for charitable contributions. That would curtail the capacity of the private sector to provide relief to vulnerable populations, at the same time that the principal programs supporting these very populations – Medicare, Medicaid and Social Security -- would be slashed.

● The deductions for mortgage interest and property taxes would be curbed or eliminated—this, during the most severe housing price collapse in at least seventy-five years.

● Deductions for contributions to IRAs, Keogh plans, and 401k plans would be ended.

● Social Security benefits would eventually be cut by 25 percent for people earning $43,000 today and by 40 percent for those earning $100,000. Note the double whammy—less Social Security and no tax-sheltered savings plans. The plan actually contains some modest increases in Social Security benefits, so that it actually increases the deficit until well after 2020

● The plan says it would fix the Medicare fee cuts for doctors scheduled for next month, but it doesn’t say how – other than to establish a new payment system to reduce costs and improve quality.

● The plan would freeze salaries of federal employees for three years, cut the federal work force by 10 percent, and dump 250,000 contract employees. To offset these cut backs, the plan calls for an increase in productivity of federal workers, but it doesn’t say how.

Bowles, a former White House chief of staff in the Clinton administration, and Simpson, a former Republican senator from Wyoming, clearly deserve real credit for highlighting the budget challenge. But the shortcomings in their proposals are profound. It is vague in key elements, sets targets and then calls on some committee or group to do something unspecified if the targets are not being met.

All in all, the draft plan is replete with magic asterisks, that infamous device in President Reagan’s first budget that promised spending cuts that never came. It sets targets for overall spending and taxation so low that it will be impossible to sustain even basic promises to provide pension and health benefits to the elderly, disabled, and poor.

The spending cuts are so numerous and so deep, the tax changes are so large and disruptive, that they are not only unlikely to be adopted but would have needlessly adverse effects if they were.

There is a better way. The first element should be a large new and quite general tax on consumption, a value-added tax. The revenue from such a tax could be used in part to lower the deficit and in part to reduce overall personal income tax revenues. We should recall why passage of the Tax Reform Act of 1986 was possible because it lowered total personal income tax collections. That tax cut permitted Congress to compensate those who lost targeted tax breaks with reduced tax rates.

The Bowles-Simpson plan proposes to increase total income tax collections. That key fact means that it is impossible to compensate those who lose from the ending of specific deductions, credits or exclusions. Revenue from a new revenue source would make such compensation possible and would greatly improve the chances of achieving the goals of simplification that tax reforms have long sought and that the Bowles-Simpson plan embraces.

Second, there is a simple fact of long-term budget reduction: its success hinges on the control of health care spending. Such control is not possible without vigorous implementation of health care reform and the various cost-reducing pilots and experiments in that bill. Of course, not all of them will succeed. But the Affordable Care Act designed to protect patients is a start. More to the point, it is the only game in town.

Third, various spending reductions will be necessary, in discretionary and mandatory spending. The Bowles-Simpson plan and all other deficit reduction plans will have to rely on spending curbs. But relying on spending cuts to achieve 70 percent of the deficit reduction requires setting spending targets so low that it calls to mind the quip attributed to the man enjoying a drink in the bar on the Titanic: “I asked for ice,” he said, “but this is ridiculous.” Or, as the British say: “Less would be more.”