The fact that antitax guru Grover Norquist, U.S. House Speaker Nancy Pelosi and AFL-CIO chief Richard Trumka all moved swiftly to condemn deficit-reduction proposals made jointly by Alan Simpson and Erskine Bowles is a sure indication these ideas are worth considering.
Despite much campaign rhetoric about willingness to make hard choices, there is little substantive evidence — either among elected officials or the broad citizenry — that anyone will actually make them.
The proposals made by Simpson and Bowles, co-chairs of a bipartisan deficit reduction task force appointed by President Barack Obama, involve some hard choices.
Their fate will indicate whether we are willing to reach the national compromises necessary to put the federal budget on a sustainable track.
The proposals are too broad to examine comprehensively, so let’s look at a few key components:
Defense. The commission co-chairs call for a significant reduction in defense spending. This is expected. Defense Secretary Robert Gates, a Republican, has been warning for months that current levels of outlays are not sustainable. And he is not alone.
Defense outlays in the current fiscal year are about $750 billion and 5.2 percent of GDP. Under Obama, this is up about $120 billion from the last two years of the Bush administration. Cutting back to the average level spent in the post-9/11 period from 2002 through fiscal year 2009 would save about $180 billion a year. Some of the increased outlays under Obama are due to the military buildup in Afghanistan. Some are to replace equipment lost or worn out in Iraq or left to the Iraqi military on our departure. Some is for purchases of new equipment that have been in the procurement pipeline for years. So leaving Afghanistan, halting procurement and freezing military pay would produce significant savings.
But those actions also would mean a deep reassessment of the role we want to play in world affairs, particularly in the Middle East and East Asia, where China is increasingly flexing its muscle against nations that have been our allies for decades. And for those who advocate going to war with Iran over its nuclear programs, this is not the time to cut back.
Social Security. This is an enormous outlay, only slightly smaller than defense and fated to grow apace as baby boomers retire in increasing numbers. The only way to cut outlays is to cut back on promised benefits. And raising payroll taxes would hit more households than any other tax change.
The current system is not sustainable in the long run. Making it sustainable is easy in economic terms. It can be done by trimming benefits here and there and by making modest increases in taxes. In political terms, it is enormously difficult. Current retirees are a powerful voting block that feels threatened by any change, even one designed to take effect years into the future. And Democrats are as quick to demagoguery on Social Security as Republicans are on taxes.
The Simpson-Bowles suggestions — including gradual increases in the full retirement age, use of different price indexes to calculate individual initial benefit levels and annual increases and tweaking of “break points” that give higher benefits to low-income people — are familiar to any student of Social Security reform. This is one on which there should be great cross-party agreement, but it is likely to be one of the most contentious.
Tax reform. The proposals did not include instituting a value-added tax or a flat tax to replace current corporate and individual income taxes. But they do include a broad Reaganesque approach of lowering tax rates combined with broadening the tax base by eliminating virtually all exemptions, deductions and credits. These include the sacrosanct deductibility of home mortgage interest, the child tax credit and the Earned Income Tax Credit.
The EITC, based on an idea by conservative economist Milton Friedman, has become a major income redistribution program, costing $50 billion by one recent estimate, and is sacrosanct to Democrats. Many economists, conservative and liberal, continue to advance it as a more efficient alternative to other entitlements like Temporary Assistance to Needy Families, food stamps and the like. But if simplification is the goal, it has to go along with many other breaks.
Most economists of both parties see the panoply of special tax treatments for homeowners, including the deductibility of mortgage interest and the near-total exclusion of capital gains on residences, as highly distorting and hence very inefficient. But these are highly popular with the higher-income, higher-voting parts of society and have been untouchable in past tax reform efforts. This may be as hard a nut as curbing Social Security benefits.
Conservatives will hate to see preferential tax rates on capital gains and dividends abolished; income from capital then would face the same marginal rates as income from labor. On this one, economists are divided. Some, including a group centered on the Federal Reserve Bank of Minneapolis, argue that zero taxation of capital income is optimal in terms of economic growth. But if you want a simpler tax structure, getting rid of preferential tax rates for investment income is a way to go. In many ways, the tax simplification in the Simpson-Bowles proposals moves closer to the flat tax so dear to the hearts of many.
Much more could and will be said. The commission leaders have kicked off a debate with a serious, detailed proposal with something for everyone to hate. Now, it is up to elected officials and American citizens to take action.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.