Paulson's First Big Test

The Bush Administration will look to Treasury nominee Hank Paulson to lead the effort to reform Medicare and Social Security

One key test for Henry M. Paulson, President George W. Bush's choice to be his third Treasury Secretary, will be whether he can push the White House to seriously tackle the massive long-term budget deficits facing the nation. And a possible vehicle for addressing that issue is a bipartisan commission with the political clout to find solutions to this future fiscal mess. That idea has been languishing in the White House for months, but Paulson could give it new life.

In his State of the Union address last January, President Bush said he would name a new panel to recommend long-term changes in Medicare, Medicaid, and Social Security. For months, the idea went nowhere. But in the weeks since Joshua Bolten took over as White House chief of staff, Administration officials have tried to revive it, reaching out to members of Congress and policy experts. Some would like to roll out the commission later this year.

But it's increasingly likely the initiative won't get started until 2007, largely because Administration aides have had trouble finding people to serve. Potential members tell BusinessWeek that with a badly weakened Bush and the poisonous partisan atmosphere in Washington, the panel is doomed to fail. "This is going nowhere," says one prominent Republican who was approached prior to the Paulson nomination, "Why would I want to waste my time?"


 It is no surprise that Washington hands are deeply skeptical. After all, in 2001, Bush handpicked a commission to endorse his plan to create private accounts for Social Security. After Bush rejected other options out of hand and refused to work with mainstream Democrats to develop a compromise proposal, his scheme collapsed in 2005.

Last year, Bush picked a bipartisan commission to study tax reform. That panel came up with some interesting ideas, but saw its work dumped in a White House trash bin when Administration political aides ran from its proposals to curb tax breaks for employer-paid health insurance and for home mortgages.

If Paulson is to restore credibility to the idea of an entitlement commission, the Goldman Sachs (GS) chief executive will have to perform a delicate two-step. First, he'll need to convince Bush that any commission must include powerful Democratic lawmakers and that it must consider using tax increases to help close the massive future budget gap. That will be a huge lift, but with just one-third of the public satisfied with Bush's handling of the economy, the normally partisan President might be willing to change course and finish his term with a blockbuster bipartisan initiative.


  Second, Paulson will have to sell the idea to Capitol Hill, which could well become even more polarized after the November elections. If Republicans lose seats in the House and Senate, but maintain narrow majorities, it is hard to see how either the GOP or increasingly aggressive Democrats would be willing to join together to cut popular benefits programs and raise taxes. However, if Democrats win control of one House, they might nod to bipartisanship, if only to show that they can accomplish something.

In recent days, senior Administration aides have begun dropping hints that an entitlement commission could consider tax hikes. On May 23, Bush economic adviser Allan Hubbard told National Journal, "[Commissioners] could put it on the table." But Hubbard added: "The last thing in the world [Bush] thinks should happen is to raise taxes."

Paulson himself, who has said surprisingly little about fiscal policy during his years as a top Wall Street executive, appears to hew to the standard Bush view. That is: Deficits are bad, but we can reduce them through a combination of economic growth and spending cuts. While he was at Goldman, at least, tax hikes were not in the mix for Paulson.


 Whatever the economic merits of that approach, there's no politically feasible way to solve the problem while holding the line on tax hikes. Here's why: The Congressional Budget Office estimates that by 2050, Social Security, Medicare, and Medicaid, plus interest the government pays on the money it borrows to run those programs, will eat up just about every dime of anticipated tax revenues. There would be nothing left to pay for the rest of government, including the Pentagon, homeland security, and environmental protection.

The Administration could try to solve the financial problem by steeply raising the age at which people become eligible for the various benefits. But that's a political non-starter for Democrats and many moderate Republicans, who fear criticism for slashing popular programs for seniors.

If the "no new taxes" view is merely a White House negotiating position, such a commission could succeed. But if it continues to be the President's bottom line, Paulson could find himself a very frustrated man, at least if he has any interest in ending the nation's ugly fiscal policy gridlock.

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