Debt and Taxes: Will Washington Ever Grow Up?

In the space of a week, the chiefs of two blue-ribbon panels in Washington have put forth tough-minded proposals for reining in federal budget deficits. The ugly reality that they emphasized—no less true for being so often described or so reliably ignored—is that Americans have undersaved, overspent, and made unaffordable commitments for the future, particularly on retiree health care. The IOUs are accumulating, and if nothing is done soon, the chits will hit the fan: Creditors will stop lending money or at least demand much higher interest rates for it, as they already have in Greece, Ireland, and Iceland.

Each deficit-reduction proposal was full of serious ideas, and each was greeted by immediate and deadly sniper fire from both sides of the aisle. Postponing action is irresistible because the political blowback from doing anything meaningful is scorching. Every interest group is passionately committed to defending its own sacred cow, trampling the concept of sharing the pain for the common good. Washington, it appears, still isn't ready to grow up.

Those ringing the deficit alarm tend to be old and indignant. Peter G. Peterson, the 84-year-old retired banker, invested $1 billion in a foundation focused on fixing budget deficits, foreign debt, and entitlement spending. He ruminates about the morality of a society that leaves a legacy of debt. "I have nine grandchildren," Peterson says. "I think a lot about them." Alan K. Simpson is 79. The former Republican senator from Wyoming, who is co-chairman of President Obama's bipartisan National Commission on Fiscal Responsibility and Reform, told Bloomberg Television's Charlie Rose on Nov. 16 that he was too old to play budgetary politics anymore. "We're not going to sign our names at this stage of life to a bunch of pap," Simpson says he told his co-chairman, Democrat Erskine Bowles, 65, the North Carolina businessman who served as White House Chief of Staff for Bill Clinton. Says Simpson: "We call it the cruelty of making promises you can't keep."

Simpson and Bowles issued the first deficit-reduction proposal on Nov. 10, one week before former White House budget director Alice M. Rivlin, a 79-year-old Democrat, and Pete V. Domenici, 78, the former Republican senator from New Mexico, unveiled the recommendations of the Bipartisan Policy Center commission that they co-chair. With old-timey affection, she calls him "Senator Pete"; he calls her "Doctor Alice." But their admonitions are grim. Letting deficits continue to run out of control, they warn, would "make us increasingly vulnerable to the dictates of our creditors, including nations whose interests may differ from ours."

Proposed Targets

Simpson and Bowles proposed to shrink or kill the sacrosanct income-tax deduction for home mortgage interest; slash $100 billion in defense spending, in part by closing bases; freeze the pay of federal workers, excluding combat forces, for three years; raise the gasoline tax by 15¢ a gallon; cut Medicare reimbursements to doctors, hospitals, and drug companies; shore up Social Security with tax hikes and benefit cuts; and sharply curtail the growth of federal health expenditures. Rivlin and Domenici rely more on increasing revenue to balance the budget. They call for a 6.5 percent national sales tax, which they package for public consumption as a "Debt Reduction Sales Tax."

Among Democrats, House Speaker Nancy Pelosi almost instantly labeled the plan of the Obama commission co-chairmen "simply unacceptable." On the Republican side, Americans for Tax Reform gravely warned that "support for the commission chair plan would be a violation of the Taxpayer Protection Pledge which over 235 congressmen and 41 senators have made to their constituents."

The fact is, it's impossible to balance the budget without infuriating the followers of both Pelosi, who will lose the Speaker's chair in January, and Grover Norquist, the single-minded president of Americans for Tax Reform. The U.S. can't put its house in order without deep spending cuts and revenue increases.

Consider first the case of the antitax purists: To meet the commission's goal of reducing the deficit to 2.2 percent of gross domestic product by 2015 yet not raise taxes, lawmakers would have to find $98 billion in spending cuts beyond those in the Simpson-Bowles plan. Getting all the action on the spending side would be painful, especially if it's from discretionary spending rather than entitlements. Defense cuts in the plan are already steep. Defense Secretary Robert Gates on Nov. 16 said he's willing to take some reductions but called the Simpson-Bowles plan "math, not strategy." Wiping out the entire Justice Dept., including all federal prosecutors, the FBI, and the U.S. Drug Enforcement Administration (projected 2015 budget: $32 billion), would get the GOP less than a third of the way to the Simpson-Bowles target. Eliminating the entire food stamp program in addition ($66 billion) would pretty much close the gap, but at the expense of an epidemic of malnutrition. Another option would be to eliminate the Energy Dept. ($28 billion), Interior ($12 billion), and unemployment insurance ($48 billion). Paul Ryan, the Wisconsin Republican who is the next House Budget Committee chairman, says the GOP has no intention of stopping critical government functions, adding, "there are a lot of ways for government to be cut." True, but how deeply? "If you want to do it all on the spending side under current law you'd have to constrain spending so it doesn't grow at all for the entire decade," says Gene Steuerle, a senior fellow at the Urban Institute in Washington.

Entitlement Puzzle

The Democrats are equally unrealistic in attempting to shield completely the entitlement programs such as Medicare, Medicaid, and Social Security that represent about 40 percent of federal spending. The task quickly becomes impossible as the baby boomer generation retires. Representative Jan Schakowsky, an Illinois Democrat who sits on Obama's deficit-reduction panel, on Nov. 16 released a plan for the short term that includes an increase in taxes of $275 billion by 2015. Even a tax hike that large doesn't suffice past 2015, when boomer retirements start to kick in. "We haven't figured that all out yet," Schakowsky acknowledges.

One fat revenue target for the Democrats would be ending most income-tax deductions. The Simpson-Bowles plan offers three options on taxes, including a "zero option" that would fully wipe away the more than 300 tax deductions, credits, exclusions, and other breaks subsidizing everything from health care to housing. But those deductions and credits are immensely popular. The elimination of mortgage-interest deductions alone "would be a huge capital loss for anybody currently owning a home because people would not be willing to pay as much for houses," says Roberton Williams, a senior fellow at the Washington-based Urban Institute. The change "would drive prices down substantially," Williams says.

O.K., but if Democrats leave the deductions and credits alone, where will the money come from? Raising income tax rates on the wealthy is a Democratic favorite. But the Democrats would have to hike taxes on more than just the wealthy. Even if lawmakers ratcheted up the top two tax rates to an unthinkable 91 percent and 86 percent, from the current 35 percent and 33 percent, the government would still show a deficit totaling roughly $500 billion by 2019, according to researchers at the Washington-based Tax Policy Center, a project of the Urban Institute and Brookings Institution think tanks. "You end up with ridiculous marginal tax rates," said Donald Marron, the center's director. "It's just not feasible."

Balancing the budget isn't just an accounting exercise. It's about setting national priorities, weighing competing concepts of fairness, and creating incentives to promote growth. Cutting the budget in a way that simply off-loads costs onto states, localities, businesses, or families doesn't do Americans as a group any good. It's taking money out of one pocket and putting it in another. The benefits come when spending and taxation policies induce greater efficiency, and when they stimulate investment for future prosperity as opposed to consumption.

Tax-Code "Misincentives"

To its credit, the Simpson-Bowles plan would fix some of the "misincentives" buried in the nightmarish Internal Revenue code. All three of the proposal's tax options would subject more of Americans' income to taxation. That would make it possible to raise the same amount of money with lower rates, or raise more money without raising rates. That's a good thing. Lower rates on the last dollar of income earned encourage people to work and save more money, which in the long run is the least painful way to balance the budget. The knee-jerk rejection of the Simpson-Bowles tax ideas by some GOP activists is hard to understand: Cutting marginal tax rates is precisely the type of reform that free-market economists favor.

Democrats who howled that the Simpson-Bowles plan was stacked against the poor were also mistaken, according to a preliminary analysis by the Tax Policy Center. The center studied a variant of the plan that gets rid of the home mortgage deduction but keeps the child credit and the earned income tax credit for low-income workers. That variant is worse for the rich than extending the Bush tax cuts in their entirety. The top 1 in 1,000 families by income would see aftertax income fall by 7.8 percent, more than any other income tier, according to the group's analysis.

What's really scary is that as painful as their prescriptions are, neither Simpson-Bowles nor Rivlin-Domenici is assured of bringing the budget into long-term balance. What's causing the long-term numbers to go kerflooey: Medicare and Medicaid. Both panels assert that the government will reduce the annual growth of its health-care spending to one percentage point above the growth of economic output, vs. predicted growth of GDP plus 1.7 percent. Vaguely, Simpson and Bowles say that will happen "by establishing a process to regularly evaluate cost growth, and tak[ing] additional steps as needed if projected savings do not materialize." That's more an aspiration than a plan, sounding like Steve Martin's joke about how to become a millionaire and not pay taxes: First, get a million dollars. Then, don't pay taxes. The Rivlin-Domenici plan would convert Medicare from a defined-benefit plan into a defined-contribution plan, like a health-care 401(k), but there's no guarantee that doing so would slow its cost growth.

Here's the depressing math. Boston University economist Laurence Kotlikoff, an expert in generational accounting, calculates using Congressional Budget Office data that the U.S. faces a fiscal gap of about $200 trillion. That's the shortfall between the expected inflows and expected outflows of the federal government in perpetuity, based on current policy and discounted back into today's dollars. (The ideal fiscal gap is zero dollars, by the way, so we're more than a little off.) By Kotlikoff's back-of-the-envelope calculation, which he presented in a column for Bloomberg News on Nov. 15, the Simpson-Bowles plan would reduce the fiscal gap to about $30 trillion. Still huge, but much better. However, if the deficit cutters' hand-waving over health-care costs fails and noninterest spending continues to rise after 2020 at the rates projected by the Congressional Budget Office, Kotlikoff estimates a fiscal gap of about $150 trillion under the plan—too high for even the world's biggest economy to sustain. Says Kotlikoff: "It's miles short of what's needed."

Political Polarization

The political deadlock in Washington is making matters worse. In their willingness to reach across the aisle, "Doctor Alice" Rivlin and "Senator Pete" Domenici are anachronisms. From the 1950s through the 1970s, the ideologies of the Democratic and Republican parties overlapped—each was a big tent sheltering politicians with a wide range of viewpoints. Bipartisanship didn't always promote budget discipline: Democrats went along with Republicans' big defense budgets, for example, while Republicans acquiesced to Democrats' social spending. Today's political polarization doesn't seem to be good for budget-balancing, either. The latest election drove the parties further apart by casting out many Blue Dogs, the centrist Democrats who sometimes bridged the two parties' differences.

Is there any hope? Peterson is staking a billion dollars that the answer is yes. His foundation's latest public-awareness campaign features a Presidential candidate, Hugh Jidette ("huge debt"), whose motto is "borrow like there's no tomorrow." Corny, yes. But as Peterson observes: "Someone once said that the job of the public is often to make it safe for the politicians to do the right thing." In other words, Washington won't grow up until America does.

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