Here's my roadmap toward fiscal sanity

Last modified: 5/14/2010 12:00:00 AM
Now that we've watched a fiscal crisis that began in Greece engulf all of Europe, maybe we should start considering the possibility that the same thing could happen to us if we don't get serious about our government's ballooning debt.

In recent months, think tanks have published a lot of scary studies showing that the long-term budget prospects are even worse than we thought - that even after the economy recovers and unemployment begins to return to more normal levels, debt service and demographic trends will quickly push federal deficits back into the danger zone.

What's still lacking, however, is a framework for tackling the budget challenge in a way that is economically coherent and politically viable. Without such a framework, it's impossible for the public to seize the discussion from the partisan ideologues and special interests whose hard-line positions have brought us to this stalemate. So let me try to start the conversation with a blueprint, using round numbers and incorporating some of the best ideas of the left and the right.

19 percent versus 26

The federal government is on path to raise about 19 percent of U.S. gross domestic product in taxes while spending 26 percent. Given our wealth and growth potential, it is not necessary to balance the budget - if we shrink spending quickly, we can safely run a deficit of 2 percent of GDP. That suggests a 'hole' to fill of about 5 percent of GDP. When you factor in much-needed infrastructure investment, that hole widens to about 6 percent of GDP, or about $500 billion a year.

As a matter of economics, it is simply not possible to close that gap entirely with tax increases on the rich, as Democratic liberals want so desperately to believe. At the same time, political reality dictates that it is impossible to close that gap entirely with spending cuts, as Republicans would like despite decades of being unable to identify the cuts they have in mind. The compromise I propose is a 50-50 split between tax increases and spending cuts in the medium run, rising to 60 percent spending cuts as limits to entitlement spending start to compound.

In truth, this budget blueprint doesn't require an overall 'cut' in spending, even after allowing for inflation. The spending restraints can be achieved simply by limiting spending growth. That's not to say people won't scream about foregone spending increases, but it should put the lie to the notion that serious spending discipline needs to be Draconian:

• Hold federal health spending increases (Medicare, Medicaid, premium subsidies) to GDP growth plus 1 percentage point a year, rather than the GDP-plus-2.5 percent that has been the norm. That's easy to say but hard to do, requiring huge changes in the way health care is paid for and delivered. Details would be left to an independent commission set up by the health care reform law to recommend ways to contain spending. Congress can either approve the commission's recommendations or come up with its own path to staying within spending caps.

• Raise the eligibility age for Social Security and Medicare by one month for each two-month increase in average life expectancy. At the same time, slowly reduce the cost of living increases on Social Security benefits for wealthy seniors (couples, say, with income over $100,000) while slowly increasing their Medicare premiums. Everyone else's benefits would remain untouched.

• Limit growth of 'discretionary' spending - defense as well as domestic - to the rate of inflation, except to pay for wars, natural disasters and safety-net spending during recessions.

Truth about taxes

On the tax side, Republicans have perpetuated the economic fallacy that any increase in revenue will expand the size and scope of government and rob the economy of growth, jobs and innovation. There is no factual basis for such a belief. While there may be some tipping point at which government tax revenue begins to rob the economy of its vitality, the experience from other countries is that 23 percent of GDP is nowhere near it. My tax blueprint adds one new tax raising $250 billion a year, while squeezing an additional $250 billion from existing taxes:

• Impose a new, broad-based value-added tax of 6 percent, with rebates to low-income households.

• Reduce the corporate tax rate from 35 percent to 25 percent, apply it only to profits earned in the United States (the same approach taken by most other countries) and close enough loopholes to increase corporate tax revenues by 5 percent.

• On the individual income tax, increase the standard deduction and personal exemptions so that no tax is paid by a family of four with income under $50,000 (for simplicity, all income numbers that follow refer to the same-sized household). Above that, wages and salaries and short-term capital gains would be taxed at only three rates: 17 percent for income from $50,000 to $150,000, 27 percent for income between $150,000 and $250,000 and 37 percent for income above that. Limit the impact of all itemized deductions by applying them against income taxed at the lowest 17 percent rate. Tax interest, dividends and long-term capital gains at 20 percent, up from the current 15 percent.

• Reduce the Social Security payroll tax slightly to 12 percent and over time impose it on wages and salary up to $150,000, up from the current cap of about $110,000. Raise the Medicare payroll tax slightly, to 3 percent, and apply it to all income.

• Replace the federal gasoline, diesel and jet fuel taxes with a carbon-based transportation fuels tax, set at a rate that would raise $25 billion more annually. All revenue from the tax would go to a new transportation infrastructure fund.

• Eliminate the inheritance tax, but require all estates to pay any deferred and unpaid capital gains taxes on all assets before any distribution to heirs.

These tax changes would simplify the tax code, improve international competitiveness, make revenues less volatile through the business cycle and modestly reverse income inequality. Even with the increases, the top marginal federal and state tax rate on wage and salary income would remain below 50 percent. Although there are many moving parts, my guess is that when it's all netted out, virtually all of the added tax burden would fall on households with incomes over $100,000.

It would take a big computer, and a lot more detail, to figure out how close this blueprint comes to filling the budget 'hole' - I relied on back-of-the-envelope extrapolations from past reports of the Congressional Budget Office.

My purpose is not so much to come up with the perfect plan as to demonstrate that taming the federal budget deficit requires neither the wisdom of a blue-ribbon panel nor the end of American life as we know it.

All that is needed an open mind, some common sense and a healthy dose of political courage.

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