“He created a bipartisan debt commission. They came back with an urgent report. He thanked them, sent them on their way, and then did exactly nothing.”
In many ways, this quote from Paul Ryan’s speech at the Republican National Convention encapsulates deficit reduction efforts over the past two years. Ryan was criticizing President Obama for failing to pursue the recommendations of the National Commission on Fiscal Responsibility and Reform, a bipartisan commission the president established. Named the Bowles-Simpson report after commission co-chairs Democrat Erskine Bowles and Republican Alan Simpson, it was projected to reduce the deficit by nearly $4 trillion over eight years and balance the budget by 2035.
Had the plan garnered 14 votes among the 18 commission members in December 2010, it would have been automatically submitted to Congress. Ultimately only 11 members voted “yes.”
Paul Ryan voted “no.”
The story of fiscal reform is truly one of lip service, finger pointing, and inaction. Both presidential campaigns pointed to Bowles-Simpson as a model for fiscal reform, yet neither fully embraced the plan. President Obama’s fiscal year 2013 budget claimed to incorporate elements of Bowles-Simpson, and Congress soundly rejected it. Several bipartisan plans similar to Bowles-Simpson have also sprung up since December 2010. None have gained sufficient congressional support.
Nonetheless, Bowles-Simpson remains a synonym for fiscal responsibility and serious compromise for many in Washington and the media. But after two years, the commission’s recommendations are far from becoming law: the plan is clearly does not offer a political solution to the United States’ deficit problem. Many of the plan’s provisions have come under fire from both the right and the left, and economists are as starkly divided as politicians.
The task of reducing the deficit is inextricably tied to broader debates over the role of government. Alternative plans since proposed depict fundamentally different conceptions of this role. Some emphasize pro-growth tax reform and spending reductions, while others promote redistributive policies to address rising income inequality. No bipartisan plan has reached the floor of either house of Congress, because while most legislators agree on the need for deficit reduction, the consensus stops there.
Until Congress, along with the Obama administration, achieves greater clarity on other issues: tax efficiency, tax fairness, and the size of entitlement programs, nothing short of a debt crisis will make comprehensive deficit reduction a reality. Nor should it. Bowles-Simpson does not transcend these issues, but is rather one potential solution among many.
Simplifying the Tax Code
At the center of the Bowles-Simpson report is an ambitious plan to reform the federal individual income and corporate tax codes. Bowles-Simpson eliminates most tax expenditures, “broadening the base,” and uses the extra revenue to both lower rates and reduce the deficit. For individuals, the plan cuts the number of brackets from six to three and lowers the top marginal tax rate from 35 percent (under the Bush tax cuts) to 28 percent. Similarly, corporate tax rates would decrease from 35 to 28 percent. The plan would reduce the deficit by $785 billion over eight years and increase the progressivity of the tax code.
This structure draws heavily upon the Tax Reform Act of 1986, passed with bipartisan support under President Reagan, which also limited tax expenditures and significantly lowered rates.
Indeed, base broadening, as a general principle, continues to hold fairly widespread support among economists and policy makers. As Seth Giertz, economics professor at the University of Nebraska-Lincoln, told the HPR, “A broader base is a good thing because it tends to treat different activities more equally.” Tax expenditures, by taxing certain types of saving, investment, and income differently, distort the market by “favoring the activities you’re allowing to be deducted and penalizing the ones you’re not.”
Economist James Galbraith mentions the mortgage interest deduction as one such distortion. As part of the compromise behind the 1986 law, the mortgage interest deduction remained in the tax code even though other forms of interest deductibility were cut. By making the mortgages effectively cheaper than all other loans, Galbraith told the HPR, the law created a “strong incentive to acquire a house that had some notional equity [the owner] could borrow against.” Galbraith argues this contributed to the housing bubble that burst in 2007.
According to many economists, including Giertz, removing these distortions while lowering marginal tax rates using the increased revenue from a broader base would bolster economic growth. Galbraith disagrees, pointing to the recession of the late 1980s as evidence that broadening the base and lowering rates is not a “magic formula” for increasing growth.
Many experts also recognize the political and social justifications for certain tax deductions. Giertz cites the deduction for charitable donations as a particularly desirable social policy tool. In addition, as economist Daniel Feenberg, co-author with Harvard professor and former Reagan economic advisor Martin Feldstein, told the HPR, “People have planned their lives around the existence of these tax expenditures.” Feenberg and Feldstein thus propose a cap on deductions that could gradually decrease over time, eventually phasing out most to all expenditures while giving Americans time to adjust their economic plans. Ultimately, he calls this “a fairness argument, not an efficiency argument.”
This divide among economists on the merits of base broadening and lowering tax rates, and how to go about it, helps explain the multitude of competing tax proposals in Congress and the lack of consensus. Bowles-Simpson, while bipartisan, garners neither complete political nor economic support for its tax approach precisely because it reflects merely only one of these options.
Revenues and Inequality
The Bowles-Simpson tax plan has also come under fire from Democrats for proposing to cut marginal tax rates for all, including the wealthiest Americans, when income inequality in America is climbing. Although the plan ultimately makes the tax code slightly more progressive by eliminating tax expenditures, which tend to benefit primarily high earners, many liberals feel the wealthy should contribute even more toward paying down the debt. President Obama and Senate Democrats won this year’s election partly on that premise, and they show little sign of backing down.
Leading the charge against lowering top marginal tax rates is Senator Chuck Schumer (D-N.Y.), who in a recent speech rejected using the Tax Reform Act of 1986 as a model for today’s deficit reduction plan because, for one thing, its goal was not to reduce the deficit. It was revenue neutral, and could lower marginal tax rates without imposing a tax increase on the middle class. He also derides Bowles-Simpson for potentially raising net tax liability on the middle class, arguing that income inequality means the rich must contribute more.
Robert Reich, former Secretary of Labor under President Clinton, agrees with Schumer in prioritizing the tax code’s progressivity. “It doesn’t matter what the rate is and which loopholes and deductions are limited,” Reich told the HPR, “as long as the result is far more progressive than it is today.” He recommends capping the mortgage interest, health-care, and charitable donation deductions to raise revenues from the wealthy while protecting the middle class. By using these caps and taxing capital gains at the same rate as ordinary income, Reich claims, “we might be able to achieve the same result Schumer wants without dramatically increasing the top marginal income tax rate.”
As vindication of these proposals, the Congressional Research Service (CRS), a highly regarded, non-partisan source for policy evidence on Capitol Hill, examined the effects of cuts on the top marginal tax rate on economic growth over the past 65 years in 18 advanced economies and found no correlation between the two. It did find, however, that top tax rates were negatively correlated with income inequality. Senate Republicans immediately rejected this analysis and called on the CRS to remove the report from publication. Although the authors of the study defended their findings, the Service complied.
Clearly, approaching tax reform in the context of deficit reduction depends on confronting the issue of inequality. As long as Democrats and Republicans emphasize inequality to different degrees, no plan or evidence will likely bring them closer together.
Another major component of the Bowles-Simpson report is entitlement reform. The plan seeks to reduce Medicare spending largely by expanding on some aspects of Obamacare reforms, and while Medicare reform received much attention during the presidential campaign, Medicaid and Social Security reforms rarely came up. Nevertheless, policy disagreement pervades these issues.
Bowles-Simpson’s Medicaid proposals consist of cutting administrative costs and making some structural changes, reducing the deficit by about $58 billion. The report calls for further reforms if growth in total federal health care spending, including Medicaid and Medicare, exceeds GDP growth plus one percent per year over a five-year period. Joseph Newhouse, professor of health policy at the Harvard Kennedy School, told the HPR that these administrative cost reductions were “one-time kind of savings,” saying they “won’t really deal with the growth of cost problems” in the Medicaid program.
Republicans have proposed turning state-federal Medicaid cost sharing into a block-grant, meaning the federal government would give each state a pre-determined sum of money to fund its Medicaid program. This proposal seeks to reduce spending by encouraging states to innovate to best make use of their grants. While Newhouse agrees that such a plan could reduce costs for the federal government, he claimed that “block grants in and of themselves don’t bend the cost curve” for Medicaid spending as a whole, because they merely shift costs onto the states.
Still, Newhouse points to improvements in care coordination, or medical management, that states are already making to reduce costs. For example, Newhouse suggests that shifting disabled patients and some elderly patients into the program, which Bowles-Simpson encourages, can improve efficiency in health care spending by centralizing patient care within Medicaid and thus reducing waste among the various programs.
When asked whether the Medicaid program needs reform, Newhouse responded, “a bit, but not radically.” Many conservatives, seeking to reduce spending on the program, disagree.
Bowles-Simpson also contains a plan to reduce costs and increase revenues in the Social Security Fund, not as a deficit reduction measure but as a means of preserving the program. The plan increases benefits for the poor, decreases benefits for the wealthy, and increases the payroll tax cap to raise more revenues. It also proposes raising the retirement age from 67 to 69 years by the year 2075 and reducing the growth in benefits by calculating inflation differently.
According to economist Dean Baker, co-founder of the Center for Economic and Policy Research, increasing the retirement age and reducing benefits as Bowles-Simpson suggests “misses what has happened in the economy over the last three decades.” Because the financial crisis ate away at private retirement accounts, the typical middle-income retiree is often “entirely dependent on Social Security” for his or her livelihood. Given this reality, he claims the reforms are merely proof of “how un-seriously [the commission] took their job.”
Baker argues, “Nothing needs to be done now” on Social Security, saying the program can pay its promised benefits for another two decades. Beyond that, he says, “It would not be difficult to determine a path that maintains full funding.” He blames the public perception of crisis in the Fund on a “well-financed campaign to undermine confidence in the program.”
With the fiscal cliff looming, this lame-duck session will be occupied by attempts at a Grand Bargain to stave it off. Do not get your hopes up. Following the election, House Republicans along with Senate Democrats and President Obama all claimed an electoral mandate. While the risk of recession following the fiscal cliff seems like a good incentive to compel compromise, the chance that Democrats and Republicans will effectively come to consensus on the core principles behind deficit reduction is unlikely.
But even if they reach a deal, most likely following the spirit of Bowles-Simpson, it may not be good. Just scratching the surface of the commission report, one can begin to see the controversial assumptions and proposals lying beneath its bipartisan allure.
The disagreements are varied and complex. Congress and the president should take longer than the lame-duck session to carefully consider the trade-offs, and certainly, the debate should not stop with a report written by 18 people two years ago.