By Clive Crook
Published: August 8 2010 22:06
Last week I argued that sooner or later Barack Obama will have to break his election promise and raise taxes on the US middle class. It would be better not to renege just yet, I said: a double-dip US recession remains a distinct possibility and fiscal policy needs to stay loose for the time being. However, before much longer, restoring fiscal control is going to require higher taxes – and not just for the rich.
Many readers took issue with the article and they often started the same way: “What about public spending? You didn’t say a word about spending.”
No, and I should have. To control borrowing without ever-rising rates of taxation, Congress will have to curb currently projected spending. But that will not be enough by itself. It is delusional to think the US can get from here to a sustainable fiscal balance with spending cuts alone.
Yet this is exactly what many conservatives do think. Often they cite the “Roadmap for America” released earlier this year by the Republican congressman Paul Ryan. Many see Mr Ryan as the party’s best thinker on fiscal reform (admittedly, not a very exacting distinction). His plan aims to cut taxes, not raise them, and still get public debt down: he does it all with spending cuts. In a column last week, Paul Krugman, The New York Times’ economics commentator, called the plan “the audacity of dopes”. Mr Krugman’s disdain may be a devalued currency, but here one can see his point.
Give Mr Ryan some credit for spelling out his plans in detail so that one can work out what they mean. This alone makes him a rarity among conservatives in Congress. The problem is, once you see what his proposals mean, you know they are politically impossible. If Republicans adopted this platform they might never be in power again. They know it, so they will not.
The distributional effect of Mr Ryan’s tax plans would be extremely skewed. Much lower capital taxation would drive taxes on the wealthy right down. For Americans of ordinary means, on the other hand, lower tax rates would be outweighed by other changes. The plan replaces the tax exemption for employer-provided health insurance with a tax credit – a good idea in principle, but not when packaged like this. Also, the projections are too optimistic. On plausible assumptions, revenues would fall too much, and the deficit would widen.
Judged as a tax reform, Mr Ryan’s plan needs some work. The much bigger problem, though, is on the spending side. In one way, the plan performs a useful service. It shows just how severe measures cutting spending would have to be to stabilise and then reduce the federal debt if higher tax revenues are left out of the mix.
Mr Ryan is right that meaningful cuts in spending demand savings in social security (pensions) and Medicare (healthcare for the elderly), the two big entitlement programmes. Growth in the first and especially in the second, thanks to demographic pressures and excess inflation in healthcare costs, is the engine driving public debt remorselessly higher. These programmes will have to be reformed, especially if you exclude defence from consideration.
A good way to start would be to raise the retirement age. People are living longer. Work is less unpleasant and less physically demanding than it used to be. Raising the retirement age is fairly painless – and politically doable. It would not be the first time, after all.
Mr Ryan’s plan does propose an “eventual modernisation” of the retirement age – in other words, an increase. But he goes much further. He calls for a new benefits formula that would reduce Social Security payments. He also wants retirement accounts funded by payroll taxes for workers under 55, a privatisation scheme similar to the one that President George W. Bush tried, and dismally failed, to push through.
What about Medicare? The recent healthcare reform includes some payment-system experiments intended to curb costs, though it would be rash to expect very much from these. Mr Ryan’s plan is far more radical. Again he calls for privatisation. He wants to replace the government-run insurance scheme with vouchers, which recipients would use to buy private insurance. The plan then imposes a far slower rate of increase in the vouchers’ value than in projected healthcare costs.
After many years, this wedge would drive Medicare spending way down – but unless costs fell commensurately, the vouchers would buy fewer treatments. No doubt, in this world, patients would force doctors and hospitals to supply services more economically. It is hard to believe that this could curb spending as sharply as Mr Ryan expects with no loss of healthcare quality.
In a way, Mr Ryan is right: dismantling Medicare and social security is what it takes if you rely on spending cuts alone. Can it be done? No. Republicans remember what happened to the Bush plan for social security and do not intend a rerun. During the healthcare debate, they furiously opposed cuts in Medicare. Do not trust Democrats to honour these government promises, the party says. So much for Mr Ryan’s plan.
You cannot hold Medicare and social security unscathed, oppose all tax increases and close the fiscal gap. The big entitlements plus defence and interest amount to some 80 per cent of federal spending. With those off the table, there is not enough left to cut.
Copyright The Financial Times Limited 2010
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