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November 2012 Issue [The Anti-Economist]

The Entitlement Crisis That Isn’t

At September’s Democratic National Convention, Bill Clinton roused his party when he said that Republicans, having left Barack Obama with a “total mess,” were now complaining that the president hasn’t “cleaned it up fast enough.” Clinton barely mentioned what got us into that mess: George W. Bush’s sharp tax cuts, mostly for the wealthy, which led more to financial speculation than to solid growth. He didn’t mention that job creation was slower in the years following the Bush tax cuts than at any other time in the postwar era. Nor did he mention that a substantial increase in taxes would go a long way toward calming the financial waters, since the very idea of tax hikes remains anathema. Though many Democrats like to bask in nostalgia for the 1990s, they rarely mention that Clinton was the last president to get a major tax increase passed by Congress. It’s no coincidence, of course, that one of the country’s greatest periods of peacetime prosperity followed.

Contrary to warnings by politicians of both parties and by almost all of the mainstream press, America’s biggest fiscal problem is not spending on Social Security, Medicare, and Medicaid; it is our almost complete unwillingness to tax ourselves sufficiently to maintain a modern state. Today’s deficit—now at about $1.1 trillion—was caused not by social spending but by the Bush tax cuts of 2001 and 2003, the Iraq war, and the recent recession. So where did the consensus that entitlements are the principal cause of all the nation’s financial problems—and that cutting them is the only path to fiscal health—come from?

It should not surprise that such right-wing groups as the Heritage Foundation insist that entitlement spending will eventually soak up all federal revenue.

By their own account this won’t happen until at least 2045, even if we accept the assumption that there will be no rise in federal tax revenues and that reforms such as Obamacare will have no serious impact on future health-care costs.

But they aren’t the only ones leading this disinformation effort. The Third Way, a centrist Democratic organization, notes that spending on entitlements has been growing while public investment in infrastructure, education, and so forth has been falling. “Entitlements are squeezing out public investments,” they conclude. But there is no causal relationship to be found here. Bill Clinton was stingy about raising public investment in the 1990s even when he had a big surplus to work with. Meanwhile, military spending has somehow not been squeezed by entitlements. Even granting such an investment squeeze, The Third Way never raises the possibility that more federal revenue might relieve it.

The preference for small government and spending cuts is not based on serious economic research. Although ideologically biased economists generate studies “proving” that higher taxes and bigger government reduce growth, the best, most objective analysis of tax rates, by Joel B. Slemrod of the University of Michigan and Jon Bakija of Williams College, finds no relationship between high taxes and reduced rates of economic growth.

The same is true of government size and growth. The most important book on the economic impact of big government around the world is Growing Public, by Peter H. Lindert, a respected mainstream economist at the University of California at Davis. A large government, he finds, simply poses no systemic impediment to growth. Big governments don’t spend money stupidly. Much of their social-welfare expenditure, including on low-cost education, parental leave, and child-care regulations, is good for growth.

Faced with these facts, pundits and politicians alike fall back on a template established a few years ago by Joshua Bolten, George W. Bush’s budget director. “In the longer run,” he wrote in 2006, “no plausible amount of tax increases could possibly close the enormous gap that will be created by the unsustainable growth in entitlement programs.” Members of the centrist commentariat take Bolten’s claim as gospel. In a July New York Times column, for example, the paper’s former executive editor Bill Keller, whose reputation as a reporter had always been excellent, wrote, “The traditional liberal alternatives—raise taxes on the well-to-do, cut military spending—are not nearly enough by themselves. The arithmetic simply doesn’t work, unless we face the fact that entitlements are a bargain we can’t afford to keep, not in full.”

But as Bruce Bartlett, a high-level adviser to Ronald Reagan and George H. W. Bush—and no fuzzy-headed liberal—succinctly puts it, Bolten’s statement is “factually wrong.” Despite Keller’s insistence, the arithmetic does work. “Almost every country in Europe has a tax/GDP ratio high enough to cover all of the projected increase in spending in the United States through higher revenues alone,” writes Bartlett. Roughly speaking, the average nation among the thirty-four members of the Organization for Economic Cooperation and Development (OECD) collected some 38 percent of its citizens’ income in taxes. U.S. citizens are taxed—including all federal, state, and local income taxes, sales taxes, and payroll taxes (the taxes that are taken out of every employee’s paycheck for Social Security and Medicare)—at only about 26 percent of their income. Yet the high-tax economies grow about as fast as ours does, sometimes faster. Prosperous Denmark, Norway, and Sweden have tax rates well above 40 percent.

To be clear, no one should raise taxes now, because the economy is still too weak. On the contrary, we need bigger deficits for a while. But when the economy is righted, we will have our chance. Imagine if the United States raised taxes by 10 percent. If this seems far-fetched, that is for purely political, not economic, reasons: such an increase would put our taxes on par with the OECD average, still well below the levels of nations like Norway. This hike would bring in about $1.5 trillion in one year alone and, by my estimate, $17 or $18 trillion over ten years. To put this figure in perspective, the bipartisan agreement in 2011 to cut the future deficit under the Budget Control Act demanded a total deficit reduction of only about $1.5 trillion. That additional $16 or $17 trillion would cover all imaginable increases in entitlement programs, even over a time span of sixty years or more—and it would also wipe out the deficit.

Let’s keep in mind that Medicare is expected to rise by only 2 percent of GDP—to just under 6 percent—by 2035, even if the health-care system is not made significantly more efficient. Social Security benefits are forecast to increase from 5 percent of GDP today to, at worst, somewhat more than 6 percent, then level off in the mid-2030s. These increases are readily manageable.

A tax hike of 10 percent may be politically impossible, but there is no reason federal taxes cannot be raised by 3 or 4 percent, which would add between $450 and $600 billion a year to government revenues. That amount would reduce the current budget deficit to 3 or 4 percent of GDP, lower than deficit levels during many years of Ronald Reagan’s presidency.

But virtually no one in a position of power is talking about a 3 percent tax increase. Cutting entitlement spending is a much more attractive pitch for politicians, who can directly blame the alleged profligates of society, mostly the poor, for our woes. The rich want lower taxes and smaller government. So be it.

When various budget-balancing commissions were set up a few years ago to explore options for shrinking the national debt, they invariably gave tax hikes short shrift. The Bowles–Simpson fiscal-reform commission, which many cite as an example of bipartisan good sense (though the Democratic Bowles and the Republican Simpson are in fact both fiscal conservatives), relied on spending cuts for two thirds of its projected savings and tax increases for the remaining third. The more sensible deficit commission presided over by Democratic presidential adviser and economist Alice Rivlin and former Republican senator Pete Domenici suggests cuts of roughly 46 percent and tax-revenue increases of 54 percent.

Such proposals, though made by economists, are largely politically motivated. How much of a tax increase can the system bear? Americans supposedly don’t like tax hikes, especially when wages have stagnated for four decades. Politicians like them even less. And rich people may like them least of all.

Are most Americans really opposed to paying more taxes? Not when they experience the benefits of those taxes. They have accepted higher taxes for Social Security and Medicare, and they consistently approve higher sales taxes at local levels. Better government, not weaker government, is the path to prosperity. The nation requires sophisticated education for all; high-speed, low-cost transportation; universal access to the Web; efficient energy usage; and adequate support for the poor and the elderly—all of which demand more government revenue.

So how can we raise taxes? First and foremost, in a time of rampant inequality, we can tax the rich. In 2007, the top 1 percent of earners paid taxes of about 22.4 percent of their income, two thirds the level they paid in 1980. If their effective tax rate were raised to 29.4 percent, according to economists Emmanuel Saez and Peter Diamond, it would increase government revenue by 1 percent of GDP. If their tax rate were 43.5 percent, nearly 3 percent of GDP would be added to the nation’s coffers. As MIT professor Andrea Louise Campbell points out, the rich have made so much money in the past four decades that the larger of these tax hikes would leave the share of income after taxes of the top 1 percent twice what it was in 1970. A lot of problems would be solved with that additional revenue of $450 billion a year.

Making Social Security completely solvent can also be accomplished with relatively little strain. Removing the payroll-tax cap, which limits withholding to incomes below $110,000, would almost entirely finance Social Security well into the future. If the cap were simply raised to $190,000, a slight increase in payroll taxes for all would also close the projected gap.

Corporate taxes account for only 10 percent of federal revenue; in the 1950s, they accounted for 28 percent. New taxes on financial transactions and even a wealth tax, as is levied in France, could also be considered.

Finally, tax benefits such as the home-mortgage-interest deduction, charitable deductions, and corporate health deductions amount to more than $1 trillion in lost government revenue. They could, and should, be reduced. A carbon tax would raise revenue while encouraging a reduction in consumption that is environmentally necessary. A European-style value-added tax could raise hundreds of billions of dollars.

Down the road—that is, in the 2040s and 2050s—federal health-care programs will soar in cost, more because of increases to the cost of delivery than because of an aging population. There is no doubt we must reform our health-care-delivery systems before then. The Patient Protection and Affordable Care Act, derisively called Obamacare, is a start to such work, and more serious reforms can be built on it. Voucher programs, such as the one proposed by G.O.P. vice-presidential candidate Paul Ryan, are simply reform by triage. They would provide the elderly with a fixed amount—insufficient to keep up with ever-rising medical costs—with which to buy insurance. Ryan and others claim private competition will make the system more efficient, but why hasn’t it done so yet? The elderly will either pay for health care out of their own pockets or simply go without.

There is no debate of good conscience in America about how to pay for the nation’s most profound needs. If there were, raising taxes would be a major part of it. Instead, the lower and middle classes will bear the brunt of deficit reduction.

Politicians and ideologues are playing a cruel game by keeping serious tax increases off the table, but it is especially hypocritical to do so in the name of fiscal responsibility. America’s budget problem is a revenue problem, not a spending problem. The current national conversation about tax hikes is a fine example of political deference to the rich and powerful. It is not good economics.

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