We Can All Do Better (6 page)

If you want to reduce the deficit without inflation, you have only four areas that will yield significant savings: Social Security, health care (Medicaid/Medicare), defense, and taxes. Cato Institute senior fellow Michael Tanner points out, in
Bankrupt: Entitlements and
the Federal Budget
, that if no changes are made in law and if revenues return to their historical level of 18 percent of GDP, by 2050 the big three entitlement programs will consume all the revenue the federal government raises in taxes. In a much closer time frame, by 2015 defense, entitlements and interest on the federal debt will consume 76 percent of the budget.
¹²
And even after President Obama's healthcare bill fully takes effect, unfunded Medicare liabilities—according to Medicare's trustees report for 2010—will be $28.7 trillion.
¹³
If we are to pay for such already scheduled spending only with income taxes, then corporate and individual tax rates must dramatically increase; the Congressional Budget Office reports that the top marginal tax rate would have to go from 35 to 88 percent and the 25-percent rate for middle-income workers would have to reach 63 percent.
¹⁴
Clearly, the answer doesn't lie in income tax increases alone. Entitlement benefits must also be trimmed, and our national defense must accede to our economic limitations. We should first identify the spending cuts and then increase taxes to pay for the rest of the needed deficit reduction, and pass both the cuts and the taxes in one integrated package, with no loopholes or earmarks or other gifts to members of the Washington club and their clients.

Fifty-five percent of all federal spending is a transfer of money from one group of people to another. For example, we tax workers and send the money to the elderly through Social Security and Medicare, and we tax companies to pay for unemployment compensation. When politicians are unwilling to cut back on these kinds of transfers, what remains to be cut are the government programs that underpin our society: Schools deteriorate; judges and teachers remain underpaid; talented civil servants go elsewhere; needed infrastructure is postponed. An unwillingness to cut the transfers or to close tax loopholes or to raise taxes leads to a country that increasingly will fall apart.

When you consider that state governments, too, have diminished revenue and have made enormous commitments in health care and
pensions, you see the full dimensions of the problem. Take the example of courts: Already in some states misdemeanors are ignored. In fourteen states, courts have reduced their hours in session. The courts have been slashed, even as the prison population is growing. The
Economist
recently pointed out that in California, because of budgetary restraints, a typical lawsuit may soon have to wait five years for a trial. The effects of rationed justice abound. As the
Economist
put it,

The recession left a vast legacy of foreclosures, personal and business bankruptcies, debt-collection and credit-card disputes. In Florida in 2009, according to the Washington Economics Group, the backlog in civil courts is costing the state some $9.8 billion in GDP a year, a staggering achievement for a court system that costs just $1.2 billion in its entirety. To make up the funding shortfall, courts are imposing higher filing fees on litigants. . . .

Even criminal cases are not immune. Some crimes, like domestic violence, have increased with the rotten economy. In Georgia, where court funds have fallen by 25% in the last two years, criminal cases now routinely take more than a year to come to trial. This means that jails are full of the innocent alongside the guilty. Their incarceration adds costs far greater than the alleged savings in the court system. Above all, it causes gross injustice.
¹⁵

I was heartened to hear about Kasim Reed, the mayor of Atlanta, who (like many mayors and governors) inherited an unsustainable pension system that accounted for 20 percent of the city's budget. In nine years, from 2001 to 2009, the unfunded pension liabilities had quintupled to $1.5 billion. Mayor Reed called the union and political leaders in and pointed out that unless they agreed to reductions in pensions the whole system would go bankrupt and
no one would have any pension at all. In addition, services would be cut and city workers would be laid off. The city council passed a measure that guaranteed $270 million in pension savings over ten years.
¹⁶

We need more of that kind of candor. Governors in many statehouses have arrived at a moment of truth: No budget gimmick or sleight-of-hand accounting can save them. Selling a few public assets, doing a few one-time fixes, and then passing the buck on to the next governor no longer works. With all the pension and healthcare promises, the situation has gotten out of control. City halls will no longer benefit from the deep pockets of fiscally compromised statehouses. The money will begin to dry up, and the mayors will have to break the news to their citizens and admit that they, too, have borrowed to near bankruptcy. They, too, will have to make the cuts or increase the taxes needed to right their ship. The truth is that state and local governments will probably have to do both.

A balanced approach will generate support—if only grudging support. No one wants to have a favorite government program cut back or pay more taxes, but if the alternative is bankruptcy, compromise just might be possible. I cannot emphasize enough the requirement of balance: asking something from everyone. Democrats want the rich to bear the burden; Republicans want to ask primarily the poor to sacrifice. Both political parties champion the middle class and neither asks anything significant of it in this crisis. A true solution cannot give the middle class a pass.

In the early 1980s, Social Security was in danger of going bankrupt. A bipartisan commission composed of respected politicians and economists was asked to recommend measures that would make Social Security secure; the Congress would then vote on those recommendations. As a first-term U.S. senator, I held over a dozen special Social Security meetings in New Jersey to get people's sense of
what should happen, given the imperative for some kind of action. At each meeting, I had a professor from the state university explain the exact situation. I then put the options on a blackboard and asked the audience to choose the ones they preferred. The common political wisdom was that the seniors would want tax increases for people paying into the system but not benefit cuts; that workers would want benefit cuts for the elderly and not tax increases for themselves; and that neither the old nor the young would want the retirement age raised. To my surprise I discovered that seniors knew that to save the Social Security system just by increasing taxes would hit their children too hard. They volunteered to take some benefit cuts so the tax increases wouldn't have to be so large. Workers knew that just cutting benefits would hurt their parents, and therefore they accepted some increased taxes. And both groups agreed to raise the retirement age to sixty-seven, if it was done not immediately but over the next several decades. The bipartisan commission recommended all three measures—benefit cuts, tax increases, and raising the retirement age—and the Congress adopted them. The solution asked something of everyone. That's what has to happen today, in the negotiations over our larger budget. And it
will
happen, if the public has anything to say about it.

Today our politicians tend to score political points by pleasing their most extreme supporters. In last August's Republican presidential debate, one candidate was asked whether he would accept a measure requiring $4 of spending cuts for every $1 of new taxes. He said, “No.” How about $10 in cuts for every $1 of tax increase? Again, the answer was no. Finally, the questioner asked all eight candidates, “Is there any ratio of cuts to taxes that you would accept?” and the answer was
still no. The exchange revealed an ideological rigidity that endangers America. In a system that requires compromise to advance the public interest, it's difficult to move the country forward if compromise is ruled out. Apparently what was most important to those Republican candidates was the next election, not the economic health of their country.

As we saw in the federal debt-limit confrontation last summer, many Republican senators and representatives seem ready to let the country default on its debt rather than raise taxes. To give you an idea of how radical the views of these latter-day Republicans are, consider Ronald Reagan. He was known by his political base as the president who cut taxes by reducing the top marginal rate in 1981 from 70 percent to 50 percent and in 1986 from 50 percent to 28 percent. What is acknowledged by only a few Republicans, and just as rarely reported by the press, is that in 1982 he presided over the largest peacetime tax increase in American history, which replaced nearly one third of the revenue lost in the 1981 tax cut, and he followed this in 1984 with another large tax increase. He did this by closing a substantial number of tax loopholes—those special exclusions, credits, and deductions that benefit only selected taxpayers. In today's budget debates, the radical Republicans reject loophole closings because they increase taxes on someone. (Actually, closing loopholes doesn't “increase” taxes—it just makes sure that someone who owes taxes doesn't get out of paying them.) By taking this rigid “no tax” position, they forfeit their claim to the legacy of Ronald Reagan.

Before Congress can appropriate money (which means to direct that it be spent), an authorizing committee has to determine the amount allowed for a particular project. The appropriations committee then decides the amount to be actually spent—usually something less than the authorized amount. For tax loopholes, there isn't even an authorizing committee; in effect, it's totally unaccountable spending.
Getting loopholes into the tax code is one of the specialties of well-heeled members of the Washington club. That's why a book about the Tax Reform Act of 1986 was entitled
Showdown at Gucci Gulch
, a reference to the hallway, lined with lobbyists, outside the Senate Finance Committee's hearing room. All you have to do in order to cut taxes for, say, corporations that buy a certain kind of machine, or people who buy a house rather than renting, is to stick a loophole in the tax code for them. From a budget standpoint, the result of this kind of tax cut is the same as if it were a spending program: It increases the deficit. You might as well have sent a check from the government to the special interest. Rewarding these taxpayers means that taxpayers who don't exhibit the encouraged behavior (by buying the machine or the house) suffer the consequences of a higher deficit.

There is more than $1.1 trillion of hidden spending in the form of credits, exclusions, and deductions in the present tax code. Most of them benefit some narrow interest—banks, oil companies, real-estate companies, insurance companies, mining companies, and charitable institutions, among others. So the rest of us pay higher taxes than we otherwise would, to make up for the lower taxes levied on the special interests. Russell Long, the chairman of the Finance Committee when I got to the Senate, told me one day, “If you give someone a tax cut, they never remember what you did. If you give them a tax increase, they never forget.” Still, politicians believe that the members of the special-interest groups will be appreciative and return the favor in either votes or campaign cash.

The narrower the loophole, the more likely, once it becomes law, that it will remain hidden in the 72,536 pages of the tax code. My favorite story is about the loophole that allows you to rent out your home for up to two weeks and pay no tax on the rent. When I asked how it got into the code, I was told it was the work of Herman Talmadge, the long-serving Georgia senator. Evidently he was petitioned
by a few wealthy homeowners near Augusta National Golf Club, which hosts the annual Masters tournament; they wanted to rent out their mansions to other wealthy people who were coming to the Masters. Talmadge accommodated them, and the provision is still in the law. Without a superb tax attorney, no one would know it exists, but the wealthy have superb tax attorneys.

It seems to be a law of nature that whenever you eliminate loopholes, they always seem to return. In 1986, we cut the top individual tax rate from 50 to 28 percent and paid for it by eliminating loopholes used by the wealthy to reduce their taxes, including the exclusion for capital gains. The result was that profits from the sale of capital assets were taxed at the same rates as income from wages. Within months of the Tax Reform Act of 1986 becoming law, lobbyists were advocating for the exclusion's reinstatement. I told them that if they succeeded, the top rate would inevitably rise to pay for it. They were not dissuaded. Capital gains taxes were cut to 20 percent, and the top rate went to 39 percent. The return of loopholes after passage of tax reform is like letting moths get into the closet and chew holes in your brand-new suit.

We can have an income tax system that has lower rates and fewer loopholes and brings in enough revenue for substantial deficit reduction. We can do this by eliminating loopholes and using some of the resulting revenue for a combination of deficit reduction and taxrate reduction. An alternative approach would be to raise the gasoline tax or institute an oil-import fee, with some of the money going to deficit reduction and some toward income tax or Social Security tax reduction or investment in infrastructure. If you increased the fuel-efficiency standard for cars to fifty miles per gallon, reinstated the cash-for-clunkers program, and phased in a one-dollar gasoline tax increase over ten years, citizens would end up a decade from now paying less for gasoline than they do today.

A third option would be to create a value-added tax and use some of the revenue for deficit reduction and some for credits that would reduce the tax's burden on low- and middle-income people. In an economy where 70 percent of our GDP, in good times and bad, comes from consumption, this tax would guarantee the long-term fiscal health of the United States, just as it has in Canada since 1991.