Use access key #2 to skip to page content.

Four Steps to US Fiscal Health

Recs

3

November 21, 2010 – Comments (10) | RELATED TICKERS: H , MMM

By Simon Johnson and James Kwak 

WASHINGTON, DC – The United States has a significant budget deficit, likely to be $1.3 trillion (10% of GDP) this year, and the long-term forecasts are worrying. According to the Congressional Budget Office (CBO, the leading nonpartisan experts), Social Security, together with Medicare, Medicaid, and other health-care programs, will grow to consume almost all tax revenues by 2035.

The US can finance these deficits in the short term – in fact, interest rates on US Treasuries have recently fallen to record low levels. But if there is no serious effort at fiscal consolidation, serious trouble lies ahead, both for the US and for the world economy. Thus, the US urgently needs to begin making four serious changes.

The first is comprehensive tax reform aimed at aligning tax policy with desirable economic incentives. In particular, the US should consider introducing a value-added tax (VAT), widely used in other industrialized countries. By levying a tax on consumption at each stage of the production chain, America could reduce the overconsumption that helped feed the recent credit bubble, encouraging savings and investment instead. To be sure, a simple VAT is regressive, though it can be made progressive by combining it with a partial rebate or by exempting necessities.

Moreover, the US should look hard at tax breaks that act like hidden spending programs. One place to start is the tax deduction for interest payments on home mortgages. The deduction is currently available on mortgages of up to $1 million, this forming a key component of America’s excessive incentives to buy houses – a policy eschewed by most other industrialized countries.

The second change is carbon pricing, either by auctioning emissions allocations or by taxing carbon directly, at rates that start low and rise over the coming decades. Given large potential revenues – in 2008, the CBO estimated that one proposal would yield $145 billion in 2012 and more in subsequent years – it would make sense to dedicate a portion to cushioning the impact of higher energy prices on the poor, while applying the rest to the fiscal balance.

Opponents argue that carbon pricing would hurt economic growth. But a recent study commissioned by The Economist found that a carbon tax would increase both government revenue and economic output – primarily by replacing existing, inefficient energy subsidies.

The third change is a tax on the financial sector, in the form of a Financial Activities Tax on profits and remuneration at big banks that enjoy implicit government guarantees. The International Monetary Fund estimates that this form of value-added tax could bring in between 0.5 and one percentage point of GDP in revenue.

Such a tax, moreover, would aim to eliminate the funding advantage that large banks enjoy over their smaller competitors, while limiting the incentive for big banks to become even bigger. As the IMF argues, if applied across the G-20, a Financial Activities Tax would help constrain the worst features of the financial system and reduce the competitive distortions created by the megabanks.

Finally, there is the issue of entitlement spending, which is mainly an issue of health-care costs. According to the CBO’s alternative fiscal scenario, growth in Social Security is comparatively modest, from 4.8% of GDP in 2010 to 6.2% in 2035. A relatively small change in the parameters of this program could lower its future costs, as was done in the 1980’s. At the same time, however, the relative cost of Medicare, Medicaid, and other health care programs will more than double, from 4.5% to 10.9% of GDP.

There are two ways to reduce the government’s health-care outlays: reduce the amount of health care the government buys, or reduce the cost of health care. The simplest solution is to mandate that the government buy less health care – by raising the eligibility age for Medicare, capping benefits for high-income beneficiaries, and so on.

The problem with this approach is that Medicare is not particularly generous to begin with. If the eligibility age were to increase, responsibility for health care for many people would simply be dumped back onto their employers, resulting in higher health-care costs for all working people. A better solution is to figure out how to reduce health-care costs.

This year’s health-care reform legislation, the Affordable Care Act (ACA), is a starting point. According to CBO data, the ACA will reduce the long-term fiscal deficit by two percentage points of GDP per year. A top priority should be to preserve and expand its cost-cutting provisions. Another obvious step to consider is to phase out the tax exclusion for employer-sponsored health plans, which would not only increase revenue, but also end the distorting effects of employer subsidization of health care.

But efforts to tackle health-care costs continue to be hampered by widespread reluctance to tackle sensitive issues, as epitomized by the “death panel” tempest of a year ago. Reshaping the US health-care system to focus on successful outcomes and quality of life, rather than on employing the newest and most expensive technology, is a challenge for which no one yet has a proven solution. It remains, more than any other single factor, the key to long-term fiscal sustainability.

10 Comments – Post Your Own

#1) On November 21, 2010 at 8:57 PM, BillyTG (29.58) wrote:

+1

So they want to add 3 big new taxes:

VAT (value added)

CAT (Carbon Allocation)

FAT (Financial Activities)

 

And a reduction in one of the most publicly prized programs of all:  Medicare/Medicaid

 

Politically, I think every one of their ideas has close to zero chance of becoming reality.

Report this comment
#2) On November 22, 2010 at 1:14 AM, awallejr (81.36) wrote:

Yes let's keep sticking it to the Average Joe.  Instead of taxing those CEOs and Board of Directors who bilk their companies obscene sums, we want to take away probably the only worthwhile tax deduction the average homeowner benefits from.

And for VAT?  Sure make those people who are just barely surviving spend more because the millionares and billionares want to disguise the issue so they don't have to pay more.

Entitlement issues are a concern with the Aging of America, but then again as the boomers die off those concerns dwindle ;p

Report this comment
#3) On November 22, 2010 at 6:28 AM, devoish (98.02) wrote:

awallejr and BillyTG,

awallejr. I agree with you on  the VAT tax as being the worst way to balance the budget that was suggested here, for the same reason - its impact on the poorest - that you point out.

Thanks for reading and replying. Obviously details matter when assessing impacts. One belief I have in favor of a Carbon tax, is that it does reduce the use of fossil fuels, and the cost of environmental degradation, that is usually imposed upon the poorest. It also most heavily taxes the least efficient uses of carbon and increases the value of energy efficiency. I understand there are those who assume that impacting value is best left to "free markets", but based upon real world examples that is probably not true.

To be sure, a simple VAT is regressive, though it can be made progressive by combining it with a partial rebate or by exempting necessities.

 Carbon Tax - Given large potential revenues – in 2008, the CBO estimated that one proposal would yield $145 billion in 2012 and more in subsequent years – it would make sense to dedicate a portion to cushioning the impact of higher energy prices on the poor, while applying the rest to the fiscal balance.

Medicare - The problem with this approach is that Medicare is not particularly generous to begin with. If the eligibility age were to increase, responsibility for health care for many people would simply be dumped back onto their employers, resulting in higher health-care costs for all working people. A better solution is to figure out how to reduce health-care costs

 Of course lowering health care costs takes me back two years to arguing in favor of a Single Payer healthcare plan - the type used in countries with higher life expectancys than th USA and half or less of the costs, and projected lower costs in the future not the projected quadrupling of costsexpected here.

Is that "average joe" fella we are both worried about the same "average joe" fella whose entitlements I keep reading need to be cut to balance that same budget?

Report this comment
#4) On November 22, 2010 at 11:36 AM, ChrisGraley (29.98) wrote:

Step 1) Stop spending voter like its going out of style.

Step 2) Refer back to step 1.

Report this comment
#5) On November 22, 2010 at 11:37 AM, ChrisGraley (29.98) wrote:

* spending voter $$$

Report this comment
#6) On November 22, 2010 at 5:03 PM, devoish (98.02) wrote:

Sorry Chris,

If I cannot have a decent lifestyle for sweeping your restaurant floor and making it possible for you to have the big bucks and a swept floor, I want different rules than you do.

Report this comment
#7) On November 26, 2010 at 11:29 PM, ChrisGraley (29.98) wrote:

You forget that under your system, I can't hire you if all you can do is sweep my floor.

Report this comment
#8) On November 27, 2010 at 12:11 AM, NOTvuffett (< 20) wrote:

Politicians love the VAT because the consumer does not see the taxes they collect.  They just blame the companies for price increases.

Carbon tax?  Pretty much the same thing- they sell it under the notion that they are going to "tax those evil polluters, and return money to the taxpayer".  When energy and goods increase in price it will be those evil companies again.

I wouldn't mind some tax increases if the govt. was really serious about controlling spending.  Govt. spending as a proportion of GDP both now and the foreseeable future is way out of line.

Report this comment
#9) On November 27, 2010 at 12:33 AM, wolfman225 (69.18) wrote:

If I cannot have a decent lifestyle for sweeping your restaurant floor and making it possible for you to have the big bucks and a swept floor, I want different rules than you do.

Isn't that about the most beautifully concise description of the leading cause of the mess we're in?  I suppose your idea of a decent life includes a house, car, "adequate healthcare", child-care, and a minimum of 2 weeks paid vacation per year?  All without having to work  any overtime, of course. Or doing anything other than "sweeping the floor".

Ignoring, of course, the inconvenient facts of what the business owner has had to go through (and the sacrifices he/she has had to make) to get to the position where he is able to hire you in the first place?

That, in a nutshell, is exactly the problem.  Far too many who can't make successes of themselves in the existing framework, want "different rules" to enable them to have the lifestyle they believe they deserve.  Or, at the very least, they insist on exemptions to the existing "rules" that will apply only to them as a way of "levelling the playing field".

Report this comment
#10) On December 03, 2010 at 9:47 PM, devoish (98.02) wrote:

wolfman225,

Are you trying to sell me "inadequate healthcare"? Too many insurers already in that business.

Yes, the rules have been changed to benefit a small portion of the population - the least productive. You want time to go to school, get educated, run a business, be an executive while i or someone else sweeps your floor. Good for you. I need to get from where i liive to where the floor is, so yes a clean place to live, and a reliable car without going into debt is important. Food would be nice too. 4 weeks paid, maybe six. And the healthcare the equal of yours. You aren't special and your sacrifices pale in comparison to the truly productive members of society.

Report this comment

Featured Broker Partners


Advertisement