James Pethokoukis

Politics and policy from inside Washington

Obama deficit panel veers dangerously off track

October 26, 2010

Here’s the problem with President Barack Obama’s deficit reduction commission: Exploding debt caused by out-of-control healthcare spending is an Extinction Level Event for the U.S economy.  By 2050, according to the Congressional Budget Office, the national debt will likely be three times as big as the overall economy with Medicare and Medicaid gobbling up half the budget.

And that’s not even the worst news. Such a fiscal path would cause an economic implosion long before 2050. Financial Armageddon. Yet the Obama panel almost certainly won’t come to agreement on any fixes for healthcare entitlements. Probably not Social Security, either.

But the group is eyeing $1 trillion in annual tax breaks as a way of cutting the budget. These “tax expenditures” include a variety of credits and deductions for federally favored activities. Many economists on both sides – and a few brave politicians – agree, however, that such favoritism introduces harmful market distortions.

While low interest rates and lax regulation had star billing in the American housing bubble, the $89 billion mortgage deduction in 2008 also was a supporting player. It’s also true an aging society and advancing technology are prime drivers of rising healthcare costs. But so too is giving related benefits a $131 billion annual tax break.

Let’s say America axed mortgage-interest deductions, child tax credits and the ability of employees to pay their portion of their health-insurance tab with pretax dollars. All these are mentioned in a Wall Street Journal story on Monday. Analysis by Americans for Tax Reform finds the net effect would be a $2.4 trillion tax hike over the next five years. (Mortgage interest deduction: $638 billion; child tax credit: $60 billion; exclusion for employer-provided health insurance: $1.66 trillion, including higher FICA taxes.)

Such a fiscal drain would surely put America back into recession, unless marginal tax rates were also lowered to compensate.  Cutting the total amount of tax expenditures by half might allow the top income tax rate to be cut from 35 percent to 25 percent.  That is what you want in an ideal, pro-growth tax system: low rates applied to a broad base.

The politics are treacherous. That’s why major reform hasn’t happened in a generation. Back in 1986, Congress agreed to eliminate scores of tax loopholes for individuals. But lawmakers wisely sweetened the bitter medicine at the last minute by lowering the top marginal tax rate by nearly half, making those breaks less valuable. Many businesses were also willing to accept fewer tax breaks and pay higher total taxes in exchange for a simpler code and a lower rate, although this didn’t make it into the final bill.

Obama’s panelists should draw on this experience. They could advocate trimming some of the $90 billion in annual business tax breaks and subsidies while also paring the tax rate on profits, currently the second highest among advanced economies. And if they want to trim tax breaks for individuals, sharply lower marginal rates should accompany.

Austerity alone won’t solve America’s debt problem. We also need to boost growth. Some on the Obama panel seem to have forgotten this.

Comments

‘We also need to boost growth. Some on the Obama panel seem to have forgotten this.’

That’s assuming they even considered the idea of boosting growth in the first place.

Posted by Gotthardbahn | Report as abusive
 

Any free marketer should be against all these welfare giveaways. We use euphemisms like “tax credits” but in reality they are not different than entitlement payments. They distort the free marker and have one group of people (renters) subsidize another group (mortgage debtors).

If the new Congress is truly free marketers, they will eliminate all these unfair welfare giveaways.

Posted by FreeLouis | Report as abusive
 

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