The economy is hot because we are spending like there is no tomorrow. It is a classic example of kicking the can down the road rather than taking on the hard allocation choices.
What needS fixing?
- Social security so it will continue past 2034 AARP
- Medicare so it will continue past 2026 USA Today
- The deficit that is expected to be $1 trillion this year CBO
- The accumulated debt that will exceed $20 trillion this year Market Watch
- Infrastructure rebuilding estimated to cost $4.6 trillion Money.CNN
The objective is to bring spending and revenues in line while still providing the essentials and avoiding a painful austerity period. Currently. the CBO’s 30-year forecast has revenue lagging behind spending the entire time, causing the debt to climb dramatically.
What is the solution? The options are raise taxes, cut spending, or do some of both. The calculations below are rough in that they are drawn from different sources and years and do not account for all the secondary impacts of the changes considered. They are intended to illustrate the magnitude of the economic challenges we face and the bold actions that need to be taken.
The case for raising taxes
The basic argument for raising taxes is that it is less contractionary than cuts in government spending. First, tax increases can be levied on the wealthy, limiting who is impacted by the increase. Second, as some part of income is saved, a dollar increase in taxes cuts spending by less than a dollar, blunting its impact. Third, as the Bradford Tax Institute graphic shows, in 2017 the top federal tax rate was nearly at an all time low historically at 42 percent and has been cut to 37 percent. From our historical experience, we know that the economy can bear higher taxes without significantly stifling growth.
Rolling back the Trump tax cuts would increase revenues by $1.4 trillion over 10 years or about $140 billion a year. Applying the Buffet tax rule of a minimum 30 percent tax on anyone who makes more than one million dollars a year will increase revenues by about $16 billion annually. Forbes Adjusting tax rates, particularly at the top of the income distribution, through a partial rollback of the 2001 to 2004 tax cuts could bring in about $70 billion per year. Another option is to institute a value-added tax. At a rate of 10 percent value-added tax (VAT) could raise the whole $1 trillion (about 5 percent of GDP)or a smaller rate could be levied along with other tax increases and spending cuts. Brookings. To ensure the VAT is not highly regressive, we could exclude staples such as food.
The case for cutting spending
As the graphic for the National Priority Project shows Social Security and unemployment insurance, Medicare, and defense comprise 76 percent of our budget. Everything else is tiny compared to these programs and frankly won’t make much difference. If we truly want to contain spending we have to bring these programs in line.
The augment for cutting Social Security and Medicare is that significant demographic changes since the two programs were enacted have worked to unintentionally expand the programs. The programs were intended to help people at the end of their lives but not for 20 years or more. Social Security was started in 1935 and Medicare became law in 1965, the average life expectancy in those days were 61 and 70, respectively. The average life expectancy is now 79 years. However, we have only increased the eligibility age for Social Security to 67 for those born after 1960 and have made no change to the Medicare eligibility age. It makes sense to continue slowly raising the eligibility age for those who are still several years away from entering these programs. However, given 68 percent of individuals retire by age 65, raising the eligibility age for Social Security and Medicare beyond age 70 will be difficult. CBO estimates that raising the entry age for both Social Security and Medicare slowly over time, would save about $380 billion over first 10 years or about $38 billion a year. The savings are somewhat tempered by the fact individuals will shift to other government programs, such as Medicaid, to get health care coverage.
The other lever we have is to cut defense spending, We outspend the world on defense. As the Forbes graphic shows, the US spends nearly three times more than China, the second highest spender. Do we really need to outspend the world by a factor of three or would spending twice as much suffice? Such a deep cut would need to be spread slowly over 10 to 20 years but the target should be a reduction of about $200 billion.
The case for raising taxes and cutting spending
None of the above tax increases and spending cuts individually or taken together are sufficient to balance the budget other than the 10-percent VAT. In fact, all the other changes would only cut the current deficit of $1 trillion to $600 billion. To eliminate the remaining $600 billion from the deficit, we could trim the non-military, non-Medicare, non-Social Security share of the budget, which is only $912 billion. Cutting more than $100 billion from this share of the budget is unreasonable. That leaves $500 billion that needs to come from somewhere. Although we don’t have to fully zero out the deficit, a 5-percent VAT would likely eliminate the deficit.