Attention: Deficit

Should progressives embrace entitlement reform? Or look elsewhere to narrow the gap? An exchange between two leading fiscal experts.

Even worse, the mania for deficit reduction threatens to sabotage the economic recovery. The preoccupation with deficits is preventing a more robust federal response to unemployment levels near 10 percent, even with large Democratic majorities in Congress, a demonstration of just how self-destructive budget hawkery has become. Undue concern over deficits is impeding additional public investment that would lead to job growth, higher consumption, and increased tax revenues from rising incomes. Virtually all economists agree that last year’s stimulus bill helped to stanch job losses, so why not build on that proven success with a major bolus of additional stimulus to drive unemployment down further? Because, we’re told somberly, our grandchildren will suffer for it in 2050.

Once solid job growth finally resumes, whenever that might be, then indeed major steps will need to be taken to prevent deficits from climbing to unsustainable levels beginning in the 2020s. As Sawhill indicated, those daunting projections derive almost entirely from expectations that health-care costs will continue to rise much faster than inflation. Skyrocketing costs will cause spending on Medicare and Medicaid to soar, just as private insurance expenses are also expected to continue escalating rapidly. The new health-care legislation–a huge progressive accomplishment, not incidentally–extends Medicare’s solvency by a full decade while including many provisions aimed at making the program more cost-effective, primarily by reducing the use of unnecessary tests and procedures. We don’t yet know which, if any, of those changes will work. But the bill creates the beginnings of an institutional framework that has the potential to eventually reduce the rampant wastefulness in our health-care system and curb the unsustainable rate of spending growth. Going forward, progressives should be prepared to aggressively build on that structure by expanding on the successful experiments and recalibrating less effective initiatives. The next round of reforms also ought to include a public option for the new insurance exchanges that would have the potential to exert leverage in ways that further control costs.

Beyond that, though, the kinds of changes for Medicare that Sawhill recommends would do nothing to affect the central cost-effectiveness challenge. Setting arbitrary limits on per-capita public spending, as she concedes, would almost certainly lead to cost shifting to individuals or to the private sector (which in turn is already shifting them further and further to individuals as well). Given the extent to which Medicare beneficiaries already bear a substantial and rising share of their health-care costs–the program’s deductibles are generally higher than is standard in private insurance, for example–imposing a global cap on spending would simply weaken already modest protections for individuals without constraining costs. What’s progressive about that?

Deficit hawks habitually invoke bank robber Willie Sutton when they talk about having no choice but to cut social-insurance programs, arguing “that’s where the money is.” But actually, there are all kinds of multi-trillion dollar targets for long-term deficit reduction that could be tapped without imposing unnecessary pain on the vast majority of Americans, and which in many cases would make the government more cost-efficient. Taking aim at those pots wouldn’t bend the notorious health-care cost curve, but going after them beginning later in this decade would keep deficits at a manageable level until reforms eventually do significantly rein in medical costs.

The most obvious source of savings is the defense budget. A bipartisan task force organized by the Project on Defense Alternatives issued a report in June spelling out specific defense cuts that would save $960 billion between 2011 and 2020 alone. The report emphasizes how those changes would not weaken America’s military capabilities. While the powerful defense industry lobby will fiercely resist reductions to their federal largesse, the pushback arising from their parochial interests would be meek compared to the public backlash against deep cuts in universal programs.

Another massive target is the welter of so-called “tax expenditures”–basically, government subsidy programs that take the form of tax breaks. The CBO tabulates that there are some 165 tax expenditures that will cost the federal government more than $5 trillion over the next five years; those include the home-mortgage-interest deduction and 401(k) tax-deferred savings plans, as well as industry-focused write-offs like the percentage depletion allowance for oil companies. Unlike conventional discretionary spending programs, tax expenditures are not subject to ongoing congressional oversight or annual appropriations, so there’s little accountability in assessing how effective they are at advancing their intended purpose. Many of them disproportionately benefit high-income individuals or narrow industry classes.

One particular inequity is the tax-favored treatment of capital gains and dividends. Taxing income from investments at the same rate as income from work would raise upwards of $1 trillion over a decade while almost exclusively affecting very high earners–the 0.3 percent of tax returns reporting income in excess of $1 million accounted for 61 percent of all capital gains in 2006. The tax code would become much simpler, more equitable, and economically efficient in the process, without significantly affecting the economy. Such a change also happens to be a reform that Ronald Reagan signed into law back in 1986 as part of a major overhaul that reduced overall income tax rates while eliminating many write-offs, a model that just might be politically plausible again in the coming decade.

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