Fasten your Seat Belts! An Even Tougher Deficit Plan
Policy + Politics

Fasten your Seat Belts! An Even Tougher Deficit Plan

Former Congressional Budget Director Alice Rivlin and former Senate Budget Committee Chairman Pete V. Domenici, R-N.M., have been combating public debt for decades, and have few peers as federal budget mavens. Today, the Bipartisan Policy Center (BPC) Debt Reduction Task Force they co-chair is releasing some of the most far-reaching proposals yet for sharply reducing the federal debt, beginning in 2020.

The task force report outlines measures to “blow up the income tax and start over,” slash projected Medicare and Medicaid costs by $756 billion over the coming decade, impose a medium-term freeze on defense and domestic discretionary spending, introduce a host of solvency-creating Social Security reforms, and impose a national “debt reduction sales tax,” Rivlin told The Fiscal Times during a recent interview in her Brookings Institution office.

The proposed national sales tax known as a Value Added Tax (VAT) will be highly controversial because it would be imposed on top of existing state sales taxes — potentially a blow to the economic recovery. And the proposal for Medicare would dramatically alter the way the national health insurance program for the elderly is financed and operated.

“Debt is a big problem, which is why ours is a bold plan,” said Rivlin, who also serves on President Obama’s bipartisan deficit commission, which is due to issue its own report in two weeks. Rivlin and Domenici believe the country is facing a serious fiscal crisis with the annual budget deficit well in excess of $1 trillion and the national debt threatening to bump up against a $14.3 trillion debt ceiling by early next year.

“This crisis is an opportunity to do some significant reforms,” Rivlin said. “And it’s important to demonstrate that a bunch of Republicans and Democrats can come together on something the group believes is viable, even if not everyone agrees with all the pieces.”

Last week, the chairmen of the President’s commission, Erskine Bowles, former chief of staff to President Clinton, and former Republican Sen. Alan Simpson, R-Wyoming, publicly floated recommendations to reduce deficits by $3.8 trillion over the next decade and spark discussion among commission members. These ideas, which overlap with some being presented today by the BPC group, have won some kudos for the boldness but already sparked fierce criticism across the political spectrum.

If anything, the Rivlin-Domenici task force recommendations are even bolder. Overall, the plan would cut the deficit by $5.8 trillion by 2020. The plan includes nine components that address virtually all aspects of federal spending and taxes in ways intended to establish long-term fiscal responsibility, spread cuts among entitlement and discretionary spending, radically revamp America’s tax system, and help stimulate economic growth. “The pieces of this plan, like any budget plan, are ones that would not have much chance if voted on by themselves, but I’m very excited about the broader package,” Rivlin said. (The task force is partly funded by the Peter G. Peterson Foundation. Peter Peterson also finances The Fiscal Times.)

The task force set a 2020 target to reduce federal debt to 60 percent of the gross domestic product by cutting annual deficits through budget cuts and revenue increases, compared to 90 percent of GDP that the Congressional Budget Office has projected by 2020, assuming that the Bush-era tax cuts are extended. In order to achieve that goal, Rivlin and her 18 colleagues call for reducing overall federal spending as a share of GDP from 26 percent to 23 percent, still somewhat above levels of the late 20th century and above Bowles’ and Simpson’s call for 21 percent.

Because spiraling costs for Medicare, Medicaid and other federal health programs are the biggest driver of long-term debt, the Rivlin-Domenici commission proposes reinforcing cost-control measures. Medicare for seniors would gradually be transformed to a “premium support” program beginning in 2018, limiting federal payments for each beneficiary.

Under one form of “premium support,” the federal government would contribute a certain amount toward the purchase of Medicare coverage, based on the premiums charged by different health plans. Beneficiaries could choose something akin to the traditional fee-for-service option or a privately-sponsored health plan such as a health maintenance organization.   

Defense spending would be frozen for five years at levels
based on sharply-diminished spending on the war in Afghanistan.

The tax exclusion on employer-provided health benefits would be phased out to encourage employers and workers to choose more cost-effective health plans. Managed-care principles would be applied to Medicaid costs for the poor, and the federal-state financing mechanism would be altered to stop what the report calls the “gaming of the matching payment system.”

Domestic discretionary spending, covering federal agencies and the general operation of government, would be frozen for four years through statutory spending caps that would be enforced by automatic cuts. Similarly, defense spending would be frozen for five years at levels based on sharply-diminished spending on the war in Afghanistan.

Many of the task force’s Social Security reforms have been embraced by other commissions and experts. Benefit growth for the wealthiest beneficiaries would be slowed, retirement benefits would be indexed to longevity, and state and local government workers’ exemption from Social Security taxes would end. The payroll tax cap, currently $106,800 a year, would be raised to cover 90 percent of all wages; cost-of-living adjustments would be limited to price inflation, and minimum benefits for low-wage earners would be increased.

Arguably, the most radical recommendations concern tax reform — a subject that most politicians are leery of addressing for fear that real or purported “tax increases” spell electoral defeat. The multipronged plan, which Rivlin called “drastic,” would eliminate income tax filing for half of the population, simplify and lower income and corporate taxes, get rid of most deductions and tax credits, and introduce a 6.5 percent national sales tax on top of existing state sales taxes. Sales taxes typically are regressive because they hit middle and lower income people the hardest, proportionate to their income. The proposed national sales tax would be phased in over two years.  

The income tax would have only two tax brackets instead of the current six brackets — 15 percent and 27 percent with the lower rate applying to the first dollar of income and the higher rate for couples earning at least $102,000. Instead of itemized deductions, the plan would provide a maximum mortgage credit of $25,000, wipe out state and local tax deductions, and provide flat 15 percent credits for charitable donations and contributions to retirement savings accounts up to a $20,000 ceiling.

The corporate tax rate would be lowered from 35 percent to 27 percent. Capital gains would be taxed as ordinary income, which is higher than the current level; Social Security benefits would be completely taxed, and the earned-income tax credit would be replaced with simpler, refundable earnings and child tax credits. 

The proposal also calls for long-term budgets for entitlement programs including Medicare and Medicaid, a switch from annual to biennial budgeting, and strict pay as you go requirements for offsetting the cost of new spending that would still exempt emergencies. In addition, before the austerity measures set in, the commission calls for a 2011 payroll tax holiday to help stimulate the economy.

Rivlin, who became the first director of the CBO in 1975 and the first woman to direct the Office of Management and Budget in 1994, is under “no illusion that the plan will be accepted in its entirety.” But she is characteristically optimistic that it, together with the recommendations that emerge from the president’s commission, can help break what she describes as the current policy logjam.  

The 19-member group was established a year ago, before Obama created his debt-reduction panel after Congress rejected a plan to establish a similar commission. Domenici served in the Senate from 1973 to 2009 — the longest-serving senator from New Mexico — and during that time he was both the chairman and ranking minority member of the Budget Committee and a member of the Appropriations Committee. As budget chairman, he produced two consecutive balanced budgets, the only federal balanced budgets in the last 50 years.

The group met regularly since this spring, supported by a staff of tax, health care and other experts. Rivlin — who was also a member of the Pew-Peterson debt-reduction commission, whose report last week focused on budget process reform — said there were frequent disagreements, and that some are reflected in footnotes to the report. Nonetheless, she said that members “made concessions and came to general agreement” on the proposals.

Rivlin declined to speculate on how the recommendations or those of the president’s commission would play with legislators, as well as what the effect this month’s midterm elections would have on the prospects for fiscal reform. “I could spin a yarn about how it will make it easier or harder,” she said. “But this plan is something for the public to get engaged in and think about, and Congress has to do something.”