Grand bargain on taxes and entitlements, redux.
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My good friend Steve Parente, professor of finance at the University of Minnesota, had a great op-ed in Politico on a "grand bargain" on deficit reduction in July 2011 . It is well worth re-reading before the President and Republicans meet on Friday to try and avert the "fiscal cliff" and, just possibly, find a serious way to address the spending challenges facing the nation.

First, a word about taxes. The president's proposal rests on the premise that fixing our fiscal woes cannot be accomplished without repealing the Bush tax cuts for Americans making more than $200,000 for individuals, and $250,000 for families. Veronique de Rugy, from the Mercatus Center, puts the president's proposal in context - how much he proposes to raise, and how much he proposes to spend over the next 10 years.

Bush-Tax-Cuts-Extension-Chart-Original.jpg

To put it another way, the president's proposal will raise about $80 billion annually in new revenues from "the rich" - when the U.S. is running annual deficits of about $1 trillion, or more than 10x that amount.

So where is he proposing to get the other 90% in spending cuts or revenues to balance the budget and pay down the debt, currently pegged at over $16 trillion?

(Cue the crickets.)

Taxing the rich is nice campaign slogan, but as a policy proposal it is utterly vacuous.

What would a serious policy proposal look like? That's where Steve comes in. His proposal would
generate $4 trillion in deficit reduction over the next 10 years, and over twice that further out. How?

1. Eliminate the employer tax deduction for health insurance and replace it with a much smaller individual tax credit. The current deduction costs the Treasury over $250 billion a year today, and helps drive up health care inflation. But wait - wouldn't the president object to this? Yes, but he'd be breathtakingly cynical about it. Obamacare already contains a 40% excise tax on Cadillac plans that is a back door way of attacking the employer tax deduction. Conveniently, it doesn't take effect until years after president Obama leaves office. Move it up, and make it serious.

2. Turn Medicare into a defined contribution plan with growth pegged at inflation plus one-half of the three years' previous growth in U.S. productivity. This would allow seniors to shop for plans that met their basic needs and focus lawmakers on making the U.S. economy as productive as possible, growing the wealth needed to sustain our entitlement programs.

3. Cap subsidies under Obamacare at 300% of the federal poverty level (down from 400%), repeal the medical device tax, and cap Medicaid growth and allow states to draw down their capped allotment from the federal treasury - this could be modeled after the current Rhode Island global Medicaid waiver.

The mix of revenue raising strategies, entitlement reforms that spur competition in health care markets, and Medicaid reforms would produce enormous savings and help rationalize federal spending.

As Steve notes,

This health bargain is likely to yield a savings of $4 trillion over 10 years, extrapolating from existing Congressional Budget Office estimates, and more than twice that amount over 20 years. Because these policies are based on existing CBO estimates, legislation can be gift-wrapped and delivered to the president's desk.

The likelihood of such a grand bargain seems slim at this point, since the President has given no serious signals that he's willing to consider reforms to existing entitlements, let alone the Affordable Care Act.

But it would be worth pushing for. The President could be calling for raising taxes on the "wealthy" as cover on his left flank for fundamental reforms and a grand compromise with Republicans. After all, at this point he doesn't need to worry about his base for his next re-election.

And if conservatives and moderates push for a grand bargain and are rebuffed it will at least clarify who is really serious about fixing the house of cards that is the U.S. budget.

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