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Rep. Ryan's Economic Road Map Is a Good Start

Josh Barro
Real Clear Markets
February 16, 2010

With over $9 trillion in federal budget deficits expected over the next 10 years, lots of people in Washington are talking about the gap between taxes and spending. Rep. Paul Ryan is unusual in that he's proposed to do something about it.

Ryan, the ranking Republican on the House Budget Committee, released last month an updated version of "A Roadmap for America's Future." The Roadmap proposes radical changes in entitlement programs and our tax code, with the intent of making the federal budget sustainable while encouraging economic growth.

The plan is not perfect, but it contains a lot of excellent components and is a good starting point for discussions on fiscal reform. It would put a brake on runaway entitlement spending; reform provisions of our tax code that discourage capital investment and foster runaway health care costs; and significantly reduce marginal tax rates. The plan's key drawback is that it takes far too long—over 40 years—to bring the federal budget deficit to a sustainable level under 2% of GDP.

The centerpiece of the Ryan plan is entitlement reform. This is important, because entitlements (especially health care entitlements) are the key driver of our unsustainable federal budget.

Under the Roadmap, federal Medicare and Medicaid spending would peak at 6.7% of the economy in 2035 and then begin falling. Under current policy, today's figure of 5.3% would nearly double to 10.0% over the same period, continuing to rise therafter.

Ryan would achieve these savings by taking Americans currently under 55 out of Medicare and instead give them vouchers to buy private insurance in retirement. The value of these vouchers would grow more slowly than medical inflation. Additionally, Ryan would introduce means testing and gradually raise the retirement age to 69. Medicaid would undergo a similar reform.

Social Security would not see short-term savings, partly because the Roadmap introduces individual accounts that raise the near-term cost of providing benefits. Like Medicare, Social Security would also undergo means testing and a rise in the retirement age (to 70) which would produce long term savings.

Aside from entitlements, Ryan makes several proposals that would look sweeping in any other context:

• Replace the tax exclusion for health insurance benefits with a fixed tax credit. Our current tax code provides greater tax benefits for people who "eat" the most health care, encouraging overconsumption. This is a reform that would "bend the cost curve" and also make reduced Medicare benefits more palatable—if demand for health care falls overall, it will become cheaper to provide a comprehensive health plan for a senior citizen.

• Freeze non-defense discretionary spending for ten years and then place a stringent cap on discretionary spending growth thereafter. The plan does not provide detail on the program cuts that would result.

• Allow taxpayers to file under the existing income tax code or a simplified version with just two brackets (10% and 25%) and a generous standard deduction, but no additional deductions except the health care credit.

• Eliminate taxes on corporate income, dividends and capital gains, and implement an 8.5% VAT. (Presumably for political reasons, the Roadmap carefully admits any use of the term "VAT," calling it a "business consumption tax.")

The Roadmap provides a lot of food for thought, but it's not a perfect or finished plan. Here are a few drawbacks and areas for improvement:

• The heart of the Medicare and Medicaid reforms is a reduction in the generosity of benefits. For this reform to be sustainable, health care cost inflation must be controlled. Otherwise, seniors may end up unable to afford health care they need or—more likely—the reforms will be revised to spend more money, necessitating tax hikes or additional borrowing. The Roadmap includes several measures that would put downward pressure on health care costs, but more study is needed to ensure that they are sufficient. This is especially true because the political demagoguery around Medicare cuts—much of it driven by Ryan's fellow Republicans—makes the public very wary of benefit reductions.

• Adding private accounts to Social Security is a major political distraction that accomplishes little. Because the government would guarantee a minimum return in individual accounts, much of the budgetary benefit of privatization is lost. As a result, the CBO notes that Social Security would have a "lower economic cost" if means testing were implemented and retirement ages increased, but partial privatization omitted.

• The proposal on business taxation needs refinement. Currently, our system subjects business income to tax twice: through the corporate income tax, then again as dividends or capital gains. By eliminating all these taxes, Ryan swings the pendulum too far in the opposite direction, creating significant opportunities to shelter income from tax by routing it through corporations.

Finally and most importantly, the plan still runs deficits that are far too large. The average postwar budget deficit is around 2% of GDP, but the Roadmap is not projected to reach this level until 2051. As a result, federal debt would peak at 100% of GDP in 2041, a level only previously breached during World War II. (The 2008 level was 41%).

While it is not impossible for an advanced country to carry this kind of debt burden—Italy does so on a regular basis—it would significantly damage our creditworthiness. Furthermore, it's simply unnecessary: we do not face a war or other crisis that requires us to build this mountain of debt.

Revisions to the plan could shrink projected deficits. Abandoning Social Security privatization (but retaining the benefit cuts) would reduce outlays; a less aggressive reduction in business taxes (for example, eliminating capital gains and dividend taxes but retaining a corporate tax at 25%) would raise more revenue. The plan also turns its scalpel to every major spending area except the military—seeking savings in defense would be wise, especially where congressional spending objectives do not match our needs in today's wars.

The Roadmap may not be perfect, but President Obama was right to call it "a serious proposal." After the midterm elections, Obama's own deficit commission will come back with its own plan for deficit reduction, which will likely involve large tax increases. A refined version of the Roadmap will serve a useful purpose in the ensuing discussion, by allowing conservatives to make the case that major tax increases are not necessary to make the federal budget sustainable.

Josh Barro is a Senior Fellow at the Manhattan Institute.

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