Rate Watch #771 Simpson-Bowles

April 15, 2011
by Dick Lepre
dicklepre@rpm-mtg.com
www.loanmine.com

Analysis

Economic fundamentals give little indication about where the economy is going. For me, the underlying fact is that inept fiscal policy is the most serious risk to the economy. In brief, who cares if QEII is zero or $600 billion if the deficit in 2.5 times that size? The President addressed fiscal policy earlier this week. To the extent that the discussion is framed more as a political left-right thing that a real discussion the probability is that the problem will not be addressed and disaster will ensue in about 2 years. If those in Congress are more interested in getting reelected and fighting about power than they are interested in fiscal sustainability then disaster is going to ensue.

Fortunately, a comprehensive plan is out there despite the best efforts of politicians to ignore it. The real problem is the same as it has long been: a real solution to out fiscal problems exists but is incompatible with reelection. If you want a solution to the fiscal crisis then you should regard Simpson-Bowles as the starting point. If you really, really enjoy inane partisan bickering than feel free to support either Obama or Ryan.

Simpson-Bowles

It took four months but the President has finally, albeit in a seriously limited manner, gotten behind part on the Simpson-Bowles deficit reduction plan. Obama's version missed many of the important points of Simpson-Bowles. The core of Simpson-Bowles is to drastically reduce deductions and lower tax rates. Obama missed the part about lower tax rates. That is understandable from a political point of view but not an economic one. Obama missed the crux of Simpson-Bowles on Medicare and did not even dwell on Social Security. By failing to present anything of substance the President leaves Simpson-Bowles as the standard.

Simpson-Bowles should be the starting point for achieving fiscal sustainability. It addressed all federal spending including Medicare, Medicaid and Social Security as well as the items which are responsible for the cyclical deficits.

The political courage to back Simpson-Bowles is simply lacking because Simpson-Bowles is not a plan for getting reelected but merely for saving the country from fiscal doom.

The Simpson-Bowles plan has six components:

Discretionary Spending Cuts
Tax Reform
Health Policies
Other Mandatory Policies
Social Security
Process Reform

The following is a synopsis of each component.

Discretionary Spending Cuts

Cap discretionary spending through 2020. Hold spending in 2012 equal to or lower than spending in 2011, and return spending to pre-crisis 2008 levels in real terms in 2013. Limit future spending growth to half the projected inflation rate through 2020. The details are on page 22 of the report. The report is not vague but describes, in detail, the mechanisms for achieving this cap in discretionary spending. If you are interested please read the details. These are too extensive to deal with here.

Tax Reform

This is where Simpson-Bowles points out that the class-warfare discussion about tax rates misses the point that the issue is not tax rates but the tax code itself or, in plainer English, deductions.

I will repeat here the language from Simpson-Bowles describing this: "America’s tax code is broken and must be reformed. In the quarter century since the last comprehensive tax reform, Washington has riddled the system with countless tax expenditures, which are simply spending by another name. These tax earmarks – amounting to $1.1 trillion a year of spending in the tax code – not only increase the deficit, but cause tax rates to be too high. Instead of promoting economic growth and competitiveness, our current code drives up health care costs and provides special treatment to special interests. The code presents individuals and businesses with perverse economic incentives instead of a level playing field."

Simpson-Bowles makes the semantic point that the IRS tax code is a spending plan as it provides tax deductions which are, in effect, givebacks of money which would be receipts to Treasury absent all the tax breaks.

The following table is a description of the tax reform part of Simpson-Bowles.

 

	Current Law	Proposal
Tax rates for Individuals	six brackets: 10%,15%,25%, 28%,33%,35%.	Three brackets: 12%,22%,28%
Alternative Minimum Tax	Scheduled to hit middle-income individuals but “patched” annually	Permanently repealed
PEP and Pease (see note)	Repealed for 2010, resumes in 2011	Permanently repealed
EITC and Child Tax Credit	Partially refundable child tax credit of $1000 per child. Refundable EITC of between $457 and $5,666	Maintain current law or an equivalent alternative
Standard Deduction and Exemptions	Standard deduction of $5,700 ($11,400 for couple) for non-itemizers; personal and dependent exemptions of $3,650	Itemized deductions eliminated, so all individuals take standard deductions
Capital Gains and Dividends	In 2010, top rate of 15% for capital gains and dividends. In 2011, top rate of 20% for capital gains, and dividends taxed as ordinary income	All capital gains and dividends taxed at ordinary income rates
Mortgage Interest	Deductible for itemizers; Mortgage capped at $1 million for principal and second residences, plus an additional $100,000 for home equity	12% non-refundable tax credit available to all taxpayers; Mortgage capped at $500,000; No credit for interest from second residence and equity
Employer Provided Health Care Insurance	Excluded from income. 40% excise tax on high cost plans (generally $27,500 for families) begins in 2018; threshold indexed to inflation	Exclusion capped at 75th percentile of premium levels in 2014, with cap frozen in nominal terms through 2018 and phased out by 2038; Excise tax reduced to 12%
Charitable Giving	Deductible for itemizers	12% nonrefundable tax credit available to all taxpayers; available above 2% of Adjusted Gross Income (AGI) floor
State and Municipal Bonds	Interest exempt from income	Interest taxable as income for newly-issued bonds
Retirement	Multiple retirement account options with different contribution limits; saver’s credit of up to $1,000	Consolidate retirement accounts; cap tax-preferred contributions to lower of $20,000 or 20% of income, expand saver’s credit
Other Tax Expenses	Over 150 additional tax expenditures	Nearly all other income tax expenditures are eliminated

PEP is an acronym for "personal exemption phase-out", which rescinds the benefit of the personal exemption from taxpayers who earn over a certain amount. Pease is the phase out of almost all deductions. "Pease" was the last name of the Congressman who suggested this in 1990.

Simpson-Bowles states that corporate tax rate are too high (they are in fact much higher than almost all other developed nations.) High corporate tax rate create a competitive disadvantage for U.S. corporations consequently lowering tax receipts and discouraging domestic jobs.

Health Policies

I find it impossible to reduce what Simpson-Bowles says about health care reform to a few simple paragraphs. The report states "Federal health care spending represents our single largest fiscal challenge over the long-run." If you want the details please read the report. It is also important to understand that the CBO's analysis of "Obamacare" is based on a scheduled 23% cut in Medicare physician payments that Simpson-Bowles believes will never occur. The "official" words from CBO and the trustees of the Medicare Fund are, according to the Simpson-Bowles document, bogus.

Other Mandatory Policies

Slightly less than one-fifth of the federal budget is dedicated to other mandatory programs. These include civilian and military retirement, income support programs, veterans’ benefits, agricultural subsidies, student loans, and others. Some points here are: privatization of some present public sector jobs, bringing military and civilian pensions in line with private sector pensions, reducing agricultural subsidies, and giving the USPS the power to make the changes necessary to survive (this is largely about closing post offices.)

Social Security

To save Social Security for the long haul, all of us must do our part. The most fortunate will have to contribute the most, by taking lower benefits than scheduled and paying more in payroll taxes. Middle-income earners who are able to work will need to do so a little longer. At the same time, Social Security must do more to reduce poverty among the very poor and very old who need help the most. The problem with Social Security are partly demographic. When SS started average life expectancy was 64 and the earliest retirement age was 65. Presently, average life expectancy is 14 years greater. In 1950 there were 15 workers per beneficiary. In 1960 there were 5 workers per beneficiary. At present there are 3 workers per beneficiary. To paraphrase Shakespeare "The fault, dear Brutus, in not in our hearts but in the math."

Process Reform

This part is an attempt to keep the budget balanced in the event that it ever actually gets balanced.

The Commission recommends adopting the “chain-weighted” Consumer Price Index for Urban Consumers (C-CPI-U) for all federal programs and tax provisions that currently rely on the CPI-U and CPI-W.

The Commission recommends an enforcement mechanism to ensure the budget achieves primary balance by 2015 and the debt is stabilized thereafter. The Commission’s proposal would require action by the President and Congress on budget stabilization legislation if the budget (excluding interest costs) is projected to have a deficit in 2015, or if the debt held by the public has not stabilized thereafter. The debt stabilization process would include fast-track procedures to facilitate changes in law necessary to protect the fiscal health of the federal budget.

I am not making the case that Simpson-Bowles is perfect. I am certain that it is many times better than the plans suggested by politicians and their media lackeys.

 

 

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Dick Lepre
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