Friday, July 22, 2011

'Why I Oppose the Gang of Six Plan'- by Keith Hennessey

POSTED JULY 21, 2011 in Keith Hennessey's very good blog, 'Your Guide To American Economic Policy'.  It is worth your subscription if you want the inside scoop on things in more detail.

Keith obviously has gotten his hands on the internal working documents of the 'Gang of Six' discussions that we did not have access to yesterday when we passed along details  gleaned from various news sources about the Gang of Six plan to end the debt ceiling debate now raging in Washington.

Suffice it to say:  He doesn't like it for reasons he clearly states below.

No word of a deal forthcoming on the debt ceiling although today's morning news reports are hinting at some sort of a $3 trillion deal still in the offing between President Obama and Speaker Boehner. We will pass along comments and details when they happen.

This is a very important debate going on right now for many reasons; presidential politics; congressional control of the House and Senate, the usual political things. Except this is dealing with the hot potato of shaking the financial markets and exacerbating the already desultory national debt outlook for our nation.  It is as important as they get on big public policy matters because the outcome affects all of us and our children and their children's children in the form of dealing with this debt forever it seems.

Keith Hennessey
'If you’d like to understand the details of the Gang of Six plan, please read my (quite long) earlier post.

I strongly oppose the Gang of Six plan. I think it is absolutely terrible fiscal policy.

First I’ll flag a few things I like in the plan.

  1. I support making a technical correction to CPI, even though it would result in higher revenues.
  2. Repeal of the CLASS Act is great.
  3. It’s good they included medical malpractice reform.

That’s it. Others right-of-center are salivating at the low marginal income tax rates described in the plan, both for individuals and corporations. I think those low rates never materialize, for both arithmetic and legislative reasons, and explain why below.

I make a lot of assertions in the following argument. For backup, please see my earlier explanatory post, which contains links to the Gang’s source documents.

Here are 17 reasons why I oppose the Gang of Six plan.

1. It provides no discretionary spending totals.

Discretionary spending is 37% of the budget next year. The Gang of Six plan does not specify discretionary spending totals. How can I support (or even evaluate) a budget plan that promises to cap 37% of spending but doesn’t tell me at what level, next year or for nine years thereafter?

2. It cuts defense spending while hiding the ball on nondefense spending.

The only discretionary spending number provided is $866 B in defense (security) discretionary savings over the next 10 years. I care about the discretionary spending total and about the balance between defense and nondefense. I am open to defense spending cuts, but not if I’m not told what the plan does to nondefense spending as well. How can I support or evaluate $866 B of defense appropriations cuts when I am not told whether the plan cuts, holds harmless, or even increases nondefense appropriations?

3. The promised deficit reduction is both overstated and less than is needed.

Their $3.7 trillion of claimed deficit reduction is bogus. It includes an unspecified amount of savings from a future legislative fast-track process that would require further Congressional and Presidential action if health spending growth exceeds a certain target.

The Gang’s plan also uses at least three different baselines in different parts of the document. Combine that with the absence of discretionary spending totals and I have no confidence in their $3.7 trillion deficit reduction number. It is easy to solve this problem – I guarantee Chairman Conrad has a table of numbers that shows these calculations. All he has to do is release that table.

Even if I did believe it, this amount of savings won’t cover CBO’s projected $5.4 trillion of net interest costs over the same timeframe. In fairness, other plans face this same problem. We need much more deficit reduction (through spending cuts).

4. It is a huge net tax increase.

The Gang of Six plan would increase taxes by $2.3 trillion over the next 10 years relative to current policy. That’s roughly a 6.5 percent increase in total taxation.

Put another way, the Gang of Six plan raises taxes $830 B more than would President Obama’s February budget.

To those who like the promise of low statutory tax rates – the benefits of low marginal rates are far outweighed by the increase in average effective rates. This is a massive hidden tax increase.

5. It’s a far worse trade than Bowles-Simpson.

The fundamental trade of the Bowles-Simpson group was higher net taxation in exchange for (huge long-term spending reduction, especially in entitlements + fundamental structural entitlement reform + pro-growth tax reform).

The Gang of Six plan drops the first two elements of that trade, the huge long-term spending reductions and the structural entitlement reforms. It instead purports to offer pro-growth tax reform in exchange for much higher net tax levels. It offers trivial spending cuts, no flattening of long-term entitlement spending trends, and no structural reform to the Big 3 entitlements. That is a terrible trade, and far worse than Senators Durbin and Conrad agreed to in Bowles-Simpson. Why did the Republicans in the Gang take a deal far worse than Bowles-Simpson?

6. It trades a permanent tax increase for only a temporary respite on spending.

The plan proposes permanent increases in net taxation levels in exchange for a temporary slowdown in spending. The entitlement spending line would be shifted ever so slightly downward – there would be no long-term “flattening of the spending curve.” The Gang tries to address that through a poorly-defined process to slow health spending growth that offers no specific policy changes and promises only to “require (future) action by Congress and the President if needed.” That sounds awfully familiar (see: Medicare funding trigger, turned off by Democrats in 2009).

The consequence of this would be kicking the can down the road. Deficits would be smaller for the next 5-10 years while the higher tax levels offset entitlement spending growth. But since the plan does nothing to flatten the curve of Social Security, Medicare, or Medicaid spending, 5-10 years from now we will be right back where we are now, but with higher levels of taxation. We will again face huge and growing future deficits, driven by unsustainable entitlement spending growth.

Then we’ll repeat this game all over again. Raise taxes once again to buy another decade or so. The Gang of Six plan raises taxes and hands off an unsolved entitlement spending problem to the next generation.

We need a solution that caps total government spending at some share of GDP. Cut, Cap, and Balance sets a limit of 20% of GDP, which I like.  Bowles-Simpson raised taxes and moved toward a spending cap (but not far enough). The rumor at the time was that the Bowles-Simpson group was working toward a 21% cap. The Gang of Six plan raises taxes but does nothing to change the underlying spending trends. I hate the tax increases in Bowles-Simpson, but at least it moved in the direction of a permanent spending fix.

7. It’s an unfair deal on CPI.

A CPI fix raises revenues and cuts spending. I’d like to use the higher revenues to cut tax rates. Those on the left would like to spend the deficit reduction from slower Social Security spending growth on their priorities. I think the legislatively balanced way to do CPI is to do neither.  All the fiscal benefits of a CPI correction go to deficit reduction. Treat it like it is – as a technical correction to more accurately measure inflation. It is not a policy change and therefore none of its effects should be mitigated. By increasing Social Security spending on low-income beneficiaries, the Gang of Six plan breaks this fair pain-all-around compromise in favor of one side’s policy preferences.

8. It precludes structural reforms to Medicare and Medicaid.

The Plan says “while maintaining the basic structure of [Medicare and Medicaid].” That language precludes needed fundamental reforms to these programs, as contemplated in Bowles-Simpson, Rivlin-Ryan, or the House-passed budget resolution. We need structural reforms to these programs to flatten their long-term spending trends.

This plan doesn’t even include the modest Medicare eligibility age increase proposed by Sen. Lieberman and endorsed by the President.

9. It does almost nothing to slow health spending growth, and even the $115 B of additional health savings are bracketed.

The Biden group agreed to $203 B of health savings over 10 years. That is pitifully small compared to what is needed.

The Gang of Six plan includes two numbers for health savings: $202 B and $85 B. It appears they are trying to sell two incompatible numbers:  they tell Republicans it’s $202 B, and Democrats it’s $85 B. The documents literally show both numbers with no explanation or clarification about which one binds.

10. It leaves the core trillion dollar ObamaCare health entitlement in place.

This problem is not specific to the Gang’s proposal, but it’s another reason for me to oppose it. Why are we talking about raising taxes and cutting defense spending at the same time that we are creating a new trillion health entitlement promise?

Yes, repealing the CLASS Act is good, but it’s far from sufficient.

11. It makes it harder to do Social Security reform, drops the specific Social Security reforms of Bowles-Simpson and increases Social Security spending.

The Gang’s plan sets up two new procedural barriers to Social Security reform. A Social Security plan cannot be considered in the Senate until and unless the rest of the Gang’s plan has passed the Senate. And 60 votes would be needed not just to break a filibuster, but to vote aye on final passage. Both changes make Social Security reform procedurally harder than it is right now.

The Gang claims the Bowles-Simpson mantle on Social Security reform, yet contains none of the specific Social Security reforms from Bowles-Simpson:

  1. raising the Social Security eligibility age;
  2. slowing future benefit growth for high earners; or
  3. raising the cap on taxable wages.

I hate the last one, but the Gang plan include none of these specific reforms. Sorry, guys, correcting the CPI for a technical flaw and erecting two new procedural hurdles does not count as Social Security reform.

The only specific Social Security policy change the Gang proposes is to increase spending on poor people. The program is going broke and is already in a cash flow deficit and they are increasing entitlement spending.

12. It sets the wrong bar for Social Security reform and tilts reform toward tax increases.

There are two ways to measure whether you have reformed Social Security: “75-year actuarial balance” and “cash flow balance.” The Trustees report both. Bowles-Simpson said their Social Security reform had to meet both tests.

The Gang’s plan sets 75-year actuarial balance as the only test. This is the easier bar, and this way of measuring reform tilts the playing field toward short-term patches and tax increases. It’s a repeat of the “permanent tax increases for temporary spending changes” problem I describe above. The only way to guarantee a permanent (or even long-term) solution on Social Security is to require a reform plan meet the cash flow balance test (as well as the easier 75-year test).

The Gang’s metric instead will lead to Social Security “reform” that will incrementally tweak benefit spending growth, combine that with a big tax increase, and appear to solve the problem for “75 years.” Then 10-15 years from now we’ll be back in cash flow deficit and we’ll repeat this all over again, only from a higher starting point on taxes. This has happened before, several times.

13. It locks in the net tax increase, then hopes to deliver on the stated tax reform policies.

Procedurally the Gang’s plan would be turned into a budget resolution that can only commit the Senate to a total level of taxation, one that is way too high. After the budget resolution has been passed, then tax reform legislation would move (the plan says “within six months.”) If you are tempted by the promised details of tax reform, remember that those details would be negotiated after the Senate had already committed to a $2.3 trillion tax increase.

Even if I could swallow a $2.3 trillion tax increase, which I can’t, I don’t trust the tax reform process enough to take that risk. The plan offers no procedural guarantees to prevent the tax policies described within it from being ignored by the Senate Finance Committee.

By the way, good luck legislating tax reform that raises taxes $2.3 trillion more revenue than current policy. You’ll create so many more losers than winners that it will be impossible to round up the votes. Even revenue-neutral tax reform is extremely hard because the losers scream more loudly than the winners.

14. It undoes most of the benefits of last December’s tax policy battle.

The keep-taxes-low crowd won a significant battle last December when a bipartisan majority of the Congress passed and the President signed a two-year extension of the Bush tax rates. Despite months of intense campaigning by the President, and a press corps that accepted the framing of “letting the Bush tax cuts expire,” the votes in Congress supported a current policy baseline perspective. Despite the rhetoric from the left, Members voted to prevent tax increases.

By framing a $2.3 trillion tax increase as a $1.5 trillion tax cut, the Gang’s plan concedes this hard-fought intellectual ground and makes it easier for those who want to raise taxes even further to achieve that goal. Switching from a current policy to a current law tax baseline biases future legislation toward tax increases.

15. It sets up a tradeoff between marginal income rate cuts and capital tax rates.

The tax reform described in the Gang’s plan is silent on capital taxation. Side conversations suggest the Gang agreed to but did not put on paper a 20% rate for capital gains and dividends. From a pro-growth perspective, lowering marginal income tax rates by raising capital taxation rates is a bad trade. And both the numbers and politics suggest that much of the higher revenues raised from “eliminating tax breaks” would come from higher tax rates on capital rather than scaling back even more popular tax preferences for homeownership, charity, and health insurance.

Lowering the corporate income tax rate is nice, but you get more growth bang for the buck by allowing immediate expensing of investment. If depreciation is treated as a tax expenditure and the lower corporate rates are paid for in part by lengthening depreciation schedules, that will slow growth, not accelerate it.

16. The rate cuts are overpromised because the Gang overestimated the revenue that would be raised from reducing tax expenditures.

I strongly support scaling back or even eliminating most if not all tax preferences. I’d go much further than I could ever get support for from elected Members of Congress. But I want to use the revenue raised from eliminating those tax expenditures to cut rates, not to make spending cuts smaller as the Gang’s plan does.

The Joint Tax Committee warns us that the revenue raised by eliminating a tax preference is less than the measured “tax expenditure,” and often far less, because of the incentive effects. It appears the Gang far overestimated the revenues that would be raised from eliminating tax preferences, and therefore are promising marginal rates they cannot deliver. Those who are attracted by the low promised rates for individual and corporate income should understand that if the revenue raised from eliminating other tax preferences is insufficient, the actual rates in reform will be higher. And that’s assuming you trust a Senate Democratic majority process to deliver the unenforceable tax policy promises described in the Gang’s plan.

Tax experts I trust tell me they can’t see how you could design a tax reform that hits the revenue targets promised (even with a +$2.3T revenue increase) and get statutory rates as low as promised. The revenue raised from “reforming” these preferences won’t be enough to lower rates that much, and repeal the AMT, and move to a territorial system, and reduce deficits.

17. The plan proposes a deficit trigger mechanism that might include automatic tax increases.

The President proposed a version of this – a trigger that would guarantee that future deficits do not exceed a given target. The Gang’s target is procedurally weaker but still dangerous. I hate big future deficits but hate as much any process which makes it easier to raise future taxes to address those deficits. The Gang’s trigger is ambiguous on this point, and the legislative language would be drafted by the Senate’s Democratic majority.

Like many others, I am attracted to Members working across the aisle and breaking the natural partisan divide. For me, the substance trumps that, and the substance of this plan is simply terrible.

(Jim Capretta and Charles Blahous have also commented on the Gang of Six’s plan.)

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