Paul D. Ryan, the Republican Congressman who is the chairman of the House of Representatives’ Budget Committee, has proposed an ambitious plan for capping federal expenditures and eventually eliminating, or at least greatly reducing, the national debt. The plan is detailed, and I will omit most of the details. The significance of the plan lies not in its details, or indeed in any of its proposals, but rather in the willingness of a major politician to challenge entitlements spending. This is only part of the plan but it has great symbolic significance, displays political courage, may open a productive dialogue, and challenges President Obama to propose his own plan for limiting such spending, which he has thus far been too timid (or politically realistic!) to do.
Ryan’s main proposals are as follows:
1. Repeal Obama’s health-care legislation, but reform health insurance by abolishing favorable tax treatment of employer-provided health insurance and giving everyone a tax credit to assist or enable the purchase of a private health insurance policy.
2. Replace Medicaid with a subsidy for purchasing private health insurance. Also make it a block-grant program rather than a matching program: that is, each state would get a sum of money allocable to Medicaid beneficiaries, rather than, as at present, the federal government’s matching state expenditures for Medicaid, which reduces the cost to the states of expanding their Medicaid enrollments.
3. Replace Medicare with a subsidy for purchase of private health insurance. But this provision of the plan would not take effect until 2021; so only persons not yet 55 years old would be affected by it.
4. Make the Bush tax custs permanent, simplify the income tax, limit the maximum income tax rate for both individuals and corporations to 25 percent, and make up the loss in tax revenues by closing unspecified tax loopholes and imposing a form of VAT (value-added tax)—in effect a sales tax—on businesses.
5. Freeze discretionary federal spending at 2008 levels for five years. Require the vote of a two-thirds majority in Congress to increase tax rates or impose new taxes, and enact automatic caps on increases in entitlement spending. Health-care entitlements spending would be indexed to the average of the consumer price index and annual increases in the cost of health care. Total federal spending could not exceed 20 percent of GDP, compared to today’s 25 percent, which President Obama hopes to reduce eventually (by unspecified means) to 22 or 23 percent.
The goal of Ryan’s plan is to reduce federal deficits by $4.4 trillion over the next ten years, and to do so entirely by reducing federal spending (by a total of $6.2 trillion).
Although there are good ideas in Ryan’s plan, what it really shows is that, barring a miracle, the fiscal condition of the federal government will continue to deteriorate. Even if the plan were enacted in full—a political impossibility—it probably would make only a small contribution to reducing future deficits.
The annual federal deficit, and therefore the national debt, grows when federal revenues fall short of federal expenditures. Revenues can be increased by higher taxes or by more rapid economic growth, so that the same tax rate produces rapidly increasing revenue; reducing the tax rate can, in some circumstances, actually increase total tax revenues, either by stimulating economic growth or by inducing more reporting of taxable income or the shifting of other income sources to taxable income. For example, reducing the corporate income tax rate would induce American multinational corporations to repatriate more of their foreign profits.
Alternatively, federal spending can be reduced either directly, or indirectly by reducing demand for federal financial assistance—the hope of health-care reformers.
In theory the most promising route to narrowing the gap between revenue and expenditure is economic growth, because the economy is much larger than the government. A 5 percent increase in GDP would amount to more than $700 billion; half of $700 billion would equal almost 10 percent of annual federal expenditures (currently about $3.5 trillion a year). Compounding could make aggregate economic growth over a period of years greatly exceed increases in federal expenditures.
But the Ryan plan would be unlikely to have substantial effects on the rate of economic growth. Judging from the effects of the Bush tax cuts, the Clinton tax increases, and the high rate of growth in the post-World War II decades, in which tax rates were much higher than at present, the modest changes in tax rates proposed in Ryan’s plan would not have a significant net effect on economic growth and hence on taxable revenues, bearing in mind that the stimulus effects of tax cuts are offset to a greater or lesser extent by the direct effects of the cuts in reducing tax revenues. Of course, merely correlating past tax rates with past growth rates is crude empiricism, but my impression of the more sophisticated empirical studies of the effect of tax rates on economic growth is that they are inconclusive with respect to the effect of incremental changes from modest levels.
I am surprised that the Ryan plan does not propose the outright elimination of the corporate income tax, which might have dramatic effects on the repatriation of foreign earnings of American corporations. The repeal of Obama’s health-care legislation would have a positive effect on economic growth by alleviating the concerns of small business, but probably the effect would be small.
The effect of the plan on economic growth might actually be negative, if, as is entirely possible, the plan if enacted would actually increase the federal deficit. It would be especially likely to do so over the next decade, when Medicare would be unaffected because the reform of it that the plan proposes would not take effect until 2021. Medicare expenditures would grow uncontrollably over that 10-year period. There would be some Medicaid savings, but probably not too many because Medicaid is already starved for resources. With entitlements largely unaffected over the next decade, to keep spending from rising at current rates would require drastic reductions in nondefense discretionary spending (defense spending cannot be reduced much, because of growing instability abroad). Such reductions are not politically feasible. So the deficit would keep rising at least until 2011, and the long-term fiscal health of the nation would thus be riding on the Medicare reform that would take effect in that year. But ten years from now the percentage of the U.S. population that is 65 years old or older, now 13 percent, is expected to reach 16 percent. That will not only increase the costs of Medicare (quite apart from cost increases owing to technological advances in medical treatment); it will also increase the average age of the elderly population, which will further increase the demand for health care, and—critically—increase the political power of the elderly. On the basis of past voting behavior of elderly people, there seems little prospect that altruism toward their children and grandchildren will curtail narrowly self-interested (one might even say selfish) voting by elderly people to preserve their entitlements.
As I said at the outset, the fact that a major politician is willing to advocate concrete entitlements reform is promising, but the key compromise that Ryan has made with political realities—deferring his proposed Medicare reforms for a decade—renders the plan economically very questionable.
Perhaps some politician will be bold enough to advocate that all entitlements programs, including social security as well as Medicare, be means-tested, as Medicaid is. There is no reason why people who can afford to provide for their retirement should be subsidized by the government, which is to say by the taxpayer. But such a reform does not appear to be politically feasible.