Paul Ryan’s Budget Proposal—Posner

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.

Comments

[Jim]

I am little surprised at some of the comments given that we are haggling over pennies while we spend thousands.

I also challenge Mr. Posner that Mr. Ryan's plan would have a more significant effect on the economy than analysis shows for the simple reason that it would signal seriousness and determination from Washington not seen in a generation. That would bring stability to markets and investors, who are presently idling trillions of dollars.

Re-opening the closed energy industry would be a great place to begin.

[Jim]

I am little surprised at some of the comments given that we are haggling over pennies while we spend thousands.

I also challenge Mr. Posner that Mr. Ryan's plan would have a more significant effect on the economy than analysis shows for the simple reason that it would signal seriousness and determination from Washington not seen in a generation. That would bring stability to markets and investors, who are presently idling trillions of dollars.

Re-opening the closed energy industry would be a great place to begin.

[edhardyclothes]

good post!

[edhardyclothes]

Thanks, and interesting observe!

[Jay Kaplan]

I cannot stand rhetoric that is nonsense. You argue for a means test for social security by asserting that there is no reason for people who can afford their retirement to be subsidized by the gvernment. Let's see if I can come up with a reason in say two seconds. Got it. People with means paid into the system for 40 years believing they would receive the benefit that was promised to them. How'd I do? I think pretty well if I do say so mysef. But the real point is why should two prominent bloggers make a rhetorical assertion that is so innane. There is only one answer: Ideology.

[NEH]

Now let's see how this works out based on my last W-2 form:

1. Federal Income tax withheld.
2. Social security tax withheld.
3. Medicare tax withheld.

Hmm... looks like I've been paying for both Medicare and Social Security upfront. So what's the problem? Inflation, misadventures in investments and robbing Peter to pay Paul. And now, everyone in Washington wants to change the terms of the Contract Americans thought they signed onto. Is this what is meant by the "Death of Contract"?

Now "Means Testing" my be a dodge on rewriting the terms of the Contract without hurting those who are truly dependent on Medicare and Social Security in their old age. But, it still just doesn't sound equitable or right. The real solution lies in increasing the revenue streams so that Congress doesn't have to continually rob Peter to pay Paul...

[Max Furniture]

I agree but believe that they all miss a very important variable alluded to by ElGreco.

[TANSTAAFL]

Obama's speech vindicated Paul Ryan's proposal. Obama actually made the amazing claim that the "middle class" does not itemize deductions and thus gets no tax benefit from paying home mortgage interest. What a severely degraded view of the "middle class" in America, heretofore identified with home ownership and paying a mortgage. Now Obama would have us believe anyone who buys a home is among the "wealthy." There is no middle class in Obama's grim "vision for the future," as he put it.

[Robert Finney, Ph.D.]

Original investigations on Kaiser Permanente, ObamaCare's model, expose fraud, waste, abuse, and mismanagement are posted on YouTube at http://www.youtube.com/watch?v=v0h7tUymj2Y and www.hmohardball.com.
Robert Finney, Ph.D.

[Jack]

"Obama actually made the amazing claim that the "middle class" does not itemize deductions and thus gets no tax benefit from paying home mortgage interest."

Did he? Well you bring up an interesting subject in terms of lowering the deficit. The "middle class" is deducting the interest on what's left of the mortgage they've been paying on, for the average (under $200k home) at their marginal tax rate of 25% or less.

The wealthy are deducting the (bit higher interest rate on a "jumbo") on their million buck place at their marginal rate of 37%.

Naturally we all know that but for such an incentive they likely not buy the million buck place, or perhaps even go to work.

[Jack]

NEH Agreed. Though the costs of Medicare, like those of ALL American style H/C has to be compressed.

"Funny thing" that many in the US pride our nation for having lower taxation than those nations in which H/C is included...... but then go home to pay a regressive 17% of GDP to our "ever so efficient" "private" H/C system.

Regressive? Yep? An 8,000 policy that almost always leaves another $2,000 (or more) for the lucky policyholder to pay is a heftier burden as incomes decrease, and the lower income folk are a lot more likely to pay the premiums and copays with after tax income.

Higher up? Much better levels of coverage that are a tax deductible part of the benefit package with fewer copays.

And...... of course hardly worthy of mention to those benefiting from the, unaffordable, Bush tax cuts, and "performance bonuses".

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It would be especially likely to do so over the next decade

[Mark W. Budwig]

We are told, "reducing the tax rate can, in some circumstances, actually increase total tax revenues." The key here is the phrase "in some circumstances," to which should be added, "and only when taxes are high by historical standards," which is not remotely true now. Republicans seem to believe that there need be no end to tax cuts that pay for themselves by encouraging growth, but even the famous Laffer curve, a favorite of anti-tax dogmatists, embodies the obvious fact that as tax rates approach zero, so do tax revenues. David Stockman, Reagan's budget director has conceded that the Reagan tax cuts, sold as paying for themselves, were actually intended to increase deficits and thereby force spending cuts as part of a "starve the beast" strategy. Predictably, they left the country awash in red ink, starting the debt problem that -- after a brief pause under Clinton, whose partial rollback of the Reagan cuts produced a temporary budget surplus -- became acute under Bush. "Starve the Beast" lives again!

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I consider it is a sober & persuasive analysis. The major point comes out is that the Ryan proposal, widely believed to be too extreme to be feasible, does not itself go far enough to actually solve the problem.

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[edhardyclothes]

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The best he can do, however, is to point to a paradox of development and what he calls the five horsemen of the apocalypse.To deepen his analysis further Morris also resorts to biology.I would imagine that those of us who are required by law to pay into Medicare or Social Security despite having a preference for providing for their own retirement would not take kindly to in addition get nothing in return.

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[Jack]

"but even the famous Laffer curve, a favorite of anti-tax dogmatists, embodies the obvious fact that as tax rates approach zero, so do tax revenues."

........... Ha! Indeed! But they keep trying to sell it for their sponsors!

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[truther]

"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."

While I agree that MORE than Ryan's plan needs to be done...your solution suggests theft from the "rich" is the appropriate solution.
There is a reason why people who can afford to provide their own retirement should still get their SS & Medicare...THEY ARE NOT SUBSIDIES! They are benefits that we bought and paid for with 30-40 years of WORK out of about 20% of our salaries. "Oh", you say..."well there really is no lock box full of benefits." So the government gave it all away to the leeches already? And now they claim I must pay my own way in retirement because they only have enough left for the leeches? Not my fault buddy...give me the bucks I contributed over 40 years + accumulated interest and I'll walk away...otherwise, I am owed that retirement money. YES...I will take cuts because that is what it will take to put the country right. But don't ask me to take cuts that are not shared by everyone equally. I've had enough "government fairness" for a lifetime.

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