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Originally Posted by Kotlikoff
FIXING OUR FISCAL INSTITUTIONS
Determining whether a country is already bankrupt or going bankrupt is a judgment call. In my view, our country has only a small window to address our problems before the financial markets will do it for us. Yes, there are ways out of our fiscal morass, including Chinese investment and somehow getting a lid on Medicare and Medicaid spending, but I think immediate and fundamental reform is needed to confidently secure our children’s future.
The three proposals I recommend cover taxes, Social Security, and healthcare and are interconnected and interdependent. In particular, tax reform provides the funding needed to finance Social Security and healthcare reform. It also ensures that the rich and middle class elderly pay their fair share in resolving our fiscal gap.
Tax Reform
The plan here is to replace the personal income tax, the corporate income tax, the payroll (FICA) tax, and the estate and gift tax with a federal retail sales tax plus a rebate. The rebate would be paid monthly to households, based on the household’s demographic composition, and would be equal to the sales taxes paid, on average, by households at the federal poverty line with the same demographics.
The proposed sales tax has three highly progressive elements. First, thanks to the rebate, poor households would pay no sales taxes in net terms. Second, the reform would eliminate the highly regressive FICA tax, which is levied only on the first $90,000 of earnings. Third, the sales tax would effectively tax wealth as well as wages, because when the rich spent their wealth and when workers spent their wages, they would both pay sales taxes.
The single, flat-rate sales tax would pay for all federal expenditures. The tax would be highly transparent and efficient. It would save hundreds of billions of dollars in tax compliance costs. And it would either reduce or significantly reduce effective marginal taxes facing most Americans when they work and save.
The sales tax would also enhance generational equity by asking rich and middle class older Americans to pay taxes when they spend their wealth. The poor elderly, living on Social Security, would end up better off. They would receive the sales tax rebate even though the purchasing power of their Social Security benefits would remain unchanged (thanks to the automatic adjustment to the consumer price index that would raise their Social Security benefits to account for the increase in the retail-price level).
The sales tax would be levied on all final consumption goods and services and would be set at 33 percent—high enough to cover the costs of this “New New Deal’s” Social Security and healthcare reforms as well as meet the government’s other spending needs. On a tax-inclusive basis, this is a 25 percent tax rate, which is a lower or much lower marginal rate than most workers pay on their labor supply. The marginal tax on saving under the sales tax would be zero, which is dramatically lower than the effective rate now facing most savers.
Social Security Reform
My second proposed reform deals with Social Security. I propose shutting down the retirement portion of the current Social Security system at the margin by paying in the future only those retirement benefits that were accrued as of the time of the reform. This means that current retirees would receive their full benefits, but current workers would receive benefits based only on their covered wages prior to the date of the reform. The retail sales tax would pay off all accrued retirement benefits, which eventually would equal zero. The current Social Security survivor and disability programs would remain unchanged except that their benefits would be paid by the sales tax.
In place of the existing Social Security retirement system, I would establish the Personal Security System (PSS)—a system of individual accounts, but one with very different properties from the scheme proposed by the president. All workers would be required to contribute 7.15 percent of their wages up to what is now the earnings ceiling covered by Social Security (i.e., they’d contribute what is now the employee FICA payment) into an individual PSS account. Married or legally partnered couples would share contributions so that each spouse/partner would receive the same contribution to his or her account. The government would contribute to the accounts of the unemployed and disabled. In addition, the government would make matching contributions on a progressive basis to workers’ accounts, thereby helping the poor to save.
All PSS accounts would be private property. But they would be administered and invested by the Social Security Administration in a marketweighted global index fund of stocks, bonds, and real-estate securities. Consequently, everyone would have the same portfolio and receive the same rate of return. The government would guarantee that, at retirement, the account balance would equal at least what the worker had contributed, adjusted for inflation; that is, the government would guarantee that workers could not lose what they contributed. This would protect workers from the inevitable downside risks of investing in capital markets.
Between ages 57 and 67, account balances would be gradually sold off each day by the Social Security Administration and exchanged for inflation-protected annuities that would begin paying out at age 62. By age 67, workers’ account balances would be fully annuitized. Workers who died prior to age 67 would bequeath their account balances to their spouses/partners or children. Consequently, low-income households, whose members die at younger ages than those of highincome households, would be better protected. Finally, under this reform, neither Wall Street nor the insurance industry would get their hands on workers’ money. There would be no loads, no commissions, and no fees.
Healthcare Reform
My final proposed reform deals not just with our public healthcare programs, Medicare and Medicaid, but with our private health-insurance system as well. That system, as is well known, leaves some 45 million Americans uninsured. My reform would abolish the existing fee-for-service Medicare and Medicaid programs and enroll all Americans in a universal health-insurance system called the Medical Security System (MSS). In October of each year, the MSS would provide each American with an individual-specific voucher to be used to purchase health insurance for the following calendar year. The size of the voucher would depend on the recipients’ expected health expenditures over the calendar year. Thus, a 75 year old with colon cancer would receive a very large voucher, say $150,000, whereas a healthy 30 year old might receive a $3,500 voucher. The MSS would have access to all medical records concerning each American and set the voucher level each year based on that information. Those concerned about privacy should rest easy. The government already knows about millions of Medicare and Medicaid participants’ health conditions because it’s paying their medical bills. This information has never, to my knowledge, been inappropriately disclosed.
The vouchers would pay for basic in- and outpatient medical care, prescription medications, and long-term care over the course of the year. If you ended up costing the insurance company more than the amount of your voucher, the insurance company would make up the difference. If you ended up costing the company less than the voucher, the company would pocket the difference. Insurers would be free to market additional services at additional costs. The MSS would, at long last, promote healthy competition in the insurance market, which would go a long way to restraining healthcare costs.
The beauty of this plan is that all Americans would receive healthcare coverage and that the government could limit its total voucher expenditure to what the nation could afford. Unlike the current fee-for-service system, under which the government has no control of the bills it receives, the MSS would explicitly limit the government’s liability.
The plan is also progressive. The poor, who are more prone to illness than the rich, would receive higher vouchers, on average, than the rich. And, because we would be eliminating the current income-tax system, all the tax breaks going to the rich in the form of non-taxed health-insurance premium payments would vanish. Added together, the elimination of this roughly $150 billion of tax expenditures, the reduction in the costs of hospital emergency rooms (which are currently subsidized out of the federal budget), and the abolition of the huge subsidies to insurers in the recent Medicare drug bill would provide a large part of the additional funding needed for the MSS to cover the entire population.
Eliminating the Fiscal Gap
A 33 percent federal retail-sales tax rate would generate federal revenue equal to 21 percent of GDP—the same figure that prevailed in 2000. Currently, federal revenues equal 16 percent of GDP. So we are talking here about a major tax hike. But we’re also talking about some major spending cuts. First, Social Security would be paying only its accrued benefits over time, which is trillions of dollars less than its projected benefits, when measured in present value. Second, we would be putting a lid on the growth of healthcare expenditures. Limiting excessive growth in these expenditures will, over time, make up for the initial increase in federal healthcare spending arising from the move to universal coverage. Third, we’d reduce federal discretionary spending by one-fifth and, thereby, return to the 2000 ratio of this spending to GDP. Taken together, these very significant tax hikes and spending cuts would, I believe, eliminate most if not all of our nation’s fiscal gap.
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