Sustainable Tax Reform Requires Taming Entitlements

The deficit indicates a spending problem, not a tax one.

Can Washington afford to cut taxes by $1.5 trillion over a decade? The Washington intelligentsia says absolutely not, given the $78 trillion in budget deficits that CBO is projecting over the next 30 years.

But the true answer requires digging deeper into that projected long-term deficit. It consists of Social Security and Medicare running an $82 trillion deficit and the rest of the budget running a $4 trillion surplus. Washington does not have a revenue problem, or even a defense-spending problem. It has a colossal Social Security and Medicare problem.

In that context, tax reformers and critics are fighting over the change in the couch cushions. Federal tax policy will ultimately be determined by the fate of Social Security and Medicare. Unless fundamental reforms are enacted within the next few years, no tax cuts can survive long-term.

Popular mythology suggests that Social Security and Medicare are self-financing insurance programs that do not contribute to deficits. If that were true, cuts to taxes other than the payroll taxes that allegedly finance the programs would pose no threat to their solvency. In reality, the 30-year deficits will total $19 trillion for Social Security, $40 trillion for Medicare, and $23 trillion in interest costs from these two programs’ deficits. (These numbers can be adjusted for inflation by cutting one-third.)

Social Security’s deficits are a recent result of Baby Boomer retirements. Taxpayers still owe the Social Security Trust Fund $3 trillion in return for raiding program surpluses for decades, after which the taxpayer bailouts will continue.

Medicare has been in deficit from the start because payroll taxes and premiums were never intended to fully finance the program. The typical couple retiring today will receive a net present value of $422,000 in Medicare benefits in return for $140,000 in lifetime contributions to the system.

Unless these programs are fundamentally reformed — and soon — any tax cuts enacted now will soon be washed away in a wave of red ink. The deficits are simply unsustainable.

That does not mean that taxes alone can close the entitlement deficits. That $4 trillion “rest of the budget” surplus that the Washington establishment is protecting from tax cuts would cover just 5 percent of the Social Security and Medicare shortfall. And then what? Even doubling marginal tax rates at incomes beginning at $100,000 for singles and $200,000 for married filers — creating a 79.2 percent income-tax bracket even before state and payroll taxes are factored in — would close just $16 trillion of the remaining $78 trillion gap. And that assumes the economy still functions at such high tax rates. (The Eisenhower economy survived a 91 percent tax bracket because only eight taxpayers paid it in a given year, according to one estimate.)

So while taxes cannot close the entire entitlement deficit, delaying the eventual reforms only expands their cost until significant tax hikes become inevitable.

That would be especially painful because taxes are not historically low. After averaging 17.4 percent of GDP for the past half-century, revenues are projected to rise to 19.1 percent over the next three decades. Thus, American families and businesses will already be overtaxed relative to the post-war tax-policy consensus even before having to further feed the insatiable entitlement beast.

Lawmakers should move forward with tax reform. Strong tax revenues require a strong economy. Under President Obama, the weak economic recovery cost $3 trillion in revenues relative to the budget projections he inherited. Raising annual economic growth by one-half of a percentage point would add $1.5 trillion in revenues over the next decade. And given the corporate tax code’s combination of high tax rates and low revenues, sensible reforms should minimize revenue losses.

Democrats have pledged to block any tax reforms that increase the deficit. However, these same Democrats repeatedly waived budget rules to enact legislation totaling $5 trillion in new deficits under President Obama. If they truly prioritized deficit reduction, they would be trying to rein in Social Security and Medicare rather than embracing Bernie Sanders’s $30 trillion single-payer fantasy.

Ultimately, whether $1.5 trillion in tax cuts is offset is a sideshow affecting 3 percent of federal revenues. Without Social Security and Medicare reform, any tax changes will prove temporary.

I am not optimistic. President Trump openly opposes the Social Security and Medicare reforms that would make his tax cuts sustainable. The Republican Congress has simply dropped the subject.

Any hope of minimizing the long-term tax burden on families and businesses — or adequately funding defense and infrastructure — requires taming the Social Security and Medicare deficits.

This piece originally appeared on National Review Online

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Brian M. Riedl is a senior fellow at the Manhattan Institute. Previously, he worked for six years as chief economist to Senator Rob Portman (R-OH) and as staff director of the Senate Finance Subcommittee on Fiscal Responsibility and Economic Growth. Follow him on Twitter here. 

This piece originally appeared in National Review Online