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The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

The Reihan Roadmap



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My latest column for The Daily includes a completely pie-in-the-sky tax-and-health reform proposal. I don’t (yet) have the resources to crunch the numbers, and there are many details missing, but here is the basic proposal, annotated for your reading pleasure:

First, we need to rebuild the tax code so that it spurs entrepreneurship rather than hinders it. One of the best ways to encourage the kind of risk-taking that gives rise to thriving new businesses is to lower marginal tax rates. At the same time, we need to raise enough revenue to pay for our enormous federal government. Fortunately, there is a way to cut rates without sacrificing a dime of revenue.

Tim Kane discussed the impact of tax levels and tax rates in a recent column; Alan Viard has described the importance of low MTRs. My rough goal wasn’t just revenue-neutrality — I was shooting for a system that might prove slightly revenue-positive, and I think my approach hits the target. 

By eliminating tax expenditures like the mortgage interest deduction and the state and local tax deduction, we could afford to put in place a hybrid system. Today’s income tax would be replaced with a 20 percent tax on all income above $50,000 for individuals and $100,000 for married couples. In one fell swoop, we’d exempt 100 million of today’s 135 million tax filers from ever having to bother with the IRS.

The trouble is that we don’t have very reliable numbers for how much eliminating various tax expenditures will raise. Marc Goldwein of the Committee for a Responsible Federal Budget kindly assisted me by drawing on the Bowles-Simpson commission’s “Zero Plan,” and we think that there’s a decent chance we can finance this exemption and payroll tax offsets for low-income households without sacrificing revenue. 

I should note that my exemption level and the broader concept of combining an income tax on high(ish) earners with a VAT is drawn from Michael Graetz’s Competitive Tax Plan, which he describes at length in 100 Million Unnecessary Returns. But I didn’t want to hold Graetz responsible for my approach, as I eliminate many tax expenditures that he preserves and I treat the VAT somewhat differently. I’ll add that this proposal leaves the payroll tax untouched, and the 20 percent rate would apply to capital income, which is less than ideal. I also bracketed the question of the corporate income tax, but like Graetz I’d want to at least have the corporate income tax rate match the 20 percent personal income tax rate. 

In addition, all Americans would pay a new 10 percent consumption tax, modeled on Canada’s GST. This would apply to virtually all purchases of goods and services, and it would be clearly marked on every receipt. Every time you buy a hot chocolate, you’d see the federal government’s take. Poor families would receive payroll tax reductions to ease the burden, but they too would make a contribution at the cash register. This new tax code would be progressive and dead simple. Many taxpayers will miss their favorite deductions, but the end result would be a much fairer and saner system that will boost growth.

The idea here is to create a tax that serves as a useful reminder of the federal spending burden even as the vast majority of households stop paying personal income tax. This tax is also paid by retirees. I’ve grown far less enamored of the VAT in recent years. Yet I think it’s possible to prevent a VAT from becoming a “money machine.” As Josh Barro mentioned to me recently, VATs outside of Europe haven’t increased markedly in recent years. The Canadian VAT, or GST, has been cut twice since it was first implemented. 

Second, let’s replace the clunky new health law, which adds a new layer of complexity to the way Americans get health insurance, with a more elegant solution. All revenue from the new consumption tax would go toward a system of universal use-it-or-lose-it, risk-adjusted health vouchers that could be used to buy private health insurance. Medicare, Medicaid and the tax break for employer-sponsored coverage would all be rolled into this new system. Raise the 10 percent tax to 11 percent and the vouchers would get a bit more generous. Cut the tax by a point and they’d become less so.

The size of these vouchers would be pegged to income, to protect poor families from paying for care out-of-pocket while encouraging better-off families to do exactly that. By encouraging cost-consciousness, this plan would help restrain the exploding cost of medical care, a major drag on incomes and long-term growth. As an added bonus, this new health system would be a boon for aspiring entrepreneurs, who wouldn’t have to fear losing their health insurance.

The idea of linking the new consumption tax to health spending is drawn from Ezekiel Emanuel and Victor Fuchs, though my vouchers would work differently. The goal of the Emanuel-Fuchs plan is to fund a fairly comprehensive benefit plan, which individuals and households could supplement by purchasing additional coverage. I’d want the vouchers to be finance something like the Feldstein plan:

 

Let’s scrap the $220 billion annual health insurance tax subsidy, which is often used to buy the wrong kind of insurance, and use those budget dollars to provide insurance that protects American families from health costs that exceed 15 percent of their income.

Specifically, the government would give each individual or family a voucher that would permit taxpayers to buy a policy from a private insurer that would pay all allowable health costs in excess of 15 percent of the family’s income. A typical American family with income of $50,000 would be eligible for a voucher worth about $3,500, the actuarial cost of a policy that would pay all of that family’s health bills in excess of $7,500 a year.

The family could give this $3,500 voucher to any insurance company or health maintenance organization, including the provider of the individual’s current employer-based insurance plan. Some families would choose the simple option of paying out of pocket for the care up to that 15 percent threshold. Others would want to reduce the maximum potential out-of-pocket cost to less than 15 percent of income and would pay a premium to the insurance company to expand their coverage. Some families might want to use the voucher to pay for membership in a health maintenance organization. Each option would provide a discipline on demand that would help to limit the rise in health-care costs.

When Graetz published 100 Million Unnecessary Returns in 2008, he estimated that a 10 percent VAT on a broad base would raise $850 billion. Recall that we’ve already axed the health insurance tax subsidy in this world. Medicare is projected to cost $468 billion and Medicaid adds another $269 billion. So we’re talking about roughly $1 trillion in federal health expenditures. Assuming a Feldstein-style approach for would yield savings in providing care for over-65s, we should be able to pay for a unified system with a VAT in roughly this neighborhood, though I’ve left out the Medicare payroll tax, which we’d retain for the purposes of this exercise. 

It’s a bit of a dog’s breakfast, but what do you think? I see the health component as a way to embrace a defined contribution model. I am encouraged that Feldstein calls for a voucher “that would permit taxpayers to buy a policy from a private insurer that would pay all allowable health costs in excess of 15 percent of the family’s income.” This, however, is a defined benefit, which could prove problematic. Perhaps we’d just grow this defined contribution at a rate of GDP +1%, or we’d just index it to revenue from the VAT, drawing on Laurence Kotlikoff’s approach in his Purple Health Plan.

I should underline that this is the stuff of fantasy. But heck, it’s the weekend. 



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