Magazine | April 19, 2010, Issue

Ryan’s Way

Rep. Paul Ryan (Darren Gygi)
A Wisconsin congressman offers a worthy alternative to Obamacare and our present fiscal bender

Almost immediately after President Obama signed the Patient Protection and Affordable Care Act, the conversation about health-care reform changed. Advocates of the proposal suddenly hit cautionary notes, insisting that difficult choices had to be made. Uwe Reinhardt, a celebrated health economist based at Princeton University’s Woodrow Wilson School, sounded the alarm about the law’s weak individual mandate, warning that it might not prevent an “insurance death spiral” in which the young and healthy drop out of the system until they fall ill, which in turn drives up premiums for everyone who’s still in the system, which in turn encourages even more healthy people to drop out.

Before the bill’s passage, this argument had been raised by a number of conservative critics, who maintained that the individual mandate was unworkable in its proposed form, and that a more effective version of the mandate would prove a punishing economic burden on young and healthy individuals. Yet while major news outlets focused their attention on inflammatory Facebook posts by conservative activists, the public barely heard arguments about serious flaws in the basic architecture of the president’s proposal.

Many conservative critics had observed that the Congressional Budget Office’s projections — which say that the law will reduce the deficit — were highly implausible. Greg Mankiw, a Harvard economist who served as chairman of George W. Bush’s Council of Economic Advisers, noted that the CBO holds the GDP’s rate of growth constant when evaluating legislation of this type, when in fact the bill might reduce GDP growth by discouraging work. The reason: Under the new health-care law, as one works harder and earns more money, one loses premium subsidies. Unless households prove entirely indifferent to this disincentive, the CBO numbers are unlikely to hold up. Moreover, the CBO made a number of highly subjective judgments regarding the likely effectiveness of the Independent Payment Advisory Board and the various pilot programs aimed at reducing costs throughout the system.

Defenders of the proposal noted that the CBO was too pessimistic about the costs of the Medicare Modernization Act of 2003. It’s worth noting, however, that many of the cost-saving elements of that act, including the infamous “doughnut hole” (once seniors receive a certain amount in benefits, they hit a coverage gap in which they must pay out-of-pocket until their expenses qualify as “catastrophic”), have been “fixed” — or, more bluntly, undermined — in the new legislation. And the CBO of course focuses exclusively on the public costs of the system, ignoring the private costs of forcing all Americans to buy insurance.

As for the various revenue provisions in the law, Howard Gleckman, a senior research associate at the nonpartisan Urban Institute with a reputation as a scrupulously objective voice, wrote, “I have never quite seen a law so full of powerful tax bombs attached to delayed fuses.” In a post at the Tax Policy Center website, Gleckman went on to describe the awkward structure of the new Medicare tax, which has an earnings floor that is not indexed to inflation.

It is instructive to compare progressives’ views on Obama’s health-care reform with the sentiments they expressed regarding John McCain’s plan during the 2008 campaign. McCain’s plan entailed eliminating the tax exclusion for employer-provided health insurance — which gives people more tax benefits for buying more-lavish insurance policies, without limit — and replacing it with refundable tax credits worth $2,500 for individuals and $5,000 for families.

Liberals attacked this as an unconscionable tax increase that would lead employers to drop coverage. Today, however, they support the “Cadillac tax” — a tax on high-end health-care plans that could similarly lead employers to scale back their coverage, that won’t be as efficient as McCain’s plan in discouraging overspending on health care, and that doesn’t go into effect until two years after the end of Obama’s potential second term.

#page#They also celebrate the government-run insurance exchanges the new law creates. Where the McCain proposal would have treated all individuals and families equally, regardless of whether they chose to get their insurance through their jobs or in the individual market, the new law gives households in the exchanges far higher subsidies than households covered by employer-based plans. One can safely assume that employers will come to resent this disparity — and that employees will stop getting insurance at work in order to take advantage of the subsidies. This will further increase health-care reform’s costs.

Meanwhile, the country’s underlying fiscal crisis goes unresolved. The new law does include some new revenue measures and notional cost savings, but it applies the proceeds to the new health-care entitlement instead of to our existing obligations.

All this is to say that the president and his allies in Congress have committed the country to a profoundly risky course, one whose dangers have been masked by creative accounting. Last month Moody’s warned that long-term fiscal imbalances threaten the AAA credit rating of the American government and that of our similarly profligate friends in Britain. The new health-care reform will only make things worse, and it is almost an article of faith in policy circles that future tax increases, driven by the spiraling costs of health-care entitlements, are inevitable.

Few conservatives have distinguished themselves in the course of this debate. The unwillingness of the congressional GOP to line up behind the McCain plan, a tough and serious proposal to move toward health-insurance coverage based on individual ownership, was an early mark of unseriousness. During the 2009–10 debate, rather than articulate a compelling narrative that accurately describes the sources of crippling cost growth, most conservative politicians offered scorched-earth attacks on “socialism” while defending the single-payer Medicare program that lies at the heart of our fiscal imbalance. While opposition to tax increases remains strong among Republicans, few have presented plans to hold the line on taxes while taming the federal budget deficit.

A key exception to Republican fecklessness has been Paul Ryan, ranking Republican member on the House Budget Committee. His “Roadmap for America’s Future,” presented in 2008 and revised this winter, proposes entitlement, health-care, and tax reforms in order to make the federal budget sustainable on tax revenues equaling 19 percent of GDP, a rate close to the post-war average.

Ryan gets three fundamental points right: We must reform entitlements (especially Medicare) by slowing their rate of growth and raising retirement ages; we must tame medical inflation by, among other things, ending damaging tax preferences that encourage overspending on health care; and we must broaden the tax base while lowering marginal rates in order to spur investment.

In recent months, the Ryan plan has come under both criticism and self-serving praise from the left. When President Obama fielded questions at the House Republicans’ late-January retreat, he went out of his way to call the roadmap “a serious proposal,” and other progressives have similarly praised it as worthy of review — probably because they expect that the proposals to cut Medicare and Social Security will be unpopular and will undermine the Republicans who attacked the health-care bill for cutting entitlements.

Meanwhile, liberal policy organizations, including Citizens for Tax Justice (CTJ) and the Center on Budget and Policy Priorities (CBPP), have attacked the plan as undermining vital programs, damaging the health-care system, and giving tax cuts to the wealthy. Some of these criticisms reflect ideological differences — do we want a “cradle to grave” government with high taxes and generous entitlements, or a slimmer government with lower taxes? What is the appropriate level of tax progressivity? But other criticisms are technical.

#page#The CTJ analysis found that the roadmap raises taxes for all but the wealthiest Americans, but failed to account for the change in the tax treatment of health insurance (i.e., eliminating the preferential treatment of lavish plans and replacing it with a standard tax credit), which helps the poor more than the rich. Accounting for this shift somewhat blunts the CTJ criticism, though Ryan’s plan still reduces overall tax progressivity.

The CBPP report (based on projections from the Urban–Brookings Tax Policy Center, a left-of-center group that produces widely respected empirical analyses of tax proposals) alleges that Ryan’s tax plan will raise less revenue than he claims and therefore fail to meet its deficit-reduction targets. But the devil is in the details, and even if the Ryan plan does not work in its current form, it can be revised to fix problems while remaining true to its guiding principles.

Here’s a 30,000-foot view of what the Ryan plan would do:

• Medicare would be voucherized for anybody currently under the age of 55. Instead of being put on a government-run plan, you would get a subsidy to purchase health insurance in the individual market. Additionally, the program would be means-tested (you get a smaller voucher if you’re wealthier), and the eligibility age would gradually rise to 69.5 from the current 65.

• Social Security would also be means-tested, and its eligibility age would rise to 70 (currently, it is scheduled to rise to 67 over the next decade). The roadmap would also introduce private Social Security accounts, though the CBO says this won’t actually reduce the deficit — more on that later.

• Borrowing a page from John McCain’s 2008 playbook, Ryan would replace the current tax exclusion for health care with a flat tax credit.

• Non-defense discretionary spending would be frozen for ten years and subjected to a growth cap thereafter.

• Individual taxpayers would be able to file under the current byzantine tax code, or under a simplified code with a generous standard deduction, two income-tax brackets (10 percent and 25 percent), and no additional deductions or credits (except the health-care credit).

• Taxes on corporate income, dividends, and capital gains would be repealed, and a value-added tax would be imposed at an 8.5 percent rate.

In January, the CBO released a letter analyzing this proposal, particularly its effects on the trajectory of entitlement spending. It found that the plan would ultimately be effective in making the federal budget sustainable — though debt levels would actually rise for the first three decades after implementation, peaking at 100 percent of GDP in 2043 before beginning to decline.

It’s important to note that in preparing this estimate the CBO did not actually score the revenue provisions of the Ryan plan, but merely assumed Ryan’s projections — that revenues would rise in line with the existing tax code until leveling off at 19 percent of GDP in the 2020s — without certifying them. The CBO does not do revenue scoring, and the Joint Committee on Taxation provides scores only over a ten-year window, which isn’t suitable for examining the Ryan plan’s long-term effects.

The Urban–Brookings Tax Policy Center, which labors under no such constraints, disputes Ryan’s figures. They modeled his plan over the next ten years and estimated that, by 2020, it would raise only 16.8 percent of GDP in taxes, substantially below the 18.6 percent Ryan uses in his own projections. They also believe the Ryan plan would not boost revenues to 19 percent of GDP until sometime after 2040, meaning that public debt would peak well above 100 percent of GDP.

#page#Ryan, in response, notes that economic projections have worsened since the roadmap was conceived, which likely explains some of the revenue gap. But he also says that his projections were developed in conjunction with the Treasury Department and other tax experts. In any case, he asserts his willingness to adjust tax rates in order to hit his revenue targets, if necessary.

In pursuit of such an adjustment, we’d encourage a rethink of the roadmap’s corporate-tax provisions. Currently, our tax code discriminates against corporate activity, taxing income first at the corporation level and again when investors receive it as dividends or capital gains. But instead of just leveling the playing field, the Ryan plan outright repeals both the corporate income tax and individual-level capital-income taxes. This could lead to significant tax avoidance; when possible, taxpayers will convert wage income into capital income. Certainly, we would expect most small-business proprietors to shift from S-incorporation to C-incorporation and thereby avoid taxes on their non-salary business income.

A modified plan, cutting the corporate income-tax rate from 35 percent to 25 percent (to match the plan’s top individual income-tax rate) while abolishing taxes on dividends and capital gains, would greatly improve the tax climate for business in America. Also, it wouldn’t encourage tax avoidance, and it would raise significantly more revenue — likely about 1.5 percent of GDP more — than Ryan’s current plan. Alternatively, Ryan could adopt Glenn Hubbard’s proposal to integrate the personal and corporate income taxes; essentially, this would eliminate the double taxation of corporations, with shareholders paying taxes on their individual returns. The effect of either approach would be to equalize the treatment of individual and corporate economic activity.

On the spending side, the disputes over the Ryan plan are more subjective: how generous our entitlements should be, at what age a “right” to retire should kick in, etc. We agree with Ryan that it is more important to avoid a significant increase in the government share of the economy than to guarantee generous health entitlements starting at age 65.

Many on the left have attacked the Ryan plan for “privatizing” and “gutting” Medicare. Again, what the plan actually does is to voucherize Medicare, giving seniors money to buy insurance on the private market. The vouchers grow slightly more slowly than medical costs do, a gap the plan hopes to make up with cost-saving health reforms. We are enthusiastic about these reforms, which include efforts to introduce more-effective price signals in the health-care market, along with tort reform and modification of health-insurance mandates. But a clearer picture of the likely cost savings will be needed — along with a willingness to adjust if sufficient savings do not materialize.

We would, however — though it may be tough for some conservatives to hear — encourage Ryan to shelve his plan to add private accounts to Social Security. While Ryan achieves significant savings in Social Security through means testing and raising the retirement age, the CBO analysis reports that private accounts would actually increase the budget deficit. And because the Ryan plan would guarantee a minimum return on private-account assets, taxpayers could end up on the hook for investment losses when they can least afford it — amidst a market downturn.

While there are strong ideological arguments for private accounts, we believe the most important fiscal-reform objective should be to reduce the budgetary imbalance, and private accounts do not help achieve this goal. Furthermore, as George W. Bush demonstrated, Social Security privatization is a political minefield, and fiscal reforms will be difficult enough without picking that fight.

#page#The CBO periodically releases a document called “The Long-Term Budget Outlook,” which projects current tax and spending policies 70 years into the future. Based on current policy, public debt will exceed 716 percent of GDP by 2080. Even assuming full expiration of the Bush tax cuts and no patches to the alternative minimum tax or Medicare rates, public debt will climb to 283 percent of GDP. In practice, the United States would face a sovereign-debt crisis long before it succeeded in borrowing 700 percent of GDP. So the Ryan plan represents a significant improvement over the policy status quo.

It’s worth giving some thought to the impact of such a massive debt burden. After surveying the history of financial crises over the last 200 years, economists Carmen Reinhart and Kenneth Rogoff found that countries with debt burdens of 90 percent of GDP or more had annual growth rates two percentage points lower than countries with debt burdens of 30 percent of GDP or less.

That other countries will grow richer faster will have clear implications for our national security. But slow growth also affects who lives and who dies, and whether science, the arts, and the humanities will flourish or decline. During the health-care-reform debate, many on the left accused conservatives of callous indifference to the suffering of the sick and the uninsured. Yet such charges overlook the invisible victims of policies that reduce economic growth, including the people who will die because some cures and technologies were never developed.

Unfortunately, the Ryan plan would take an awfully long time to bring the budget deficit back to earth. Again, the public debt would grow as a share of GDP for the next 33 years, peaking at 100 percent of GDP in 2043. Deficits would not fall below 2 percent of GDP until 2051 (for comparison, from 1955 to 2004, the average budget deficit was 1.9 percent of GDP).

It is not necessarily impossible for the United States to support a debt level this high — indeed, we (just barely) breached it after World War II, and Great Britain significantly exceeded it. Today, Italy and Japan have debts that total over 100 percent of GDP. But high public debt, like high tax rates, is a drain on the economy, and it also increases the risk of a sovereign-debt crisis. We should run up such a massive debt only for a good reason.

During World War II, we had excellent reasons, and we paid our debt off promptly — it fell below 50 percent of GDP in the early 1960s. But the cost pressures we face today are not temporary; they are the effect of long-term shifts in demographics and in the health sector of our economy. So why does it make sense to increase the public debt every year for the next 30, expecting that our children will pay it off later and incurring economic losses in the meantime?

Far from a reckless plot to ravage the welfare state, Ryan’s roadmap is a sober, responsible preview of the hard choices we’ll have to make. If anything, its central flaw is that it might not be tough enough.

–Mr. Barro is a senior fellow at the Manhattan Institute. Mr. Salam is a policy adviser at e21. Both blog at agenda.nationalreview.com.

Reihan Salam is president of the Manhattan Institute and a contributing editor of National Review.

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