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View related content: Health Care
While the deficits caused by the fiscal stimulus package will end in
2011 and will help to sustain a fragile recovery in 2010, the deficits
projected for the longer term are a threat to our economic future. The
starting point for controlling those future deficits is for Congress to
abandon the administration’s health-care plan–a plan that will cost
more than $1 trillion.
The deficits projected for the next decade and beyond are
unprecedented. According to an assessment released in March by the
Congressional Budget Office (CBO), the president’s budget implies that
deficits will average 5.2% of GDP over the next decade and will be 5.5%
of GDP in 2019. Without the president’s proposals, the budget office
forecasts a 2019 deficit of only 2% of GDP.
The CBO’s deficit projections are based on the optimistic
assumptions that the economy will grow at a healthy 3% pace with no
recessions during the next decade; that there will be no new spending
programs after this year’s budget; and that the rising national debt
will increase the rate of interest on government bonds by less than 1%.
More realistic assumptions would imply a 2019 deficit of more than 8%
of GDP and a government debt of more than 100% of GDP.
Such enormous deficits would crowd out productivity-enhancing
investments in new equipment and software as the government borrows
funds otherwise available to private investors. The result would be
slower economic growth and a lower standard of living.
In the nearer term, the projected deficits could cause interest
rates on bonds and mortgages to rise sharply if bond investors fear
that the government will not prevent inflation. This is a greater risk
now that more than half of the U.S. government debt is held by the
Chinese and other foreign investors. Such an interest rate rise could
kill a recovery in 2010 or 2011 and depress growth in the years that
Dropping the Obama health plan would significantly reduce fiscal
deficits over the next decade and help restore public confidence in the
ability of Congress to control spending. The CBO estimates that the
House committee versions of the Obama health plan would add more than
$1 trillion to federal deficits over the next decade. But the actual
costs would be much higher.
For starters, $1 trillion of extra debt-financed spending would
cause the government to pay about $300 billion of extra interest in the
next decade. Moreover, the CBO’s method of estimating the cost of such
a program doesn’t recognize the incentives it creates for households
and firms to change their behavior.
The House health-care bill gives a large subsidy to millions of
families with incomes up to three times the poverty level (i.e., up to
$66,000 now for a family of four) if they buy their insurance through
one of the newly created “insurance exchanges,” but not if they get
their insurance from their employer. The CBO’s cost estimate
understates the number who would receive the subsidy because it ignores
the incentive for many firms to drop employer-provided coverage. It
also ignores the strong incentive that individuals would have to reduce
reportable cash incomes to qualify for higher subsidy rates. The total
cost of ObamaCare over the next decade likely would be closer to $2
trillion than to $1 trillion.
The administration’s claim that the health-care plan would be
“self-financing” is both false and irrelevant. It is false because it
would only be self-financing if one counts a variety of President
Obama’s proposed tax increases–and even those would produce much less
revenue than is assumed in the budget calculations. The claim is
irrelevant because those tax increases have nothing to do with health
care and could be used instead to reduce other projected deficits.
For example, the administration and the congressional designers of
ObamaCare say they would finance a substantial part of health reform
with the revenue from new taxes on corporate foreign profits and on
high-income individuals. The likely revenue from these tax changes
would be much less than the official estimates because of the induced
changes in taxpayer behavior that the estimators ignore.
Previous experience with changes in the marginal tax rates of
high-income individuals implies that the current proposal to raise the
marginal tax rate to about 50% from today’s 40% would produce only
about half of the official revenue estimates. No one knows how much of
the estimated extra tax revenue on foreign profits would be lost as the
resulting fall in international competitiveness reduces profits, and as
businesses sell their overseas subsidiaries or shift their profits in
While abandoning health reform would be an important step, it would
not be enough to limit the exploding level of future deficits and debt.
That requires substantial reductions in existing spending programs, if
large tax increases are to be avoided. Since Medicare is the largest
contributor to the explosive growth in government spending, a good way
to start shrinking government outlays would be by restructuring
Medicare to shift more of its costs to supplementary private insurance,
perhaps on an income-related basis.
Given the perceived need for significant additional tax revenue to
shrink future fiscal deficits, there is now talk in Washington of
introducing a value-added tax (VAT), the kind of national sales tax
that European governments use to finance their welfare states. That
would be a triply bad idea. Although it is a tax on spending, a VAT
effectively raises marginal tax rates. Like the income tax, it reduces
the reward for work and entrepreneurship by adding a tax to the prices
of all goods and services. A VAT would also be grossly unfair to those
whose lifetime savings would now be subject to a new tax when they
start to spend those savings.
A VAT would open the door to an explosion of new spending programs.
That’s because, no matter how low the initial rate, the tax rate would
be drawn inevitably to European rates of more than 15%–on top of
existing income and payroll taxes.
The key to raising revenue without raising marginal tax rates or
creating a new tax is to reduce or eliminate some of the “tax
expenditures” that now lower tax revenue by special deductions and
exclusions. Ending the current exclusion from taxable income of
employer payments for health insurance would increase income tax
revenue by more than $1 trillion over the next five years and nearly $3
trillion over the next decade. Eliminating this subsidy would also lead
to a restructuring of private health insurance that would give patients
the incentive to seek more cost-effective care and thereby bring down
the overall cost of health care.
Restructuring Medicare and reforming tax rules would be politically
difficult. But a failure by Congress to address the exploding path of
fiscal deficits would be morally irresponsible.
Martin Feldstein is a member of AEI’s Council of Academic Advisers.
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