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The Debtor Economy: A Proposal

Taxes should be increased in two ways. First, by a tax on consumption—not an indiscriminate sales tax, but a tax on energy consumption that would encourage energy conservation and the use of small, fuel-efficient cars instead of the present return to large ones. (Its other advantages could be considerable, as we shall see.) Second, a minimum tax should be imposed on corporations, which are, in many cases, paying little or no taxes at all. In 1975, corporate taxes made up 15.6 percent of federal revenues; in 1983 they made up only 6.2 percent of revenues.

The bill of Senator Bradley of New Jersey and Congressman Gephardt of Missouri suggests, in my view, the most useful pattern for personal taxes. It proposes a minimum rate of 14 percent—which would apply to four out of five taxpayers—and a maximum personal income tax rate of 28 to 30 percent, while eliminating many deductions and most tax shelters. If the maximum personal income tax rate is around 30 percent, moreover, there would be no need for the proposed “indexation” that would adjust tax rates to take account of inflation. Indexation is a necessary brake on spending when marginal tax rates are high; its benefits are reduced as marginal rates come down. Under this tax structure, moreover, capital gains could be taxed at the same rate as ordinary income. A minimum corporate income tax somewhere between 15 and 20 percent (depending on the definition of income) seems to me equally sound. The Bradley-Gephardt plan, if it were combined with the elimination of indexing and a minimum corporate income tax, could raise an additional $20 billion by the third year.

A consumption tax on energy could be applied through a combination of excise taxes on crude oil and oil import fees. These energy taxes should raise between $40 billion and $50 billion annually; phased in over three years, they would not hurt the economy. Part of these taxes would undoubtedly be translated into higher gasoline prices. However, gasoline prices in Europe are $2.50 to $3.00 per gallon; here such a tax would still leave gas prices at 50 percent of European prices.

The critical question concerning any new tax increase is whether the revenue raised will simply be translated into new spending or whether it will genuinely be used to reduce the deficit. The only way to ensure that the energy tax revenues would be used to offset the deficit would be to set them apart from other revenues. One way to do so would be to create a trust fund into which all new energy taxes would be paid. The trust fund would be managed by the Federal Reserve Bank, which would use the proceeds solely for the purpose of retiring a part of the federal debt.

In order to make this arrangement an effective deterrent to spending, two additional features could be attached: first, it could be combined with a limitation on the growth of the federal debt to a fixed percentage of GNP. Second, it should provide for the energy tax (or another tax segregated for debt repayment) to increase automatically by the amount that the debt limit is raised, in any one year, beyond those limits.

These provisions would ensure that the government’s unrestrained freedom to borrow would be both sharply curtailed and combined with an offsetting tax penalty. By reducing the need for government financing by some $40 to $50 billion per year, it would also make more money and credit available to the financial markets for investment. It would ease the pressures driving up interest rates and might allow the Federal Reserve to carry out an easier monetary policy without risk of inflation.

A variation of this arrangement was used when New York City sales taxes were segregated from the expense budget to guarantee the payments on MAC bonds. Segregating a new source of federal revenue for the sole purpose of reducing the size of the national debt deserves serious consideration now. It will not relieve either the president or Congress of the need to control the growth in expenditures; on the contrary, a comprehensive revision by Congress of our tax and budget structure remains our most urgent national need. However, if deficits are inevitable because of the demands of a great many political interests, a mechanism such as the energy trust fund not only would help to keep down interest rates, but would offset to some degree our low national savings rate. In effect, the trust fund would be a national savings plan. As for a constitutional amendment to balance the budget, that would be like a unilaterally declared nuclear freeze: it would give a quite unreal illusion of safety, without any guarantee of the real thing.

Military Budget Cuts

Annual defense outlays will grow from $300 billion to $400 billion from fiscal year 1986 to fiscal year 1989. Virtually every conceivable military system is being acquired: MX, B-1, Trident II, air-, sea-, and ground-launched cruise missiles, Stealth, to name just a few. Funds have already been appropriated for the “Star Wars” defense system. I am not a military expert, but I am familiar with large organizations. There is no question in my mind that the military budget, like that of practically any huge organization, can be cut significantly without affecting our military capacities. The Congressional Budget Office, among others, has made a convincing case for a multibillion-dollar annual savings in the procurement of weapons systems. The Committee on National Security has proposed a “prudent defense budget” slowing the growth of outlays from $282 billion in fiscal year 1986 to $365 billion in fiscal year 1989.1 Military pensions and other personnel costs also seem to me capable of being cut substantially. An annual rate of savings of $25 to $30 billion, by the third year of such a program, can and must be achieved.

Social Programs

No one can talk convincingly about reducing the budget deficit without also discussing entitlements—social security, Medicare, Medicaid, etc. Establishing fair limits to the growth of entitlements may be the most important issue facing this country. Medical advances are being made on every front—in pharmaceutical and DNA research, in diagnostic techniques, in operating-room procedures and equipment. The resulting increase in life expectancy could be dramatic. How this will affect not only social costs, but the agonizing choices to maintain life or accept death, is now only dimly perceived. Recent speculation that applying every available technology to every patient could eventually require more than 100 percent of GNP is not as wild as it may sound. Significant changes and savings are obviously necessary and a detailed program for ways of containing costs will have to be worked out. Lowering social security benefits for people in the higher income brackets will probably become necessary. So will taxing some benefits, putting a limit on cost-of-living allowances, changing benefits for new entrants into the social security system, etc.

I doubt that the problem of medical care, however, can be dealt with just as a matter of making a number of more or less painful adjustments. We have to reexamine the entire system, in which the various attempts to regulate the rising fees charged by doctors have not been notably successful, and in which a two-class system of medical care has, for the most part, prevailed.

We would do well to examine objectively other systems of medical care to see what we can learn from them. The following description of the Canadian system is suggestive:

Canada’s provincial health-insurance systems, like ours, use third-party reimbursement. You go to the doctor, and the insurance system pays the bill. But in the United States, the insurer might be Blue Cross Blue Shield, or Prudential, or Medicare, or one of hundreds of others. In Canada, there is only one insurer—the provincial health plan. Each patient simply pays the bill with a credit card, and the insurance system reimburses the provider. As a result, Canadian hospital administrative costs are about one sixth those of American hospitals. Moreover, with one unified system, the state has a much easier time regulating rates, procedures, and fees. In the early 1970s, when Canada first adopted its comprehensive plan, it was spending about the same total health outlay as the United States: roughly 7.3 percent of GNP. Since then, health-care costs in Canada have stabilized at about 7.5 percent of GNP, while in the United States, they have soared to the 9–10 percent range.2

This does not mean that the US should or could simply adopt the Canadian system. But if the Canadians have managed to contain costs and provide reasonably good medical services through comprehensive health insurance, then Congress should ask why we have not been able to do so here.

Freeze on Spending

In view of the complexity of these budget cuts and their urgency, I believe a one-year freeze on all spending programs is worth considering while a new tax plan is worked out. This would save about $40 billion during the first year and may well be the most practical approach for the time being. In any case, Senator Dole was right to recommend that a bipartisan economic “summit” conference be held immediately after the election, to deal with the budget. If we wait until the next recession, it will be too late.

Any new approach to social programs will be irresponsible if it does not confront the deep question of poverty in the US. It is a melancholy, but undeniable, fact that there are more poor people in this country today than there were a few years ago. The income disparity between classes seems to be growing larger, and there is little on the horizon to suggest change for the better. The recent Urban Institute study stated:

From 1980 to 1984, the typical middle class family’s income rose from $18,857 to $19,034 or up about 1 percent. The average income of the poorest one-fifth of all families declined from $6,913 to $6,391, or by nearly 8 percent, whereas the average income of the most affluent one-fifth increased by $37,618 to $40,888, or by nearly 9 percent.3

Although the tax and budget policies of the Reagan administration no doubt aggravated this problem, it derives from deep trends in the economy that would face any administration.

Economic growth and new technology now have a tendency to leave behind larger and larger numbers of people who lack the skills, education, or social advantages that would enable them to compete for jobs. The technological changes now being made will put the same downward pressure on employment in the service industries as it has in manufacturing industries. More and more people will have fewer and fewer chances to accumulate even a minute amount of savings or capital.

A one-year freeze on expenditures would permit a serious review of social welfare programs on the basis of need and means. The current low inflation makes this the most appropriate time both to forgo current cost-of-living adjustments and to reconsider the entire welfare system. Any new approach must explicitly recognize the quite different claims of those who need Medicaid and school lunches, for example, and those who benefit from Medicare and federal pensions.

  1. 1

    See Reducing the Deficit: Spending and Revenue Options, Congressional Budget Office (Washington, D. C.: Government Printing Office, 1984). See also Spending for a Sound Defense: Alternatives to the Reagan Military Budget, issued by the Committee for National Security, 2000 P St., NW, Washington, D. C., 20036

  2. 2

    From The Economic Illusion: False Choices Between Prosperity and Social Justice, by Robert Kuttner, recently published by Houghton Mifflin, pp. 251–252.

  3. 3

    See The Reagan Record, edited by John L. Palmer and Isabel V. Sawhill (Ballinger, 1984), p. 320.

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