Academic journal article AEI Paper & Studies

Tax and Spending Reform for Fiscal Stability and Economic Growth

Academic journal article AEI Paper & Studies

Tax and Spending Reform for Fiscal Stability and Economic Growth

Article excerpt

Recognizing the unsustainable fiscal outlook facing the United States, the authors present a plan to constrain the growth of federal spending and reform the tax system to promote economic growth. The plan replaces the income tax system with a progressive consumption tax, eliminating the bias against savings and investment. The plan revamps Social Security to provide a flat, universal benefit that would virtually eliminate poverty in old age, making the program more effective in protecting low earners, more conducive to saving and longer work lives, and better aligned with the work and retirement conditions that will prevail in the coming decades. Additionally, the plan adopts health reforms that are intended to slow the growth of spending while maintaining access to high-quality health services, by shifting away from the defined-benefit approach that characterizes Medicare and Medicaid today to a defined-contribution philosophy. The plan also brings federal spending and revenue into closer alignment, sparing future generations from the explosive growth of federal debt.

Absent major policy changes, growth in entitlement spending over the next 25 years is projected to push the federal debt as a share of GDP to more than 100 percent, an untenable fiscal prospect and one that will force undue burdens onto future generations. The objective of this plan is to achieve long-term fiscal stability and promote economic growth. (1) We cannot simply tax our way to fiscal stability without suffering the consequences of a slower economy and reduced prosperity. Yet we also cannot address the imbalance simply by cutting spending without regard for the risks of eliminating essential services for an aging population, undercutting our infrastructure on which economic growth builds, and reducing our ability to defend the country against its enemies.

The tax proposals presented in this plan (2) raise necessary revenues with the least possible impact on saving and economic growth. Our spending proposals make entitlement programs better targeted and more efficient.

Our proposals would hold the national debt to 62.7 percent of annual gross domestic product (GDP) in 2040. Ambitious cuts in federal spending are required to achieve that goal while minimizing tax burdens on the American people and the drag that high marginal tax rates impose on long-run economic growth. The plan emphasizes reductions in the growth of the major entitlement programs--Social Security, Medicare, Medicaid, and health insurance subsidies established by the Patient Protection and Affordable Care Act (ACA).

Many of these policies will be politically unpopular, but some version of our proposal is necessary. None of the authors of this plan fully agrees with every policy advanced here, but we have been able to reach the kind of compromise that is needed to address the long-run fiscal imbalance. Our plan addresses three key areas.

Taxes. The federal government raises much of its revenue from individual and corporate income taxes, which penalize saving and investment. Our proposed tax reform eliminates these penalties by replacing the income tax system and the estate and gift tax with a progressive consumption tax. To address environmental concerns in a more market-friendly manner, the proposal replaces an array of energy subsidies, tax credits, and regulations with a modest carbon tax.

Social Security. The Social Security reforms we outline are designed to make the program more effective in protecting low earners, simpler for individuals at all earnings levels to understand and plan around, more conducive to saving and longer work lives, and better aligned with the work and retirement conditions that will prevail in the coming decades. The Social Security program will provide a flat, universal benefit that would virtually eliminate poverty in old age. This flat payment would increase benefits for the roughly one-third of retirees whose current Social Security benefit is less than the poverty threshold. …

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