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Tip of the Month for December, 2010

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Deficit Reduction: An Update on Capitol Hill Happenings

Deficit reduction is the hot topic in Washington with reports already released by the President’s bipartisan deficit commission and the bipartisan Rivlin-Domenici Debt Reduction Task Force. Co-chaired by former Congressional Budget Director Alice Rivlin and former Senate Budget Committee Chairman Pete Domenici, the task force’s mid-November proposals are the most far-reaching to date, with specific recommendations designed to cut nearly $5.9 trillion in government spending from 2012 to 2020. The report calls for bold reform to the nation’s tax code, as well as a new national sales tax (value-added tax), spending freezes for defense and discretionary spending, cost-control measures for Medicare and Medicaid, and a payroll holiday from Social Security taxes. Some of the key points from the proposal are:

  • Tax Code Reform
    The multipronged proposal calls for only two individual tax brackets – 15 percent and 27 percent – instead of the current six for taxpayers. The lower rate would apply to the first dollar of income earned and the higher rate would kick in for couples earning at least $102,000 annually. The proposed revisions are recommended in conjunction with a new 6.5 percent national sales tax – which co-authors Domenici and Rivlin have dubbed the Debt Reduction Sales Tax – to be phased in over a two-year period. Recognizing that opposition to a national sales tax is likely, Domenici commented that the value-added tax component was needed or the debt problem will never be solved. Instead of itemized deductions, the tax reform recommendations include a maximum mortgage credit of $25,000, wiping out state and local tax deductions, and providing a flat 15 percent refundable credit for charitable donations. The corporate tax rate would be lowered to 27 percent from the current 35 percent. Capital gains would be taxed as ordinary income, Social Security benefits would be taxed, and the earned-income credit would be replaced with earnings and child tax credits.
  • Deficit Reduction
    The plan calls for the reduction of overall federal spending as a percentage of GDP from the current 26 percent to 23 percent and phasing in a freeze on discretionary spending (so as not to derail economic recovery), starting in 2011 – with estimated savings of $1 trillion through 2020 (excluding interest). This doesn’t include stimulus funding, which currently is winding down. Defense spending would be frozen for five years at levels based on the assumption of decreased spending on the war in Afghanistan.
  • Health Care and Social Security
    The plan proposes a yearlong suspension of Social Security payroll taxes for employers and employees to free up about $650 billion for consumers to save or spend. It is believed the payroll tax suspension could create between 2.5 million and 7 million new jobs over a two-year period. Social Security reform proposals include slowing benefit growth for the most affluent beneficiaries, indexing retirement benefits to longevity and ending the exemption from Social Security taxes for state and local government workers. The payroll tax ceiling, currently $106,800 per annum, would be increased to include 90 percent of all wages. The plan’s authors believe that spiraling health care costs are one of the major drivers of the nation’s long-term debt; accordingly, their proposals are focused on stringent cost-control measures. The plan aims to save $756 billion on health care through 2020. It calls for a transition to premium-support programs to control rising costs – limiting cost increases to the rate of economic growth plus 1 percent – between now and 2018. Medicare beneficiaries would have the option to choose either something like a traditional fee-for-service plan or an HMO.

What’s next?
The solution lies with Congress. The commissions and task forces have released their ideas for fiscal reform. How soon and how resolutely our elected representatives will bite the bullet and face the reality of either reducing services and/or raising taxes remains to be seen.

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