Arnold Kling  

The Commission, the Deficit, and the VAT

Question for David... Recommended...

Greg Mankiw writes,

let's suppose that you are a conservative and you want the fiscal commission to succeed. You will have to agree to higher taxes as part of the bargain. But what should you aim to get in return?

He would ask for an increase in the age of eligibility for both Social Security and Medicare. He would also ask for tax reform, including the introduction of a value-added tax (VAT), elimination of the estate tax, and lower tax rates on personal and corporate income.

Tyler Cowen also makes the case for a VAT.

My position is that we redistribute far too much income from the young to the old. This requires taxes that reduce total output, which makes the redistribution bucket very leaky--a lot of wealth is lost in doing all this redistribution. If I were a conservative on a Budget commission, I would hold out until the liberals agree that redistribution should be limited to a safety net, not a program of transfers to the affluent.

Social Security's age of eligibility should be in the early 70's. More importantly, Social Security benefits should be very much means-tested, based on lifetime wage income prior to age 70. Benefits should gradually be phased out with lifetime income, so that someone not in the bottom 25% of lifetime income should receive no benefits.

Medicare as currently structured--reimbursement for services--should be scrapped. Instead, I would have the government provide supplemental extreme catastrophic insurance along with fixed-sum vouchers. The catastrophic insurance would not really kick in until you incur $50,000 of health costs in one year. The idea is not to protect the typical individual, but to provide enough of a supplement so that private health insurance companies would be willing to insure those who are not in perfect health. Think of my proposal as a variation on catastrophic reinsurance, an idea that was floated by Democratic wonks during the 2004 election, applied to the elderly.

Honestly, I do not see any alternative that looks feasible. Given all of our other taxes, I doubt that a VAT would raise enough money at the margin to make a difference. Already, marginal tax rates are very high for several classes of people, particularly those with low enough incomes to qualify for various means-tested government programs. Introduce a significant VAT on top of the current tax system, and lots of people are going to decide that housework and the underground economy are more lucrative than working in the market.

Tax reform, along the lines that Mankiw suggests, might produce more net revenue, but not nearly enough to rescue Social Security and Medicare.

Stare at the table.

Comments and Sharing

COMMENTS (16 to date)
ajb writes:

Of course, if you believe Robin Hanson that long term growth is going to be much higher than we anticipate it makes sense to take from the future for the present.

Not that I endorse that position...

John B. writes:

If Social Security is changed as you suggest, it is essentially turned into a welfare program. That would remove the public support for the program and it would probably unwind pretty quickly.

The political trick behind not means-testing a program is that it looks to the general public as though everyone pays and everyone benefits; who really pays and who really benefits is thus concealed. C.f. Bismark and Bevan.

Speaking as someone who didn't want to be in the Social Security system because he anticipated it would be a bad bet (and it was) but who nonetheless was forced to contribute for decades, the system owes me what it's promised and I'll vote accordingly. I suspect many other Boomers feel the same way.

All the more reason not to do the same stupid thing with health care, of course, as you point out.


Lord writes:

Prepare yourself for single payer healthcare, if not the easy way, then the hard way. All proposed solutions merely push people more rapidly on to medicaid with government paying all the costs.

tom writes:

Again with means testing!

I agree with John B that means-testing would convert SS to a welfare program, which would hurt its popularity. But I would go further and guess that is your unstated goal.

Even if that worked eventually, I think there would be a very dangerous interregnum of several decades where people try to game the system to fall under the means-testing thresholds.

You may be trying to deal with the dangers of gaming the means-testing by having it be based on based on lifetime wage income, instead of assets. But that's probably a non-starter since lifetime wage income is such an obviously imperfect proxy for neediness.

Wealth is the best/only measure of need. So I think that effective means-testing must evaluate wealth. But that creates a huge incentive to destroy, hide or not accumulate capital. It would be much more destructive of the incentive to earn and save than high marginal income tax rates.

I complained about this in Bryan's means-testing-is-awesome post from a week ago: if we are means-testing nursing homes (as we do already) and Social Security, people getting old will all be playing a High-Low game where lots of them will go low. (And that ignores college tuition financing/grants and low-'income' housing for younger people.)

I think the best fix is the one people already know--David Henderson's approach of raising the age requirement and indexing it (though I am sincere while I think he, like you, sees his method mainly as a way to undermine the long-term popularity of SS). The way to sell it is the time-honored method of buying off those who are already 50+. And screwing over the young would probably have the beneficial effect of increasing their efforts to earn and save, which is the opposite of what means-testing would do.

dcpi writes:


If you want a higher retirement age for SS eligibility the proper bargain is to get a current reduction in the SS contribution rate. At least those of us paying in what then be getting for giving.

Of course, that kind of bargaining -- the kind were both sides get something tangible -- never seems to occur to those in Washington.

How about a raising of the eligibility age to 75 in exchange for cutting the SS tax to 6% -- 3% for employer and 3% for worker?

What you offer ... means testing in exchange for higher retirement age ... is a lose-lose for those of us worker bees paying into the system.

David writes:

As long as we're going to convert SS and Medicare into welfare programs, can't we please eliminate payroll taxes as the means to fund these programs and make them part of the regular tax and budget process? I'll even volunteer to pass out cans of cat food to the seniors on the streets since we all know that they'll lose their homes and have nothing to eat without social security.

Doc Merlin writes:

"If I were a conservative on a Budget commission, I would hold out until the liberals agree that redistribution should be limited to a safety net, not a program of transfers to the affluent."

We live in a country where political power and voting make the rules. Thus, any attempts at "providing a safety net" will eventually become just a way to pay off the politically powerful.

The only answer is to:
1) Stop talking about compromise, you are showing your hand.
2) fight to get rid of the entire redistributionary system.

JPIrving writes:

What a lousy bargain. Professor Kling has some great remedies but we all know nothing like them will be considered. This is going to end badly.

Young people should consider moving to smaller, better governed countries.

Randy writes:

Re; Social Security and Medicare

1. Keep the contract. Drain the entire federal budget if necessary, but pay those who are currently committed in the system in accordance with the current formulas. This may mean that the US Government would have to declare bankruptcy and wipe out other debts. So be it. The holders of those other debt instruments were voluntary investors in a political system. Pay those who were "invested" against their will first.

2. End the contract. Let anyone 18 or under drop out immediately. Prorate everyone else between 18 and 40 on the basis of their contributions.

3. Create a voluntary program for anyone still dumb enough to voluntarily invest their life savings in what is basically a political/military organization.

Matthew Gunn writes:

Is it politically possible for the U.S. to even raise that much tax revenue!?

Federal revenue has consistently been in the neighborhood of 18% of GDP since WWII, a rather remarkable fact given all the changes to tax rates and structure. Tax revenue / GDP reached a high point under Clinton, but then Bush ran on a tax-cutting agenda and the rate was driven back down as GDP growth dominated revenue growth. In California, tax revenue was growing rapidly in the 1970s and that triggered the anti-tax revolt of Prop 13.

Paying for unreformed Medicare, Medicaid, and Social Security would require levels of taxation dramatically higher than anything ever seen before in the history of the Republic. There's no historical evidence to suggest the public would accept that level of taxation and significant evidence to the contrary.

Ella writes:

Ultimately, I don't think the Congress is going to do anything remotely useful. They won't let people opt out, they won't implement means-testing, they won't raise the age limit.

So staring at the table just makes me really, really sad.

Arthur_500 writes:

The conundrum of how to pay for things you can't afford. Social Security and Medicare have never been adequately accounted for so it has been easy for Legislators to add on the the number of ways they can spend that money. After all it doesn't show up in the budget! It's a win win.

My problem with vouchers is the problem with any program in which each person is going to be guaranteed a minimum amount of money - it creates an artificial floor. If I know the government is going to give you an insurance voucher to $10,000 per year for a policy currently worth $12,000 per year then I simply set my prices at $15,000 because I know you are going to be getting two thirds of that for free so the pain to you is relatively small and I increase my profitability.

Currently health insurance company earning figures show that those big bad capitalists are raking in slightly over 5% return. An artificial floor would certainly be benificial to shareholders who might want to improve their ROI.

Ever try to stand on an artificial floor?

DaveL writes:

It is difficult to square raising the age for Social Security and/or Medicare with the fact that older workers (which means people over 50, not 60 or 65) are heavily discriminated against in the job market.

Means-testing seems to me to be much more fair, and it has the philosophical advantage that it would finally do away with the fiction that SS is a savings plan.

Nikonman writes:

I believe that raising the age of eligibility for both Medicare and Social Security makes a lot of sense, from both an economic and historical perspective.

When originally conceived, the age of eligibility for these programs was pretty close to the average life expectancy at birth; i.e., 65 years old. We probably need to move that number considerably higher, since we are now looking at 14+ years of additional life expectancy.

Now, as long as I have the floor, may I add a couple of other budget suggestions?

I would like to retire all farm subsidies, and let's get rid of the Dept of Agriculture while we are at it.

Dept of Commerce? Gone.
Dept of Labor? Gone.
Dept of Education? Gone.
Dept of Energy? Gone.

I haven't done the math, but I am pretty sure the cost/benefit analysis will show that my cost-cutting suggestions have a pretty good return on investment.

Dave writes:

This sounds basically like my own position: get rid of entitlements for the middle class and set up actual social safety nets. Right now, the government is in the business of retirement saving for everyone via a Ponzi scheme. Let's get rid of the illusion that Social Security is some form of savings, and just help out the least fortunate and the unlucky. No one would struggle through life just to take advantage of such a means-tested scheme. And without the illusion that government is saving for everyone, you might see individuals take more responsibility with their own finances, instead of levering up to the breaking point.

Chester White writes:

[Comment removed for supplying false email address and for multiple policy violations. Email the to request restoring your comment privileges.--Econlib Ed.]

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