The Catholic University of America
Nov 16 2010

Let the (Deficit Reduction) Games Begin

Posted by Ernest Zampelli at 8:28 PM
- Categories: Economy

Well, here we go.  No sooner than the preliminary report from the President’s National Deficit Reduction Commission is released do we begin to hear the volcanic-like eruptions of discontent and hostility towards many of its recommendations.  From both the left and the right, the rhetoric of class warfare and ideology can be heard loud and clear.  And it is not only coming from pundits and politicians, but from respected economists like (left-leaning) Nobel prize winner, Princeton professor, and New York Times columnist Paul Krugman.  Truth be told, a number of these recommendations will be DOA because they relate to entrenched sacred cows backed by powerful interests.  But, this does not mean that they should not be put on the table because many of them make economic sense.  Now, before I get started, let’s be clear.  We are talking long-run recommendations meant not to interfere with our current anemic/fragile recovery.  Indeed, another heavy dose of short-run stimulus would be welcome—though that is likely to be DOA as well.

Let’s begin with a look at the Commission’s recommendation regarding some tax breaks—tax expenditures in econspeak.  Eliminate the home mortgage interest deduction.  Realtors, homeowners, homebuiders, and mortgage lenders are just crazed over this one.  How can one possibly even consider such a change that’s been part of the tax code for one-hundred years?  Because it’s a boondoggle and most economists have always recognized it as such.  There little to no economic justification for it and costs the Treasury more than any other tax expenditure.  It distorts housing market decisions, keeps home prices artificially high, and directs too many resources toward homebuilding versus other productive uses.  And, because it’s a deduction, it’s more valuable to higher income homeowners than lower income homeowners.  At the very least, it should be converted to a tax credit and capped.

Eliminate the preferential tax treatment of employer provided health benefits.  It makes eminent sense.  First, it’s a form of income that totally escapes taxation and second, it provides an incentive for employers to raise worker compensation through the offering of expensive gold-labeled health plans.
Eliminate the deduction of state and local taxes from federal taxes.  Again, little to no economic rationale for such a provision—we don’t get taxed on the benefits we receive from state and local government services so why should we get to deduct the price we pay for them? 

Raise the retirement age at which an individual receives Social Security benefits according to increases in life expectancies.  I see no problem with having this on the table.  Krugman indicts this because the life expectancy of lower income workers who depend on Social Security benefits the most has increased less than higher income workers.  Though true and of concern, this alone need not remove such a proposal from consideration.  At least some of the difference in life expectancies between lower and higher income workers can be explained by the poor health choices of the former.  It is possible, then, that such a policy change could lead to better health choices by the lower income cohort.

For full disclosure, I do take issue with some of the Commission’s recommendations.  First, their recommended cap on revenues as a percent of GDP at 21 percent is fundamentally arbitrary and unnecessary.  Second, their proposed income tax rate reductions seem to be much steeper than necessary.  It forces reliance on discretionary spending cuts and freezes that are too large and that will likely have adverse impacts on the social safety net and research and development spending.  And third, their recommendation for raising gas taxes by a meager 15 cents per gallon per year is woefully and laughably inadequate.  

But, the fact is that the Commission has in general made recommendations that have been made by many, if not most, in the economics profession in the past.  To use these recommendations as fodder in the wars between ideologies and classes is unfair, divisive, and unproductive.  They deserve thoughtful consideration not knee-jerk reaction.



Youniss wrote on 11/17/10 10:10 AM

I am not an economist. But I've read some of the Nobelist, Elinor Ostrom's research. It shows that people who share public resources, such as pasture land or fishing beds, can actually decide to limit use so as not to deplete the resource beyond the point of recovery. They do this without government intervention, presumably because cooperative usage is in everyone's long-term interest. Why in the present instance is this principle not working? Is it because people do not see the situation clearly? For instance, is it that their tax deduction for a home mortgage is not viewed as being related to their social security or Medicare benefit? Is it that at the level of Federal budget involing trillions, people cannot see costs and benefits as clearly as farmers do with pastures or seafood merchants do with fishing areas? Ernie's analysis of the immediate rejection of change by both sides seems accurate. Since no one wants to give up what they have, nothing is likely to change. However, what if the issue were recast in terms of the Ostrom's sharing common resources? How could this be done? And would that help?

Matt wrote on 11/17/10 11:30 AM

Thankfully, your voice in support of the commission's initial plan is not the only one. Many folks in what I'd call the "reasonable blogosphere" are also suggesting the plan is, at a minimum, a good starting point for addressing the national debt.

Sadly, it will take *enormous* courage to take on some of the structural changes that I think are necessary to end future deficits -- courage which is in extremely short supply in DC these days.
Stephen Schneck

Stephen Schneck wrote on 11/17/10 4:25 PM

The New York Times has a thought-provoking interactive deficit reduction applet. You pick what you want to cut and what revenues you want to raise. See if you can do better than the commission. (Bet you can't.)

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