Beware ‘Grand Bargain’ that Promises to Cut Spending in Return for Higher Taxes

Published December 21, 2012

The idea of a grand bargain is very much on the minds of Washington, DC insiders these days. But any grand bargain that promises to cut spending in return for higher tax rates is unlikely to come to fruition, because the spending cuts are likely to be only an illusion.

Just prior to the election, more than 80 CEOs from some of the nation’s largest companies were making this argument: to get the country’s fiscal house in order, they said, we need both spending reductions and tax increases. This has been consistent with President Obama’s rhetoric: tax increases on the wealthy, in his view, are an essential part of any deal.

On the campaign trail, President Obama thought he was speaking off the record to the Des Moines Register when he reported that wanted to negotiate a “grand bargain” with the congressional Republicans that would include spending reductions and tax increases to reduce forecasted federal deficits. Indeed, in one of his first public statements after the election, Obama said higher taxes on the rich must accompany any agreement to avoid the fiscal cliff toward which the nation is heading.

This could easily be a trap for Republicans and the taxpayers. We are likely to see tax increases immediately and permanently, while the spending cuts may never occur.

Spending Cuts Mean Entitlements

The only way to get substantial spending reductions is to cut outlays for entitlement programs, including Social Security, Medicare, and Medicaid. And although the Democrats have said they are willing to do that, they always have two conditions: (1) the spending cuts must come in future years, and (2) they must not involve fundamental reform.

Fundamental reform of Social Security, for example, would scrap the Ponzi scheme of the current system, where each generation expects future generations to pay for its benefits. In its place would be a private, funded system in which each generation would save and invest and pay its own way.

Fundamental reform of Medicare and Medicaid dual eligibles (the elderly portion of Medicaid) must proceed in much the same way. Young people need to start saving right now to pay for their future health care and their nursing home needs during retirement. We also need to create more private sector options so seniors will have access to the same kind of health insurance the rest of the nation has access to, as in Paul Ryan’s plan.

Democrats Oppose Any Reform

The Democrats, however, will have none of this. Democratic Senate leadership and the administration have both taken fundamental reforms off the table. Sen. Dick Durbin (D-IL) said any deal for Medicaid and Medicare reform is out of the question. Treasury Secretary Timothy Geithner has said Social Security is off the table as well. So what does that leave?

Democrats’ idea of Social Security reform is raising the retirement age, reducing the rate of growth of benefits, raising the maximum wage subject to the payroll tax, etc. In other words, they want to tinker around the edges. And although they are perfectly willing to increase the payroll tax on higher-income taxpayers immediately, all the spending reductions must apply to future retirees only, not current ones.

You see the problem? Tax increases get legislated now. Spending cuts take place when some future Congress will have the opportunity to rescind them.

Obamacare Illustrates False Approach

Reform of government health care programs follows much the same pattern. Congressional Democrats favor only tinkering with government health care programs—they oppose anything that looks like real reform. Tax increases are immediate. Spending reductions get phased in in future years—but only if future representatives can withstand the political pressure.

One way to appreciate how the Democrats approach entitlement reform is to consider the way they chose to fund the Patient Protection and Affordable Care Act. Over the next 10 years, a new health insurance entitlement for young people is to be paid for by reducing Medicare spending by $716 billion. There is also a hefty increase in the Medicare payroll tax for higher income taxpayers.

However, the new Medicare payroll tax kicks in in 2013, whereas the spending reductions phase in slowly, over time. Democrats’ campaign rhetoric assures us seniors won’t be harmed at all, since the spending reductions will come at the expense of doctors, hospitals, and insurance companies.

Of course, when the doctors stop seeing senior patients (or start converting to concierge care), when the hospitals leave the market (as one in seven will in the next eight years, according to the Medicare Actuary) and when the insurance plans cut back on the benefits they are providing, there will be enormous pressure on Congress to reverse all of this. And most inside-the-Beltway folks are firmly convinced they will be reversed.

Ultimately, no grand bargain can be arranged in a climate where serious entitlement reforms aren’t on the table. Instead, this is just another example of a crisis being used as an excuse to achieve political ends.