Five Foolish Fears About Taming the National Debt

by: Rick Newman

Americans don't like government the way it is, but apparently they don't want it to change much, either.

With a credible plan for cutting government spending and reining in the national debt finally out in the open, we're now moving from easy rhetoric to ugly reality. Talking about shrinking government is easy. Doing it is a lot harder—and perhaps prohibitively hard—as the new report from President Obama's fiscal-responsibility commission makes clear. The panel, headed by Erskine Bowles and Alan Simpson, could have been named the National Commission to Alienate Everybody, since the spending cuts and tax increases outlined in their plan would hit nearly every American. But that's what it's likely to take to reduce the nation's deficits by $4 trillion over the next 10 years and get America back on sound financial footing.

The scare stories have already snowballed, thanks to exaggerated claims by those firmly affixed to the government teat and Tweet-sized analyses by pontificators who haven't even read the report. Some of it is true: One way or another, the beneficiaries of pointless pork projects, undeserved agriculture subsidies, do-nothing jobs, and other forms of government waste are going to get called out and cut off.

But most Americans will be much better off if Washington reins in its debt than if the problem simply festers, unaddressed—even if it costs them out-of-pocket cash. That's because the U.S. government is bound to hit a limit on its borrowing if nothing changes. Nobody's sure when that will happen. But one thing we can be sure of is that waiting for a crisis as a pretext for finally axing the debt is the most costly and worst possible approach.

As the government's debt rises from 62 percent of America's GDP now to 80, 90, 100, or 125 percent—roughly the level in Greece, when its debt load became overwhelming earlier this year—investors will start to worry about getting back the money they invest in Treasury securities. So the government will have to pay higher interest rates, and that alone will intensify the cash crunch and force urgent fixes. The nonpartisan and usually reliable Congressional Budget Office estimates that addressing the debt in 10 years instead of doing it now could shrink the economy, triggering a recession, and require twice the levels of spending cuts and tax increase as a plan put in place today.

It's oh-so-tempting to argue over who's responsible for this infuriating mess, but whoever did it, the fact is that most Americans need to give something up to help fix it. And if the pain seems to be spread more or less fairly, it will make individual sacrifices easier to bear. The Bowles-Simpson plan is merely a proposal, and it will probably be years before Congress takes on the toughest issues, like reining in Medicare spending and reforming the tax code. But we may finally be on the first step of a long journey, and it's time to start poking holes in the hysteria. Here are five fears about fixing the debt that are overblown:

It will eviscerate middle-class homeowners. The Bowles-Simpson report calls for eliminating the mortgage-interest tax deduction in its current form and replacing it with tax credits that would be capped at $500,000 worth of mortgage interest. The proposal would also eliminate mortgage-interest deductions for second homes and home-equity loans. Another debt-reduction proposal, overseen by Alice Rivlin and Pete Domenici, makes a similar suggestion, with different percentages and caps. Both proposals target the mortgage-interest deduction because the giveback is one of the most costly to the Treasury. Both proposals, in fact, aim to eliminate all itemized deductions, because they create an Orwellian maze of loopholes that mostly benefit people who can afford good lawyers and accountants. In its place they'd impose a new tax code with lower marginal rates on income, and far fewer gimmicks for lowering your tax bill.

Changing the rules regarding the mortgage-interest deduction would obviously be destabilizing if done quickly, since millions of homeowners have committed to monthly mortgage payments that count on the interest deduction being there. For that reason, there is no chance whatsoever that Congress will do something rash and raise the costs of homeownership for the entire middle class overnight. No. Chance. Whatsoever. Members of Congress may be venal, but they're not stupid, and it's a safe bet that any changes affecting middle-class pocketbooks will be phased in very slowly, so that the politicians who vote for it don't get run out of town. And there will almost certainly be new tax benefits that offset much of the cost of those that are eliminated and make people feel better.

Plus, the mortgage-interest deduction was intended to promote middle-class homeownership, not million-dollar homes or vacation properties or home-equity lending. Those extra benefits were nice when times were flush, but the government can't afford to subsidize king-size luxuries any more. We'll be lucky in a few years if it can subsidize a basic primary residence.

It will immobilize American drivers. Another controversial Bowles-Simpson suggestion is to raise the federal tax on gasoline by 15 cents a gallon, to fully fund the Transportation Trust Fund and end its need to borrow from general revenues every year. Motorists love to complain that increases in the gas tax are un-American and will impair our famed ability to roam the country at will. But if you're forced to raise taxes—which we will be, eventually—this is a good one to raise.

Higher gas prices would reduce consumption of a product that is mostly imported, contributes little to our core economy, is a major source of pollution, and is geopolitically destabilizing to boot. Even a fair number of auto-industry leaders favor a gas-tax increase, because it would make future gas prices more predictable and create a strong incentive for industry to develop gasoline alternatives and much more efficient cars. Jeremy Anwyl, CEO of car-research site, says he wouldn't mind a gas tax of $5 per gallon—raising the total price of a gallon to $8 or so. That's roughly what drivers pay in Europe and Japan—where some of the world's most advanced cars originate.

The right way to increase the gas tax would be to give several years advance notice, so car owners had time to downsize or adjust during their normal purchase cycle. A tax hike could be phased in for even more flexibility. There could also be a hardship tax credit for people below a certain income level. People might end up driving a bit less, but they'd also drive much more efficient cars and find other ways to adapt.

Retirees will end up impoverished. Any plan to fix America's finances needs to make Social Security solvent—not that hard to do—and plug a huge funding gap for Medicare, which could be the hardest fiscal problem of all. The Bowles-Simpson proposal calls for gradually raising the retirement age to 69 and raising Medicare eligibility ages as well. But those changes wouldn't fully go into effect until 2075—a date so far in the future that the youngest Social Security recipients by that time were just born a few years ago. Sixty-five years seems like enough time to adjust. Other changes would reduce retirement benefits for the wealthy, a common-sense fix that even some of the targeted recipients agree with.

The proposal would also revamp Medicare, with a lot of changes that would affect doctors and insurers but not necessarily patients. The plan would, however, ask seniors to pay a portion of their own care, ranging from $500 to about $3,000 a year, even with supplemental insurance. The idea is for patients to bear enough of the cost of their own care to compel them to shop hard for the lowest cost and best quality, as they would any other product. It's an unsatisfying idea because healthcare isn't priced like other goods, and seniors may have no way of knowing what's cheapest or best. But there needs to be some way to force down the skyrocketing cost of healthcare, because it's the single biggest factor driving the federal government toward insolvency. If cost-sharing doesn't do it, a more severe cutback in benefits or coverage levels could be the only solution.

The fear factor here is huge, since opponents of Medicare cutbacks can dial up hysteria at will by raising the specter of "death panels" and "rationed care." But keep in mind—seniors are perhaps the most active voting bloc in America, with effective lobbying groups like AARP behind them. And the ranks of seniors are swelling, not shrinking. Members of Congress aren't about to bankrupt seniors at the risk of their own careers. They'll find a way to manage the pain.

National defense will falter. Defense spending has surged since the 9/11 terrorist attacks in 2001, and that spending needs to come down under any realistic debt-reduction plan. The Bowles-Simpson proposal is to cut defense spending by about 20 percent by 2015, compared with the Obama administration's proposals for that year, which would amount to roughly $125 billion. That's a big cut, but the defense budget would still be much higher than it was in the 1990s.

Battles over defense budgets have taken the same general tone for the last 40 years. Ships, fighter jets, helicopters, nuclear weapons, armored vehicles, and other fancy weapon systems cost way more than simply training and outfitting the troops, and even Defense Secretary Robert Gates wants to kill some of the huge projects gobbling up his budget. But members of Congress whose home districts would benefit most from the weapons programs tend to prevail, and when budgets are flush the military gets its toys whether it wants them or not. It's quite possible to pare the defense budget while keeping the military strong, by following the Pentagon's own spending priorities, balanced by recommendations of the CBO and other reputable analysts on which programs provide the most bang for the buck. We should probably also come to grips with the fact that we can no longer afford gee-whiz weaponry that dazzles our enemies from the heavens or defeats magical air defense that only exist in theory.

It needs to happen immediately, or else. Many interest groups oppose the Bowles-Simpson plan simply because it would start too soon. And it probably would, in fact, be a bad idea to start slashing government spending while the economy is still weak and unemployment painfully high. But investors worried about America's debt have repeatedly pointed out that it's more important for there to be an ironclad plan set to go into effect sometime over the next few years than to start slashing today. In fact, if there were such an ironclad plan, it would be much easier to enact some new stimulus spending now, to assure the recovery roots deeply and the economy is even stronger once the cutting starts.

On this one, the plan's opponents will probably get their way. Some Republicans emboldened by their surge in the November midterms are coming to Washington in January with axes drawn, but a political process that's notoriously slow—especially in the Senate—will bog that down. It's a good bet that nothing serious will happen until after the 2012 elections—and that Obama, if re-elected, would be more likely to push big cuts than a fresh Republican, because he wouldn't be running again in 2016. If a debt-reduction deal is in place by then we'll probably be lucky. In politics, unpopular moves never happen fast—and usually don't happen at all.

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