IMO, credible fiscal consolidation will require some tax hikes. First, revenue changes will be necessary to develop a sufficiently broad base of political support to enact, implement, and sustain such a program. Second, real problems exist in the Tax Code that should be addressed. One such problem is the high percentage of Americans who pay no income taxes, as
cited by former Comptroller General David Walker. Third, efficiency gains could be achieved by broadening the tax base and simplifying the Tax Code (eliminating deductions/closing loopholes in exchange for somewhat lower rates).
IMO, the widely-popular home mortgage deduction should be examined, as part of a larger review, especially as such a deduction likely contributed (in part) to the run-up of the housing bubble, as taxpayers subsidized additional leverage. Whether the deduction would be eliminated, reduced in size/capped and tied to nominal GDP (not housing prices, as a cap tied to housing prices would be procyclical and enhance the risks were a new bubble to develop well down the road), etc., would depend on the examination. Moreover, a transition whereby existing homeowners are held harmless could be politically necessary. Another deduction that should be reviewed relates to the deductibility of interest on state and local government bonds. States/localities would object to a loss of that deduction. However, the reality is that this program also creates incentives for states/localities to increase their debt. Balanced budget requirements aside, state and local government debt has steadily increased. Of course, such a move might need to be tied to a more transparent program of transfers to state/local governments. Fourth, changes related to the 2001 and 2003 tax relief programs will very likely have to be considered in the larger context of overall tax reform given the amount of revenue involved.
Having said all that, while I believe some revenue increases will be needed to contribute to fiscal consolidation, those increases cannot account for a majority of the fiscal consolidation effort. Spending reductions/mandatory spending reforms should account for 2/3 or more of the fiscal consolidation (note: interest savings from debt reduction are not a spending cut, but are attributable to the overall balance of spending reductions/tax hikes involved in fiscal consolidation). Any greater involvement of tax hikes would likely create a growing risk of increasingly sluggish economic growth. Reduced economic growth could exacerbate the nation's long-term fiscal picture, leading to a more negative outlook, increased risk premia that raise the cost of servicing the nation's debt, etc. If nominal GDP growth were to fall toward and then below the nation's cost of financing its debt, that would present an especially perilous situation.
A similar situation prevails with respect to public investments (expenditures that yield long-term benefits). If investments are treated as little different from other discretionary spending, the country could also risk putting itself on a slower economic growth trajectory.
Finally, revenue increases cannot become an excuse for policy makers to try to avoid restructuring of the nation's mandatory spending programs. Already, problems inherent in those programs are becoming more urgent as the enormous Baby Boom cohort continues to retire. Social Security can readily be fixed with benefit changes, increased age of eligibility (pegged to life expectancy changes), and some payroll tax hike (rate and/or ceiling increase). Medicare and Medicaid present a much more complex problem. IMO, addressing those two programs will require the kind of reform that dramatically reshapes U.S. health care, namely addresses the industry's excessive cost growth problem. Such a solution almost certainly will require major changes with respect to technology procurement/deployment and supply side remedies that significantly increase the supply of medical practioners in the U.S. Premiums and benefit formulas for Medicare and Medicaid will need to be adjusted. The latter approach, absent a remedy for the excessive cost growth problem, would lead only to increased rationing, whether it is through reduced purchasing power of vouchers vis-a-vis the price of medical services or budget-driven mechanisms.
Unfortunately, at present, the American public appears ill-informed about the main drivers of the imbalances and
unprepared to support the required changes. That will make it difficult for the nation's policy makers to enact robust reforms, as well as to sustain the effort, absent the emergence of a transformational political leader of an FDR, JFK, or Reagan stature who can lead big change.
