Dodging the Perfect Storm

Posted: Jan 19, 2007 12:01 AM
Dodging the Perfect Storm

There’s a tsunami on the horizon -- and it’s heading our way.

No, it won’t drown innocent lives or destroy the landscape as did the horrific tsunami of 2004. This tsunami is a financial one that threatens to bankrupt our children. The “perfect storm” has been created by the convergence of the promises our government has made through the Big Three entitlement programs: Medicare, Medicaid and Social Security.

If policymakers in Washington do nothing -- and let’s face, inaction is a specialty of theirs - and the deficit keeps rising, then by 2027 the Big Three (plus the resulting interest on the debt) will consume the entire U.S. budget.

That means there will be nothing left for defense, infrastructure, or anything else. And if that isn’t enough to make you want to seek higher ground, consider this: Every child in this country already is already on the hook to pay off the equivalent of a $187,000 mortgage -- but with no house attached. That’s how much each young person will have to pay in taxes just to provide promised Medicare, Medicaid and Social Security benefits to their elders.

You can understand why Stuart Butler and Alison Fraser, two of our top domestic policy experts at The Heritage Foundation, refer to this as “an entitlement spending tsunami” in an alarming new paper that outlines the dangers inherent in this approaching storm -- but also offers a way to soften the blow of this looming fiscal catastrophe.

A chart that accompanies the paper shows at a glance why this is no exaggeration. Tax levels over the last 50 years or so have hovered around 18 percent of GDP. Under current law -- that is, if we let President Bush’s tax cuts expire and we don’t fix the Alternative Minimum Tax, or AMT (a ticking time bomb I’ll return to below) -- that level will spike to 24 percent. As Butler and Fraser note, that’s “well above the highest levels the nation has ever experienced.”

Well, you may say, change the law: Make the tax cuts permanent and fix the AMT. Those are fine suggestions, ones that Butler and Fraser endorse wholeheartedly. Unfortunately, though, tax levels would still rise under such a scenario -- just not as high. Why? Because the Big Three -- Social Security, Medicaid and Medicare -- remain on autopilot, set to skyrocket in the decades ahead as 77 million baby boomers retire.

Entitlement reform is obviously a must, and sooner rather than later. The longer we delay reform, the more complicated and costly it becomes. But first things first. The more pressing need at the moment is to avoid making things worse. To this end, Butler and Fraser outline a simple yet powerful four-step plan. Number one is pretty straightforward, but certainly not a foregone conclusion in today’s political climate: Don’t raise taxes. As the Heritage experts explain,

“Any tax increase on top of this rising burden would put America well on the way to European-level taxes, causing European-style economic stagnation, slow income growth, and unemployment. Even France has begun to recognize how damaging such levels are, and French President Jacques Chirac has proposed to cut France’s corporate income tax rate from 33 percent to 20 percent. Congress must ensure that the U.S. does not take even one step down the road to higher taxes and a slower economy. Instead, it should face up to the challenge of entitlement spending.”

Step two: Don’t raise the Social Security wage cap. The cap limits how much of an individual’s income is subject to the Social Security payroll tax. Some congressional Democrats have suggested raising this cap as a way to solve the entitlement crisis. Good luck. This would just buy a little time; the financial crunch would merely be postponed. Worse, it would exact a price of its own: a large marginal tax rate hike on 3 million entrepreneurs and small-business owners, which, the Heritage experts say, would cost jobs, decrease personal savings and undermine American competitiveness.

The remaining two steps we’ve already covered: Make permanent the Bush tax cuts (we can credit our current, strong economy in large part to them) and scrap the Alternative Minimum Tax. The AMT should have been ended years ago. It was created in 1969 to keep a small number of millionaires from paying no taxes. But it was never indexed for inflation, and it now threatens to ensnare millions of hard-working taxpayers with more modest incomes.

You can find more tax policy solutions at The Heritage Foundation’s Web site.

It won’t be easy to avoid the financial tsunami that threatens to engulf our economy and obliterate our children’s future. But forewarned, as they say, is forearmed. And with sensible policy solutions -- low taxes combined with low spending -- we can extend our prosperity. And we can ensure that the American Dream stays within reach for all Americans.