washingtonpost.com  > Opinion > Editorials
Editorial

The Tax Cuts Re-Examined

Sunday, August 15, 2004; Page B06

THE DEBATE OVER the Bush administration's fiscal policy has been grinding on for three years, producing few concessions or apologies. Critics, including this page, say the tax cuts are not affordable; defenders retort that the president has a five-year plan to halve the deficit and that a combination of economic growth and entitlement reform can shore up the government's finances in the longer term.

To break out of this stalemate, we have taken a fresh look at these hopes for long-term salvation. We have assumed, for the sake of argument, that a second-term Bush administration could overcome the political obstacles to entitlement reform and pro-growth policies such as tort reform, and we have sought estimates for the impact of such reforms on government finances. For example, a jump in labor productivity like the one experienced in the 1990s would likely eliminate the deficit in 2014, which is otherwise projected to clock in at around 3.5 percent of gross domestic product, according to calculations by Alan J. Auerbach of the University of California at Berkeley and Peter R. Orszag and William G. Gale of the Brookings Institution. Or, to take another example, Medicare reform could theoretically cut the system's costs by 30 percent, according to Elliott S. Fisher of Dartmouth Medical School.

_____Today's Post Editorials_____

_____What's Your Opinion?_____
Message Boards Share Your Views About Editorials and Opinion Pieces on Our Message Boards
About Message Boards
_____Free E-mail Newsletters_____
• News Headlines
• News Alert

This exercise, in which we have strained to make assumptions that might support Mr. Bush's claims that the tax cuts are affordable, has reinforced our view that these cuts are a mistake. Put simply, every plausible vision of the future suggests that government is going to grow as a share of the economy, partly because of the need to support baby boomers but also because societies demand more things of their government as they grow more prosperous. The share of government in GDP has more than quadrupled in the United States over the past century, and a World Bank cross-country study has shown that the richer a country, the larger the share of its resources that flows through the government. As people grow richer, their appetites for newer and jazzier consumer durables taper off, and the things they want more of include health, education, clean air and safety from threats both foreign and domestic. These things are often provided by the government. To starve the government with tax cuts is to misread this trend.

Over the next two days, we will examine ways of boosting economic growth and cutting health costs -- options that hold out considerable hope for reducing deficits, though not enough to close the projected gaps. But today we address the long-term policy that generates the most excitement in pro-administration circles: Social Security privatization.

There are problems with privatization. Individual retirement accounts would be expensive to administer. They would shift investment risks onto the shoulders of households, which already have to cope with the job insecurity and income volatility created by technological change and globalization. Still, Mr. Bush's sympathizers are right that Social Security privatization could reduce long-term deficits and right that the nation should not be deterred by the transition costs. On a long-term view, high transition costs might be worth paying, even though "transition" in this instance would last for four decades or so.

Under most versions of privatization, the government would forgo some revenue from payroll taxes, which would instead be diverted into private savings accounts. These accounts would be allowed to hold equities, which would generate an investment return; this would unlock a new source of money to finance Social Security. If bundled together with modest benefit cuts, privatization could contain the projected growth in Social Security costs.

Privatization could also stimulate economic growth, boosting tax revenues and so strengthening the nation's fiscal prospects via a second route. By converting the payroll tax into contributions to personal accounts, government could reduce the tax burden on workers, thereby boosting incentives. Moreover, private accounts would boost national savings, which might drive down interest rates and stimulate extra corporate investment and growth. This might or might not happen in the short term, depending on whether private accounts foster a savings culture -- a plausible outcome, but not a sure bet. In the long run, however, privatization is a way of shifting the nation from a pay-go system to a pre-funded one. Savings would become more plentiful.

How much this could shrink the future deficit depends on the details of the reform plan. But make an assumption that's generous to the privatizers: Suppose that reform could cut in half the expected increase in the cost of the program. Between now and 2040, the cost of paying retirees is projected to rise from 4.3 percent of GDP to 6.5 percent; halving that rise would reduce the deficit in 2040 by just over 1 percent of GDP. Is that a big deal? The Berkeley-Brookings projections put the size of the deficit in 2040 at 20 percent of GDP, so containing Social Security costs might address one-twentieth of the problem.

What about the growth effects? Nobody really knows how much extra labor or savings there would be, let alone how far extra savings would boost corporate investment, which is how savings help growth. But consider, again for the sake of argument, the high-end estimates from Harvard University's Martin S. Feldstein, the leading academic proponent of privatization. Mr. Feldstein believes that the boost to the labor supply could eventually increase GDP by 1 percent, and that the savings boost could add a further 4 percent. These gains, while valuable, would boost the government's tax take by only around 1.5 percent of GDP -- and this would occur in the second half of this century, after reform's transition is completed.

The dirty little secret about Social Security is that it's too small to transform the fiscal future. For all the books and seminars devoted to the subject, it is a side show next to the policies we consider in our next two pieces: the growth rate and health care.


© 2004 The Washington Post Company