10 PARTISAN MYTHS

FROM RUNNING ON EMPTY, BY PETER G. PETERSON. © 2004 BY PETER G. PETERSON. TO BE PUBLISHED BY FARRAR, STRAUS & GIROUX.

Our two parties have organized themselves around two lopsided and mutually exclusive world views: Democrats believe every American is "entitled" to government largesse, while Republicans see only the ball and chain of punitive taxation. Each of these views has a set of self-justifying "myths." But their consequences go well beyond making our political process seem foolish. While federal deficit projections soar to dangerous heights, threatening our kids with unconscionable tax hikes, these myths have polarized the two parties and ruled out the sort of bipartisan consensus Americans need to avert fiscal catastrophe.

FIVE DEMOCRATIC MYTHS ABOUT ENTITLEMENTS

1. Because federal benefits go to the poor, reform will amount to a shedding of our social safety net.

We should never forget the critical role that federal benefits have played--and continue to play--in protecting Americans against the hardships of poverty. "I see one third of a nation ill-housed, ill-clad, and ill-nourished," announced President Roosevelt in 1937. Most of the benefits originally paid out through his New Deal programs were directly targeted at alleviating this misery.

However, this is no longer the purpose toward which most benefits are directed. In 2002, out of $1.2 trillion in federal, state and local benefits, the poor received roughly $140 billion, according to the Census Bureau. That's about 12 cents of every full benefit dollar.

2. Even if they don't go to the poor, federal benefits foster equality by going mostly to lower-income households.

In truth, social-welfare programs no longer redistribute wealth in favor of low-income households. Total federal benefits to the affluent are at least as substantial as those to the needy. Among Social Security beneficiaries, for instance, households with incomes of $150,000 or more receive, on average, checks that are twice as large as those of households with incomes of less than $15,000. If our purpose were simply to straighten out the national income distribution, we'd do a better job by mailing our benefit checks to random addresses. Even when we add back in other federal sources, including welfare and food stamps, benefits are distributed evenly across households of all incomes.

3. Federal benefits go to the elderly, who everyone knows are much less well off than younger Americans.

Federal benefits do go mostly to the elderly. And 40 years ago it was true that the elderly were less well off than other demographic groups. But today, thanks in part to all the benefit programs that were expanded on their behalf, the elderly now have a lower poverty rate (10.4%) than any other age group.

4. Social Security and Medicare are earned rights by contract; beneficiaries are only getting back what they paid in.

It seems natural to assume a certain justice about the arrangement. Until one considers timing and demographics, that is. When you start a new pension system, full contributions from covered workers start arriving right away--but benefit payouts remain small for many years until enough workers with enough "credits" begin retiring. During the early years of both Social Security and Medicare, Congress kept tax rates unrealistically low and awarded ever-higher benefits to new retirees who had contributed only for a year or two. That meant that the children of the World War II generation (including the boomers) would have to contribute at much higher tax rates over their entire working lives just to keep benefits flowing to their parents. It's even worse news for today's young Americans, whose payroll tax rate will have to double to fund the demographic tsunami of retiring boomers unless the system is reformed.

5. The future growth in the cost of senior benefits, whatever they may be, can easily be borne by younger generations.

Every year, the social security trustees release an estimate of the system's "actuarial deficit," which many assume represents what we would need in hand today to cover Social Security's cash shortfall over the next 75 years. In 2003, the actuarial deficit officially amounted to $3.5 trillion.

But to arrive at a true estimate, we need to include Medicare as well as Social Security, unless we believe that health-care costs will miraculously turn around and head south on their own. This adds $15.6 trillion. (All of these dollar figures are "present values.") Next, we have to add back in the value of the mythical "trust funds," which aren't going to save the American people one nickel in future tax liabilities. Adds another $1.6 trillion. And if we use an unlimited time horizon, which we must do unless we want our kids to pass this problem along to their own kids, that adds an extra $24 trillion to the actuarial deficit, for a grand total of roughly $45 trillion in 2003, according to research commissioned by the Treasury Department. That exceeds our nation's entire net worth ($42 trillion).

FIVE REPUBLICAN TAX MYTHS ABOUT TAX CUTS

1. Because the American people are overtaxed, they want and deserve our tax cuts.

Are we really overtaxed? Certainly not compared to other developed countries. Of all 27 developed countries (defined by the OECD), the United States is roughly tied with Japan as the least taxed as a share of GDP. Are we overtaxed relative to our past? We'd have to go back to 1968 to find a year when total government revenues were lower as a share of GDP.

Tax cutters often imply that Americans are becoming much more hostile to taxes over time. But this isn't true either. According to two Gallup polls taken in 2003, for example, the share of Americans who say that the federal income tax is "too high" is lower than in any year since 1962.

2. OK, forget the long-term tax burden. Our tax cuts are still a sensible near-term means of stimulating a weak economy back to health.

This argument certainly has much truth to it. The vast majority of economists agree in principle that a tax cut could be a legitimate means to substitute for diminished consumer and investor demand.

I say in principle, because the critical issue here is timing. To be effective, the stimulus must be applied during the early part of a recession. That is, it must put money now in the pockets of people who will spend it now. Over the entire last century, unfortunately, Congress has never been able to time this stimulus very well. The tax cuts typically don't kick in all the way until late in the recession and then continue long after the recession is over. That's certainly true for most of the recent Bush tax cuts. It's why many economists have grown to dislike countercyclical tax cuts in practice.

3. Even when they don't deliver near-term stimulus, tax cuts make the tax code more efficient.

Over the years, many tax reformers have defended their proposals--creating fewer tax brackets, establishing a national value-added or "flat" income tax, or phasing out the taxation of estates or dividends--by citing efficiency advantages.

In theory, we'd be better off with a tax code that raises the same revenue with fewer distortions in economic behavior. But a pure efficiency reform must leave revenue unchanged. Current proposals do not. Reducing the taxation on corporate earnings, for example, may marginally raise private-sector savings--cited by some as an efficiency improvement. Even if it does, the extra savings will be overwhelmed by the loss in federal revenue, which adds directly to the federal debt and, over time, subtracts nearly dollar for dollar from national savings.

4. The critics just don't get it. What our tax cuts are really about is improving "supply side" incentives to work, save and invest.

The marginal tax rate is the rate that applies to the last or highest or "marginal" dollar that you earn in a year. A core proposition of the "supply side" argument for tax reform is that reductions in high marginal tax rates can sometimes have a dramatic and positive impact on economic activity and (even) on revenue.

The reality is that supply-side claims have become a theology, ruling out any reasonable discussion of the evidence. In fact, there's plenty of empirical evidence that when marginal tax rates are not high, the efficiencies you gain by cutting them may be modest and the impact on economic activity may be ambiguous.

5. Let's be honest. This is all about politics. In the long run, our tax cuts will force Congress to cut back spending and, with that, cut back government.

I know several brilliant Republicans who admit to me, in private, that much of the supply-side hype about the economics of tax cuts is not really true. But, they say, it's the only way to reduce government spending in a world in which powerful interest groups, allied with the opposition party, stand ready to punish any attempt to cut off the flow of government largesse.

This is a clever apologia, but it is unfair because nothing excuses holding the next generation hostage on the dubious bet that another party will have the good will to relent. It is cynical because it assumes that Americans no longer share any common values on which open agreement can be reached. I for one refuse to accept this dismal view. And it is hypocritical. One could take the ostensible goal of the tax cutters--smaller government--more seriously if we saw that they were also at least trying to reduce government spending. But we see nothing of the sort. Instead, spending has exploded on their watch.

What needs to happen for all the myth-spinning to stop? The heads of the Democratic and Republican parties need to pause and assess the potential damage they're doing. Voters need to demand that politicians adhere to the truth, even if it's not what they want to hear. We must learn again to cooperate politically and embrace a positive vision of what our nation can become. Instead of obsessing over the tax hike that outrages us or the benefit cut that shocks us, we need to come to think of our future. Not since the Kennedy administration have presidents asked us what we can do for our country. It's time to demonstrate to the next generation that this is a virtue Americans have not forgotten.

10 PARTISAN MYTHS | News