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Laurence J. Kotlikoff

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We Are Our Children's Keepers

Posted: 06/28/2012 1:08 pm

Ask red Republicans and blue Democrats what they value most and their answer will be the same -- their children. Strange, then, that both parties have devoted the postwar to spending enormous amounts of their children's money. The mechanism is simple -- raise oldsters' benefits and cut oldsters' taxes and leave youngsters the tab.

Thomas Jefferson believed no generation should leave debts to the next. But federal debt is approaching one year's GDP, and unofficial debt (promised Social Security, Medicare, and Medicaid benefits) exceeds a decade's GDP. The taxes required to cover these IOUs will destroy our children's futures.

Indeed, based on the Alternative Fiscal Scenario projections released by the Congressional Budget Office two weeks ago, the U.S. Fiscal Gap -- the difference between all future expenditure commitments (measured in present value) plus the official debt less the present value of all future taxes is $222 trillion! The fiscal gap last year was $211 trillion. So our country's true deficit over the past year was $11 trillion, over five times the $1.7 trillion official deficit.

Eliminating that fiscal gap via tax hikes would require an immediate and permanent 64 percent increase in all federal taxes or a 40 percent immediate and permanent cut in all federal spending apart from servicing the official debt. Waiting longer to pay these bills entails even higher tax hikes or spending cuts.

In short, the American dream is turning into a fiscal nightmare. It's also wreaked havoc on the real economy. In fact, transferring vast sums for six decades from the young to the elderly has produced a dramatic rise in the consumption of the elderly, leaving our country saving nothing, investing next to nothing, running a huge current account deficit, and experiencing derisory real wage growth.

Fiscal child abuse is the moral and economic issue of our day. Yet neither party is acknowledging, let alone stopping, "Take As You Go."

Restoring generational balance requires bold new tax, healthcare, and Social Security policies that make both parties happy. The purple (red plus blue) plans, discussed in my recent book with Scott Burns -- The Clash of Generations and laid out at www.thepurpleplans.org, fit this bill. If you like these plans, please endorse them online and send others to the site.

The Purple Tax lowers rates, eliminates annual filing, and hits the rich. Here's the trick: Replace the personal income, corporate income, and estate and gift taxes with progressive payroll (FICA), consumption, and inheritance taxes whose top effective rates are all 15 percent.

Specifically, remove FICA's ceiling on taxable wages and its employee tax on earnings up to $40,0 and add earned income and child tax credits.

Next, tax all consumption goods purchased at the store and consumption services generated by homes, planes, boats, and cars. But provide a monthly payment to each household based on its size that's large enough so the poor pay no consumption tax on net. Finally, tax inherited wealth plus gifts received above $1 million.

Many people think taxing consumption is regressive. But economists have long known that taxing consumption is an indirect way of taxing wealth as well as wages, since both are used to pay for consumption.

Take Joe, the Billionaire. When consumption is taxed, prices rise, immediately reducing Joe's purchasing power. Joe can spend his reduced real wealth now, later or give it away. It doesn't matter. His real wealth falls on day one. The outcome is identical to taxing his wealth directly and having prices stay put.

The 15-15-15 Purple Tax substantially improves work incentives, removes all saving disincentives, shifts the tax burden from workers (who are generally young) to the rich (who are generally old), eliminates most tax compliance costs, and should raise about 20 percent of GDP in revenue.

Best yet, the Purple Tax will jumpstart the economy via a tremendous investment surge as the U.S. adopts the world's lowest corporate tax rate -- zero.

The Purple Health Plan eliminates Medicare, Medicaid, the new Health Exchanges, and the tax subsidy to employer-based healthcare. It gives every American a voucher, each year, to buy a basic health plan from an insurer. All insurance companies must offer precisely the same basic plan and can't refuse coverage. This turns the basic plan into a basic commodity fostering real competition among insurers.

The vouchers are larger for those with pre-existing conditions. A doctors' panel determines what's covered by the basic plan such that total voucher costs never exceed 10 percent of GDP. Ten percent is huge. Germany and Switzerland spend 11 percent of GDP on all their healthcare.

Given their pre-existing conditions and age, the poor and elderly will, on average, receive much larger vouchers. So the Purple Health Plan is both highly progressive and responsive to the greater healthcare needs of the aged. But government healthcare spending will stay within budget and no longer endanger our children and economy. The "cost" to the elderly will come in the form of slower growing, but financially secure benefits.

Social Security is another major threat to our kids. It is 31 percent underfunded and a morass of indecipherable rules. Our Purple Social Security Plan freezes the current Social Security Old Age Insurance system. It fills zeros in workers' Social Security earnings records going forward. Current retirees are unaffected. But today's workers will receive only benefits accrued to date.

The Purple Social Security Plan replaces the current Social Security system with personal accounts to which each worker contributes 8 percent of earnings. Contributions are shared between spouses and the government matches low earners' contributions.

All contributions are invested in a single global, market-weighted index of stocks, bonds, and real estate. The government guarantees that account balances at retirement equal at least past contributions, adjusted for inflation.

In retirement, each worker's holdings are gradually converted to inflation-indexed pensions. All investing and conversion is done by computer. Wall Street plays absolutely no role.

This reform limits Social Security's long-term liability to accrued benefits, which are vastly smaller than projected benefits. And it gives our children a progressive, transparent, downside-protected, fully-funded, globally-diversified, and zero-cost saving system.

The Purple Plans protect our children from an economic future we wouldn't wish for ourselves. Their adoption will reteach a message long forgotten: "We are our children's keepers."

 

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