The US Federal Deficits and Debt: Simpson-Bowles 2010-11. Sooo close…..

Article #8 Purple Wayz: Navigating to the Center

Happy New Year! Welcome back to Purple Wayz. Appreciate the time off over the holidays. As a reminder, Purple Wayz is a series of articles that highlight the need to bring Centrism back into the national debate so that we can tackle some of our nation’s biggest problems. We covered potential electoral reforms in the early articles and concluded Open Primaries, Ranked Choice Voting, and Gerrymandering Reform hold the most potential. Lots of work to do there. Then we moved onto apply our Purple Wayz of thinking to the National Debt and Deficits and how they could be addressed by a more compromise-oriented Congress. We’re in the middle of that discussion, and I have been ELATED to read a lot more articles in the general press about this issue. During the campaign, it was nowhere. Still, political will remains a major issue as long as the threat of being PRIMARIED is central and as long as the two party Duopoly reigns. And it still absolutely does.

So let’s get back to it. In our last article, we covered the components of our National Spending (66% Entitlements, 26% Discretionary, 8% Interest) and Tax Revenues (50% Individual Income Taxes, 33% Payroll Taxes, and 17% other–mainly Corporate). We have also covered the fact that as we run annual deficits that exceed 6% of GDP, our interest payments grow faster than anything else. And being the ‘reserve currency’ of the world, we really don’t have any choice but to pay this interest. Default is not a viable option for the US compared to countries we looked at like Greece.

In the coming weeks ahead of Trump’s inauguration, we will likely be reading more articles in the national press about the US’ credit being potentially lowered by the rating agencies. This will make it more expensive to borrow–which just compounds the situation. What can be done? Fortunately, we have a recent helpful guide from our great teacher: History.

15 years ago…in 2010, President Obama convened the National Commission on Fiscal Responsibility and Reform, which became known as the Simpson-Bowles Fiscal Commission (named after its two leaders Alan Simpson and Erskine Bowles). Obama did this amid a deep discussion in the House and Senate in early 2010 about the deteriorating fiscal situation in the country, which was recovering from the 2008-09 recession. And a little help from the 2010 midterms when the Democrats lost their Exec/House/Senate ‘trifecta’. As you saw in the last article, Net Debt/GDP had gone from 36% to 63% in a few years, so it was a major front burner issue at the time.

From April to December 2010, a bipartisan group of 18 members debated potential fixes and finally published a plan. That plan needed 14 of the 18 to vote YES on the plan, which would automatically send it to the House and Senate for an up/down vote. Only 11 voted yes, so it never saw the floor. Four of the No votes were Democrats. Three were Republicans. A bipartisan failure. Commission Members voting no were Max Baucus, Xavier Becerra, Dave Camp, Jeb Hensarling, Paul Ryan, Jan Schakowsky, and Andy Stern. I’m sure they had their reasons, but man, this group lost the forest for the trees. Wouldn’t want that on my resume, and I’m happy to call their names out today. Accountability is a bitch. Sadly, this was the last real chance at comprehensive, bipartisan fiscal reform.

As part of the package, the Commission included the chart below in late 2010. They weren’t BS’ing us: the country has stayed on the Current Policy (green) line since then. It’s 14 years later. The frog is boiling. We have DOGE on the Discretionary Spending side, but there’s no hint of another Commission.

Very high level Proposal: The Simpson-Bowles process and proposal are really helpful as we look at how we could tackle this problem next time. You can imagine that a comprehensive proposal that would turn around the debt situation was extremely complex. In fact, it was so complex that people couldn't even agree on where the savings came from, even though they were reading the exact same proposal! Depending on assumptions made, anywhere from 52-66% of the reforms were spending related, meaning 34-48% were tax revenue related. I’ll present this as 60% spending / 40% tax revenue, which is my take. Using the component framework from the last article, here are the major features:

1. Mandatory Programs: (26% of impact)

• Healthcare: New cost-sharing rules. Tort Reform. Cap and phase out tax exclusion for health insurance. Convert federal employee health from defined benefit to defined contribution. Expand managed care. Global cap on Healthcare spending to GDP growth plus 1%. Medicaid payments down–more responsibility to states.

• Social Security. Raise retirement age slowly over time. Switch to ‘chained’ CPI which will grow benefits slower. Adjust benefits upwards for lowest income beneficiaries.

2. Discretionary Spending (34% of impact)

• Cut Military Spending. Reduce weapon systems. Reform compensation.

• Freeze spending in early years, then grow by 50% of CPI later years.

3. Tax Revenue (40% of impact)

• Close tax loopholes that disproportionately benefit high-income individuals. They really took a hatchet to loopholes, eliminating nearly all deductions and credits. For those skeptical of the impact of closing loopholes, see brief Appendix below.

• Lower Individual Income tax rates to 3 brackets of 12%, 22% and 28%. (Again, you can do this when you expand the tax base by a lot–tax revenue goes up and growth incentives are better)

• Raise the cap on payroll taxes to 90% of income up to $190k.

• Capital gains taxed at ordinary income rates instead of 15 or 20%. Importantly, this meant most capital gains would’ve been taxed at either 22% or 28%, which is likely close to the revenue maximizing rate.

• Lower Corporate Tax rate from 35% to 28% for competitiveness. Get rid of almost all deductions and loopholes. Trump tax cuts in 2017 lowered them to 20% and didn’t get rid of loopholes.

4. Reforming the Budget Process:

• Fast track ability to submit and approve new policies should certain Debt/GDP benchmarks not be hit

• Put in place automatic triggers for extended unemployment benefits, which helps during recessions.

Why didn’t it pass? There’s a ton of blame to go around. But basically, it was just too hard to gain bipartisan agreement. On balance, but not completely, Democrats couldn’t swallow the Healthcare and Social Security impacts, and Republicans couldn’t swallow the tax and defense impacts. Shocker. Since then, things have gotten muddier, as the Republican party has joined the Democrats in embracing the idea that Healthcare and Social Security benefits are untouchable. Also, as you saw in the prior article, mandatory spending as a percentage of total spending has gone way up. Discretionary spending was over ⅔ of the total spending cuts in Simpson-Bowles. It would have to be the inverse now, which is a lot harder.

I really respect what this group proposed. Kudos to you, Erskine Bowles and Alan Simpson. You are two of my heroes. Your plan was comprehensive and ballsy. And you ran a good process. Importantly, your proposal hit every category materially. It would have worked. Per usual in our government, though, politics got in the way. Now, it’s gonna be a lot harder.

In the next article, we look at what a Grand Bargain could look like in the modern day, now that Mandatory Spending programs have come to dominate total spending. DOGE has generated a lot of buzz, but realistically, they’re going after the small part of the pie.

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APPENDIX: CLOSING TAX LOOPHOLES

In 2010, according to IRS data, individuals who used itemized deductions had $5.2T of Adjusted Gross Income. These people took $1.2T of itemized deductions against that. The vast majority of these deductions were mortgage interest, charitable donations, and state and local taxes (SALT). A proposal that would’ve cut off the use of 80% of deductions would have freed up nearly $1T of taxable income in 2010. Using a blended income tax rate of 33%, this $1T prevented $333B of tax revenue that year.

One of the major impacts of the Trump Tax Cuts and Jobs Act (TCJA) was the increase in the standard deduction. In 2016, a married couple filing jointly could automatically deduct $12,600 of their joint income. In 2018, after the TCJA was in place, this nearly doubled to $24,000. Now it’s almost $30,000. This change caused lots of people to use the new standard deduction instead of itemizing deductions–it would end up with a lower tax bill. In 2017, the last year of the lower standard, 31% of people itemized. In 2020, this had reduced to 9%. This change had a major positive impact on tax efficiency, but it had a mildly negative revenue impact. Basically, lower / middle income people who had never itemized got a bigger deduction, and then, those who had previously itemized between $12.6k and $24k got a bigger write-off than before, thereby saving on taxes. Contrary to popular belief, then, this particular change ‘helped out the little guy’. But in doing so, it also slightly hurt the deficit issue.

There remains an opportunity with the remaining 9% to lower deductions AND increase tax revenue by closing loopholes. But it’s not quite as big as before. The total AGI of people who still itemize was approximately $4.7 trillion in 2022. And the deductions taken were $589 billion against that–or $170-190 billion potential. Add on to that the $36.3 billion of tax credits taken, and you still have over $200 billion of ‘opportunity’ in loopholes. And this is only individual income tax related. There are still lots of corporate tax loopholes to close too that represent $50-100 billion or so per annum.

Note: I’ve had a lot of questions and comments about taxes, who pays, what could work to increase revenue without harming incentives too much, etc. So a few articles from now, I’m gonna do a deeper dive on it. SPOILER: Tax revenue is a Price (tax rate) * Quantity (tax base) simple equation. To preserve growth/investment incentives and avoid the dreaded ‘deadweight losses’ that come with high tax rates, you always want the lower tax rate against the higher tax base.